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Timing Trades with Fibonacci Retracements

This article is part of a series of articles we've written on different aspects of technical analysis: GBP/USD trading system, how to use williams %R, and others

Swing traders would find the Fibonacci retracement patterns very useful when identifying trend reversal on the activity chart. The first thing that you should be aware of is the fact that Fibonacci tools are best suited for trending markets. The idea is simple; it expects traders in an upward trending market to go long on retracement at a Fibonacci support level and in a downward trend when price retraces at a Fibonacci resistance level to go short.

In order to pinpoint the various levels of retracement, it is imperative that one tries to identify recent Swing Highs and Swing Lows. If in an uptrend, click the Swing Low and drag the cursor to the most recent Swing High. The opposite of the aforementioned is applicable in a downtrend (click on the Swing High and move the cursor to the most recent Swing Low).

Fibonacci numbers are a series of numbers designed by Leonardo Fibonacci that describes an additional series in which adding the previous two numbers would result into next number in the sequence. An example is shown below:
1, 2, 3, 5, 8, 13, 21, 34

You can clearly see how adding 1 and 2 yields 3, the number 2 and 3 yields 5, and you can continue in that vein. We would be simply looking at how this sequence aids swing traders. Generally, investors look at price movement towards the 23.6%, 38.2%, 50%, 61.8% and 78.6% levels during trading. Investors who watch these levels for support and resistance can then proceed to adopt the strategy of their choice.


Downtrend
We need to look at how Fibonacci retracement reacts in a downtrend. Find below a 4-hour EUR/USD chart.
fig1

Fig. 1.0

As you can see, we got our Swing High at 1.45466 on August 28 and Swing Low at 1.34978 on September 12. The retracement levels are 1.37462 (23.6%), 1.38980 (38.2%), 1.40231 (50.0%), and 1.41464(61.8%).


What investors expect is that for a downtrend, price should be able to retrace from a low, it would face resistance at some of the Fibonacci levels (since traders would be ready to sell orders there). Let's take a look at how the market acted going forward.

fig1.1
Fig. 1.1


Wow! Isnít that such a splendid thing to behold?


The market did try to rally, stalled below the 23.6% level for a bit before testing the 38.2% level. If you had some orders either at the 23.6% and 38.2% levels, you would've made some really excessive profits on the position.
It is imperative for us to take note that the Fibonacci retracements can be employed on different charts as well as time frames. Once we pinpoint the retracement levels, these technical levels borrow themselves to actually trade a swing back in the direction of the major trend. Investors can decide on placing entries around the Fiboinacci retracements, but quite a lot of times Fibonacci retracement can be employed in consonant with other technical indicators.



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