Fibonacci Retracement in the Stock Market: The Technical Tool That Predicts Where the Price Bounces

▶ Why Fibonacci is So Effective in Technical Analysis

In financial markets, price movements rarely move in a straight line. After each bullish or bearish impulse, an inevitable retracement occurs. This is where Fibonacci retracement becomes a valuable ally. This tool uses mathematical proportions derived from an ancient number sequence to identify key levels where the price might pause or change direction.

The secret lies in the golden ratio, which is equivalent to 1.618. When we apply this ratio to market movements, we get specific percentages: 23.6%, 38.2%, 50%, 61.8%, and 76.4%. Each of these levels acts as an imaginary line that the price tends to respect, becoming support or resistance depending on the context.

▶ The Story Behind the Numbers

Fibonacci numbers originated from the work of Italian mathematician Leonardo Pisano in the 12th century. His series begins simply: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144… Each number is the sum of the two previous ones. The fascinating thing is that this sequence appears constantly in nature: in tree branches, seashells, even in the human body.

Financial analysts discovered that markets follow similar patterns. From this, the application of Fibonacci in trading emerged, using the proportions derived from this series to predict price behaviors.

▶ How Fibonacci Retracement Works in the Stock Market

The basic logic is simple: when an asset begins to retrace after a strong move, we draw Fibonacci between the starting point (low or high) and the breakout point. The tool automatically generates the retracement levels.

In an uptrend that corrects, for example, Fibonacci levels indicate how far the price could fall before resuming the upward move. In a bouncing downtrend, they show how high it could go before continuing to fall.

Correct drawing

The procedure is straightforward but critical: always draw from left to right, identifying the last high and the last low of the trend. It doesn’t matter the timeframe (1 minute, 1 hour, 1 day, 1 week) nor whether the trend is bullish or bearish. The levels are the same: 23.6%, 38.2%, 50%, 61.8%, and 76.4%.

Some traders debate whether to use the full wick of the candle or just the body. The reality is that both approaches can work; it depends on your style and experience.

▶ Practical Application in Real Cases

Case 1: Position Trade (EUR/USD daily chart)

The daily chart of EUR/USD showed a clear downtrend. The high was at 1.09414 and in May a new low of 1.03489 was reached. When the market started to rise, Fibonacci was drawn between these points.

The entry was placed at the 61.8% level (1.07139) because it coincided with a 50-period moving average, creating a confluence of signals. The stop loss was set at the previous high (1.09414), risking 228 pips. For the profit target, Fibonacci extensions were used, setting the take profit at 1.01810 (aiming for 532 pips).

Result: The trade closed with profits on July 5, approximately 43 days after entry. With a volume of 0.01 lots, the risk was $22.8 USD and the profit was $53.2 USD (net of commissions).

Case 2: Intraday Trade (EUR/USD 1-hour chart)

In the same pair, but with a different approach. The 1-hour chart showed a buying opportunity at the 61.8% Fibonacci level (1.04651). Simultaneously, the 1-day Fibonacci indicated upper resistances, acting as a limit for the profit target.

The confluence of two different timeframes allowed for more precise trading: buy at 1.04651, stop loss at 1.04250 (40 pips risk), and take profit at 1.06011 (135 pips gain), generating a risk-reward ratio of 1:3.4.

Result: The trade closed with profits on June 22, just 3 days later (excluding weekends). With 0.05 lots, the risk was $20 USD and the profit $62.5 USD (net of commissions).

▶ Fibonacci for Entry, Exit, and Risk Management

Once levels are drawn, each serves a specific function:

Entry levels: More conservative traders prefer entering at 61.8%, while more aggressive ones may do so at 38.2%. The chosen level determines the size of the stop loss.

Take profit (TP): Usually placed at the 0% Fibonacci level (the original high or low) or using Fibonacci extensions to project higher targets.

Stop loss (SL): Located beyond the 100% Fibonacci level or at the absolute high/low of the previous trend.

A common conservative approach: entry at 61.8%, TP at 0%, SL at 100%. Although this offers lower risk, it also limits potential gains. A more aggressive approach might look for deeper bounces to capture larger moves.

▶ Fibonacci Extensions: Projecting Gains

Beyond retracements, Fibonacci extensions exist. While retracements measure how far back the price has gone, extensions project how far it could advance after the retracement.

This is especially useful for setting realistic profit targets. If you know an extension is at 1.06157, that is a level where many traders will take profits.

▶ Fibonacci Works Across Multiple Markets and Timeframes

This tool is not limited to currencies. It is equally effective in:

• Individual stocks
• Stock indices
• Commodities
• Cryptocurrencies
• Futures

And it operates across all imaginable timeframes. However, its effectiveness significantly increases on larger periods. A Fibonacci on a daily chart is more reliable than one on a 5-minute chart. This is because broader timeframes reflect more fundamental market decisions.

▶ Is Fibonacci 100% Reliable on Its Own?

The honest answer is no. Fibonacci provides probabilities, not certainties. Its true power emerges when combined with other tools: moving averages, historical support and resistance levels, technical indicators, volume, or fundamental analysis.

Confluences (when multiple signals converge) are where real confidence in a trade is generated. A Fibonacci retracement coinciding with an important moving average is more reliable than Fibonacci alone.

▶ Developing Experience with Fibonacci

Familiarity with this tool grows over time. As you trade, you will discover that certain levels work better than others in specific markets. Some traders modify standard percentages based on their experience.

Practice on a demo account is invaluable. There, you can identify highs and lows across different timeframes without real capital risk. You will learn to recognize which setups work in clear trends versus sideways markets.

Fibonacci retracement in the stock market is not a magic formula, but it is one of the most precise tools available for traders seeking to balance risk and reward in a structured way.