The Fibonacci sequence, introduced by an Italian mathematician Leonardo Fibonacci, gave birth to many mathematical tools used by the traders in the financial markets. The sequence looks like this – 1,1,2,3,5,8,13,21,34… Fibonacci Retracement levels are primarily ratios derived from this sequence which are used to ascertain important resistances and supports. The most important ratios are 0.618 and 1.618, followed by 0.50 and 0.382. The length of any up move (or decline) is divided into these ratios and checked if those are providing significant support (or resistance) in any of the corrections. There are more tools like Fibonacci Arc or Fibonacci Fan but those are not that popular.
Advantages And Limitations of Fibonacci
Fibonacci Retracement levels are among the most popular technical tools and hence followed by a lot of traders around the globe. Even if it is driven by self-fulfilling prophecy, the sheer universal acceptance and applicability makes it a significant weapon in a trader’s arsenal. Specifically, the 61.8% or 0.618 retracement level works more often than not. On the other hand, the subjectivity regarding the actual top and bottom determination, before the retracement levels can be drawn, make it problematic sometimes. The inability of the tool to provide any way to determine strength of the signal provided is another important limitation.