The game plan
With this method we want to enter a trade earlier, somewhere between points B and C, after a confirmation signal:
The first few points are the same as in the previous method, but they differ later on.
1. Identify the main trend. You should know what the main trend is and which direction you will be looking in to enter a trade.
2. Identify the low-high/high-low swing. Find the swing which you will draw the retracement and extension lines from.
3. Wait for the correction to part C to end. When there is a bounce back from the retracement line, get ready.
4. Wait for a confirmation signal. When there is a signal, enter the trade.
5. Close the trade at one of the extension lines (later I will show you how).
So as not to confuse you, I will write more about confirmation signals in a separate part. Now, let’s focus on the logic of this method.
You know what the trend direction is, so you know in which direction you will be opening the trade. After a low-high swing, you wait for a correction to point C. You do not open a position right at the retracement line because it is too risky. You simply wait for the price to accept the retracement line as support (or resistance). When the price goes back to move in a trend direction, there should be a signal somewhere between point C (retracement line) and point B.
What kind of signal? It depends on the trader. It may be a signal from the price action, oscillator, trend line or moving average. There are some good candidates here. You will read more about it shortly.
Let’s take a look at the example. The signal was a break above the resistance line.
You enter a trade between points B and C, that is, earlier than in the previous, safer scenario. Because of that, your possible profit is larger, but so is the risk.
Where to place the stop loss in this scenario?
Again, the stop loss should not be placed too wide. Remember, this is a risky scenario, so the possibility that the move will not continue in the trend direction is bigger.
There are a few scenarios here when it comes to setting the stop losses.
C ends at 38.2%
The move is wide and the retracement levels are far away from each other. You decide to enter after the correction to the 38.2% line. My advice is to place the stop loss behind the next retracement line or the recent low. Remember, it was after you entered the trade with your signal.
On certain occasions, when I confirmed that the main trend on a higher time frame was very strong, I would place a wider stop loss (below 61.8% or 78%). The reason for that is that even if my signal was false, I still assumed that after a deeper correction, the price would go with the main trend. However, when the AB swing is very long, then the retracement lines may be far away from each other (a bigger potential loss).
This is a tricky trade. There is always a chance that the price will go lower, to the 50% or 61.8% retracement. When you place the trade, you are not 100% sure that point C was at the 38.2% line.
If you still decide to open the position between 38.2% and point B, open a smaller position and add later, after the breakout.
C ends deeper
When the correction is deeper, up to 50% or 61.8%, I place my stops behind the 78% line or recent low.
When C ends on the 78% retracement, I place my stop behind the 100% point (that is, below point A).
These are only propositions of where you can place your stop losses. You should test various scenarios and choose the one that works best for you. Always remember that the most important rule is to protect your capital.
The confirmation signals
When you decide which direction you want to open position in, you have to know when to do it. It is a good idea to define a set of entry and exit signals that you will follow. This way, you won’t be making trading decisions based mostly on your emotions.
It is not enough to define a correct trend, draw the retracement levels and enter the position blindly between points A and B. You should have some signal to enter and exit. First, let’s focus on the entry signals.
The close above/below the moving average
The signal I use often is closely above (or below in the downtrend) the 50 moving average (50 MA). This is an important MA and, on many occasions, when the price closes above that line, it is a sign that the sentiment is changing. As on the chart below, after the correction to 78%, I would wait and enter after the candle closes back above the 50 MA (red line).
The moving averages crossover
Some traders like to wait for the moving averages crossover. Of course, this is a lagging signal, but that is what we want to have. We want confirmation that the correction might be over and it is a good moment to enter the position.
What periods of the moving averages are the best? It is up to you. Some prefer faster MAs (you get a signal earlier, but there is a higher risk that it might be false), whilst others like slower averages.
In the example below there are two simple moving averages: 10 SMA (red) and 20 SMA (blue). The main trend is down, after the correction up to 78%, the price falls back. When the red MA crosses with blue MA, we get our signal to enter a short position.
Try to use the moving averages of other periods, 10 and 20 are the example here. Test other combinations, such as 5 and 15, 8 and 13, 8 and 21, 20 and 33, or if you want to use slower MAs, check 33 and 55.
Why not simply give you one set of MAs to follow? Because some traders trade on 4-hour Eur/Usd and some MAs work better than others there. Other traders prefer Eur/Usd, but on a 5-minute chart, and here other MAs may be a better choice. Can you see how many combinations there can be? You have to learn how to choose the best MAs for individual stock, index or currency.
The trend lines
Sometimes you do not need to use tools like the moving averages. If you have some experience in drawing the trend lines, it is also a good way to look for where to enter the position.
In the example below, the price is in a downtrend. When a correction occurs, we can draw the trend line.
The price moved to the 38.2% level and down below the green trend line. It turned out that this was a false signal. In the next move, after hitting the 50% level, there was a break below the support line. This signal was correct and it was a good place to enter the position.
The Williams %R as confirmation
You can use oscillators as a source of a confirmation signal. If you have your favorite oscillator, test it and check what signals work as best confirmation.
My favorite one is the Williams %R. Most of the time, I use it for 33 back periods. For time frames lower than 1 hour, I use 55 periods.
It is a slightly different oscillator because its range is between 0 (at the top) and -100 (at the bottom). When the line is between 0 and -20, then the price is overbought. When the line is between -100 and -80, the price is oversold; similarly to the stochastic oscillator, but the levels are different.
What I look for as regards the Williams %R are two things:
1. A break of important support/resistance on an oscillator – I use it especially when the price action is not clear to me.
Many people do not know that you can draw support, resistance and trend lines on the oscillators also! I find it to be very useful. When the price action is too blurry for me, I look for some tips on an oscillator chart by drawing the trend lines there.
2. A break in the overbought or oversold area.
In an uptrend, when there is a correction, I look at the oscillator and wait until its value is back at the -20 level and then I enter a long position.
In another example, there is a strong trend down. There is a correction, but the price action is not that clear. What I look for is the %R back at the -80 line. When it happens, I enter my short trade.
It is not a 100% correct signal and it is not the best tool to choose in all cases. In my trading, I find this to be quite good and effective. With good money management and using the Williams %R, your results should be better.
Below you can see a weekly chart of copper. After the correction to the 38.2% retracement line, the price closed back above the 50 moving average. This was the entry signal, and it turned out to be the right one.
I only use this method strong trends like the one above. When the trend is weaker, it is possible that this signal may be a false one.
Let’s go back to the example with the WTI oil from the part about the safe scenario. The black moving average is a 200 SMA. You can see that it had been working as support for a long period of time (the blue rectangle). After that, there was a correction to the 78% retracement line and then a move back below the 200 simple moving average. When the price closed below that line, it was a good place to enter the short position. Why? Something changed. Suddenly, the MA stopped working as support and the price moved below it. That was the sign for traders.
In another example,a daily chart of oil is presented. It is easy to draw the resistance line. After the close above it, there was a good place to enter.
The range trading
It is not always so easy and obvious to trade with the Fibonacci tools. Not every move is a clear A to B, correction to C and then strong move up to point D at the extension. Sometimes, the correction to C may last longer. Anattempt to break towards the extension may be a failure.
On the chart below you can see that the correction ended at the 38.2% retracement level, but the price failed to move up to the next high.
You can see that, from that moment, the price moved in the range between the last high and the 38.2% line. Eventually, it broke up but, for a long period of time, it was not going in any particular direction.
This is something you can see on numerous occasions. The price range will very often be between the recent high/low and the Fibonacci retracement levels.
The move will not always continue in the main direction. A range means that there is no winning side there at the moment. Bulls and bears are struggling, eventually, one side wins. In the example below, the main trend is up, then there is a correction, but the bulls fail to move to the next high. For a while, there is a range move, but, in the end, the bears took control and the Eur/Usd price started to fall.
In the foregoing chart, we could observe a narrow range. There are also wide ranges. A good example is a daily chart of Eur/Usd. Here you can see that the 78% and 61.8% lines act as strong resistance in the range move.
Notice that this rage lasted from May till September! All that time there was no clear direction and investors were confused. That is why it is good to know that, on numerous occasions, the range is between the Fibonacci levels. The best thing about it is that you can trade it.
In order to do this, you can seek some help with oscillators, such as stochastic, RSI or ADX. The idea is simple here – you buy at support and sell at resistance. It sounds simple, but it is quite hard at the beginning. It is far different from the trend trading, but still, you can make money in a range. As you can see above –these skills are sometimes useful.
In this guide, I focus on trading with Fibonacci in the trending markets. Trading in a range and using oscillators as entry/exit signals is a very wide topic.
My advice is to practice the range trading using a demo account. With your real account, go for trades you know how to trade and have succeeded within your previous setups.
When there is a range, do not trade your real money in it, trade using the demo account. With time, you will get better at this and you will have bigger experience. One day, when you feel strong enough, you will include this in your trading plan.
The advanced guide to fibonacci trading - parts:PART 1. INTRODUCTION
Basic information about Fibonacci numbers and why it is good to know how to use them.
PART 2. THE FIBONACCI RETRACEMENT LEVELS
How they are build and how to draw them to find possible leveles during correction.
PART 3. THE FIBONACCI PROJECTIONS
How to predict where is the best place to exit trade - Fibonacci Extension and Expansion will be helpful here.
PART 4. THE FIBONACCI CONVERGENCE
Learn what convergence is and how to spot it.
PART 5. WHEN TO ENTER A TRADE – A SAFE SCENARIO
Here we put knowledge into practice - you will learn a safe way of opening positions.
PART 6. WHEN TO ENTER – A RISKIER SCENARIO
Little bit riskier scenario of opening trades where possible profit is bigger.
PART 7. WHEN TO EXIT A TRADE
Closing trade is very important, but where is the best place? This should help you to find the best place to exit.
PART 8. MY TEMPLATE
Few examples of different templates you can use in Metatrader software.
PART 9. A FEW IMPORTANT THINGS YOU SHOULD KNOW
How to define trend, the importance of the higher time frame and how to trade the news with Fibonacci tools.
PART 10. FIBONACCI AND PIVOT POINTS
How to combine Fibonacci tools and pivot points.
PART 11. MONEY MANAGEMENT
Proper money management is very important - without it you will be loosing money fast.
PART 12. MORE EXAMPLES OF TRADES
More exapmles where we put together knowledge from guide.
13. THE “HOW-TO” ARTICLES
Few helpful articles about installing templates and using Fibonacci tools.