Fibonacci levels - how to use in trading?

What are Fibonacci levels? How to use Fibonacci levels in trading? How to determine with their help price reversals and the end of the correction? How to build and trade Forex Fibonacci levels?

Welcome you friends! In this article we will look at one of the most popular technical analysis tools - Fibonacci levels. This is a technical indicator that detects various patterns in price dynamics that cannot be determined with the naked eye. Fibonacci levels in trading work best in a trending market. As you know, in a trending market, prices always come back, then to move further along the trend. This is called correction. The idea of Fibonacci is to determine the level of completion of the correction and enter the market at the best price, and also exit the transaction on time before the price reversal occurs. In this article you will learn what Fibonacci numbers and sequence are, how to build Fibonacci levels in a trading terminal, how to determine the end of correction with their help, and how to trade by Fibonacci levels.

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Who is Fibonacci?

Leonardo of Pisa (also known as Leonardo Fibonacci) was an Italian mathematician in the 13th century. He studied mathematics and is known for popularizing Hindu-Arabic numbers in Europe.

In his book Liber Abaci (The Book of Abacus), Leonardo described a sequence of numbers that return a constant ratio when dividing one number by the next number in the series. Each number in the Fibonacci sequence is equal to the sum of the two previous numbers. Example: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.

What is interesting in this sequence is that it always returns the same ratio when dividing one number by the next number in the series, excluding the first few numbers. For example, 34/55 is 0.618, just like 55/89, 89/144, 144/233, and so on. This ratio (0.618) is well known as the Fibonacci Golden Ratio and can be observed in various natural phenomena.

By dividing each number by the second number on the right, you always get .382. For example, 13/34, 21/55, 34/89 and 89/233 all return .382 as a result.

When used in trading, traders apply these ratios to determine possible zones of support and resistance. In financial markets, the most commonly used Fibonacci levels are 23.6%, 38.2%, 50%, 61.8%, 76.4%. In a strong buying market, traders expect recovery to 38.2%, while in a weaker trend, traders expect recovery to 61.8%.

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How to plot Fibonacci levels on a chart?

You can find Fibonacci levels in the MetaTrader 4 trading terminal in the graphic tools: Insert - Fibonacci - Fibonacci lines. You can also find the F symbol at the top of the toolbar of the trading terminal. By clicking on it, you can return to the chart to draw Fibonacci levels. Just click on the minimum price and, without releasing the left mouse button, connect it with the maximum for an uptrend. In a downtrend, it is necessary to combine a maximum with a minimum price. By double-clicking on the inclined Fibonacci line, you can delete or edit this tool.

There are some basic rules that you must follow when building Fibonacci levels. It is always necessary to remember that Fibonacci levels are a subjective tool for technical analysis. Two traders can get different results based on how they determined the main low / high price when building levels. As a rule, it is better to practice on charts with higher time frames before moving on to hourly and especially minute charts.

STEP 1. Define the main high / low. Looking at the weekly USDCAD chart, it is obvious which two points we should connect.

STEP 2. Select the Fibonacci Levels tool and connect the two points (minimum and maximum prices). In MT4, the trend line and the necessary Fibonacci levels will automatically appear.

STEP 3. Use Fibonacci levels as support / resistance. A good example in the chart below is the 38.2% level, which was tested twice, after which the price was able to move up.

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Fibonacci Trading

Most traders use Fibonacci levels as classic support / resistance levels. This means that they can be used as an entry level or help traders determine their goals: stop loss and take profit.

Example 1. A trader uses several technical analysis tools, and all of them indicate that the upward trend of USDCAD will continue. However, the trader feels that in the short term currency pair is overbought, and what else will happen one rollback before the resumption of the trend. As a fan of Fibonacci retracements, he sees the area around 38.2% as a potential entry point.

Example 2. A trader bought USDCAD and is trying to determine where he should place his stop loss. He sees that the 38.2% level previously acted as a key support level, and decides to place his stop loss 5 points below it.

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Fibonacci levels are a powerful and popular technical analysis tool. They work best in a trending market. Traders can use Fibonacci to determine significant support / resistance levels. Do not forget that Fibonacci levels are subjective and depend on the accuracy of determining the highs and lows of the price. It is necessary to build Fibonacci levels from minimum to maximum in an uptrend, and from maximum to minimum in a downtrend. The most popular Fibonacci retracements are 38.2%, 50% and 61.8%.

Now you know how to use Fibonacci levels. You can use this tool alone to generate trading signals, but for greater confidence in your trading decisions, combine them with others indicators or technical analysis tools. Happy trading!

Read also the article "What are the types of Forex charts?".