The Fibonacci retracement is considered a predictive technical indicator that can help investors gauge future levels of a currency pair after a sharp increase or decrease in price. More specifically, plotting the lines of the Fibonacci retracement on a chart can help traders find points of support and resistance on which to place stop-loss and take-profit orders.
The Fibonacci retracement is popular among forex traders, and when used in combination with other technical analysis indicators, it can bolster any trading strategy.
The levels marked by the Fibonacci retracement derive from a sequence of numbers that the 13th century mathematician Leonardo Fibonacci discovered, and which seems to consistently recur in nature.
Traders, however, don’t need to understand the mathematical equations behind the sequence in order to use the Fibonacci retracement.
A trading platform offering the Fibonacci retracement tool, such as the FXTM platform, will automatically calculate the appropriate levels of the equation.
Traders simply need to identify the Swing High and the Swing Low points or either an uptrend or a downtrend and draw a horizontal line at the level of each point so as to measure the distance between them.
The Fibonacci retracement tool will calculate five levels in between these points, at 23.6 percent, 38.2 percent, 50 percent, 61.8 percent, and 78.6 percent of the distance.
By extending the lines of these percentages beyond the current spot rate, traders can identify the possible retracement levels that the price will hit before turning once more to continue on its previous upward or downward path. With these indicators plotted on the chart, traders can review and adjust their trading strategy accordingly.
For example – if a falling price moves past a Fibonacci retracement level, it is likely to find support at the next one, and traders monitoring that level (after corroborating the validity of the signal with other technical indicators as well) might want to place a stop-loss order for their trade at that level.
Conversely, if a rising price climbs beyond a Fibonacci retracement level, it can give traders good reason to consider placing a take-profit order near the next level, as the price might change direction once it hits that point.
The adaptability of the Fibonacci retracement to a variety of charts and time frames has made the tool one of the most popular ones among forex traders.
As with all technical indicators, however, the Fibonacci retracement levels provide only suggestions regarding the future movements of a currency pair that traders need to analyse and cross-reference with other signals, before deciding on whether or not to incorporate them into their trading strategy.
Technical indicators are a great aid in reading forex charts and understanding how the market might move, but they do not eliminate the risks associated with forex trading.
Disclaimer: The content in this article comprises personal opinions and ideas of the writer and not that of Nigeria CommunicationsWeek
Lukman Otunuga is a Research Analyst at FXTM
—