How to use Fibonacci retracement in Forex trading

How to use Fibonacci retracement in Forex

If you're familiar with technical analysis, then you should know what is Fibonacci retracement in Forex. This term is applied when we talk about technical analysis, which references support, where prices stop going lower, or resistance, where prices stop moving higher. The Fibonacci retracement is the potential retracement of a certain financial asset's original price movement. Those retracements utilise horizontal lines in order to identify areas of either support or resistance at the main Fibonacci levels before continuing in the original solid direction. Those levels are produced by drawing a trendline between two extreme points and after that dividing the vertical distance by the main Fibonacci ratios. They are the following: 23.6%, 38.2%, 50%, 61.8% and 100%. Forex retracement is a popular tool used by technical traders. It helps them to indicate strategic positions for transactions to arrange, target prices or stop-losses. The conception of retracement is applied in many indicators like Gartley Patterns, Tirone levels and Elliot Wave theory. In addition, after an important price move, whether up or down, the new support and resistance levels are frequently at or around these lines. This article has been developed with the purpose of exploring how to profit from Fibonacci retracements in Forex trading.

The role of Fibonacci retracement in creation of trading strategy

Forex traders utilise Fibonacci FX retracements to spot where to position orders for market entry, for either taking profits or for stop-loss orders. These retracements indicate key levels of resistance and support. Fibonacci levels are most often calculated after the FX market has made a particularly big movement either up or down, and accordingly seems to have flattened out at a particular price level. Traders organise the key Fibonacci levels of 38.2%, 50% and 61.8%. To do so, they draw horizontal lines across a concrete chart at these price levels to point out areas where the market may actually retrace to, prior to resuming the general trend formed by the initial big price movement. Fibonacci retracement levels are regarded as significant when the market has approached or surpassed a great price support or resistance level. The 50% level is not technically part of the Fibonacci number sequence, although it is included thanks to widespread experience in Forex trading of a market retracing approximately half a major move prior to resuming, and consequently continuing its trend.

We're now going to look at some examples of Forex strategies traders often apply when using Fibonacci levels:

  • Purchasing near the 38.2% retracement level with a stop-loss order positioned a little below the level of 50%.
  • Purchasing around the 50% level with a stop-loss order arranged a slightly below the level of 61.8%.

While joining a sell position around the top of the big move, traders often utilise Fibonacci levels in Forex to determine take-profit targets.

In case the market retraces near to one of the Fibonacci levels and after that resumes its preceding movement. That works thanks to utilizing the higher Fibonacci levels of 161.8% and 261.8% to indicate possible future support as well as resistance levels. However, that is only in case the market moves beyond the high or low that was achieved before the retracement.

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The introduction to main strategies for trading Fibonacci retracements

There are a number of strategies which can be used to trade with Fibonacci FX retracements, although some are more suited than others. We have a number of strategies we would like to introduce in order to explain how to use Fibonacci in Forex. These strategies are:

  • the Fibonacci number sequence
  • the Golden Ratio
  • Fibonacci levels applied in the financial markets
  • The 50% retracement level
  • Fibonacci retracement levels as the crucial part of a trading strategy
  • The appliance of Fibonacci extensions

The Fibonacci number sequence

In the Fibonacci sequence Forex of numbers, after 0 and 1, every number is the sum of the two previous numbers, and looks like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610. As you can see, this sequence can continue extend to infinity. Every number is approximately 1.618 times bigger than the former number.

The Golden Ratio in Forex

The figure 1.618 is called Phi, which also known as the Golden Ratio. The exact inverse of 1.618 is 0.618.

Fibonacci levels applied in the financial markets

Forex Fibonacci levels applied in Fibonacci Forex retracements in trading are not actually based on numbers in the sequence. They are instead obtained from the mathematical relationships between numbers in the sequence. The main basis of the golden Fibonacci ratio, which is 61.8%, comes from dividing the number in the Fibonacci series by the certain number that succeeds it. For instance, 89/144 = 0.6180.

In addition, the 38.2 ratio is acquired from dividing a certain number in the Fibonacci series by the number two places to the right, e.g 89/233 = 0.3819. The 23.6 ratio is derived from dividing a number in the Fibonacci series by the number three places to the right, for example 89/377 = 0.2360.

Fibonacci levels are illustrated by taking high and low points on a certain chart and marking the main Fibonacci ratios of 23.6%, 38.2% and 61.8% horizontally to generate a grid. In turn, those horizontal line are used to determine possible price reversal points. At this point, you should now know how to draw Fibonacci retracement in Forex.

The 50% Retracement level

The 50% retracement level is commonly included in the Fibonacci levels' grid that can be drawn applying charting software. Since the 50% retracement level is not based on a concrete Fibonacci number it is generally viewed as a significant reversal level, peculiarly recognised in Dow theory, as well as in the work of W.D Gann.

Fibonacci retracement levels as the crucial part of a trading strategy

Fibonacci retracements are mainly used as part of a particular trend trading strategy. In scenarios like this, Forex traders see a retracement occurring within a trend and consequently try to make low risk entries in the initial trend's direction utilising Fibonacci levels. In other words, traders applying this strategy expect that price has a high chance of bouncing from the Fibonacci levels back accordingly in the direction of the initial trend. Additionally, the possibility of a reversal extends where there is a convergence of technical signals by the time the price reaches a Fibonacci level.

Other common technical indicators that are applied along with Fibonacci levels include volume, trendlines, momentum oscillators, moving averages and candlestick patterns. A substantial number of confirming indicators in play relate to a more vigorous reversal signal.

Forex Fibonacci retracement is based on the diversity of financial instruments involving foreign exchange, stocks and commodities, and is used multiple time frames. Nonetheless, like with other technical indicators, the predictive value is proportionate to the timeframe applied, with bigger weight give to relatively longer timeframes. This leads us to the point that a 38% retracement on a weekly chart is a much more significant technical level in comparison to a 38% retracement on a 5-minute chart.

The appliance of Fibonacci extensions

When it comes to Fibonacci levels, you may address the question of how to use Fibonacci retracement to predict Forex market. They can be utilised to predict potential support or resistance areas where Forex traders can join the market with a view to catching the beginning of an initial trend. A Fibonacci extension can favour this strategy by giving Forex traders Fibonacci based profit targets. Additionally, Fibonacci extensions comprise of levels drawn beyond the ordinary 100% level. This can be exploited by Forex traders to project areas that assemble good potential exits for their trades in the direction of the trend. As we have previously mentioned, the major Fibonacci extension levels include 161.8%, 261.8% and 423.6%.

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Conclusion

Using Fibonacci in Forex trading is a good way to potentially increase your profits. Fibonacci levels frequently mark reversal points with a good degree of accuracy. That being said, they can be difficult to trade and traders often prefer to utilise the levels as tool within a broader Forex strategy, which focuses on areas of low risk as well as high potential reward trade entries. Strategies of trading retracements are quite popular and you will undoubtedly find a suitable one to meet your trading needs. As a consequence, you should know how to use Fibonacci retracement in Forex.