The Fibonacci indicator is one of the most useful and most widely used tools in the Forex traders arsenal. This indicator is one of many tools that traders have invented but there is no real scientific backing for why it works. This indicator works because everybody believes it will work and everybody uses it therefore it becomes a self-fulfilling indicator. That is why it is important to know how to use it. I could explain about the Golden ratio and all the science behind the Fibonacci formula but that's all really just fluff. What you do need to know is that you draw Fibonacci retracement line from the lowest point in a trend to the highest point of a trend on your chart. You charting software will take care of the rest. The important levels to know the 38.2%, 50% and 61.8% lines these are the most common price levels currency will retrace to after a strong trend. Many traders will pay attention to these levels and will buy or sell accordingly.

Here is an example of the fibonacci retracement levels in action on a 30 minute chart. We have a sharp rally, so we start the fibonacci point at the lowest point of the rally, and place the final point at the top of the rally. Notice how the price trends down and just barely touches the fibonacci 38.2% line before bouncing off. It then ranges between the 23.6% and 38.2% levels until making it's way lower to the 50.0% level. But notice how clean these lines act as support and resistance. There are several trades on this graph, depending on when you noticed the price reversal. If you noticed it early enough you could sell the currency with a profit point of about 10% above the 38.2% level.

If you noticed it after it had already hit the 38.2% level, you could trade the bounce from 38.2% to the 23.6% level. Using the 10% rule above and below the fibonacci lines to set your entry, stoploss, and profit points.

Here is another example of the fibonacci levels at work on a longer term chart. The beauty of the foreign exchange is that all of these technical indicators work on all the different time frames. In this graph we have a strong rally over a period of days with a range from 1.3805 to 1.4138, about 330 pips. Notice how the fibonnacci levels work here, there is a strong retrace all the way to the 61.8% level, followed by a rally to the 28.6% level. Then a quick break down below the 50.0% level before rallying back up to the 0.00% level (the top of the first rally). Remember this is a 4 hour chart, so there are numerous entry and exit points for these trades. As you can see Fibonacci levels are very powerful, and useful, however, knowing what levels will be hit and how to trade them takes experience.

Homework Trade:

Find a strong trend that has just reversed. This can be on any chart, but is most useful on the longer charts. Then draw a Fibonacci retracement from the bottom to the top of that trend. The first thing to notice is the 38.2% level, carefully watch the price of the currency pair. You are waiting for the price to test that level and then to bounce off. If it doesn't bounce off, we watch the 50.0% and then the 61.8% levels. Once again, the trade you will place depends the difference in pips between a maximum height of the trend and the Fibonacci retracement level. You're waiting for the price to bounce off of these key levels by 10% of the total trading range. Place your stoploss 10% below the Fibonacci retracement line and when you've gained pips equal to your risk raise your stoploss to break even. Your first profit point should be double your risk (difference between entry price and stoploss) to start and then you can take more profit as you rise. When taking profit make sure to note the 23.6% level since many traders will take profit here, and you'll see it act as resistance.