Trading with Advanced Fibonacci Strategies

[RichardCox 10]

One of the most commonly used terms used by Technical Analysis traders in the Forex market is “Fibonacci,” or the “Fibonacci Retracement.” Despite its prevalence, many still view strategies developed with Fibonacci tools with skepticism because, it could be argued, the numbers used in its calculations have nothing to do with the underlying markets that are being traded. Is there any special reason why the EUR/USD should find support at a 61.8% Fibonacci level, especially when considering the possibility that only a minority of the market is watching (and actually placing orders) at that level?

 

In this article, I will argue that even though I agree with the idea that there is no direct relationship between the Fibonacci sequence and any of the commonly traded asset markets, traders still can (and do) place trades based on these levels and can achieve consistent gains when these levels are viewed in terms of what they actually are: approximate stalling points within a much larger trend. What becomes confusing and problematic (and results in losses) for many new traders is that Fibonacci is viewed in terms that are too exact, rather than in the context of what is happening in the larger trend. Trades based on Fibonacci levels are contrarian in nature (as we are looking for reversal points) and because of this additional flexibility is required when fighting against the market’s momentum.

 

With this in mind, we will look at a specific strategy to put these ideas into practice. Using a 4-hour chart, we will plot a 100-period EMA alongside a 150-period SMA. For indicators, we will use a 14-period daily RSI and against all of this we will plot the Fibonacci retracements of a significant bullish or bearish move. These levels will match the 0.382, 0.50 and 0.618 levels (which are the areas most commonly watched) and in addition to this, we will plot a 0.250 retracement as well as a 0.750 retracement level.

 

For our stop loss, we will set our levels at 2 percent (or less) of our entire trading account value but this can then be adjusted to align against significant support or resistance levels in this region. Profit targets are more flexible, as we will bring our stop loss to break even once the position is showing reaches the 0.750 retracement (for long positions) or the 0.250 retracement (for short positions). Trailing stops will then be used and we will close the position on a rejection of the support/resistance levels of the larger Fibonacci move.

 

In our trade, the main focus is the Fibonacci zone that is seen between the 0.382 retracement and the 0.618 retracement level within our impulsive Fibonacci move. This is our “price zone” and is our major concern in the trade. Our rules for trade entries will require the following: our shorter term moving average will show a positive cross in an uptrend or a negative cross in a downtrend. In an uptrend, we need to see the RSI reading below 50 while in a downtrend we will need to see a reading below 50. This helps us identify levels where markets are becoming over-extended.

 

Once a major Fibonacci move has been identified on a visual basis, we will wait for prices to enter into the “price zone.” The trigger signal is a close (using candlestick charts) and once this occurs, our parameters are set. The most important thing to remember is that trades cannot be entered “in anticipation” of these criteria being met. This is how traders get caught on the wrong side before the real moves occur. Fibonacci strategies can only work (over the long term) if specific risk to reward ratios are met. “Incorrect” entries are the most problematic obstacle for this type of position and this can be avoided as long as we honor our our original trading parameters.

[RichardCox 10]

Here we go again.So a restatement for the uninformed is required. 0.50 is not a fibonacci ratio.Ma's RSI MACD etc have nothing to do with fibonacci.And neither does some arbitrary zone inbetween ratios have anything to do with fibonacci.

I would suggest that the reason traders either struggle with fibonacci,or don't believe it even exists is pretty obvious. But believing 0.50 is a fib sure doesn't help.

 

Well, if you want to be literal about it, there is no direct mention that 0.50 is a Fibonacci level. It is, however, one of the most common retracement levels watched by tech traders and helps make up the "price zone" which is just a cluster of levels that often act as reversal points. I never suggested that RSI, MACD and MAs have anything "to do" with Fibonacci. The article simply explains a strategy for combining indicators with Fibonacci levels to create high probability trading setups.

[SIUYA 11]

50% retracement might not be a fib, but on most systems its the easiest way to get a tool to show it.

Personally I find the 50% retracement better than the 61.8% in FX, One of the first books I bought as a youngster was Amazon.com: The Trading Rule That Can Make You Rich (9780934380034): Edward D. Dobson: Books

 

It basically just talks about buying at a 50% retracement.....so its simple and not really a recommendation as a book but interesting as food for thought.

 

However, the real issue with Fib/or any retracements is - which swing are you retracing? sometimes they are obvious, sometimes not, but they can offer a good indications of levels sometimes - however I would apply another generalized rule I have learnt. Trade only on the first attempt at them, 2nd and 3rd attempts are usually likely to fail.

[SunTrader 10]

.....For our stop loss, we will set our levels at 2 percent (or less) of our entire trading account value but this can then be adjusted to align against significant support or resistance levels in this region. Profit targets are more flexible, as we will bring our stop loss to break even once the position is showing reaches the 0.750 retracement (for long positions) or the 0.250 retracement (for short positions). Trailing stops will then be used and we will close the position on a rejection of the support/resistance levels of the larger Fibonacci move....

As always a chart would help to visualize things because I'm not following you when you say bring stop to break even once position reaches 0.75 retracement - for longs.

 

Are you another one of those who draw their fibs upside down? Because fibs drawn on a retrace of upmove will show levels of 0.250 / 0.382 / 0.500 / 0.618 / 0.750 in descending order.

 

Or do you then draw another fib retrace of downmove which inverts those levels and use them to determine profit points?

 

Also I think there is a typo RSI < 50 for both up and down trends (?). And specific reward to risk ratios are met only if the market allows for it.

[SIUYA 11]

There's a lot of it about..misinformation that is:)

 

................................................................................

 

of course there is....this is a market, there are many ways to skin a cat, and no statistics to show certain things work all the time.

All we can do is assimilate the info, and think about what works for you....unless someone is looking to buy the secrets (ahem information), as they are for sale.

 

Ever been to law school - how is it the same people are taught the same things and then told to go out and argue with each other that what they know is wrong.....and charge for it!

[SunTrader 10]

You touched on something here in this post that is a big clue on how fibs actually work in the market and why they appear invisible to many.I'm not going to spell it out here for obvious reasons.But for anyone interested in gaining a deeper insight into the subject you really need to do 2 things.The first most important thing is to not use software,since it's designed by people who don't know or care what fibs really are.So that would include any tool that just throws in other levels for the hell of it.But more importantly,to realise that the market is dynamic

Using other things in order to make the fibs work better is............a complete blind alley.

If you are trying to make a point .......... it helps to make a point. Not spelling it out does nothing.

 

The fact that markets are dynamic should be obvious to anyone who has stared at a chart for more than a minute or two.

[SIUYA 11]

Damn i should have been a lawyer,i love arguing...it's the reason i took so bloody long to learn this game:(

 

far better to play with yourself than argue with yourself....even better to both play and argue with others.

[Vince50 10]

One of the most commonly used terms used by Technical Analysis traders in the Forex market is “Fibonacci,” or the “Fibonacci Retracement.” Despite its prevalence, many still view strategies developed with Fibonacci tools with skepticism because, it could be argued, the numbers used in its calculations have nothing to do with the underlying markets that are being traded. Is there any special reason why the EUR/USD should find support at a 61.8% Fibonacci level, especially when considering the possibility that only a minority of the market is watching (and actually placing orders) at that level?

 

In this article, I will argue that even though I agree with the idea that there is no direct relationship between the Fibonacci sequence and any of the commonly traded asset markets, traders still can (and do) place trades based on these levels and can achieve consistent gains when these levels are viewed in terms of what they actually are: approximate stalling points within a much larger trend. What becomes confusing and problematic (and results in losses) for many new traders is that Fibonacci is viewed in terms that are too exact, rather than in the context of what is happening in the larger trend. Trades based on Fibonacci levels are contrarian in nature (as we are looking for reversal points) and because of this additional flexibility is required when fighting against the market’s momentum.

 

With this in mind, we will look at a specific strategy to put these ideas into practice. Using a 4-hour chart, we will plot a 100-period EMA alongside a 150-period SMA. For indicators, we will use a 14-period daily RSI and against all of this we will plot the Fibonacci retracements of a significant bullish or bearish move. These levels will match the 0.382, 0.50 and 0.618 levels (which are the areas most commonly watched) and in addition to this, we will plot a 0.250 retracement as well as a 0.750 retracement level.

 

For our stop loss, we will set our levels at 2 percent (or less) of our entire trading account value but this can then be adjusted to align against significant support or resistance levels in this region. Profit targets are more flexible, as we will bring our stop loss to break even once the position is showing reaches the 0.750 retracement (for long positions) or the 0.250 retracement (for short positions). Trailing stops will then be used and we will close the position on a rejection of the support/resistance levels of the larger Fibonacci move.

 

In our trade, the main focus is the Fibonacci zone that is seen between the 0.382 retracement and the 0.618 retracement level within our impulsive Fibonacci move. This is our “price zone” and is our major concern in the trade. Our rules for trade entries will require the following: our shorter term moving average will show a positive cross in an uptrend or a negative cross in a downtrend. In an uptrend, we need to see the RSI reading below 50 while in a downtrend we will need to see a reading below 50. This helps us identify levels where markets are becoming over-extended.

 

Once a major Fibonacci move has been identified on a visual basis, we will wait for prices to enter into the “price zone.” The trigger signal is a close (using candlestick charts) and once this occurs, our parameters are set. The most important thing to remember is that trades cannot be entered “in anticipation” of these criteria being met. This is how traders get caught on the wrong side before the real moves occur. Fibonacci strategies can only work (over the long term) if specific risk to reward ratios are met. “Incorrect” entries are the most problematic obstacle for this type of position and this can be avoided as long as we honor our our original trading parameters.

 

Richard, Im very happy to read your article on Fibs. It reminded me of something very important I discovered about them. As you say they are just zones, mot exact buy/sell points, although a very few can use them as such. For ,what I do lately and am seeing more and more of, is that when price is approaching an important area, you say to yourself "yellow light, get read ,something may happen". Then it gets to the area, and if it bounces off the area and you take it and you win all is well. But if ity hits your area ,bounces and then falls thru the area....I still go "uh oh, yellow light, proceed with caution." I dont throw the level out like I used to. Also, when a level is broken and then price comes back to it and then it keeps going back and forth or at least hanging around that level, often it is wise to look for another trade as indecision has set in! Thanks for this article. As someone getting involved in Harmonic fibonacci trading, this is something I must be aware of. Why? WHAT HAPPENS IF YOU STOP OUT OF A TRADE BUT THEN PRICE COMES BACK INTO THE ZONE AGAIN...DO YOU TRY AGAIN? OR..WHAT DO YOU CHANGE IN YOUR STRATEGY? Shhhhhhhhhh....dont tell anyone, but if I get stopped out on lets say a USD long pair but see 2 other USD pairs keep going, this may give me the reason to try a second time. If I dont see this I never will. Its over. Next trade. Agree?