Fibonacci levels are commonly used in forex trading to identify and trade off support and resistance levels. After a significant price movement up or down, the new support and resistance levels are often at or near these trend lines.
What are Fibonacci tradi
From a trading perspective, the most commonly used Fibonacci levels are the 38.2%, 50%, 61.8% and sometimes 23.6% and 76.4%. In a strong trend, which we always want to be trading, a minimum retracement is around 38.2%; while in a weaker trend, the retracements can be 61.8% or even 76.4%.
Fibonacci Numbers
Fibonacci numbers are nothing but a series of natural numbers, beginning with 0 and 1 and continuing infinitely. Each next number in the series is derived by adding two previous numbers. Hence, the numbers formed are:
0 + 1 = 1
1 + 1 = 2
1 + 2 = 3
2 + 3 =5
3 + 5 = 8
5 + 8 = 13
8 + 13 = 21
13 + 21 = 34
21 + 34 = 55
34 + 55 = 89
55 + 89 = 144, and the sequence extends to infinity.
It is also found that whenever any number in the series is divided by its immediate predecessor, the ratio obtained is the same, i.e., 1.618. This ratio is termed the Golden Ratio. For example:
55/34 = 1.618
89/55 = 1.618
144/89 = 1.6179 = 1.618
How To Calculate Fibonacci Retracement Levels?
There is no specific formula to determine retracement levels. However, traders can draw them on a stock chart by identifying the trend and considering the potential price range (high or peak and low or trough) for a specific asset at support and resistance levels. In the next step, they need to calculate the difference between the two prices to find a target price. Lastly, they have to multiply the resultant with a Fibonacci ratio or percentage and subtract it from or add it to the high or low price, depending on the trend.
The most commonly used ratios include 23.6%, 38.2%, and 61.8%. Based on the price trends of an asset in the financial market, traders rely on the following formula to calculate Fibonacci levels:
Uptrend Retracement = High Swing – ((High Swing – Low Swing) × Fibonacci percentage)
Downtrend Retracement = Low Swing + ((High Swing – Low Swing) × Fibonacci percentage)
Let us consider two scenarios – uptrend and downtrend.
For example, assume an asset recording a high swing of $150.44 and a low swing of $140.56 in an uptrend. In that case, the uptrend and buy order would be:
$150.44 – $140.56 = $9.88
Hence, the uptrend retracement for the asset at the Fibonacci ratio 38.2% at the support level would be:
Uptrend Retracement = $150.44 – (($150.44 – $140.56) x 38.2%)
$150.44 – ($9.88 x 0.382)
$150.44 – $3.77
$146.67
Similarly, if high swing for an asset in a downtrend is $160.76 and low swing is $154.64, the downtrend and sell order would be:
$160.76 – $154.64 = $6.12
Hence, the downtrend retracement for the asset at the Fibonacci ratio 61.8% at the resistance level would be:
Downtrend Retracement = $154.64 + (($160.76 – $154.64) x 61.8%)
$154.64 + ($6.12 x 0.618)
$154.64 + $3.78
$158.42
The retracement for different Fibonacci percentages in both trends can be obtained in the same way.
Start Trading Fibonacci Forex Levels
To start trading using Fibonacci retracement levels in an uptrend, you need to see whether the price finds support at 38.2% and 50% retracement levels.
A confirmation will be on when the price touches or moves below 50% level but remains above the 61.8% level. It starts moving back up towards the original uptrend.
Once you get the confirmation your ideal entry would be somewhere between 38.2% and 50% retracement levels. Your stop-loss will be below the 61.8% retracement level.
Likewise, for a downward trend, you can place your sell entry after the price finds resistance at 38.2% and 50% retracement levels. Once again, the confirmation would be when the price finally starts to move below the 50% level towards its original direction.
Ideally, your sell entry would be between the 50% and 38.2% levels. While your stop loss would be above the 61.8% retracement level.
Fibonacci Retracement and Extension
There are many Fibonacci terms, but only two of them are necessary in forex trading: extension and Retracement.
Fibonacci sequence refers to a ratio obtained by adding only two numbers to form a third number, and the second number is added to the third number to form a fourth number. When the last number is divided by the second last number, the ratio is about 1.618.
This is just a basic introduction to let you know how Fibonacci came about. Nonetheless, in Forex Trading you won’t actually need to calculate those rations because they are often included in your Trading platform.
Every Forex trading broker will place the Fibonacci icon somewhere in their trading tools. You only need to click the icon and set the time period, currency pair or asset, and any other information that may be required by your broker to calculate the Fibonacci.
For now, you only need to know the principle or idea behind the Fibonacci retracement. The term actually means that the price of an asset (Forex for us) retraces back to its previous position or price level before going in its initial direction.
Fibonacci retracement levels can be viewed as a point of resistance or support; while the extension level is used as a take profit level. Look at the example below:
Fibonacci Forex Conclusion
A Fibonacci Forex tool can be a great way to find support along with price targets. When you’re either in a trade, or looking to get into one, look at the retracement levels. They’ll be a great help to any trader.
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