How to Use Fibonacci Retracement
Forex traders use Fibonacci retracements to help identify possible key support and resistance levels. These levels are used as a guide for traders who want to enter or exit the market along with appropriate risk management techniques.
HOW TO CREATE FIBONACCI RETRACEMENT ON FOREX PAIRS
Before delving deeper into practical examples, a trader should have a basic view of the entire market being analyzed (EUR/USD or USD/ZAR etc.). It starts with identifying the trend, this can be long, medium or short term depending on the trading style. There are various methods that can be used to identify trends such as price action, indicators such as Moving Averages (MA), as well as other methods. The reason why identifying trends is important is that the Fibonacci tool itself doesn't determine trend bias, but rather identifies key support and resistance levels.
Applying Fibonacci retracement requires identifying a large move either up/down on the forex price chart. This will generate key levels using the Fibonacci metrics. The dueling nature of forex pairs has an average reversal tendency, which can produce large moves from which Fibonacci retracements can be drawn.
The key levels to watch out for are 38.2% and 61.8% respectively. The 50% level is not technically a Fibonacci level but is often included in charting packages and is considered an important threshold. This level marks only half the market movement between the initial high and low or vice versa.
Once the Fibonacci retracement is drawn, traders can use these price levels for possible entry and exit signals. The USD/CAD example, shows how price action tends to return to various Fibonacci levels. The blue rectangle highlights the area between the 61.8% and 38.2% Fibonacci levels. It is clear that the price respects these two main points of support and resistance. Traders may look to go short at 61.8% - as a result of the previous downtrend, with initial support coming from the 38.2% level.
It is important to note that Fibonacci points should not be seen as concrete levels but rather guidelines or reference points. Prices will not always trade at this exact level. It is common to see prices simply falling short or pushing past levels which can be frustrating for traders looking at the right level. With reference to stop and limit orders, traders should allow allowance for potential price fluctuations around Fibonacci levels.
This is the simplest form of Fibonacci retracement in the forex market. The flexibility of the Fibonacci retracement function means it is not limited to one time frame. A more complicated approach involves multiple Fibonacci retracements across different time frames. Expanding multiple time frame analyzes can allow for multiple Fibonacci retracements taken from major moves.
FIBONACCI RETRACEMENTS TO HELP SEE A BIGGER IMAGE
Forex traders often make the mistake of relying solely on Fibonacci levels to take positions in the market but this can be detrimental as it can make them too one-dimensional. Additional support from other indicators, chart patterns, candlestick patterns and fundamentals is very important to formulate a better overall strategy; and finally a well-informed trading decision. Fibonacci can be a very powerful tool in forex trading so fully understanding its foundations can be beneficial for any trader who wants to apply the tool in their trading strategy.
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