Fibonacci Levels

Hello, dear blog readers! When I started to learn to trade Forex, I associated Fibonacci levels with something complicated and incomprehensible that the “smart guys” use in trading, but I certainly cannot understand 🙂 And the most trouble caused the process of building a fibo grid on the chart - for some reason I have not found sensible instructions anywhere that time. In the following post, I have tried to make such a tutorial on how to use Fibonacci levels which would be useful to me in the initial stages.

From this article, you will learn about what a levels retracement and Fibonacci expansion are, how to use them in Forex trading, how to define objectives and entry points in the market and, of course, how to build them directly on the chart. There are lots of materials and many books on the internet about the history of the Golden section, about Leonardo Fibonacci’s invention of his famous sequence and its reflection in the world around us. So I did not focus on this aspect.

 

What are the Fibonacci levels?

In the 13th century, Leonardo Fibonacci introduced the world to a sequence of numbers where each successive number is the sum of the previous two. Moreover, the ratio of any number in the sequence to the previous number is approximately equal to 1,618. This sequence is based on the Golden section, which is represented in nature. For example, the human body largely is a sample of the Golden section. Shells of snails, plants, and even out of reach galaxies, which are visible from space.

We are not going to focus on the Golden section and the Fibonacci sequence in nature and around us. You can read about it in various books or on the Internet if you are interested. We will find out how these numbers can help us in Forex trading. First, let’s talk about the internal levels of Fibonacci retracement.

How to put the Fibo levels to the chart

Why do we need them on Forex? Imagine that we have some trend.

We need to determine when it is the best time to enter this trend. Levels of retracement Fibo enable us to identify potential levels where the retracement of our ascending trend will change to the trend upwards. Then we will be able to buy and make a profit.

Suppose that we have movement up:

We decided that a bullish trend will start now and we need to decide where to enter the market.

We need to determine in advance where the retracement will end.

For this, we will use a tool in Metatrader 4 that is called the Fibonacci Retracement.

It is located by default in the toolbar and can be found in the menu “Insert – Fibonacci – Retracement»:

For the upward trend we need to mark the lowest point where the trend started:

And without releasing the mouse button to hold the grid to the point where, in our opinion, the retracement was started:

We get the levels of 38.2, 50, 61.8 and 78.6. Values are the percentage. If you take the whole cut, which we used for constructing the grid, it will be 100%. Simply say the level 38.2 means 38.2% of the entire length of the segment.

By default, the levels of Fibonacci retracement will look like this:

We have added a level of 23.6, which I think is very minor and I do not advise to use it in trading at all. Also there is no level 78.6, because it is not a part of the Fibonacci sequence, but it is the square root of 0.618, which is closely linked to this sequence. Very often at this level occur turns, jumps and so it must be taken into account.

How to set the grid of Fibonacci levels?

To do this, you have to click twice on the left mouse button the dotted red line, which means a cut. Then points will appear on the dotted line:

Now you can drag it, if the first time you built it wrong:

Next, we open the settings menu by clicking on the point with the right mouse button and select “Fibo Properties…”:

There appears a table with settings. Here we can change the color of display levels, remove one of the levels or add it. Find the unwanted level 23.6 and delete it. Now this level will not disturb us.

Now let’s add the level of 78.6%. Click on the Add button to do this:

Write 0.786 in the field “Level”, and we write 78.6 in the “Description”:

Click OK and you can watch that 23.6 level disappears and 78.6 level appears:

You can add your own levels that fit you. This allows you to configure the grid completely for yourselves.

Practice of Fibo applying

So why do we need it? We observe that the levels of Fibonacci are the potential levels of retracement and returning to trend.

We have the end of retracement at 50% level:

I think everyone understands that this Pin bar pattern (candle with a large tail) was just a deceptive movement and acted as a “spring”:

But even if we consider its tail, we see that it is situated at the level of 61.8% from our existing segment. We can consider 38.2, 50, 61.8 and 78.6 levels as potential entries to the market. By themselves, they have not super-strong power, and just opening the order to buy when the price reaches 38.2% or 50% you will not achieve profitability in trading.

You need to use these levels only in combination with other elements of technical analysis. For example, if you trade graphic patterns, a Pin bar pattern can be considered as the entry point, as it relies on the level of 61.8. Thus, the graphic figure gets a foothold, and we can open the order to buy having a base in the form of a graphic pattern and Fibonacci level.

But you should not open the trade just because the price has reached Fibo level.

Let’s imagine that we have entered the trade, have earned something and the price moved higher, having reached a new high. What do we do next?

We just drag the grid higher, to a new high:

The minimum of the trend remains the same.

And again we get the levels for the potential end of retracement. As we can see we have the price that initially stopped at the level of 38.2%:

And then it reached the level of 50% and the upward trend continued. As soon as the price reaches 38.2%, this does not mean that you need to buy immediately.

You have to use the Fibo levels only in combination with some other trading indicators or strategies.

If you see that the price reaches the level of retracement and a rebound is possible, then you can buy. But if there are no signals on what happens now, except that the price has reached the level of retracement, then do nothing. The Fibo levels are a tool, but it is not a major tool in any way.

Let us consider one more example but in a downtrend.

In the very beginning, the price went down, then it slowed down and a retracement started. We need to determine where it could potentially end up and at what levels we should look for entry points to the market.

Select the tool Fibonacci Retracement. For a downtrend we need to point the mouse the highest point, where the trend began and hold the left button to bring our grid to the level where, in our opinion, the retracement has begun:

The first time the price has pushed off from the level of 38.2, it didn’t show a new low and went up up again to the level of 61.8. These levels are very approximate, and you should understand that price is not obliged to push off the line that you drew and is not obliged to rebound then. Fibonacci levels are the levels, not the lines.

The price reached the level of 61.8% and drew a Pin bar:

And then it moved down again and drew new lows. When reaching a new low we are able to drag our grid below:

And you can see that the price did not reach the level of 38.2 and went down:

Fibo levels are not always practiced. But anyway they should be taken into account because very often they play a good supporting role. It’s all about levels of retracement.

But we also have a tool called Fibonacci Expansion. It helps to define goals.

One more example. There is a trend and we need to know what are the goals and the likely levels of profit we should take if somewhere in this area we have bought and at what level we should look for signals to exit the trade:

To draw Fibonacci Extension, choose “Insert – Fibonacci — Expantion»:

To determine where we should exit if we have bought at this movement, we need to note the first section of the trend, i.e. the first movement and the first retracement.

We start from here:

Until first movement end:

We mark our movement and next, click twice on the dotted line. It is required to specify the place for the second line where the first retracement ended:

We get a grid, but it shows not potential levels, where trend retracement will end, but it shows the objectives for taking profits that are built on the basis of Fibonacci sequence.

As we can see we have the default levels of 61.8%, 100%, 161.8%:

These levels are built on the basis of the segment of the first section of the trend, which was set aside from the end point of the first retracement:

In my opinion, we should add a level of 50% to Fibonacci Extension as it is taken into account by the price very often. To do this, click the mouse on the dotted line, choose “Expansion properties..” and add exactly the same as in the tool Fibonacci lines.

To add a level of 50%, press the add button and specify level 0.5 in the column, and FE 50 in the description:

Thus, we create 50% level. As we can see below, the Fibonacci Expansion indicated quite accurately the point at which the retracement began:

These are good points to take profits and exit the market. The first point was reached in the amount of 50%, then there was a rollback and there was a new point at the level of approximately 60%. Then the market reached the level of 100% and there was downward retracement again. This is not a sly way to use the Fibonacci sequence for purposes of determining the trend.

Similarly, we can use Fibonacci Expansion to identify targets on a downtrend.

Find the first wave of a downtrend and the first retracement. With the help of the tool “Fibonacci Expansion”, you can build a grid for potential points of profit.

Upon reaching level 50%, nothing happened. At the level of 61.8%, price slightly stopped, but there were not any strong movements upward. And then it fell to the level of 161.8%. As in the case of the levels of Fibonacci retracement, Fibonacci expansion is just an auxiliary tool. They are good for setting goals, but if you use it without combining with other elements of technical analysis they will not bring you so many benefits.

As in the case of the levels of Fibonacci retracement, Fibonacci expansion is just an auxiliary tool. They are good for setting goals, but if you use it without combining with other elements of technical analysis they will not bring you so many benefits.

Summary

Don’t forget that Fibonacci levels should not be used separately — you will lose outright. It should be combined with other elements of technical analysis, such as indicators, trend lines, Price Action patterns, etc. This is an accessory tool and you should remember about it.

Take care, Michael

Forex Trader Portal.com