For those who do not not know what a Fibonacci retracement is I will give a quick introduction. Fibonacci retracements are a popular piece of technical analysis used to determine resistance and support levels. They are named so due to their use of the Fibonacci sequence discovered by Leonardo of Pisa who was also known as Fibonacci. The use of Fibonacci retracements is based on the idea that markets will ultimately retrace a portion of a move in a predictable manner, after which the market will continue to move in the original direction.
Do Fibonacci retracements work? Well there are certainly a huge number of people who claim that you can make huge profits from using Fibonacci retracements. However I think there are plenty of reasons to be skeptical about the use of Fibonacci retracements. For example, Burton Malkiel who is best known for his book A Random Walk Down Wall Street completely rejects the idea that you can use Fibonacci retracements profitably. When he studied the use of Fibonacci retracements and technical analysis in general he found that one could not make any valuable predictions using Fibonacci retracements.
What then explains the appearance of Fibonacci retracement levels acting as support or resistance levels? Well according to Malkiel, asset prices display signs of a random walk and the fact that Fibonacci retracements appear to sometimes act as support and resistance levels can be explained away by pure coincidence. With traders being unable to outperform market averages over the long term.
One reason that Fibonacci retracements are supposed to work is due to the fact that a large number of traders put their faith in them. This makes Fibonacci retracements some kind of self fulfilling prophecy with traders opening and closing position on the basis of these retracement lines. As I see it, there are two problems with this view. Firstly, I’m not sure that many traders do put faith in Fibonacci retracements and even if a decent proportion do this may still not be enough to sway the market. Secondly, Fibonacci retracements are quite subjective in the sense that it is possible to draw a trend line in a number of different ways, each which would effect where the retracemnts are placed.
In conclusion I really sincerely doubt whether Fibonacci retracements can be used on their own to any effect. For me the jury is still out on whether they can be used in conjunction with other forms of technical analysis, but personally I think any application that Fibonacci retracements can have is really quite limited.
