Fibonacci Retracement in Forex Trading
Fibonacci is a trading tool, commonly used by technical traders to help them predict the retracement levels or turning points in a trend. Also, they use the Fibonacci levels to predict future target levels where prices may store. This is allowing us to take profits or look for countertrend opportunities.
I will ask you this question: Do you think Fibonacci is a load of old hocus-pocus nonsense, or does it still hold relevance in today’s market? But before you answer, take a look below.
What Are Fibonacci Numbers?
Hundreds of years ago, Leonardo Fibonacci was a 13th-century mathematician. He developed a simple formula consisting of a sequence of numbers which showed to have relevance in multiple events in nature. From the stars in the sky to the patterns on a shell, and the number of petals on a rose, all were related to his numbers.
It may sound difficult to understand, but the sequence is quite simple to calculate. Each number is the sum of the two preceding ones, starting from 0 and 1.
Always the pattern repeats itself, no matter how far you go down in the number sequence.
For example, if you take a number from the sequence, and divide it by the next one or two numbers is going to give you a number that repeats itself.
The Fibonacci Retracement
Traders like to use these numbers as potential retracements. Why? Because it happens in human nature, so why can’t it happen in the markets?
We multiply these numbers with 100 to give us a percentage retracement.
You can do this calculation throughout the sequence and get up other the numbers as well, but these are the most commonly used.
On the uptrend chart below you will see exactly why these numbers are relevant. As you can observe prices are moving up, making higher highs, but trends rarely move in a direction without pullback through retracements.
Basically, Fibonacci numbers are used for potential turning points or pause in the pullback. To scheme the Fibonacci levels you need to take a price from the low to the high and plotting a percentage retracement.
So this is how a 23.6%, 38.2% and 61.8% retracement will look like:
Potentially, if this market reverses, it could find support at 23.6%. This means Fibonacci traders may buy at that level. Also, it may break the 23.6 level and carry on going down to 38.2. Again, there might be some buyers expecting this 38.2 to be a level of significance and support.
How can you use Fibonacci levels?
That was just one way of using Fibonacci levels. Besides, you could use them for extension levels, take profit targets, key reversal levels in trend and many others.
If you noticed, I have not included a 50% level above because it is often used by Fibonacci traders in retracement analysis. However, it is not actually a Fibonacci level in terms of the patent calculation, because 50 it doesn’t repeat throughout the sequence like the others.
On the price chart below you can see the market is clearly broken out into trend. To enter this kind of trend, you need to use the Fibonacci levels for a potential pullback stalling point.
Anyway, most broker platforms have a Fibonacci drawing tool. On MT4 you can find this tool in the tab from the top left.
I recommend to take the tool from a swing low up to a swing high, and this way it can automatically plot a potential turning point. As you will progress through the chart, you will see exactly how well these levels have been respected.
The Fibonacci retracement levels can be very powerful levels of a pause in a pullback.
So to answer the headline question, is Fibonacci just a load of old hocus-pocus or does it hold relevance in today’s markets? I’ll let you be the judge, but certainly, it seems to have amazing respect on longer periods.
I like to use some Fibonacci in my daily strategies. Especially I like the 50% and the 61.8% extension levels.
Either way, I suggest you, to use Fibonacci in conjunction with other price action and not as a standalone indicator.
I hope you have found this valuable. If you would like to learn more, join me in the Trading Room. I hope to see you there! Happy trading and good luck.