How To Use Fibonacci Sequence Analysis

Leonardo Fibonacci was a world-renowned mathematician in the 13 century.  During the course of his personal studies he discovered a natural sequence of numbers that tended to reveal a natural order in the universe.  Fibonacci did not actually discover the sequence himself, but he did largely popularize it by using it in one of his major publications, Liber Abaci.  Many centuries later, stock traders noticed that when applied to a price chart, the Fibonacci sequence offered some fascinating insights.

Fibonacci In Financial Markets

Basically, when a financial asset such as a stock, commodity, or currency, is moving in a trend, it never moves from point A to point B in a perfectly straight line.  Instead, the asset will move forward 2 steps, back 1, move forward 3 steps, back 1.5, etc.  There is a certain rhythm to the forward movement of any asset in financial markets.  When traders began to apply the Fibonacci number sequence to financial markets, they noticed that the price of an asset will oftentimes retrace 38.2%, 50%, 61.8%, or 79% of its move before it will resume its forward direction in the direction of the trend.  Therefore, the Fibonacci number sequence was transformed into a trading tool to help traders discover possible reversal areas in trending markets when analyzing the market at an online brokerage.

In the picture above, you can see that price makes a strong move from the 1.1875 area up to a HI of 1.3330.  Then as it begins to retrace, traders use the Fibonacci Tool in order to determine how far price will retrace before it continues in its intended direction.  You can see in the first yellow shaded bubble that price hit the 38% retracement and bounced up several hundred pips in fx trading.  Then, price moved a bit lower down to the 50% retracement and bounced up again.  That bounce from the 50% proved to be the one that held, and the EUR/USD then resumed its upward trending direction.  Price eventually moved from the 50% fib level of 1.2600 up to a HI of over 1.4000 for a total move of 1,400 pips!

Fibonacci Extensions

Traders also discovered that Fibs were not only accurate in determining possible reversal areas in a retracement, but they also could be used as extensions in order to determine where price was going to go after it retraced and resumed the direction of the trend.

In the chart above, price makes a move from 1.2330 to a LO of 1.1875 as shown by the red arrow.  When price makes this move, traders then apply a fib to see where price may retrace.  You can see that price bounced at the 38% retracement for a nice 90+ pip trade, then price continue to move up and it bounced again at the 62% fib for a nice 100+ pip trade.  Then, as price continued to move up, traders are now looking at the 127% retracement at 1.2450.  Sure enough, price bounced there and moved down for over 200 pips. Forex Scalping Instructions will oftentimes make use of Fibonacci analysis. Note that this example is provided as an illustration and was prepared with the benefit of hindsight. It does not reflect any actual trading results.

How To Use Fibonacci As A Strategy

There are several keys to using the Fibonacci Tool correctly in the forex market or in any financial market.  First of all, it is best for Fibonacci analysis to be combined with other tools of technical analysis such as trendlines, support/resistance lines, Pivot Points, MACD, RSI, Stochastics, etc.  When Fibonacci analysis provides a particular trading signal, and that trading signal is confirmed by several other technical tools, then the trade probably has a decent probability of working out.  However, if Fibs are used by themselves, they are not that effective.

Furthermore, it is always best to enter trades in the direction of the overall trend.  Using Fibs to develop a counter-trend strategy is definitely a challenge and much more difficult than trading with the trend.

Bio: This article was provided by Forex Traders, an online resource for forex news and currency trading.