Fibonacci refers to the application of Fibonacci ratios and sequences in analyzing financial markets, particularly in price actions. Fibonacci analysis is based on the mathematical relationships discovered by Leonardo Fibonacci, an Italian mathematician from the 13th century. Fibonacci ratios and sequences are believed to have relevance in financial markets due to their phenomenon in nature and human behavior.
There are several types of Fibonacci analysis commonly used in technical analysis, below four main types are most used by analysts among them-
Fibonacci Retracement: This technique involves drawing horizontal lines at key Fibonacci levels on a price chart to identify potential support and resistance levels. The main Fibonacci retracement levels used are 23.6%, 38.2%, 50%, 61.8% and 78.6%. Traders look for price reversals or consolidations around these levels as potential opportunities to enter or exit trades.
- Example: In a bullish trend, a trader identifies a significant price swing from a low of Tk. 100 to a high of Tk. 150. They apply Fibonacci retracement levels and observe that the price retraces to the 61.8% level (Tk. 120) before resuming its upward movement. The trader sees this as a potential buying opportunity, expecting the price to continue the uptrend.
Fibonacci Extensions: Fibonacci extensions are used to identify potential price targets or levels of resistance beyond the current price trend. Traders apply Fibonacci extension levels after identifying a significant price move that usually a retracement and project potential future levels where the price may reverse or stall. Common Fibonacci extension levels include 127.2%, 161.8% and 261.8%.
- Example: After a prolonged uptrend, a stock's price begins to retrace. A trader identifies a retracement from Tk. 200 to Tk. 150 and applies Fibonacci extension levels. They project potential targets for the next upward move and notice that the 161.8% extension level corresponds to Tk. 250. The trader sets a price target at Tk. 250, expecting the stock to reach that level before encountering significant resistance.
Fibonacci Fans: Fibonacci fans consist of diagonal trendlines drawn from a significant price high or low to other points on the chart. The trendlines are based on Fibonacci ratios typically 38.2%, 50% and 61.8%. Traders use Fibonacci fans to identify potential support and resistance levels as well as trendlines that may act as dynamic support or resistance levels.
Fibonacci Time Zones: Fibonacci time zones are used to identify potential reversal or continuation points based on time intervals rather than price levels. Traders plot vertical lines on a price chart based on Fibonacci ratios e.g., 1, 1.618, 2.618 etc. and look for price reactions near these time zones.
Analysts should remember that, Fibonacci analysis is just one tool among many used in TA and its effectiveness can vary depending on market conditions and other factors. It is often used in conjunction with other technical indicators and analysis techniques to make informed trading decisions.
