An Introduction to Fibonacci Ratios and Levels
As you study the fluctuation of the currencies in the forex market, you will notice that prices, after surging in a particular direction (be it up or down) will move back, or retrace their paths to levels near the Fibonacci numbers, hence the name of the instrument used in monitoring these movements.
Before learning how to use Fibonacci ratios and levels, it is important to learn what the Fibonacci numbers are. Basically, these are a sequence of numbers that when added together, brings up the next number in the sequence. Examples include the following: 1+1 = 2, 1+2 = 3, 2+3 = 5, 3+5 = 8 and so on and so forth.
By dividing Fibonacci numbers, ratios will appear: divide 34 by 55 and you will get 0.618. Divide 34 by 89 and the Fibonacci ratio will be 0.382. These numbers are crucial to the forex analyst because the support and resistance levels of currencies settle in the vicinity of these ratios.
The ratios are used in two types of Fibonacci levels. In Retracement Levels, the following ratios are important: 0.236 (23.6%), 0.382 (38.2%), 0.500 (50%) and 0.618 (61.8%).
In Fibonacci Extension Levels, the pertinent ratios are 0.382, 0.618, 1.000, 1.382 and 1.618. These can also be expressed in percentages.
The basic usage of Fibonacci levels involve taking the high and low points of the market (spread over a specified period). The computer software will then show the Fibonacci levels, and will help the forex trade decide on the appropriate steps to take.
Fibonacci Retracement Levels are often used by analysts to gauge the support and resistance levels of a forex currency, which aids in deciding whether to buy, sell or set up a Stop/Loss order.
If you are going to use the Fibonacci Retracement in a bullish market, the ideal way is to setup a Swing High and Swing Low chart and select the high and low points, and the Fibonacci levels near the support line will be apparent. In a market going down, the same process is used by the forex analyst, except the ratios to look for are in the resistance levels.
While Fibonacci Retracement Levels are used mainly for setting buy/sell and stop orders, Fibonacci Extension Levels are utilized for profit taking. Again the process is the same; select the high and low points, and depending on whether the forex is up or down, the ratios for the support and resistance levels will be clear.
What makes Fibonacci levels effective is that forex traders almost always buy or sell at these numbers. However, the challenge lies in knowing which ratio the support and resistance levels will settle in.
Fibonacci ratios and levels may seem confusing at first, but the fact is that most of the calculating is performed by your software. The more you utilize this instrument, the easier and more profitable your forex career will be.