Fibonacci retracements are a technical indicator used by many traders in the forex market. This indicator is based on the Fibonacci sequence, a series of numbers where each number is the sum of the two previous numbers. The Fibonacci sequence can be applied to many different aspects of trading, but it is most commonly used concerning price action.
Fibonacci retracements are used to identify potential support and resistance levels. These levels are based on the Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. These ratios represent the percentage of a move retraced before continuation in the original direction. For example, if the price of a currency pair moves from 1.0000 to 1.1000 and then retraces to 1.0500, this would be a 50% Fibonacci retracement.
Fibonacci levels can be used with other technical indicators or chart patterns to provide traders with potential trade entry and exit points. If you’d like to put your knowledge to test, you can open an account with Saxo Markets. Saxo offers a demo trading platform so you can practise technical analysis without risking any real capital.
How to use Fibonacci retracements in the forex market
Identify the trend
Firstly, you will need to identify the overall trend. This can be done by looking at the price action on a longer-term timeframe, like the 4-hour or daily chart. If the price is an uptrend, you will look for buying opportunities near Fibonacci support levels. Conversely, if the price is a downtrend, you would look for selling opportunities near Fibonacci resistance levels.
Apply Fibonacci retracements to a shorter-term timeframe
Once you have identified the overall trend, you can switch to a shorter-term timeframe and apply Fibonacci retracements. For example, if you are trading on the 4-hour chart, you could switch to the 1-hour chart to apply the Fibonacci retracements.
Look for confluence with other technical indicators
After applying Fibonacci retracements to a shorter-term timeframe, you should then look for confluence with other technical indicators or chart patterns. It will help to improve the accuracy of your trade entries and exits.
Some common technical indicators you can use in conjunction with Fibonacci retracements are:
- Moving averages
- Bollinger Bands
- RSI (Relative Strength Index)
- MACD (Moving Average Convergence Divergence)
Enter your trade
Once you have found a potential trade setup that meets all of your criteria, you can enter your trade. If the price is an uptrend, you will look for buying opportunities near Fibonacci support levels. Conversely, if the price is a downtrend, you would look for selling opportunities near Fibonacci resistance levels.
Place your stop-loss order
After entering your trade, you should then place your stop-loss order. It will help protect your capital if the market moves against your position.
You should place your stop-loss order below the most recent swing low (for long positions) or above the latest swing high (for short positions).
Take profit at Fibonacci resistance levels
If you are in a long position, you will take profit at Fibonacci resistance levels. These levels are typically used as potential exit points for traders looking to take profits.
You should place your take-profit order above your entry point at the next Fibonacci resistance level.
What are the risks of using Fibonacci retracements?
There is no guarantee that the market will retrace to a Fibonacci level
The market may continue toward the trend without retracing it to a Fibonacci level. It can result in missed trade opportunities or stop-loss orders being triggered prematurely.
The market may reverse at a Fibonacci level
The market may reverse at a Fibonacci level, resulting in losses if you have placed a trade in the opposite direction.
A false breakout is when the market breaks out of a Fibonacci level but quickly reverses back into the range. If you have placed a trade in the breakout direction, it can result in losses.
The market may not move in a linear fashion
The market may not move linearly, making it challenging to apply Fibonacci retracements.
The market may move in a zig-zag pattern
The market may move in a zig-zag pattern, making it challenging to apply Fibonacci retracements.
You may miss critical Fibonacci levels
You may miss critical Fibonacci levels if you are not paying attention to the market. It can result in missed trade opportunities or stop-loss orders being triggered prematurely.