The Magic Of Fibonacci Numbers and How to Use Them In Your Trading

In this article, we will look at one of the most popular technical analysis tools - the Fibonacci retracement levels.

Fibo...who?

Fibonacci was a famous Italian mathematician.

He came up with the Fibonacci sequence of numbers, where each number is the sum of the two previous numbers, starting from 0 and 1.

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

Why is it used in trading?

The Fibonacci levels (or "Fibo levels") are considered a self-fulfilling prophecy. If enough traders keep an eye on those levels and use them actively in their trading, they will become levels of support and resistance.

The idea behind it is that prices never move in a straight line. After a large price movement, a retracement may follow before the prevailing trend continues. Fibo levels help traders identify levels where those levels of support and resistance are.

Which numbers are used in trading?

When you draw a Fibonacci retracement on your chart, you will notice that we do not actually use the numbers in the sequence. Instead, the ratios or differences between the numbers in the sequence are utilized.

Let´s have a look at the most popular one - 61.8 % - as an example. We get this number by dividing a number in the Fibo sequence by a certain number that succeeds it.

  • Example 1: 21 / 34 = 0.6176 %
  • Example 2: 144 / 233 = 0.6180 %

The major Fibonacci retracement levels are:

  • 2 %
  • 50 %
  • 8 %

Minor levels:

  • 6 %
  • 4 %

Some traders prefer to focus just on the major levels, while others like to include all of them.

Drawing a Fibonacci retracement

There are some basic rules that need to be followed when drawing Fibonacci retracements, but there is also a certain degree of discretion present. It already starts with the point where you choose to measure the Fibo retracement. Two traders might get different results, based on what they identified as major low/high. Generally, it is easier to practice on the higher timeframe charts, before moving down to the hourly or minutes charts.

Step 1:

Identify the major high/low. Looking at the USD/CAD Weekly chart below, it is obvious which two points we should connect.

Step 2:

Connect the two points (major high/low). In MT4, a trendline and the required Fibonacci levels will automatically appear.

Step 3:

Utilize the Fibonacci levels as support/resistance. A good example in the chart below is the 38.2 % Fibonacci, which was tested twice following the December 2018 high and from where the currency pair was able to recover.

How the Fibonacci levels are used

Most traders use the Fibo levels as classic support/resistance levels.

This means, they can be used as entry level or help traders determine their stop/take profit targets.

Example 1: A trader uses multiple technical analysis tools, and they all indicate that the USD/CAD uptrend will continue. However, the trader feels that in the short-term, the currency pair is oversold and that there will be another retracement before the trend resumes. As a fan of Fibonacci levels, he is looking at the area around the 38.2 % Fibo as a potential entry point.

Example 2: A trader who is currently long USD/CAD is trying to determine where he should place his stop loss order. As a user of Fibonacci, he sees that the 38.2 % level has acted as key level of support before, and he decides to place his stop 50 pips below it.

Fibonacci in MT4

Drawing the Fibonacci retracement on a chart in your MT4 could not be easier. You will find the "F" symbol in the menu at the top. Clicking on it will enable you to go back to the chart to draw the Fibo levels. Simply click on the high/low and connect it with the other point. The levels and trendline will automatically appear.

To adjust the Fibo tool (levels/colours) simply right click anywhere in the chart and select "Objects List". The Fibonacci retracement should appear there, and you can then select "Edit" in the menu on the right side.

Using Fibonacci levels with other tools

As Fibonacci levels are essentially classic support/resistance levels, it is not difficult to combine them with other technical analysis tools. While some traders may choose to build a whole strategy around the Fibo numbers, many of them use it as a supporting tool.

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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