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What is a Fibonacci Trading Strategy?

There are several technical analysis tools that are driven by a mathematical concept that has been around for hundreds of years. They all stem from a ratio that is driven by the Fibonacci sequence discovered by an Italian mathematician in the early 1400’s. The Fibonacci sequence can provide you with support and resistance levels as well as profit targets and stop loss level. You can use Fibonacci retracement levels on their own or combine them with other trading methodologies. The Fibonacci ratios are used by day traders and foreign exchange traders to generate investment decisions.

The Fibonacci Sequence

The inventor of the Fibonacci sequence was Leonardo Pisano Bogolla. He was an Italian mathematician and lived in the city of Pisa.  The Fibonacci sequence follows a pattern that can be observed in nature. Excluding the first number in the sequence every other number is the sum of the prior 2-numbers. The sequence starts at 1, and then progresses to 2, 2+1 is 3, and then 5, 8, 13,21, etc. Another property of the sequence is that ratios can be created from the Fibonacci numbers. The ratios are calculated by dividing the lower number by the subsequent higher number, and by dividing the lower number by the sequence higher number that is 2-places higher than it.

How to Use Fibonacci Retracement Lines

The most popular technical analysis tool constructed from the golden ratios of the Fibonacci retracement levels. Both the 32.8% ratio and the 61.8% ratio are calculated by evaluating the price of the security or exchange rate of a currency pair from a high point to a lower point.

 To draw Fibonacci retracement lines, you need to find the highest high over the time frame you are evaluating and subtract the price or exchange rate from the lowest low.  The difference is then multiplied by 61.8% and 38.2%.

Strategies for Trading Fibonacci Retracements

There are no restrictions on the time frames that you can use for a Fibonacci trading strategy. You should feel just as comfortable using this technique on intra-day data as you would on daily or weekly prices. The golden ratios will work on all periods you decide to analyze.

Fibonacci Retracement Support and Resistance

Fibonacci retracements, can be used to create support and resistance levels.  If you are a day trader and interested in using Fibonacci retracements on intra-day data, you can target profit and loss levels using support and resistance. In the chart below the EUR/USD using 15-minute bars, you can quickly generate support and resistance levels following a bounce as prices dropped from 1.2388 to 1.2285.  The first level of resistance which eventually became support was the 38.2% retracement.  Prices moved to the next target resistance level at the 61.8% retracement level.

Summary

The Fibonacci sequence which was created hundreds of years ago, has been developed into a technical analysis tool that can be used to target support and resistance as well as take profit and stop loss levels. The Fibonacci sequence was created using the golden ratios, which include the percent 38.2% and 61.8%. Fibonacci retracements are used to calculate support and resistance levels and can be used as a risk management tool. Once you are in a trade, you can use a Fibonacci retracement level as a target to take profit. You can use the Fibonacci retracement on any time frame which can help you manage your position as a day trader.

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