Support and resistance levels are an important consideration for most traders to help identify entry and exit points when trading. Fibonacci percentage "retracement" levels based upon the Fibonacci number sequence and golden ratio are very popular with many traders but what are they exactly?

What are Fibonacci Numbers and the Golden Ratio?

The Fibonacci sequence first appeared as the solution to a problem in the Liber Abaci, a book written by Leonardo Fibonacci in 1202 to introduce the Hindu-Arabic numerals used today to a Europe still using Roman numerals.

The original problem in the Liber Abaci posed the question: How many pairs of rabbits can be generated from a single pair, if each month each mature pair brings forth a new pair, which, from the second month, becomes productive.

The Golden Ratio

After the first few numbers in the Fibonacci sequence, the ratio of any number to the next higher number is approximately .618, and the lower number is 1.618. These two figures are the golden mean or the golden ratio.

Its proportions are pleasing to the human senses and it appears throughout biology, art, music, and architecture. A few examples of natural shapes based on the Golden Ratio include DNA molecules, sunflowers, snail shells, galaxies, and hurricanes.

Important Retracement Levels

The two Fibonacci percentage retracement levels considered the most important in trading are 38.2% and 62.8%. Other important retracement percentages include 75%, 50%, and 33%. Three Profit Tips for Using Fibonacci Numbers

1. Fibonacci Defines Stop Loss Levels

A trader can use Fibonacci numbers to set stop loss orders.

For instance, if at least three Fibonacci price levels come together in a relatively tight zone, a stop loss placement just below or above the zone may be set.

A Fibonacci number helps define stops in the following way, if a trader trades against a support zone, if the support zone is violated and the price trades below that zone, the reason for the trade is negated and the position should be closed.

Setting stops using Fibonacci retracements takes the emotion out of trading and gives a pre defined exit point.

2. Fibonacci Defines Position Size

Depending on the risk you are prepared to take per trade, Fibonacci numbers can also define position size. For instance, if prices are right on a specific level, you may wish to have more positions than if the price is further away.

3. Fibonacci Defines Objectives

With Fibonacci numbers, once a pattern completes against a Fibonacci price zone you can use them to set profit objectives to bank partial profits or tighten stop loss levels. This clear objective for traders helps them to lock in profits. The great advantage of Fibonacci numbers and the golden ratio is the fact that they take the emotion out of trading and can define not only stop losses to exit a market, but also set profit objectives as well.

W D Gann and Fibonacci - The Perfect Trading Combination!

One trader who incorporated Fibonacci numbers and The Golden Ratio into his trading was the legendary trader W D Gann. We feel that the use of Fibonacci numbers with the Gann trading method provides traders with the best possible combination to seek long term trading profits.