How Using Fibonacci Levels Can Improve Your Trading

Leonardo Fibonacci was an Italian mathematician who lived in thirteenth century Italy

. He was not the first to observe repeating patterns and ratios in nature however his studies led to our understanding and the application of Fibonacci in Forex as it is today.

From his studies he discovered a particular number series that was applicable to the natural proportions of matter it in both nature and the universe.

The Fibonacci sequence is a numerical sequence beginning with 1. Each subsequent number in the series is created by adding together the two previous numbers. Therefore the second number would be 1+1, the third number 1+2, the forth number 2+3 and so on. From this sequence (1,2,3,5,8,13,21...) he identified what became known as the Fibonacci Golden ratio. If you divide any number in the series after 3 by the next highest number the resultant answer is 62.5. The more you carry on up the number closer this ratio comes to 61.8%, which is termed the 'Golden Number.'

The ratios applied in Forex trading make use of this Golden Number and also set out additional incremental stages of this ratio. These are 23.2%, 38.2%, 50.0 % and 61.8%. The low point of the move is referred to as 0.0% and the limit of the price action move is referred to as 100.0%

These levels are used in Forex trading to project both price contractions and price extensions within the market.

1. Fibonacci retracement levels

Retracement levels are defined areas, based on the Fibonacci ratio, which aim to identify where the market is likely to pull back to after a preceding move. In an up trending market these are often term as a Fibonacci support level. In a market that is trending down these are called Fibonacci resistance levels. These provide a chance for traders to position themselves to enter the preceding trend after a retracement has competed.

2. Fibonacci price extension levels

While Fibonacci retracements can be used to profit following a market move, Fibonacci price extensions are used to predict how far a move is likely to travel. Again the Fibonacci retracement levels are applied but in this instance they are used as price targets for the trader to take profits.

Fibonacci levels tend to work due to the expectation of many traders watching and entering the market at these points. As result it can be argued that to some degree these levels become a self-fulfilling prophecy.

You can calculate Fibonacci levels by entering the high and the low of a move into a Fibonacci Calculator and apply them to your own charts.

Fibonacci levels make an important addition to the traders' technical toolbox. It is certainly worth thinking about Fibonacci retracement levels the next time you are analysing a trading opportunity. However as with the majority of technical methods it is safest to seek confirmation by the use of additional indicators rather than simply relying on Fibonacci methods alone.

by: Leo Forex

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