Last week, I told you about how adding a technical analysis layer to my stock vetting made me a much better investor.

This week, I’m going to share with you how I do it.

Today, I’ll be discussing another neat tool: Fibonacci retracements.

It’s not the only tool I use. In fact, Fibonacci is most effective when used with other technical indicators. But it’s definitely one I like a lot.

For one, it’s versatile. It can help predict the extent of both pullbacks and rallies.

So what exactly are Fibonacci retracements?

They’re ratios that indicate when price reversals may be drawing near.

What this means is when a price line hits these levels, it signals a possible turnaround. When other technical indicators also point to a turnaround at the same time, the signal is amplified.

The most common Fibonacci ratios are 23.6%, 38.2% and 61.8%. (You’ll also see a 50% level with most Fibonacci charts – though technically, it’s not a part of the Fibonacci sequence.)

Curious as to where these ratios come from?

Well, we have to go back nearly a thousand years to identify their origins.

Leonardo Pisano Bigollo (aka Fibonacci) was a mathematician from Pisa who introduced the Fibonacci sequence to the West in the 12th century. It is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610… and so on to infinity.

Fibonacci demonstrated how a number divided by the previous number in his sequence approximates 1.618. And, lo and behold, a number divided by the next highest number approximates 0.6180.

It’s known as the “golden ratio,” and it is the ratio I consider the most important. (By the way, the inverse of 1.618 is approximately 0.618!)

What I find fascinating is that these ratios are also found throughout nature, architecture, art and biology. They can be seen in everything from sunflowers to the spirals in galaxies.

The next most significant number? It’s 0.3820.

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