The lines of Fibonacci retracement are based on the Fibonacci sequence. They are regarded as lines that can predict in the form of technical indicators. They give feedback on a possible scenario of the levels of exchange rates in the future. There are many traders who depend on the Fibonacci Retracements and they like to predict the future exchange rates by using these lines. Technical analysts also use these retracements widely.
As a forex trader, it is recommended that you need to know how you can interpret the Fibonacci numbers. It is wiser to search for additional sources to back up your initial analysis before you start basing larger trades on the Fibonacci Retracements or Fibs, as they are popularly known.
Understanding the Sequence of Fibonacci
It is a series of numbers which occur consistently. Their discovery is attributed to the famous mathematician of the thirteenth century, Leonardo Fibonacci. They were also made popular by the novelist Dan Brown in his blockbuster novel, `Da Vinci Code’. The technique for calculating the Fibonacci sequence is to add any number together with the number that precedes it in a sequence. With the assumption that the initial two numbers are 0 and 1, the calculation for the first ten numbers in the sequence can be done in this way:-
0 + 0 = 0
0 + 1 = 1
1 + 0 = 1
1 + 1 = 2
2 + 1 = 3
3 + 2 = 5
5 + 3 = 8
8 + 5 = 13
13 + 8 = 21
21 + 13 = 34
The first ten numbers will be 0, 1, 1, 2, 3, 5, 8, 13, 21, 34.
Series of ratios can be derived from the Fibonacci sequence. These ratios take on a very important meaning to the forex traders. The most significant Fibonacci ratio is 61.8% and it is popularly called the `golden ratio’. It is also known as the `golden mean’. It is considered to be a reliable ratio for retracement. It is derived by dividing any number in the Fibonacci sequence by the number that follows it. The answer will always be 61.8%. The other important ratios are 38.2% and 23.6%. The first ratio is obtained by dividing any number in that sequence by the number which is two places to its right and the second ratio set is obtained by any number divided by a number which is three places to its right. In the forex market, levels of retracement can also be pegged at 100% and 50%. This video will give you an understanding of the Fibonacci retracement lines,
Fibonacci Retracement can predict forex rates in the future
By inserting the Fibonacci lines over a price chart and extending them past the existing spot rate, you can establish each of the retracement points. You can then adjust your trading strategy in the future. The levels of retracement can indicate potential resistance and support levels as the rate is retraced in an upward direction. If the exchange rate goes below the retracement level with the trend showing an upward move, you can then go on to the next level in the Fibonacci sequence as a resistance level in the future for the currency pair being studied. When the trend is downward, the opposite approach will apply.
Setting stop loss instructions based on Fibonacci Retracements
It is a challenge to identify possible swings and the extremity in price levels when you work with the Fibonacci Retracement lines. It is not easy to locate an upward or a downward trend that emerges and one that can retrace back to its previous low or a high. A safe strategy used by many traders is to take the Fibonacci Retracement lines as a guiding force for executing stop loss instructions for limits. To cite an example, if the prices are moving upward and you are holding on to a long position, you may consider placing the stop loss just below the last low swing rate. As this swing low rate may often become a support level, the fall in the price is likely to recover before it falls actually through a support level, previously. When you set the stop loss instructions just below the support levels, it will reduce the loss because it will be triggered when the rate falls below the determined support level. The exchange rate may retrace to the high swing but it is not very likely to surpass it. Hence, when you set the stop loss a little above the level of resistance, it will indicate that the stop loss will be triggered only when the resistance level gets broken.