Fibonacci tools are important indicators used in the technical analysis of the financial markets, such as stocks and forex. In forex, it is used as a predictive tool to determine future price action of a currency pair. While many traders may be familiar with the most common use of the Fibonacci tool, which is the Fibonacci retracement, it can actually be used in four other different ways. Let us now take some time to describe the five applications of the Fibonacci tool on forex trading.
1. Fibonacci Arcs
This technique of Fibonacci charting employs the use of three curved lines (or arcs) to determine areas of support and resistance, as well as areas of ranging. The key Fibonacci levels that are used are the 38.2 percent, 50 percent and 61.8 percent Fibo levels. Fibonacci arcs are plotted by tracing the tool from the key points (high to low for downtrend, and low to high for uptrend) and then plotting three arcs that intersect this line at the three key levels of 38.2 percent, 50 percent and 61.8 percent. The trader can now decide whether to range trade these levels or use them as support and resistance levels when trading.
2. Fibonacci Fans
A Fibonacci fan refers to a Fibonacci charting technique that draws diagonal lines that correspond to the Fibonacci ratios in order to determine support and resistance points. The charting technique is to select the Fibonacci fan tool, apply it from the candle low to the high for uptrend or candle high to the low for downtrend. Three diagonal lines corresponding to the 38.2 percent, 50 percent and 61.8 percent Fibonacci ratios will show on the chart. These can then be used as a basis for support and resistance points to take your trades.
3. Fibonacci Time Zones
The Fibonacci time zones are a series of vertical lines that divide a chart into time increments that correspond to the Fibonacci sequences.
4. Fibonacci Extensions
Fibonacci extensions are used to determine price targets that extend beyond the 100 percent retracement ratio. When the market has ended a retracement and has resumed a move in the direction of the trend, the extension tool can be used as a determinant of how far the price will continue in the resumed uptrend, allowing a trader to set a good profit target. The Fibonacci extension is plotted by using the Fibo extension tool to plot points at two swing price levels. The Fibonacci extension levels are 138.2 percent, 150 percent 161.8 percent, 231 percent, etc.
5. Fibonacci Retracement
This is the most popular application of the Fibonacci tool. The Fibonacci retracement tool is used to detect points of support and resistance, especially when a trader is trying to gauge where a market retracement will end before continuing an uptrend.
The Fibo tools will help traders to avoid mistakes in setting stops and profit targets. Talk about taking the guesswork away from trading; the Fibo tool is one of the best that can achieve this for the trader.
By Alexander Collins, author of Pipburner Forex blog, which also features free Forex tools for download such as Camarilla and Fibonacci Forex calculators and indicators.