Forex trade has been around for about five centuries and recently, it has grown to be the largest investment market in the world. Rapid growth in this market can be attributed to increasingly open borders and markets as well as individuals who are seeking to supplement their income through alternative means.

Like any other market trade, Forex trading is complex and requires a disciplined approach to learning its ways. Strictly speaking, there are no shortcuts, but there are proven approaches to better understand trade patterns and make more money.

One of those ways we will look at today is pattern recognition and retracement using the Fibonacci approach. The name and underlying assumptions of this approach trace their roots back to the Italian mathematician of the same name - Fibonacci. It will serve us well to first understand Fibonacci’s numbers before attempting to understand their relevance to Forex trade.

If you have heard of the golden ratio, you may also have heard of the man behind the genius observation of nature’s elegance. The golden ratio is derived from the relationships between numbers in a set of a Fibonacci sequence. Fibonacci numbers are a series of numbers in which each number is a sum of the two numbers before it. From 1, a series may look like 1,1,2,3,5,8,13...and so on until infinity. Each larger number is approximately 1.618 times larger than the number before it regardless of how far up you go in the sequence. This is the golden ratio and it has been proven to be useful to understanding trade patterns and predict favorable trade zones.

## How it works

The end products of a Fibonacci retracement calculation are support and resistance levels. For a trader, these numbers are quite helpful in making trade decisions. By narrowing down zones in which a trend pattern is likely to fluctuate and provide favorable trade zones, trade decisions are made easier with minimized risks for loss.
To calculate resistance levels, Fibonacci retracements use the golden ratio, also known as phi, as well as swing high and swing low points. Swing high points are peaks in a trend at any given time frame which are preceded and followed by a lower high.

Swing low points are trough reached by a given security’s price. This is a low point lower than any surrounding prices in a particular time frame. Once identified, the distance between the swing low point and the swing high point (also known as the trough to peak or peak to trough distance) is then divided by the golden ratio to populate results on levels in a trend that a future price is likely to fall.

Most trading software has a Fibonacci calculation feature. To use it, the trader would identify the swing high and swing low points and select the Fibonacci calculation. The software will populate results with support and resistance levels. Support levels are the low price cap which prices cannot go lower while resistance levels are the opposite - a high price cap which prices cannot go any higher.

Traders can use Fibonacci retracements to guide where to place stop-loss limits. For instance, where there is an observed upward trend, a trader would hold a long position while if there is an observed downward trend, they are likely to choose the short position. The long position places the stop loss below the latest swing low level. This allows room for safety in case the swing low rate becomes a level of support. In this approach, falling prices may recover before falling through the chosen stop loss place. On the other hand, the short position places the stop loss a little above the swing high level where the potential resistance level is. Although slightly bolder and riskier, this approach could yield high income in cases where the trend continues upwards.

## Not a foolproof technique

Trading of any kind is complex and requires multiple methods of analysis to yield any meaningful outcomes. Using the Fibonacci method alone may give useful insights in trend progressions, but it does provide a guarantee on the accuracy of predictions. A smart trader would understand that there is a large risk of trends reversing contrary to predictions before resuming the predicted trend. In these cases, it is smart to have risk mitigation strategies to avoid significant losses.

A common problem traders have is identifying appropriate swing high and swing low points and without a keen eye to learn the best practices in identifying these points, a trader can find themselves on the wrong side of calculations quite often. After all, everyone looks at charts differently and interprets trends differently. There is no right or wrong way to identify these levels, however, part of this mastery comes with experience in choosing time frames and knowing which tools to combine to get the best estimates.