4.18 Finer Points about Fibonacci retracements

 
Let’s have a quick look on some of what’s. How’s, when’s and where’s about Fibonacci retracement levels.
 
Correct ways of using Fibonacci retracement.
 

No Trend – No Fibonacci

 
Yes, you heard that right! Go for checking up Fibonacci retracement levels only when you have a healthy trend in place. Do not, repeat DO NOT take trade positions, according to Fibonacci retracement levels, when the market is running sideways of the strength of the trend is very weak. 
 
The whole idea about retracement levels is to expect a consolidation before the trend resumes again. In absence of that the Fibonacci levels lose their meaning and in that case you cannot expect them to bring results.
 
The following chart explains it better:
 
Fibonacci retracement levels in absence of a trend.
 

Which Retracement Level?

 
Prices may retrace slightly to 23.6% or 38.2% levels or the retracement can run deeper to 50% or 61.8% level. A consolidation may even stretch to 76.4% level. And why only that, it may go as long as 100% level. How do you decide where to enter and where to exit?
 
Well, the answer lies in the following:
 
  1. Strength of the trend, and 
  2.  

  3. How long the trend is going on
 
If trend is very strong then the consolidation may be as short-lived as only 23.6% or 38.2%. On the other side if the trend is weak, the retracement can extend deeper to 50%, 61.8% or even 76.4% levels. However, the trend duration is also an important criterion. Even if the trend is very strong but if the trend has been going on for a very long time, the retracements can be quite deep before the trend resumes again. When you have been running hard for a long time continuously, you need a longer break, right? 
 
Similarly even if the trend is weak but if it has just started, the retracement may end up being a short one.
 
Let’s not miss an important point here. If the retracements are too deep, there is always a possibility that the price-action may go for a trend reversal. Be careful about that.
 
Let’s take a look on the following charts:
 
 
Deeper retracements during weaker trends.
 
 
Limited retracements during strong trends.
 

Which Time-Frame - Don't Forget about Trend within a Trend

 
You may say that’s funny if we say that there are always multiple trends in the market. Well, it’s not funny at all – it all depends on the time frame of the chart you are looking at.  A currency pair may be in a multi-year long uptrend and a monthly chart will show that but during the past one year the market may be going for a consolidation and a weekly chart would show a downtrend - but then the prices may be moving up during past two months and a daily chart would show an uptrend.
 
Confusing?
 
Now exactly! You can use Fibonacci retracement levels to trade on the chart of any time frame. The only point to consider is that whatever time-frame you use; take starting point of the current trend as the beginning point to draw the Fibonacci levels.
 
Take a look on the following three charts of USD/CHF, during the year 2002 to 2014, which explain the concept of trends within a trend.
 
 
Uptrend during an overall downtrend.
 
Retracement during a long-term downtrend.
Shorter-term chart showing opposite trend during an overall downtrend.
 
 

How to identify the end point?

 
How would you know that price is going for a deeper retracement during the ongoing trend or it is just a market noise? Well, you may use the following aids for this:
 
  1. Swing highs and Swing lows ( we had explained this in the previous lesson).
  2.  

  3. Moving averages or MACD crossovers. Please use short-time frames for these indicators as longer time frames are used for finding out about the trend reversals and not for small consolidations.
  4.  

  5. Supports and resistances.
  6.  

  7. Trend lines, channels and other chart patterns.
  8.  

Where to take Profit?

 
Previous supports may tend to turn into resistances and previous resistances have the tendency to turn into supports. This tendency helps you using the various retracement levels, themselves, as profit targets. For example, if during an uptrend the price retraces to 61.8% level, before turning back towards the trend direction, then it may find resistances at 50% level, 38.2% level, 23.6% level and then at the 0 level. All these levels provide you with profit taking targets.
 
One finer point to know here is that it's always better to put you take-profit order a few pips ahead of the targeted level. If you are targeting a move back towards 61.8% retracement from the 38.2% retracement for your long position, then put the take-profit order a few pips below the 61.8% level.
 
Once the retracement completes and the trend resumes, you may use Fibonacci extension levels as profit targets. Don’t worry, we are going there now.
 

Fibonacci Levels as Stop-Loss

 
Fibonacci levels also help us in helping us in deciding the stop-loss order levels. Once we find a retracement level acting as support and we enter a trend, you may use the previous level as the stop-loss. Similar to profit targets, place your stop-loss order a few pips away from the identified level.
 
For example you find a retracement getting resistance at 50% level during a downtrend and you enter a short-selling position, put your stop-loss order a few pips above the 61.8% level in such case.

 

 

 

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