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How to trade forex with fibonacci levels

Nick Goold

Many traders use Fibonacci levels to identify potential support and resistance levels in financial markets.

What Are Fibonacci Levels?

Fibonacci levels in trading are retracement points derived from values in the Fibonacci sequence. The Fibonacci sequence is a series of numbers where each number is the sum of the two preceding numbers, like this:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, ....

If we take the ratio of each number to its predecessor, then as the numbers get larger, that tends towards a value of 1.61804, also known as the golden ratio. This ratio frequently occurs in nature and has long held some mystical significance. The inverse of this ( 1 / ratio ) is 0.618, or 61.8%. Similar percentages can be found between increasing intervals in the sequence, which give Fibonacci levels used in trading:

23.6%, 38.1%, 50.0%, 61.8%, 76.4%

How do Fibonacci Levels work?

Fibonacci levels are used in trading to identify potential support and resistance levels. When a market is trending, it is expected to retrace a predictable portion of the move before continuing in the direction of the trend. Therefore, traders use Fibonacci levels to identify potential retracement levels, where the market may reverse and move in the original direction of the trend again.

The key Fibonacci levels used in trading are 38.2%, 50%, and 61.8%. These levels are derived from the Fibonacci sequence and are based on the assumption that markets tend to retrace a predictable portion of a move. For example, if a market is in an uptrend, it may retrace to the 38.2% or 50% level before continuing in the direction of the trend. If the market retraces beyond the 61.8% level, it may signal a potential end of the trend.

Fibonnaci chart

Why do Fibonacci levels work?

The effectiveness of Fibonacci levels in trading is based on the belief that human psychology plays a role in how markets move. As a result, traders tend to react to certain price levels predictably, which become potential support and resistance levels.

In addition, Fibonacci levels are often used with other technical analysis tools, such as trend lines and moving averages, to identify potential turning points in the market. When multiple technical indicators converge at the same level, it can increase the likelihood of a significant turning point in the market.

Risk Management

Fibonacci levels can improve risk management. Traders can set stop-loss orders at key Fibonacci levels to limit potential losses. For example, if a trader buys a UDDJPY at 132 after the market has risen from 122, they could buy at the 50% retracement level at 127 and set their stop at 125 below the 61.8% retracement level.

Summary

Fibonacci levels are a popular technical analysis tool traders use to identify potential support and resistance levels in financial markets. These levels are derived from the Fibonacci sequence and are based on the assumption that markets tend to retrace a predictable portion of a move. The effectiveness of Fibonacci levels in trading is based on the belief that human psychology plays a role in how markets move, and traders tend to react to certain levels predictably. Fibonacci levels can also be used for effective risk management by setting stop-loss orders at key Fibonacci levels to limit potential losses.