Fibonacci retracement is a method in technical analysis which helps traders determine support and resistance levels. When it comes to forex, traders have significant leeway in designing a custom trading strategy. However, there’s simply no substitute for technical analysis. From the very basic to the incredibly complex, all successful strategies seem to rely on some form of technical analysis.
The concepts of support and resistance are two of the most often discussed attributes of technical analysis. After all, these concepts are supposed to tell you which levels forex pairs have difficulty exceeding. Although there are many ways of doing so, very few compare to the Fibonacci retracement.
Fibonacci Retracement: An Introduction
Simply put, Fibonacci retracements help traders pinpoint where to place orders. This applies to market entry, take-profit orders and stop-loss orders. In other words, Fibonacci retracements are used to identify support and resistance levels.
Like other technical analysis tools, Fibonacci levels must be plotted on a chart. They are usually calculated after a market has made a large move either up or down. When this occurs, traders can plot the retracement levels by identifying swing highs and swing lows.
Fibonacci Retracement on MT4
Using MT4, you can simply click and drag the mouse from the lowest level of the chart (i.e. a swing low) to the highest level (i.e. swing high). In between them you will see a series of horizontal bars with the levels 23.6%, 38.2%, 50% and 61.8%. These are the Fibonacci retracement levels, or the areas of support and resistance. (Note that the 50% level wasn’t originally part of the Fibonacci sequence, but is plotted anyway because traders prefer to see the midway point of a major move.)
Traders often buy a forex pair when the price approaches or exceeds the 38.2% Fib. Level. They normally set a stop-loss order below the 50% level.
Traders also buy near the 50% level with a stop-loss placed around the 61.8% Fib. retracement.
Traders also sell their position near the top of the sequence.
The 61.8% retracement is usually the most significant because it tends to represent the maximum pullback area as bargain-hunters rush to take advantage of falling prices. In a downtrend, the 61.8% level often signifies that the buyers are overstretched, giving sellers the opportunity to enter the market.
Fibonacci Method in Combination with MACD
The Fibonacci method is commonly used alongside a momentum indicator, such as the Stochastic Indicator or the Moving Average Convergence Divergence (MACD). These tools help traders pinpoint better entries in the market based on short-term momentum.
The Fibonacci retracement might seem intimidating at first, but is very simple once you get the hang of it. If you can read horizontal lines and check a momentum indicator or two, you are well on your way to executing this extremely popular strategy.