All about Fibonacci Trading

All you should know about Fibonacci Trading

Fibonacci trading can significantly improve forex performance for both long and short-term positions, identifying key price levels that show hidden resistance and support. Fibonacci used in conjunction with other types of technical analysis builds a very powerful foundation for trading strategies that perform well through all forms of market conditions and volatility levels.

12th-century mathematician, Leonardo de Pisa discovered a numerical sequence that appears throughout nature and in classic works of art. Though his discovery was theoretical, these Fibonacci numbers show remarkably profitable applications in our modern financial markets,  vividly describing the relationships between price waves within trends, as well as how far this waves will carry before reversing and testing prior levels.

The .386, .50 and .618 retracement levels comprise the main Fibonacci structure found in charting packages, with .214 and .786 levels adding more depth to the market analysis. These secondary ratios have taken on greater significance since the 1990s, due to the deconstruction of technical analysis formula by funds looking to trap investors using those criteria. As a result, whipsaws through primary Fibonacci levels have increased, but harmonic structures have remained the same.

For instance, it was popularly believed the .618 retracement would involve countertrend swings in a strongly trending market. That level is now routinely violated, with the .786 retracement offering strong resistance or support, mostly depending on the direction of the primary trend. Investors and market timers have adapted to this slow evolution, altering strategies to accommodate a higher frequency of violations and whipsaws.

Fibonacci Trading

Historical Analysis

Fibonacci grid applications can be roughly divided into two major categories, trade preparation and historical. The second category requires a thorough examination of long-term trends, identifying harmonic levels that triggered major trend changes. Most active market players will spend more time focused on the first category, in which Fibonacci grids are placed over short term price action to build exit and entry strategies.

There is great synergy between the two applications due to the fact that price levels uncovered through long-term historical analysis work perfectly well with short-term trade preparation, especially at key inflection points. Since forex pairs oscillate between contained boundaries through nearly all economic conditions, these historical levels can impact short-term pricing for years.

Given the small number of popular crosses compared to the bonds or stocks, it makes perfect sense to perform a historical analysis on each pair, outlining primary trends and levels that might come into play in coming years. Perform this task by zooming out to monthly or weekly charts, and placing grids across secular bear and bull markets. The analysis only needs to be performed once as long as price action doesn’t exceed the lows and highs of the long term grids.

Trade Preparation

Begin your trade preparation analysis by placing a single grid across the biggest trend on the daily chart, identifying major turning points. Next, add grids at shorter and shorter time intervals, looking for convergence between major harmonic levels. Similar to moving averages and trend lines, the power of these levels tracks relative time frame, with grids on longer term trends setting up stronger resistance or support than grids on shorter term trends.

Many forex investors focus on day trading, and Fibonacci levels work in this venue due to the fact that daily and weekly trends tend to subdivide naturally into smaller and smaller proportional waves. Access these hidden numbers by stretching grids across trends on 15-minute and 60-minute charts but include daily levels first because they will dictate major turning points during the 24-hour forex trading day.

Having a hard time figuring out where to place ending and starting points for Fibonacci grids? Stretching the grid across a major low and high works well in most cases but most investors take a different approach, using the first lower high after a major high or first higher low after a major low. This approach tracks the Elliott Wave Theory, focusing on the second primary wave of a trend, which is often the longest and the most dynamic.

Fibonacci Trading with Other Indicators

The reliability of retracement levels to stop price swings and start profitable counter swings directly correlates with the number of technical elements converging near or at that level. These elements can include Fibonacci retracements in other time periods, Trend Lines, gaps, moving average, prior highs/lows, and relative strength indicators hitting oversold or overbought extremes.

For instance, multiple grids on a daily chart that align the.618 retracement of one trend with the .386 retracement of another trend raise odds that currency pair will reverse near or at that level. Add a 50- or 200-bar moving average and the odds increase further, encouraging bigger positions and a more aggressive trading strategy. This methodology is applicable to exits as well, telling forex investors to take profits when price reaches a retracement level that shows multiple alignments.

The Bottom Line

Add long-term Fibonacci grids to favorite forex pairs and watch price action near popular retracement levels. Add shorter term grids as part of daily trade preparation, using alignments to find the best prices to exit or enter positions.

When committing Fibonacci Trading add other technical indicators and look for convergence with retracement levels, raising the odds that prices will reverse in profitable counter swings.

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