From Forex Dummy to Top Tier Trader: Forex Fibonacci Trading Secret
Fibonacci analysis is the study of identifying possible support and resistance levels in the future based on previous price trends and reversals. Fibonacci analysis is established on mathematical pattern discovered by Leonardo Pisano—also known as Fibonacci. Fibonacci is credited with finding a sequence of number pattern, which is named after him: The Fibonacci sequence.
The Fibonacci sequence is a series of numbers that progresses as 0,1,1,2,3,5,8,13,21,34,55…. The sum of the two preceding numbers becomes each subsequent number in the sequence. For example, you add 21 +34 (the two preceding numbers) to arrive at the number that follows 34 in the sequence. The sum of 21 +34 is 55, which is the next number in the sequence.
The groundbreaking part of Fibonacci sequence is that there is a specific ratio between the numbers. Each sequence in Fibonacci sequence is 1.618 times larger than the previous number. For example, 34 is 1.618 times larger than 21 (34 ÷ 21 = 1.618).
Fibonacci ratios are commonly used in the forex market with the following analysis tools:
When a currency pair reverses trend, it is natural to wonder how far the pair is likely to move towards new direction. That’s when Fibonacci retracement levels become handy tool. Specific Fibonacci ratios are useful to determine the new behavior against previous trend.
The ratios are helpful for you to find the following retracement levels:
Calculated by dividing a number in the Fibonacci sequence by the third number following it in the sequence (21 ÷ 89 = 23.6%).
Calculated by dividing a number in the Fibonacci sequence by the second number following it in the sequence (34 ÷ 89 = 38.2%).
Calculated by finding the middle between 61.8 % and 38.2 %
((61.8% + 38.2%) ÷ 2 = 50%).
Calculated by dividing a number in the Fibonacci sequence by next number (55 ÷ 89 = 61.8%).
Calculated by finding the distance from 38.2 % and 23.6 % (38.2% – 23.6% = 14.6%)
and adding it to 61.8 percent (61.8% + 14.6% = 76.4%).
Calculated by finding where the previous trend began.
Determining all six Fibonacci retracement levels gives potential support and resistance levels that you can utilize in your Forex trading. See how Fibonacci levels can be used on the daily GBP/USD chart below. The levels were illustrated along with the trend highlighted by the red arrow. You can use each level to help you determine the entry and exit point as the currency pair began to turn around and move lower.
Starting from Mid-June, see how the price of the currency pair moved up and down, bouncing off of these support and resistance levels for months, until finally going back up above the high established in late July by the previous trend (also known as the zero percent level) in late October.
Trends will never appear as a straight line. A trend always moves in one direction initially, pulls back and moves in the reverse direction for a while, then it turns around and continues to move in the previous direction. This is a natural outgoing tide and flow of a trend. When a currency pair continues its previous trend, forex traders should estimate how far the pair likely to continue its momentum. That’s when Fibonacci projection levels are useful. The Fibonacci ratios are convenient when you are trying to estimate how far a currency pair is going to move once it resumes its earlier trend. The ratios you will be using in your forex trading will help you find the following projection levels:
This level is calculated by dividing a number in the Fibonacci sequence by the number immediately prior to the sequence.
(89 ÷ 55 = 161.8%).
This level is calculated by dividing a number in the Fibonacci sequence by the second number prior to the sequence (89 ÷ 34 = 261.8%).
This level is calculated by dividing a number in the Fibonacci sequence by the third number prior to the sequence (89 ÷ 21 = 423.8%).
Preparing all three Fibonacci projection levels will give you potential support and resistance levels you can apply in your forex trading. These Fibonacci levels are shown on the daily GBP/USD chart below. The levels were illustrated along with the trend highlighted by the red arrow. Now that the GBP/USD has continued its up trend, you can use FP level to help you target a specific profit points (potential exit levels) as you buy this currency pair.
Watch that the currency pair has possibility to increase up to the 161.8 % projection level in the near future. When it reaches 161.8%, you can establish 261.8 percent projection level for your next profit target.
Fibonacci levels can also be used in making diagonal support and resistance level as well as horizontal. The diagonal levels of support and resistance are also known as Fibonacci fans. It is based on three Fibonacci retracement levels: 61.8 %, 50 % and 38.2 %. To construct a Fibonacci fan, follow the instructions below:
- Find a trend
- Find the 3 horizontal Fibonacci levels (61.8 %, 50 % and 38.2 %) as they relate to that trend
- Draw a vertical line that crosses through these levels at the point where the trend ended
- Draw 3 lines, each one beginning where the trend began and crossing through a separate point where the vertical line intersects one of the Fibonacci levels. With Fibonacci fans drawn, you can project possible support and resistance levels that you can use in your forex trading. Look at the Fibonacci fan on the daily GBP/USD chart below. The illustrated levels were calculated based on the trend highlighted by the red arrow. You can use the rays from the fan to help you determine when to enter and exit your trades as the currency pair began to turn around and move lower.
Notice how the value of the currency pair went through the middle ray of the Fibonacci fan for a while in early August, and then it went through that bottom ray of the fan for a few days. It is also remarkable that the levels created by the Fibonacci fan continue to be a factor far into the future. You can see how the GBP/USD went down after hitting the bottom ray of the fan four months later in November.