Fibonacci

This has to be one of the most fascinating mathematical calculations used in forex & life. I am absolutely rubbish at maths. I can work out the basics & profit % etc, but throw algebra and fractions at me then I am lost. When all of my kids reached 12 years of age I could no longer help them with their homework. But fibonacci & the golden ratio* blew my mind.

It is far too complex a story for me to relate now, but the important thing for budding forex traders is that IT WORKS. (If you want to know more about this fascinating subject check out the links at the bottom of the page).

Fibonnaci & Forex

Some forex systems trade solely using fibonacci. Personally I think thats a little bit nuts. There are lots of indicators available to a forex trader, some would argue too many. So, as with all things in life, we need to find a fair balance. If you use too many indicators then the danger is you never make a trade as there is always going to one indicator that contradicts the rest. "This is known as paralysis by analysis." 

Fibonacci for me is an essential part of my trading toolkit. The basic premise of fibonacci is that it provides area of support & resistance and most importantly areas where a reversal is likely. Therefore we can use fibs, as forex traders call them, to look for entries & exits. 

Why fibonacci works

Because so many traders use fibs, then they become a self-fulfilling prophecy. If 90% of traders have them on their screens, then they are going to be looking for the same thing. The way in which fibs work is this. Markets rarely, if ever, go up or down in a straight line. What happens is that a strong movement (as buy & sell orders automatically kick in) is normally followed by a period of reflection - known in forex as a pullback.

Basically traders are taking a time out whilst they decide where the market is going next. A trader who trades soley with fibs is looking for entries & exits around the 50% area and specifically at the golden number, 61.8%. The following example, which took place february 2009 on the GBP 4 hour chart, is a classic example of fibonacci in action. 

The market was heading down, so I set the fibs going down. With me so far !
The market then retraced initially to 50%, which would have given a fib trader a possible entry point. The market then ranged between 23.6 retracement  & 100% before pulling back for a text book 61.8% entry. The exit on this was spookily text book as well. From my experience a 50% retracement will often stop at 100% (as below) & 61.8 will stop at 121.4

On the following pages I will show you how to set up your fibonacci indicator on metatrader. How to decide which direction to place the fibs. Up or down again. Lets keep this simple !

If you would like to know more about the spooky & fascinating world of
Leonardo Fibonacci have a look here http://en.wikipedia.org/wiki/Fibonacci

Next Page: How to use fibonacci in forex