Trading Fibonacci Retracement Levels – Better Way to Use Fibs

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Fibonacci levels are just a tool and like any tool and any type of trading system, the usefulness depends on the user and the rules they follow in their application.

You have probably heard that the main knock of Fibonacci levels is: “place a bunch of Fibonacci retracements and extensions on your charts and some are bound to be hit.”

While that may be true, there are several ways that may help you get a handle on Fibonacci retracement trading to find potential reversal points on your chart.

 

Using Fibonacci Retracement Levels

These are the levels that you would use to find support or resistance in your given instrument. The issue has always been where to start and end the measurements.

Taking a step back, ask yourself what are these levels representing?  For me, they are a measure of human behavior and are a framework to understand emotional extremes.

Given how I look at the representation, I look to the overall move, the obvious swings (can be subjective) and also to pockets of consolidation.

My mentor when I was learning the basics of Fibonacci would also use thrust bars and gaps which show where extreme action resides.

The retracement levels I use from the Fibonacci sequence are 38.2 and 61.8 because less clutter on the chart will show you the most important variable – price.

Let’s go through a simple example using Fibonacci retracements to find resistance in a down trending market – BTCUSD

FIBONACCI RETRACEMENTS - DOWN TREND - BITCOIN
FIBONACCI RETRACEMENT LEVELS – DOWN TREND – BITCOIN
  1. We start the Fibonacci retracement by pulling from the highest high on the Bitcoin chart
  2. Ending at number two, the levels 38.2 and 61.8 are plotted on the chart (the 38.2 has been removed for this example – the 38.2 is for the next example)
  3. Price rallied up to the 61.8% Fib level and using your entry method, you would short this market
  4. Using the extreme high again, we being a Fib pull ending at….
  5. Ending the Fib pull here, Fib levels are plotted and for this example, we remove the 61.8% level
  6. Price rallies into this zone, presents a double top, and then price collapses

This is a simple example of using Fibonacci retracements and you may see a confluence of other factors on this chart.

FIBONACCI CONFLUENCE
FIBONACCI CONFLUENCE

 

  1. This yellow arrow is highlighting a former resistance level that breaks as price puts in the highest high.  Carried over to the right, this zone lines up with the Fib level
  2. This area is the support area we pulled the first Fib to and you can see, carried over the right, price stalled in the confluence zone

As I said in the beginning, the biggest knock of Fib levels is that a bunch of lines will get hit by random price action.

To use Fib levels as a framework helps you zone in on certain areas and then find supporting structure as indicated in the two charts above.

 

Using Fibonacci Expansions On Your Chart

An expansion is a measurement of the impulse leg of a move projected from the correction leg.  To plot a Fibonacci expansion , you will use the Fib tool that requires three clicks and I use the numbers .618, 100 and 161.8% as I was taught.

We can use expansions in a number of ways but the most popular way is to find profit targets using the Fib ratios.

FIBONACCI EXPANSIONS FOR PROFIT TARGETS
FIBONACCI EXPANSIONS FOR PROFIT TARGETS

This is the Yen futures chart and in this case, we are using the green circles starting at the left, going up, and then pulling the third click to the last green circle.

The expansions are plotted and what is interesting is the 61.8% lines up with potential resistance and in the end, price tops out at the 100% expansion level.

 

Using Expansion To Find Symmetry In The Market

One thing you may have seen is how price seems to move in waves not much different than the ones that came before it.  In some cases, swing in price have been the exact same length in terms of price which makes symmetry something to consider.

You can measure the distance of one swing and project that swing to another swing and look for the 100% level which shows symmetrical pullbacks in price.

MARKET SYMMETRY - MEASURING SWINGS
MARKET SYMMETRY – MEASURING SWINGS

This is the daily chart of wheat futures and the market is in an uptrend.  Here is how we plot the yellow lines:

  1. First click at the swing high
  2. Lowest swing low after the swing high at one
  3. The leg price distance from 1-2 is projected from 3 which gives us the first yellow line.  You would determine a trade entry in that location
  4. This is where the first measurement ended and we can also use the 3-4 leg and project from number five
  5. This high also contains that measure from 1-2 projected from five and 3-4 project from five

With the last horizontal line set, we are using the distance from two corrective swings and projecting from the highest high to give us an idea where this current pullback could terminate.

Just like the lines plotted by Fibonacci retracements, these zones are potential reversal points where you could look for a trading entry.

 

100% Symmetry Breaks Can Be A Red Flag

The symmetry measures previous swings in the market and are a good read on the current volatility in terms of pullbacks.

If pullbacks are too strong or further in distance than previous pullbacks, you may determine that something has shifted in the current trend direction.

SHIFT IN MARKET RHYTHM

Here is an example of using symmetry to determine a shift in the dynamic of the market.

  1. This white line is projected from the number three high
  2. Current price location has retraced from the highest high to virtually the same price distance as we see at number one
  3. This begins a smaller measure, the green line, and is projected down
  4. Price has broken this level which would have been the end of a complex correction in this stock.

What we can determine in NKE is that something has shifted in the dynamic of this market.  Complex corrections have broken and we have retraced the distance as the largest pullback in the near recent price action.

But the price action, the large momentum candlesticks, are hinting that something has changed in this current retrace in price.

By using the symmetry feature, we can either remove ourselves from a strong bullish stance, be prepared to exit a position, be prepared to reduce risk.

 

Develop Your Fibonacci Trading Strategies

Using Fibs to determine potential pivot points in the market can help you frame price action and ensure you are looking to trade at specific locations on the chart.  There is nothing magical about Fibonacci ratios and they are hard to back test given the subjectivity that can be involved.

You can design a trading strategy that takes into account:

  • Trend direction – using a moving average as an example
  • Retracements in price
  • Symmetry measures where breaks in symmetry are a red flag

What is vital is that you understand that Fibs are just measures of price movement and that markets move in a rhythm.

If the rhythm is broken (think symmetry) then something has changed in the market and you should understand what that is.

Pullbacks are a common market mechanic and the Fibonacci series is just a measure of the pullback.  What should be clear is that using Fibs alongside market structure is much better than relying on the Fib lines themselves.

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CoachShane

Trader at Netpicks
Shane his trading journey in 2005, became a Netpicks customer in 2008 needing structure in his trading approach. His focus is on the technical side of trading filtering in a macro overview and credits a handful of traders that have heavily influenced his relaxed approach to trading. Shane started day trading Forex but has since transitioned to a swing/position focus in most markets including commodities and futures. This has allowed less time in front of the computer without an adverse affect on returns.

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