What it is
A Fibonacci retracement divides a completed price swing into horizontal levels used to anticipate how far a pullback might carry before the prior move resumes. The standard set is 23.6, 38.2, 50, 61.8 and 78.6 percent of the swing, drawn as lines across the chart.
How it works
Construction is mechanical: choose a swing low and a swing high, then place each level at the high minus the range multiplied by the ratio. The ratios derive from the Fibonacci sequence — 61.8 percent is the reciprocal of the golden ratio, 38.2 percent is its square, 78.6 percent its square root — with the exception of 50 percent, which is not a Fibonacci number at all but a convention inherited from Dow theory. Extensions beyond the original swing, commonly 1.272 and 1.618, are used to project targets.
How traders use it
In practice the tool is most useful for defining a zone rather than a line. Traders look for confluence: a retracement level that coincides with prior structure, a moving average, an anchored VWAP or a high-volume node is far more interesting than the level on its own. As a rough character read, shallow pullbacks into the 38.2 area are associated with strong trends and deep ones into the 61.8 to 78.6 area with weaker ones.
Where it breaks down
The tool depends entirely on which swing the user selects, and reasonable analysts pick different swings on the same chart, so results are not reproducible in the way a computed indicator is. There is no credible evidence that markets respect these ratios for any mathematical reason; whatever tendency exists is better explained by a large number of participants placing orders at the same widely published levels. Treat the numbers as coordination points, not as laws of price.
Educational reference. This entry describes how a concept is defined and used. It is not investment advice, not a recommendation, and not a signal. Any rule you build from it should be tested with realistic costs before it is traded, and no historical result guarantees a future one.