What is the Fibonacci sequence?
Fibonacci is a mathematical sequence named after its creator Leonardo of Pisa who was born in Italy in 1170. The Fibonacci sequence is used in both maths and science for a number of uses including computer algorithms and biological arrangements. It is also very popular in the financial markets and used to predict possible reversals in price using Fibonacci retracements and possible targets using Fibonacci extensions.
The Fibonacci sequence is:
The sequence is calculated by adding the previous two numbers to create the next number, this will continue for infinity.
e.g. 0+1=1 1+1=2 2+1=3 3+2=5 ect.
The preceding number is always greater by 1.618, this is known as the golden ratio and is found frequently in the natural word.
How to use Fibonacci when trading forex
When trading forex traders use Fibonacci as percentages, to calculate the percentages you divide the Fibonacci number by the next number to the right, 21 divided by 34 = 0.618 this is the first percentage number used, next divide the number by the second on the right, 21 divided by 55 = 0.3819 this is the second percentage number. This is continued to produce the Fibonacci percentage used in forex trading. 50% is also used, this is not a Fibonacci number but is a huge phycological number.
How to trade using Fibonacci retracements and extensions
There are two ways to use Fibonacci when trading forex, either buy using Fibonacci retracements to find potential reversals in price or by using Fibonacci extensions to find price targets.
The most popular percentages when using Fibonacci retracements are 0.236, 0.382, 0.500, 0.618 and 0.764. These are the points it is highly probable for price to reverse after a retracement from a strong trend. First use the Fibonacci tool and draw it from the beginning to the end of the original trend, this will show the Fibonacci retracement percentages.
The most popular percentages when using Fibonacci extensions are 1.618, 2.618, 3.618 and 4.236. These are good points to set as targets after a retracement and another possible reversal to form. Again use the Fibonacci tool and this time draw it from the end to the beginning of the original trend, this will also show the Fibonacci extension percentages.