Fibonacci is a very popular tool used by forex traders and was developed in the 13th century by a mathematician named Leonardo Fibonacci. Essentially it is a series of numbers with each number adding up to the previous two. The Fibonacci sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.
However, what has this got to do with forex trading I hear you ask? There is something known as the Golden Ratio which on the Fibonacci tool is 61.8%, and this is derived by dividing 144 x 89. Don’t ask me where it came from, who knows, but what we do know is it is a very popular level that traders react to. Because so many people react it becomes a self-fulfilling prophecy. This is very similar to the 50% line, which is more of a psychological level and based on Dow theory, but more about that in another article.
To use the Fibonacci Retracement tool and it to your chart like below:
Now you have access to the tool lets look at how to use it by looking at some charts. Here we can see we have a downtrend in the AUDUSD and we have used the Fibonacci tool in the most recent downward move. In a downtrend we measure from the recent swing high to a recent swing as indicated by the circles.
This now us the opportunity to measure the retracement.
As you can see price moved up and down over a period of days but eventually would back to the 61.8% Fibonacci level.
After hitting the 61.8% level we can see that the AUDUSD continued on its downward trend. Now you shouldn’t use Fibonacci its own, just like every trading technique, you are looking for numerous reasons to enter a trade. Comparing the above strategy with price action such as looking for pin bars, or perhaps where it coincides with moving averages then this can be a really powerful tool to help you find entries.
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