The Fibonacci retracement is one of the most valuable and popular tools for forex traders. Most forex traders use it to determine essential support or resistance levels, place pending orders, or structure their trades. The best brokers, like the team at Saxo, use Fibonacci retracements often.
You can use the Fibonacci retracement tool on any time frame as it does not have a specific market bias as some other tools, such as moving averages, do. You can also use it in all types of trading strategies, including scalping, swing trading, and trend trading.
We will explain how to use the Fibonacci retracement tool with different chart patterns to improve your trading performance. Remember in trading knowledge is your primary component needed to remain calm in any situation, so read on and learn the basics of Fibonacci retracements.
Fibonacci Retracements – The Basics
Before we begin, let’s quickly go over the Fibonacci retracements tool and how it works. The number of levels that a trader will draw depends on their market bias or preference for a particular time frame.
For example, a long-term forex swing trader might prefer to use 61.8%, 100%, and 161.8%, while a short-term scalper will likely choose 38.2%, 50%, and 75%.
To draw these retracement lines on your chart, you would need to add the Fibonacci tool from your charting platform’s drawing tools section or download Inkscape (free) and install this free plugin. You can then enter the key support or resistance levels into their respective fields, e.g. 38.2%, and click the draw button. You will see a line drawn from your open price and create support or resistance levels depending on whether you drew above or below your open price.
What to look out for when drawing Fibonacci levels?
When choosing the key levels that you want to plot, it’s best practice to avoid plotting too many lines as this will make it difficult for other traders to follow and make it more difficult for yourself as a trader. I would recommend using three levels at most: 38.2%, 50%, and either 61.8%, 100%, or 161.8%. We chose these particular retracement values because they are closely linked with solid psychological numbers such as round numbers and psychologically significant Fibonacci levels.
You must avoid plotting these lines on obvious market structures such as double tops or bottoms instead of plotting them where you expect there to be strong support or resistance. It is the best place for any new traders wanting to use it in their trading strategies.
How can I use Fibonacci retracement levels?
Moving Averages: Another popular tool used by forex traders of all types, moving averages are a lagging indicator that shows the average price of a currency pair over a given time frame. They are beneficial when determining the market’s overall direction and act as dynamic support and resistance levels. There are various ways to use this tool; on its own as a trading strategy or combined with other tools such as Fibonacci levels.
Moving averages provide excellent support and resistance levels that you can use for several strategies, the most popular being the breakout strategy. This forex trading strategy is based on finding currency pairs trending upwards and placing buy orders just above the moving average.
Similarly, you could apply this strategy to currency pairs that are trending downwards using sell stop orders placed just below the moving average. You can also use moving averages in various other ways, from price action analysis to finding hidden divergence signals within your charts.
The application of Fibonacci retracement levels alongside a simple moving average can help you pinpoint precise areas where you should place your pending orders. For example, if you were trying to buy a currency pair that is trending upwards and you drew the Fibonacci retracement level at 38.2%, 50% and found that these levels coincided with your 5,10, 20, or even 200 simple moving average, then this would be considered an extremely high probability trade!
How can I use Fibonacci in my strategy?
Price Action: If you are familiar with price action trading patterns, adding the Fibonacci retracements tool to your chart could help give you even more confidence when deciding where to place your pending orders. Using the retracement levels alongside traditional forex trading patterns can significantly impact your overall trading performance.