- Previous part of tutorial: Pivot Points in Forex trading
- Next part of tutorial: Trailing stop in Forex
There are many tools based on Fibonacci numbers. Below short overview.
Fibonacci retracement is the most popular tool used by traders who are trading with Fibonacci. It helps you to predict where correction might end.
Do you remember how in the beginning of this article I wrote about nature of trends? When price is in an uptrend, there is a sequence of higher highs, but there is also a sequence of higher lows, or simply corrections. This is something natural for uptrend – price move up, up and suddenly it is falling down. That is correction and it is a good thing, because it let you to enter position for better price.
Fibonacci retracement helps you to find places where correction might stop. With that knowledge you can plan to enter a position from there in a direction of main trend.
You can also predict where there will be the next high or low. You can do this with Fibonacci expansion. To do that you need to find three points. A and B from main swing (low and high) and point C where correction ended (similar points as you would be looking to draw retracement levels but here you have to know/decide where correction ended). With that points you are able to draw Fibonacci expansion and in result you have few projections where might be next high/low. There are more levels, but standard are 61.8%, 100% and 161.8%.
There is also extension based only on two points (A and B), which also gives projection levels, but lets do not complicate things too much.
Fibonacci time zones
Interesting tool which you draw horizontally. There is many ways you can draw it – from high to high, high to low, low to high… In a result you have vertical lines, which represents time when there might be end of move or some change of direction.
It is another tool which represents areas of support/resistance, but in another way. You draw Fibonacci arc from high to low or low to high. As a result you can see three curves 38.2%, 50% and 61.8% which represents possible place where price action might stop/reverse.
With this tool you get three diagonal lines. Each one of them represents Fibonacci ratio and when price is getting close to this lines, you know that this might be area of support or resistance. You draw a trendline between low and high to get this lines.
Actually, this tool is pretty handy. Try to exercise on historical data, or test it in your trading. It is all about selecting right low and high and you will get good results.
There are some other tools based on Fibonacci numbers, but these are most known. If you are confused right now and you do not know which one you should use, then let me give you small advice. Start from Fibonacci retracement and master using it. Then add to your toolbox Fibonacci expansion – it is important tool, because it let you predict the best points to close position.
Most popular combination is Fibonacci Extension + Fibonacci Retracement:
Fibonacci Extension – they work as possible target for the move (take profit area)
Fibonacci Retracement – they work as support during a correction
Fibonacci Setup in Metatrader
Now let’s have a look how to setup Fibonacci so you have most popular levels in place.
Below you can find instructions with most popular setup.
Where can you find Fibonacci Retracement in MetaTrader4?
Go to top bar and find Fibonacci Retracement icon:
Or you can go to the top menu and select Insert -> Fibonacci -> Retracement:
How to change Fibonacci retracement and extension levels?
When you have selected Fibonacci tool described in point 1., draw it on a chart. Now, double click on the line that goes from 0 to 100%:
And click mouse right button. Next, select Fibo properties:
Fibonacci retracement and extension levels list
In Fibo properties, go to the second tab. You will find there a table with two columns: Level and Description:
Probably you will see some default values. You can edit fields and add new ones. Correct the list in the second tab so it looks like list below:
These are levels that I use in my daily trading. Sure, you can customize this list so it fit your trading style. You can add levels like 261.8, 150 etc. In my experience, you are good to go with the list I provided above:
Fibonacci trading in Forex
To draw Fibonacci, we need to select a swing move. Additionally, we have to try to do that in the right direction. That is why it is crucial to understand price behavior, trends, swings.
Let’s start from tricky question and basics of price behavior. In which direction, can price move? You probably would answer: up and down. That is correct answer, only that there is one “but”. What if there is no main trend? If there is no strong trend, price will probably move sideways. Statistics says that price is about 30% of time in trend and rest of this time is moving in range. Why moving in range is so bad thing? Because there is no clear direction and price move up and down so it is very hard to make money in that kind of movement. Just look at chart below, is it something you would like to trade?
I think so. What we want to trade is trending market. Going into trend direction increases your chances of success. Look at this beautiful trend below. Isn’t it something you would like to trade? On the short side of cource!
We want to use Fibonacci technique in that kind of market. Before I go further and explain more about this, there is another important thing you must learn.
How to recognize trend?
You should be able to easy recognize if there is a trend in place or not. Sometimes it is hard because of the “noise”, but there are some tips you can use.
Look for higher highs and higher lows, if you are looking for uptrend. I have probably showed you this charts before, but this is important. On chart below you can see an example of uptrend. You can see that every high is higher than the previous one, and every low is higher than previous low.
When you can find these elements on chart, then you have identified an uptrend.
In downtrend you should look for lower lows and lower highs. Each low is lower than the previous one, and each high is lower than previous high. Just like on chart below:
If you are able to identify lower lows sequence, than you have found a downtrend and you can plan to enter short position.
In range market there is no sequence, therefore there is no trend.
You can also use simpler tools to define trend. Most popular moving average is a good choice. Lets say you are using 200 simple moving average. When moving average is rising and price is above that line, than there is a strong chance that trend is up. If trend is down, price will be under 200 SMA. Of course this method does not make you 100% sure, but the chances are good.
So, what really Fibonacci trading is?
Now, when you know what kind of trends there are and how to recognize the current trend, we can move to answer the question from title. What is Fibonacci trading about?
Fibonacci trading is a technique, where you are using tools based on Fibonacci numbers to predict possible turning points (if you want to read what it is Fibonacci number, just go here).
There are many tools which you can use for trading with Fibonacci. Each of them do a different job. Some are more important, some less. Lest review them quickly.
How to trade with Fibonacci?
Now you know what does it mean Fibonacci trading, and what kinds of Fibonacci tools we have (plenty of them!). There is one more important question to answer. How should you trade with these tools?
Notice that all this tools give you a potential level of support/resistance or potential exit points. This is very valuable information! But how to use it for your benefits? Of course, I am not able to answer you in few words, but I can give you some advice what should you do.
You should build trading plan. The main core of your trading plan will be Fibonacci tools. As I wrote before, first include Fibonacci retracement and extension to your plan. Next, you need some signals which help you to enter and exit positions. The logic here is that when price is in uptrend and correction occur, you draw retracement levels. When price is near one of them, you do not know which one will be a support.
That is ok, because you define your own signal and when price return to move up from correction, you get your signal. It might be something simple like moving averages crossover or signal from some oscillator.
Same with closing position. You should define on which signal you will exit your position. It will be probably near one of expansion levels, so you will be ready to act.
The last, very important part of your trading plan is money management. You should keep your losses small. It is very important to trade smart and not to risk too much.
Some of this information are not very specific, but the whole topic about trading with Fibonacci is very wide. In the end, it is about practice, practice, practice. You should be testing new ideas and getting experience. Trading with Fibonacci is great, because you have possible support and resistance levels and even exit points. Of course, they are only possible levels, but on many times they work excellent. You need to build your whole trading plan around these levels, so around Fibonacci tools. Add to this entry and exit signals and proper money management system and you are on great way to success in trading.
ABCD and Fibonacci trading
There are more advanced techniques to trade with Fibonacci, but you should start with ABCD. This is simple yet powerful approach. In short, we look for a swing. Based on that swing we draw our Fibonacci lines (A and B). Next, we wait for a correction to retracement – C. After that we open a trade and wait for continuation move towards D (which is an extension line).
Look at some examples below, it should be clear.
Fibonacci trade examples
GBP/JPY 1 hour chart
Here we have example of GBP/JPY. We can see that after strong move down (from A to B) there was a correction up. This was a good moment to draw Fibonacci lines and wait for signal to go short. Correction ended at 78.6% and after that there were signals from MACD and Stochastic. This short trade worked well. Move ended at 138.2 Fibonacci extension and it was our D point.
In this EUR/USD example time frame is 30m. We are in an uptrend and after strong move to the B there was a correction. It was rather deep, down to the 78.6 retracement line (our C point). Next EUR/USD returned to the uptrend. We saw some signals to go long. This was a strong move up, with short stop at 161.8% extension line. Eventually move ended at 200% extension line, this was our D point.
- Previous part of tutorial: Pivot Points in Forex trading
- Next part of tutorial: Trailing stop in Forex
Menu for Forex trading for beginners tutorial
Part 1. Introduction to Forex trading
- 1.1. About forex trading
- 1.2. How can I start Forex trading
- 1.3. Pracitce Forex trading - demo accounts
- 1.4. How to learn to trade Forex
- 1.5. Forex trading questions - our Forex tips
- 1.6. Best time frame for Forex trading
- 1.7. How much do Forex traders earn
- 1.8. Is day trading for you – trading forex for a living
- 1.9. Trading plan in Forex Trading
- 2.1. Forex trading tools and strategies
- 2.2. Pivot Points in Forex trading
- 2.3. Fibonacci trading tools in Forex
- 2.4. Trailing stop in Forex
- 2.5. Moving averages in forex trading (and not only FX)
- 2.6. GMMA and others Multiple Moving Averages