How to use Fibonacci Retracement to enter a trade

Fibonacci retracement can be used to determine entry points for trades.

When trading with fibonacci retracements, we maily aim at trading in the direction of the main trend.   The fibonacci retracement levels work best when the market is trending. That is either in a downtrend or uptrend.

When in an uptrend, buy when the price pulls back and holds on any of the Fibonacci retracement levels, and then begins to bounce back to the upside which is the inintial trend direction. Place a stop loss just below the price low or below the lower Fibonacci retracement level.

When trading in a downtrend sell when the price pulls up and holds at any of the Fibonacci retracement levels, as it moves back to the downside. Place a stop loss just above the price high or above the higher Fibonacci retracement level.

This simply means that to trade the fibonacci retracement levels, we have to treat them as support and resistance levels. That is, by buying low when price bounces off the retracement level after a pullback when in an uptrend and selling high when price bounces of the retracement level after a pullback when in a down trend. 

We can also take advantage of fibonacci breakouts by selling when price breaks the fibonacci level when in a down trend and buying when you notice a break out on the fib level in an uptrend.

Like we said before,to draw fibonacci retracements, we need to pick a swing low and swing high and we connect the two with the fibonacci retracement tool.

Let’s say you want to trade in a downtrend. After you have identified a strong down swing with a potential pullback, pick the fib retracement tool from the tool bar on the platform and draw  from the high of the swing to the low of the swing.

Identify the level at which price is likely to hold after a pullback from the main trend for monitoring and wait for a correction that points on the downside before taking  a short position.

The commonly watched levels are 38.2%,50.0% for a strong trend and for a weak trend you can consider 61.8% fibonacci retracement level.

Let’s take a look on the chart below.

The chart below shows how price continued fall strongly after retracing the fibonacci level 50.0% on GBP/USD.M30 chart.

AS price continued to drop after the high, it hit the 0.0%level and closed with a long pin bar showing strong rejection on that level. It made a pull back from the 0.0% fibonacci level, held shortly at 23.6 level and hit the 50.0 level where it bounced back with a large bearish candlestick engulfing the small bullish candlestick.

This gave us a signal for a strong down move a head and so the formation of the next bearish candlestick  gave us the confirmation for a Sell entry.

After retracement the price continued to fall strong and if you had taken this trade you would make yourself clean profits.  Stop loss should be set slightly above the high as indicated on the chart above. Target profit can be adjusted as you watch the next fibonacci levels below your entry point.

Now let’s see how to use fibonacci retracement tool when in an uptrend.

NZD/USD,H1 chart with fibonacci retracement tool

After the swing high, price made a pullback held at the 23.6, 38.2 bounced off shortly, pulled back again and finally retraced  level 61.8 where it formed a strong candlestick pattern identified with the black circle that gave us a reliable signal . The formation of a small correction gave confirmation for a buy entry with a bullish candlestick closing above the 50.0 level. Stop loss should be slightly below the low as indicated above.

Trading fibonacci levels may not be that easy as it appears, it also has its own short comings and can also give fake outs in the market sometimes. For instance, looking at the above chart, if we had entered a buy position as price bounced of level 38.2, our stop loss would be hit and we wouldmiss out on that strong movement that occured after retracing the 61.8 level. It is always important to wait for a correction after reversal from the fib level before taking any position to avoid fake outs.

It is also important to know that not all the time these level will hold or price will always bounce off these levels. It can break the level or fails to reach it. But this doesn’t mean you can’t make profits trading the fibonacci level. Choose 1-2 levels to which you will base your analysis and trade only that. Forexample you can choose to watch level 38.2, or 61.8 or 50.0 and trade only when price bounces off any of these levels. You should also consider using other technical analysis tools such as candlestick patterns, momentum oscillators and trend indicators to confirm your signals.

 

 

 

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