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In addition to Fibonacci Retracement, you must also know about Fibonacci Extensions and Fibonacci Projections. However, Fibonacci retracement method is used so extensively in trading that sometimes the markets start reacting to these levels as if the markets also believe in Fibonacci Retracement. Read the whole article and know why the markets react to Fibonacci Retracement and why you should be aware of Fibonacci Retracement levels. Now, traders use Fibonacci ratios to determine future levels of support and resistance based on previous moves in the currency markets. In other words, previous moves in the market determine where the Fibonacci levels will be placed.
Fibonacci analysis is an exercise in identifying the support and resistance during both the trend retracement and the trend continuations based on a series of numbers and ratios derived from the Fibonacci sequence. This sequence was discovered by an Italian mathematician Leonardo Pisano Fibonacci.
The sequence begins with 0, 1 and 1. The next number in the sequence is obtained by adding the previous two numbers. For example, take the first two numbers 0 &1; the next number will be 0+1=1. Take the next two recent numbers, 1 & 1; the next number will be 1+1=2. So the Fibonacci sequence looks like this: 0,1,1,2,3,5,8,13,21,34,55.
The remarkable thing about this sequence is that the ratio of number at specific intervals would consistently be the same, no matter how high you count the numbers. Fibonacci sequence gives us two very important ratios. These two ratios appear over and over again in nature such as sunflowers, shells, pine cones etc. These two ratios also appear in forex markets.
The first important ratio is 38.2% calculated by dividing any number in the Fibonacci sequence by the number two places higher in the sequence. In the above Fibonacci sequence, 55 is two places higher than 21. Divide 21 by 55you get 21/55=38.2%. The second important ratio is 61.8% obtained by dividing any number in the Fibonacci sequence by the next number in the sequence. For example, divide 34 by 55 (the next number), you get 34/54=61.8%.
Trends in currency markets dont go in a straight line. Up trends never go straight up and down trends never go straight down, the price will always trace along the way as buyers and sellers enter and exit the markets. The important question in every investors mind is how far these retracements will penetrate into the previous price movement. This is where the Fibonacci ratios become useful and is extensively applied.
Traders use the three additional ratios of 0%, 50% and 100% in addition to the two primary Fibonacci ratios. Two secondary Fibonacci ratios namely 161.8% and 261.8% are also used in the trend continuation projections. The secondary ratio 161.8% is obtained by dividing any number in the sequence by the number preceding it, in the sequence dividing 55 by 34 gives 55/34=161.8%. Similarly the ratio 261.8% is obtained by dividing any number in the sequence by the two numbers preceding it, divide 55 by 21, you will get 55/21=261.8%.
Fibonacci ratios are used by currency traders and investors in making entry and exit decisions for each trade. The first ratio 38.2% is used as an entry point in a trending market. The ratio 0% is used as the exit point. The question that you may ask is what the reason markets react to these levels is. You should not forget currency markets are just investors and speculators buying and selling currencies. So if many investors and speculators start believing in a thing, it starts becoming a self fulfilling prophecy. As most of the investors use Fibonacci analysis in determining the support and resistance and placing there entry and exit orders based on these ratios, the markets starts reacting to these levels.