Master the Fibonacci sequence: the most powerful technical analysis tool in forex trading

In the foreign exchange market, no technical indicator is as mysterious and powerful as the Fibonacci ratio. From nature to financial markets, this magical mathematical system can accurately predict asset price turning points. Many professional traders regard Fibonacci indicators as their core tools for identifying support and resistance levels, while beginners often do not understand the underlying principles.

Where Does the Fibonacci Sequence Come From?

The story of the Fibonacci ratio dates back to the 13th century. Italian mathematician Leonardo of Pisa (nicknamed Fibonacci) first introduced this concept of the golden ratio, originating from India, to the Western world. Although the golden ratio is widely present in the universe and is believed to maintain balance in all things, it was only after Fibonacci introduced it into finance that traders realized this system also applies to market trend analysis.

So, what exactly is the Fibonacci sequence? It is a special series of numbers where each number equals the sum of the two preceding ones:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765…

Observing this sequence, we find an astonishing pattern: any number is approximately 1.618 times the previous number. For example, 1597 divided by 987 is approximately 1.618, and 610 divided by 377 is also approximately 1.618. This number 1.618 is the legendary golden ratio.

Further research shows that if you divide a number in the sequence by the following number, you get about 0.618 (the reciprocal of 1.618). For instance, 144 divided by 233 is approximately 0.618, and 610 divided by 987 is also approximately 0.618. This 0.618 forms the basis of the 61.8% retracement level.

Another important ratio is 0.382. When dividing a number by a number two places larger, the result is close to 0.382. For example, 55 divided by 89, or 377 divided by 987, verify this. Therefore, 0.382 forms the basis of the 38.2% retracement level.

Why Are Traders Obsessed with Fibonacci Retracements?

Fibonacci retracement lines (also known as golden ratio lines) are highly regarded by traders because of their forward-looking nature—they help predict where prices might pause or reverse.

What are Fibonacci retracement levels?

Simply put, Fibonacci retracement lines are reference lines connecting two extreme points (usually a high and a low) of an asset’s price. These lines help identify potential support and resistance levels. On Fibonacci levels, traders see the following percentage markings: 23.6%, 38.2%, 50%, 61.8%, and 78.6%. These percentages represent areas where price reversals may occur.

For example, suppose the price rises from $1681 to $1807.93. Drawing Fibonacci retracement lines between these two points, we can calculate the retracement levels:

• 23.6% level: 1807.93 - (126.93 × 0.236) = $1777.97
• 38.2% level: 1807.93 - (126.93 × 0.382) = $1759.44
• 50% level: 1807.93 - (126.93 × 0.5) = $1744.47
• 61.8% level: 1807.93 - (126.93 × 0.618) = $1729.49
• 78.6% level: 1807.93 - (126.93 × 0.786) = $1708.16

When the price retraces downward, it often finds support near these levels. Many traders place buy orders at these points, betting on a rebound.

Two Practical Applications of Fibonacci Retracement

Operation logic in an uptrend

When an asset’s price rises sharply and begins to retrace, traders need to identify points A (bottom) and B (top). Then, they look for support at the retracement zones (23.6%, 38.2%, 50%, 61.8%, 78.6%) between A and B. Once the price stops falling at a Fibonacci level, traders may buy at that point, waiting for a rebound.

Operation logic in a downtrend

Conversely, when an asset’s price drops sharply and starts to rebound, traders mark from the top. The retracement from point A (top) to B (bottom) helps predict the location of point C (resistance). Traders can set sell orders at point B and exit profitably when the price reaches the Fibonacci level at point C.

It is worth noting that professional traders rarely rely solely on Fibonacci indicators. They usually combine them with other technical analysis tools or trend patterns to confirm whether the price will truly reverse at a Fibonacci level.

Fibonacci Extensions: A Tool for Setting Profit Targets

If Fibonacci retracement helps traders find entry points, Fibonacci extensions are used to determine when to exit.

Extension levels are based on the 1.618 golden ratio. Common Fibonacci extension percentages include 100%, 161.8%, 200%, 261.8%, and 423.6%.

How to use extensions in an uptrend?

Traders need to identify three key points: X (initial low), A (rebound high), and B (a Fibonacci retracement level). After confirming these points, traders buy at B and use extension levels to predict where the price might rise to at different zones C. When the price reaches C, it signals an exit.

How to use extensions in a downtrend?

The same logic applies in reverse: X is the high point, A is the low point, and B is the retracement level. Traders sell at B and use extension levels to find target points C.

Why Does Fibonacci Keep Proving Effective in Financial Markets?

The effectiveness of Fibonacci indicators has several reasons. First, this ratio is ubiquitous in nature, and the human brain is inherently sensitive to it. When millions of traders are watching the same Fibonacci levels, these levels tend to become self-fulfilling prophecies. Second, institutional traders and algorithms also use this system; their large buy and sell orders near Fibonacci levels can trigger price reactions.

The Power of Combined Application

True trading experts do not rely solely on Fibonacci retracements or extensions but combine both. They use retracements to find entry points, extensions to set targets, and also consider other technical indicators to confirm signals. Only then can they achieve consistent profits in the foreign exchange market.