Trading Forex is not a simple craft - in fact many regard it as an art. In every art you have to use not only your talent, but you also have to be able to master special techniques and have specialist knowledge. In Forex this is much the same, but with the distinction that you deal with financial markets and currencies. In order to progress and have a chance of success in Forex, a trader must take the time to analyse any information that is important to his trading, and it's here that many traders will use technical analysis.
Technical analysis is the method of evaluating securities by thoroughly analysing statistics produced by market activity such as past volume and past prices. Technicians do not attempt to assess a security's intrinsic value. Instead they use charts and other tools to determine patterns that can suggest future activity.
Technical analysts first of all rely on the historical performance of stocks and markets and will use them as indications of future performance. We would like to draw your attention to a popular terms in technical analysis - Fibonacci retracements. These are used to create the Fibonacci trading strategy. This term has a connection with areas of resistance and support - i.e price stops going higher and price stops going lower. Therefore, one can conclude that Fibonacci retracement is the potential retracement of a financial asset's movement in price.
Retracements use horizontal lines in an attempt to indicate areas of support or resistance at the key Fibonacci levels prior to the moment when it continues in the original direction. Furthermore, these levels are generated by drawing a trendline between two extreme points and then dividing the vertical distance by the key Fibonacci ratios, which are: 23.6%, 38.2%, 50%, 61.8% and 100%.
As Fibonacci retracements have proven to be useful in Forex, they can be used to create a viable Fibonacci Forex trading strategy to supplement trading. The aim of this article is to explain the advantages of this strategy, explore the basic steps of creating a Fibonacci strategy and to introduce some examples.
Why using Fibonacci retracements to create a strategy is a good idea
Some currency traders believe in Fibonacci retracements as a way of identifying small price correlations and in determining areas of support and resistance. Technically, the retracements themselves are ratios that are based on the mathematical concepts of the Fibonacci sequence. This sequence is utilised to guess the extent of correlations in normal market waves. There are many popular technical indicators that are applied in conjunction with Fibonacci levels, including candlestick patterns, volume, trendlines, moving averages and momentum oscillators.
Forex traders will know that the most common retracement levels are 38.2% and 61.8%. As a matter of fact, after a strong bear or bull movement, a retracement level in a Fibonacci Forex trading system can be exploited to predict the extent of any correlations, pullbacks as well as continuation patterns. If a retracement has actually proven to be effective in determining support or resistance levels within the historical price patterns of a particular security, currency traders can then apply breakout strategies if they wish to locate entry-exit positions.
For instance, if a price rises from $60 to $85 and then retraces to $72.50 prior to rising again, the Fibonacci retracement level is said to be 50%. Indeed, this price point forms a new line of support and the 50% level turns out to be a significant indicator for the security's future price movements.
Fibonacci retracements can be used universally by those traders who rely on them. The underlying principles behind Fibonacci trading and the Forex Fibonacci strategy are not necessarily experiential, so they are subject to alterations based on the trading instrument.
There is one tip for you. You should not place trades just due to the fact that a price has reached a common retracement level. In fact, the confirmation is necessary to make sure that the price does not continue to decline and that the general trend is likely continue. Otherwise, you may improperly trade into the wrong side of a reversal.
How Fibonacci retracement levels may serve to create an FX strategy
As we have specified above, currency traders employ Fibonacci retracements to determine where to place orders for market entry. In addition, they may identify places for taking profits and for stop-loss orders. As for Fibonacci levels, they are typically employed in order to determine and trade off support and resistance levels.
In every Fibonacci Forex strategy, Fibonacci levels are most frequently calculated after a market has made a large move up or down and seems to have flattened out at a particular price level. As you know, traders plot the key Fibonacci retracement levels of 38.2%, 50% and also 61.8%. This is done by drawing horizontal lines across a chart at those price levels, to pinpoint areas where the market can retrace, prior to resuming the general trend formed by the initial large price movement. However, that is not all - the Fibonacci levels are regarded as immensely important when a market has either reached or approached a major price support or resistance level.
Technically, the 50% level is not really part of the Fibonacci number sequence, but it is included due to the general experience in trading of a market retracing about half a major movement prior to resuming and continuing its trend.
There are a few strategies currency traders apply using Fibonacci levels. One is buying near the 38.2% retracement level with a stop-loss order placed a little below the 50% level. The next Fibonacci trading strategy is buying near the 50% level, with a stop-loss order placed a slightly below the 61.8% level. You can also use Fibonacci levels when entering a sell position near the top of a large move, using the Fibonacci retracement levels as take-profit targets. The last example here is the following. If the market retraces close enough to one of the Fibonacci levels and then resumes its previous move, traders can use the higher Fibonacci levels of 161.8% and 261.8% to define possible future support and resistance levels, if the market goes beyond the high or low that was reached before the retracement.
What is the most common Fibonacci strategy?
Let us start with this Fibonacci Forex strategy. When a market has moved a significant distance, especially if the market appears to have actually topped or bottomed out at a major support or resistance level, Fibonacci retracement lines are frequently plotted on a chart by technical traders to determine potential levels to which the market might retrace. If the market price has moved higher, those horizontal lines displayed on the chart are considered potential support levels and price levels where the retracement can end - and where the market might resume an uptrend. In the reverse situation, the Fibonacci levels would be regarded as resistance levels in a market that has actually moved down in price.
We remind you that the key Fibonacci retracement levels encompass the 38.2%, 50% and also 61.8% levels. Although the 50% level is not a true Fibonacci number, it is often included in the Fibonacci sequence due to the belief that a market frequently retraces nearly half of a move prior to resuming its overall trend. We would like to provide you with some additional strategies using Fibonacci retracements that you may find useful.
The first Fibonacci trading system we'll look at is when a currency trader is looking for an entry point into a particular market that has made an important move to the upside. They might place limit orders in an attempt to buy near the 38.2% or 50% retracement levels, with the respective stop-loss order placed below the following Fibonacci level down. For instance, a desire to buy near the 50% level with a stop under the 61.8% level. The second strategy is if a Forex trader has recognised a market reversal following a significant move up and accordingly entered a sell position, he may exploit Forex retracements as profit targets. The last Forex Fibonacci strategy - a substantial violation of the 61.8% level - is frequently regarded as a sign of complete market reversal of direction. If this occurs, currency traders may enter short positions, anticipating to move much lower.
It is no secret that Fibonacci retracements can be of great value in successful Forex trading. Knowing how to set, draw and consequently apply them is of paramount importance. Besides enriching your technical analysis knowledge, you will most likely find Fibonacci retracements are useful if you decide to create a Forex trading strategy with Fibonacci retracement.
Fibonacci retracement levels frequently mark reversal points with excellent accuracy. They are however more difficult to trade than they look. In addition, the levels are best exploited as a tool within a broader strategy that looks for the confluence of a number of FX indicators in order to pinpoint potential reversal areas, offering you low risk and high potential reward trade entries.