Fibonacci retracement is a strategy that is commonly used for analyzing the potential areas of movement of the prices of currencies. The strategy is based on the notion that price will usually pull back or retrace a percentage (38%, 50%, or 61.8%) of the previous move before continuing to move in the original direction. Nearly all forex trading terminals have an in-built Fibonacci retracement tool to assist traders in carrying out technical analysis. In drawing Fibonacci retracement levels on charts, traders usually drag the tool from the highest swing low level to the lowest swing low level. A majority of professional traders have found this strategy an important asset in their traders’ toolboxes.
If you want to use the Fibonacci retracement strategy in your trading, it is of essence you know the Fibonacci series itself. An interesting aspect of the Fibonacci series is that it is present all around us. It is a sequence of numbers in which each number is the sum of the two numbers before it, and the sequence goes on infinitely. And, the ratio between the first four numbers is referred to as the golden ratio that is popularly used in the business of trading currencies. The ratio is roughly equal to 0.618 or 61.8 per cent to the next higher number. This key Fibonacci ratio is evident in many fields of study; thus, it is regarded to be very essential in carrying out analysis.
In the trading of currencies, the ratios of 0.382 (38.2%), 0.50 (50%) and 0.618 (61.8%), are popular among forex traders as they are regarded to be the most powerful in determining the likely points of retracements. Essentially, Fibonacci retracement strategy holds that the price of a currency pair will usually correct itself or pause when it retraces 38.2 per cent, 50 per cent and 61.8 per cent of the most recent price trend.
The main benefit you will get by adding Fibonacci retracement to your collection of strategies is that it assists you to determine your entry and exit positions in the market. If you plot the Fibonacci pattern on your charts, you will be able to know the potential areas of price reversals, and then enter or exit your trades accordingly. Nonetheless, it is important to note that just like with any other strategy for forex trading, Fibonacci retracement should not be used in isolation. Thus, its benefits can more if used together with another profitable strategy.