The Fibonacci tool makes use of the premise that after an uptrend, price will retrace by a certain percentage of the original price movement before continuing on in the original direction.
So, in an upward movement, the price will retrace back down by a certain amount before continuing on up.
In this example, You can see the price has retraced 78.6% from the peak of the swing high.
The underlying principle is that after a significant price movement, the market will often retrace or continue by a Fibonacci ratio before resuming its original direction.
Self Fulfiling Prophecy
Fibonacci levels tend to work very well because they are observed and used by many traders, making them a self-fulfilling prophecy.
Whenever the price reaches a Fibonacci level, traders will act accordingly by buying or selling, which strengthens these levels as stronger support or resistance.
It is important to note that Fibonacci levels also behave in the same way as normal support and resistance levels. And so support can become resistance and resistance can become support.
You can use the Fibonacci retracement levels for an entry into the market as the price comes back to them.
We shall discuss on how to use the Fibonacci tool for “target” in the later section. Meanwhile, although from the previous images, you can see that chola has went to 141.4% level, lets keep the target at 100% for this current discussion.
In a downtrend, an entry could be taken after price has found resistance at one of the retracement levels. Traders can wait until price begins to move down in the same direction of the original downtrend.
Again, the entry is made with the stop loss above the retracement level and profit can be taken at another Fibonacci level.
As usual, the target level has been written arbitrarily here.
In the past two examples –
So, the profit targets should be adjusted to 138.2% for chola and 161.8% for BankNIFTY in the above cases following the rules of Fibonacci Projections.