How to use Fibonacci to trade Forex

Fibonacci analysis can improve forex performance for both short and long positions by identifying key price levels that show hidden support and resistance. Using Fibonacci in conjunction with other forms of technical analysis creates a powerful foundation for strategies that perform well in all types of market conditions and levels of volatility.

Leonardo of Pisa, a 12th-century monk and mathematician, discovered a number sequence that appears in nature and in classical works of art. While their studies were theoretical, these Fibonacci numbers show profitable applications in our modern financial markets, describing the relationships between price waves within trends, as well as how far the waves will go before reversing and testing previous levels.

The retracement levels of .386, .50 and .618 comprise the main Fibonacci structure found in charting packages, with levels of .214 and .786 adding depth to the market analysis. These secondary indices have grown in importance since the 1990s, due to the deconstruction of the technical analysis formula by funds seeking to ensnare traders using those criteria. As a result, the oscillations through the primary Fibonacci levels have increased, but the harmonic structures have remained intact.

For example, it was commonly believed that the .618 retracement would contain counter-trend swings in a strongly trending market. That level is now routinely violated, with the .786 retracement offering strong support or resistance, depending on the direction of the primary trend. Market traders and timekeepers have adapted to this slow evolution, altering strategies to accommodate a higher frequency of counterfeits and violations.

Historical analysis

The applications of the Fibonacci grid can be roughly divided into two categories, historical analysis and trade preparation. The first category requires an examination of long-term currency trends, identifying the harmonic levels that triggered major trend reversals. Active market players will spend more time focused on the second category, in which Fibonacci grids are placed over short-term price action to build entry and exit strategies.

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There is great synergy between the two applications because price levels discovered through long-term historical analysis work well with short-term trade readiness, especially at key turning points. Since currency pairs oscillate between contained limits through almost all economic conditions, these historical levels can affect prices in the short term for decades.

Given the small number of popular crosses compared to stocks or bonds, it makes sense to do a historical analysis of each pair, outlining the major trends and levels that could come into play in the coming years. Accomplish this task by stepping away from weekly or monthly charts and placing grids on secular bull and bear markets. The analysis should only be done once, as long as the price action does not exceed the highs or lows of the long-term grids.

EURUSD Historical Fibonacci Grid.

Image by Sabrina Jiang © Investopedia 2021

The EURUSD currency pair came to life in the 1980s near .90000 and traded through 1.42890 in 1995. It fell to an all-time low at .82300 in 2001 and soared to an all-time high at 1.60380 in 2008. A grid placed over The massive uptrend has captured all the price action in the last eight years. The initial drop from the rally high ended near the .50 retracement a few months later, with that level providing support during testing in 2010 and 2012. Meanwhile, a 2014 breakout found new support at the .618 retracement. , with the currency pair spending 2015 bouncing along that level.

Commercial preparation

Begin your trade readiness analysis by placing a single grid on the largest trend on the daily chart, identifying key inflection points. Then add grids at shorter and shorter time intervals, looking for convergence between key harmonic levels. Similar to trend lines and moving averages, the power of these levels tracks the relative time frame, with grids on long-term trends establishing stronger support or resistance than grids on short-term trends.

Many forex traders focus on day trading, and Fibonacci levels work in this place because daily and weekly trends tend to naturally subdivide into smaller and smaller proportional waves. Access these hidden numbers by spreading the grids through the trends on 15 and 60 minute charts, but add the daily levels first because they will dictate the major turning points during the 24 hour forex trading day.

Having a hard time figuring out where to place the start and end points of the Fibonacci grids? Stretching the grid through a major high and low works fine in most cases, but many traders take a different approach, using the first lowest high after a major high or the first highest low after a major low. . This approach follows Elliott wave theory, focusing on the second primary wave of a trend, which is usually the longest and most dynamic.

Interaction with other indicators

The reliability of retracement levels to stop price fluctuations and start against profitable fluctuations is directly correlated to the number of technical elements converging at or near that level. These elements can include Fibonacci retracements in other time periods, moving averages, trend lines, gaps, previous highs / lows, and indicators of relative strength reaching overbought or oversold extremes.

For example, multiple grids on a daily chart that align the 618 retracement of one trend with the .386 retracement of another trend increase the odds that the currency pair will reverse at or near that level. Add in a 50- or 200-bar moving average and the odds increase further, encouraging larger positions and a more aggressive trading strategy. This methodology applies to exits as well, telling forex traders to take profit when the price reaches a retracement level that shows multiple alignments.

EURJPY indicator alignment.

Image by Sabrina Jiang © Investopedia 2021

The EURJPY currency pair is selling from 133.75 to 131.05 in just six hours, creating a vertical trend reversal that offers a perfect fit for a Fibonacci retracement entry on the short side. The counter trend wave creeps up for four days, finally reaching the .618 liquidation retracement at the same time as the 200-bar EMA descending to the same price level, in a tight alignment. This increases the odds that the pair will turn down in a profitable short sale. The subsequent fall leaves almost 70% of the counter trend wave.

The bottom line

Add long-term Fibonacci grids to your favorite currency pairs and watch price action near popular retracement levels. Add short-term grids as part of daily trade preparation, using alignments to find the best prices to enter and exit positions. Add other technical indicators and look for convergence with retracement levels, increasing the odds that prices will reverse into profitable counter swings.

About the author

Mark Holland

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