Understanding what are Fibonacci Retracements and how to use it while trading: The concept of Fibonacci was introduced by Italian Mathematician called Fibonacci (also known as Leonardo Bonacci or Leonardo of Pisa). This concept was primarily introduced to solve the problem of understanding the population growth of Rabbits. And it has now become one of the most interesting and sought after concepts in Mathematics and Trading.
In this article, we’ll cover what is a Fibonacci Series, the implication of Fibonacci on trading, and how exactly to use Fibonacci while Trading. Let’s get started.
What is Fibonacci Series?
The Fibonacci is a series of numbers starting from zero and arranged in such a way that the next number is a summation of the previous two numbers.
Therefore, the Fibonacci series is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377………
Here are the calculation involved while finding the numbers in the Fibonacci series:
- 0 + 1 = 1
- 1 + 1 = 2
- 1 + 2 = 3
- 3 + 5 = 8
- 5 + 8 = 13
- 8 + 13 = 21
- 13 + 21 = 34 and so on.
A Few Fun Facts about Fibonacci series
Before moving forward, here are a few fun facts about Fibonacci series that you should know:
- If we divide any number by the previous number, then the ratio is always equal to 1.618 (233/144 or 144/89 or 89/55 or 55/34, etc.)
- Second, if we divide the number by the next number, then the ratio is always equal to 0.618 (21/34 or 34/55 or 55/89 etc.)
Needless to that the number 0.618 (or 61.8%) holds a lot of significance while calculating Fibonacci.
- If we divid any number in the series by a number which is two places higher, then the ratio is always equal to 0.382 (21/55 or 34/89 or 55/ 144, etc.)
- And if we divide any number in the series by a number which is three places higher, then the ratio is always equal to 0.236 (21/89 or 34/144 or 55/233, etc.)
From the above facts, we get the percentage series for Fibonacci to be 61.8%, 38.2%, 23.6%
The implication of Fibonacci on trading
The Fibonacci series of 61.8%, 38.25, and 23.6% have a very impactful presence in all the charts of the share price of any company. It is applied regularly when we see movement in the prices of the shares. And it can be applied in all the time frames.
It is a known fact that the share price of the company does not move in one direction. The prices always have a zig-zag pattern. If the share price of the company has gone up from 100 to 150, then before having another leg up, it is most likely to retrace back. But to find the level of retracement, Fibonacci retracement levels come in very handy.
For example, if the share price of the company before going up = Rs. 100. In, the first leg of the move, the share price goes up to = Rs. 150
Therefore, if the share price retraces to 38.2% then it will fall to = 150 – 38% of 50 = 131. And if the share price retraces to 61%, then it will fall to = 150 – 61 % of 50 = 119 (approx.)
Fig 1: Daily chart of Maruti (www.zerodha.com)
If we look at the above figure above, Maruti looks strong in the move up from Rs. 4000 to Rs. 5500. And looks poised to go up more. But before going up, the market makes a correction and it’s till the projection range of 38.2% to 61.2%. And after consolidating in that range, it makes a fresh move up and makes new recent high.
Therefore, if someone is looking for a correction in the market, Fibonacci retracements are a very useful tool and it also helps in entering the market if someone had missed the first move in the market.
Fig 2: Daily chart of BajajFinsv (www.zerodha.com)
In fig 2, If we look at the figure above, the share price of BajajFinsv is on a downward trend. And looks poised to fall more.
However, before falling, the market has made a small correction rally and is consolidating around a 38% retracement level. And now we see, that the share price is making lower highs and lower lows. Therefore, we could see the bearish momentum coming back and market breaking or re-testing previous lows.
Uses of Fibonacci while Trading
Assume, if we are looking to buy the stocks of a particular company but because of the strong momentum in the price, the share price has gone up substantially and it is very expensive to buy the shares at the current price. Here, we wait for a correction in the share price of the company and wait for it to retrace around 61.8%, 38.2%, or 23.6% levels.
Anyways, before picking the right retracement levels, the following factors also need to be considered: The candlesticks formation near the retracement levels, The price action around the level, The support and resistances around it, The volume at these retracement levels, And the overall fundamental picture.
In this article, we tried to explain what are Fibonacci Retracements and how to use it while trading. Here are a few conclusions from this post to take away:
- The Fibonacci should be used when one is looking to plot the retracement or projection levels.
- Then Fibonacci is useful when one has missed the entry at first instance but is still interested in buying the shares of a particular company.
- The important levels of Fibonacci are 61.8%, 38.2%, and 23.6%
- Just the Retracement levels of Fibonacci should not be the only basis of entering the trade. Overall, fundamental and technical factors should also be considered.
That’s all for this article. I hope it was helpful to you. If you have any doubts related to Fibonacci Retracements, feel free to comment below. I’ll be happy to help. Happy trading.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!