Forex traders use Fibonacci retracements to pinpoint where to place orders for market entry, taking profits and stop-loss orders. Fibonacci levels are commonly used in forex trading to identify and trade off support and resistance levels. After a significant price movement up or down, the new support and resistance levels are often at or near these trend lines.
- The Fibonacci trading strategy uses the "golden ratio" to determine entry and exit points for trades of all time frames.
- This type of trading is highly contested as it is based on ratios that don't necessarily correlate to the individual trade.
- Sticking to a numerical trading strategy like the Fibonacci strategy will help to limit or remove emotional bias from trades.
What Are Fibonacci Retracements?
Fibonacci retracements identify key levels of support and resistance. Fibonacci levels are commonly calculated after a market has made a large move either up or down and seems to have flattened out at a certain price level.
Traders plot the key Fibonacci retracement levels of 38.2 percent, 50 percent and 61.8 percent by drawing horizontal lines across a chart at those price levels to identify areas where the market may retrace to before resuming the overall trend formed by the initial large price move.
Fibonacci levels are considered especially important when a market has approached or reached a major price support or resistance level.
The 50-percent level is not actually part of the Fibonacci number sequence, but it is included due to the widespread experience in trading of a market retracing about half a major move before resuming and continuing its trend.
Forex Strategies by Traders Using Fibonacci Levels
Each trader's strategy will be different, so as an investor you need to consider how each of the strategies below might fit into your overall angle on the market. Not every trader uses the options below, and it is alright if none of them align with your strategy. Strategies that utilize Fibonacci retracements include the following:
- You can buy near the 38.2 percent retracement level with a stop-loss order placed a little below the 50 percent level.
- You can buy near the 50 percent level with a stop-loss order placed a little below the 61.8 percent level.
- When entering a sell position near the top of the large move, you can use the Fibonacci retracement levels as profit-taking targets.
- If the market retraces close to one of the Fibonacci levels and then resumes its prior move, you can use the higher Fibonacci levels of 161.8 percent and 261.8 percent to identify possible future support and resistance levels if the market moves beyond the high/low that was reached prior to the retracement.
Almost all traders have a trading style or set of strategies they utilize in order to maximize profit potential and keep their emotions in check. The Fibonacci trading strategy utilizes hard data and if a trader adheres to their strategy, there should be minimal emotional interference.
The Fibonacci trading strategies discussed above can be applied to both long-term and short-term trades, anything from mere minutes to years. Due to the nature of currency changes, however, most trades are executed on a shorter time horizon.