The Fibonacci retracement indicator is a very popular tool among Forex traders, and it is based on a set of key numbers identified in 1175 by Leonardo Fibonacci, an Italian mathematician.
What Are Fibonacci Numbers?
The Fibonacci series is derived by first adding numbers as follows:
2+1 = 3
3+2 = 5
5+3 = 8
8+5 = 13
13+8 = 21
…and so on until infinity.
The next number is always calculated as the sum of the previous two numbers. However, these numbers themselves aren’t important. Rather, it is the ratio between these numbers that form the Fibonacci series.
If you take the first number (i.e. 3) and divide it by the next (i.e. 5), you’ll get an estimate of about 61.8%. This is the same as if you take 5 divided by 8, and so on. You’ll always get a ratio close to 61.8%. 61.8% is the first Fibonacci ratio.
The next Fibonacci ratio is derived by taking the ratio of the first number and third number. For example: 3/8, 5/13, 8/21 and so on. You will roughly get 38.2% this time. This is the second important Fibonacci ratio.
The third Fibonacci ratio is calculated by taking the ratio of the first number and fourth number. For example: 3/13, 5/21 and so on. You’ll get roughly 23.6%
How Do I Use Fibonacci Ratios In Forex Trading?
In technical chart analysis, Fibonacci levels are usually created by taking a chart peak and trough, and dividing the vertical distance by the key Fibonacci ratios. These graphical levels on the trading chart are important support/resistance areas.