Recently, I’ve been studying technical analysis in forex trading and noticed that many people use Fibonacci indicators but don’t fully understand them. So I’ll organize my own understanding here.

Speaking of Fibonacci, many traders know about this thing, but not necessarily where it comes from. Actually, these ratios have existed in nature for a long time, and later they were introduced to the West by Italian mathematician Leonardo Pisano (everyone calls him Fibonacci) in the 13th century, which is why they’re named after him. Interestingly, the golden ratio isn’t just a mathematical concept; it truly exists widely in financial markets, which is why traders trust it so much.

To understand how Fibonacci is used in trading, you first need to grasp the math behind it. The Fibonacci sequence is quite simple: it’s a series of numbers where each number is the sum of the two preceding ones: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597... and so on infinitely.

Here’s where it gets interesting. When you divide one number in the sequence by the previous one, the result approaches 1.618. For example, 1597 divided by 987 is approximately 1.618, and 610 divided by 377 is also about 1.618. This 1.618 is the legendary golden ratio. What if you do the reverse division? Dividing a number by the following one yields 0.618, which is the reciprocal of 1.618. Digging deeper, dividing a number by a larger number two places ahead results in about 0.382. These numbers—1.618, 0.618, 0.382—form the basis of Fibonacci retracement levels.

So, how are these numbers used in actual trading? Fibonacci retracement lines (also called golden ratio lines) help traders identify potential support and resistance levels. Imagine drawing lines between two price points, usually a high and a low, and the system automatically marks levels at 23.6%, 38.2%, 50%, 61.8%, and 78.6%. These levels are areas where the asset’s price might pause or reverse.

For example, if gold prices rise from 1681 to 1807.93, Fibonacci retracement can be used to calculate these levels. The 23.6% retracement is at $1777.97, 38.2% at $1759.44, 50% at $1744.47, 61.8% at $1729.49, and 78.6% at $1708.16. When the price pulls back to one of these levels, traders can judge whether it’s a good entry point or a place to set stop-loss orders.

In practical application, the logic for upward and downward trends is reversed. In an uptrend, after a significant rise, the price pulls back, and traders look for rebounds at Fibonacci levels from the bottom. In a downtrend, starting from the top, they look for where the price might stop falling at these levels. Usually, traders combine Fibonacci with other technical indicators or chart patterns to strengthen confirmation signals.

Besides retracements, there are Fibonacci extensions. If retracements are used to find entry points, extensions are used to set target prices and determine exit points. The foundation is still the 1.618 ratio, extending to levels like 161.8%, 100%, 200%, 261.8%, and 423.6%. In an uptrend, traders identify three key points—low point X, high point A, and retracement point B—and buy at B, then exit when the price reaches the extension point C. The logic is similar in a downtrend, just with the high and low points swapped.

To summarize, Fibonacci retracement helps you find support, resistance, and entry points; Fibonacci extension helps you set targets and exit points. This tool is effective because market participants recognize these ratios, creating a self-fulfilling prophecy. Of course, relying solely on Fibonacci isn’t enough; combining it with other analysis methods yields better results.