Fibonacci Retracement Based Trading Strategy
This strategy is a mechanical trading technique that is based on support and resistance. The tools that are used to identify entries, support and resistance, exits and take profit points are the following:- Fibonacci.
- Trend lines.
- Fractals.
In this case it can be useful to have knowledge about Japanese candlestick patterns.
Fibonacci ABCD Patterns
Retracements are momentary changes in the direction of the trend (up or down) in which the trend builds momentum to continue the movement. Retracements are always part of a larger amplitude wave or move.Tools such as those based on Fibonacci allow you to determine the extension of the wave and measure the percentage (Fibonacci number) of this wave where a retracement is most likely to occur. This in turn allows us to set potential destinations for those secondary moves.
In this way, if we add some Fibonacci levels on a chart between two points A and B (A is 100% and B is 0%) that define a trend, we will obtain something similar to the following image:
https://preview.redd.it/kl63pjaph9n91.png?width=834&format=png&auto=webp&s=a4dbc37d3c41179fa380f249dbd50e85ec0f4d6e
Regarding the Fibonacci levels, the most important are the following:
- Major Retracement Levels: 38.2, 50, 61.8, 78.6 and 88.6. In this case 61.8 is a key level as it corresponds to the Golden Mean in the Fibonacci sequence, and the market tends to bounce off it quite often on most retracements.
- Main Extension Levels : These are the levels that are below 0. They are the levels at which the market tends to move when it bounces and continues with the prevailing trend. The most important ones are -38.2, -50, -61.8, -78.6, -88.6, -100, -127.2, -161.8, -200, -224, and -314.
Rules for trading the Fibonacci ABCD pattern
The rules themselves are very simple and are detailed below:- In a downtrend, we sell at C and buy at A.
- In an uptrend, we buy at C and sell at D.
https://preview.redd.it/b9i1u19uh9n91.png?width=868&format=png&auto=webp&s=9ecc4ed4b4b16e09ea1bd9d9f77e40f6a280cd05
As we can see from the example above, the entries and exits in many cases will not be ideal or very accurate due to the fact that the market has many retracement options, and each retracement level has multiple target options. For this reason it is important to combine what has been explained so far about Fibonacci levels with other tools that allow validating entry and exit points and obtaining better results.
Trading system based on the 50% Fibonacci level
Whenever there is a major move higher or lower, the 50% level, also called the pivot level, acts as support when price closes above it or resistance when it closes below it. The only levels that we will use in this case are 0%, 50% and 100%.-If the market is trending up and provides sell signals through candlestick patterns at the points mentioned above, we apply Fibonacci levels from the highest to the lowest point of the trend and mark the 50% level as support.
If bullish candlestick patterns appear above this level, the trend is likely to continue. Conversely, if there is a break below the 50 level, it becomes resistance and an opportunity to open a short position presents itself.
-If the market is trending down and provides buy signals through candlestick patterns at the points mentioned above, we apply Fibonacci levels from the lowest to the highest point of the trend and mark the 50% level as resistance. If bearish candlestick patterns appear below this level, the trend is likely to continue.
Conversely, if there is a break above the 50 level, it becomes support and an opportunity to open a long position presents itself.
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