FIBONACCI
Fibonacci Retracement is one of the most common technical tools used by traders to identify key hidden potential support and resistance levels.
Example of FIB in a bullish market (Uptrend)
These are the main pullback/retracement levels:
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0.382 or 38% is the fastest bounce
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0.5 or 50% is the medium retracement bounce
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0.618 or 61.8% is the Key retracement that we look for
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0.784 or 78.4% is the a key area we use as stoploss level
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Fibonacci levels used as target zones are:
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-0.61 and -0.27 Orange lines act as D extension
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Traders use theses key Fibonacci retracement levels to help determine and forecast potential pullbacks or retracements. Fibonacci Retracement is used to identify the length of a counter trend bounce.
How to utilise Fibonacci when trading
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The beauty of Fibonacci retracement is that many people may adjust and add them to their chart using their own method and style; however when adjusting and adding your Fibonacci we advise you to use the most recent swing low to the most recent swing high in a bull trend (A to B wave). The higher timeframes work better for Fibonacci.
So Fibonacci is another one of those important confluences used as a trader to build a high probability trade setup.
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It’s really important that you use the Fibonacci tool correctly:
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-Use the most recent A-B wave
-Remember it works best in a trending market
-Use as one of many confluences (not on its own)
-Look for reversal candlestick formations around the key levels
-Use on higher timeframes, 4h and above.
Below is an example of how you would draw on Fibonacci.
You can see that these levels are areas of hidden support, you would draw it on from the A to the B and you can see that the golden retracement level 0.618 (green line) has acted as strong support many times.
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The sequence is filled when we hit fib level 0.27 which finishes off the pattern ABCD.
Rules to trading Fibonacci:
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- Draw all your analysis onto your charts (trendlines, long term, inner, outer and your levels of support and resistance)
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- Find the A to B wave and draw on the Fibonacci with the tool and have a look at what possible outcomes there are.
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- Find the C retracement, this is your action level where you will buy in an uptrend or sell in a downtrend.
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- Look at candlestick formations around these areas (reversal patterns/lots of rejection and wicks)
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- Note down where the D extension levels are and place your targets on so they correspond with these.
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- Before you enter the trade, work out the amount you’re willing to risk.
If you’re unsure of what your risk should be, check the risk management section of this course.
Below we have an example of a GBPUSD short trade. You can see all of the analysis on the chart including: key areas of support and resistance, trendlines and you can see the Fibonacci too.
We built up a number of confluences, which created a very high probability setup.
Before the trade
The golden 0.618 retracement level didn’t disappoint, it dropped into profit and smashed our target to hit fib extension D with ease. It’s all about building your own trading plan which includes all of your chosen confluences to ensure that you’re trading with the odds in your favour.
After the trade
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Below is an example of a perfect case scenario with Fibonacci in a bullish/Up trend
We can see price leaves an area of consolidation as shown in the blue box at the bottom of the example. Firstly we would look to buy the breakout of the range at the red line. Price then hit resistance at B and we look for possible retracement areas where we establish point C.
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Once we hit support at C we go long and price moves to D extension and the process starts again. Remember Fibonacci works best in a trending market, that could be a bear trend or a bull trend it doesn't matter
Below is an example of how you would apply Fib to a downtrend/bear trend.
Using your Fib tool drag from A to B, then wait for price action around the Fib retracement levels and you can also see there’s a double top around the 0.618 retracement area which is the golden retracement level.
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So here we have made our trade setup even more probable by using not only fibs, but also a double top formation and candlestick rejection around the key level of retracement.
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Fibonacci plays out nicely here you can see A, B, C and D extension which is where you would have put your target once entering short at C retracement 0.618.
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Here is an example of how you would apply Fib to a uptrend/bull trend
You find the A to B wave as shown and you build up a number of confluences to enter long at the C retracement level. The golden 0.618 area holds strong as support along with a triple bottom, and the sequence (ABCD) is completed when D extension is hit which is our target.
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Don’t forget that these Fib levels are areas of support/resistance, not an exact line as you can see from the example here. We may dip slightly below but it’s generally respecting this level. Many traders are looking to get in at these levels, which is why you see price reversing to the upside.
Here is an example of how Fib doesn't always reach extension D.
This is why its important to monitor your trades. You should still be very aware that ANYTHING could happen in the market so you need to monitor your trades to make sure D extension is hit. If we don’t successfully break and close higher than point B and hit resistance before breaking higher, then we exit the trade.
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There’s no point waiting for the trade to go against us. In the example here it almost makes a double top too, so you need to be aware of what price action is telling us even when we are already in the trade.
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Its important to note that Fib levels are not set in stone
Anything can happen in the markets. You can see below that we established our A to B wave and we’re looking for resistance at the hidden retracement levels, but they were continuously broken.
Be wary of this and read price action in an unbiased way.
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By doing this you can clearly adjust to what price action is telling us. Stay unbiased, even if you are in a particular long or short trade.