Lesson 27 – Fibonacci, A Guide for forex traders
This is perhaps the most interesting concept during your forex education. It is a very curious numerical phenomenon not just in markets, but also in the natural world.
There is a specific sequence of numbers that we see across the entire natural world frequently. We call this sequence the Fibonacci sequence and it goes like this:
As you will have seen, the sequence is super simple. Just add the previous two numbers to get the next number.
Now this is where things get interesting.
When you divide any number in the fibonacci sequence by the number before it (excluding the first 5 numbers), you get the same result:
This number is commonly referred to as the golden ratio and can be found very commonly across the natural world, and across the most successful man-made designs.
There is something unconsciously satisfying about this specific ratio as we know it unconsciously from the natural world.
We see it in pine cone arrangements, flower petal arrangements, seashell spirals, hurricane formations, human faces, DNA sequences, galaxy formations, etc etc.
Definitely do some googling on Fibonacci in the natural world and have your mind blown.
So, What in the hell does this have to do with forex trading?
It turns out that this ratio gives us significant price levels in some unique cases.
Using charting software such as MT4 or MT5, or most brokers’ software, we can plot the fibonacci tool on our graph to figure out a fibonacci retracement and fibonacci extension levels.
We then use these when we enter our long and short position to estimate the exit point of a trade. More often than not, these exit points are accurate and can function as excellent take-profit areas. So it is very profitable to familiarize yourself with this tool as it will make your current trades more profitable by taking more advantage of your winners.
Let’s begin with the most used tool: the fibonacci retracement.
This is based on finding retracements via 3 key levels within the fibonacci sequences.
When we divide any fibonacci number by the number after it, we get 0.618.
When we divide any fibonacci number by the number two after it, we get 0.382.
And with the same thing, three along, we get 0.236.
Now that we have the key numbers (which are all automatically programmed into the fibonacci retracement tool), we turn them into percentages.
So here is where we use it in trading:
Take your fibonacci tool and draw a line from the very bottom of the swing in price action to the very top. And vice versa the other way around.
The tool will then display the key fibonacci levels outlined above as the key retracement levels. There then is a good likelihood, if you have drawn your tool on the highs and lows (best used in the 1h, 4h, or day chart), that the price will ‘retrace’ or bounce back to one of these levels.
These levels are treated as additional but hidden support resistance levels of minor importance (treat is as support tested only twice), and we use these levels in the market to place our entry, exit, take-profit, and stop-loss points around these areas as applicable.
These are essentially retracements the other way around. Here we aim to see to which levels the price action will extend up to. Here the key levels are 138.2% and 161.8%.
These levels will act as similarly as additional support and resistance levels. Treat them accordingly.
Fibonacci tools should be used as a supporting tool to accompany your previous trading strategies and should not be used as a primary reason for any trade. If you see that a Fibonacci level coincides with another indicator such as proven support or a moving average crossover then take that as additional validation to enter into that trade or set your trade exit plan.