Fibonacci ratios are derived from dividing one Fibonacci number by another. The most common ratios are 0.618, 0.382, and 0.236. These ratios can be used to create Fibonacci retracements and extensions, which are horizontal lines that indicate where the price of a stock may bounce back or break out after a significant move.

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Fibonacci retracements are drawn by connecting two extreme points of a price movement, such as a high and a low, and dividing the vertical distance by the Fibonacci ratios. The resulting levels are potential areas where the price may reverse or stall. For example, if a stock rises from $10 to $20, and then falls to $16.18, it has retraced 38.2% of the previous rise.

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Fibonacci extensions are drawn by extending the Fibonacci retracement beyond the original price movement. They can be used to project where the price may go after a pullback or a breakout. For example, if a stock rises from $10 to $20, and then falls to $16.18, and then resumes its uptrend, it may reach $23.62, which is the 161.8% extension of the previous rise.

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Fibonacci analysis is based on the assumption that the stock market moves in predictable patterns that reflect human psychology and natural phenomena. By using Fibonacci tools, traders can identify potential entry and exit points, as well as risk-reward ratios for their trades.

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