Fibonacci ratios – will be using a lot in trading.
A Fibonacci sequence is formed by taking 2 numbers, any 2 numbers, and adding them together to form a third number.
Then the second and third numbers are added again to form the fourth number.
The ratio of the last number over the second-to-the-last number is approximately equal to 1.618.
This ratio can be found in many natural objects, so this ratio is called the golden ratio.
It appears many times in geometry, art, architecture, and even on Sonic the Hedgehog.
The golden ratio is actually an irrational number, like pi, and is often denoted by the Greek letter, phi (φ).
Fibonacci Retracement Levels
0.236, 0.382, 0.618, 0.764
Fibonacci Extension Levels
0, 0.382, 0.618, 1.000, 1.382, 1.618
Fibonacci retracement levels work on the theory that after a big price moves in one direction, the price will retrace or return partway back to a previous price level before resuming in the original direction.
Traders use the Fibonacci retracement levels as potential support and resistance areas.
Since so many traders watch these same levels and place buy and sell orders on them to enter trades or place stops, the support and resistance levels tend to become a self-fulfilling prophecy.
Traders use the Fibonacci extension levels as profit-taking levels.
Again, since so many traders are watching these levels to place buy and sell orders to take profits, this tool tends to work more often than not due to self-fulfilling expectations.
Most charting software includes both Fibonacci retracement levels and extension level tools.
In order to apply Fibonacci levels on charts, Swing High and Swing Low points need to be identified.
A Swing High is a candlestick with at least two lower highs on both the left and right of itself.
A Swing Low is a candlestick with at least two higher lows on both the left and right of itself.
How to Use Fibonacci Retracements
Fibonacci retracement levels are horizontal lines that indicate the possible support and resistance levels where price could potentially reverse direction.
The first thing about the Fibonacci tool is that it works best when the market is trending.
The idea is to go long (or buy) on a retracement at a Fibonacci support level when the market is trending UP.
And to go short (or sell) on a retracement at a Fibonacci resistance level when the market is trending DOWN.
Fibonacci retracement levels are considered a predictive technical indicator since they attempt to identify where price may be in the future. The theory is that after price begins a new trend direction, the price will retrace or return partway back to a previous price level before resuming in the direction of its trend.
How to Use Fibonacci Retracement with Support and Resistance
While the Fibonacci retracement tool is extremely useful, it shouldn’t be used all by its lonesome self.
Fibonacci Retracement + Support and Resistance
One of the best ways to use the Fibonacci retracement tool is to spot potential support and resistance levels and see if they line up with Fibonacci retracement levels. If Fibonacci levels are already support and resistance levels, then they can be combined with other price areas that a lot of other traders are watching, then the chances of price bouncing from those areas are much higher.
How to Use Fibonacci Retracement with Trend Lines
Another good tool to combine with the Fibonacci retracement tool is trend line analysis.
After all, Fibonacci retracement levels work best when the market is trending, so this makes a lot of sense !Remember that whenever a pair is in a downtrend or uptrend, traders use Fibonacci retracement levels as a way to get in on the trend.
How to Use Fibonacci Extensions to Know When to Take Profit
The 61.8%, 100%, and 161.8% levels all would have been good places to take off some profits.
- Price rallied all the way to the 61.8% level, which lined up closely with the previous Swing High.
- It fell back to the 38.2% level, where it found support
- Price then rallied and found resistance at the 100% level.
- A couple of days later, the price rallied yet again before finding resistance at the 161.8% level.
Traders could have taken off profits at the 38.2%, 50.0%, or 61.8% levels. All these levels acted as support, possibly because other traders were keeping an eye out for these levels for profit-taking as well.
How to Use Fibonacci to Place Your Stop so You Lose Less Money
Method #1: Place Stop Just Past Next Fib
The first method is to set the stop just past the next Fibonacci level. If trader were planning to enter at the 38.2% Fib level, then you would place your stop beyond the 50.0% level.
Method #2: Place Stop Past Recent Swing High/Low
Another way to set your stops would be to place them past the recent Swing High or Swing Low.
Summary: Fibonacci Trading
The key Fibonacci retracement levels to keep an eye on are: 23.6%, 38.2%, 50.0%, 61.8%, and 76.4%.
The levels that seem to hold the most weight are the 38.2%, 50.0%, and 61.8% levels, which are normally set as the default settings of most forex charting software.