Forex trading essential skills: How does Fibonacci help you find support and resistance levels?

Why Are Traders Using Fibonacci?

When it comes to technical analysis tools in the forex market, Fibonacci is definitely the most frequently used one. From Wall Street traders to retail investors, everyone is using it. Why? Because it can help you identify key levels where an asset’s price might reverse.

The core of Fibonacci trading tools is the golden ratio, a proportion that can be found everywhere in nature and also mysteriously appears in financial market price movements. Traders use this mathematical pattern to predict support levels, resistance levels, and even set stop-loss and target prices.

So, where does this tool come from, and how can it be applied in real trading scenarios?

The Mathematical Secrets of the Fibonacci Sequence

To understand how Fibonacci is applied in trading, first, you need to know its mathematical foundation.

The Fibonacci sequence is simple: each number is the sum of the two preceding ones. The sequence looks like this:

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

Within this sequence, three important ratios are hidden:

1.618 Ratio: Dividing any number in the sequence by the previous number results in a value approaching 1.618. For example, 1597 ÷ 987 ≈ 1.618, 610 ÷ 377 ≈ 1.618. This is the famous golden ratio.

0.618 Ratio: Conversely, dividing a number by the next number yields approximately 0.618. For example, 144 ÷ 233 ≈ 0.618, 610 ÷ 987 ≈ 0.618. This is the reciprocal of 1.618 and forms the basis for the 61.8% Fibonacci retracement level.

0.382 Ratio: Dividing a number by the number two places ahead results in about 0.382. For example, 55 ÷ 89 ≈ 0.382, 377 ÷ 987 ≈ 0.382. This underpins the 38.2% Fibonacci retracement level.

Traders leverage these ratios to determine when prices might pause or reverse.

Fibonacci Retracement: A Powerful Tool for Finding Support and Resistance

What is Fibonacci Retracement?

Fibonacci retracement lines are horizontal lines that mark potential support or resistance zones. Traders draw these lines between any two points (usually a high and a low).

The most commonly used Fibonacci retracement levels are: 23.6%, 38.2%, 50%, 61.8%, and 78.6%. These percentages represent different retracement depths from the high to the low.

Practical Example: Application in Gold Trading

Suppose gold rises from $1681 to $1807.93, a gain of $126.93. Now, we use Fibonacci retracement to find key levels.

Based on different retracement ratios, the five important support levels are:

• 23.6% retracement: $1777.97
• 38.2% retracement: $1759.44
• 50% retracement: $1744.47
• 61.8% retracement: $1729.49
• 78.6% retracement: $1708.16

These levels are where gold might pause or reverse during its decline. The 61.8% level is often the strongest support because it is closest to the golden ratio.

How to Trade Using Retracement Lines?

In an Uptrend: After a significant rise, when the price begins to retrace, traders identify the retracement from point A (bottom) to point B (top), then place buy orders at the 61.8% or 38.2% retracement levels. If the price bounces at these levels, it indicates support is holding, and the uptrend can continue.

In a Downtrend: After a sharp decline, traders identify the retracement from the top A to the bottom B. When the price rebounds from the bottom, sell orders are placed at the 38.2% or 61.8% retracement levels. If the price encounters resistance and falls back, resistance is confirmed.

Traders often combine Fibonacci retracement with other technical indicators (like moving averages, RSI, etc.) to improve accuracy.

Fibonacci Extension: Predicting the Next Target Price

What is Fibonacci Extension?

If Fibonacci retracement helps traders find entry points, Fibonacci extension is used to predict exit points. It helps determine potential target levels where the price might reach after reversing.

The main Fibonacci extension levels include: 100%, 161.8%, 200%, 261.8%, and 423.6%. Among these, 161.8% is the most important, derived from the golden ratio 1.618.

Practical Application of Extension Lines

In an Uptrend: Traders identify three key points—X (low), A (high), and B (a Fibonacci retracement level). After confirming these points, they place buy orders at B and set profit targets based on Fibonacci extension levels. When the price reaches point C (the extension percentage level), they can choose to close the position.

In a Downtrend: X becomes the high point, A the low point, and B a retracement level. Traders place sell orders at B, using extension levels to predict where the price might ultimately fall, and take profit at the appropriate C point.

Conclusion: Fibonacci Is a Skill, Not Magic

The patterns of Fibonacci sequences appearing in nature and financial markets are indeed fascinating. However, it’s important to remember that Fibonacci is just one of many technical analysis tools, not an infallible predictor. Price movements are influenced by multiple factors, and relying solely on Fibonacci retracement or extension can lead to pitfalls.

True trading experts combine Fibonacci with other indicators, market conditions, and risk management to form a comprehensive trading system. As you repeatedly practice applying this tool on Gate.io or other trading platforms, you will gradually experience its practical value.