Using Fibonacci Retracements in Forex Trading
The main issue traders face is knowing the exact entry and exit point of a trade. Fibonacci is a technical analysis tool that tells traders the exact time to exit or enter a trade. In this article we will focus on Fibonacci retracement levels, and how to use this technical analysis tool in Forex trading. You will also learn how to employ Fibonacci retracements in forex trading. This article will also cover the basic and advanced properties of the Fibonacci sequence and how it is used in Forex trading
WHAT IS FIBONACCI?
Most traders are probably wondering, who established Fibonacci and how it came into existence?
Fibonacci is also referred to as Leonard of Pisa, born in 1170. He was an Italian mathematician and is known as one of the most capable mathematicians of his era. Apart from the Fibonacci sequence, he was well-known for his thesis on arithmetic named “Liber Abaci”. In the 19th century, A statue in honor of Fibonacci was erected. The statue still exists to this day.
WHAT IS THE FIBONACCI SEQUENCE?
The Fibonacci sequence is referred to as a row of numbers that the third number is the addition of the two numbers that come before it. Let’s say 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, till infinity. Which is, 0+1 = 1, 1+1= 2, 2+1=3, 3+2=5. The Fibonacci can be mathematically represented as Xn+2 =Xn+1 + Xn.
Every number present in the Fibonacci sequence is obtained by summing the two preceding numbers together.
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377… till iniquity.
The important thing about this sequence is that the ratio of each number next to another in the pattern is always 0.618.
Example: 34/55 = 0.618
55/89 = 0.618
89/144 = 0.618
The second ratio is 0.382, this is the ratio of any digit to the digit two points forward in the sequence.
Example:
21/55 = 0.382
34/89 = 0.382
55/144 = 0.382
Furthermore, the rate of any digit to the digit three points forward tends to be 0.236.
Example:
21/89 = 0.236
34/144 = 0.236
55/233 = 0.236
These listed ratios are widely known as Fibonacci ratios.
These Fibonacci ratios are always 0.618 or 0.382
WHAT ARE THE FIBONACCI RATIOS?
As stated earlier, the Fibonacci sequence 0,1,1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, till infinity produces the Fibonacci ratio. The Fibonacci ratio is obtained through a mathematical relationship found in a formula. The following ratios are obtained from the sequence: 23.6%, 38.2%, 50% 61.8%, 78.6%, 100%, 161.8%, 261.8%, and 423.6%.
Note: 50% is not an official Fibonacci ratio. But it is still used by traders as a support and resistance level.
HOW FIBONACCI RETRACEMENT WORKS
In Forex trading, these ratios are referred to as retracement levels. Traders using this strategy wait for the price to move toward this Fibonacci level before acting on it. Normally, they check out price reversal alerts on these Fibonacci levels before entering into a trade. The most prominent level used by traders is 0.618 with an inverse golden ratio of 1.618.
HOW TO ILLUSTRATE THE FIBONACCI RETRACEMENT LEVELS
These levels can be illustrated in three easy steps.
They include:
In a Bullish trend:
• Specify the direction of the Market, bullish.
• Fix the Fibonacci retracement tool to the lower part of the chart and pull it to the right, to the upper part of the chart.
• Examine and survey the possible support levels which are 0.236, 0.382, and 0.618.
In a bearish trend:
• Specify the trend of the market, downtrend.
• Fix the Fibonacci retracement tool at the upper part of the chart and pull it to the right, to the lowest part of the chart.
• Survey and examine the price chart for possible resistance levels: 0.236, 0.382, and 0.618.
However, it is advisable to look for more signals, and not rely only on the Fibonacci level to act on a trade position. Do not determine the state of the market by just using the levels. It’s not always a guarantee that when the price reaches the level it will automatically reverse.
While using the Fibonacci levels also make use of other signals. Like the Japanese candlesticks patterns, oscillators, and indicators for a more reliable signal. This will show a more precise result of the price action.
WHAT IS FIBONACCI TRADING?
Every trader’s dream is to comprehend the act of trading using Fibonacci retracement levels. To achieve this, the trader needs to learn the Fibonacci theory. Most traders use this trade signal to pinpoint probable support and resistance levels on a price chart. It is used to know when a price is about to reverse. Many traders make the mistake of opening trade positions once the price has reached one of the retracement levels. This should not be the case, as that is not a guarantee that the price of the trade will reverse. While using Fibonacci levels, ensure to use other technical indicators such as the Moving averages and Oscillators to confirm a price trend.
WHAT ARE FIBONACCI RETRACEMENT LEVELS?
Simply put, Fibonacci retracement levels are known as the support and resistance levels established from the Fibonacci numbers. These numbers include 23.6%, 38.2%, 61.8%, and 78.6%. When illustrating the Fibonacci levels, the trading platform being used probably adds a 50% level. However, the 50% level is not an official Fibonacci retracement level.
WHY DO TRADERS USE FIBONACCI RETRACEMENT LEVELS IN FOREX TRADING?
The Fibonacci levels are mainly used by traders to determine support and resistance levels. When traders actively use these levels in their everyday trades they will be able to determine support and resistance using the levels.
Prices are constantly changing, prices can never be in a straight line. After a big price movement, a price reversal might occur before the dominant trend continues. Fibonacci retracement levels assist traders to determine the exact levels of support and resistance. Fibonacci is one of the most popular and prominent technical indicators used by traders when conducting technical analysis.
Which numbers are mainly used by traders in Forex trading?
When you illustrate the structure of Fibonacci retracement on a price chart, you will notice that numbers in the sequence aren’t used. Rather, the numbers used are the ratios of the differences between the sequence numbers.
For example,
61.8%. This number is obtained when a Fibo sequence is divided by a particular number following it.
Example 1:
When you divide 21/34 you’ll have 0.6176%
Example2:
When you divide 144/233 you’ll have 0.6180%
The Main Fibonacci retracement levels are
23.6%
38.2%
50%
78.6%
The Minor Fibonacci retracement levels are
50%
Most traders prefer to use only the Main/Major levels when trading, while some other traders like using all the levels in their trades.
USING FIBONACCI RETRACEMENTS IN FOREX TRADING
HOW DO TRADERS MAKE USE OF THE FIBONACCI LEVELS?
Most Forex traders utilize the Fibonacci levels as a typical support and resistance levels
That is, they use these numbers to determine the entry-level of a trade or to specify the stop loss or take profit target of a trade.
Below are some instances where traders used the Fibonacci technical indicator in their trades:
Example 1:
A trader employs the use of multiple technical indicators which signals that EUR/USD will continue a bullish run. However, the trader thinks that the currency pair is oversold in the short term, and a price reversal is foreseen before the continuation of a trend. As a trader who employs the Fibonacci levels, he/she will be monitoring the price area at 38.2% as a probable entry point.
Example 2:
A Forex trader currently buying EUR/USD is trying to specify the level to set his stop-loss order. As a trader using the Fibonacci technical tool, he notices that 38.2% has functioned as the main level of support in the past. He/she determines the stop-loss order 50 pips below.
WHICH IS THE BEST FIBONACCI RETRACEMENT LEVEL?
The most used replacement ratio by Forex traders is 38.2℅ and 61.6%. The price trends always seem more significant in the two levels.
MISTAKES MADE BY TRADERS IN FIBONACCI RETRACEMENTS
There are some common mistakes made by traders when applying Fibonacci retracements. These mistakes can greatly affect the outcome of your trades.
1. NOT MAINTAINING A PARTICULAR REFERENCE POINT
When setting Fibonacci retracements to price trends, it’s important to maintain consistent reference points. So, when a trader is using the lowest price of a trend via the closing price or the body of the candle, the trader is expected to use the beat high price accessible within the body of the candle at the peak of the trend. A trader referencing the body of the candle should stick to the body of the candle. And a trader referencing the wick should stick to the wick.
Inaccurate calculation and errors are formed once the reference points are mixed by moving from a candle body to the wick of the candle.
2. EXCLUDING THE LONG-TERM TRENDS
Traders who are not experienced always focus mainly on the significant actions and drawdowns in the short term without referring to the long-term trends. The limited scope of trade analysis always ends up misguiding the short-term traders. As an upcoming trader, it is advisable to apply Fibonacci not only to short-term trends but also to long-term trends. This helps in broadening the trader’s trade opportunities.
3. RELYING SOLELY ON FIBONACCI
It has already been established that Fibonacci is a significant technical analysis tool that helps traders in determining support and resistance levels. However, Fibonacci can give valid trade setups, but these trade setups still need confirmation.
Employing other technical indicators like Moving Average convergence divergence, or Stochastic Oscillators will help confirm a price trend and also increase the profitability of the trade. Placing a trade without using these techniques to confirm the market trend is as good as guessing.
4. APPLYING FIBONACCI IN A SHORT-TERM TRADE
Day reading in the Forex market is highly lucrative. However, the market is highly unpredictable and volatile.
Due to the high volatility of the market, applying the use of Fibonacci retracement tools in a short time frame is inefficient. If the time frame of trade is too short, the Fibonacci levels will be ineffective. High volatility always changes support and resistance levels. Thereby, making it hard to pick the exact levels to be traded. And also in short-term trades, spikes occur frequently. These features make it impossible to set adequate stop loss and take profit targets using retracement levels.
PROS AND CONS OF FIBONACCI RETRACEMENTS
PROS OF FIBONACCI RETRACEMENTS
This technical tool is used as a means of specifying the levels of support and resistance, Fibonacci retracements can also be used to detect a potential change in market trend.
Levels of support and resistance are used to deduce the probable bullish or bearish market trends. Therefore, it enables traders to know a good point to enter and exit a trade.
When a trader knows how to properly use a Fibonacci technical tool, it will enable them to have more successful trades.
CONS OF FIBONACCI RETRACEMENTS
However, Fibonacci retracements need a thorough level of knowledge to be used properly. It requires more than just drawing lines on price charts. Beginners are advised to be more careful when using technical tools.
FIBONACCI RETRACEMENT METATRADER 4 FREE CUSTOM INDICATOR
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CONCLUSION
Irrespective of the technical tool being used by a trader, it still doesn’t take away the risk of trading involved. A lot of risks are involved in Forex trading and CFDs. This is mainly because the market is volatile and highly unpredictable. Using technical analysis narrows down your risks to a bare minimum, but it doesn’t take away the risk completely.
Any slight news or event can cause the change of trend thereby rendering your stop loss and profit target ineffective. This is why it is advisable to use the money you can afford to lose in trades. Don’t be too greedy and don’t over-trade. And always consider your level of expertise before going into any trade. Don’t shy away from seeking additional knowledge to improve your trading skills. Also, ensure to confirm trends by using Fibonacci technical tools together with other technical indicators.
