How Does Fibonacci Indicator Works?
In today forex faq, we have a question from one of our fellow readers in this blog regarding the fibonacci indicator.
Below is the question:
Hi Kelvin, i am a new trader and wanted to know more about fibonacci. How does this works and what to look for in fibonacci. I believe there are some percentages indicate on the fibonacci and what is it for?
First of all, I must tell all of you that the Fibonacci indicator is one great tool that I will suggest all of you to use in your trading. This is because this indicator is widely used among institutional trader and therefore you will find that price usually respect major Fibonacci levels in trading.
That is why it is very important for a trader to be able to find the major Fibonacci levels that the market will respect. Once you manage to find that particular levels, you can enter a trade to profit from the repulsion of the price when it hits that level.
That is also why I dedicated 2 modules in my Forex Street University course to Fibonacci as there are various ways you can use it in your trading. Once you master how to draw the right Fibonacci level and how to identify a major Fibonacci level that the price will respect, you will find that you are going to make more profitable trades than losing trades.
So let me spend sometime to share with you how does this forex indicator work.
If you have taken a look at your forex chart, you will find that it is moving in the form of retracement and extension that forms a wave. Basically the fibonacci indicator is for you to see how much the price has retraced from a high and how much the price is extended from the point of retracement.
There are 3 major retracement of Fibonacci and they are 0.382, 0.500 and 0.618. For the 0.618 Fibonacci retracement level, it means that the price has retraced by 38.2 percent from the highest level. For the 0.500 Fibonacci retracement level, it means that the price has retraced by 50 percent from the highest level. For the 0.382 Fibonacci retracement level, it means that the price has retraced by 61.8 percent from the highest level.
Do note that when the price hits the 0.382 Fibonacci retracement level and get repelled by it, it will usually moved to the 1.272 extension level. If you see the price hitting the 0.500 or 0.618 Fibonacci retracement level, you will find that it usually moved to 1.618 extension level.
Let me go through an example with you below
To draw a Fibonacci level, you will need to identify a swing high and swing low. If the price is moving upwards, you will then draw the Fibonacci level with upward extension.
Once you do that, you will then drag your Fibonacci indicator from one point to the other and the retracement level will be plotted.
From the picture above, you can see that the price has hit the 0.382 Fibonacci level and get repelled by it.
From the picture below, you can see that the price moves upward until it hits the 1.272 Extension level and then it started to move back down.
Therefore most trader will take profits at the 1.272 extension level and that explains why the price started to move back down after that level.
Just in case you are not sure about the example above, I have added another example for you below
First of all, you will have to identify a swing high and swing low. In the picture below, you can see that the price is moving downwards and therefore your extension must be downward.
Similarly, you will then plot your Fibonacci Indicator as directed
As you can see from the picture above, the price hits the 0.382 Fibonacci retracement level and then repelled by it.
From the picture below, you can see that the price eventually moved down to the 1.272 extension level and then the price started to move back up. This is mainly due to the fact that most traders take their profits at the 1.272 level if the price retraces to the 0.382 Fibonacci retracement level.
I hope that I have helped you better understand how the Fibonacci Indicator works and do feel free to ask more question by commenting below. If you are interested to learn more about how to use the Fibonacci Indicator effectively, you can take a look at my Forex Street University Course from the link below