Named after 13th century mathematician Leonardo Fibonacci, the Fibonacci numbers are an integer sequence in which each number is the sum of the previous two. The sequence is closely related to the golden mean and its ratios are to be found in many places in nature, from shell spirals and tree branches, to the ratios of the human body’s appendages and joints.
In technical analysis Fibonacci retracements are support and resistance lines drawn on an asset’s price chart in order to discern the Fibonacci relationships that are thought to also exist in asset price fluctuations. Instead of them simply being plotted at high and low points like traditional support and resistance lines, they are drawn according to the Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.
To apply them, select Fibonacci retracements from your terminal and draw a line from a recent lowest low to a recent highest high (or vice versa depending on whether the market is trending bullishly or bearishly), your platform will automatically plot the ratios for you between these two points. Fibonacci retracements work best when plotted on strongly trending markets. When drawn from low to high the levels indicate retracement support levels that price action may pull back to, thus generating buy signals for traders. When drawn from high to low the levels indicate retracement resistance levels that price action may momentarily spike back up to, thus generating sell signals for traders. It is thought that one of the reasons Fibonacci retracements seem to work so well as a predictive tool has more to do with the levels being self-fulfilling due to so many investors observing them, rather than there being some essential mathematical ratio that defines price movement.