If you have been familiar with the Forex market for some time now, you have come across Fibonacci trading. The Fibonacci sequence refers to a series of numbers. In this sequence, each subsequent number is found by adding the two numbers before it.
The sequence has the numbers 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and can be calculated to infinity. If you go ahead and divide a number in the series by the previous number, you will find a ratio of about 1.618.
This ratio is also called the golden ratio. It is seen to be at work in the stock market, the Forex market, and many other trading phenomena. Read ahead to find what Fibonacci trading is.
Fibonacci Trading
Fibonacci trading has several facets to it. However, there are two that are important to this discussion. These are Fibonacci retracement and extension. The Fibonacci sequence was introduced by an Italian mathematician called Leonardo Fibonacci.
The series that he created was based on the natural proportion of things in the universe. As discussed above, these give rise to a ratio of 1.618. You may also want to note that the ratio between alternate numbers in the sequence is 0.382.
These ratios appear in geometry, art, and architecture, among other structures. This golden ratio is also an irrational number. It is often denoted by the Greek letter phi (φ).
In trading, a few ratios matter more than others. The ratios for Fibonacci retracement levels are 0.236, 0.382, 0.618, 0.764. For Fibonacci extension levels, the ratios are 0, 0.382, 0.618, 1.000, 1.382, 1.618.
If you’re worried about the numbers being complicated, you should know that charting software can get all of these calculations done for you. There are also calculators available that will do the work for you.
Fibonacci retracement levels suggest that following a big price movement in one direction, this price will retrace. It will return partly backward to the earlier price level before it begins moving in the original direction again.
From this, traders derive potential support and resistance areas. Because several traders follow this logic and place buy and sell orders based on this, it often tends to become a reality.
Most charting software in the market include tools for Fibonacci retracement and extension. How can you apply these levels? You will have to use Swing High and Swing Low points. A Swing High refers to a candlestick that has two highs that are lower than itself on its right and left side.
A Swing Low refers to a candlestick that has two higher lows on the right and left side of itself. You can read ahead to find out how these can affect trading.
Using Fibonacci Retracement
To use Fibonacci retracement, you will first have to understand Fibonacci retracement levels. These are horizontal lines with which you can mark the potential support and resistance levels. Here, prices may reverse their direction.
It is important to know that the Fibonacci tools work best when the market is trending. How can you use these levels to trade?
When the market is trending upwards, you will want to go long or buy. You can do this on a retracement at a Fibonacci support level. When the market is trending down, you can go short or sell on a retracement at a Fibonacci resistance level.
The Fibonacci retracement levels attempt to identify where the price may be in the future. Hence, they are also known to be a predictive technical indicator. In this sense, the Fibonacci retracement theory suggests that the price will retrace partly to the previous level.
Only following this it will move again in the initial direction.
How Can You Find Fibonacci Retracement Levels?
To find Fibonacci retracement levels, you will first have to identify recent Swing Highs and Lows. For the downtrend, you will have to drag the cursor on the Swing High. You can go ahead and drag the cursor down to the most recent Swing Low.
For uptrends, click on the Swing Low. You can now drag the cursor to the most recent Swing High. With this, you can apply Fibonacci levels.
Uptrend
For Fibonacci levels during an uptrend, you will have to plot on a chart. For instance, you may find the most recent Swing Low during an uptrend. Drag the cursor and join to the recent Swing High. The charting software will now show you the retracement levels.
These will be shown in ratios and percentages. Now, say you are trading a EUR/USD currency pair. Now you may expect the uptrend to retrace at a certain point. When it does, one of the Fibonacci retracement levels will act as support.
This is because you will find the traders place buy order at these levels. This happens as the price moves back. Once the price reaches a certain support level, it resumes the uptrend. This time around, it goes ahead and crosses the Swing High.
If you had bought at the Fibonacci support level, you would have made a profitable trade.
Downtrend
You can also use this retracement tool during a downtrend. You can find the most recent Swing High and draw the cursor to the Swing Low. The chart will deliver Fibonacci retracement levels for you.
The idea with these levels is that one of these Fibonacci retracement levels will act as a resistance level. At this level, traders who are looking to benefit from the downtrend will be ready with sell orders.
At any of these resistance levels, the market will stall before moving in the downwards direction again. Hence, a trade made at these levels would lead to good profits.
Do note that Fibonacci levels and software are used by several traders. Hence, the support and resistance levels during uptrends and downtrends, respectively, are self-prophesized. This simply means that traders collectively act during these levels to get the market to adhere to Fibonacci numbers.
However, do note that Fibonacci levels don’t always work as well and aren’t easy to use.
Fibonacci Level May Not Always Work
Fibonacci levels are not foolproof. They don’t always work, and the tool may fail. For instance, consider a downtrend where you have calculated the Fibonacci resistance levels. At a certain level, the market may begin to uptrend.
It may find resistance here, say at the 50.0% level. You may now be led to believe that the market has retraced, found its resistance level, and will now move downwards again. However, this may not be the case.
You may have been exited by the prospects and placed an order here. At times, the market may completely ignore the Fibonacci levels and trend upwards, crossing the Swing High. The activity may not be a Fibonacci retracement but a new uptrend in all.
In this case, the Swing Low would just be the bottom of the new uptrend. If you did place an order at the resistance level, it is likely that you will incur a loss.
Hence, it is advisable not to use the Fibonacci levels in themselves. It is a good idea to combine them with other tools and indicators so that you can make the best of them.
How to Use Fibonacci Retracement with Support and Resistance?
Using Fibonacci levels to predict your trade may or may not always work in your favor. However, it is possible to use a few ways to make them work for you.
The idea is to supplement the Fibonacci levels with other tools. With some backup, you can go ahead and work on the Fibonacci levels to put your best foot forward as you trade. How can you do this?
You will have to see that the Fibonacci retracement levels are aligned with the support and resistance levels. You can do this by using the Fibonacci retracement tool. You may want to see if the Fibonacci levels are already resistance and support levels.
If this is true, several traders will also be paying attention to these levels. You may also want to keep an eye on other price areas that traders are looking out for. Together, you can spot the right positions for you to execute your trade.
The best way is to study the entire chart and take a look at the promising levels in the past. For instance, consider an uptrend. You can take the Swing Low and drag the Cursor to the recent Swing High.
You now have an uptrend and can generate Fibonacci levels for the same. The market is now retracing, and you may be wondering which Fibonacci resistance level you can place an order at. Let’s say you are trading a EUR/USD pair.
Now you can begin to take a look at the chart to spot previous trends. During a previous trend, a certain level, say 50.0%, may have been a good resistance level. If this coincides with a present Fibonacci retracement level, you now know that this level has a good past.
In the current uptrend, this level may have surpassed. If this is the case, you can consider the 50.0% line as a potential support level. This may be a good point for you to place your order.
You can use the same logic to find the appropriate Fibonacci level during a downtrend. Pay attention to areas of interest in the past and use these to guide your trade.
How Can Taking Account of Past Levels Help?
You may wonder why past areas of interest may repeat themselves and come into play yet again. This is because of the collective eye on these areas. Because of their previous success, other traders will also pay attention to these areas.
Further, since many traders use Fibonacci levels, they may use the same logic to take advantage of previously successful levels. They may try to reapply them in the new trade. Since many traders are paying attention to the same levels, there may be several orders during these support and resistance levels.
Hence, the probability will stand on your side. You will hence be able to make a confident and profitable trade in the long-run.
How to Use Fibonacci Retracement with Trend Lines?
Now you know how you can use support and resistance lines to supplement Fibonacci levels as you trade. There are several other tools that can assist you in using the Fibonacci levels in the right way.
One of these is the Fibonacci trend line analysis. How can this line help? Note that Fibonacci levels work best when the market is trending. Whether the market is on an uptrend or a downtrend, Fibonacci levels can be a good way of getting in on the trend.
For instance, let’s say you are trading in EUR/USD. Say that the trend line has been showing a constant rise in price for the past few days. You may want to get in on this uptrend and buy once your currency pair hits the trend line.
Yes, you can go ahead and do this in the short-term. However, you may not have an idea of precisely where to enter. You can use your Forex tools and specifically use the Fibonacci tool to help you determine this.
Use the Swing Low and the recent Swing High to plot a Fibonacci retracement level. Now you can spot those Fibonacci levels that are intersected by the rising trend line. Say that these points are 50.0 % and 61.8% Fibonacci lines.
These points may be great entry points. The price may bounce at these points before it begins to rise again. These levels are important as several other traders will be keeping an eye on these levels as well.
You may want to note, however, that traders may draw subjective trend lines. However, you cannot ignore the fact that the trend is an increasing one. With this, you can place your order at the appropriate intersecting level.
How can you make the best use of this? Look for potential entry points when a trend just starts developing. Follow it through so that you can understand the pattern of the trend. In this way, you can predict which intersecting Fibonacci level will prove to be the most beneficial.
How to Use Fibonacci Retracement with Japanese Candlesticks?
Another great combination for figuring entry levels for trade is the combination of Fibonacci Retracement and Japanese Candlesticks. The idea is to look for exhaustive candlesticks. Such exhaustive candles indicate the reversal of a particular trend.
To spot an exhaustive candlestick, look for ones that have a much longer wick or tail when compared to their bodies. The tails will be at least 2 to 3 times longer than the bodies of these candlesticks. They will also tend to appear at the top or bottom of a trend.
By themselves, these candlesticks are not of much help. However, when combined with Fibonacci levels, they can indicate some key levels to get in on the trade.
Using these, you will have to note down the areas where selling or buying pressure is getting exhausted. These points may indicate the points where the price will continue trending. You can use this, for instance, to spot a downtrend in says the EUR/USD pair.
This pair may have been seeing a downtrend for a long time. However, it may pause for a little in the downtrend. How can you enter this downtrend? You can use the Fibonacci retracement tool to do the same.
You can take the Swing High of the downtrend and drag it with a cursor to the recent Swing Low. Now you have the Fibonacci levels ready. You may now notice that the EUR/USD pair has shown an uptrend from the 50.0% level to the 61.8% level.
You may notice an exhaustive candle right at the 61.8% Fibonacci level. This may suggest that the buying pressure at this level has died down. If this is coupled with holding resistance at the Fibonacci level of 61.8%, you may want to pay attention to this level.
You can go short and sell right after this exhaustive candle is formed. The idea is that several traders were also eyeing this level. If you were right, you would see the price fall, and a downward trend begins right after this exhaustive candle.
If the Fibonacci retracement was true, you might see that it dips all the way down to the Swing Low level, allowing you to make a major profit. If the price level for the EUR/USD falls, it is a further indication that other traders have eyed the specific resistance level.
This can strengthen your entry. An advantage of using a combination of Fibonacci levels and Japanese candlesticks is that there is no need to place any limit orders at this level.
However, do note that there may be a few concerns regarding using only support levels to plot entry levels. This is because you will be looking at specific zones rather than a precise entry level when you use just support and resistance levels.
At this point, you should wait for an exhaustive candlestick to form just above or below the specific Fibonacci level. With this, you will have a clearer indication of how you can proceed with the trade.
If you see an exhaustive candlestick form at or near a Fibonacci line, you can go ahead and enter the trade at market price.
How to Use Fibonacci Extensions to Know When to Take Profit?
Now that you know Fibonacci levels can be beneficial in trade, you may wonder how you can use them to find targets. Read ahead to find out.
You can take profits during an uptrend by employing Fibonacci levels. Look for a Fibonacci extension during an uptrend. At this point, you can take profits on a long trade.
How can you determine the Fibonacci extension level? You can do this with three clicks of your mouse. You can begin by first clicking on a relevant Swing Low. Once you do this, drag the cursor to click on the most recent Swing High. Once you’ve done this, you can go ahead and drag the cursor to click on one of the Fibonacci retracement levels.
With this, you will be able to see each price extension level. You will see both the ratio and the price level for each. You will notice that the price tends to find a support or resistance level at Fibonacci levels.
Fibonacci Extensions During Uptrend
Consider a EUR/USD pair during an uptrend. The pair may see an uptrend and see a Fibonacci retracement. Here, you will see the prices falling down. It may arrive at 0.50, where it finds its support level.
However, the price may also move upward and come back to resistance level thrice before proceeding upwards again. The third time, it may go ahead and move beyond the Swing High. In this scenario, you may be wondering where you could have made a profit.
You can figure this out by applying the Fibonacci extension tool. With this, it may reveal that the price would have gone up to 61.8% from the support of 50.0%. From there, it may have fallen down to 38.2%, where there was support.
It then moved up to find resistance at 100%. It may then have moved upward again before finding its resistance at 161.8%. Within these smaller trends, you can take profit at the resistance levels.
These levels are 61.8%, 100%, and 161.8%. Hence, you can see that the levels for profit coincide with the Fibonacci levels.
Fibonacci Extensions During Downtrend
Consider a downtrend of the EUR/USD pair. In such a downtrend, you can take your profits on a short trade at the Fibonacci extension levels. This is because the market finds support at these levels.
The price may have increased before retracing at the 61.8% Fibonacci level. If you had gone short at this level, you might wonder where you can get some good profits. You can use the Fibonacci extension tool to find out.
Consider that during the reversing downtrend, the price found the first support level at the 38.2% Fibonacci level. It may have then fallen to the 50.0% level and then the 61.8%. The 100% extension level may also have acted as support at some point.
The profits could have been taken at 38.2%, 50.0%, and 61.8% levels. These levels, and even the 100% levels act as support. These tend to coincide with the Fibonacci levels as many traders may have had their eyes here during the trade.
There are a few issues that will crop up when you use Fibonacci extension levels. You will have to use your discretion to figure out which Fibonacci extension level you want to make your trade at. Since there may be multiple support levels, you will have to judge the strength of a trend yourself.
How to Use Fibonacci to Place Your Stop so You Lose Less Money?
Now you know where you can get your profits using a Fibonacci extension level. However, with trading, risk management is very important. Here is how to use Fibonacci levels to place the stop loss.
Enter The Stop Just After the Next Fibonacci Level
Say you enter the trade at the Fibonacci level of 38.2%. Your Stop can be placed just beyond the 50.0% level. If you think that the 50.0% level will hold, you can then put your Stop just beyond the 61.8% level.
This kind of Stop works well to limit your loss if you are engaging in short-term trades. Why would you use such a Stop? The idea is that you are sure that the current level at which you are trading will hold. With this, if the market does not retrace and move against you, it will move in the same direction.
This would go against your Fibonacci retracement prediction. Hence, you can place the Stop here to minimize losses. However, do note that if you use this method, you will be letting go of any chance of profiting from the next Fibonacci level that may act as the support or resistance level.
Enter the Stop Just Past the Most Recent Swing High or Low
If you are in a market with an uptrend, you may want to place the Stop just under the latest Swing Low. This point would act as a possible support level if the market were to go against your prediction.
On the other hand, if the price is a downtrend, you will likely be in a short position. You can place the Stop just over the recent Swing High. This acts as a possible resistance level and can minimize your losses if the trend goes against your predictions.
With this method, you will be able to give your trade more room to breathe. Many support or resistance levels will be given a chance to prove their mettle. Hence, you can take bigger chances while also minimizing your losses.
Summarizing Fibonacci Trading
Now that you know what Fibonacci trading is and what tools you can use, you can go ahead and give it a shot. Know that the important Fibonacci retracement levels are 23.6%, 38.2%, 50.0%, 61.8%, and 76.4%.
Most Forex software use 38.2%, 50.0% and 61.8% as default Forex levels. The main idea behind taking a profit or loss at these levels is that multiple traders are eyeing these levels at the same time. This adds movement to the trade.
You can use these with charting tools, trend lines, and Japanese candlesticks to determine where you can enter the trade. Pay attention to the Swing High and Swing Low. These levels will let you use the Fibonacci charting tools well. Learn more about forex trading with a demo trading account at IC Markets or eToro
