Hello and Welcome to the ditto educational series that will provide you with the skills you need to become a forex trader!
Today we are going to be talking about entering and exiting trades using a technical analysis based method that is one of many tools that can be used to identify a precise entry or exit point in any given trade set up.
We have discussed many of the subjects surrounding trading in the beginner series but not how to identify exact entry and exit points with any given tool. Today’s we will look at the Fibonacci retracement tool an it’s practical function when analysing markets.
Firstly let’s discuss the background of the tool itself!
The Fibonacci sequence reflects patterns of growth spirals found in nature.There is an underlying geometry in the evolution of living things that the Fibonacci sequence of numbers identifies in. The Fibonacci sequence is found in music, art, nature and biology and seems to be almost a tool of measurement for life itself.
This is a very deeply intricate subject that I could produce its own series of videos on but let’s skip ahead to the how! How does this apply to forex and how can we determine our trade entries and exits using this sequence of numbers.
In order to answer this we must look at the Fibonacci Retracement tool and it’s application.
A Fibonacci retracement is a term used in technical analysis that refers to areas of support or resistance .Fibonacci Retracement levels use horizontal lines to indicate where possible support and resistance levels are.
Each level has a assigned percentage, and these percentages reflect how much of a prior move the price has retraced and are Fibonacci sequence numbers. The Fibonacci retracement levels are 23.6%, 38.2%, 61.8% and 78.6%. There is a 50% level which is also used but it is not a Fibonacci number.
This indicator is used by drawing it between any two significant price points, such as a low and a high, and the indicator will show the levels between those two points where the percentages apply.
basically we are looking to trade the retracement of price using these percentage levels as one or more entry points with a high degree of Accuracy.
Retracements occur because when the market is trending and gaining momentum some traders will take profits which results in a small sell off forcing price back down slightly until the original momentum returns resulting in a continuation.
Firstly we need to identify a strong uptrend and then look to enter during the formation of the pullback. We can draw our retracment from the swing low to the swing high. We always start with 100% and draw it to 0% as we look to measure the increasing percentage of the pullback. The most popular percentages are 38.2% 50% and 61.8%. 61.8% is the most prolific number in the Fibonacci sequence as many of the numbers divided by the prior numbers equate to this value but 50 and 38.2 are just as regarded. We could also highlight this as an entry zone.
Once we have drawn in our retracement tool from the low to the high we can now begin to strategise about potential entry points. We have our 38.2% 50% and 61.8% lines so using the market prices given we could place for instance a small pending order at each percentage. This would offer us the best possibility at at least catching one of them before the continuation of the trend.
There is no telling how far the the market will retrace however the accuracy of these measurements will make most new traders look at you like you have just invented fire when you show them for the first time. It’s really incredible when you look over historical data how much this method has paid off for pinpointing entries vs how many times it has failed.
Fibonacci is applicable in any time frame and absolutely defines the market price in some larger scale analysis. Here are some examples of where Fibonacci has accurately predicted entry on multiple occasions.
Here we see how over and over again we are given entry after entry by this remarkable tool.
Now is the Fibonacci retracment technical analysis tool, which is regarded as the formula of measurement for so many aspects of life a magic and mystical secret to trading the forex markets? Not exactly! Although it is widely regarded and factored into market participants decision making, perhaps the reason for its reoccurring accuracy is that traders and automated trading systems read the market and trade the market the same way.
If everyone is using the same ruler then we can expect the same results! What I mean by this is if in a upward trend price starts to retrace and generally the majority of market participants are expecting to buy in at one of the 3 per mentioned values, then we can expect the continuation of the trend to continue from one of those points!
Psychology and shared knowledge play their part here and we are trading in a way that anticipates the market participants thought processes.
I believe we have covered this aspect reasonably well so let’s move on to exiting our trades.
Wether we are exiting our trades via stop losses being triggered, usually this is due to markets behaving differently to our analysis, or we are looking for reasons to exit our active trades, knowing when to exit or having strategy surrounding exiting our trades is imperative to preserving profits.
Now this video is about Fibonacci strictly speaking so let’s discuss at which point we could think about placing our stop losses or exiting our trades. If we are placing 3 entries at our levels of 38.2%, 50% and 61.8% then we could set our stop losses beyond the 78.6% level. This would give our trades enough room to breathe and be a reasonable stop loss in terms of our analysis not making sense any more.
However if our trades are all triggered and go on to continue to profit with the trend where should we place our next stop loss if we adopt a trailing stop loss method. The answer would of course be just beyond the next established higher low in accordance with price action and more than likely it would fall just beyond the 78.6% value.
In accordance with our risk reward educational videos we know that we are looking for at least a 1:2 ratio of risk reward and your lot sizes should be calculated for percentage of account risked between entry and stop loss, please see our pips and lots video for more information regarding this subject.
In summary Fibonacci retracment is a powerful technical analysis entry tool, we have seen its application and reliability and together with everything in this beginner series you now have a very broad understanding of the forex markets and are more than ready to trade a demo account and starts refining what you have learnt.
I hope you have enjoyed our video today ladies and gentleman please open your charts at hope and start applying Fibonacci to current and previous market charts. Practice makes perfect and remember contemplation is the key to learning.