Retracement levels are most commonly associated with Fibonacci retracements, although there are some older retracement trading theories including the Gann and Elliott Wave systems. The Fibonacci strategy relies on ratios found in nature to predict points of support or resistance in an asset's price action. For example, the most "powerful" Fibonacci number is believed to be 0.618, or 61.8%, so Fibonacci traders consider it very bullish for any bearish price retracement to drop approximately 62% before heading north again.
The entire system is predicated on the assumption that Fibonacci numbers appear in nature, and therefore traders have some sort of unconscious tendency toward trading at these levels. Despite not being as scientific or deductively consistent as many other technical trading strategies, Fibonacci tools remain popular among those who search for retracement levels.
The most common Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8% and 76.4%. The 50% retracement level is not actually a Fibonacci ratio; it is most likely a leftover from the Gann system. To place these levels, wait for a defined price trend to begin to retrace in a noticeable way. The trend can be either bullish or bearish. From the apex of the trend just before the retracement begins, mark various retracement levels at 23.6%, 38.2%, etc.
Only place the retracement levels within the context of the prior price swing. For example, if a stock began a bull movement at $8 and rose all the way to $24, the 50% retracement level is placed at $16, or halfway between $8 and $24. Many kinds of charting software offer Fibonacci retracement tools, making it easier for individual traders to correctly place the levels. If the retracement seems to reverse at one of the major Fibonacci retracement levels, proponents of this system view it as a signal the previous high/low will be exceeded by the coming price swing.
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