Fibonacci in the Forex Market
Forex traders utilize Fibonacci retracements to aid in identifying possible key levels of support and resistance. These levels are used as guidelines for traders looking to enter or exit the market along with appropriate risk management techniques.
How to Create a Fibonacci Retracement on a Forex Pair
Before delving deeper into practical examples, traders need to have a basic view of the overall market being analyzed (EUR/USD or USD/ZAR etc.). This starts by identifying the trend; this can be long, medium or short-term depending on trading style. There are various methods that can be used to identify the trend such as simple price action, indicators like Moving Averages (MA) , as well as other methods. The reason why identifying the trend is important is because the Fibonacci tool itself does not determine a trend bias, rather it identifies key support and resistance levels.
Implementing the Fibonacci retracement requires identifying a large move either up/down on the forex price chart. This will produce key levels using Fibonacci metrics. The dueling nature of a forex pair has the tendency for mean reversion, which can produce major moves from which Fibonacci retracements can be drawn.
The key levels to look out for are the 38.2% and 61.8% respectively. The 50% level is not technically a Fibonacci level but is often included in charting packages and regarded as an important threshold. This level simply marks half the market move between the initial high and low or vice versa. The chart below shows a simple implementation of the Fibonacci retracement on a GBP/ZAR daily chart. Highlighted in black are the respective low to high points which are used to plot the Fibonacci levels.
GBP/ZAR daily chart – uptrend:
<alt image desc> GBP/ZAR daily chart with Fibonacci
Chart prepared by Warren Venketas, IG
Traders may also utilize the Fibonacci retracement from a high to low price level as expressed on the USD/SGD chart below.
USD/SGD daily chart – downtrend:
<alt image desc> USD/SGD Daily chart with Fibonacci
Chart prepared by Warren Venketas, IG charts
Once the Fibonacci retracement is drawn, traders can use these price levels for possible entry and exit signals. The USD/CAD example below shows how price action tends to revert to the various Fibonacci levels. The blue rectangle highlights the area between the 61.8% and 38.2% Fibonacci levels. It is evident that price respects these two key support and resistance points. Traders may look to enter into short positions at the 61.8% - as a result of the preceding downward trend, with initial support coming from the 38.2% level.
It is important to note that the Fibonacci points should not be seen as concrete levels but rather guidelines or reference points. Price will not always trade at these exact levels. It is common to see price just falling short or pushing passed a level which can frustrate traders who look at exact levels. With reference to stop and limit orders, traders should give themselves some leeway for potential price fluctuations around the Fibonacci level. The chart below shows an example of this above the 23.6% level (yellow) where bulls are seen pushing price up but quickly reverting back down below the 23.6% level.
USD/CAD daily chart:
<alt image desc> USD/CAD Daily chart with Fibonacci
Chart prepared by Warren Venketas, IG Charts
This is the most simplistic form of the Fibonacci retracement within forex markets. The versatility of the Fibonacci retracement function means that it is not limited to one time frame as seen above. A more complicated approach involves several Fibonacci retracements across different time frames. Instituting multiple time frame analysis can allow for multiple Fibonacci retracements drawn from major moves. The next article in the Fibonacci series will go into more depth with and practical examples to show how exactly traders can implement this strategy.
Fibonacci Retracements to Help to See the Bigger Picture
Forex traders often make the mistake of relying solely on Fibonacci levels to take positions in the market but this can be detrimental as this can make them too one dimensional. Additional support from other indicators, chart patterns, candlestick patterns and fundamentals are essential to formulate a better overall strategy; and ultimately a well-informed trade decision. The Fibonacci can be an extremely powerful tool in forex trading so fully understanding its foundations can be beneficial to any trader looking to implement the tool within their trading strategy.
If you would like to try drawing Fibonacci retracements, this tool is available on IG’s platforms, and can be accessed with a demo account. To sign up for a demo account with IG Group, please click here.
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