Fibonacci FOREX Training
The foreign currency exchange market, or Forex, is a large network of individual and institutional traders around the world who speculate the valuations of currencies. Forex is a fast-paced and highly liquid market where traders seek profit from small fluctuations in a currency's value. Fibonacci analysis is often used to predict key price reversals. When correct, a Fibonacci level can lead to substantial profits.
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Fibonacci Sequence
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The Fibonacci sequence is a popular mathematical pattern often taught in secondary schools and explored in the natural sciences. It begins with the numbers 0 and 1, and then each subsequent number in the series is the sum of the previous two. Thus, 1, 2, 3 and 5 would follow. The pattern has been observed throughout nature, from the breeding of rabbits to the structure of pine cones. For this reason, it became a popular way of analyzing the "natural" human fluctuations in market activity. Both stock markets and Forex trading are often subject to Fibonacci analysis. Most traders do not understand the underlying math, but the application of Fibonacci is simple and common. The "Golden Ratio" is the quotient of any two adjacent numbers in the sequence. This number quickly approaches 0.618 as the pattern is taken further out.
Price Fluctuations and Retracements
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Price action in any auction-based market such as Forex or the stock market never moves in a straight direction without fluctuation. The overall move of a market may be up, but frequent declines occur along the way before prices continue their trends. When prices fall after creating a new high, this is referred to as a "retracement." The stopping point of a retracement when prices reverse to continue a trend is a key level where supply and demand forces shift. Fibonacci calculations aim to predict where these reversals will occur, and are usually referred to as "Fibonacci retracements."
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Self-Fulfilling Prophecy
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Many question the validity of Fibonacci patterns when applied to financial markets. Whether or not they are in fact tapping into a universal pattern is a subject of much debate. However, these levels do often hold, if for no other reason than that many traders around the world expect something to occur from these calculations, thus making them work simply due to their popularity. If a large collection of potential buyers all believe that prices will reverse at a certain level-regardless of reason-then they will likely move the market based on this idea.
Calculations
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The key ratios in Fibonacci analysis for Forex trading are 0.382, 0.500 and 0.618. These are the levels between any two price extremes where prices may stop and reverse. The 0.618, or 61.8 percent retracement level, corresponds to the Fibonacci Golden Ratio, while the 38.2 percent retracement is the 61.8 percent retracement in the opposite direction (1-0.618=38.2). The 50 percent level is used simply as a halfway point though it is not calculated from actual Fibonacci theory. By multiplying these numbers with a trading range and adding these retracements to the lowest price, you arrive at the price levels determined by Fibonacci mathematics. For example, if the year-to-date (YTD) low in a Forex currency is priced at 1000, and the YTD high is 2000, the trading range, or difference between these, is 1000. Thus the key Fibonacci levels are 1382, 1500 and 1618.
Caution
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Fibonacci analysis is not used by everyone. There are many complex forces at work in the Forex market. A Fibonacci level tends to work if the majority of traders are analyzing the market in this way. But when significant news events or economic policies shift to affect currency valuations, this simple analytical tool is no match for the large institutional trading that will shift the Forex market. Often, reversals due occur coincidentally at Fibonacci levels as they are sometimes quite close together. This fuels the debate as to their validity.
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References
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