Fibonacci Retracements & Placing Targets & Stops.
Every trader should well be aware of the levels at which he should exit from the trade even before entering the transaction and that is known as the ‘Exit policy’. It is always a difficult decision to come out of the trade, either in red or in green. Closing the trade is more of an emotional decision than opening the trade which is more of a spot-on decision. Our traders buy in haste and repent in leisure.
As we all know, there are only two possibilities in a trade-either it is profit or loss. The trader should take the decision to fix the timing of exit in either case. If in profit, when do we book it and in case of loss how long should we wait-these are the questions to be addressed by the exit policy. Even when the trade is in green, it is difficult to decide the level at which the profits may be booked. Often the investor is tempted to get on with the trade with still more profit expectations. If the trade is in loss, the trader cannot carryon with his trade to a longer period as he is at a risk of losing the capital.
Here the Fibonacci retracement comes handy in identifying such targets & stops which can also be used as potential support & resistance areas. Most of the forex trading platforms offer the Fibonacci retracement and extension levels which are easy to draw - one need to just identify the swing high & low points and leave it to the software to mark the other areas.
When we look at any trend, up or down, we can identify 3 stages before the formation of trend is complete. The following figures best illustrate them:
We may notice here at every rise or fall, there is a pullback: high to higher low in the uptrend and the low to lower high in the down trend. This pullback is called retracements and Fibonacci series numbers helps in identifying the percentages of these levels when the market is trending. Fibonacci retracements are drawn from 100% to 0%. Check the following figures.
The above figure is of uptrend &
The below figure is of downward trend.
The retracement levels commonly employed in forex are 23.6, 38.2, 50.0, 61.8 & 76.4% out of which the percentage of 61.8 is considered crucial and is referred to as ‘Golden Fibonacci number’. We can observe from the above two figures that these are important support & resistance levels which help us in coming out of trades either for profit booking or placing the stoplosses. In the downward trend, if we sell at 61.8, the trade may be closed at 50.0. Similarly, if we buy at 61.8, in an upward trend, the same may be closed at 38.2 or 23.6. Never ever depend on one indicator or method and Fibonacci retracements may be combined with candlesticks to get more accurate results as the market has its own options for pullbacks. The Fibonacci retracements may be combined with the trendlines which complements it beautifully because of the simple reason that the Fibonacci retracements work only in trends.
We all know that Trendlines acts as support & resistance. Whenever the price touches the trendline, the maximum selling & buying happens at the third such hit. It requires much practice to draw these trendlines. Trendlines are drawn along the lows in the downward trend and along the highs in the upward trend. Connect the first two lows/highs and extend and mark the third point where it is likely to re-bounce. See the following figure.
Similarly the buying and selling support may
obtained by this 1-2-3 method. See the
Now coming to the crux of the matter-Placing the Take profit & Stoploss levels in case of the right and the wrong trade respectively. If you open a trade at 38.2% Fibonacci level, then you could place the stoploss beyond the 50% or if you feel that this level will not hold, then go past the 61.8% level. Similarly you may place the take profit levels.
The above method may sometimes fail due to the defect in the drawing tools or the market forces rushing in one direction. You may then rely on the recent swing high or swing low to place your stoploss & take profits levels. It gives your trade some chance to bounce back.
Fibonacci extensions may be used to identify the levels for profit booking. It is below zero and the commonly used extension levels are -38.2, -50, -61.8, -78.6 & -100.
Finally, Fibonacci retracements seem to go well with most of the pairs. It is not specific to any one time frame. Try this method in demo & practice drawing trendlines. But readers should keep in mind that the key to success lies with the effective money management without which even the trader equipped with the best system in the world may fail.