In this lesson, we’ll discuss the Fibonacci Retracement Levels and how to use them in your trades!
The Fibonacci formula can be found in almost all aspects of human life – art, nature and even pop culture. Today we’ll discuss it within the context of forex trading!
Lesson Overview
- Fibonacci Analysis is used to apply the Fibonacci ratio to the price chart
- The most significant ratios in forex are the retracement levels and the extension levels
- Fibonacci levels are considered a self-fulfilling prophecy and are used to predict support and resistance levels
What are Fibonacci Retracement & Extension Levels?
Using Fibonacci retracement and extensions tell us where a price may move next or when price patterns will repeat.
Traders use the Fibonacci ratios to predict how far a security’s price will move or how low it will drop. In other words, Fibonacci ratio can be used to identify support and resistance levels across a price chart.
Fibonacci retracements and extension levels come from the ratios found in between the Fibonacci number sequence and applied as percentages to the forex chart.
The Fibonacci Sequence
The Fibonacci number series begins with 0, 1, 1, 2, 3, 5, 8, 13 and so on.
Forex traders pay special attention to the ratio between each of the numbers. They are represented as percentages when applied to a price chart.
The most important retracement levels are 38.2%, 50% and 61.8%.
Although 50% is not officially part of the Fibonacci sequence, traders still consider this to be a very important level.
Extension levels are found at 138%, 150%, and 161.8%
Take a look at the chart below for reference.
On a price chart, we can select the lowest and highest price points and apply the Fibonacci analysis to determine potential support and resistance levels.
The formula for the ratio is the total of two lengths divided by the longer length (a+b/a). If the golden ratio is achieved, then the formula equation equals the number phi, or 1.61.
In forex, Fibonacci levels are considered a self-fulfilling prophecy.
Why? Because the popularity of the Fibonacci analysis makes the predicted levels accurate most of the time. If most traders follow the support and resistance levels from the Fibonacci calculation, you can expect the market to follow.
Learn more about Fibonacci Trading basics.
Quick tip!
Most charting systems have a Fibonacci Retracement drawing tool. These tools allow you to view the Fib retracement levels on the chart automatically.
Origin of the Fibonacci Formula
The Fibonacci Formula is named after the Italian mathematician Leonardo Pisano Bigollo. Despite its name, the sequence was actually developed in Ancient India and was in use as early as 100 BC to 350 AD.
The most notable of its originators is Indian mathematician Acarya Virahanka, who developed the method. Next generation Indian mathematicians such as Gopala, Hemacandra, and Pandita referenced and developed the numbers into the formula we know today.
Fibonacci introduced these numbers to Western Europe after learning about them from Indian merchants, and thus the name we know now.
Coined as the “magical numerical series,” the Fibonacci sequence and “the Golden Ratio” can be found naturally occurring in our world – in flowers, our DNA, hurricanes, and even the galaxy.
How to Use Fibonacci in a Forex Price Chart
Fibonacci levels can be used to identify support and resistance levels.
Take a look at this example.
Say this is the price chart for USDZAR for the past 4 hours. You can also see that we’ve selected the lowest and highest price points and connected them through a dotted line.
The two points will be our basis for applying the Fibonacci ratios to the chart and identifying where the Fibonacci retracement levels are.
This way, we can identify the retracement levels of the prices in the last four hours.
As you can see, 61.8% is the most significant level for this chart. This is where we can see the most movement in prices throughout the time period.
Meanwhile, 100% is the major resistance level because the price did not break through 100 but reversed back to the retracement levels.
We can then say that the USDZAR's support and resistance levels are around the price ranges of 38.2% and 61.8%.
Fibonacci Retracements vs. Fibonacci Extensions
Fibonacci Extensions apply the percentages to a price uptrend. This is what happens when a price breaks through 100% of the retracement levels.
If the price continues to rally, new support and resistance levels will emerge.
How Fibonacci Retracement Levels help your decisions
Fibonacci retracements can be used to place entry orders, determine stop-loss levels, and even set price targets.
Compared to other technical analysis tools, the Fibonacci retracement levels are static. This makes it easier for traders to identify patterns and make quicker decisions! This is particularly helpful for short-term or swing traders.
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