Fibonacci Sequence is one of the prime indicator used in forex trading. They act as huge support or resistance levels and are amazingly accurate.
Fibonacci Sequence was created by Leonardo Fibonacci. The sequence is a series of number where the sum of previous 2 numbers gives the next number of the sequence. So the sequence is -
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 ……
As you can see, the next number in sequence is calculated by 1+2 =3, 2+3 = 5, 3+5 = 8 and so on
But this is not it. Here is another amazing thing. If you divide the alternate numbers, their ratio is between 0.60 to 0.62. For e.g. 3 / 5 = 0.6, 5 / 8 = 0.62, 8 / 13 = 0.61 etc..
This ratio later on stabilizes at the value 0.618
Similarly, the ratio between alternate numbers in fibonacci sequence is in range 0.38 to 0.40. This number later on settles at 0.382
Fibonacci Retracement Patterns
The ratio of 0.382 and 0.618 is what is known as Fibonacci retracement levels. In Forex Trading Terms, if a currency pair reverses in direction, then the supports can be expected at 31.8%, 50% and 61.8% of the overall length of the trend.
Please refer to the image below for understanding this better
The fibonacci's can be plotted by taking the high and low of a trend. Most of the Forex Charts have the capability to plot these levels once you provide high and low.
Along with indicating the potential support and resistance levels, the fibonacci indicators also tell the strength of the trend. If the currency pair hits 38.2% level and then reverses to continue the original trend, that kind of tells that the market is in strongly trending.
However if the currency pair touches the 61.8% level and then reverses, it would signify that the currency pair is about to run out of steam and the trend can come to a halt very soon.
Should you close your forex trade if the currency pair hits the fibonacci levels?
To be honest, not necessarily. Please note that fibonacci levels are potential levels where the currency can reverse, but not all the times.
I typically recommend to watch the behaviour of currency pair at the fib levels and use it as a target . If the market reverses, then only I would go ahead and close the trade.