Trading Forex price swings using Fibonacci numbers is a common Forex trading technique. Today, I’ll show you exactly how the Fibonacci sequence applies to trading Forex.
Fibonacci Ratios in Uptrend Trading
Just as we see Fibonacci numerical sequences and ratios in nature, we can see them in Forex trading. In fact, in an uptrend, Fibonacci ratios are hidden levels of support and can give important entry and exit signals.
When trading Forex in an uptrend, the Fibonacci ratios represent the up swing retracement as a percentage of the up price swing. Imagine that the bottom of the up price swing (the low) is 100% and the top of the up price swing (the high) is 0%.
The retracement (the market’s downward reaction to the up price swing) will cover some percentage of the original swing, from 0 to 100%. If the retracement covers 38% of the up price swing and then bounces (turns into a rally which could potentially lead to sideways movement or an extension) then it is said to have bounced at the .382 Fibonacci ratio.
If the retracing market bounces at 50%, 62%, or 79% then it is said to have bounced at the .500, .618, or .786 Fibonacci ratios, respectively.
If the uptrend is going to continue, the market will, after bouncing at one of the four Fibonacci ratios, rally and form an extension (remember that to qualify as an extension the market must make a new high). This is important to understand for trading Forex.
The extension will likely either extend to 162% of the original price swing or 127% of the original price swing, and then bounce there. Specifically, if the market bounces at the .382, .500, or .618 lines then the extension will cover 162% of the original up price swing (that is, the market will extend from the .382, .500, or .618 line to the 1.618 line).
If the market bounces at the .786 line, then the extension will cover 127% of the original price swing (that is, the market will extend from the .786 line to the 1.27 line).
To visualize the extension, imagine that the beginning of the original up price swing (the first low) is at 0 and the end of the original up price swing (the first high) is at 100. Then the extension will either be at 127 or 162.
It is in this sense that in an uptrend, Fibonacci ratios are hidden levels of support in Forex trading. As the market swings within the overall trend, it bounces (making higher lows) at the Fibonacci ratio numbers.
Uptrends move at different speeds – The speed of the trend is defined by how sharply it is rising in Forex trading. Notice that the smaller the Fibonacci ratio, the faster the market trading Forex moves.
This is because the market is retracing less after a price swing, moving more quickly to the extension and the continuation of the trend. In contrast, the higher the Fibonacci ratio, the slower the market moves. With Forex trading, the market retraces a larger percentage of the original price swing, so it moves less rapidly to the extension and the continuation of the uptrend.
Imagine that if the Fibonacci ratio were 0 (that is, the retracement covered 0% of the original price swing), then the market would be moving straight up. If the Fibonacci ratio were 1 (that is, the retracement covered 100% of the original price swing), then the market trading Forex would be moving horizontally (sideways).
While neither 0 nor 1 is a Fibonacci ratio, it is useful to visualize how the market would move if they were. A Fibonacci number closer to 0, then, moves more closely to straight up which a Fibonacci number closer to 1 moves more closely to horizontally (sideways).
Be careful that if the market is slowing down when it bounces at .318, .500, or .618 it may not immediately go into an extension (it may not immediately go to 1.618). It is possible that, if the market is slowing down, after bouncing at .318, .500, or .618, it may first extend to 1.27, bounce there, and then fully extend to 1.618.
In the next blog post I’m going to explain how to use Fibonacci numbers in downtrend Forex swing trading.
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