How to use Fibonacci retracement -Part 1 of 2

What is Fibonacci retracement? Fibonacci is a sequence that is formed by summing the two preceding numbers ( 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55,89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10946, 17711, 28657, 46368, 75025, 121393,196418, 317811, ...)

The ratios of the preceding number are important because the proportion is commonly known as the golden ratio (PHI) this is always around 1.618 or inverse 0.618 as the numbers move towards 144 or example 21/13 = 1.615 , 13/8 = 1.625, 377/233=1.618 , 987/610= 1.618 and so forth inversely this would be 8/13 =61.53%, 233/377 =61.8% and so forth. It is drawing the line between the average of the extreme points.

Almost everything has the proportion of 1.618 this is found in

> The portions of the human body and many animals

>Plants

> DNA

>The solar system

>Architecture

>Music

>Art

>Population growth

and of course THE STOCK MARKET

Why do traders use Fibonacci retracement? Fibonacci retracement is used with many traders to find a trend sequence in a series expressed as a ratio. It is used to forecast the pullback of a stock or after a decline forecast the bounce. It uses 23.6%, 38.2%, 50% and 61.8%

These are critical points that cause the price of the stock to reverse. Depending on the trend prior ( UP TREND or DOWN TREND) it is likely to show continuation once the stock has been retraced to the ratios above. It is at those ratios that the stock price changes in direction as it approaches these support and resistance levels.

The golden ratio is 61.8% as explained above.

50% - From the peak to the through / 2

The 38.2% is found by dividing the number that is found two places forward for example 34/89 = 38.2%

The 23.6% is found by dividing the number that is found 3 places in front for example 21/89= 23.6%

How do we use Fibonacci retracement?

Step 1: Take the two major points in the range the (Top =Peak, Bottom = Trough) then dividing the vertical distance by the ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. The new support and resistance lines are found closer to these lines. Please note this only acts as an alert and can be used for entry points and exit points.

Step 2: Draw horizontal lines across to identify support and resistance points. (See below)

http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:fibonacci_retracemen

Above is an example of taken from the website above that shows $HD - Home Depot retracing around 50%

Above also taken from the website above shows the inverse application to an up trend after a decline for $MMM-3M retracing to about 50% of its former decline.

Still to come Part 2 - more in depth examples for common, moderate and golden retracements.