This is guide to trading with Fibonacci numbers. There are many tools based on Fibonacci. You will learn how to use most popular like Fibonacci Retracement, Fibonacci Extension and Expansion. You will also learn how to build a trading plan based on Fibo tools.
This is rather long guide and I hope it will help you to build your own trading plan. I show you some examples of entering and closing positions, but remember that in the end you are responsible for your trading results. I do not take responsibilities for your trading results and I do not give any kind of guaranties that with this guide you will make money. This is an educational material, not ready system.
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Here is what you are going to learn in this 20,000 plus word guide:
PART 1. INTRODUCTION
Basic information about Fibonacci numbers and why it is good to know how to use them.
PART 2. THE FIBONACCI RETRACEMENT LEVELS
How they are build and how to draw them to find possible leveles during correction.
PART 3. THE FIBONACCI PROJECTIONS
How to predict where is the best place to exit trade – Fibonacci Extension and Expansion will be helpful here.
PART 4. THE FIBONACCI CONVERGENCE
Learn what convergence is and how to spot it.
PART 5. WHEN TO ENTER A TRADE – A SAFE SCENARIO
Here we put knowledge into practice – you will learn a safe way of opening positions.
PART 6. WHEN TO ENTER – A RISKIER SCENARIO
Little bit riskier scenario of opening trades where possible profit is bigger.
PART 7. WHEN TO EXIT A TRADE
Closing trade is very important, but where is the best place? This should help you to find the best place to exit.
PART 8. MY TEMPLATE
Few examples of different templates you can use in Metatrader software.
PART 9. A FEW IMPORTANT THINGS YOU SHOULD KNOW
How to define trend, the importance of the higher time frame and how to trade the news with Fibonacci tools.
PART 10. FIBONACCI AND PIVOT POINTS
How to combine Fibonacci tools and pivot points.
PART 11. MONEY MANAGEMENT
Proper money management is very important – without it you will be loosing money fast.
PART 12. MORE EXAMPLES OF TRADES
More exapmles where we put together knowledge from guide.
13. THE “HOW-TO” ARTICLES
Few helpful articles about installing templates and using Fibonacci tools.
Why is using the Fibonacci tools better idea than buy and hold?
Before we move on to learning more about the Fibonacci numbers, we should answer the question included in the title of this chapter: why use the Fibonacci tools rather than other tools? What is the difference?
Buy and hold is not that great
Many people still believe in old concepts of trading. Some are convinced that buy and hold is the best way to make money. They want to be like Warren Buffet. They read about investing in value. They believe that buying and holding shares of some good company is the smartest way to earn money and this way they will beat short-term trading gamblers. In crisis and recession as we have today, it doesn’t really matter if a company is that great. In panic, people very often sell off all their assets. They withdraw money from invest funds, so the funds have to sell their shares, even those of good companies.
Just look at the chart ofS&P500. If you bought long contract at this index in 2001,after 10 years your profit would oscillate around zero dollars!
Yes, now we have a bull market, but in the long term you do not know if markets will be higher.
This could be money for your retirement, college fund for your kids or simply your savings. No profit here. S&P500 includes 500 biggest companies in the USA. Even if you have invested in some of them, the chances are that you have made no profit.
Trend following is simple, but…
OK, if not buy and hold, then maybe trend following? You constantly hear:
• Trend is your friend
• Trend following is the best way to make money in the market
• Follow the trend and never look back
…and so on, and so forth.
However, the problem is that nowadays markets tend to move very fast, especially when they fall. What is the best tool to follow trends? Where should I enter and close position? Is it the end of a move or will be there a continuation?
In many cases, trend following investors try to make decisions based on moving averages and oscillators.
When the market is oversold, you should go long, and then follow the trend and exit on the signal that the market is overbought. Sounds pretty easy, doesn’tit? So, why are the majority of investors losing money?
The main difference on an example
Let’s have a look at the same trade.
The first investor makes his decisions basing on the trend following system. He is using the Stochastic oscillator, and two simple moving averages (later I will be using the MA shortcut) – 10 and 20 period long. The buy signal is when Stochastic is oversold, and there is a cross of 10 MA over 20 MA. The exit signal is when 10 MA is back below 20 MA.
Here is the trade example:
The entry point was very late because of the fast move of price and the late cross of MAs. The exit signal was also very late.
The other trader is using the Fibonacci technique. He chooses swing, draws the Fibonacci retracement levels and waits for an entry signal at correction. When the signal occurs, he pulls the trigger and enters the trade. He draws the Fibonacci extensions level to get the idea of when to close the trade. After a while, his target is achieved and he exits the trade.
Naturally, both examples are simplified, so that you can see the difference more clearly. Don’t worry if you don’t understand the second example. When you finish this guide, this will be an easy thing for you to do. For the time being, just follow the decision process of the two traders.
Mind when the first trader made his decision to enter the trade. Look when he closed it. It was very late to take profit.
And now take a close look at the second trader. Again, it is the same chart, same day, but the second trader is using different tools. Notice that his enter and exit decisions were made long before the first trader’s! He made more money on the same trade, and exit when the first trader was still hoping for continuation of the trend.
This is the main difference between traders using lagging indicators and those using leading indicators.
Lagging indicators are based on prices from the past. It may be a price that was open, close, low, high, but a price from the past in all cases. It does not matter if you are using MACD, moving averages, RSI, CCI or other oscillators. They all are lagging indicators and they give signal after it took place, like we could see in the first example.
The Fibonacci tool, on the other hand, is a tool belonging to leading oscillators. These give you support and resistance levels for the price before it even gets there. You should decide or use others tools to take the most probable signal. There is a whole chapter about choosing best signals later on in the guide, so you will understand it better. Using the leading indicator let the second trader get ahead of the rest people using lagging indicators. This is the main reason why so many investors are not profitable. Professionals use leading indicators to be the first to enter and exit the trade.
Soon enough you will join this group!
Where do Fibonacci numbers come from?
I will try to make the Fibonacci topic simple and comprehensive. In a moment, we will focus on trading, but some basic topics have to be explained.Try to understand them well. Do not worry; it is not as complicated as you think!
Leonardo Pisano Bigollo (born around 1170in Italy), also known as Leonardo Fibonacci, introduced the Fibonacci sequence to the western world in his book Liber Abaci. What is interesting, this sequence was known to Indian mathematicians back in six century.
The Fibonacci sequence is present in many different areas, such as mathematics, nature (spirals of shells or tree branches) and, of course, in trading! If you are interested in other areas that you can find this, you should read a publication about Fibonacci numbers.
Firstly, a few words about Fibonacci numbers. What are they, anyway?
Fibonacci numbers are the sequence of numbers startingas follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 337, 610, 987…
Each number is a sum of two previous numbers (two to the left).
Look at number 3. It is the sum of number 2 and number 1, because 2 and 1 are to the left of 3.
The two numbers to the left of 34 are 21 and 13. So, we add 21 to 13 and the resultis 34.
This is the answer to where Fibonacci numbers came from. Each Fibonacci number has its own place in the sequence. The sequence is the base to calculating other Fibonacci numbers, such as ratio or extension.
What is the Fibonacci retracement and ratio?
Based on the sequence, we can calculate the ratio. The Fibonacci ratio is counted by dividing a number by the number that follows it in the sequence. Let’s take a look at some examples:
The last ratio listed: 61.8% is the most important ratio and is often called the golden ratio. But there are more ratios, as you have noticed. Where do the other ratios come from? The answer is simple: it is the result of dividing a number standing two, three and four places to the right.
For instance, two places to the right from 8 there is 21:
Three places from 8 there is 33:
Here we have them – the most important ratios: 23.6%, 38.2%, 61.8%.
A ratio is also called a retracement level. It is because there is a chance that a price will stop and reverse at one of those levels.
Traders like to use a few levels more, so the list of most popular full retracement levels is as follows:
23.6%, 38.2%, 50%, 61.8%, 78%
The 50% retracement level does not come from the Fibonacci sequence, but it’s an important level. Traders tend to react when a price is near half of the previous swing, so they added it to retracement levels.
Before we learn more about the Fibonacci retracements, let’s focus on price behavior for a minute.
Let’s start from one tricky question and the basics of price behavior. In which direction can price move? You will probably answer: up and down. This answer is correct, there isa “but” though. What if there is no main trend? If there is no strong trend, the price will probably move sideways. Statistics say that the price is moving about 30% of time in a trend and rest of this time it is moving in a range. Why is moving in a rangesuch a bad thing? It is because there is no clear direction and the price moves up and down, so it is very hard to make money inthis kind of movement. Have a look at the chart below, is it the way you would like to trade in?
No, it is not. It is a very tough market to stay profitable in. Unless you like to trade in a range, you should avoid this kind of market. The best way is to wait until it is over and then start to make money when the trend is back.
Price can be trending up, down or move sideways. Of course, we look for investment opportunities in an up and downtrend, trying to avoid investing when there is no clear direction.
Let’s assume that we have identified an uptrend. Does the price go up all the time? No, it makes higher highs and higher lows. This is a sign for us that there is an uptrend. It may look similar to the example below:
It is similar with the downtrend. The price makes lower highs and lower lows. Again, look at chart below and you should understand it right away:
Can you see the clear sequence of this move? There is certain noise around it, but you should be able to spot significant highs and lows.
This behavior gives us important information. First of all, we are able to identify the current trend. When we are able to see the higher highs, we can draw the Fibonacci retracement levels. Identification of the turning points (higher highs and higher lows or lower highs and lower lows) is necessary to draw retracement correctly. You can read how to draw it in a little while.
Remember: in some unusual cases the price will go straight up or down. This happens mostly when some unexpected news is causing panic or euphoria among investors. It looks promising on a chart, but trading this is very hard. You have to take your position early; otherwise, later your entry point will be very risky.
What is the aim of this guide?
Before you “make your hands dirty” with trading, I want to tell you about the main aim of this guide and the idea behind it.
There are some good books about Fibonacci numbers and using them in trading. There are also some courses which you can buy for as little as 799$ (sic!) and you can learn from them about the magic system based on the mystic Fibonacci tools.
There is no such a thing! (I know that I am repeating myself already, but it is important.)
There is you and there is the market. Many have failed in trying to make a fortune on trading, so you have to be careful and respect the market. There is no magic trick or system, there is a lot of hard work and a lot of things you have to learn. You should learn the best techniques that will give you advantage.
This is the aim of this guide. I am convinced that the Fibonacci tools are your edge in trading. You have to get to know them and use them well to be successful. It does not matter if you trade stocks, Forex or bonds. You will find the Fibonacci ratios there.
I focus mainly on the Fibonacci retracement and extension and I will show you how to enter and exit the trade at best moments. There is also a chapter about money management. It is also a very important part of trading.
I will only mention other Fibonacci tools like time zones, arc or fan. Is it because they are not useful? No, but, in my opinion, they are not the most important ones. I know from my experience that using all the tools at the same time can do more bad than good. Master one tool and then try to use other tool. That is the main goal for me: to teach you the best techniques and give you solid background in the Fibonacci trading.
Now, as we understand each other better, let’s move on to more advanced topics.
READ NEXT PART: PART 2. THE FIBONACCI RETRACEMENT LEVELS