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.”
The fact is that Fibs are just a tool and like any tool and any type of system, the usefulness depends on the user and the rules they follow in their application. I want to show you several ways that may help you get a handle on Fibonacci trading.
What We Will Cover
I started trading in the Fibonacci world and to this day, utilize certain aspects of it as you may see from the various postings I’ve made over the years.
From trade locations to profit targets…
Fibs are a wonderful addition to a traders toolbox and I have shown how effective they can be over and over again in live trading.
I’m only going to cover the techniques that have worked for me (including those I’ve learned from over the years) and will do my best to avoid pontificating about the best way to use them.
To give a definitive “best way/right way/only way” comment would mean I’ve done enough testing in all instruments and market environments to be able to objectively discount any other usage. I have not undertaken that task.
Take it all as “food for thought”, pick out what may be useful for your strategy and then discard the rest.
There is a ton of information on the internet about sunflowers, pyramids, Fibonacci numbers and how to calculate them so I am not going to cover that information in this piece.
Let’s jump right into how these lines can aid in your trading and then wrap them all together in a framework of a possible basic trade plan.
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 certainly show where extreme action resides.
The levels I use are 38.2, 50, 61.8, and 78.6 and really like to see the last two numbers in a potential zone of opportunity.
This is a four hour chart of the AUDUSD Forex pair and it is coming off a down trend in price and we are going to look for zones of support.
- This extreme is anchoring at the areas marked with the light blue squares. There is a stacking of two Fibonacci ratios (61.8% and 78.6%) which we call confluence. I don’t trade off a singular level and a confluence is always a welcome sight. The pull areas are clear: The extreme of the low and an area of consolidation which saw rapid price movement. Price rebounds to the pip and advances.
- Anchored with the red squares and why those swing were chosen should be clear. There is another confluence (although 50% is not a Fibonacci ratio but is used as an “eyeball” pullback level) of ratios and price advances.
- Represented by the black squares, this level is a confluence of levels and once again advances.
The last chart ends on the last thrust and our next chart will show the down move after the last chart ended.
- Price rallies from the low and stops at the 78.6% level. There is no confluence of levels on this time frame however there is a resistance level not drawn on this chart as well as a backward bounce off a trend line. For me, that is also considered confluence as I am not a “Fibonacci purist”.
- The red line shows the rally that terminates at a confluence of Fibs.
- Price rallies to the 78.6% level and terminates to the pip and crashes to the downside.
Heading back to number three, you will notice a horizontal line running across the chart. This is the 78.6% retracement of the previous uptrend leg from our first chart pulled from extreme to extreme.
As I said in the beginning, the biggest knock of Fib levels is that a bunch of lines will get hit or exceeded.
While true, it is also a very simplistic way of looking at the usage of Fibonacci levels. These two charts have demonstrated using obvious multiple levels as well as looking at a confluence of factors before considering a trading opportunity.
There is so much more to Fibonacci than retracements that you may find interesting.
Using Extensions In Fibonacci
An extension is a measurement greater than 100% of the previous move and are also used to determine potential areas of resistance and support.
These numbers are 127.2, 161.8, and at times 261.8.
There are a few ways that extensions can be useful and that is to look for previous swings to terminate at the 127% level. This can be used for profit taking and for finding a confluence at a potential area of support/resistance. I’ve written about the 127% extension in the past and it is tagged quite often once we see a break of the 78.6% retracement level.
This chart should look familiar as I am going to use the same sections throughout this piece so I am not tempted to find the best case scenarios to fit my narrative.
The up arrows will show where the retracement was pulled from and the down arrows will show where the extensions end.
- This area is the last swing into the low before the uptrend began. Note the highlighted inset box as it shows that this level at #1 is also the 78.6% retracement of the prior swing up in price which gives us a retracement and extension confluence.
- A swing inside of a bigger swing is valid and this extension terminates at the 127% level.
- Much like #2, a swing inside of a swing.
- This may not be as obvious but remember that most times, price details are hidden with higher time frames. This area was inferred due to the smaller retracement in the run up. Dialing down to the one hour chart confirms that it was an actual swing in price formed from a momentum bear bar countered with a momentum bull bar.
Look back at our first chart and will see that we have a confluence of extensions and retracements at all of these turning points.
What Are Profit Extensions
We covered that extensions can determine potential support and resistance so we can use these as objective profit targets by changing how we draw them.
The arrows on the chart show that we draw our retracements from high to low into the swing and then extend our ratios to the upside (uptrend context. Reverse for downtrend).
The red lines show were we had a confluence of Fib ratios, price supporting, and you would look for a trigger into a trade.
Objective profit targets
You have objective targets for your trade and could opt to exit at 127 or use it as a scale out position and look for 161.8, 200 or 261.8.
That would depend on your trade plan and if you have other means to determine that the momentum in your trade direction may experience a pause/pullback in price.
Price Projections and Symmetry
Projections use three areas on the chart and you need to use the tool that allows you to measure A to B and then project from C. Charting packages have different names for them so just make sure you have that tool.
A simple measure……
What happens when using this tool is you are measuring a previous swing in one direction and projecting it in the same direction at another place on the chart.
Before moving forward, I think you’ve seen how price can have a “rhythm” to it. You’ve probably seen it occur in trend channels where price moves back and forth in a descending/ascending fashion and makes contact with the channel extremes.
Price will move in this fashion before spiking in one direction or another. It will then start the process over again.
Price is like a Russian Nesting Doll….
Inside of each major leg of a move, there are smaller counter legs (pullbacks/rallies) that are often times extremely close in price and time.
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.
Once you see a counter move in price that exceeds with conviction 100% of the previous moves, you can be on alert for a potential change of state in the market.
Transitions Can Be Dirty
I am using the same area of a previous chart that showed the downtrend to once again keep things consistent. It actually makes things more difficult as the evolution from an up trend to a down trending market is rarely neat and tidy.
I am also going to include price up to the date of this article.
This chart shows an overview and the circles indicate the hits of price and the 100% symmetry level. The left side of the chart is a little sloppy as this is the area of the turn of trend.
You can use the last swing into the high (in the case of this uptrend) and use those for projections as well. The blue lines are the swings that are being projected.
Two areas of interest are:
- This pullback, although large, is virtually 100% of the last major pullback into the high before we turned lower. At this point we can use this rally in price as the “line in the sand” and if price rallies in the future greater than this, we may want to shift gears to looking for buying opportunities.
- You can see that price has rallied almost to the same degree as #1 has but at this point, shorting opportunities can still be considered because this is a “normal” rally in this leg of the move.
Another use for the projection tool is called expansions. I won’t cover them because I don’t use expansions in a Fibonacci sense although I do use it for a measured move target once a trading range has broken.
Fibonacci Trading Strategy
Simply drawing Fib lines and looking for hits is not something I’ve ever done and is the sign of someone who only has a rudimentary knowledge of Fibonacci trading. I’ve used and continue to use combinations of all that we have discussed but time refines your trading in many ways.
You Can Build On This
I want to give you a bare bones trading strategy that you certainly can build upon and don’t be surprised if you start seeing price in a whole different way.
This can lead to “aha” moments of realizations and understanding that may only be found when you do the work.
There were so many opportunities on the AUDUSD Forex pair so I choose to use one where the detail was much clearer due to the size of the rally. This was off the high that we saw a few charts earlier.
- This is the final move leading into the high and where the symmetry projection was anchored from and then projected from the bottom leading into the rally. The 100% projection (red line) is plotted.
- A high to low retracement is pulled and the blue horizontal line represents the 78.6% retracement.
- A swing into a low is made and we again pull our Fibonacci retracements from high to low and then project to the upside noted with the pink horizontal line which is our 127% extension.
- Fibonacci retracement from the low to the high of the rally and a profit projection is made at 127% 5. This represents extended target of 161% and not shown however price bottoms out 40 pips below the 200% mark.
You can see that everything that’s been covered has been applied to this example.
It All Follows A Sequence…
Starting with our symmetry projection, we roll through each tool and see if there is a confluence of levels lining up so we may zero in on a zone of opportunity.
I rarely will take a trade that does not have a 100% symmetry projection in close proximity to the setup. I want to see a pullback in price in the same ballpark as previous ones.
If the pullback exceeds the symmetry of prior ones, I am extremely cautious and will look for structure to be in place as well as momentum turning in my direction.
No triggers have been mentioned in this piece however you want to find a way into these moves other than just pushing buttons.
I have covered how to enter a trade setup in a previous article that you can explore. That said, I have many times “set and forget” at levels that have Fib confluence as well as structure involved at a level.
Higher Time Frame Fibs
We are generally always trading inside of bigger picture price structure and what is covered here also applies to higher time frame charts.
Think back to the chart that showed our up trend turning into a down trend. Near the turn there was a trade setup to go long and just looking at that chart, there doesn’t seem to be a pressing issue.
This daily chart shows a yellow highlighted area and that is where the trade setup took place. We were running into quite a few issues and although the trade hit both the 127 and 161 areas, it could have turned out for the worse.
The blue arrow is a high to low retracement that gives us a 38.2% zone at the blue line. The red line and arrow is our symmetry measurement that is projected from the “x”.
Finally, our green arrows and lines are our extension levels from two swings. We also had an area marked “Z” where price resisted in the past and although you never know if price will resist in the future, we have a huge confluence in the zone that should be a red flag.
We covered a lot of ground here and I have to say that the examples were not cherry picked. I simply took a Forex pair, scrolled to the recent past and bar by bar plotted the Fibs. Areas where there was not a confluence, the single Fib lines were removed.
Like any aspect of trading though, these are not foolproof.
Price will bust through even the heaviest of confluence at times so you may want to read the price action around the zones, a price pattern or use some other type of trade trigger to get you in the trade.
For more updates from Mark and the team at NetPicks, be sure to visit their trading tips blog at NetPicks.com.