The forex trading world has been using technical analysis indicators to get the upper hand in trading the trends. Fibonacci retracements use ancient mathematical scripts to evaluate the price movements and help identify support and resistance levels.
Throughout history, mathematical proportions and ratios have been used and continue to be used in everything from determining the shape of snail shells to the construction of buildings. However, if you want to use Fibonacci’s mathematical principles to inform your forex trading strategy, you need to understand the retracement concepts.
Understanding Fibonacci Retracements
When using Fibonacci retracements in forex trading, the areas of support are indicated when the price stops decreasing and vice versa for when the price stops increasing. On the trading chart, Fibonacci retracement levels are drawn in close relation to the price of the asset to be evaluated. Hence, it appears as a horizontal line on the chat that works by identifying retracement levels for analysis purposes.
To determine these levels, the trendline connects between the high and low. Ratios established at 61.8%, 38.2%, and 23.6% stratify the vertical distance. 50% is commonly used as a retracement level in this method of analysis. These retracement levels are valuable for forex traders because they help us evaluate the price action to predict future price behavior.
Evaluating the price action using Fibonacci retracement will help you identify strategic opportunities to buy orders, set stop losses, target prices, and much more.
You can combine this concept with other indicators like Tirone levels, the Elliot wave theory, Gartley patterns, among others. Resistance and support levels can be seen after significant price movements. Unlike moving averages, Fibonacci retracement levels don’t change over time; they are static price levels.
Hence, the identification becomes simple using these retracement levels, allowing you to react very fast when a price level changes. Think of these levels as infection points where you can expect either a break or rejection in the price action.
Creating a Trading Strategy using Fibonacci Retracement
You can use Fibonacci retracements for a few trading strategies. For instance, in bullish or bearish price action, you can use 38.2% and 61.8% retracement levels to determine a continuation pattern, as well as correlation and pullback degrees. You can deploy a breakout strategy if the retracement appears to be active in indicating resistance or support levels.
You can also adopt another strategy using the 38.2% retracement level to take long positions using a stop-loss order below 50% retracement level. You can alternatively use the 61.8% level to place a stop-loss order and enter a long position at a 50% level.
Around the peak of a big move, you can also deploy Fibonacci retracement levels in short order and use the levels as take-profit marks. However, while Fibonacci levels are popular technical indicators being used in forex trading, they don’t consider variables that affect the price action like trading volume, volatility, and other crucial data points, which makes them limiting at revealing more about a trading pair.
They purely reflect an asset’s price on the chart in relation to the previous price. Therefore, we recommend using Fibonacci retracement levels with other technical information for accurate predictions.
According to the key ratios, if you use the retracement levels, you can set target prices or stop losses because you can measure and evaluate continuation patterns through Fibonacci numbers. Resist looking at the same levels because prices can just fall short or push past a level.
Give yourself leeway for any potential price fluctuations around these retracement levels with reference to stop and limit orders. The versatility of retracement levels is not limited to a single time frame but across different time frames. Hence, relying solely on the retracement levels to take a position in the forex market can be detrimental and frustrating.
Managing and molding a trading strategy is never easy, but by appropriately handling certain basics, it can be more accessible. The forex market always moves in waves, and the patterns keep repeating over time. Fibonacci retracement levels will help you mark reversal points. To position yourself for larger margins and better performance, we recommend combining Fibonacci retracement levels with other technical analysis indicators and strategies.