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The Fibonacci Method Of Forex Trading

May 26, 2008
I'm sure you have heard of the great mathematician Leonardo of Pisa, also known as Leonardo Fibonacci? He was a highly influential Italian who lived almost 800 years ago, so you're probably wondering what Fibonacci has to do with forex trading, I'll get to that shortly.

He is most famous for developing the numerical sequence that is widely known as the Fibonacci Numbers or the Fibonacci Sequence (he is also credited with introducing the decimal system in Europe).

The very first number of the sequence is 0 and the second is 1. The sequence develops as each subsequent number is the sum total of the previous two numbers. In mathematics it's known as a recurrence relation. Below are the first numbers in the sequence:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, and so on.

e.g. 2 + 3 = 5, 3 + 5 = 8, 5 + 8 = 13 etc.

Leonardo Fibonacci discover that the Fibonacci sequence and their ratios could be found everywhere throughout the natural world, existing in the most unlikely places, almost as universal rule.

So how does Fibonacci and forex trading go hand in hand?

The Fibonacci numbers are important for charting, spotting patterns and indicators in the forex markets, and are used as an important method of analysis

Why?

When you analyse the currency markets carefully, you often find the same ratios as those in the Fibonacci number sequence. You'll also find them in investments such as stocks.

The main three numbers you need to be aware of, and ideally should commit to memory are 0.618, 0.500 and 0.382. There are other numbers, but for starters these are the big 3 and most important.

So what are they used for?

The Fibonacci numbers are used by forex traders to calculate what are known are retracement levels, which are used to determine when to place buy orders or sell orders. It works like this:

If a currency pair is trending upward lets assume, then history will tell us then at some point it's going to hit a peak and go into at least a temporary decline or reversal, and then resume the upward trend. When it starts the reversal, that's where the Fibonacci numbers come into play.

The prices of the currency pair that are following the upward trend is usually predicted to reverse/decline backwards to one of the key Fibonacci numbers, and then bounce back again to follow the upward trend. The key is to forecast this point accurately so that you can buy in before the trend continues upward, so that you capitalise on the reversal and then profit.

You should have a charting mechanism built into your online trading platform which will chart the Fibonacci numbers. Your retracement levels should be automatically mapped on your chart when you simply draw a line up from the low point to the high point.

Obviously there are other things to take into account, it's not as simple as just buying into a trade when the price hits a Fibonacci number.

For a start you never know which retracement level the price will drop to and stop at. If you opted for 0.382 and the price ended up dropping to 0.618, you've just lost a whole load of pips.

Conversely, if you buy in at the wrong high or low points, the retracement levels are going to be completely out of sync.

It can be problematic. They sometimes don't work at all. The forex market is such a dynamic complex system with so many variables at play it would be foolish to rely solely on one method to predict price changes.

Moral of the story?

Find a trading system or strategy that incorporates as many elements and variables as possible, do lots of research, data mining and plenty of good old hard work.
About the Author
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