Fibonacci technical analysis moves the market due to its sheer popularity! Get on board and be moved by it too, like a surfer catching a wave…
Somewhere around the year 1175 A.D. a man was born in Pisa, Italy who would forever change the face of mathematics across the Western world and become known as the greatest mathematician of the Middle Ages. We now know this man by the name Fibonacci, though he went under several names such as Leonardo of Pisa, Leonardo Pisano etc.
Amongst Fibonacci’s contributions to mathematics were the Fibonacci series or sequence. This is the sequence of numbers beginning with 0 and 1, and proceeding through subsequent numbers by adding the sum of the previous two numbers. So we get, 0+1 = 1; 1+1 = 2 and so on as below:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34 and continuing to infinity…
Notice how the figure at the right, which is drawn according to the principles of the Fibonacci sequence, resembles the structure of a snail shell. It is constructed by drawing circular arcs connecting the opposite corners of squares; this one uses squares of sizes 1, 1, 2, 3, 5, 8, 13, 21, and 34 (source: Wikipedia)
Of course, our interest in Fibonacci is in how to apply its principles to forex trading. Most charting packages provide this indicator automatically. Metatrader 4 includes one indicator for Fibonacci plotting that is completely configurable.
The most common use of Fibonacci is using retracements for possible trade entries, stop trailing and exits. For example, after a significant move down, we draw our Fibonacci tool from the high to the low. This gives us a set of Fibonacci retracement levels where we might reasonably expect price to react if it begins moving up again.
The standard Fibonacci retracement levels are: 23.6%, 38.2%, 50%, 61.8%. (Most people accept the 50% level as a Fibonacci retracement level, but strictly speaking it is not really part of the Fibonacci series.)
Extra retracement levels include the 78.9%, and going one step further there are even a couple of exotic retracement levels which some traders use, namely around the 82% and 89% level.
It all gets to be a little confusing, but for the purposes of discussion here I will be using the following set of retracement levels:
Also, for simplicity, I usually drop the decimal point when referring to Fibonacci levels. This irritates purists, but it makes it easier for me!
Of course, after the 79% (78.9 for purists) the next level price reaches is when it retraces completely to the origin of the move, in other words the 100% level or the beginning of the move up or down. After that, price can can continue to retrace beyond the point of origin so that we get retracements equalling 127%, 162%, and some people even use the 262% as well.
There are also Fibonacci extensions, as well as retracement levels. The most common are the 127% and the 162%, and again, some people use the 262% as well.
So if we plot the above levels on a standard Metatrader 4 chart we get something that looks like the following:
Forex Chart with Fibonacci Levels Drawn
Notice how price reacts at some of the Fibonacci retracement levels, especially where those levels coincide with old support and resistance levels. This emphasises how, as with every worthwhile indicator, Fibonacci should only be used in conjunction with other indications of significant trader interest at certain price levels.
For example, we could use pivot points, we could use support and resistance areas and so on. In other words, Fibonacci is a very powerful tool when used in confluence with other indicators. Wherever a significant Fibonacci level coincides with another forex indicator, price is likely to react.