Fibonacci retracement levels are a popular trading indicator that is used by forex traders to determine when to enter or exit a trade. The reason that this indicator is popular is because it helps demonstrate support and resistance levels. Some people question whether this indicator is actually found in the natural world, or whether traders are convincing themselves to believe it is true based upon their trading patterns.
The first Fibonacci retracement levels have been credited to an Italian mathematician named Leonardo Fibonacci. He found that certain proportions appear regularlly in nature, and devised a series of numbers that represent these ratios. They are 23.6%, 38.2%, 50.0%, 61.8%, and 76.4%. One example of this ratio in the natural world is that the elbow is located about 61.8% of the way between the hand and shoulder. There are many other examples can be found in the natural world.
Forex traders have applied these ratios in their technical analysis of currency charts. The price of a currency could be trending up or trending down and traders found that pullbacks usually occurred at Fibonacci retracement levels. An example may be a price in an uptrend may retrace 61.8% before continuing its uptrend. These ratios that form at retracement levels serve as a basis to define support and resistance.
The question that people are beginning to ask is whether Fibonacci retracement levels are occurrences in the natural world, or have Forex traders simply created this phenomenon by their own behavior. As per the prior example, if traders operate under the assumption that a price will retrace to 61.8%, then many traders would place buy orders at that level, thereby creating the phenomenon that they are claiming to actually observe.
In the end, it doesn’t really matter if Fibonacci retracement levels are established by nature or by trading behavior. The important thing is that it has proven itself as a solid method to identify support and resistance pull backs. Certainly, Fibonacci retracement levels do not work 100% of the time. No indicator is perfect. But it does provide traders an edge in making profits.