What is Fibonacci Retracement in Forex Trading?

Fibonacci… Sounds like some new kind of pasta, doesn’t it? But it’s not. Nor is it the fella from Prison Break. In fact, in forex trading, Fibonacci is a predictive technical analysis indicator used to forecast possible future exchange rate levels.

The Fibonacci retracement tool is a huge subject in analyzing financial markets and we will be using Fibonacci ratios a lot in our trading so you better learn it and love it like your mum’s homemade chicken soup.  Because Fibonacci retracements are so popular among technical traders, you must get familiar with the Fibonacci numbers and their importance as technical indicators. 

Also, keep in mind 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 start off by introducing you to the man himself: Leonardo Fibonacci. 

Who is Leonardo Fibonacci?

Leonardo Fibonacci was an Italian mathematician from Pisa, also known to be a super mega geek, who lived in the 13th century. The Forex market has been around that long, you ask?

Not by a long shot.

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. They were originally applied to everything from studies of the universe to defining the curvature of naturally occurring spirals, such as those found in snail shells and the pattern of seeds in flowering plants.

leonardo-fibonacci, forex trading

Yes, you read that right – snail shells and plants. He had an “Aha!” moment 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 really 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 together the two previous numbers. It looks something like this.

1 1 2 3 5 8 13 21 34 55 89 144 233 377 …

And so on.

You can continue this until it’s not fun anymore. 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. 

Anyway, with all those numbers, you could put an elephant to sleep. Let’s take a look at the interesting bit. The golden ratio can be found in geometry, art, architecture, and even on Sonic the Hedgehog.

golden-ratio-sonic

and all of these symbols and logos:

fibonacci golden ratio

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

Fibonacci Retracement Explained – 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 obviously 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 really 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 that can calculate those Fibonacci retracement levels for you.

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 actually use Fibonacci retracement levels in your forex trading.

Using 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. 

fibonacci retracement levels, forex trading

By using the Fibonacci tool, traders usually try to identify support and resistance levels in currency markets. These levels represent areas wherein there is a high chance of a price reversal and they are extremely important 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 trading chart so it’s easier for you to find trading opportunities.

Summary

The bottom line, if you add the Fibonacci tool to your trading strategy, trading will be much easier for you. Simply put, all you need to do is to learn how to draw support and resistance horizontal lines and apply Fibonacci retracement levels on your charts.

But don’t worry. In this course, we are going to 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.

So get yourself a coffee and let’s explore how you can grab some pips using the Fibonacci ratios in the next lesson.