One of the essential principles of applying technical analysis to forex trading in a profitable manner is that you want to see multiple confirmations for an entry point before you actually enter the market.
If you are making trading decisions based upon prominent candlestick formations on a long term chart, it would also be wise to check with a number of other indicators when you get a buy signal in order to make sure that there are no contradictions. In this article we are going to focus on how Fibonacci retracement levels coincide with support and resistance levels, and how you can use these two different technical indicators in conjunction with each other in order to yield accurate market entry signals.
Let’s start by defining what both of these types of indicators are. Fibonacci retracements are based on the number 1.618 (also called the Golden Ratio) that is found in all natural orderly systems from flowers to the human body to the financial markets. Over the years it has been proven that when the price of a currency pair has a large move and then retraces back in the direction of the previous value, it is statistically more likely to rebound at the levels of 38.2%, 50%, and 61.8% of the original price move.
The way that many traders use Fibonacci retracement levels is to determine when to enter and when to exit the forex market. A Fib retracement can give a buy signal when the price hits one of the three Fib values and then rebounds, or it can show that the market is ‘running out of steam’ and it is time to exit when the price approaches one of the three Fib values and then falls. While Fib levels can be excellent indicators, it is never wise to enter into a trade based on these values alone.
Support and resistance levels are pretty much exactly what they sound like: Support levels are the price values below the current price data that the market will tend to rebound off of, and resistance levels are exactly the same except they are above the current price data. Support and resistance levels can offer strong forex entry signals when the price breaks through an established level, as when this happens the price has a tendency to continue moving in that direction.
S&R levels and Fib retracements are both powerful trading tools individually, but when you combine them together the trading signals become much stronger and more reliable. As mentioned above, a Fib retracement can give a strong market entry system when the price retraces a given movement and then switches direction around one of the three main Fib values.
As a general rule of thumb when trading the forex market, the longer the time frame of a chart, the more reliable the trading signals that are generated. So if you happened to be looking at a 4-hour or 8-hour chart and you saw a strong Fib retracement signal, the way that you could confirm this signal using support and resistance levels is to see whether the Fib value is also a predominant S&R level.
If the price bounces off the S&R level, this is not as strong an indication for market entry as when the price passes through an established level, because once the price crosses an established support or resistance level then it has a tendency to continue moving in that direction.