Introduction: Fibonacci Retracement And Extension
The Fibonacci sequence has often been seen as the blueprint of the universe, the divine logic underlying the creation of the world.
You can see it everywhere, from the arrangement of flower petals to the shapes of galaxies.
It is not surprising, then, that this logic found its way into stock market trading strategies tool.
Fibonacci Series, a series in which nature manifests itself.
Offers a compelling basis for one of the most promising and prominent stock market strategies: the Fibonacci Retracement and Extension strategy.
Leonardo Pisano Bigollo, popularly known as Fibonacci, was an Italian mathematician. He described a numerical series known as the Fibonacci sequence of numbers.
According to this sequence, after 0 and 1, each succeeding number is the sum of two prior numbers per this sequence.
Following is the Fibonacci sequence: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377 and so on.
What’s more peculiar is that each number is 1.618 times greater than the previous number. 1.618 is known as ‘Phi’.
It is the Golden Number and can be found in fine art, biology, architecture, etc. Also, if the number is divided by a succeeding number, then the answer is 0.618 or 61.8% i.e.
● 34/55 = 0.618
● 55/89 = 0.618
● 89/144 = 0.618 etc.
If a number is divided by the second number succeeding it, then the answer comes to 0.382 or 38.2%, i.e.,
● 34/89 = 0.382
● 55/144 = 0.382
● 89/233 = 0.382 etc.
If the number is divided by the third number succeeding it, then the answer comes to 0.236 o 23.6%, i.e.,
● 34/144 = 0.236
● 55/233 = 0.236
● 89/377 = 0.236 etc.
All these percentages i.e., 61.8%, 38.2% and 23.6% are Fibonacci ratios.
What is Fibonacci Retracement and Extension?
Fibonacci Retracement
After a stock moves upwards or downwards, it retraces before its next move.
For instance, a stock that has run from Rs. 100 to Rs. 150 is likely to retrace back to Rs. 120 before moving to Rs. 180. This is known as retracement.
As per Fibonacci Retracement, 23.6% is the first level up to which the stock can retrace.
If the stock retraces further, it can further retrace until 38.2% or 61.8%. Let’s understand with a practical example!
Suppose the share price of A Ltd. Increases from Rs. 200 to Rs. 250. Then it starts dipping.
Therefore, as per Fibonacci Retracement, it can go down to Rs. 238.2 [250 – ((250-200) * 23.6%)].
In case it dips further, then it can go up to Rs. 230.9 [250 – ((250-200) * 38.2%)] before rising up.
Fibonacci Extension
Some of the common Fibonacci Extension ratios are 23.6%, 38.2%, 61.8%, 161.8%, 261.8% etc.
Fibonacci Extension shows how much a share price could increase after the retracement.
Now suppose, after the share price of A Ltd. falls to Rs. 238.2, it could increase Rs. 250 as per 23.6% Fibonacci Ratio.
Traders use both Fibonacci Retracement and Fibonacci Extension to determine the point at which the price can find a retrace or support.
It gives the idea of profit target placement to the traders.
Many traders use Fibonacci ratios to determine the price at which they shall place the stop loss and price triggers with the help of the Fibonacci tool.
Fibonacci Ratios are one of the most efficient stock market strategies you should master if you are a stock enthusiast.
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