How To Use Fibonacci Retracement And Extension

What Is Fibonacci?

Leonardo Pisano was a mathematician that came up with the Fibonacci Sequence. Unlike modern day mathematicians he started the sequence from 1 and not 0. The sequence goes 1, 1,  2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233. The number and the previous number are added together to make the next number. This is significant because the Fibonacci ratios are what we use in Forex to predict the market. 

What are the ratios?

The ratios are 23.6, 38.2, and 61.8 for the retracement. The way you get the ratio is by dividing the first number by the second number. For example 21/34=.618 which is considered the golden ratio. To get the 38.2 you would divide the 1st number by the 3rd number, for example 8/21=.382. To get the 23.6 you would divide the first number by the fourth number. For example 21/89=.236.

To get the Fibonacci extension ratios you divide the 2nd number by the 1st number. For example 144/89=1.618

Right now this might not make a lot of sense but as I continue everything will come together.

To use the Fibonacci retracement tool you have to know what a retracement is. A retracement is when the trend takes a small break and goes in the opposite direction, but eventually goes back to the direction of the trend.

The chart above shows two retracements. You have to be careful because that retracement could be a reversal, and that usually happens at major support and resistance lines.

As you see in the above picture the reversal happened after the 2nd retracement. You have to know the currency well enough to know when it will continue the trend and when it will reverse. 

How To Do Fibonacci Retracement & Extension

Now that you know what Fibonacci is I will show you how to use it. I will be using the USD/JPY graph to predict the next movement.

So I will start from a swing low and go to a swing high. Swing lows and swing highs indicate the high point that the market has been at without a retracement. If it retraces it is not recommend to continue the Fibonacci retracement past the retracement. You will want to start over. In the picture it retraced off of the golden ratio .618.

As we continue we will measure the swing high to swing low which will predict that it will hit the area of 1.619. This is called Fibonacci Extension. It is called that because we measured the retracement which allows you to predict how much it will go up.

We measure again from swing low to swing high and it retraces to the .618 area which means it will go up again. Notice that it bounced off the area multiple times, which gives signs of rejection. That further indicated that it will move up. Right now the market is consolidating. If any of you are familiar with harmonic patterns this is basically an extreme variation of the 3 drive. Once complete the market should drop quite a bit. How much? I am not exactly sure, but my prediction will most likely be a very bearish one.

Hope this helps.

Sincerely,

ManBearBull