Many people have heard about trading with Fibonacci, but they do not know what it is. In this article I will explain what term Fibonacci trading does mean, how traders are using it and how can you learn to trade with Fibonacci tools.
Lets start from tricky question and basics of price behavior. In which direction can price move? You probably would answer: up and down. That is correct answer, only that there is one “but”. What if there is no main trend? If there is no strong trend, price will probably move sideways. Statistics says that price is about 30% of time in trend and rest of this time is moving in range. Why moving in range is so bad thing? Because there is no clear direction and price move up and down so it is very hard to make money in that kind of movement. Just look at chart below, is it something you would like to trade?
I think so. What we want to trade is trending market. Going into trend direction increases your chances of success. Look at this beautiful trend below. Isn’t it something you would like to trade? On the short side of cource!
We want to use Fibonacci technique in that kind of market. Before I go further and explain more about this, there is another important thing you must learn.
How to recognize trend?
You should be able to easy recognize if there is a trend in place or not. Sometimes it is hard because of the “noise”, but there are some tips you can use.
Look for higher highs and higher lows, if you are looking for uptrend. I have probably showed you this charts before, but this is important. On chart below you can see an example of uptrend. You can see that every high is higher than the previous one, and every low is higher than previous low.
When you can find these elements on chart, then you have identified an uptrend.
In downtrend you should look for lower lows and lower highs. Each low is lower than the previous one, and each high is lower than previous high. Just like on chart below:
If you are able to identify lower lows sequence, than you have found a downtrend and you can plan to enter short position.
In range market there is no sequence, therefore there is no trend.
If this is still confusing for you, I have found a good, short video about that topic:
You can also use simpler tools to define trend. Most popular moving average is a good choice. Lets say you are using 200 simple moving average. When moving average is rising and price is above that line, than there is a strong chance that trend is up. If trend is down, price will be under 200 SMA. Of course this method does not make you 100% sure, but the chances are good.
So what really Fibonacci trading is?
Now, when you know what kind of trends there are and how to recognize the current trend, we can move to answer the question from title. What is Fibonacci trading really about?
There are many tools which you can use for trading with Fibonacci. Each of them do a different job. Some are more important, some less. Lest review them quickly.
Fibonacci retracement is the most popular tool used by traders who are trading with Fibonacci. It helps you to predict where correction might end.
Do you remember how in the beginning of this article I wrote about nature of trends? When price is in an uptrend, there is a sequence of higher highs, but there is also a sequence of higher lows, or simply corrections. This is something natural for uptrend – price move up, up and suddenly it is falling down. That is correction and it is a good thing, because it let you to enter position for better price.
Fibonacci retracement helps you to find places where correction might stop. With that knowledge you can plan to enter a position from there in a direction of main trend.
You can also predict where there will be the next high or low. You can do this with Fibonacci expansion. To do that you need to find three points. A and B from main swing (low and high) and point C where correction ended (similar points as you would be looking to draw retracement levels but here you have to know/decide where correction ended). With that points you are able to draw Fibonacci expansion and in result you have few projections where might be next high/low. There are more levels, but standard are 61.8%, 100% and 161.8%.
There is also extension based only on two points (A and B), which also gives projection levels, but lets do not complicate things too much.
Fibonacci time zones
Interesting tool which you draw horizontally. There is many ways you can draw it – from high to high, high to low, low to high… In a result you have vertical lines, which represents time when there might be end of move or some change of direction.
It is another tool which represents areas of support/resistance, but in another way. You draw Fibonacci arc from high to low or low to high. As a result you can see three curves 38.2%, 50% and 61.8% which represents possible place where price action might stop/reverse.
With this tool you get three diagonal lines. Each one of them represents Fibonacci ratio and when price is getting close to this lines, you know that this might be area of support or resistance. You draw a trendline between low and high to get this lines.
Actually, this tool is pretty handy. Try to exercise on historical data, or test it in your trading. It is all about selecting right low and high and you will get good results.
You can also watch this short video, where trader use Fibonacci fan together with Fibonacci time zones and retracement.
There are some other tools based on Fibonacci numbers, but these are most known. If you are confused right now and you do not know which one you should use, then let me give you small advice. Start from Fibonacci retracement and master using it. Then add to your toolbox Fibonacci expansion – it is important tool, because it let you predict the best points to close position.
You can also try Fibonacci fan, which is also pretty good. When you gain some experience, you can experiment with Fibonacci time zones or arcs, but really mastering Fibonacci retracement and expansion is a great start!
How to trade with Fibonacci?
Now you know what does it mean Fibonacci trading, and what kinds of Fibonacci tools we have (plenty of them!). There is one more important question to answer. How should you trade with these tools?
Notice that all this tools give you a potential level of support/resistance or potential exit points. This is very valuable information! But how to use it for your benefits? Of course I am not able to answer you in few words, but I can give you some advice what should you do.
You should build trading plan. The main core of your trading plan will be Fibonacci tools. As I wrote before, first include Fibonacci retracement and extension to your plan. Next, you need some signals which help you to enter and exit positions. The logic here is that when price is in uptrend and correction occur, you draw retracement levels. When price is near one of them, you do not know which one will be a support. That is ok, because you define your own signal and when price return to move up from correction, you get your signal. It might be something simple like moving averages crossover or signal from some oscillator.
Same with closing position. You should define on which signal you will exit your position. It will be probably near one of expansion levels, so you will be ready to take action.
The last, very important part of your trading plan is money management. You should keep your losses small. It is very important to trade smart and not to risk too much.
Some of this information are not very specific, but the whole topic about trading with Fibonacci is very wide. In the end, it is about practice, practice, practice. You should be testing new ideas and getting experience. Trading with Fibonacci is great, because you have possible support and resistance levels and even exit points. Of course they are only possible levels, but on many times they work excellent. You need to build your whole trading plan around these levels, so around Fibonacci tools. Add to this entry and exit signals and proper money management system and you are on great way to success in trading.
And this is really what trading Fibonacci is! Good luck in your trading!