Fibonacci Forex Trading Strategy - Fibonacci Retracement Levels

June 03, 2021 16:30 UTC
Reading time: 22 minutes

'Mastering the time and price advantage' is one way to sum up the art of the Fibonacci Forex trading strategy. But first, it always helps to know some background of where this growingly popular trading method comes from. It all starts with Leonardo Pisano Bogollo, an Italian mathematician, who first introduced the Fibonacci sequence to the West in the 13th century. These strings of numbers contain unique mathematical properties and ratios which can be found - to this very day - in nature, architecture and biology. The wide-ranging presence of these ratios in the Universe also extends to the financial markets. It's just one reason why many traders use a Fibonacci Forex trading strategy to identify turning points in the market, and why you should consider it too. In this online trading education guide segment, we will overview how to use Fibonacci retracement levels effectively in your Forex trading strategy.

In this article, you will learn the unique properties of the Fibonacci sequence in Forex trading, as well as how to use Fibonacci levels across different markets through a Fibonacci Forex trading strategy. You will also learn specific techniques on trading Fibonacci by using Fibonacci retracement levels and Fibonacci extension levels and how to get started on an advanced, free to use Fibonacci Forex trading software. Keep in mind, you always have the option to sign up for a FREE Demo Account with Admirals (formerly Admiral Markets), where you can test out your knowledge without risking any capital. Let's get started by looking at what the Fibonacci sequence is and how it works in trading.

How Does Fibonacci Work In Trading?

Before we look into the mechanics of Fibonacci trading and how it translates into a Forex Fibonacci trading strategy, it is important to understand the Fibonacci sequence and the unique mathematical properties it provides first.

The Fibonacci sequence is a sequence of numbers where, after 0 and 1, every number is the sum of the two previous numbers. This continues to infinity.

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765….

There are some interesting relationships between these numbers that form the basis of Fibonacci numbers trading. While we cannot cover all of these relationships in this article, below are the most important ones you will need to know about when we look at a Fibonacci Forex trading strategy later on:

  • If you divide a number by the previous number it will approximate to 1.618. This is used as a key level in Fibonacci extensions as you'll learn later on in the article.
  • If you divide a number by the next highest number it will approximate to 0.618. This number forms the basis for the 61.8% Fibonacci retracement level.
  • If you divide a number by another two places higher it will approximate to 0.382. This number forms the basis for the 38.2% Fibonacci retracement level.

1.618 is known as the Golden Ratio, Golden Mean, or Phi. The inverse of this is 0.618 and both numbers are found throughout nature, biology and in the cosmos. In fact, according to William Hoffner from the Smithsonian Magazine in December 1975: "The proportion of .618034 to 1 is the mathematical basis for the shape of playing cards and the Parthenon, sunflowers and snail shells, Greek vases and the spiral galaxies of outer space. The Greeks based much of their art and architecture upon this proportion."

So, how are the Golden Ratio and other Fibonacci levels used in trading? Firstly, these 'special' numbers are split into Fibonacci retracement levels and Fibonacci extension levels which then provide values where possible turning points could take place in the market. Let's have a look at these in more detail.

Fibonacci Retracement Levels: How To Use Them

Fibonacci retracement levels help to provide price levels of support and resistance where a reversal in direction could take place and can be used to establish entry levels. The Fibonacci retracement levels are based on the prior move in the market:

  • After a big rise in price, traders will measure the move from bottom to top to find where price could retrace to before bouncing higher and continuing in the overall trend higher.
  • After a big fall in price, traders will measure the move from top to bottom to find where price could retrace to before correcting lower and continuing in the overall trend lower.

Before we go through how to use Fibonacci trading software and Fibonacci indicators to help identify these retracement levels, it can help to view the pattern visually which is shown below:

Earlier, we calculated the relationship between the Fibonacci sequence to identify some important Fibonacci ratios such as the 0.618 (which forms the 61.8% Fibonacci retracement level) and the 0.382 number (which forms the basis of the 38.2% Fibonacci retracement level).

There are also other Fibonacci trading ratios that traders use such as 23.6% and 78.6%, among others. The four listed in the diagrams above are the most commonly used Fibonacci retracement levels.

  • The buy pattern is used when the market is an uptrend. Traders will attempt to find how far price retraces the X to A move (swing low to swing high) before finding support and bouncing back higher (B). These support levels are the Fibonacci retracement levels and could be a 23.6%, 38.2%, 61.8% or 78.6% retracement of the X to A move.
  • The sell pattern is used when the market is in a downtrend. Traders will attempt to find how far price retraces the X to A move (swing high to swing low) before finding resistance and correcting back lower (B). The B point could be any one of the Fibonacci retracement levels already listed.

It is common for traders to use other technical analysis tools such as trading indicators or price action trading patterns for confirmation of which Fibonacci retracement level price may turn. This is covered in more detail later on in the  Fibonacci Forex trading strategy section.

If you'd like to learn more about technical tools that can help with identifying Fibonacci retracements, take a look at the webinar below, which covers how to use basic Fibonacci retracements and extensions in MetaTrader 4 and MetaTrader 5

This webinar is from our Trading Spotlight webinar series where three pro traders offer live sessions three times a week. Just some of the topics they cover include how to do technical analysis, how to identify common chart patterns and trading opportunities and how to implement popular trading strategies such as the Fibonacci Forex trading strategy. To sign up for these complimentary webinars, simply click on the banner below:

How To Trade Fibonacci Extension Levels

Fibonacci extension levels also help to provide price levels of support and resistance but are used to calculate how far price may travel after a retracement is finished. In essence, if Fibonacci retracement levels are used to enter a trend, then Fibonacci extension levels are used to target the end of that trend.

As previously discussed the 1.618 is a key number in the Fibonacci sequence which is why it is called the Golden Ratio. This forms the basis of the most popular Fibonacci extension level - the 161.8% level.

In an uptrend, traders will attempt to enter the 'bounce' at point B and then measure the last Fibonacci retracement from A to B, to find how far the trend could go before reaching point C - the 161.8% level.

In a downtrend, traders will attempt to enter the 'correction' at point B and then measure the last retracement from A to B, to find how far the trend could go before reaching point C - the 161.8% level.

Reversal traders may also use the 161.8% level to enter into counter-trend trades but this is more suited to advanced traders.

So far, you have learnt that Fibonacci retracement levels are used to find support and resistance levels to enter a trade in the direction of the preceding trend. Fibonacci extension levels are used to calculate how far the trend could go before reversing and are used as exit levels.

Now you know what type of visual pattern and cycle, or wave, formations you are looking for - but how do we plot this on the price chart of a market to find entry and exit levels? Your best tool to use in this case is a Fibonacci trading software. Here at Admirals we provide this to our traders for free!

Fibonacci Trading Software and Fibonacci Retracement Indicators

When using Fibonacci trading software (like our MetaTrader 5 FREE trading platform, pictured below), there are two different types of Fibonacci indicators that can help traders plot retracement and extension levels. All the trader needs to do is measure the X to A cycles as shown in earlier examples and will be explained in more detail in the next few sections.

Once the trader has measured the X to A distance using the Fibonacci tool, the software will then divide the vertical distance by the Fibonacci ratios (23.6%, 38.2%, 61.8%, 78.6%, etc) to plot the Fibonacci levels. This means that you do not need to learn how to calculate Fibonacci retracement and extension levels manually as the software will plot it for you - making it a huge time saver!

An example of the MetaTrader 5 trading platform provided by Admirals showing the price chart of EUR.NZD, a trading ticket window, the Market Watch column, the Toolbox window, the different Fibonacci tools available and an example of Fibonacci retracement levels on price.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

With the MetaTrader 5 trading platform provided FREE by Admirals, users can access a wide variety of Fibonacci indicators and tools for their Fibonacci Forex trading strategy. It also allows users to access other trading indicators and technical tools and trade directly from the chart - in essence, providing you with an all-in-one trading platform. Admirals offers the following MetaTrader trading platforms which are all free to download:

The MetaTrader 5 trading platform offers traders the ability to trade on multiple asset classes and provides more features than MetaTrader 4 such as a wider range of chart timeframes and styles. To start using the full range of Fibonacci indicators and to follow through the live trading examples in the next few sections, click on the banner below to start your free download.

How To Use Fibonacci Retracement Tool in MetaTrader

Before we look at how to use the Fibonacci retracement tool in your MetaTrader trading platform, let's first set up the correct Fibonacci levels using the following steps:

  1. Open your MetaTrader trading platform provided by Admirals.
  2. From the top menu, select Insert -> Objects -> Fibonacci. This will show the following Fibonacci indicators:

3. The Fibonacci retracement tool is used to plot both Fibonacci retracement levels and Fibonacci extension levels. After selecting Fibonacci Retracement, your cursor will change from an arrow to a plus sign with some small horizontal lines beneath it.

4. After you click on the chart then you will find a box pop up which allows you to customise your Fibonacci levels, as shown below:

5. The 'level' column is the Fibonacci ratio derived from the Fibonacci sequence. The 'description' is how it translates into a Fibonacci level for trading. While there are different Fibonacci ratios the most commonly used are:

Level

Description

0

0.0

0.236

23.6

0.382

38.2

0.618

61.8

0.786

78.6

1.00

100

1.618

161.8

6. Some of these levels and descriptions may not be in your trading platform. To add them, simply click the Add button on the right.

Now let's look at how to plot Fibonacci levels on to your chart and what they actually mean.

Drawing Fibonacci Retracement Levels In an Uptrend

  1. Find the X to A cycle which is one big cycle, or wave higher.
  2. Select the Fibonacci Retracement tool from the top menu: Insert -> Objects -> Fibonacci -> Fibonacci Retracement.
  3. Left-click and hold down at the bottom of the cycle, X.
  4. While holding the mouse button down, drag the line to the top of the cycle, A.
  5. The Fibonacci indicator will automatically draw the Fibonacci retracement levels on, as shown below:

An example of the MetaTrader 5 trading platform provided by Admirals showing Fibonacci retracement levels drawn on using the Fibonacci retracement tool in an uptrend.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the price chart above, the Fibonacci levels are plotted as horizontal lines with the Fibonacci descriptions written on the right side of the chart. You may have noticed that the X level is plotted as 100 and the A level is plotted as 0. This is because if the price retraced from point A all the way back to point X it would be a 100% retracement.

This also means that when price retraces to the 38.2 level - for example - it means that price has retraced 38.2% of the X to A move. In an uptrend, these Fibonacci levels provide areas of support where the market could bounce higher and continue the trend up. In the example above price did indeed find support at the 38.2% Fibonacci level. Traders will then look at other technical analysis tools such as price action patterns to find more clues on whether price could bounce at this level.

Drawing Fibonacci Retracement Levels In a Downtrend

  1. Find the X to A cycle which is one big cycle, or wave lower.
  2. Select the Fibonacci Retracement tool from the top menu: Insert -> Objects -> Fibonacci -> Fibonacci Retracement.
  3. Left-click and hold down at the top of the cycle, X.
  4. While holding the mouse button down, drag the line to the bottom of the cycle, A.
  5. The Fibonacci indicator will automatically draw the Fibonacci retracement levels on, as shown below:

An example of the MetaTrader 5 trading platform provided by Admirals showing Fibonacci retracement levels drawn on using the Fibonacci retracement tool in a downtrend.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the price chart above, the Fibonacci levels are plotted as horizontal lines with the Fibonacci descriptions written on the right-side of the chart. You may have noticed that the X level is plotted as 100 and the A level is plotted as 0. This is because if the price retraced from point A all the way back to point X it would be a 100% retracement downtrend. These Fibonacci levels provide areas of resistance where the market could correct lower and continue the trend down. In the example above, price did indeed find resistance at the 38.2% Fibonacci level and then correct lower. Typically, traders would look at other technical tools to further confirm the possibility of a correction lower. This will be evident in the next section as we go through a Forex Fibonacci trading strategy.

How To Trade with Fibonacci Retracement Levels

So far you have learnt that in an uptrend Fibonacci retracement levels can act as a support level where price may bounce and continue moving higher. Conversely, in a downtrend Fibonacci retracement levels can act as a resistance level where price may bounce and correct lower. You have also learnt how to plot these levels using the Fibonacci indicator in the MetaTrader trading platform provided by Admirals, as well as how to use Fibonacci extension levels.

Both Fibonacci retracement levels and Fibonacci extension levels are used by a wide variety of traders covering different trading styles and timeframes, such as long-term trading, intraday trading and swing trading. The levels are also used across different markets such as Forex, Stocks, Indices and Commodities.

While the next section will focus on a Fibonacci Forex trading strategy, you can apply and test the same principles on other asset classes. In fact, with Admirals you can access a wide variety of different asset classes completely risk-free by using a demo trading account. This will also give you the chance to practice and test your Fibonacci trading skills with zero risk! Simply click on the banner below to open a demo account today:

Fibonacci Forex Trading Strategy

We have already established that the price of a market can often turn, or find support or resistance, at different Fibonacci levels. Within a Fibonacci Forex trading strategy, traders can go one step further and add in more technical analysis to help confirm whether the market will actually turn or not.

One of the most popular confirmation tools that can help identify whether the price of a market may turn or not is price action analysis. This is the study of candlestick or bar formations on the chart and there are a variety of price action trading patterns traders can choose from. If Fibonacci retracement levels give us the area to buy or sell, then price action trading patterns can help us time when to buy or sell.

Two of the most common types of price action trading patterns are the 'hammer' and 'shooting star' patterns.

The hammer pattern, as shown above, is a bullish signal which signifies the failure of sellers to close the market at a new low and buyers surging back into the market, to close near the high.

The shooting star pattern, as shown above, is the opposite of the hammer pattern. It's a bearish signal which signifies the failure of buyers to close the market at a new high, and sellers surging back into the market, to close near the low.

So how can we use these patterns with Fibonacci levels? Let's take a look at some examples! It is important to note that the following strategy has not been tested historically for its effectiveness but merely serves as a starting point for you to build upon. Traders can take this strategy one step further by experimenting with different technical tools, Fibonacci ratios and markets by learning more in the Admirals Education library.

Uptrend

Let's start with a simple set of rules for when the market is in an uptrend:

  1. Identify large cycle up (X to A) and draw on Fibonacci retracement levels from the bottom of X to the top of A, using the Fibonacci indicator in the MetaTrader trading platform provided by Admirals.
  2. Identify bullish price action trading pattern, such as the 'hammer' pattern at one of the Fibonacci retracement levels.

Both these rules are shown in the example price chart below:

An example of the MetaTrader 5 trading platform provided by Admirals showing Fibonacci retracement levels and the 'hammer' price action pattern, finding support at the 23.6% Fibonacci level.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

We can also add a third rule on identifying a possible target level for the trade:

3. Use the 161.8% Fibonacci extension level as a price target level by using the Fibonacci retracement tool and measuring from the A to B cycle, as shown below:

An example of the MetaTrader 5 trading platform provided by Admirals showing the Fibonacci extension level 161.8%.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the example above, the price has moved higher from the 'hammer' price action pattern which formed at the 23.6% Fibonacci retracement level. However, it is yet to reach the 161.8% target level. While the trader may want the market to go the target level there is no guarantee it will. In fact, the market - at any time - could reverse the other way and change trend.

This is why risk management and using a stop loss will prove to be beneficial in the long run as it can help to minimise losses.

Downtrend

Let's start with a simple set of rules for when the market is in a downtrend:

  1. Identify large cycle down (X to A) and draw on Fibonacci retracement levels from the top of X to the bottom of A, using the Fibonacci indicator in the MetaTrader trading platform provided by Admirals.
  2. Identify bearish price action trading pattern, such as the 'shooting star' pattern at one of the Fibonacci retracement levels.

Both these rules are shown in the example price chart below:

An example of the MetaTrader 5 trading platform provided by Admirals showing Fibonacci retracement levels and the 'shooting star' price action pattern, finding resistance at the 23.6% Fibonacci level.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

We can also add a third rule on identifying a possible target level for the trade:

3. Use the 161.8% Fibonacci extension level as a price target level by using the Fibonacci retracement tool and measuring from the A to B cycle, as shown below:

An example of the MetaTrader 5 trading platform provided by Admirals showing the Fibonacci extension level 161.8%.

Disclaimer: Charts for financial instruments in this article are for illustrative purposes and do not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the example above, price did indeed move lower from the 'shooting star' price action pattern which formed at the 23.6% Fibonacci retracement level. In this instance, the price went all the way to the 161.8% Fibonacci extension level.

Within the uptrend and downtrend Fibonacci forex trading strategy above, we used a combination of Fibonacci retracement and extension levels and price action. To learn more about different types of strategies and the tools you can add to the above then visit this article on The Best Forex Trading Strategies.

Conclusion

You should now feel comfortable with what Fibonacci trading is and how to apply Fibonacci Retracement levels using the MetaTrader platform, as well as having a new Forex Fibonacci trading strategy to try out on either on a demo or live account.

There are several other Fibonacci tools available for use with the MetaTrader trading platforms. If you are interested in learning more about these additional tools, including the Fibonacci channel and Fibonacci fan tools, as well as an associated trading strategy for each, then why not have a look at this related article.

Trade With Admirals

If you're feeling inspired to start trading, or this article has provided some extra insight to your existing trading knowledge, you may be pleased to know that Admirals provides the ability to trade with Forex and other asset classes, with the latest market updates and technical analysis provided for FREE!

 

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or recommendation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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