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Fibonacci & Trend Trades

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How to Apply Fibonacci

Traders looking to apply Fibonacci want to first locate the trend that they are looking to trade. As is the case with many other permutations of technical analysis, the longer time frames will generally offer a greater degree of efficacy due to the larger sample sizes, and the fact that more traders may be making similar observations. So, the first step in applying Fibonacci is to identify the most recent major move with which a trader is looking to trade. The chart below will show how traders might look to do this with a recent EURUSD Daily chart:

Trading_Trends_with_Fibonacci_body_Picture_4.png, Trading Trends with Fibonacci

Created with Marketscope/Trading Station II

Now that the trend the trader wants to trade has been identified, the Fibonacci retracement can be added to the chart with the trader’s charting software.

The picture below will illustrate how Fibonacci could be drawn on the above chart. Notice the green-edged box from above; the below picture will show this portion of the chart in much greater detail:

Trading_Trends_with_Fibonacci_body_Picture_3.png, Trading Trends with Fibonacci

Created with Marketscope/Trading Station II

Fibonacci Retracement Levels

The prominent feature of Fibonacci is the series of retracement levels that are offered as potential support and/or resistance.

Once applied, intervals will be applied to the chart – and traders could look to these prices to function as resistance (for down-trends) or support (for up-trends).

The most popular Fibonacci interval speaks directly to the study of Fibonacci, and is linked to the ‘golden ratio,’ of .618. This interval is often interpreted as 61.8%; so from the trend that was just drawn – 61.8% up the trend-line will offer this price as a potential resistance level.

From the 61.8% retracement levels, traders have taken the reciprocal of the golden ratio (1-.618) to find the next common Fibonacci retracement level of 38.2%.

The next two common levels are 76.4% and the reciprocal of this number 23.6%.

Traders will also commonly plot the 50% level – although that is not a true Fibonacci number. The picture below will outline these levels:

Trading_Trends_with_Fibonacci_body_Picture_2.png, Trading Trends with Fibonacci

Each of these levels are relative to the prior trend. If a trader is looking to enter at the 38.2% retracement, they are looking to trade in the direction of the original trend – when 38.2% of that trend has been retraced. The 76.4% retracement – the deepest of the levels outlined above – would come into play when more than ¾ of the original trend has been given back.

Trading Fibonacci

Now that the trader has prices with which they can look to the re-ignition of the previous trend, the next step is to wait for price to hit these levels. When these levels get touched by price, that is when traders can look to enter trades in the direction of the original trend; once again – looking to buy up-trend cheaply or to sell down-trends expensive.

In the EURUSD example above in which Fibonacci has been applied, traders can look to sell if resistance forms at any of the pre-defined levels. The chart below will illustrate further:

Trading_Trends_with_Fibonacci_body_Picture_1.png, Trading Trends with Fibonacci

Created with Marketscope/Trading Station II

Not All Levels are Created Equal

One of the first things traders will notice when trading with Fibonacci is that not all levels will furnish support and/or resistance at the pre-defined prices and intervals.

Because of this, it is advisable for traders to wait until support and/or resistance forms at these levels before trading them.

Once support or resistance forms, traders can look to trade in the direction of the original trend – with a stop-loss order just above resistance (or below support in the case of up-trends).

— Written by James B. Stanley

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