The famous Fibonacci numbers often appear to have strong correlations with nature, and their relevance to forex trading is no exception as they influence the financial market as well. Developed by Joseph Granville in 1963, Fibonacci Retracement Indicator helps forex traders identify potential support and resistance levels in a currency pair. This article explains how to use a Fibonacci Retracement Indicator to increase your trading profits!
Forex Trading with Fibonacci Retracement Indicator: Key Takeaways Forex traders can benefit from using the Fibonacci retracement indicator in a few different ways: 1. Identifying levels of support and resistance: Fibonacci retracement indicator helps traders identify key levels of resistance and support based on price movements. 2. Setting stop-loss and take-profit levels: Traders can use the Fibonacci retracement levels as potential places to set stop-loss and take-profit levels for their trades. 3. Determining trend strength: This indicator can also tell you how strong a trend is. If a price can retrace a significant part of a move, it means the trend is losing strength and a reversal is coming. 4. Understanding market direction: Fibonacci retracement can also be used by traders to determine the direction of a market trend. Identifying key levels of support and resistance allows them to make educated guesses about the market's direction. It's important to note that while Fibonacci retracement is a useful tool, traders should use it in conjunction with other analyses and indicators before making trading decisions.
What is Fibonacci Retracement?
Fibonacci retracement is a technical analysis tool that uses horizontal lines to indicate areas where an asset’s price may experience support or resistance. These levels are derived from the Fibonacci sequence and are commonly used in conjunction with trend lines to find entry and exit points in the market.
The history of the Fibonacci sequence begins with the Italian mathematician Leonardo Pisano Bogollo, also known as Fibonacci, who wrote about it in his book Liber Abaci, written in 1202. The Fibonacci sequence can be written mathematically as: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, ….
It is interesting to note that certain mathematical properties and ratios are found in these strings of numbers that can be found in nature, architecture, and biology, making them universal in nature. Not surprisingly, these ratios are widely present in the financial markets as well. Many traders use Fibonacci Forex trading strategies to identify turning points in the market, and you should too!
Simply put, a Fibonacci retracement consists of a series of horizontal lines illustrating an asset price based on the ratios between the numbers in the Fibonacci sequence.
What Are Fibonacci Retracement Levels?
Fibonacci retracement levels, which are derived from the Fibonacci sequence, show where support and resistance in an asset price are likely to occur.
Each Fibonacci retracement level corresponds to a percentage. Based on the percentage, we can determine how much a price has reversed from a previous move. There are officially four Fibonacci retracement levels: 23.6%, 38.2%, 61.8%, and 78.6%. 50% is also used, although it is not officially a Fibonacci ratio.
The Fibonacci Retracement Indicator can be used to determine the distance between two significant price points, such as a high and a low. Based on these two points, the indicator will create levels between them.
Fibonacci retracement levels are used as a predictive technical indicator because they attempt to predict where prices may go in the future. According to this theory, after the price initiates a new trend direction, it will reverse or retrace partway back before resuming its trend.
What Do Fibonacci Retracement Levels Tell You?
When it comes to Forex trading, Fibonacci retracement levels are used to identify entry orders, set stop-loss levels, and determine price targets. These levels are considered to be key levels at which the price may experience support or resistance.
- The 23.6% level is considered a shallow retracement and is often seen as a strong level of support or resistance.
- The 38.2% level is considered the next level of retracement, and can also be seen as a significant level of support or resistance.
- The 50% level is considered a midpoint retracement and is sometimes seen as a psychological level of support or resistance.
- The 61.8% level is considered the “golden ratio” or “golden retracement” level and is often seen as a strong level of support or resistance.
- The 100% level represents a complete retracement, which can be used to measure the strength of the original move and anticipate a potential trend reversal.
To sum up the art of the Fibonacci Forex trading strategy, one can say it’s about mastering the time and price advantage.
How to Calculate Fibonacci Retracement Levels?
In order to calculate Fibonacci retracement levels, you must identify high and low points on a chart. Based on the selected points, Fibonacci levels can be calculated effectively.
When a market is in an uptrend or bullish, Fibonacci retracement levels are calculated using the formulas given below:
`UR = H - ((H-L) * percentage) `
`UE = H + ((H-L) * percentage) `
When a market is in a downtrend or bearish market, Fibonacci retracement levels are calculated using the formulas given below:
`DR = L + ((H-L) * percentage) `
`DE = L - ((H-L) * percentage) `
- H – High Price
- L – Low Price
- UR – Uptrend Retracement
- UE – Uptrend Extention
- DR – Downtrend Retracement
- DE – Downtrend Extention
Once you have calculated the retracement levels, you can then plot them on the chart as horizontal lines. These horizontal levels represent areas where the price may stall or reverse.
How Does Fibonacci Work In Trading?
When it comes to trading, Fibonacci levels (lines) can be used both as standalone indicators and as part of strategies incorporating other technical indicators. Fibonacci sequences are often used in trading to identify support and resistance levels. Based on the price chart of a particular security, mathematical ratios are applied to determine these levels.
As mentioned above, the most commonly used levels are 23.6, 38.2, 50, 61.8, 76.4, and 100. These levels represent the levels where the security’s price may experience resistance as it rises or support as it falls.
The easiest way to open an order using Fibonacci Retracement Indicator is to set a pending order after breaking through the 100% level. This can be achieved by stretching the Fibonacci grid after a trend wave has formed from its endpoint extremum to its start point extremum.
Conducting Fibonacci Retracement Analysis
Finding a strong upward or downward trend in the stock price is the first step in performing Fibonacci Retracement Analysis. Study ranges are the highs and lows of the trend under study. The two points are used to calculate Fibonacci retracement levels.
Downtrend Fibonacci Retracement
If you want to create a Fibonacci retracement in a downtrend, you need to pick the high and low prices. Based on the pair, Fibonacci levels are calculated. Using the following formula, we can calculate the levels from the downtrend:
Fibonacci levels are derived from the levels above, e.g., 38.2%, 61.8%, 23.6%, etc. A price chart is overlaid with the calculated levels to gain an intuitive understanding of future support or resistance levels.
Uptrend Fibonacci Retracement
A Fibonacci retracement level can be created by selecting the high and low-price levels for an upward trend. Fibonacci price levels will be calculated using the levels. Calculating the price levels for an uptrend can be done using the following formula:
The Fibonacci levels are the same as those used in downtrend calculations, viz. 38.2%, 50%, 61.8%, and 78.6%.
An important takeaway from this post is that a trader can use Fibonacci levels to place buy orders during an uptrend. Based on the trend, it is likely that the price will reach its lowest point and then bounce back.
Fibonacci Trend Line Trading Strategy
The Fibonacci trend line trading strategy is a popular method of identifying potential levels of support and resistance in the financial markets. This strategy involves drawing trend lines that connect a series of swing highs or swing lows and then applying Fibonacci retracement levels to the trend lines to identify potential levels where the price may stall or reverse.
The basic idea is to connect the swing high and swing low, the most recent swing high and low-price points, and then draw horizontal lines at the 23.6%, 38.2%, 50%, 61.8%, and 100% retracement levels to identify areas where the price may find support or resistance. In case the price breaks through a key Fibonacci level, it can indicate a strong change in trend.
Fibonacci retracement levels can also be used in conjunction with other technical indicators, such as Moving Average, MACD, or RSI, to confirm or invalidate potential trades. It is worth noting that this strategy is only one of many ways to analyze the markets and it’s important to use multiple strategies in conjunction with each other to build a robust trading strategy.
Fibonacci Support and Resistance Levels
The support and resistance levels shown at the Fibonacci Retracement Indicator indicate entry points at which a reversal is likely to occur.
During an upward trend, we take long positions when retracements reach a Fibonacci support level.
It may be a good idea to wait and see if the price stays around the level and then buy when the price starts moving upwards.
In the case of a downward trend, you would adopt a sell position when the price reaches Fibonacci resistance levels.
In technical analysis, it is expected that prices will repeat their past behavior, and retracements to certain levels can indicate reversals. Fibonacci patterns are based on their retracement levels, so you should define your trading strategy based on them.
While Fibonacci trading can be a profitable way to enter and exit trading positions, you should be aware that not every retracement will reverse the trend. When a price reaches a certain level, you cannot automatically assume a profitable signal.
Fibonacci Retracement Levels and Their Types
Despite the fact that Fibonacci levels generally perform the same function, they differ both in appearance and in function. Here are the different Fibonacci retracement levels and their types.
1. Fibonacci Levels (Lines)
Fibonacci levels, also known as Fibonacci lines, are the most basic and popular Fibonacci tools. It appears as a grid made up of several lines on the chart. With the Fibonacci ratio, you can calculate the distance between them. In general, these lines represent key levels for price movements. Price tends to move towards the lines and often reverses when approaching them. If, however, the price breaks this level, it signals a strong trend is emerging.
In Fibonacci lines, the last evident trend is taken into account. A grid is drawn from the trend’s start (level 0) to its end (level 100). Levels within this range (61.8, 38.3, etc.) serve as benchmarks for potential trend reversals, while levels after 100 (161.8, 261.8, etc.) serve as targets for a trend continuation.
You can set a stop loss at internal levels and a take profit at external levels when you follow a trend and place an order. The price targets for trading retracements should be set at the internal levels. A pending order can also be placed on a level breakthrough to open positions.
2. Fibonacci Time Zones
Fibonacci time zones are different from other Fibonacci tools. Based on the previous momentum duration, this indicator predicts the time of the next wave (retracement or trend). Instead of lines, time zones stretch from the start of a trend to the point of its reversal.
Due to the difference in wavelength between each currency pair and each time frame, time zones are rarely used. As a result, pending orders cannot be placed with this tool since it does not provide specific signals for entering the market at a specific price.
3. Fibonacci Channel
A Fibonacci Channel is an expanded version of a line. In contrast to lines, which are always horizontal, channels can be inclined. By using this feature, you can create trend line grids and determine price targets based on the angle of the trend. A Fibonacci channel is built using two extrema (one for an uptrend and one for a downtrend): if the trend is up, the indicator is linked to the minimum levels, and if it is down, it is linked to the maximum levels.
A trend line is drawn based on these points which becomes either a resistance level or a support level. By moving the second line, the whole grid can be adjusted. Retracements are determined by stretching the channel from second to first extrema, against the trend’s direction.
4. Fibonacci Arcs
Fibonacci Arcs can be considered one of the most effective tools when there is a flat price trend. The indicator is used to identify trend retracements. The arcs are stretched between the boundaries of a trend or wave, just as with other Fibonacci indicators. Arcs can also be built from the start to the end of a trend.
In the classical version, the initial trend range only contains three arcs. When the price moves away from the key points, the lines diverge and the range of price targets begins to widen.
5. Fibonacci Fan
Fibonacci Fan is another dynamic tool. You can think of it as several rays moving in different directions from one point. Taking the first trend (rays starting point) as a base, we stretch the fan based on two trends. In an uptrend, the fan appears under the price chart. The trend reversal level will appear above the price chart if the price is in a downtrend.
The Fibonacci fan can be used with a dynamic stop loss as well. If the price moves along one of the fan lines, you should move the protective order along that line.
6. Fibonacci Extensions
Analyzing waves often involves the use of extensions. Three points from two waves of this indicator: trend waves and retracement waves. Benchmarks in trend direction are indicated by extensions. Taking profit orders can be set with this tool most effectively.
It is quite rare for traders to use time zones, fans, and arcs (except for trading systems designed specifically for these indicators). Using Fibonacci levels (lines) is quite common and is often used in conjunction with other strategies (for example, when looking for more signals or confirming existing ones).
How to Adjust and Add Fibonacci Levels to the Chart?
Adjusting and adding Fibonacci levels to a chart can be done in several ways, depending on the charting software or platform that you are using. In most charting software, or forex trading app, there should be a built-in Fibonacci retracement tool that can be easily accessed and applied to a chart. To add Fibonacci levels to a chart, you can typically do the following:
- Identify the swing high and swing low on the chart. This can typically be done by clicking and dragging the cursor over the relevant price points.
- Select the Fibonacci retracement tool from the list of available tools on the platform. It might be labeled as “Fibonacci retracement” or “Fib”
- Click on the swing low point, then click on the swing high point, and the retracement levels should be plotted on the chart. This will display the 23.6%, 38.2%, 50%, 61.8%, and 100% retracement levels as horizontal lines.
- You can adjust the Fibonacci levels by dragging the lines on the chart or using the input field provided by the charting software to adjust the levels.
- You can also add other levels of Fibonacci by right-clicking on the chart, then selecting “Add Level” and entering the percentage of retracement you wish to add.
You may also be able to customize the appearance of the Fibonacci retracement levels, such as the color or line style, using the charting software settings.
It’s important to note that adding Fibonacci retracement levels on a chart is just one of the many ways to identify potential areas of support and resistance. Therefore, it’s essential to combine multiple strategies and other indicators in order to make more accurate predictions about the market.
Limitations of using Fibonacci Retracement Indicator
Fibonacci retracement is a widely used technical analysis tool, but like any other tool, it has its limitations. Some of the limitations of using the Fibonacci retracement indicator in trading include:
- Subjectivity: The way in which Fibonacci retracement levels are applied to a chart can be subjective. The selection of the high and low points can vary, which can lead to different retracement levels and different trading decisions.
- False Signals: Fibonacci retracement levels can generate false signals. Prices may temporarily break through a key retracement level, but then quickly revert back to their original direction, which can lead to losing trades.
- Not Suitable for Sideways Markets: Fibonacci retracement is based on the idea that prices move in trends, but in sideways markets prices tend to move horizontally. This makes the retracement levels less useful in these conditions and may lead to false signals.
- Lack of Confirmation: Fibonacci retracement is only one tool and does not provide any confirmation of a potential reversal. Traders should combine it with other indicators or tools like trend lines, volume, or Moving averages for example.
- Limited to Technical Analysis: Fibonacci retracement is based on the study of past prices and is therefore limited to technical analysis. It does not take into account any fundamental information such as economic data, company financials, etc.
- Over-reliance: Some traders rely too heavily on a Fibonacci retracement, and may use it as the sole basis for their trading decisions. This can lead to missing other important factors and may lead to poor trading performance.
Technical traders should never solely use Fibonacci retracement values as a measure of support and resistance since they are not dependent on them. Taking support and resistance values as a determinant can be done at best if they are accompanied by a recognizable candlestick pattern. Before making a trade, a wise forex trader takes into account additional factors that seem unrelated.
Fibonacci Retracement Indicator – FAQ
How do I use the Fibonacci retracement indicator in my trading platform?
To use the indicator, first select the currency pair you wish to trade and then apply the Fibonacci retracement tool from the technical indicators’ menu. Next, you need to click and drag the indicator from the high point to the low point on your chart. The retracement levels will appear automatically.
Is Fibonacci retracement good for day trading?
Yes, Fibonacci retracement is a must-have tool for day traders. Since day traders rely heavily on technical analysis to identify market trends, using Fibonacci retracement levels is useful when you are sure of an upward or downward trend. However, intraday charts may be less useful if the market ranges or you’re seeking short-term bounces. A trader’s trading strategy can also affect the outcome.
What are the most important Fibonacci retracement levels to watch for?
The most widely used levels are 23.6%, 38.2%, 50%, 61.8%, and 100%. 23.6% level can be seen as a strong level of support or resistance, while 38.2% is a significant level, 50% is a psychological level, 61.8% is considered the “golden ratio” or “golden retracement” and 100% level represents a complete retracement. Combining these levels with trend lines and candlestick patterns can make decision-making easier.
How accurate is the Fibonacci retracement indicator?
No, like any other indicators or technical analysis tools, Fibonacci retracement cannot be always accurate. it’s one of the tools that can help traders in their decision-making process, but it should not be the only one used. Traders should always use a combination of technical and fundamental analysis before making any trading decisions.
How does Fibonacci Retracement differ from other indicators?
The greatest disadvantage of the Fibonacci Retracement is the complexity of the results which makes them difficult to understand for many traders. Furthermore, Fibonacci levels should not be relied on as compulsory support and resistance levels, and it is advisable to use multiple indicators and methods to confirm potential trades and mitigate risk.