Intermediate 10: Understanding Fibonacci

    November 22, 2022

    Fibonacci is one of the tools that Forex traders often use. Let’s figure out how the Fibonacci instrument works.

    Leonardo Fibonacci, a mathematician from the 1300s, came up with a set of numbers (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.), with every number in the list the sum of the two numbers that came before it. The relationship between these numbers is the same as in nature. For example, tree branches grow or split according to Fibo numbers, and the seed pods on a pinecone are arranged in a Fibonacci spiral pattern, etc.

    Even in the financial markets, Fibonacci ratios are often used to explain how markets move.

    There are a few constant ratios in the Fibonacci sequence. The Fibo ratios that matter the most are:

    – 161.8%, the “golden ratio” (the ratio between the first number and the one before it, for example, 89/55 = 1.618).

    – 61.8% (the ratio of the first number to the second number, like 55/89 = 0.618).

    -38.2% (the ratio comes from a division jump of one order, like 55/144 = 0.382).

    To put it on a chart in MetaTrader, click “Insert” and then “Fibonacci” from the menu. In your trading terminal, you can find the retracement, expansion, fan, arc, and time zone Fibonacci tools. All of these tools use Fibo ratios as their basis.

    There are several Fibonacci tools, but Fibo retracement levels and Fibo expansion are used a lot.

    Fibonacci retracement levels

    Successful traders predict market price fluctuations using several approaches and tools, such as the Fibonacci retracement levels. The Fibonacci retracement lines represent price support and resistance on a price chart, helping traders determine when the price can retrace before continuing the trend.

    Formulas for Fibonacci retracement levels

    Math is the basis for the Fibonacci retracement tool. You need to use the following formula to find Fibonacci retracement levels:

    For an uptrend, UR = H – ((H – L) x percentage); 


    DR = L + ((H – L) x percentage) for a downtrend.


    UR is a retracement of a trend going up, DR is a retracement of a trend going down, H is a high price, and L is a low price.

    Even though most trading platforms can do these calculations for you, it’s good to know how to do it yourself.

    How to calculate Fibonacci retracement levels

    Now that you know the formula for calculating Fibonacci retracement levels, you can figure out how to do it.

    First, look at the price chart and pick two price points—one high and one low. It is essential to make sure that there are no higher highs or lower lows. If you don’t find it right, your calculations won’t be correct, and you won’t find the right retracement level. Then, once you’ve found the high and low, you can use these two numbers in a formula to figure out the retracement levels for a specific area of price action.

    What are the ratios of Fibonacci?

    However, it’s not enough to know the highs and lows. You also need to know what percentage to put into the formula. Traders use Fibonacci ratios to figure out the levels of Fibonacci retracements.

    The Fibonacci ratio is the percentage of the chosen price range that shows where the price movement will stop and start. Fibonacci ratios come from the Fibonacci numbers, a series of numbers where each is the sum of the two numbers before it. If you divide a Fibonacci number by the following number, you get 0.618, which is 61.8%. When you divide the same number by the following number to the right, you get 0.382 (38.2%) and then 0.236 (23.6%). This ratio and 50% are price support and resistance levels, so they are used to find Fibonacci retracement levels.

    For instance, the price of an asset goes up from $15 to $18.43. Here’s how to find the Fibonacci retracement levels:

    $18.43 – (($18.43 – $15) x percentage)

    So, the retracement levels will be $17.62 (at 23.6%), $17.12 (at 38.2%), $16.71 (at 50%), and $16.31 (at 61.8%).

    How can you use Fibonacci retracement levels in charts?

    Fibonacci retracement levels can be used to find the best time to enter a trade by looking at charts. After a steady trade, the most common way to use this tool is to see if the price goes back to one of the Fibonacci levels. 

    For example, if the cost of an asset drops 23.6% after a significant rise and then goes back up, it might be an excellent time to trade.

    How to draw the retracements of Fibonacci?

    Even though Fibonacci retracement levels are hard to explain, they are seen as a reliable way to predict how prices will move, primarily when used with other methods of technical analysis. 

    However, some traders may find it hard to draw Fibonacci retracement lines because once done incorrectly, they can lead you to the wrong conclusions and mess up your whole trade. 

    That is why it’s essential to know how to draw Fibonacci retracements correctly.

    Most trading platforms already include the Fibonacci tool, so you don’t have to draw the lines and levels by hand. You must look at how prices have moved in the past and pick the swing highs and lows. 

    Then, to draw a line, you need to move your cursor from low to high (for an uptrend) or high to low (for a downtrend).