Updated: Oct 17, 2021
This article is written for investors and traders who are already proficient in technical analysis (TA) or early stages. You probably have heard that Fibonacci numbers and ratios are undoubtedly essential concepts in TA camp.
We believe in their efficiency considering Fibonacci numbers have proven quite successful in pinpointing market reversals and better entry points for our trades. There are two approaches in using the Fibonacci retracement tool depending on your trading style:
Swing/Positional trading: Fib. retracement 23.6%, 38.2% for trend following in larger timeframe;
Intraday/Scalping: Fib. retracement 50%-61.8%-78.6%. - we will talk only about this part.
To correctly draw a Fib. retracement, you need two swings:
A high and a low point to study the down move and its bounces;
A low and a high point to study the up move and its pullback.
One can start drawing Fibonacci levels only when the up-trend or the down-trend is at its early stages and avoid applying it somewhere in the middle where the market's psychology is not the same as the initial phase.
The most critical Fib. ratio is the Golden ratio of 61.8%. Hence, for intraday trading, we use the concept of The Golden Zone to identify the Fib. cluster of 50% & 61.&%.
Main Rules for Intraday Trading
If we study "a high and a low" move, anything above 61.8% means that the prior trend has resumed, and it is advised not to have open trades against that trend. Conversely, if price manages to hold below the 61.8% or the Golden Zone, we can attempt to short this bounce.
On the other hand, if we analyze "a low and a high" move in the market, then the Golden Zone will act as support. Therefore, anything below the 61.8% Fibonacci retracement means sellers are back in control. Conversely, if the Golden Zone holds as support, we can attempt to open a buy position.
For instance, take a look at the following chart on #GBPJPY 60-minute timeframe:
In this specific timeframe, and in retrospect, we could have applied a Fib. retracement as follows:
At point 1, we identified a Fibonacci Golden Zone acting as support where the cluster held, hence providing us with a favorable buy position;
At point 2, the same pattern repeated as in the prior example;
At point 3, we had a strong reversal where the market challenged the Golden Zone and went quite deep, down to the 78.6% level. Buy at that stage was challenging. At this point, we studied the up-move from mid-May to June's high.
At point 4, we studied the down-move from June's high to the 78.6% low to understand whether the Golden Zone would act as resistance or not. At the first test, the market pulled back slightly; however, it then started the uptrend.
A few examples
Gold 240 minute chart
Leg B retraced slightly more than 61.8% of leg A. Same goes for leg C and D. The overall pattern resembles that of a triangle formation. The Fibonacci Golden ration helped us identify take profit and possible reversal zones in Gold spot while allowing us to remain realistic in our expectations.
USDCAD 15 minute chart
Using the Golden ratio to understand whether the downtrend would keep going or be reversed.
NZDUSD 4H chart
Since April, this pair has been a solid uptrend, and all pullbacks to previous support levels have held. We have currently reached a critical point from the Daily timeframe, and if the price fails to close above the Golden Zone and 61.8%, we believe the market will correct lower.
We cannot stress enough how critical it is for a trader and investor to analyze a market on the larger timeframe before scaling down to shorter scales. Make it a habit always to follow the TOP-DOWN Approach to keep things in perspective and then and only then analyze and take trading decisions from the shorter-timeframes (1 minute up to 1H).
We strongly suggest the TDA framework we have built for those struggling with Multiple-Timeframe analysis, trend identification, or reversals. There is no proper advancement to other TA concepts if you are not fully proficient in breaking down the market into key support and resistance area. You can get your TDA framework as part of the Individual Session HERE.
You might want to read up on the following concepts as well:
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Until the next time, Don't forget:
To always prepare & analyze before executing a position;
To know your risk before you execute the trade;
To know the style of your trading: intraday vs. swing;
To journal your trades - create your Book of Charts;
To be a Mindful Trader!