Pt2: How to use Fibonacci Retracement
George here again, with the second part of my series on Fibonacci retracements. I hope you caught my first tutorial on Wednesday (if not, you can catch up here). Part One covered the basics of what Fib levels are, and why they are so powerful.
Today I’m moving on to the really exciting stuff – how you can use them in your trades.
There are several ways that you can use Fibonacci levels in your trading, and confusion between the different approaches traders take can too easily put people off Fibonacci before they’ve even got started.
Which is why, here, I want to focus on just one of these methods – one that I believe is one the simplest to apply and the most successful for trading profits … trading a Fibonacci pull-back in a trend.
All we need to apply this technique is to have a trend in place.
Trends are, of course, one of the trader’s best friends, but if we’re going to put our money into the market, we need to know when to open a trade in a trending market.
As I discussed in Part One, no trend moves in a straight line, so the optimum entry point for our trade – the entry that will give us the very best chance of a good move in the right direction – is to trade on a pull-back.
Let’s say that we have a bearish downtrend in place. At some point, the price will stop moving lower and retrace upwards. This is our moment to be ready for action.
Here are the rules for our entry:
1. Wait for price action to stop and start moving back against the trend.
2. Set our Fibonacci grid between the last swing high and the just formed, swing low.
3. Wait for price to turn back in the direction of the main trend as it bounces off the Fib retracement line.
And here is how to put this plan into action. Again and again …
Trade One
The down trend is in place and, as soon as the first bounce starts, mark the Fibonacci levels between the last high (A) and the current swing low (B). We get a retracement to the Fibonacci level at C (the 38.2% level). As price moves away from the Fib line at C, we enter a sell short trade with a stop above the 38.2% Fib line.
Trade Two
As price moves lower than D there is another Fibonacci retracement opportunity. This time our Fibonacci levels are drawn between the swing high at C and the next swing low. The level D is 50% of the last swing that runs down from C. We can enter a short trade as soon as the price moves away from the 50% line at D.
Trade Three
The next trade entry occurs at F, which is the 50% level of the D to E move. Enter the short sell as price confirms the move back in the direction of the main trend.
As you can see, Fibonacci entries occur a good many times here and this pair – the AUDUSD, works very well using the Fib retracement technique It also works in all major markets, particularly the S&P500, FTSE100, Dax and so on.
Enhancements
In this second tutorial, you’ve seen how Fibonacci levels at their most basic can enable you to get the very best entry points in a trend.
However, as I mentioned earlier, there are many more ways to take the technique further.
• To use multiple, or a confluence of Fib retracements, to confirm future support and resistance areas for targets and future trades.
• To project future swing trend extensions based on the last swing trend.
• To combine retracements with extensions to give trade target areas and entries for limit orders.
• To find future time-based targets for significant highs and lows.
• To trade specific Fibonacci chart patterns including the Gartley and BAT and several more.
Some of these I use myself. Some are, for me, a step too far, like time extensions, which I’ve seldom found to be successful.
For my money, Fib retracements and trading the specific Fib patterns that I’ve recognized and developed over the years are the most reliable ways to use Fibonacci.
Any questions, please fire them off to me by clicking on the comments button below. I hope you’ve enjoyed these tutorials. Mark will be back as usual next week.
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10 comments
Mark Rose
Thanks for the great response to George’s series. Some very exciting news tomorrow for anyone who’d like to find out more about George’s techniques. Please watch out for my email.
Mark
Here’s my questions George. what’s the best timeframe to use Fibs on? When you have marked the Fib where doe’s your confidence come from that any retrace level it has hit won’t be broken again. Lastly, would your entry be below the last low of a fib level being hit? Many thanks
George
Another excellent question Mark. The AUDUSD usually works well with Fibs and the time frame so often depends on us as individuals. That said, the retracement approach will work on any time frame particularly the daily charts. Intra-day, I find the hourly or 15 minute charts works for me.
It’s always possible the retracement will switch back and retrace further of course and I have a money management approach that keeps risk to a minimum. The most reliable retracements have a-b-c legs. A bounce up (a), then a small pull back (b) and then another bounce up (c) that hits a fib level, then sell as it rolls over.
paul wilson
Retracement – I’d be interested to know what method/technique you use? ie. when does a retracement start and end?
Of course it’s easy to see … looking at a chart from right to left (hindsight). Not so easy as chart moves left to right (future).
Using your AUD (1 hour) example:
Leg DE – starts retracement about midway between D and E. It fails and resumes Fall down to E.
Leg EF – pullback, Fall resumes but then retracement resumes.
Thanks
Paul
George
Good questions Paul, the method is to find a trend, defined as a succession of lower highs and lower lows in the AUDUSD chart, I then want to sell, but only after a retracement against the new trend to keep risk as low as possible. Many traders do the opposite, selling (buying) break outs to new lows (highs) only to find a retracement moves against them and so can be shaken out of their trade.
Quite right re the small attempted retracement with the DE leg down. Leg EF is another retracement giving an entry at 0.8875 to continue with the trend. The trend ends when the sequence of lower lows and lower highs reverses and that may be about to happen at the right hand edge of the chart – a good place to take some profits.
robert
nice of your to spend time on this trading strategy but must be me it was not very clear.regards
George
You can think of retracements as the zig zag nature of trends, they move up (or down) and profit taking brings price back down against the main trend only to bounce back up in the trend direction again. The best trade entries are as price bounces up from these Fib retracement levels. They are measured between the previous high and low. Hope this helps.
Vic
Can’t wait to start trying these out for myself. Would love to find out more about the Gartley and Bat patterns that you mention …?
George
There are several ways to apply Fibs, retracements are the most often used. The Gartley and BAT patterns take the idea much further, they do occur as retracements within an established trend, but can be very powerful signalling the end of one trend and the start of a new one in the opposite direction – more info coming soon…
Mark Rose
Thanks again George, for another great explanation of just how simple it is to use these key levels.