FIBONACCI RETRACEMENT LINES
A “predictive” technical indicator used by technical analysts to forecast possible future exchange rate levels.
IDENTIFYING POTENTIAL RETRACEMENT LEVELS
Fibonacci Retracements are considered a predictive technical indicator as they attempt to identify a future exchange rate. The theory is that after a rate spike in either direction, the rate will often return – or retrace – part way back to the previous price level before resuming in the original direction.
Given their popularity and widespread usage by technical analysts, it is good to know how to interpret Fibonacci numbers. However, as with any indicator, it is wise to seek confirmation from additional sources to bolster Fibonacci analysis before basing a large trade. When it comes to using Fibonacci Retracements as a technical indicator, trader discretion is advised.
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Introduction to Fibonacci
USING FIBONACCI RETRACEMENTS TO PREDICT FUTURE RATES
By placing the Fibonacci lines over the price chart and extending the lines past the current spot rate, you can locate each of the potential retracement points and, if you wish, adjust your trading strategy based on this feedback.
- The retracement levels show possible support and resistance levels as the rate retraces upwards. If the exchange rate is below a retracement level and the trend displays upwards momentum, you may wish to consider the next Fibonacci level as a potential future resistance level for the currency pair.
- In the case of a downtrend, you must take the opposite approach. When trending downwards, each Fibonacci retracement level identifies a potential support level where traders begin to buy the currency pair, thereby reversing the downtrend.
In the image note that we are basing our analysis on a 1-Hour chart. You can see that the rate fell from a recent high, and then tested the previous level of support before reversing. In this example we draw our Fibonacci retracement from the lowest low and extended it up to the highest high which automatically creates the retracement price levels. Notice that price reacted in some way at each of these fibonacci levels starting from the 23.6%, 38.2%, 50%, 61.8% (Golden Ratio Number), and at the 78.6% where the price really started to push higher to continue the uptrend.
When it comes to Fibonacci ratios and currency pair retracements, there may be more at play than first meets the eye. Few traders would argue that on its own, the Fibonacci Sequence has a direct effect on currency prices. However, if enough market participants believe that a retracement could occur near a Fibonacci ratio level and act accordingly, then all those pending orders could impact the market price.
FIBONACCI EXTENSION LINES
Notice the 1.618 Fibonacci extension in this example. This level is a highly looked at level known as the Golden Ratio number. You can use this Fibonacci extension levels in 2 helpful ways:
1. Traders can use the extension levels as an area to focus on for a target area. The 1.618 extension can measure for you a natural price movement which occurs all the time in your charts. If you know this level already by using your Fibonacci extension tool then you can use this level to place your targets. Many traders find it difficult to know where to take profits, and find themselves taking very small profits while having larger stop losses. Understanding these extension numbers can help predict where a likely area price could go especially when trading inline with the underlying trend.
2. Locate price areas where price could exhaust once its completed a natural price movement to a 1.618 Fibonacci number. This can be very helpful when a trader sees a trend and is looking for ways to enter the move. One way could be to wait for price to retrace to a 1.618 extension level and look for signals that tells you price can start to continue in the underlying trend on a larger timeframe.
IDENTIFYING SWING HIGHS AND SWING LOWS
A “Swing High” is identified by showing a recent high with two lower highs on the left and right of the high itself. This is known as a “Head and Shoulders Pattern”.
A “Swing Low” is characterized by a recent low with at least two higher lows on either side of the low itself. This is known as a “Reverse Head and Shoulders Pattern”.
SETTING STOP LOSS ORDERS BASED ON FIBONACCI RETRACEMENTS
Traders use Fibonacci Retracements as guidelines to place stop loss limits. For example:
When prices are trending upwards and you hold a long position, one consideration is to place the stop loss just below the latest swing low rate. Because the swing low rate sometimes becomes a level of support, a falling price may recover before it actually falls through a previous support level.
When trading in a downtrend and you are short the currency pair, the usual approach is to set a stop loss just above the swing high as this could represent a potential resistance level
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