The Fibonacci is a very powerful forex indicator that can do an excellent job when it comes to identifying significant support and resistance levels. We can use the Fibonacci levels for trading Fibonacci breakouts or reversals. I think some traders avoid the Fibonacci indicator because they think it will be too complicated to use, but this is not the case from my experience. In this guide I will look at a simple Fibonacci reversal strategy that you can use to analyse all of your favourite currency pair charts and timeframes to find actionable forex signals.
What is the Fibonacci indicator in forex?
Fibonacci, also known as Leonardo Bonacci, Leonardo of Pisa, or Leonardo Bigollo Pisano, was an Italian mathematician from the Republic of Pisa, considered to be “the most talented Western mathematician of the Middle Ages”.
The Fibonacci sequence is a set of integers (the Fibonacci numbers) that starts with a zero, followed by a one, then by another one, and then by a series of steadily increasing numbers. The sequence follows the rule that each number is equal to the sum of the preceding two numbers.
Fibonacci levels are commonly used in forex trading to identify and trade off support and resistance levels. After a significant price movement up or down, the new support and resistance levels are often at or near these Fibonacci trend lines.
he most commonly-used Fibonacci retracement levels are at 23.6%, 38.2%, 61.8%, and 78.6%. 50% is also a common retracement level, although it is not derived from the Fibonacci numbers.
The Fibonacci retracement tool is one of the must-use tools in forex day trading. It is used to identify reversal and extension points. While the Fibonacci sequence is a bit difficult, the tool itself is relatively easy to use.
Fibonacci reversal strategy
Fibonacci retracements are often used as part of a forex trend trading strategy. This is when forex traders would observe for a price retracement taking place within an established currency pair trend and try to make low-risk entries in the direction of the initial trend by using Fibonacci levels.
We first need to establish the trend direction of a currency pair. There are many trend trading indicators to choose from, but we will keep things simple and use a 200-period moving average which is as good as any other.
The 200-day moving average is a long-term indicator. This means you can use it to identify and trade with the long-term trend. If price is above the 200 SMA, we will look for buy signals. If price is below the 200 SMA, we will look for sell trades.
Now that we have determined the direction which we are going to look for Fibonacci reversal trades, we need to plot the Fibonacci levels by using the Fibonacci retracement tool which is included free of charge with most forex platforms, including MetaTrader.
To draw Fibonacci retracements in a downtrend, you would start with the swing high point, and then drag the cursor down to the swing low point. After selecting these two points, your Fibonacci retracement tool will then automatically generate the relevant Fibonacci levels.
To draw Fibonacci retracements in an uptrend, you would start with the swing low point, and then drag the cursor up to the swing high point. After selecting these two points, your Fibonacci retracement tool will then automatically generate the relevant Fibonacci levels.
- Price is above the 200 moving average
- Price has formed a resistance level
- Price reverses back to a Fibonacci level
- Price bounces from the Fib level and continues up
- Bullish price action
In the GBP/USD 4-hour chart below, you can see that all of the Fibonacci reversal strategy signals for a buy trade have been met. The price is moving above the 200 SMA whereas the 61.8% Fib level is holding up as support. Entry could have been confirmed with various bullish price action formations including the hammer candlestick pattern. We could have placed the stop loss on the other side of the 61.2% Fib level which is about 30 pips. Price then continued up for at least 1,100 pips which presented plenty of opportunity to take profits along the way. Interestingly, the 200 SMA would have been a decent trailing stop so far whereas the 161.8% Fib level could be used our target to bank some pips.
- Price is below the 200 moving average
- Price has formed a support level
- Price reverses back to a Fibonacci level
- Price bounces from the Fib level and continues down
- Bearish price action
In the GBP/USD 4-hour chart below, you can see that all of the Fibonacci reversal strategy signals for a sell trade have been met. Price is below the 200 SMA whilst we have clear swing high and swing low points to use for drawing Fibonacci retracements. Price tested the 61.8% Fib level before continuing the downtrend. We can see that there is a large red engulfing bar where the sellers eventually won the race after some indecision as evident by the doji candlestick patterns. We could have placed the stop loss just above the 61.8% Fib level which would have been around 30 pips. The price dropped over 1,300 pips which shows how powerful the Fibonacci reversal strategy can be when implemented correctly. The 161.8% Fib level could have been a good price point to bag some pips.
Fibonacci reversal Pros & Cons
- Catch some good market trends
- Very powerful Fibonacci levels
- Fibonacci levels watch by many traders
- Self-fulfilling prophecy of the Fib levels
- Provide clear levels for support and resistance
- Fibonacci indicator is free to use
- High and low points for Fib retracements can be open to interpretation
- Takes time to learn how to master trading with the Fibonacci tool
- Requires the user to be able to time entry and exit
Conclusion: is the Fibonacci reversal strategy any good?
Yes, in my opinion this is one of the most powerful forex trading strategies that there is. We can spot long-term trends and time our entry on pullbacks. This means that we can catch some big forex market trends and avoid buying high or selling low.
However, it does require some skills on behalf of the user as you will need to learn where to draw Fibonacci retracements and how to read price action around the key Fibonacci levels. Therefore, it takes some practice.
You could always try trading the Fibonacci reversal strategy on a demo account to see how things go. Most forex brokers provide a free demo account which is a great way to brush up on your trading skills and build some confidence without taking any unnecessary risks.
As with any forex strategy you will need sensible money management and good trading discipline. This can be the difference between good and bad results. If the stop loss is too wide then it will only take one bad trade to wipe out a run of winners. I would try to lock winning trades in at breakeven point and use a trailing stop to try and maximise good moves. The Fibonacci levels can be an optional place to use for stops and profit targets.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.