Fibonacci Trading - How To Use Fibonacci Numbers in Forex and Stock Trading

by Vahid | Technical Analysis | Thursday, January 17th, 2008

Fibonacci trading methods: After reading this article, please also read another article that I have written about using Fibonacci in forex trading: More About Using Fibonacci in Forex Trading

Fibonacci trading is becoming more and more popular, because it works and market, Forex or stock, react to Fibonacci numbers and levels. Fibonacci is a sequence of numbers discovered by Leonardo Fibonacci, an Italian mathematician: 0, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10946, 17711, 28657, 46368, 75025, 121393 …….

Fibonacci numbers are started by 0, followed by 1, and then the third number is calculated through adding 0+1 (the first and the second number). Then for getting the forth number (3), the second and third numbers should be added (1+2) and …….

It was easy so far, isn’t it?

Now if you measure the ratio of each number to the next one, you will have the Fibonacci Ratios that are the same numbers (levels) we use in our Forex or stock market technical analysis: 0.236, 0.382, 0.500, 0.618, 0.764 …….

To use these numbers in technical analysis you don’t have to make any calculation and you don’t have to even memorize them because all the trading platforms let you draw the Fibonacci levels and they have everything ready to use.

The only thing you should know is how to use the Fibonacci levels in the technical analysis.

Fibonacci trading means to know when and where market reverses to keeps on moving. The most important thing in Fibonacci trading is that the Fibonacci levels act as support and resistance. When the price goes up, they act as the resistance and visa versa. Also like ordinary supports and resistances, when a Fibonacci level is broken as a resistance, it can act as a support and to be retested. It is the same as when a Fibonacci level becomes broken as a support (it can act as a resistance then).

You may ask why Fibonacci levels work in forex and stock market? What is the relation between the price of the currencies and the Fibonacci numbers?

The answer is “we don’t know”. The only thing we know is that Fibonacci numbers work in everything from the microscopic materials like DNA molecule to the distance between our eyes, ears, hands, even the distance of the planets in the solar system and the way they move in the space, even the distance and pathway of the stars in the universe and finally in the currencies’ prices and the way they move up and down. Fibonacci numbers can be found anywhere in the world.

Why? You have to ask God !

Of course I don’t know why “Fibonacci numbers and why not any other number?” but I do know why the same numbers can be found in everything: The same numbers can be found in everything because everything is created by the same God.

I think you have already seen the below painting by Leonardo Da Vinci (he is another Italian scientist and physician). If you draw the Fibonacci levels on it (as I did) you will see how the Fibonacci numbers specially the 0.618 works. They say 0.618 ratio can be seen in everything in our body in the internal and external organs.

Note: Your charting platform can not draw Fibonacci levels on your face. Do not try it!

Fibonacci Trading in Forex!

Anyway!

Fibonacci trading is not complicated. How can we use the Fibonacci numbers in Forex trading? That’s the question.

By using the Fibonacci numbers in the charts, you can find more supports and resistances. It will be a big help to choose the right direction and avoid entering to a wrong trade.

To use the Fibonacci numbers in the charts, you have to find the top and the bottom of the previous trend. When the previous trend has been a downtrend, you draw the Fibonacci levels from top to the bottom and extend the lines in the way that they cover the next completing trend and when the previous trend has been an uptrend, you draw the Fibonacci levels from the bottom to the top and extend the lines in the way that they cover the next completing trend.

>>> You have to wait for the trend to become completed: You can not draw the Fibonacci levels while the trend is not completed. When you can not find a completed trend in a time frame, you have to look for one in the smaller or bigger time frames in the same currency pair or stock.

For example at the below chart, I drew the Fibonacci levels from the beginning of an uptrend that was started on 16 Aug 2007 to the end of it that was on 23 Nov 2007. I drew the levels from the bottom to the top.

Now lets see how the Fibonacci levels worked as support and resistance in the next trend.

Follow the red numbers on the chart:

1. The price that started to go down on 23 Nov 2007, touched the 23.60% level on 5 Dec 2007. This level worked as a support and so the price went up as soon as it touched the level but then went down to retest the 23.60% level.

As you know, usually when the price can not break a support or resistance, it tries to retest them later and sometimes it can break them after retesting.

2. So the price went up but tried to retest the 23.60% level eight days later on 14 Dec 2007 and succeeded to break the 23.60% level this time and so went down.

3. The price touched the 38.20% level on 17 Dec 2007 and tried to break it for five days but failed and so started to go up on 23 Dec 2007. It touched the 23.60% level when it was going up and could break it without any problem on 27 Dec 2007.

4. On 31 Dec 2007 it went down to test the 23.60% as a support. On 2 Jan 2008 it failed and went up.

5. Currently (17 Jan 2008) it is retesting the 23.60% level once again as a support and if this time it breaks the 23.60% level, it will go down and if not, it will go up.

Let’s look at some another example. Follow the red numbers on the chart:

There was a big downtrend in the GBP/JPY that started on 22 July 2007 and ended on 17 Aug 2007. So I drew the Fibonacci levels from the top to the bottom (from 22 July 2007 to 17 Aug 2007).

1. While going up, the price touched the 23.60% level on 20 Aug 2007 and could break it easily but on the next day it went down to retest the 23.60% level as a support. It could not be broken and so the price went up.

2. The price didn’t show any reaction to the 38.20% level as a resistance and went up but was stopped by the 50% on 26 Aug 2007. From 26 Aug to 1 Oct 2007 the price went up and down between the 23.60% and 50% levels. During this period of time, the 38.20% level worked as support and resistance several times and it seemed that the price was rotating around the 38.20% level. It made a consolidation around the 38.20% level.

3. The 50% was broken finally on 1 Oct 2007 and the price went up.

4. It had a hard time in breaking the 61.80%. It tried for ten days from 5 to 16 Oct 2007 to break the 61.80% level but failed and bounced down.

5. While going down, it passed through the 50% level without any problem but was stopped by the 38.20% level that acted as support on 22 Oct 2007. It went up on 23 Oct, tested the 50% level, went down on 24 Oct and then tested the 50% on 29 Oct and could break it up.

6. On 31 Oct 2007, it reached the 61.80% once again and tried for several days but failed again, went down and made a double top.

It became completely disappointed about going up and retesting the 61.80% level because it went much lower after it failed to break the 61.80% level.

7. On 9 Nov 2007 it broke the 38.20% level and made a consolidation around the 23.60% level. Like the 61.80% level, the 23.60% level acted as support and resistance several times and a consolidation was formed around it.

As you know, consolidations including, triangles, wedges, pennants and channels are continuation patterns. It means the price will go to the same direction that it was used to go before the consolidation forms.

8. Finally it went down, broke the 0.00% level on 2 Jan 2008.

What do you think now?
Can you ignore the Fibonacci numbers in your trades?

As you see the effect that they have on the market is not negligible and in fact is highly considerable. I know this question is formed in your mind that why they have such a big effect on the market. Why the prices become stopped sometimes for several days below or above the Fibonacci levels?

(Of course if you use the Fibonacci levels in the bigger time frames like weekly and monthly charts, you will see that sometimes the price becomes stopped by one of the Fibonacci levels for several weeks.)

The answer of this question has no effect on our trading. I mean whether you know the reason or not, you can use the Fibonacci levels in your trades. I know most of you don’t care about the answer but some of you are eager to know.

Well! If the Fibonacci numbers are used in the formation of our body, from our genes (DNA molecule) to our internal and external organs, So they are also effective in our behavior.

And the price of the market goes up and down because of the behavior of the traders: Buying and Selling >>> Bulls and Bears

So the market has to show reactions to the Fibonacci levels.

What time frame is better for using the Fibonacci levels?

It depends on your trading system.

You can use the Fibonacci levels in all time frames. When you use them in the bigger time frames like daily, the result will cover and will be applicable for the several next days, weeks and even months and when you use them in smaller time frames like 5 minutes, the result can be applicable only for few hours because the price will leave the Fibonacci level area very soon.

You drew the Fibonacci Levels on your chart. What next?

Fibonacci trading is considering the Fibonacci levels as support and resistance levels and taking proper positions based on them. As I already explained, Fibonacci levels act as support and resistance.

So when the price is going up and you have already entered to a long position (you have bought), you should be careful when the price becomes close to one of the Fibonacci levels. It is possible that it goes down and you lose the profit you had already made. So you have to move your stop loss to the open price of the first candlestick that is touching the Fibonacci level or a little higher. It depends on the length of the candlestick.

Or simply if you have made enough profit, you can close your trade and wait for the price to break the Fibonacci levels or fail and go down. You can take a new position then.

It is the same as when the price is going down but in this case the Fibonacci levels act as resistance.

Also keep in your mind that when one of the Fibonacci levels is broken, the price usually returns to retest. If you get ready for all these possibilities, you will not be trapped.

You treat the Fibonacci levels like real supports and resistances. They really have no difference and sometimes they act even stronger.

If you have not understood what I have explained above or you have any question, please leave a comment and I will get back to you shortly.

Further Reading:

24 Comments:
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Comment by Ateeq

2008-01-17 17:54:52

hi vahid

just wonderful. you have a very good teaching style. after reading this, i made fib on aud/usd and now i found out the price is sitting on .38% right now and looks very tempting to go long but looks very bearish. waiting for you today’s article on currency.
please keep your excellent work for us.
ateeq