Fibonacci ratios - Stock Trading Glossary

Fibonacci ratios are commonly used by technical analysts to identify potential price targets for retracements and extensions in a trend. The ratios are derived from the Fibonacci sequence, which is a series of numbers where each number is the sum of the two preceding numbers (1, 1, 2, 3, 5, 8, 13, 21, 34, 55, and so on).

The most commonly used Fibonacci ratios in technical analysis are 38.2%, 50%, and 61.8%. These ratios are derived from dividing one number in the Fibonacci sequence by the number that follows it. For example, 55 divided by 89 equals 0.618, which is the 61.8% ratio.

When a trend is retracing, technical analysts will often look for levels where the retracement is likely to stop and the trend will resume. These levels are often identified using the Fibonacci ratios. For example, if a stock is in an uptrend and then pulls back, the technical analyst might look for support levels at the 38.2%, 50%, or 61.8% retracement levels.

Likewise, when a trend is extending, the technical analyst might use the Fibonacci ratios to identify potential price targets for the trend extension. For example, if a stock is in an uptrend and has a strong move up, the technical analyst might look for resistance levels at the 161.8% or 261.8% extension levels. One of the reasons why Fibonacci ratios are so popular among technical analysts is that they can often provide a useful framework for understanding market behavior. In many cases, market movements can seem random or chaotic, but Fibonacci ratios can provide a sense of order and predictability.

However, it's important to note that Fibonacci ratios are not infallible and should not be relied upon exclusively. Market behavior is influenced by a wide range of factors, including economic fundamentals, geopolitical events, and investor sentiment, among other things. Technical analysts should always consider multiple indicators and factors when making trading decisions.

Another important point to keep in mind is that Fibonacci ratios are not the only ratios used in technical analysis. There are other ratios and patterns that can also be useful for identifying trends and potential price targets. For example, the Gann ratio and Elliott wave theory are two other popular approaches used by technical analysts.

Overall, Fibonacci ratios are a useful tool for technical analysts, but they should always be used in conjunction with other methods and indicators to gain a more complete understanding of market behavior.