Forex trading is a rewarding skill that one who horns on the skill gets to enjoy the reward of their risk. This comes with the knowledge one has to acquire in order to have longevity and a path to profitability in Forex trading. Technical analysis happens to be a key factor for most traders to consider before buying and selling their trades.
Fibonacci tools are one of the tools used by traders and in this event we will focus in the Fibonacci retracement tool. Fibonacci retracement tool- one of the technical analysis tools are horizontal lines that indicate where support and resistance are likely to occur on a price chart over a specific time. The Fibonacci sequence is one of the most famous formulas in mathematics.The sequence originates from a mathematical formula that was coined in the 13th century by the medieval Italian mathematician Leonardo Pisano (“Fibonacci”). Each number in the sequence is the sum of the two numbers that precede it. So, the sequence goes: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, and so on continuing indefinitely. The Fibonacci retracements is used to show how much of a prior move the price has retraced. The levels are plotted as 23.6%, 38.2%, 61.8%, and 78.6% on the Fibonacci retracement tool.
Importance of Fibonacci Retracements
The retracement tool is important to traders as it helps in placing entry orders in trades. It can also be used to set stop loss targets and take profit targets in trades. Case in point, a price on a time chart may be bullish. After a consistent uptrend, a retracement occurs at the 61.8% level. Thereafter the price rallies back up. Since the retracement occurred at a Fibonacci level during an uptrend, as a trader, this offers you a perfect entry into the market for a bullish run. You therefore have to set a stop loss at the 61.8% level, as a return below that level could indicate that the rally has failed.
Fibonacci retracements also arises in other ways within technical analysis. Such as, it is prevalent in Gartley patterns and Elliott Wave theory. How this works is that after a significant price movement up or down, this form of technical analysis finds that reversals tend to occur close to certain Fibonacci levels. i.e. most likely 38.2%, 50.0% and 61.8%.
Fibonacci retracement levels are static prices that do not change, unlike other technical analysis tools such as the moving averages. The static nature of the price levels allows for quick and easy identification. That helps traders and investors to anticipate and react in a cautious manner when the price level is tested. These levels are points where some type of price action is expected, either a reversal or a break.
Difference between Fibonacci Retracements and Fibonacci Extensions
Fibonacci retracements apply percentages to a pull-back or reversal in the market, while the Fibonacci extensions apply percentages to a move in the trending direction. For example, If an asset class goes from $50 to $60, and then back to $55. The move from $60 to $55 is a retracement. If the price starts rallying again and goes to $70, that is an extension.
Cons of using the Fibonacci Retracement Levels
Since the retracement levels indicate where the price might find support or resistance, there is no assurance that the price will actually stop there. This is why other confirmation signals are combined in using the Fibonacci retracement tool.
This equally implies that as a trader, you should not only rely on one technical analysis tool as a confirmation to enter or exit a trade.