Technical analysis is replete with tools and concepts that attempt to forecast an asset’s price movement, and few enjoy the acclaim or popularity of Fibonacci retracement. It is a technique used by traders to determine reversal and entry/exit points based on proportions discovered by Italian mathematician Leonardo Fibonacci.
In this blog post, we will discuss what Fibonacci retracement is, how it works in real-world situations, and its effective use through case studies of Indian stock markets.
What is Fibonacci Retracement?
As with other tools in technical analysis, retracement levels can signal an opportunity for traders to enter or exit positions of previously trending securities. Various levels known as Fibonacci ratios: 23.6%, 38.2%, 50%, 61.8% and 78.6% are thus created.
While stocks tend to move significantly in one direction over time, there’s usually partial retracement along the way. Traders utilize these patterns for establishing support zones during uptrend corrections while downtrend counter movements are capped at resistance zones.
How Are Fibonacci Levels Drawn?
To draw Fibonacci retracement:
1. Identify important highs and lows.
2. In uptrends: Draw from swing low to swing high
3. While the market is in a downtrend, draw from the swing high to swing low.
The specific trading software or program you use will automatically place horizontal marks at important Fibonacci ratios.
Why Do Fibonacci Levels Work?
Even though these Fibonacci levels will not work magically, they end up workingdue to self-fulfilling prophecy. Their widespread adoptionby traders of all experience levels has caused reactions at those price points. They are most effective when combined with:
Market movements (e.g., candlestick formations)
Traded Volume
Trendlines/moving averages
Key support and resistance zones
Market Case Study: Reliance Industries
Let us study the case of Reliance Industries (NSE: RELIANCE):
Hypothesis: Strong Uptrend With Retracement
In March 2023, RELIANCE surged from ₹2,200 to ₹2,600 sharply retracing up.
Then came a pullback with lots of traders trying to capitalize during buy-on-dip strategies.
When you plot Fib tool from ₹2,200(swing low) to ₹2,600(swing high), we can derive the following key areas:
23.6% retracement: ₹2,507
38.2% retracement: ₹2,416
50% retracement: ₹2,400
61.8% retracement: ₹2,353
The stock took support near the 38.2% level and ₹2,416 socioeconomic mark where supplied made it turn back and Price crossed above prevailing bearish candlestick turning bullish once again resonating further positive sentiments after rising verification proving this mark indeed showed true Fibonacci reinforcement as expected.
Insight Gained: Acceptable risk offers arise for positions lurking on or above either the forty eight two point five percent or thirty eight two percent levels marked on retreating momentum backed by their approved signals can lead optimally rewarding downsides hinged role ascertain strategy confirmation setups
Current Market Illustration: NIFTY 50 Correction
Situation: Downtrend + Response Upwards
In Jan 2022, NIFTY was at approximately₹18,600.
By June 2022, it had dropped to around ₹15,200.
If you use Fibonacci from 18,600 (swing high) and apply it to 15,200 (swing low), the retracement levels will be as follows:
23.6%: ₹16,026
38.2%: ₹16,773
50%: ₹16,900
61.8%: ₹17,066
After the sharp fall of plunging to fifteen thousand two hundred rupees, nifty retraced and hit a resistance at seventy one sixty seven which is sixty one point eight of eighteen thousand six hundred thus facing selling pressure off fibonacci.
Lesson Learned: We can notice how these levels become resistive in a down trend and allow traders to enter short positions.
How To Use Fibonacci Rather Effectively
Fibonacci should be used with candlestick patterns to capture key reversals like hammer, engulfing or pin bar at the fibonacci level.
Do not set limit orders on the fibonacci levels without waiting for price action confirmation.
A trendline or moving average should atleast validate reversal improving chances.
The volume must support decline or advance through crucial marks including reversal or break out points pertaining to bounce base areas
Avoid using retails where expected accuracy will be too tight relying on reversal space after crossing target borderlines.
Advanced Tip: Use Multiple Timeframes
Imagine you are looking at TATA Motors on a daily chart and notice that the price is pulling back to 50% Fibonacci level.
Now look at the hourly chart and see if you can find:
- Bullish price action around that level
- Increased volume
- Momentum change (through RSI/MACD)
This form of multi-timeframe analysis really helps to build confidence in your setup.
Strategy: Fibonacci + RSI + Price Action
An example of an easy intraday or swing trading strategy is:
1. Identify a recent strong price movement (either upwards or downwards).
2. Apply a Fibonacci retracement tool.
3. Maintain patience as the price approaches either 38.2%, 50%, or 61.8% levels.
4. Check if RSI shows divergence or sits in overbought/oversold territory.
5. Recognize reversal candlestick patterns.
6. Execute long/short trades with stop losses set below recent swing lows for longs and above swing highs for shorts.
7. The targeted profits can be set at a zero balance, or on subsequent extension levels of your drawn Fibonacci lines.
Drawbacks of Fibonacci Retracement
- Subjective Swing Points: Different traders can have different plotted levels leading to confusion within order flow during execution phase at the market’s opening.
- False Signals: Dynamic response to market range bound scenarios creates numerous opportunities, enabling destruction zones beyond layered cut thresholds which make logical sense but lack rational significance, only fuelling novice belief systems instead of applying reasoning based cognitive analysis frameworks .
- No Time Element: Along with volatility induced changes captured time sequences exists where reversals don’t follow predetermined levels.
That’s why these techniques should always be supplemented by other useful tools and methods!
Closing Remarks
Fibonacci retracement is not merely an idea—it is effective in practice and very much dynamic in nature when deployed correctly. Malhotra’s RELIANCE, NIFTY, and several other instances from the Indian Market showed us how prices respond in proximity to Fibonacci levels.
Do bear this in mind: Fibonacci retracement does not provide certainty; rather it serves as a gauge for probable outcomes. Informed traders combine it with price action, volume analysis, confirming trends, and above all—a tight control on risk management and strict adherence to trading discipline.
Conclusion (In Short) - TL;DR
| What is it? | Possible reversal areas calculated using % level retracements
| Key Levels | 23.6%, 38.2%, 50%, 61.8%, 78.6%
| How to Use | Draw from high of swing to low (or vice versa), await confirmation
| Best Used With | Volume, RSI trendlines, candlestick patterns
| Indian Examples | Reliance support at 38.2%, Nifty reversal at 61.8%
| Pro Tip | Multi-timeframe analysis adds value so utilize it.
