What is Fibonacci Retracement in Forex Trading?

The Fibonacci retracement tool is a huge subject in analyzing financial markets and we will be using Fibonacci ratios a lot in our trading.  Because Fibonacci retracements are so popular among technical traders, you must get familiar with the Fibonacci numbers and their importance as technical indicators. 

Also, remember that there are many different Fibonacci studies out there, but we will keep it relevant and stick to the two main ones: Fibonacci retracements and Fibonacci extensions. But before we dig into that, let’s introduce you to the man himself: Leonardo Fibonacci.

Who is Leonardo Fibonacci?

Let’s pause and ask: Who was Leonardo Fibonacci? This renowned Italian mathematician from Pisa marked his era in the 13th century with groundbreaking discoveries. 

The truth is Fibonacci retracement levels have been adapted for use by traders in the Forex market, but they were never intended for this use. Initially, their application spanned from cosmic studies to defining curvatures in natural spirals — think snail shells or the mesmerizing patterns of seeds in flowering plants.

Fibonacci’s “Eureka” moment was when he discovered a simple series of numbers that created the key Fibonacci ratios describing the natural proportions of things in the universe.

The Fibonacci sequences arise from the following number series: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144… But let’s see how the Fibonacci sequence works. 

The Fibonacci Sequence 

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. Don’t worry. It will make more sense in a minute. In the Fibonacci sequence, each number or Fibonacci ratio is calculated by adding the two previous numbers together. It looks something like this.

1 1 2 3 5 8 13 21 34 55 89 144 233 377… And so on.

After the first few numbers in the sequence, if you measure the ratio of any Fibonacci number to the succeeding higher number, you get .618. If you measure the Fibonacci ratio between alternate numbers, you get .382. If you divide a number by the previous number, it will be approximately 1.618. This ratio is also known as the Golden Ratio, Golden Mean, or Phi. 

Let’s take a look at the interesting part. The golden ratio can be found in geometry, art, architecture, and even on Sonic the Hedgehog.

And all of these symbols and logos:

But that’s enough mumbo jumbo. Let’s cut to the forex chase and see how technical traders use a Fibonacci retracement level in forex trading.

What are Fibonacci Retracement Levels?

As you may guess, many forex traders use the Fibonacci sequence numbers as a technical analysis tool that helps them identify key levels and find entry and exit levels. Why? Because these are not only “magical,” but they are watched by many forex traders in the market. And, if many forex traders look at the same numbers, then Fibonacci retracements become crucial price levels.

First, you need to know these magic Fibonacci numbers – these are the ratios that, as a Forex trader, you HAVE to know:

0.236, 0.382, 0.618, 0.764 (on trading charts, the numbers are presented as 23.6 38.2 50 61.8)

Fibonacci Extension Levels

0, 0.382, 0.618, 1.000, 1.382, 1.618

Luckily, you don’t need to know how to calculate Fibonacci retracement levels. Your charting software will most likely do all the work for you. If not, you can find Fibonacci calculators online to calculate those Fibonacci levels.

However, it’s always good to be familiar with the basic theory behind the Fibonacci technical analysis indicator so you can impress your mates (or dates?). But let’s see how you can use Fibonacci retracement levels in your forex trading.

How to Use Fibonacci Retracement Levels to Find Support and Resistance Levels

Although the Fibonacci sequence is used for many real-life applications, such as the number of petals of flowers and the growth of living cells, many forex traders also use Fibonacci retracement levels to predict price movements in the forex market.

Using the Fibonacci tool, traders usually try identifying support and resistance levels in currency markets. These levels represent areas with a high chance of a price reversal, and they are extremely important to price levels when they trade around the same level of Fibonacci retracements. When you combine Fibonacci levels and support and resistance levels, you essentially create target prices on your forex chart, making it easier to find trading opportunities.

Key Takeaways

• Fibonacci retracement is a technical analysis tool used in forex trading to forecast potential future exchange rate levels, using a series of numbers known as the Fibonacci number sequence.
• The Fibonacci sequence, discovered by 13th-century mathematician Leonardo Fibonacci, was not initially intended for financial markets but has since been adapted by traders for analyzing price movements.
• The sequence leads to key ratios such as 0.618 (Golden Ratio), 0.382, and 1.618, which are significant in identifying support and resistance levels in currency markets.
• In forex trading, specific Fibonacci ratios like 0.236, 0.382, 0.618, and 0.764 (retracement levels) and 0, 0.382, 0.618, 1.000, 1.382, 1.618 (extension levels) are used to find entry and exit points.
• Traders use Fibonacci retracement levels to identify potential support and resistance areas, predicting price reversals and setting target prices for trading opportunities.

Summary

The bottom line is that if you add the Fibonacci tool to your forex trading strategy, trading will be much easier for you.

The rest of this course will cover everything you need to know about Fibonacci retracement levels. We’ll show you how to draw Fibonacci retracement lines on a price chart on your trading platform and explain in detail how to use Fibonacci trading tools with other technical indicators like trend lines, support and resistance levels, and various candlestick patterns.