Way no. 1
The tool we will be using to define the exit point is the Fibonacci extension. If you do not remember what it is, go back to Part 3 and read it once again.
There are some rules which traders follow, basing on how deep the correction was. Have a look at the table below and then move on to examples.
Correction to: Look for the exit at the extension of:
The best way to explain this method is upon examples.
Let’s assume that we have found an uptrend. We wait for a correction to enter a long position. Correction is shallow, only the 38.2% retracement line. We go long and now there is a question –when to close this trade? Many traders follow the rule that the move up from the 38.2% retracement may end at the 138.2% extension line (exactly as in the table presented).
It is not something written in the stone. They are simply aware of the statistics and probability. They know that there is a big chance that the move will end or stop for a while there.
Check the daily chart of Eur/Usd. The small correction ended at 38.2% and after that, the price continued to move up. Eventually, there was resistance just at the 138.2% extension line.
When the correction is deeper, there is a greater chance that the continuation of the main move will be stronger. As you can see in the table, a correction to a 50%, 61.8% or 78% retracement may lead to a stronger move up to the 161.8% extension level.
In next example, there is an hourly chart of SPX index presented. From a higher time frame, we know that the main trend is down. There is a correction ending at the 61.8% extension. Pay attention that this is just below the 200 SMA – this is information for traders that the move may end there. After the correction, the SPX moves down and ends exactly at the 161.8% extension. So as it can be seen in the table – there is a move from 61.8% to 161.8%.
On the daily EUR/USD chart, there was a correction down to the 50% retracement. Then, buyers came back, the 200 SMA (strong resistance before) was broken and euro started to move up strong. The move lasted up to the 161.8% extension.
Does it always work like this? Should you simply buy at 50% and sell at 161.8%? Is it that simple? No, it is not. It does not always work like this. In the example below, after a shallow correction to the 38.2% line, there is a strong move up to 161.8%.
Has there been anything wrong with the table from the very beginning of the chapter? No, the table is just fine. You have to understand that it is about probability. As I mentioned before, there is a chance that the move from the 38.2% line would extend to at least 138.2%. It sometimes ends before that level, and sometimes the price moves further on.
How to use the table?
You have seen some examples of situations when the connections between the correction and extension movements are very accurate. There are cases when they are not so useful. So, when to use the table? Whenever you are in doubt when to close your trade, it is wise to follow this rule. Remember, we are not here to catch bottoms and tops. We just want to make money. When you see that the price action is fast and you are confused about it, follow the table.
You can connect this to the money management system. Divide your position into 2 or 3 parts. Close the bigger part at the extension level based on the table. Let the rest of the position catch the rest of the move or scratch it when the price return.
Let me assure you that, having a plan of when to exit, you place yourself in the top 20% of traders. The remaining 80% have no idea when to exit. They just go with the flow, hoping for the best. In the meantime, you make money.
Is it perfect? No, but it is a plan and you can include it in your trading plan.
Setting an exit place
When you are placing an exit order, it is a good idea to place it just before the level you plan to exit at. You should practice it yourself, but my advice is to place exit orders a few points earlier than the exit level.
There are two reasons for that.
Sometimes, the price will not touch the extension line, like in the previous examples. It may miss it just by a few points and it will still be a valid move to the Fibonacci extension line.
Another reason is that when the price reaches a certain extension line, you are not the only one trying to exit. The price might just touch the line and move back fast and your close order may not be completed.
By setting an exit point just in front of the extension line you increase your chances to close your trade with profit.
Surely, on certain occasions, the price will move beyond the extension line. That is the life of a trader. The most important thing is to have a plan which can give you good exit points, and not tops and bottoms.
I have one observation regarding this way of closing positions.
The lower time frame you trade, the more you should follow rules from the table. On lower time frames, moves are very fast. People and “robots” trade here very actively and you should adjust to it. Do not try to catch the whole movement from the beginning to the end. There are many opportunities here. Are you in a profitable trade? It is great. Now, if you are not sure where to exit, follow the table.
Way no. 2
Exiting a trade is very important, yet it is not so easy. We want to exit at the very best moment, but it is hard to tell when this moment comes. What is worse, the price very often climbs slowly to a certain level, and then suddenly it can fall hard.
Trying to exit at the top does not make sense because there is always a chance that there will be another top and this one is only a stop. Be not concerned about catching tops.
In order to define a good exit point, we have to connect the Fibonacci extension levels, technical analysis, and money management. With this, it is easier to decide when to close the position. I am not going to cheat you – on numerous occasions, you will close your trade too early or too late. It is normal and you have to work on your exit strategy to make it better.
Any exit plan is better than simply letting the trade run and hoping for the best.
Thanks to the Fibonacci extension we get the potential levels where the price will stop, or where even the whole trend can stop and reverse. As you have seen in the previous chapter, it can be very accurate. The problem is that we do not know which of those levels is going to work.
That is why we use money management. You can read more in the chapter about money management, and now I will show you a good way of using the MM in closing trades.
When it looks like that you have been correct and your trade is profitable, you move your stop loss to the entry point. This way, even when the price moves back, you will protect your capital.
The 3 parts rule
Next, you have to divide your position into three parts. You close the first part right at the 127% extension. If the price still goes according to the trend, you close the second part at the 161.8% extension (or at 138.2% if you think that the trend is not so strong). You let the third part to rise and you can close it manually at a different extension level or a technical trigger.
This way, you protect your profit, but you let it grow.
In the example below, the correction ends at the 61.8% retracement level. The entry signal is the close of the candle above the 50 moving average. When the trade is profitable, the 1st part is closed at the 127% extension. It continues to rise, so the 2nd part is closed at the 161.8% extension. The 3rd part is still open. You can close it manually at any moment.
This trend is strong, but if you are in doubt, you should close the 2nd part at the 138% extension.
Sometimes, only the first target will be hit and the price won’t reach the next Fibonacci level.
In the example below, a downtrend can be identified. The correction is deep, up to the 78% retracement level, the entry point is after the close below the 50 MA.
It is going nicely down to the 127% extension, where the 1st part of the position gets closed. Suddenly, buyers show up and start to buy. The price reverses and starts to rise. There are still 2 parts of the position open, but the stop loss is raised to the entry point. It is important to remember to raise your stop loss to the entry point while managing your trade.
The rise continues and eventually we get stopped out, but still, we close the trade with a profit. All thanks to the 1st part closed at the 127% extension and the raised stop loss.
This is how it works. At times, you get lucky, the trend is strong and you close all three parts at higher levels. On another occasion, you will be stopped out with a loss, or only a small profit from the first extension level.
If this rule is a too complicated for you, start from dividing your position into two parts. When you manage your trades carefully, you should be making good money on it.
This is the main way I manage my trades, but you may want to choose some technical tool to confirm the exit signal (for example for parts 2 and 3). In such a case I would recommend something simple. Just lower your time frame. If you trade with a 4-hour chart, lower it to a 1-hour chart and watch the reaction of the price and the extension levels closely. You can draw some short moving average (5 or 10 periods) as help.
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.