As a forex trader, something which you will doubtless encounter at many points throughout your trading career is Fibonacci retracements. These are a key technical indicator used to identify levels of support and resistance. It is one of the most fundamental and simplistic charting techniques which can be easily implemented by all levels of forex trader. In the following post from TradeFW.com broker, you will find out what is Fibonacci Retracement and how to use it for effective trading.
This popular technical analysis technique will help you decide upon key entry points, target prices, and where to set a stop-loss throughout your forex trading career. With that in mind, it is vital to learn more about the use cases and how to identify and implement Fibonacci retracement in a forex trading environment to enhance your own trading skills.
The History and Fundamentals of Fibonacci Retracement
Fibonacci retracement is based on a sequence of key numbers which were identified in the 13th century by the Italian mathematician, Leonardo Fibonacci. This number sequence and specifically the relationship of the numbers to each other when expressed as a ratio are a key to identifying support and resistance levels in trading.
The sequence of numbers set out by Fibonacci, and adapted by modern mathematicians is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. As we can see from a more detailed analysis, each number is the sum of the two preceding numbers. This continues infinitely and is key to deducing the ratios used in retracement.
The Fibonacci ratios are, 23.6%, 38.2%, 50%, 61.8% and 100%. These are used hen dividing the vertical distances on a chart between two points to create a Fibonacci retracement. The “Golden Ratio” is derived by dividing one number in the sequence by its following number. This will always equal approximately 0.618. The other key points are derived in a similar fashion.
Top forex traders who engage in technical analysis, will plot these lines horizontally across a chart in order to identify the key points of support, where the market may retrace to, and levels of resistance which may be reached in future movements.
Why it plays an Important Role in Forex Trading
Starting out in the forex trading industry, you soon learn that it is key to introduce some form of organization and strategy to your trading. Beyond the basics of choosing the best forex broker, and funding your account, you will start to engage in technical analysis to try and get a step ahead of the market.
Fibonacci retracement is one of the simplest, yet most effective ways in which you can conduct a simple technical analysis to identify key points of entry and exit within a forex market. Ultimately, this can help guide your decision making in an organized fashion. The method is most commonly used after large-scale movements in the market, after which the price has reached a stable position.
Fibonacci retracement is useful as a target-setting guide. This can be set in the sense of when to take profits, or also, where to position a stop-loss. Furthermore, levels can be set higher than 100%, at the same ratios, to identify possible future levels of support and resistance.
How reliable is Fibonacci Retracement
Fibonacci retracement is one of the most widely used tools for technical analysis within the forex industry and beyond. This is thanks in part to their simplicity of implementation. By simply plotting horizontal lines at the given ratios from left to right between two points, a forex trader can identify key levels for trading.
Whilst widely used, Fibonacci retracement is also subjective in many ways. Firstly, the use of the tool may be altered by traders depending on their intention and desired outcome. This can be said of any technical indicator, effectiveness will first rely on the method of implementation.
Another key point in regard to Fibonacci retracement which makes it divisive among some traders is the fact the Fibonacci sequence from which the chart is derived, offers no concrete evidence or proof of concept. It is simply a product of mathematical anomaly which has been demonstrated as effective, but with no reasoning as to exactly how or why. This may prove uncomfortable to some traders who wish to base decisions on objective facts alone.
Ultimately, whether or not traders choose to agree on its effectiveness, Fibonacci retracement is one of the most implemented technical analysis techniques among forex traders today. Within any high-quality forex trading educational program, it is one of the fundamental tools which you will learn how to use.
With a solid foundation in Fibonacci retracement, you can set yourself up to continue learning about other more advanced technical analysis tools. This is a learning process, which, regardless of how you feel about it, can only enhance your knowledge and potential to emerge profitably from the lucrative forex market.Get the 5 most predictable currency pairs