Fibonacci is an enormous subject and there are many different Fibonacci lessons with unusual sounding names, but we are going to stick to two, the retracement and extension. Popularized by an Italian mathematician name Leonardo Bonacci known as Fibonacci.
Fibonacci Retracement Tool is one of the tools used in technical analysis and is created on the Fibonacci numbers.
The indication is to go long or buy on a retracement at a Fibonacci support level when the market is trending up, and to go short or sell on a retracement at a Fibonacci resistance level when the market is trending down. To be able to find these Fibonacci retracement levels, you have to find the latest significant Swing Highs and Swings Lows.
For downtrends, click on the Swing High and drag the cursor to the latest Swing Low.
For uptrends, click on the Swing Low and drag the cursor to the most recent Swing High.
A Swing High is a candlestick with no less than two lower highs on both the left and right of itself.
A Swing Low is a candlestick with no less than two higher lows on both the left and right of itself.
Now let’s see how to apply Fibonacci retracements levels to the currency markets.
This is a daily up trend chart of AUD/USD.
We strategized the Fibonacci retracement levels by clicking on the Swing Low at.74593 on July 27 and dragging the cursor to the Swing High at .77516 on August 10. The software will show you the retracement levels.
You will see on the chart, the Fibonacci retracement levels were .76751 (23.6%) .76260 (38.2%) .75864 (50.0%)and .75461(61.8%).
Right now, the expectation is that if AUD/USD retraces from the recent peak, it will find support at one of those Fibonacci retracement levels because traders will be positioning buy orders at these levels as price pulls back.
Now, let’s look at what happened after the Swing High happened.
Later on, around August 31, 2016, the market resumed its upward move and eventually broke through the swing high. Clearly, buying at the 38.2% Fibonacci level would have been a profitable long term trade!
Now, check out how we would use the Fibonacci retracement tool during a downtrend.
If you notice, there is a Swing High at 0.77539 on August 10 and our Swing Low at 0.74867 a few days later on August 31. The retracement levels are 73965 (23.6%), 74639 (38.2%), 75187 (50.0%), 75758 and (61.8%)
The anticipation for a downtrend is that if price retraces from this low, it could come across resistance at one of the Fibonacci levels for the reason that traders who want to play the downtrend at better prices may be ready with sell orders there.
Depending on setting on the chart, the Fibonacci retracement tool paints 5 or 6 levels. These links to Fibonacci numbers that show possible areas to which the price action will retrace to before the trend resumes. These Fibonacci retracement levels are:
Most of the retracements happens to the 38.2%, 50% and 61.8% retracements. However, there is no point in predicting because markets are changeable. And although these Fibonacci retracement levels are potential areas of entry, the trader must know the exact retracement level where an entry can be made.
Fibonacci extensions are used in Fibonacci retracement to forecast spaces of resistance and support in the market. These extensions include all levels drawn past the basic 100% level. They are commonly used by traders to decide the areas that will earn profits. One widely held extension, the 161.8% level, is used to set a price goal on a breakout of an ascending triangle this objective is calculated by multiplying the vertical distance of the triangle by key Fibonacci ratio 61.8%, and then adding the end result to the triangle’s upper resistance level.
The very first thing you need to know about the Fibonacci tool is that it works best when the forex market is trending.
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