Fibonacci for Technical Analysis in Forex (Currency) Trading:
What goes up comes down and what goes down comes up. Even in strong trends (up or down), the prices take temporary reversal or correction. It’s like taking the breathing time before moving ahead. But to what level?
The famous Italian mathematician Leonardo Pisano who is better known by the name Leonardo Fibonacci (the nick name) was probably born in 1170 in Italy (Brief Biography). Fibonacci series of numbers founded by him is a series where each number after two number is the sum of the previous two numbers
The important thing to consider is that its not the numbers which are important in the series but the ratio of the numbers i.e.
21/34 = 0.618
13/34 = 0.382
8/34 = 0.236
You will see the same ratio if you take any number in the series e.g. 233 instead of 34 and the previous numbers of 233 i.e. 144, 89 and 55 instead of 34, 13 and 8 respectively.
These proportions can be found in nature, science, architecture, music, art. A few examples of Fibonacci numbers are pine cones, sunflowers, pineapples, palm trees, spider webs, snail shells, DNA molecules and millions of other things in the universe.
When applied on Forex charts, Fibonacci Retracement Levels are used as support and resistance levels: 0.236, 0.382, 0.500, 0.618, 0.764.
The number sequence was known to Indian mathematicians as early as the 6th century, but it was Fibonacci's Liber Abaci that introduced it to the West. and it was well received by educated Europe and had a deep impact on European thought when the book "Liber Abaci" by Fibonacci came out in the year 1202.
These proportions of Fibonacci series can be found in nature, science, architecture, music, art. A few examples of Fibonacci numbers are pine cones, sunflowers, pineapples, palm trees, spider webs, snail shells, DNA molecules and millions of other things in the universe.
Some interesting readings about Fibonacci, which are not essentially related to investment / Forex Trading, are as follows:
The most common levels (ratios) from Fibonacci series to be watched for are 0.382, 0.500 and 0.618.
Fibonacci Retracements: When Fibonacci and Why Fibonacci in Forex Trading:
Fibonacci retracement levels are best in trend. Be it uptrend (bullish market) or downtrend (bearish market). Take an example of a person running fast for a long time. He is running and running. There will comes a time when he or she will pause. Take a breath before resuming the run again. Its slowing down. When currency pair's price is going up and up, there will be times when it comes a bit down and then go up again.
When Fibonacci:
In Forex trading, when, during an uptrend you see that the upward movement is slowing, catching a breath. The market, for some time, starts going sideways instead of continuing upward movement.
When during a downtrend you see the that the downward movement is slowing, and the market, for some period of time, starts going sideways instead of continuing downward movement.
Those are the times that a pull back or retracement may happen for the currency pair’s prices.
Why Fibonacci:
When the pull back from the current direction (upwards or downwards) happen, it would be nice to know that to what level the price of the currency pair (or stock or any commodity) may reverse before continuing the journey in the same direction.
The three important levels of retracement are 0.382. 0.50 and 0.618.
The Forex chart in Fig 3 above is of the currency pair EUR/USD. There is an uptrend and prices moved from point A to point B. Before moving up again, there is a drop. Just see how perfectly the prices drop down to exactly 0.382 level before moving up again?
A = 1.4458
B = 1.5900
B – A = approx 551 Pips
Hence the drop of 551 pips from 1.5900 to 1.5349.
Please do not expect the retracements to be exact. But you will be surprised to find that how close the retracements would be to Fibonacci levels.
How to enter the market and how to exit using Fibonacci in Forex Trading:
When there is a continuous trend (up or down), wait till a reversal in price movement starts taking place. When reversal starts, enter the market with targeted profit taking orders at Fibonacci level. In very strong trends you may like to put orders at small reversal i.e. at 0.382. When the momentum of the trend is not very strong then you can expect more reversal i.e. 0.50 or 0.618 levels or even more than these levels.
In the Forex chart chart above (fig4), which is again of the currency pair EUR/USD, the price starts going up from point A. The price reached B and then pulled back. Please see the small green candle encircled by the yellow circle. This green candle shows that during this period the price opened between Fibonacci retracement levels 0.382 and 0.50 and closed also between these two levels. But during this period it went down up to point X which is Fibonacci retracement level 0.50 and went up to point Y. During the next period (the bigger red candle) the price went further down closer to 0.618 level. During the next period (the still bigger green candle) the prices went and crossed Fibonacci retracement level of 0.50 and then moved up. The price, subsequently moved higher and higher towards point “C”
The above two examples are of uptrend. The similar pull back can be seen during downtrends in Forex market. When the prices are moving down, they would pull back to higher levels before going down again.
Please see the Forex charts in Fig 5 and the continued price movement in Fig 6 below:
Please see the continuation of the price movement in the Forex chart in Fig 6. Fig 6 highlights that the prices retreated upwards during this downtrend shown in Fig 5 above. Please note the retracements Fibonacci retracement levels 0.382.
Even if a trend continues there are always small correction and reversal on the way.
It’s just like that even if the runner is very strong and still full of energy; he or she would stop for having a breath before continuing running further.
If it’s just a small breathing break, consider 0.382 as your retracement level. But then you would find retracement level 0.50 quite common. If the currency pair prices have moved in a big way during a strong trend then target for 0.618 as retracement level.
How to use Fibonacci Levels in Forex Trading (currency trading):
Fibonacci retracement and extension levels carry important information for Forex traders as they help to identify entry and exit points during the trade.
Fibonacci Extension Levels are used as targets for Taking Profit and Stop Loss or Resistance and Support Level.
These Fibonacci retracement levels i.e 0.382, 0.500 and 0.618 are used as points to enter the trade when the ongoing trend still continues. Of course the best entry position would be at the lowest possible swing e.g. at 0.618 retracement level.
The price tends to go to different levels to take U-turn from: it may hit 0.382 and reverse back, sometimes it gets to 0.500, and at times it even moves further to 0.618 level before turning back. Fibonacci forex traders will already be waiting for these opportunities to enter the trade.
Fibonacci Retracement Levels::
0.382, 0.500, 0.618 the most important levels
Fibonacci retracement levels are used as support and resistance levels.
Fibonacci Extension Levels are:
0.618, 1.000, 1.618 are the most important levels
Fibonacci extension levels are used as profit taking levels.
Important Fibonacci Analysis Tools in Forex Trading (currency trading)
Most of the Forex trading platforms offer the flowing Fibonacci analysis tools:
Fibonacci Retracements:
Fibonacci retracements use horizontal lines to indicate levels of support or resistance. They are calculated by first locating the high and low of the chart.
Down Trend: Select Fibonacci Retracement tool from the available technical analysis tools and join the Top and Bottom points
Up Trend: Select Fibonacci Retracement and join the Bottom and Top Points.
The tool automatically draws dotted lines for 0.382, 0.50 and 0.618 levels.
You will also find lines being drawn beyond the Top-to-Bottom (downtrend) or Bottom-to-Top (uptrend) range. These are Fibonacci Extension levels
Fibonacci Retracement are shown in Figures 1 to 9 above and Figure 10 below.
Once we find the high and low points in a chart and join them after selecting the tool “Fibonacci Arcs”s then, with a compass-like movement, three curved lines are drawn at 38.2%, 50% and 61.8%, from the desired point. These lines anticipate the support and resistance levels, and areas of ranging.
The major difference between Fibonacci Retracement analysis and Fibonacci Arcs is as follows:
Fibonacci Retracements: Straight lines for retracement levels (0.382, 0.50, 0,618 without considering the time)
Fibonacci Arcs: Not straight but curved lines. Means its not only the flat retracement levels but the time is also taken into consideration. In simple words Fibonacci retracements are simple mathematical calculation and considers that if the market is moving from 0 to 100 the first retracement will be from 100 to downwards to 61.8 (100-38.2) (Why 38.2: The price movement of 100 multiplied by 0.382 = 38.2)
Fibonacci Arcs takes into consideration the time i.e. the probability of pulling back to various Fibanacci levels goes down if the market is not able to reach that level for longer time. So while Fibonacci retacement level lines point to the same levels for possible retracements, the Arcs changes the levels (curves up or down)
See the chart in Fig 11 and Fig 12 below for illustrations.
Fibonacci fans are composed of diagonal lines. After the high and low points of the chart are located, and joined. This joining line is then divided into 38.2%, 50% and 61.8%, and lines are drawn from the leftmost point through each of these points. These lines indicate areas of support and resistance. This is again a version of Fibonacci Retracements like Fibonacci Arcs where the Retracement levels are not considered as flat levels but breaking the area in angles. Similar to Arcs it takes into account the time i.e. probability of reaching the expected Fibonacci retracement level going low with time. Fibonacci Fans (with other Fibonacci indicators) are shown in figure 13 as follows.
Unlike the other Fibonacci methods, as mentioned above and which are for predicting the retracements, Fibonacci time zones are a series of vertical lines. They are composed by dividing a chart into segments with vertical lines spaced apart in increments that conform to the Fibonacci sequence (1, 1, 2, 3, 5, 8, 13 and so on.). These lines indicate areas in which major price movement can be expected:
This is just one tool available as an extension of resources but to our best understanding is not used so commonly. Fibonacci Time Zones are shown in Fig 14 as follows.
