Sunday, March 24, 2013

Fibonacci trading


Fibonacci Extensions
Picking a high potential entry point is half the battle.  How do we know what kind of move
price is expected to make? Projecting price movement beyond the swing points is the answer
everyone seeks. In our first example we entered a long position on the 23.6% retracement
from the swing high.  How far can we expect the position to run?  In Example 3,
we identified 3 potential entry points.  Now it is time to figure out possible exit points.
Fibonacci Extensions take into account three price points. A swing high and swing low,
plus the swing point where price reversed from a retracement. Like Fibonacci Retracements,
I use exactly the same set of Fibonacci levels when using Fibonacci Extensions.
Fibonacci extensions
Figure 8
I find Fibonacci Extensions the most useful as a money management tool. The last thing we want
to do is turn a winner into a loser. As price moved above the 23.6% level, I would start to bring
my stop loss up in trail. Accordingly, I would continue to raise my stop as price increased.
The level of risk is entirely up to your trading plan, but tools like Fibonacci Extensions help
identify key levels from which stops can be placed.
You can see in the next chart, Figure 9, that after price penetrated the 100% Fibonacci
Extension level, we entered into a period of consolidation.  While during the consolidation there were obvious entry points, however, remaining in the initial trade would have proven to be frustrating.
Fibonacci extensions
Figure 9
Fibonacci extensions
Figure 7
Fibonacci extensions
Figure 10
In Figure 7 we found the GBPUSD creating a bottom and breaking out to the upside.
We also identified 3 potential entry points.  Let’s look at each of the entry points and use Fibonacci Extensions to project profit targets.  In the first trade we entered the market thinking that a swing
low was in place off the 38.2% Fibonacci Retracement level.  You can see in Figure 10,
while price did bounce to the 23.6% Fibonacci Extension level. It was enough to make a profit,
but it was not a major winner.
This is a trade that once you did not see a continuation through the 23.8% level, you could have
take that as a cue to exit the position.  Or at the very least move you stop up to maintain some
level of profit.
Moving on to the second entry point, we sold short at the 50% Fibonacci Retracement level.
Fibonacci extensions
Figure 11

This was obviously a solid entry point. On the way down you can clearly see opportunity
to tighten up your stop loss values.  There are many ways to manage a trade like this
without being overly tight with your stops. In fact some would have taken profit
at the 23.6% Fibonacci Extension level. I believe that taking profit at any of the levels
would have been a prudent strategy.
Now let’s look at the final entry point from our Figure 7 example. This trade was by far
the most troubling. Even the correct entry could have been painful. However, if you did
stick it out, there were multiple exit points based on the Fibonacci Extensions. (Figure 12)
Fibonacci extensions
Figure 12

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