Fibonacci Retracement is one of the most popular methods in technical analysis, used for predicting market movements in Forex markets. It has a vast history behind it. The name is derived from an Italian mathematician Leonardo Pisano with the nickname Fibonacci.
Born in the Republic of Pisa (hence the name) around 1170, Leonardo Pisano was considered to be “the most talented Western mathematician of the Middle Ages”. The nickname Fibonacci is believed to be short for filius Bonacci (‘son of Bonacci’). Fibonacci popularized the Indo–Arabic numeral system in the Western world primarily through his composition in 1202 of Liber Abaci (Book of Calculation) and also introduced Europe to the sequence of Fibonacci numbers, which he used as an example in Liber Abaci.
Today, the mathematician’s name is mostly known among traders and financial market professionals for his “Fibonacci Retracement”, a mathematical theory that allows for an easy prediction of the market movements.
When trading, it is important to identify the downtrend and uptrend of a Forex market for effective trading. Fibonacci Retracement plays a key role in finding potential entry/exit levels, retracements, and trend reversals.
In this article, we will get you through a detailed guide about Fibonacci and how its strategies are applicable in forex and CFD trading.
What is Fibonacci Retracement?
To understand the Fibonacci Retracement it is important that you are clear what support and resistance levels are. Support indicates a specific price floor at which a given exchange rate will automatically correct itself. The opposite of support is Resistance – the price that may act as a ceiling.
Fibonacci Retracement is a robust technical method and tool to identify potential support and resistance levels in a financial market. It is a series of ratios such as 23.6%, 38.2%, 61.8%, 78.6%, and 50%.
These are the official retracement levels in Fibonacci Retracement and are placed horizontally in grid lines. The horizontal lines help you to identify reversal levels in a forex market.
Every retracement is 1.618 greater than the other. The inverse of 1.618 is 0.618 known as the golden ratio. The “golden” Fibonacci ratio of 61.8% is derived by dividing a number in the Fibonacci sequence by the next number in the series. This division consistently approaches 0.618, or 61.8%, as the numbers increase in size.
Understanding Fibonacci Retracement
We can simply understand Fibonacci with a mathematical example. There is no actual formula behind it. However, expert traders take one high point and one low point. Here’s an example. Suppose, the price of GBP/USD increased from 1.3004 to 1.3157. We have placed Fibonacci retracement at 23.6%.
The retracement level for 23.6% will be 1.3157 – (0.0157 × 0.236) which equals 1.311. Equivalently, the 50% retracement level will be 1.3157 – (0.0157 × 0.5) equals 1.307. Hence, it means these are the numbers that the market can potentially reverse.
The traders can use 1.311 and 1.307 levels as resistance and place a stop loss for maximum profits.
How to Use Fibonacci Retracement in the Forex Market?
Fibonacci Retracement is used by CFD traders in the forex market for potential reversal points. After several calculations, traders can spot resistant and support levels. Here are some of the important points to use Fibonacci in your trading strategy:
· Identify The Trend: It is important to identify the trend first before placing Fibonacci retracement on the chart. This can help you with potential buying or selling after the price pullback.
· Choose Two Points: It is indispensable to choose two points before plotting Fibonacci retracement. Choose the highest and lowest points based on the time frame and plot Fibonacci. It will show grid lines with different ratios such as 23.6%, 50%, 61.8%, etc.
· A Valid Confirmation: Fibonacci retracement levels should not be used in isolation. Always look for confirmation before entering a trade.
· Identify Reversal Points: The prices are most likely to reverse at 0.618, 0.236, and 0.5 points. Consider placing buy or sell orders near these points for potential results.
Top Fibonacci Strategies for Effective Trading
Fibonacci retracement works best for 1hr, 4hr, and 1-day time frames. Make sure to check this before plotting Fibonacci. Here are the top strategies with Fibonacci to spot reversal points.
Swap Zone Strategy
In Forex trading, when the price breaks above the resistance level, it becomes a support. Similarly, when the price breaks below the support level, it becomes resistant. The level of support and resistance is known as the Swap Zone. It is one of the easiest strategies to learn.
Here is an example of it.
As you can see, the price was making higher highs and higher lows and pulled back to form a resistance. The price then shifted gears and broke above the resistance level. We plotted Fibonacci retracement on this impulsive move. The price coincides with the golden zone of 61.8%. This indicates a great buying position.
Before doing this, it is crucial to identify the trends in the market. In the above screenshot, the trend was upward. For a downward trend, the price will break the support level. Note the impulsive movement and then plot the Fibonacci retracement.
Fibonacci With Moving Average
Fibonacci Retracement used with Moving Average works best for entering the market. Moving Average creates support and resistance levels. For example, if a 61.8% Fibonacci retracement coincides with a 200-period moving average, it strengthens the likelihood of a price reaction at that level.
Let’s have a look at an example of a EUR/USD chart.
The price took an impulsive downward movement, breaking the support level and forming a resistance level. As you can see in the screenshot, we have plotted our Fibonacci retracement with this move. The 200 EMA bar coincides with the golden zone, which is signaling us a sell signal.
Parabolic Pop Strategy
Parabolic Pop is one of the unique Fibonacci retracement strategies. The strategy is leveraged to find out the breaking points below and above the retracement levels. By combining this strategy with Fibonacci retracement, traders can identify key levels where price pullbacks occur and where to position their trades for potential reversals or continuations. This strategy is more suitable for longer time frames such as 1hr, 4hr, and 1 day. This helps traders find out early breakout or continuation points before making their entry into the market.
The traders carefully track the price pullbacks near the Fibonacci 38.2%, 50%, and 61.8%. These areas act as potential reversal or continuation points. You can also combine this strategy with 50 EMA.
Advantages of Fibonacci Retracements
Fibonacci Retracements is a famous technical tool that helps traders find potential entry and exit points. Here the some advantages of the Fibonacci Retracements:
Support and Resistant Levels
Traders can find accurate support and resistance levels with Fibonacci retracements. 38.2% 50%, and 61.8% are the potential levels that help traders identify precise points for support and resistance.
Easy to Understand
One of the advantages of this technical tool is its easiness. There is no complexity to understand Fibonacci levels. Beginner traders can find potential reversal or continuation points only by plotting Fibonacci retracements.
Potential Entry & Exit Points
Fibonacci Retracements are valuable for determining optimal entry and exit points in a trade. Traders can use these levels to enter trades during pullbacks in a trending market and set exit points based on potential reversal zones. This helps maximize profit potential while minimizing risk.
Wrapping Up
Fibonacci Retracements play a key role in profitable trading as they signal strong reversal and continuation points with accuracy. It is easy to understand, navigate, and find potential entry/exit points. There are other Forex trading strategies that you can combine with Fibonacci.
