Our goal in this article is Fibonacci!
Get ready for the Ultimate Guide to Fibonacci Trading!
Why Fibs? I realized how often I actually refer to Fibonacci and Fib levels in my articles. Choosing this topic was very easy, to say the least.
I will provide you with a grand and excellent explanation of Fibonacci and Fib trading, so make sure to take notes and grab some extra coffee just in case!
OVERVIEW OF FIBONACCI
Fibonacci was actually named Leonardo Pisano Bigollo. He was an Italian Mathematician and considered "the most talented western mathematician of the Middle Ages.” Fibonacci is well known for the Hindu-Arabic numeral system in Europe, which was published in 1202 in his book Liber Abaci (Book of Calculation). He is also known for the Fibonacci number sequence. However not because he discovered the sequence himself, but they because were named after him. The numbers were used as an example in the Liber Abaci. The numbers are : 0,1,1,2,3,5,8,13,21,34,55,89,144, etc. The trick is to add the first two numbers, which equals the third (0+1=1), then continue by adding the 2nd and 3rd which equals the 4th number (1+1=2), etc.
Now that we have introduced the name to all our fellow traders, let us move on to explain how to trade with Fibonacci? Having knowledge is one element, but actually implementing is a whole other matter. So we will also look at how to trade a Fibonacci Trading Strategy and how to trade using Fibonacci retracements. You can also read about budgeting in forex for better trading.
FIBONACCI BONUS (!) LEVELS
What Fibonacci retracement levels do you use?
My regular blog readers already know that I LOVE Fib levels. Why?
They are a great method when measuring market psychology. Who wouldn’t want to get a 50% discount?
I mean picture you in front of your favorite retail outlet and all of a sudden a person steps out and says: “hey everything in here is 50% discounted!” Guess what that does with the psychology?
The same holds true in the Forex market. Let’s assume there is a trend taking place. The trend stalls and retraces back 50% of the way. Traders are going to use that opportunity! Just like shoppers.
The KEY is trending markets.
Fibonacci levels work best in trend markets. I repeat ...trends! 🙂
In consolidations, corrections, ranges, and sideways moves, the Fibs have less value. Especially on smaller time frames. The reason is simply that the traders, the market in general and therefore price action tend to ignore these levels. In these, the currencies act and react to different tools and items such as tops and bottoms.
If the currency, however, is indeed trending or if the Fib is used on higher time frames, then the tool is a great asset because it gives you a great indication where the market turns back in the direction of the trend.
So what are the levels?
Well, all of you have heard of the 382, 500 and 618 Fibonacci retracement levels of course. Also written like this sometimes: 0.382 / 0.500 / 0.618.
These numbers are calculated by dividing the Fibonacci sequence numbers. Except the 500, which is just the halfway mark.
8/13 = 0.618…. 34/89 = 0.382.
But there are other Fib levels as well! Here is the full list I use:
1) The 236 or 0.236 - i.e. 13/55 = 0.236
2) The 382 or 0.382 - i.e. 13/34 = 0.382
3) The 500 or 0.500 - halfway
4) The 618 or 0.618 - i.e. 13/21 = 0.618
5) The 786 or 0.786 - square root of 0.618
6) The 886 or 0.886 - square root of 0.786
The phi is a crucial element in Forex Trading. The phi is often called the golden ratio. Two quantities are in the golden ratio if: the ratio of the sum of the quantities to the larger quantity is equal to the ratio of the larger quantity to the smaller one. In math this means ((A+B)/A) = PHI.
The PHI is equal to 0.618!! That is why the 618 Fib retracement is so important in Forex trading.
BUT, this number is not only important in Forex trading! The Phi number can be seen in arts and even nature! Wow.
That said, all Fib levels have their importance, and once you know these great Fib levels, you have completed the first baby step in succeeding with Fibonacci trading. You now know how to trade with Fibonacci retracement levels. The fun increases a lot more in the next section!
The targets are more important and this section will really dazzle you! This is the real beauty of how to trade with Fibs! So sit tight and postpone that dog walking you might have planned for a just a few more minutes! 😉
Pay good attention… the targets you want to add to your Fibonacci retracement tool are:
These are AMAZING targets. The market truly respects these levels.
With these targets now your Forex toolbox, you will never ever have to doubt one single second in your life where to take profits?!?!
I can give you tons and tons of examples on the charts. The market keeps repeating itself over and over. These are the levels you want to keep in mind!!
Other targets which can have importance are:
You can add these targets by clicking on your Fibonacci properties and then adding these levels to your Fibonacci retracement tool. Oh and make sure to add the minus sign!
The big question from my side:
Are any of those numbers new to you?
And my 2nd question: how frequently do you use Fibonacci retracements and Fibonacci targets?
Thanks for your feedback!
AVOID THE TRADING TRAP
What I mean with this is: be careful with what you Fib!
Every Forex trader wants to place the Fib on the correct swing high swing low!!!
That is vital. Otherwise, you could be fibbing the wrong leg of a move and get stopped out for a loss!
Finding the correct leg does take time and practice. But it is well worth the effort!
If you ever need any help with placing the correct Fib, make sure to add us to your twitter following list and ask us for our opinion. Send us a screenshot and we will give back our feedback! So make sure to use that free resource!
A few key items to be aware of:
a) Use tops and bottoms on your time frame à use natural tops and bottoms for swings and legs to place your fib;
b) Use Elliott Wave à always make sure you are fibbing a wave 1, a wave 3, a wave A or an entire 5 wave sequence, otherwise, the Fib might not work all too well;
c) Use the AO à check when the zero line has been crossed and wait for a retrace back to that zero line. You now have confirmation that the move is 1 leg;
d) Wait for the Fib targets to be hit before placing a new Fib. If the currency doesn’t hit the target, wait with Fibbing a new leg, because the currency could be ranging!
GREAT TRADING STRATEGY
Read here Nathan's great Fib trading strategy for the long-term charts: "long-term-trading-strategy-for-forex."
Fibonacci levels go hand in hand with the Waves. And every Forex trader should know this golden guideline:
- Wave 2’s usually have a deep retracement;
- Wave 4’s usually have a shallow retracement.
- A deep retracement is a 500/618/786/886 Fib.
- A shallow retracement is a 236/382/500 Fib.
- A wave B retracement in a fast correction (zigzag) is often 3382/500/618 retrace.
- A wave B retracement in a slow choppy correction is often a 786/886/double top or break of top till 1.380.
MY TRADER’S TRICK
My number 1 tip for everyone is this: find confluence.
Confluence is key, just like confidence.
With confluence, I mean finding multiple reasons for taking a trade.
1. That could be for example a Fibonacci retracement and a Fibonacci target at the same level. When a Fib target and a Fib retracement line up at the same price, then the likelihood of price reacting to it has substantially increased.
2. Another method for confluence is using price action at important Fib levels. Waiting for a confirmation of price reaction to a Fib level is a great method of reducing risking and making sure that the Fib placement you used is correct.
3. Using the Fib tools with key levels in the market such as day and week support and resistance levels is definitely a wise idea. This another great way of combining various technical analysis tools in the Forex market.
4. Last but not least, needless to say, that using moving averages and/or trend lines with Fibs of course just as good as well!
In the next section, we will teach you how to setup breakout and Fibonacci forex trades.
HOW TO SETUP BREAKOUT & FIBONACCI FOREX TRADES
At one time, the AUDUSD downtrend offered an interesting chart to search for short setups. In fact, the price had already approached the 38.2 retracement level, which could have easily become a turning spot for downtrend continuation.
Looking at the 4-hour price action, it becomes clear that several candlesticks were showing struggle at the 38.2 Fibonacci retracement level but bullish engulfing twins could have annulled the bearish signals.
I, therefore, kept a close eye on the upcoming 4-hour candles looking to see if the price showed renewed bearish signals or will it keep retracing higher.
In both cases, I am specifically looked for shorts only because of the downtrend (see blue trend line). Here are the two bearish scenarios I am counting with:
- A break of the 4-hour candle low (green circle) for a break out trade to lower levels (orange arrow);
- A bounce at the Fibonacci confluence of Fib retracement and Fib target:
- The 50% Fib retracement and the -27.2 Fib target (red circle);
- The 61.8% Fib retracement and the -61.8 Fib target (dark red circle).
In both scenarios, it is useful to wait for a candlestick pattern to confirm that price is bouncing at the resistance spot or pushing through the support level. This helpful tactic has a high rate of ensuring a decent entry at the right time.
The same upside movement could also occur on the NZDUSD. The Kiwi was in a big downtrend as well but recent choppiness has put bearish ambitions in the freezer. You can also trade with the breakout triangle strategy.
LOOKING AT THE FIBONACCI RETRACEMENT LEVEL
Looking at the upside momentum (green arrow), the break of the downtrend line (blue) and the double bottom (purple circle) at the 61.8 Fibonacci retracement level (light blue), the price could be ready for a bullish breakout (blue arrows) above the resistance line (red).
I was interested in taking a long upon the break of resistance (aft candlestick confirmation) and/or taking a short at the Fibonacci targets. There are two valid options for catching the bullish counter trend breakout setup:
- One is to look for a daily candle pushing through the trend line;
- The other is to monitor the same bullish breakout but on a lower time frame such as the 4-hour chart.
The advantage of the H4, in this case, is the potential for an earlier entry and hence more space to targets as well.
When I zoom into the 4-hour chart, I am able to see both a bull flag and contracting triangle type of forex chart pattern. The break below support and the break above resistance would indicate the break of the contracting triangle. A break of both the resistance and support levels will be the trigger I am looking for trade setup. Also, in this case, a strong candle is warranted: close near low or high, sizeable candle and the majority of candle outside of trend line.
Do not be shy and tell us what you think of the above! Have you traded these pairs in the past? Do you currently trade them? What is YOUR reason for perhaps not trading them?
Let us know down below in the comments section!
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Have a great weekend! And wish you Good Trading next week!
We will take a look at what kind of effect NFP had on the weekly price action on Monday.
Thank you for reading!
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