Fibonacci numbers are very popular in technical analysis and every trading platform offers the following Fibonacci tools; Retracement, Expansion, Arcs, and Time Zones. Out of all these tools, the Fibonacci Retracement is the most popular one and has extensive uses.
Some traders are using it to simply find out retracement levels, like the golden ratio, the 61.8%. Other traders are using the Fibonacci retracement tool to count waves under the Elliott Waves theory, as the theory is based on Fibonacci numbers.
We all know that market is moving based on the general supply and demand levels. In other words, if there are more buyers than sellers, when it comes to volume, then the market will move to the upside. The opposite is true as well, with the market moving to the downside if there are more sellers than buyers.
The areas where supply and demand are changing hands are called confluence areas and they can be found using the Fibonacci retracement tool. The idea behind this is to use the most important Fibonacci levels, like the 61.8%, 50%, 38.2% and 23.6% in a top/down manner, from the bigger time frames to the lower ones, and find if/where multiple levels are coming in the same place. If they do, the area is being called a confluence one, and it is difficult to be broken.
What this technique does is find strong support and resistance levels. The moment a support is broken, it turns into resistance, with the other way around being valid as well.
The whole concept should start from a monthly time frame, and the idea is to take a Fibonacci retracement tool and drag it from the highest to the lowest point and market the Fibonacci levels mentioned above. The chart below shows the USDJPY pair on the monthly time frame, with the highest and lowest point on the chart being marked with two horizontal lines.
The 61.8%, 50%, and 38.2% levels are marked on the chart as important Fibonacci levels and the next thing to do is to go on the lower time frame, the weekly one, and do the same thing, but for the most recent move. The reason why the Fibonacci retracement tool is drawn like you see it below is because the chart shows the highest value before the lowest one.
Moving on to the weekly chart, the principle is the same: we’re using the Fibonacci retracement tool to find out the retracement levels for the recent move. Because the weekly chart has the lowest point before the highest one, the Fibonacci retracement tool should be drawn the other way around.
On the chart above, the blue lines represent the Fibonacci levels from the monthly chart, and the blue ones are the 38.2% and the 50% levels that correspond to the move price made on the weekly chart. While the 38.2% level on the weekly chart doesn’t come close to a monthly Fibonacci level, we can see that the 50% retracement on the weekly is close to a Fibonacci level derived from the monthly chart.
That being said, the area between the two Fibonacci levels is a confluence area or a cluster area, and it is a difficult one to be broken. This is where buyers and sellers are most likely to exchange hands, and where supply and demand dominates trade.
To clear such an area is a difficult task and in the case, it is broken, it should transform in resistance. At this very moment, we can say that the support held so far and the bounce from it is almost magical.
What is interesting here is the fact that we could find this confluence area before price reaching it, so fading the move lower was the right thing to do. Only because price bounced from the confluence area doesn’t mean that the support will hold forever. Keep in mind though that by the time the area is cleared, it should act as a resistance moving forward.
The whole process should be repeated this time on the daily chart. Find out the highest and the lowest points on the daily time frame and find the Fibonacci levels mentioned earlier. If any of those levels are coming near the previous weekly and monthly Fibonacci levels, the area is a confluence one.
As a rule of thumb, the bigger the more levels are coming in the same area, the more powerful the support and resistance are supposed to be, and the more difficult to clear it. Such a cluster should act as a strong incentive to close earlier trades if the market is reaching support/resistance and to go for a trade in the other direction.
It is not recommended to move lower than the daily chart with this process as the forex market is characterized by large swings and the levels would simply become irrelevant.