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Fibonacci Trading in Forex: Step by Step.

Started by Qoption, Apr 24, 2020, 04:45 am

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Qoption

Typically, I place stops just below the 88.6 level or the 100.0 level. Ask yourself first, what is the risk/reward ratio on the trade? If your minimum target of reaching the beginning of the retracement, i.e. the Zero Level on the Fib lines, cannot be reached with a decent risk/reward, then pass on the trade.
The above examples are for long trades. They work the same in reverse with short trades. In those cases, the 100.0 Fib level is at the previous high, and the Zero Level at a low, and you're looking for the price to move up to the 88.6% and bounce down.
Simplify your Fib retracement lines to 61.8% and 88.6% (or even just 88.6%) and start looking for these bounces.
In Summary.
1. The 88.6% Fib retracement level is one of the more powerful Fibonacci levels when it produces a bounce; you can consider a trade just on that level or with previous support/resistance (the best trades are often in line with the larger trend). 2. The 88.6% level gives good risk/reward ratio trades when caught early. Always consider risk/reward for every trade. 3. Bounces off 88.6% retracements often travel much further than just the previous retracement allowing you to trail some of your position.
Fibs and Triangles: Getting 80 Pips with a 25 Pip Stop.
We've written about the importance of a much overlooked chart pattern, the "Triangle", and how it can produce accurate trades with excellent risk/reward ratios.
Here, we're going to look at this concept tied in with a Fibonacci retracement level that I love, the 88.6 Fib percentage. To recap, the Fibonacci Golden ratio is 61.8%. If you square root that percentage, and square root it again, you get 0.886, or 88.6%. I often use a bounce off the 88.6% Fib level as a trade entry.
Let's dive right in and look at an example. This is a live trade that I took on the GBP/USD on a 15-minute chart.
The following chart is the point at which I saw the trade developing:
My logic was this: The price moved from a high to a low (marked by the 100% and 0% lines) and then moved back up to the 88.6% level (highlighted by the small blue line). The price bounced off that level to the exact pip. I felt the price would continue moving down and extend the previous down-move past the 0% level.
I could have entered a short position immediately but the nearest place for a stop was around 45 pips away (above the previous high); whilst the profit-target was over 80 pips giving an okay risk/reward, I felt I could get a tighter stop-loss on a consolidation. So instead I waited for a pull back or a consolidation (such as a triangle) to plan the trade from. The risk with waiting is missing the trade entirely as the price could just rocket down and not consolidate at all.

Qoption

Getting Into the Trade.
When I checked the chart again, I noticed a triangle consolidation that the price had just broken out from and decided this made a good entry point. I used a 25 pip stop that was just above the triangle. In the following chart, I've marked just the initial high as Point X, the low as Point 1, and the 88.6% level as Point 2 (and removed the other Fib levels for clarity). And the triangle pattern is marked with the red lines.
Getting Out of the Trade.
My target was a 100% extension of Wave 1. This means you take the size of Wave 1, i.e. from Point X to Point 1, and measure 100% of that size from Point 2. That gave me a target of about 80 pips away from my entry. This was a risk/reward ratio of over 1:3 which I think is very acceptable.
When it hit the target, it broke it by 1-2 pips before rebounding and going through it firmly. See the following chart.
In Summary: 1. A Fib level can often produce a good setup, but if you don't see it quick enough, you may miss the trade or must accept a wide stop 2. The triangle pattern can give you a tighter entry and therefore a better high risk/reward 3. In Forex, the pips made only makes sense when you compare it to the pips you risked!
How to Trade Price Action with Fibonacci.
We are going to recap the detailed examples shown above by going back over the general principles you should apply when using Fibonacci levels to trade Forex.
The Fibonacci is normally used by taking two extreme points (the high and low) and measuring the key Fibonacci ratios in between.
An example of the three common levels and how to use them are below. In these examples all 3 diagrams are in an uptrend. They all retrace lower to a Fibonacci level before again moving higher with the trend.
The number 1 on the above diagrams is the first move higher. This is followed by number 2 which is the market retracing lower to the key Fibonacci level. It is here at these key levels where Price Action traders would be looking for solid Price Action and hints from the market to get along with the uptrend. Number 3 represents the market respecting the key Fibonacci levels and moving back higher.

Qoption

The chart below shows how this pattern works in the Forex market. Price has been moving higher. A retrace back lower falls into the 61% Fibonacci level. The market respects this key Fibonacci levels and again moves higher completing the pattern.
The Fibonacci pattern can be used the exact same way when traders are looking to short the market. The only change is traders are looking to get short and are looking for retraces back higher into key Fibonacci levels to get on board the down trend. An example of the Fibonacci tool being used in a downtrend is below. Notice price is stopped at the 38.2% Fibonacci level before again moving lower.
The Fibonacci tool can be a very successful tool when used correctly. To increase the chance of placing a wining trade, traders should look for Price Action at the key Fibonacci levels to confirm a trade.
As suggested with all new trading techniques, make sure you practice this technique with a demo account before ever considering going live. Until you have proven you can use this tool and profit consistently on a demo account do not start "live" trading! If you can't make money on a demo, you have no chance once trading live!
How to Set Stops with Fibonacci.
Most traders are familiar with the use of Fibonacci ratios as entry and take profit points, but few have considered placing stops with FIBS. Using unconventional methods for setting stop loss levels can have a surprisingly uplifting effect on profitability, and when a method can be found that is both unconventional and reliable, a serious edge can be uncovered. Placing stops with FIBS can be such a method.
The point of a stop loss is to limit risk. Most traders tend to take the view that a stop loss should be placed at the point where the trade becomes "wrong", i.e. an adverse point which if reached means the trade is likely to continue going in the wrong direction. Traders also tend to set stop losses very conservatively, telling themselves that the trade needs "room to breathe" as they place the stop one pip above or below the trigger candle or swing high or low. Is this the correct attitude to take? That depends very much upon the individual trader's risk to reward profile and trading style.
The best trades often spend little time in negative territory. This is not always true, but if one looks at a large sample of historical trades produced by most types of strategies, especially breakout strategies, a positive correlation of approximately 0.25 is usually found between the trades that take off immediately and the trades that ultimately are winners. This has serious implications for the traditional approach of setting stops so that trades have room to breathe, as a disproportionate number of winning trades don't need any room to breathe!

Qoption

This means that many strategies, especially shorter-term breakout strategies, produce a higher positive expectancy if stops are placed more tightly than the other side of the candle or swing. There will be more losers, but the winners will be larger overall. How to tighten these stops? One approach is to look within a shorter time frame for obvious micro support or resistance levels. This can work extremely well, however often such a level is not clearly identifiable, and it is not practical under seriously pressured entry conditions to spend much time looking for one. This is where FIBS can come in. Calculate the pips risk mentally from your entry to where you would traditionally place your stop and apply that number to a FIB calculator. You can select any of the common FIB ratios as they all have some power, but the 50% level does tend to be the strongest. Placing your stop two or three pips beyond the 50% retrace level can almost double the size of your winning trades while being surprisingly protective of many of the best ones. It is recommended to review your past trades and see how your results would have been different using type of stop loss strategy.
There is an alternative approach that can be taken in placing stops with FIBS that is especially appropriate for longer-term strategies that utilize wider, larger stop losses. We can take it for granted that there is stop loss hunting especially during periods of low liquidity. These hunts can and will take the price to those areas one pip above or beyond the swing high, where the herd tends to place its stops. Consider trying to place your stops more out of harm's way by finding a widely used FIB retracement or extension ratio that can be applied to a larger swing that is placed not too much further away than their traditional stop loss placement area. Place your stop loss a few pips the other side of that level and you might find better protection from the hunters, at a small extra premium. If your trade is for a large target, it can be worth it.
I'm a retail Forex trader and I exclusively use Technical Analysis to trade. I believe that Technical Analysis offers the cleanest way to predict the future direction of price movements. The fundamentals and news create the market sentiment and emotions, and that in turn is reflected in the price chart. Your bet as a trader is not on the fundamentals - it's on what happens to the price as a result of those fundamentals.
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Please make sure your comments are appropriate and that they do not promote services or products, political parties, campaign material or ballot propositions. Comments that contain abusive, vulgar, offensive, threatening or harassing language, or personal attacks of any kind will be deleted. Comments including inappropriate will also be removed.