From the outset, let's assume you don't know what Fibonacci trading is. (if you do, you can skip directly to the strategy below). Fibonacci Retracement trading is a technical analysis tool for finding areas of reverses in price. i.e support and resistance levels.
If you would like to know more about the history of Fibonacci, you can check this out for information on the mathematician behind these numbers.
Commonly know as Fibonacci series or Fibonacci levels, these are a group of numbers where we could expect price to bounce or at a minimum hit a road block.
What are these numbers?
The most popular Fibonacci retracement numbers readily available on charting software are :
Most charting software has this tool available for free but if you don't know where to get it, just visit tradingview
Alternatively, you can use a Fibonacci calculator and get your levels from that.
If you are more visual and want to learn about Fibonacci, the history & how it is applied to charts, take a look at the video below. (this is only beneficial to complete beginners who don't know about this type of trading tool.)
How To Use Fibonacci Retracement
For the purposes of the strategy outlined below, I will be focusing specifically on the 61.8% retracement level. This is most commonly known as the golden ratio.
Check out a simple chart with Fibonacci retracement in action.
You can see how price acted as resistance at the 61.8% level in the chart example above.
Now that we have an understanding of how Fibonacci trading works, let's dig into a trading strategy. After all, it's why we are all here in the first place!
If you prefer video format, you can check it out below.
Fibonacci Trading Strategy
As with all the trading strategies I discuss, we will divide it into three sections.
As mentioned above, we will focus on the 61.8% level, i.e. the golden level. We are looking for price to trade into this level on our charts and then we seek an entry.
Here is an entry example on the monthly chart of Eur/Usd. Since the strategy only involves entries off 61.8%, I took out the other fib levels to make it easier on the eye to see.
Look how the price traded into that level on the monthly chart and then sold off. Now, for more shorter term traders, you don't need to stick to longer term charts.
There is ample opportunity on lots of timeframes.
Right, here is where the strategy is different from traditional Fibonacci trading. We then drill down the timeframe. In this example we move down from monthly to daily.
We look to see how price reacts off the level instead of blindly entering a short trade. Let's take a look at the daily chart of above Eur/Usd
Price formed a chart pattern after it rejected the fib level. A break of the pattern marked 2. is where the entry short is. Very good risk reward example.Waiting for price to react off the level stops some of the many false signals you may get from just shorting into it.
Below is another example. This time we start on the daily to plot the Fibonacci level and then work down to an hourly chart for entry.
So we have our level from the above daily chart. Now we drill down to the hourly. (See below)
Price forms a chart pattern around the level and entry is on a break marked on chart at number 2. If we blindly entered the trade at the level, we would have been stopped out.
When we let the price consolidate and give us an indication of what it the higher probability of what it will do next, it gives us time to assess. We can then set a clear risk and entry.
The next stage of the strategy is when we are in it. What must be do ?
Well before entering you will know where to place stop. But when we are in it, we need to monitor things. Now, ideally you are all diligent and will know where to stop out or take profit BEFORE even entering into the trade.
But as you study these setups more and more, you may notice patterns like your average gain and average loss. This will make managing your trades more easy once you know your statistics.
How so ?
Well, if you know that on average you make 2.5r on a trade, that is 2 and half times what you risk, then you will be aware that when you are up that much to take profit. Otherwise, if you hold it might retrace back and stop you out.
We've all been there and it's a nightmare to experience !
For exits, I like to use trendlines. Below you will see in a more visual way what I'm talking about. So using the above trade example of USDCAD, let's look at an exit based off the hourly chart.
You can practice with the trendlines to figure out which works best for you. This is more of an art than a science but as a general rule, the more touches off the line, like the above example whereby it acted as support and resistance, more weight should be placed on those lines as potential targets.
One of the most misunderstood part in trading for newbies is they believe they have to be right a lot to make money. As humans we are programmed to associate being right as good and wrong as bad.
We want higher grades so naturally our minds think a higher win percentage equals more profits. Well look at the chart below and ponder on it for a few moments.
Having looked at this, can you see why risk reward is more important than winning percentage?
How does making money by only being successful on 25% of trades sound ? In the chart, we can see that a 3 to 1 ratio of reward to risk would make this a reality.
I don't know about you but I like to make money overall even when I have a very low win percentage. With this strategy, even if you go through lower periods of success, if you can get the risk/reward right, you'll still make money.
Important risks that need to be monitored when trading this strategy.
These are just three examples of risks that may reduce or not trade a setup. If there is an important news announcement out, it can do anything to the market so we don't want to encounter a price spike and stop us out.
For stocks, important news might be earnings releases whereas for currencies, it is non farm payroll etc. Dailyfx calendar has a list of all news being released in a given week as well as the impact on the markets. (tailored more for currency traders)
Any liquid market and you are good to go. I encourage you all to dig through different markets and look for examples of Fibonacci setups in action. Some of you might find it better in stocks, others in commodities etc.
Heck, even look at it in bitcoin. It really doesn't matter.
If you can make a viable consistent return from one market over another, that's great ! So explore all your options.
Here's a list of the most common and popular markets to test this strategy on:
Always check the volume before studying a market. You need liquidity for scaling as you get bigger and better over time.
It works on all timeframes but I generally prefer to get my levels off a daily chart and work down to lower timeframes for entry. Again shorter term traders can start at lower timeframes for their levels and work down even further for entries.
What I find great is this strategy can be applied to longer term position trading as well as day trading.
Right, now that you know all the details on the trading strategy, you will want to backtest it. Personally I love to go through the charts manually and eyeball them for previous opportunities.
This helps train myself on what to look for. The more examples you find, the more experienced you get over time.
I also love to print out charts to review. Now, it's not necessary but it always helped me when I was learning. Alternatively you can use backtesting software if you are able to code. Or you could hire someone to backtest for you.
Whatever you find easiest for yourself and your own circumstances!
You can paper trade the strategy in real time to help familiarize yourself and I would encourage you all to do that. The obvious benefit is you won't lose real money as you practice trading this strategy.
When starting anything new, most of us suck. It's normal. The same goes for this strategy. You may suck but don't get discouraged. Study and review charts. It's the only way you'll get better at it.
If you can overcome the obstacles you may face, you'll find yourself a self sufficient consistently profitable trader. This strategy can and has worked. The biggest and most deciding factor is YOU.
Psychology can play a very big role in determining whether this will work for you or not. Have a look at this improving trading psychology post if you need tips on that.
There is no right or wrong way for any trader to approach the market once they find their own consistent method.
Like all strategies, it is only as good as the trader trading it. So with that in mind, always remain disciplined and stick to your rules. You can see from the chart above that by having good risk/reward, your winning percentage isn't as significant.
Consistent profitable returns is the ultimate goal and if this strategy can put you on the right path to that, great !
Again, there is no holy grail in trading, it boils down to sound trading principles. So stay focus, work your butt off and learn all you can and some of you may make it in this industry.
I wish you all the best on your own trading and I hope some of you find this strategy useful to further explore.