Today I would like to talk a little about the Fibonacci indicator. For those of you who are not familiar with Fibonacci, he was a mathematician from the 13th century who helped come up with a mathematical principal that there are is a pattern or sequence of numbers that tend to repeat themselves and that this pattern or sequence tends to repeat itself everywhere we look in nature.
The theory with Fibonacci sequences as they relate to trading or specifically Forex Trading is that by using Fibonacci numbers traders can potentially predict how far a trend will retrace before the trend resumes and continues on its way, and also how far a trend may potentially run before it is exhausted. Assuming there is merit to this theory wouldn’t you agree that this would be very very valuable information for a trader?
Now to be honest I have taken a look at Fibonacci a few times over the last 6 or 7 years and I have been rather dismissive. The problems I always had with Fibonacci is that I found it too subjective and honestly too confusing to be of any value. I always found myself struggling where where to draw and plot the Fibonacci retracement and extension tools. Eventually I would give up and continue with other things.
Recently I have given Fibonacci another look and I am really glad I did. A little while back I came across the website www.fxknight.com which is run by a very well known Forex Trader named Andrei Knight. I spent some time going through Mr. Knight’s free webinars and tutorials on how he uses Fibonacci to trade and I must say I was blown away. As I was going through his tutorials and actually plotting the Fibonacci tool on my charts it was scary how often price would come to the levels plotted by the Fibonacci tool and either bounce from these levels as resistance or support, or go through the level and come back to retest them as new resistance or support.
Lets look at an example of how this works on the EurUsd Daily Chart below.
The EurUsd currency pair has been on a nice consistent uptrend the last few months. Could Fibonacci be used to predict how far this trend may go or at what levels along the way may act as support or resistance? Well you be the judge.
You will notice the letters A, B, C, and D drawn in Red. The idea behind using Fibonacci is you look for the start of a trend which is A. Then you look for the first major reversal or correction in the trend, which is Point B. These are the only two points you need to worry about and plot on your chart. The theory goes that statistically price will most often retrace to the 38.2, 50.0, or 61.8 level before the trend then resumes. You will notice on the EurUsd chart above price retraced to the 50.0 level almost to the pip before the trend continued on its way. Now take a close look at all the other Fib level drawn by the tool. Do you notice how price would react with those levels almost to the pip on most occasions? This really amazed me and caught my attention.
Now you are probably asking how can I use this to predict how far the trend will run before exhausting. Well according to Mr. Knight and other proponents of Fibonacci here is how it works. If price retraces to the 38.2 level before continuing on its way, price will most likely make it all the way to the 138.2 level before exhausting and turning around. If price retraces to the 50.0 level before continuing on its way, price will most likely make it all the way to the 161.8 level before exhausting and turning around. If price retraces to the 61.8 level before continuing on its way, price will also most likely make it all the way to the 161.8 level before exhausting and turning around.
I would encourage you to go ahead and start plotting some fibonacci’s on your own charts and back test this theory. I suspect you may be quite impressed and surprised at how accurate this theory really is.
Now at this point you are also probably also asking “how did he get his fibonacci tool to draw the retrace lines and the extension lines all at once like that?”. Well that is a very good question. If you are using the metatrader default Fibonacci indicator tools there is one for the retrace and one for the extension but it does not have both combined as it is showing on my chart above. On Mr. Knight’s website he provides a pdf with step by step instructions how to very easily change the setting on your MT4 Fib tool so that it can be used like this. Here is the link to his pdf instructions: click here.
If this post was of interest to you I would highly recommend that you check out www.fxknight.com. He has a ton of free Fibonacci webinars and information to help you navagate your way through this. The other thing I like about Fibonacci is that it works very well with the price action principles that I usually use in my trading.
Below is a sample of one of Andrei Knight’s great Fibonacci Webinars:
Well if you have enjoyed this post I would kindly ask that you comment, like or share 🙂
Also please remember the information on this blog is for educational purposes only and not to be taken as trading advice.
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