Fibonacci Methods in Forex Trading

There’s a good chance you’ve heard of Fibonacci numbers and are familiar with their famous sequence of 0,1,2,3,5,8,13,21…..continuing onward as two adjacent numbers are simply added together to make the next number in the series. There’s an equally good chance that you’re not aware that the real Fibonacci magic lies in the relationship between the numbers—the ratios—and not in the numbers themselves. It’s the ratios that have been used throughout the ages to influence architecture and music, and that are found throughout nature, and it’s the ratios that can have a direct and positive effect on your forex trading decisions if you let them.

The ratios are found by dividing Fibonacci numbers into each other. The key ratio of 0.618 is found by dividing any Fibonacci number by the number that follows it in the Fibonacci sequence. The next key ratio of 0.382 is found by dividing any Fibonacci number by the number that appears two places after it in the sequence, and the third most useful ratio of 0.236 is found by dividing any Fibonacci number by the number that appears three places after it in the famous sequence.

Fibonacci ratios are useful in identifying where a trend may reverse itself before continuing in its original direction. If you can identify these points within your trend lines, you can predict, with relative accuracy, an up or downtick that you can exploit to your benefit as the trend then continues toward its natural completion. This methodology lends itself as easily to the technical interpretation of Forex prices as it does to stock prices, and is both significantly more accurate and significantly simpler than you may first be inclined to believe.

When Forex or stock is trending up or down, it never moves in a perfectly straight series of increments. As it makes its way to the natural completion of its trend, there are always reversals along the way, after which the trend will continue through what is known as “retracements”. Applying Fibonacci ratios within the trend lines to identify where these retracements will most likely occur helps you to determine the range within which you should place your stops for a high probability of achieving optimal return. Once you have identified this range, you can enhance your chart with candlesticks to identify even more exact price points within the currency pair’s support and resistance levels, and thus, will know where and when to take action.

Imagine that you’ve been following and charting an upward-trending currency pair. You know where the support and resistance levels lie, and you can use them as the top and bottom of the range within which you will now plot your Fibonacci ratios; remember, you’re doing this so that you can identify the points at which prices will most likely reverse before retracing along their original momentum. Divide the vertical distance between the support and resistance lines on your chart with horizontal lines at each of the key ratio levels of 0.618 (i.e., 61.8%); 0.382 (38.2%); and 0.236 (23.6%), or use Forex software to draw the lines for you. These lines now represent the most likely price points at which the currency pair will begin to retrace itself and continue to move in the original trend direction after a reversal. In other words, these lines now represent the most likely new support and resistance levels for the currency pair.

Markets retrace in predictable patterns that become clear and easy to identify when traders utilize the proper tools. In truth, while no one can explain why Fibonacci methodology is so consistently accurate, no one can dispute the value of using Fibonacci methods to predict market swings and help you to plan your stop loss and take profit points. Try charting a Forex pair over a long range of perhaps a year, then applying Fibonacci ratios to the chart wherever you notice a reversal within the charted period. You’ll be amazed at how close to the Fibonacci lines the retracements lie.

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