Fibonacci Currency Trading means using Fibonacci Ratios in making the entry and exit decisions in your trading. Fibonacci Ratios are also known as Fib Levels. Fib levels are 0%, 23.6%, 38.2%, 50%, 61.8% and 100%. The three most important fib levels are the 32.8%, 50% and 61.8%. It has been found that the market tends to react with a high degree of probability at these levels.
Fibonacci ratios are based on the famous Fibonacci Sequence that is obtained by adding the two previous numbers to find the new number. The sequence starts from 0. The first two numbers are 0,1. The following numbers are obtained by adding the previous two numbers to get the next number as said before.
So, the sequence develops like this 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89…
This sequence was discovered by an Italian mathematician in the 13th century. The most important thing about this sequence is that if you divide a number by the next number you will get 61.8%. In the same manner if you divide a number by the number two places ahead you will get 38.2%.
These ratios are also known as the golden ratios and it has been found that these ratios have important applications in nature. As far as the markets are considered, whenever a new move starts, it has been observed that the currency pairs or the stocks tend to make a pullback or reverse a percentage of the previous move.
This is the basis of Fibonacci Currency Trading. When a new move starts, we divide the previous move into 6 horizontal levels of 0%, 23.6%, 38.2%, 50%, 68.2% and 100%.
If the market moves from swing high to low and then turns up, first calculate the swing range by subtracting the high point from the low point in the swing. Then apply these ratios of 0, 0.236, 0.382,.5, 0.682 and 1 to the range and then subtract that number from the swing point high. That’s it you have got the fib levels. In the same manner, you can calculate these Fib Levels fro swing low to high.
However, you don’t have to worry much. Most charting software will calculate the Fib Levels automatically for you. Once the price action reaches close to these levels look for confirmation using candlestick patterns or other indicators for a possible retracement. This is how we use Fibonacci Ratios in currency trading.