How to Trade with the Fibonacci Tools
The Fibonacci tool in Forex is a sequence of numbers used to determine key levels at which the price action could retrace to, and by extension, continue the move in the direction of the trend. The concept of the sequence of numbers was derived from the Fibonacci sequence, which was discovered by an Italian Mathematician called Leonardo Fibonacci.
In financial analysis, the Forex Fibonacci calculator can be used in four different ways, but the commonest usage is in the technical analysis to determine retracements and extensions. The MT4 platform has two Fibonacci tools, which are referred to as Fibonacci retracement and extension tools.
In previous article, I wrote about Pivot Point calculation, so don’t forget to read it too.
Application of the Fibonacci retracement levels
One of the greatest dilemmas that newbie traders face is being able to determine when and where retracements are likely to occur, and when the price action resumes its move in the direction of the trend. Too often, such traders witness a situation where they make entries into the market when a trend is on, only to see the price retrace and take out their stops, then resume its regular move in the trend direction. In other words, the trader may get the trade call right but get his entries all wrong. The Fibonacci retracement tool is available to prevent this unfortunate situation from plaguing such traders.
What does the Forex Fibonacci software do? The Fibo retracement tool uses horizontal lines to determine areas of support and resistance. In order to use it, the trader should select the Fibonacci retracement tool, and carefully apply it to the high and low of the chart. The tool will now draw five horizontal lines, which correspond to the following Fibonacci retracement levels:
- 100% (the high of the chart)
- 0% (low of the chart)
These lines can then be used to gauge points of support and resistance, and this will help a trader to plot stop loss points appropriately. Traders who trade using support and resistance levels as entry and exit points will also find this tool very useful indeed.
In this chart example above, the market is in a downtrend for the GBPUSD. We used the daily chart to determine the trend because the longer time frames are better indicators of the trend of a currency pair.
In a downtrend such as we have above, the Fibonacci tool should first be applied to the candlestick high in the time frame, and then dragged to the low in the time frame. The Fibonacci retracement tool will then be visible as five horizontal lines, which correspond to the retracement levels mentioned above. From this chart, we can see that the retracement halted at the 61.8% Fibonacci retracement line before it continued the downtrend.
A trader that looking for profiting from such a move can use the Fibonacci retracement calculator to predict possible reversal points, and set a pending order to take the trade. In this case, the trader can set a Sell Limit order around the 61.8% Fibonacci level, set the stop loss beyond that point and set an appropriate profit target.
The same principles are used in an uptrend if we look at this chart below:
Here we can see that the price action retraced at the 50% Fibonacci retracement level before continuing its uptrend. The chart was expanded to show the full-price action that occurred post-retracement.
Fibonacci retracement calculator
The Fibonacci retracement calculator is a very indispensable tool in Forex trading. Most trading platforms don’t come with built in Fibonacci tool, but no worries – I have got an easy to use Fibonacci calculator for you that can be installed on any PC. You can download Fibonacci calculator here. The best part to all this is that the tool is not only powerful and easy to use but also free.
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