eToro – Forex Trading Forum

[djsheckie]

While, Fibonacci sounds like some kind of yummy Italian dish with a cream sauce it's actually the last name of a medeival Italian (well I did get the Italian part right)mathemetician famous for introducing the Fibonacci sequence of numbers.

The Fibonacci sequence is one where the first number is 0, the second is 1, and each number after that is equal to the sum of the previous two numbers in the sequence.

So for example: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34... etc.

Which is neat, but why should you care about some old Italian math nerd, and his number sequence?

Fibonacci is frequently used in FOREX trading, and while you can't rely on it alone it can help you find patterns in the data. If you're able to predict movements and find patterns obviously that can help you make more money, and that is always a good thing. :)

However, Fibonacci requires a bit of study and understanding before it can be implemented successfully. I'll be back later on with the specifics of implementing Fibonacci in your trading, but until then I must leave you in suspense. ;)

[djsheckie]

So how exactly does a nifty sequence of numbers help with or even relate to FOREX trading? Well, it's not so much the Fibonacci sequence itself as it is the ratios between the numbers.

If you divide any of the numbers in the sequence by the next higher number you'll always get .618 or 61.8%. For example, 21 divided by 34 equals .618.

It also works out that if you divide alternate numbers you'll get .382 or 38.2%. So take 21 divided by 55 and you’ll get .382 this is true if you divide any alternate numbers in the sequence.

You don't really have to know how these numbers are derived, but I thought it might be comforting to know that I'm not just making this up. :)

[djsheckie]

At any rate there are several Fibonacci ratios which are important to traders and they fall into two categories known as retracement levels, and extension levels.

Fibonacci Retracement Levels
0.236, 0.382, 0.500, 0.618, 0.764

The retracement levels are used for support and resistance.

Fibonacci Extension Levels

0, 0.382, 0.618, 1.000, 1.382, 1.618

The extension levels are used for profit taking.
So far this seems like a lot of mumbo jumbo but hopefully it’ll all come together in a minute so please hang in there.

To apply all these nifty numbers we have to determine whether our chart is in an uptrend or a downtrend. Then we need to identify the highest and lowest swings on our chart.

The swing high point is a candlestick that has no less than two lower highs on its left and right sides whereas, the swing low is a candlestick with two higher lows its left and right sides.

[djsheckie]

Once you have found the swing high and swing low you can either use a Fibonacci calculator to find all the retracement levels for you, or calculate the numbers yourself if you’re feeling particularly brainy.

The equation to find retracement levels in an uptrend is: C = B — (B — A) x N%

A being the swing low point, B is the swing high, and N is Fibonacci percentage you’re using (38.2%, 50%, 61.8%, etc.)

The equation to find retracement levels in a downtrend is: C = B + (A — B) x N%:

A being the swing high point, B is the swing low, and N is Fibonacci percentage you’re using (38.2%, 50%, 61.8%, etc.)

Once you have all your retracement levels all you need to do is plot them on them on your chart and if the currency retraces it should find support at one of these predicted levels.

Here's a sample chart with the retracement levels plotted. A is the swing low, B is the swing high, and C is where the retracement levels hit.

fibonacci_calculations.png (8.68 KB) Viewed 324 times

[djsheckie]

The Fibonacci retacement levels seem to play an important role in the stock market and many think that since traders are looking for these specific levels, and move on them that it becomes a sort of self-fulfilling prophecy. Often, the trend continues even once the price has retraced to one of the retracement levels listed above.

While the market generally finds either temporary support or resistance at the predicted Fibonacci levels it doesn’t always follow this pattern. Sometimes the market ignores the levels altogether and moves in a different unexpected direction. This might be due to the release of economic data, or other regional circumstances so it’s a good idea not to get too wrapped up in technical analysis or rely too heavily on tools like Fibonacci since you’re likely to get burned if you don’t keep some kind of balance. After all Fibonacci isn’t magic it’s just a tool, and like any tool is only as good as the person using it.

This pretty much sums up retacement levels next I hope to post a little more on finding the extension levels.

[djsheckie]

Alright, as promised I am posting on how to calculate the Fibonacci extension levels. Just to recap a bit the Fibonacci ratios used in trading are called the retracement and extension levels.

Retracement levels are used when calculating possible support and resistance levels.

When you have an uptrend you can use the Fibonacci Price Extension level to calculate the opportune time to take your profit.

However, you’ll first need to calculate the extension level. Here’s the equation need to find Fibonacci extension levels formula for an uptrend if you’d like to calculate it yourself.

D = B + (B — A) x N%

Once again A is our swing high point, and B is our swing low point.

[djsheckie]

Otherwise, if like me you have a bit of an aversion to math you can use the Fibonacci calculator of your choice, and save your brain power for the fundamental analysis.

One of the biggest problems when calculating your Fibonacci retracement or extension levels is determining which point to use as the swing low or swing high. One method you can use is to take the last possible swing low on the chart or alternatively you can calculate using the lowest possible swing low point in the last 30 bars.

Unfortunately, there isn’t a hard and fast rule for calculating the swing lows or highs so at times it can be a bit of a guess and that’s another reason why you shouldn’t rely too heavily on Fibonacci alone.