By Sean Hyman As you may know, I’ve taught currency courses to fellow colleagues in the industry and novice Forex traders for years.

In my classes, once I get past the basic “this is a currency pair” and “this is a trend line,” my students always inevitably want to know about Fibonacci.

Fibonacci or “fib lines” on a chart seem to be the most intriguing but also the most mysterious tool for newbie Forex traders to use and understand.

Indeed, if there’s one indicator I see misused most often, it’s fib lines.

But once you grasp how to use fib lines, they really can boost your success in trading. I know traders who have used Fibonacci levels to grab winners as high as 134% and 227%.

Let’s take a moment and examine how you can do the same…

The 13th Century Profit Signal Still Used Today

So first things first! In case you’re unfamiliar with the concept, the idea of Fibonacci dates back to the 13th century. The Fibonacci concept says a number is the sum of its two immediate predecessors.

The pattern goes like this 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. You will notice that in the pattern you add the first two numbers together and you get the third number. This process repeats itself until infinity. However, the numbers develop a ratio of 1.618 roughly.

In trading, the really big industry traders use Fibonacci or fib levels to see when a particular asset (stocks, commodities, currencies, etc) will retrace within its trend and then return to its down or uptrend.

In other words, traders use the fib pattern to see when an upward trend is going to climb higher, or when a downward trend is going to continue lower. Using this method, traders know when to both enter a trade and ride the trend, or close out a trade as the trend is about to fall apart.

Indeed, the BIG professional traders use fib levels to find out where they should pull the trigger on the really big Forex trades.

Back to the Basics…How to “Draw” On Your Fib Lines

Let’s talk about the practical use of fib lines in Forex trading.

First of all, you should know that most trading platforms will show you the Fibonacci lines for each currency pair, or allow you to draw them on yourself by dragging your cursor over specific areas of the chart. Take a look at your platform’s tools, so you can be ready to use fib lines on your currency charts.

Once you’re ready to “draw” on your fib lines, eyeball the currency chart. Which direction is your currency pair headed overall? Up? Down? This is important to note, because fib levels will tell you when your currency pair is going to retrace (read: “return”) to its upward or downward trend, so you need to know which direction it’s heading.

So let’s say your currency pair is heading up, like on the chart below. Once you’ve noted that, you should draw your fib lines in that direction only. (See the blue line below for the proper fib lines.)

Since the Trend Is Up, Draw Your Fib Lines on the
Upswings within the Major Trend!

Since this trend is upward overall, we want to look for entry points into this overall upward move. So let’s draw fib lines on an upswing. (I’ll draw on one that has already happened only so you can see how these turn out. However, to see where prices may pull back to in the future, you’d draw on the latest upswing to the right).

On the chart below you will see the fib level that ended up holding the price and reversed the price back upward. However, that’s in hindsight.

How to Know You Should Buy Now!

Remember, these charts above are both showing a trade that’s already played out. I did that on purpose, so you can see how Fibonacci can show you where a trade will return to its trend.

It’s a bit more difficult if you’re looking at a trend as it’s developing. But that’s why Fibonacci is so important. It helps you predict where the trend is headed next when you don’t have the advantage of hindsight to see how it’s already played out.

But now let’s talk about how to use this charting pattern while it’s happening. How do you know which level to buy in at? First of all, just by using the candles above, you would generally want to see 2-3 candles or more hold a specific level before you would consider buying (on a candlestick chart like the one above, you can spot these 2-3 candle holding spots by looking where the pattern seems to flatten out). When that happens, that’s your first clue that you may have a level that’s holding steady, and therefore a good place to buy.

However, thankfully there are other things we can look to. We can look to reversal candle patterns. For instance, the first time the pair hits the 50% middle fib line, it produced a bullish engulfing pattern. Then the second time it reversed at that level, it produced a morning star reversal pattern. (These are bullish reversal candle patterns that can help you to know when a pair may be reversing at the fib level.)

So the more you learn to recognize candle patterns, the more you’ll “unlock the code” and can use those to help you with your entries too. (In the meantime, when you see 2-3 candles hold a level and start to reverse, you have a high likelihood that the pair will reverse at that level.)

You can also use other indicators to help you “time” your entry at a fib level. You can look at the stochastics on your trading platform, or the MACD (a combination of two moving averages). If they are both flattening out at the same time as the fib chart, that means all are showing buy signals at the same time. See the chart below and you’ll see what I mean.

Now I don’t use all of these indicators at once on my chart. However, I do use one of the three indicators. But keep in mind that all of these three indicators are all looking for the same thing…oversold indications. Therefore, I recommend only using one or two of them at maximum. Too many indicators just clutter and confuse the trader.

Use 1 or 2 Indicators to Know When to Buy

As you can see by the chart above, the Slow Stochastic indicator became oversold and crossed into a buy signal twice at the 50% fib line as several candles held the level.

However, the RSI also hit oversold levels and turned higher at this level too.

The lowest indicator, the MACD’s histogram, started to improve by making shorter lines, showing less selling pressure. That indicates that the pair may be attempting a turn to the upside.

So you can use any one of these indicators to help you to determine when to enter when a pair appears to be holding a fib level. This way you are more likely to buy at the right level and save yourself a lot of downside before the pair turns.

Now, with all of this said, do realize that fib lines are more like “zones” or “regions.” A pair doesn’t necessarily turn right down to the exact pip of where the fib line is. Therefore, you have to give these trades some room to move in the direction you want.

This is why many traders will go so far as to place a stop below the fib line that is lower than the one that they are trading on. This way the trade has plenty of breathing room and would have to break both levels in order to get stopped out.

Therefore, keep your number of lots small enough and your stop wide enough to where you can give your trade some breathing room but yet not risk a high percentage of your capital either. By doing so, you will be giving yourself a high probability of a winning trade!

Have a great weekend!
Sean Hyman, aka “Professor FX”

P.S. Over the past six years, our Money Trader subscribers have used these types of small (seemingly insignificant) profit triggers to exchange not millions, but billions of dollars in cash on the spot Forex market. And they’ve walked away with profits as high as 410%, 560%, and 710% for their trouble. Find out the secret behind their success here.