Fibonacci
The Fibonacci sequence was published by Leonardo of Pisa in the year of 1202. Thats right! It was presented more than 800 years ago, but it has been known by indian mathematicians even longer. How can we use something that old in our trading?
What are the Fibonacci numbers?
They are based on the following sequence:
0,1,1,2,3,5,8,13,21,34,... As you can see, the numbers are the sum of the two previous numbers. Leonardo described them with help of a rabbit population.
* First month we have one pair of rabbits (0 additional pairs)
* Second month the pair have babies (1 pair) (1 additional pairs)
* Third month both pairs of rabbits have an other pair, and the first pair dies. (1 additional pairs)
* Fourth month the second pair and the two new pair have one pair each and the second pair dies. (2 additional pairs)
Based on this Leonardo founded that the sequence appears in many places in nature. Tree branches, growth of nautilus shell and more...
What are the Fibonacci ratios?
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Enough with the history lesson, how to use it in trading? Every chart application has different methods to applyi fibonacci to your chart. They don't use the fibonacci sequence, instead they use ratios from the sequence. Each number is aproximately 1.618 times greater than the one before. There are three ratios you need to know they are 61.8%, 50% and 38.2%.
The key fibonacci ratio is 61.8% and is calculated by dividing one number with the one that follows it.
For example 13/21= 0.619
The 38.2% ratio we get by dividing on number with the number two places away.
For example 3/8 = 0.375.
Lucky for you the chart application does everything for you, so you NEVER have to calculate these. |
How to use Fibonacci in trading?
It is unclear why the Fibonacci ratios work in the Forex market, but they do. Traders believe it's a self fulfilling prophecy, and the ratios only work because we believe it to.
The Fibonacci ratios most common usage in the currency market is to find possible reversal levels.
Let's say we have a clear uptrend in the EUR/USD, but the price has slowly starting to go down. We want to find possible entry levels where the price will reverse and resume its uptrend.
Look at EUR/USD below with clear uptrend:
How do we find possible reversal levels? That's done within 10 seconds in our charting application. We select fibonacci reversal tool and drag from the low to the high.
We get this result:
We got the levels plotted out, and all we have to do is wait for the price to reach them and see what happens. Guess what?
The EUR/USD finds support several times at the 38.2% level and then contiues its uptred. Easy!
The Fibonacci reversal tool works at downtrends aswell, look at this USD/JPY chart:
The USD/JPY had been in a nice down trend but had started to go up. Where do we find possible reversal levels? We plot the fibonacci reversal from top (green line) to low (blue line), and wait. As you can see, price hit the 38.2% level and reacts with a couple of bounces. It then breaks through 38.2%, finds resistance at the 50% level and contiune its downtrend.
It is impossible to know what level is going to act as reversal, but we know that the levels most of the time acts as support/resistance. We could easily made +200 pips at the first bounces of the 38.2% level.
Go back to Learn forex for intermediate
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