Fibonacci retracement is a popular trading strategy among forex traders. Since the importance of technical analysis cannot be understated, traders choose to utilise indicators such as Fibonacci retracements to assist them in the prediction of future price changes and positions. It is these trends that enable traders to know when and on what asset they should invest in.
The term Fibonacci refers to the Italian mathematician who came up with a number series in which the next digit is obtained by adding the two previous ones. Retracement on the other hand is defined as the interim turn-around of an overarching currency price trend. Both terms combined refer to the horizontal stripes in the trading chart that show where support and resistance are expected to take place.
Support is a phenomenon that transpires when plummeting prices halt and begin to go up after changing direction. Meanwhile, resistance is defined as the price at which an asset’s price stops increasing and begins moving in a downward trajectory. Support is often seen as a base which is sustaining the prices as they go higher while resistance is viewed as plafond preventing prices from rising above it.
Fibonacci Sequence Properties that are used in Forex Trading
The Golden Ratio
The golden ratio is obtained by dividing a number by the one either preceding or succeeding it in the Fibonacci series. 1.618 is the value obtained by the former while 0.618 is its inverse that is gotten through the latter operation. The golden ratio is utilised as a key level in Fibonacci extensions while also forming the basis of various retracement levels.
Another retracement level can also be obtained by division of a number by the one two steps above it. The golden ratio together with the retracement and extension levels are used in trading to provide forecasts on the prices at which possible market turnarounds may occur.
Fibonacci retracement levels are used to determine the best possible market entry points as far as price trends are put into consideration. This means that the previous moves in the market are used as the basis for determining the possible market turnaround points. 23.6, 38.2, 61.8 and 78.6 are the most common examples of Fibonacci retracement levels
A significant increase in price will prompt traders to engage in bottom to top measurement to try and determine where price is likely to retrace to before resuming the upward trajectory. Likewise, a significant decrease in price will occasion traders to perform top to bottom measurement so as to find out where price is likely to retrace to before resuming the downward spiral.
Fibonacci extension levels are utilised in finding out how far a price is likely to go after a retracement is completed. As opposed to retracement levels, extension levels are used in determining the end point of a particular market trend. Examples of extension levels include 100, 161.8 and 200.
When an increase in prices is the prevailing market trend, traders attempt to begin trading at the lowest point of the bounce before attempting to find out the most probable end point by measuring the previous retracement. Similarly, a trending decrease in price prompts traders to start trading at the lowest point of the correction as they measure the last retracement in an attempt to determine the possible endpoint of the trend. Advanced traders often use 161.8 to go into counter-trend trades.
Fibonacci Trading Strategies
The following are the various trading strategies that can utilise Fibonacci levels:
Fusing Moving Average Convergence Divergence with Fibonacci Retracement
MACD is an indicator that is used in order to find out and evaluate new bullish and bearish market trends. When an asset’s price matches a significant Fibonacci level, a position is likely to be opened within the bearing of the trend due to the crossing over of the MACD indicator.
Joining Fibonacci Levels to Stochastic Indicators
The stochastic indicator is a trading indicator that is used in forecasting trend reversals as well as in deducing situations where currencies have either been over-bought or over-sold. This strategy examines important stochastic signals when price comes in contact with a significant Fibonacci level.
Fibonacci levels are an important predictive technical analysis indicator. Mastering them is a vital step in achieving great success in the forex market.