How to apply Fibonacci Retracement for IntraDay Trading

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Fibonacci Retracement Levels in Day Trading

Tool to Help Isolate When Pullbacks Could End

Moves in a trending direction are called impulses, and moves against a trend are called pullbacks. Fibonacci retracement levels highlight areas where a pullback can reverse and head back in the trending direction, making them helpful in confirming trend-trading entry points.

Origins of Fibonacci Levels

Fibonacci levels are derived from a number series that Italian mathematician Leonardo of Pisa—also known as Fibonacci—introduced to the west during the 13th century. The sequence starts like this:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89.

Each new number is the sum of the two numbers before it. As the sequence progresses, each number is approximately 61.8% of the next number, approximately 38.2% of the following number, and approximately 23.6% of the number after that. Subtract 23.6 from 100, and the result is 76.4.

These are Fibonacci retracement levels: 76.4, 61.8, 38.2, and 23.6.

The Relevance of the Sequence

What Fibonacci and scholars before him discovered is that this sequence is prevalent in nature in spiral shapes such as seashells, flowers, and even constellations. As a spiral grows outward, it does so at roughly the same rate as the percentages derived from the Fibonacci ratios.

Some believe these ratios extend beyond just shapes in nature and actually predict human behavior. The thinking is that people start to become uncomfortable with trends that cause changes to happen too rapidly and adjust their behavior to slow or reverse the trend.

According to this theory, if someone started out with $100 in his wallet, he would begin to slow his spending—or stop altogether—once he has spent about $61.80 and has only about $38.20 remaining.

How to Use Fibonacci Retracement Levels

When a stock is trending very strongly in one direction, the belief is that the pullback will amount to one of the percentages included within the Fibonacci retracement levels: 23.6, 38.2, 61.8, or 76.4. Some models also include 50%.

For example, if a stock jumps from $10 to $11, the pullback should be expected to be approximately 23 cents, 38 cents, 50 cents, 62 cents, or 76 cents. Early or late in trends, when a price is still gaining or losing steam, it is more typical to see retracements of a higher percentage.

In this image, you’ll notice that between 61.8% and 38.2% there are two downward trends. This is an example of a Fibonacci retracement. The theory states that is a usual circumstance for stocks to trend in this manner because it is inherent in behavior to follow the sequence.

If your day trading strategy provides a short-sell signal in that price region, the Fibonacci level helps confirm the signal. The Fibonacci levels also point out price areas where you should be on high alert for trading opportunities.

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Using a Fibonacci retracement tool is subjective. There are multiple price swings during a trading day, so not everyone will be connecting the same two points. The two points you connect may not be the two points others connect.

To compensate for this, draw retracement levels on all significant price waves, noting where there is a cluster of Fibonacci levels. This may indicate a price area of high importance.

Retracement Warnings

While useful, Fibonacci levels will not always pinpoint exact market turning points. They provide an estimated entry area but not an exact entry point. There is no guarantee the price will stop and reverse at a particular Fibonacci level, or at any of them.

If the price retraces 100% of the last price wave, the trend may be in question. If you use the Fibonacci retracement tool on very small price moves, it may not provide much insight. The levels will be so close together that almost every price level appears important.

Fibonacci retracements provide some areas of interest to watch on pullbacks. They can act as confirmation if you get a trade signal in the area of a Fibonacci level. Play around with Fibonacci retracement levels and apply them to your charts, and incorporate them if you find they help your trading.

Applying Fibonacci For Day Trading

Fibonacci Retracements are one of my favorite trading tools. The levels predicted by the tool are remarkably accurate and provide a great number of trading opportunities for me in my day to day routine. The thing is, Retracements are best used when dissecting a pronounced trend or sharp movement in stocks so they are not neccesarily the first thing you would turn to as a day trader. Why is this, simply because the day to day movement of any one asset, particularly a forex pair, is not that great. To understand let’s touch base quickly on what Fibonacci Retracements are. They are price levels determined by the Golden Ratio as laid out by the famed mathematician Fibonacci. The levels are percentages of a given price movement and are a useful as target areas for entry points. This tool is commonly available as a standard feature of most charting packages and comes with a few variations. Typically I would draw retracements on a chart of weekly or daily prices and then use those levels as potential areas for continuation or reversal. This method doesn’t provide a whole lot of entries for day traders but there are two methods of using Fibonacci that do.

Warning! Fibonacci Retracements are not signals, they are target areas where a signal may occur. Trading simply because price has reached a retracement level is not a sound method. Other signals indicating direction and duration are required before trades can be taken.

The Long Bar Method

Believe it or not I just made up the name of this strategy but the strategy itself is old, very old. The Long Bar Method targets specific days and is not for use on a day to day basis, unless of course the asset you are trading is volatile and makes a lot of wide swings. For this method to work you need to be patient and wait for a day when news, a technical break out or some other event causes the market to make a much larger than normal daily movement,say in the range of at least 1% or better. The bigger the day the better because you can expect the bounce back from that day to be stronger than on an average day. Once you have identified a day as a potentially good one draw (on the daily chart) a Fibonacci Retracement from the high to the low of the day; if it’s an up day from the low to the high, if a down day from the high to the low. Once this is done you can move down to a chart of hourly, 30 or 15 minutes as you prefer. Then as price bounces, or retraces, its way you can use the Fibonacci Lines as target areas for signals.

One note of warning, there is not always a snap back following a major market movement. If a rally is strong then there might be two or three days of upward movement or more before any kind of a snap back occurs. The same is true in a strong bear market. If this happen then you can draw your retracements for the entire movement, not just the one day.

This strategy works best when the market has made a major movement in the magnitude of 1% or more. Knee jerk reactions to bad news and speculative rallies on good news are two such events. Any time the market makes a significant movement a Fibonacci can be applied to that day or week.

The Day Wave Method

For this method I suggest that you use a chart with 30 or 60 minute candle sticks. This is a good time frame for watching the day to day swings in the market and for using Fibonacci Retracement. This method is also more useful for the average day trader as it can be used any day, not just after a strong market movement. To apply it, pull up a chart of 30 or 60 minute prices and then apply a Fibonacci to the most recent trough and peak. It does not matter if it is drawn from a peak to a bottom or vice versa as this is not a trend following technique. With this we are simply trying to find appropriate areas where a signal, any signal, can be found. Look at the chart below. I have drawn a Fib from the top of an intraday peak to the bottom of an intraday trough. The Fib tool provided several levels where signals might form. The bounce back was strong enough to blow through the first two retracement levels but gave an early signal at the 50% line. Then a second signal, a much stronger and tradable signal, forms from at a place where put trades could have been taken.

One note of warning, day to day market moves are highly susceptible to news and other near term market moving events. These can have an adverse affect on your trading if unprepared. Always check the economic and earnings calendar before entering a trade.

Top 4 Fibonacci Retracement Mistakes to Avoid

Every foreign exchange trader will use Fibonacci retracements at some point in their trading career. Some will use it just some of the time, while others will apply it regularly. But no matter how often you use this tool, what’s most important is you use it correctly every time.

Improperly applying technical analysis methods will lead to disastrous results, such as bad entry points and mounting losses on currency positions. Here we’ll examine how not to apply Fibonacci retracements to the foreign exchange markets. Get to know these common mistakes and chances are you’ll be able to avoid making them—and suffering the consequences—in your trading.

Top 4 Fibonacci Retracement Mistakes To Avoid

Key Takeaways

  • A Fibonacci retracement is a reference in technical analysis to areas that offer support or resistance.
  • Foreign exchange traders, in particular, are likely to use Fibonacci retracements at some point in their trading career.
  • One common mistake traders make is confusing reference points when fitting Fibonacci retracements to price action.
  • New traders tend to take a myopic approach and mostly focus on short-term trends rather than long-term indications.
  • Fibonacci can provide reliable trade setups, but not without confirmation, so don’t rely on Fibonacci alone.

1. Don’t Mix Reference Points

When fitting Fibonacci retracements to price action, it’s always good to keep your reference points consistent. So, if you are referencing the lowest price of a trend through the close of a session or the body of the candle, the best high price should be available within the body of a candle at the top of a trend: candle body to candle body; wick to wick.

Incorrect analysis and mistakes are created once the reference points are mixed—going from a candle wick to the body of a candle. Let’s take a look at an example in the euro/Canadian dollar currency pair. Figure 1 shows consistency. Fibonacci retracements are applied on a wick-to-wick basis, from a high of 1.3777 to a low of 1.3344. This creates a clear-cut resistance level at 1.3511, which is tested, then broken.

Figure 1: A Fibonacci retracement applied to price action in the euro/Canadian dollar currency pair.

Source: FX Intellicharts

Figure 2, on the other hand, shows inconsistency. Fibonacci retracements are applied from the high close of 1.3742 (35 pips below the wick high). This causes the resistance level to cut through several candles (between February 3 and February 7), which is not a great reference level.

Figure 2: A Fibonacci retracement applied incorrectly.

Source: FX Intellicharts

By keeping it consistent, support and resistance levels will become more apparent to the naked eye, speeding up analysis and leading to quicker trades.

New traders often try to measure significant moves and pullbacks in the short term without keeping the bigger picture in mind. This narrow perspective makes short-term trades more than a bit misguided. By keeping tabs on the long-term trend, the trader can apply Fibonacci retracements in the correct direction of the momentum and set themselves up for great opportunities.

In Figure 3, below, we establish the long-term trend in the British pound/New Zealand dollar currency pair is upward. We apply Fibonacci and see our first level of support is at 2.1015, or the 38.2% Fibonacci level from 2.0648 to 2.1235. This is a perfect spot to go long in the currency pair.

Figure 3: A Fibonacci retracement applied to the British pound/New Zealand dollar currency pair establishes a long-term.

Source: FX Intellicharts

But, if we take a look at the short term, the picture looks much different.

Figure 4: A Fibonacci retracement applied on a short-term timeframe can give the trader a false impression.

Source: FX Intellicharts

After a run-up in the currency pair, we can see a potential short opportunity in the five-minute timeframe (Figure 4). This is the trap. By not keeping to the longer-term view, the short seller applies Fibonacci from the 2.1215 spike high to the 2.1024 spike low (February 11), leading to a short position at 2.1097, or the 38% Fibonacci level.

This short trade does net the trader a handsome 50-pip profit, but it comes at the expense of the following 400-pip advance. The better plan would have been to enter a long position in the GBP/NZD pair at the short-term support of 2.1050.

Keeping in mind the bigger picture will not only help you pick your trade opportunities, but will also prevent the trade from fighting the trend.

3. Don’t Rely on Fibonacci Alone

Fibonacci can provide reliable trade setups, but not without confirmation.

Applying additional technical tools like MACD or stochastic oscillators will support the trade opportunity and increase the likelihood of a good trade. Without these methods to act as confirmation, a trader has little more than hope for a positive outcome.

In Figure 5, we see a retracement off a medium-term move higher in the euro/Japanese yen currency pair. Beginning on January 10, 2020, the EUR/JPY exchange rate rose to a high of 113.94 over almost two weeks. Applying our Fibonacci retracement sequence, we arrive at a 38.2% retracement level of 111.42 (from the 113.94 top). Following the retracement lower, we notice the stochastic oscillator is also confirming the momentum lower.

Figure 5: The stochastic oscillator confirms a trend in the EUR/JPY pair.

Source: FX Intellicharts

Now the opportunity comes alive as the price action tests our Fibonacci retracement level at 111.40 on January 30. Seeing this as an opportunity to go long, we confirm the price point with stochastic, which shows an oversold signal. A trader taking this position would have profited by almost 1.4%, or 160 pips, as the price bounced off the 111.40 and traded as high as 113 over the next couple of days.

4. Using Fibonacci for Short-Term

Day trading in the foreign exchange market is exciting, but there is a lot of volatility.

For this reason, applying Fibonacci retracements over a short timeframe is ineffective. The shorter the timeframe, the less reliable the retracement levels. Volatility can, and will, skew support and resistance levels, making it very difficult for the trader to really pick and choose what levels can be traded. Not to mention in the short term, spikes and whipsaws are very common. These dynamics can make it especially difficult to place stops or take profit points as retracements can create narrow and tight confluences. Just check out the Canadian dollar/Japanese yen example below.

Figure 6: Fibonacci is applied to an intraday move in the CAD/JPY pair over a three-minute time frame.

Source: FX Intellicharts

In Figure 6, we attempt to apply Fibonacci to an intraday move in the CAD/JPY exchange rate chart (over a three-minute timeframe). Here, volatility is high. This causes longer wicks in the price action, creating the potential for misanalysis of certain support levels. It also doesn’t help that our Fibonacci levels are separated by a mere six pips on average, increasing the likelihood of being stopped out.

Remember, as with any other statistical study, the more data used, the stronger the analysis. Sticking to longer timeframes when applying Fibonacci sequences can improve the reliability of each price level.

The Bottom Line

As with any specialty, it takes time and practice to become better at using Fibonacci retracements in forex trading. Don’t allow yourself to become frustrated—the long-term rewards definitely outweigh the costs. Follow the simple rules of applying Fibonacci retracements and learn from these common mistakes to help you analyze profitable opportunities in the currency markets.

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