The tool’s major benefit is in identifying where potential entries and exits may arise. This is only logical as Fibonacci is a leading indicator. Leading indicators, unlike lagging indicators, can predict the inflection points in a market. A trader can effectively identify where a trend may start or end. The tool can also help reduce false signals, since levels where prices may react are identified from the key natural sequences.
Using Fibonacci does require a basic understanding of technical analysis, such as being able to identify where the extreme highs and lows of a trend may be. Once these have been identified, a line from the high to the low is drawn, which in turn creates three horizontal lines at different points. These points suggest areas of future support and resistance.
The default Fibonacci levels are 38.2, 50 and 61.8 per cent, values that seed back to the natural sequences discussed earlier. In an uptrend, these levels may suggest regions of support, and areas of potential resistance in a downtrend.
The Fibonacci tool can also be used with trend lines and act as an early signal of where to add or even exit a trade. When the Fibonacci is combined with other indicators, such as pivot points and the MACD, a stronger signal and more clarity may be attained.
For more information about how to trade using Fibonacci, please visit bit.ly/Fibo1
Lukman Otunuga is a currency analyst at FXCM.