When trading Forex, using Fibonacci retracements can help identify potential reversal, support and resistance levels so learning how to use this tool can be very helpful for any Forex trader.
Fibonacci in Forex work well together. But what is Fibonacci?
Fibonacci lines or Fibonacci retracements are based on the Fibonacci sequence and are considered a “predictive” technical indicator providing feedback on possible future exchange rate levels. There are some traders who swear by the accuracy by which Fibonacci Retracements can predict future rates, while others argue that Fibonacci numbers are more art, than science.
Fibonacci’s sequence was introduced by Leonardo Fibonacci , a mathematician in the thirteenth century and has become a very popular tool among technical traders.(read more about Leonardo Fibonacci at http://www.math.rutgers.edu/courses/436/436-s99/Papers1999/oneill.html)
Fibonacci’s sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. The sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this succession is simply the sum of the two preceding terms and the order continues infinitely. One of the remarkable characteristics of this numerical arrangement is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies. The key Fibonacci ratios are 23.6%, 38.2%, 50%, 61.8% and 100%.
Why these ratios work the way they do is not clear but they seem to play an important role in financial markets. Using Fibonacci in Forex trading can pinpoint the areas of support (price stops going lower) or resistance (price stops going higher) and the potential retracement of a financial asset’s original move in price. (You can learn more about Fibonacci at http://www.fxacademy.com/learn/sr-fibonacci-retracement)
Fibonacci retracements use horizontal lines to indicate areas of support or resistance at the key Fibonacci levels before it continues in the original direction. These levels are created by drawing a trend line between two extreme points and then dividing the vertical distance by the different ratios.
To use the Fibonacci numbers in the charts, you have to find the top and the bottom of the previous trend. When the previous trend has been a downtrend, you draw the Fibonacci levels from top to the bottom and extend the lines in the way that they cover the next completing trend and when the previous trend has been an uptrend, you draw the Fibonacci levels from the bottom to the top and extend the lines in the way that they cover the next completing trend.
When using Fibonacci in Forex both newbie traders as well as professional Forex traders can see clearly the strong points of reversal, support, and resistance. All these are useful during your trading day in order to define potential entry points, market reversal points, and also your exit strategy. If it is not your main trading strategy that you are relying upon, using Fibonacci in Forex you will help you see the lines more clearly and will confirm your own entry or exit strategy.