The Fibonacci sequence exists everywhere, so it is also present in the investment and financial market. The Fibonacci indicator is one of the most loved tools by traders. In particular, Fibonacci retracement is a technical indicator capable of predicting future prices. Let’s explore with Forex Trading how Fibonacci supports trading in the following article.
Overview of the Fibonacci sequence in Forex trading
The Fibonacci sequence is an infinite sequence of natural numbers discovered by Italian mathematician Fibonacci. The Fibonacci sequence is built based on the rule: the first two numbers are 0 and 1, and the following numbers are calculated by the sum of the previous two numbers.
Introduction to Fibonacci sequence in Forex Trading
In forex trading, the Fibonacci number sequence can assist traders in the following cases:
- Helps identify price zones that are likely to form support and resistance. Traders thus make wise buying and selling decisions.
- Provides a comprehensive system to help identify important price zones. Traders can make better trading decisions thanks to accurate technical analysis.
- Supports placing stop-loss orders and determining risk-to-total ratio. Traders will manage risk effectively and protect their investment capital better.
- Identify potential locations to enter and exit the market.
Learn about the 3 types of Fibonacci indicators
Fibonacci retracement:
With the support of the 38.2%, 50%, and 61.8% Fibonacci sequence ratios, this tool will measure the level of price retracement after the most recent increase. A retracement is a phenomenon where the price temporarily goes down but still maintains the main trend.
When the market is trending up, the price adjustment rarely exceeds 2/3 of the previous increase. It is usually limited to the 61.8% range according to the Fibonacci scale. Thanks to Fibonacci retracement, traders can identify potential reversal areas and choose appropriate buy points.
Fibonacci fan:
This tool helps identify potential support/resistance levels, contributing to detailed price structure analysis. The Fibonacci fan draws a series of diagonal lines based on the 23.6%, 38.2%, 50%, 61.8%, and 100% levels of the Fibonacci sequence. It will form a fan-like shape on the price chart.
Fibonacci fans help traders predict potential price levels where the price may encounter resistance or find support. In addition, it also helps investors grasp market trends and fluctuations.
See more: Profession forex trade thanks to Fibonacci applying
Fibonacci arc:
This tool creates a series of curves based on the 38.2%, 50%, and 61.8% levels of the Fibonacci sequence. Each Fibonacci arc is centered at the highest or lowest price of the trend being evaluated. Through arcs, traders identify potential price locations where support or resistance may appear.
Limitations of the Fibonacci sequence in investing
After learning the definition of what is Fibonacci, you need to clearly understand some of the disadvantages of this tool. Because like other technical analysis tools, the Fibonacci sequence is not perfect.
- The application of the Fibonacci sequence in technical analysis can be subjective. It is especially subjective when determining the starting and ending points of a trend.
- The reliability of using the Fibonacci ratio to identify support/resistance zones depends largely on the level of market volatility.
- Although it can reflect future price movements, the accuracy of the Fibonacci sequence in prediction still depends on many other factors.
- Influence from the crowd can lead to misleading information, reducing the effectiveness of using the Fibonacci sequence indicator.
- Independent use of this tool carries the risk of making the wrong decision.
How to use Fibonacci retracement to trade forex effectively
The Fibonacci sequence indicator is a big topic in investing. However, this article will focus on exploiting Fibonacci retracement. This is the most popular and best-performing tool that helps traders read trending markets.
Instructions for using the Fibonacci sequence in investing
In investing, one of the most important applications of the Fibonacci sequence is Fibonacci retracement. This tool is most effective when the market is trending. Fibonacci retracement is used to predict potential future price levels. Traders can take advantage of Fibonacci retracement levels to determine buy points (when the market is rising) and sell points (when the market is falling).
According to theory, the price after establishing a new trend will retrace or return to a part of the previous price level. The price will then continue following the established trend.
To find the Fibonacci retracement level, do the following:
- Step 1: Identify the most important recent Swing High and Swing Low levels.
- Step 2: When the market is trending down, click on Swing High, then drag the cursor to the nearest Swing Low.
- Step 3: When the market is trending up, click on Swing Low, then drag the cursor to the nearest Swing High.
In the chart below, the price has dropped below the 0.5 level. But the appearance of a bullish candle later pushed the price to close above the 0.5 level. Next, the price forms a bottom and turns around, continuing the trend as before. Thus, Fibonacci sequence levels are very important in identifying potential resistance areas when prices tend to recover before continuing the old trend.
Combining the Fibonacci sequence with Elliott waves
Elliott Wave is a form of chart showing market trends commonly used in the foreign exchange market. According to Ralph Nelson Elliott, investor psychology changes periodically, creating price waves. These cycles tend to repeat. Based on past trading data and the wave principle, traders can predict future price movements.
The structure of each Elliott wave follows the ratio of Fibonacci retracement and Fibonacci expansion. The combination of Elliott and Fibonacci sequences will assist in identifying support and resistance levels. Traders will use Elliott to identify market wave patterns. Meanwhile, Fibonacci will provide information about important price points.
In short, with the two tools Elliott wave and the Fibonacci sequence, traders will be able to identify effective entry points. Note that you should take advantage of the combination of these two tools in your medium and long-term strategy to achieve the highest profits.
Combining Fibonacci retracement and resistance-support theory
Combining support-resistance theory and Fibonacci retracement is a way to determine resistance levels more accurately. The ability of price to react at potential resistance-support zones will be significantly strengthened if these zones coincide with Fibonacci levels.
The chart below shows that the USD/CHF currency pair is trending down. So when should you enter an order?
Fibonacci level 0.618, Swing High 0.9140, and Swing Low 0.8994 coincide with the old resistance – support zone 0.907-0.908. Fibonacci retracement and previous resistance level coincide. Therefore, this is the ideal time to enter orders.
After a few candles, the old resistance becomes support. Price is showing signs of surpassing the Swing High point. At this time, traders can take profits on part or all of their investment if they believe the price will continue to go up. With a downtrend, you can do the same.
Combining Fibonacci Retracement and trend lines
The combination of Fibonacci retracement and trend lines is highly effective in analyzing trending markets. The chart below shows that the price is following the trend. This has been confirmed by trend lines.
According to the current uptrend, traders should consider entering a buy order when the price touches the trend line again. Take advantage of the Fibonacci sequence to find the ideal entry point with Swing High 69.02 and Swing Low 67.75!
The price has returned to the trend line, and at the same time touched the 0.618 level of the Fibonacci retracement.
The 0.618 Fibonacci level and trendline crossover have created a strong support zone. This helps the price bounce up and continue the outstanding uptrend. By combining trend lines and Fibonacci retracements, traders can identify potential price levels with high accuracy.
Combination of Fibonacci retracement and Japanese candlesticks
Fibonacci retracement combined with Japanese candlesticks will help traders grasp the point of exhaustion of buying and selling power. From there you will identify when the price is likely to reverse the trend.
The EUR/USD 1H chart below shows a Swing High at 1.3364 on March 03 and a Swing Low at 1.2523 on March 6.
EUR/USD has increased significantly compared to the price recorded at the market close. After holding at 0.5 for several sessions, the price broke out to 0.618. The last candle is bullish, you should monitor the developments of the next candle to make a decision.
The appearance of the Doji candle at the 0.618 Fibo level indicates the possibility of a high price reaction. Doji candles are also a sign that buying and selling pressure has been exhausted.
Short selling after the Doji candlestick forms can help you earn significant profits. Prices tend to level off temporarily after the Doji candlestick and then continue to decline. Then the price touches the Swing Low. However, the surprise was a trade worth 500 pips!
As a general rule, one should not try to predict the exact reversal point. Focus on resistance and support zones as potential areas. You then use the Japanese candlestick pattern to confirm a trend reversal. When the Japanese candlestick pattern appears at or below the Fibo level, you can enter an order.
Combining Fibonacci with reversal candlestick patterns
When using the candlestick reversal pattern, it means that the price will rotate in the opposite direction, meaning it will follow the previous main trend. The chart below shows that the EUR/USD currency pair last week had a downward trend. But for the time being, the downward trend has stopped. At this time, the trader may be thinking about how to execute a sell order. You can trace the Fibonacci line from the highest price 1.3364 (March 3) to the lowest price 1.2523 (March 6).
The price retraced to the 50% Fibonacci level before continuing to increase to 61.8%. Then the long-shadow Doji reversal candlestick pattern appeared. This shows that buying pressure is weakening. It also signals a potential entry point for a selling strategy.
After the Doji candlestick pattern appeared at Fibonacci 61.8, EUR/USD immediately reversed and dropped sharply to the old bottom. Traders will make a profit if they place a sell order.
Note, that you must wait until the candlestick pattern forms. You should not place buy or sell orders, but take time to observe. After understanding the price movements, start relying on the candlestick pattern to decide to enter the order.
Use Fibonacci extensions to determine profitable points
Taking advantage of Fibonacci extensions will help increase your chances of profiting in long-term trend trading. First, you choose a key Swing Low, then the nearest Swing High, and finally at the trend retracement level.
The chart below shows the price trending up and retracing towards the 0.618 Fibonacci level. The price then continued its upward momentum and surpassed the previous Swing High. At this time, take advantage of the Fibonacci extension to identify profit-taking points.
After hitting the retracement level:
- Price forms a bottom, surpasses the Swing High, and heads towards the Fibo Extension level at 1.
- The price touched 1,272 and then retreated to support level 1. Then the price rebounded, heading towards the resistance level of 1,618.
Level 1 and level 1.618 Fibonacci are potential profit-taking points. When setting up a trade for a downtrend, apply the same method as for an uptrend. However, you must select the Swing High point first and then select Swing Low.
In general, taking profits based on Fibonacci levels is a viable method. However, you must use Fibonacci extension levels with caution to determine resistance and support levels. The reason is because there is no way to know the absolute level of accuracy.
See more: Together XM Forex: Master the game, increase income
Use fibonacci sequence to set Stoploss
The importance of placing a stop-loss order is on par with knowing the effective entry and profit-taking points.
The first method is to place Stoploss above the next Fibonacci level. This method is suitable for short-term intraday trading. For example, a reasonable stop loss for a long trade at 38.2% of the Fibonacci sequence is higher than the 50.0% level. The success of this method of placing stops is influenced by the accuracy of the entry point. The capital market is very unpredictable. The seemingly stable resistance zone can still be broken by market fluctuations.
The second, safer method is to cut losses above the Swing High and below the nearest Swing Low. To limit risk during an uptrend and when you are in a long position, place a stop loss below the latest Swing Low where support may appear. If in an uptrend and you are in a short position, place a stop loss above the nearest Swing High where resistance may appear.
The advantage of the second method is increased command flexibility. It also allows orders to fluctuate more in response to market fluctuations. However, the downside is that traders need to reduce trading volume. This results in a lower R: R ratio. Broken Swing High and Swing Low levels can signal a trend reversal.
Summary
The article provides useful information about the Fibonacci sequence and how to apply the Fibonacci indicator in forex. At the same time, the applications of Fibonacci retracement have also been updated in detail. To better support your trading strategy, don’t forget to follow the Forex Trading next blogs.
FAQs
What are the important levels of the Fibonacci sequence?
23.6%, 38.2%, 50%, 61.8%, and 100% are important levels in the Fibonacci number sequence. These levels identify price levels that can act as support or resistance to the stock price.
How accurate is the Fibonacci indicator?
The Fibonacci sequence indicator is not 100% accurate. Traders need to combine with other tools to support trading.
Why is the Fibonacci Retracement indicator the most popular?
The popularity of this indicator can be explained by two main factors. These include simplicity and applicability to almost any trading instrument. Traders can use Fibonacci retracement to draw support lines, identify resistance levels, set stops, and set target prices.
