Trend retracement strategies using Fibonacci

Trends can be seen on all currency pairs and all have the common feature that they experience corrections and, eventually, come to an end. Across all timeframes trends form an integral part of forex trading with many traders preferring to use the trend ‘as their friend’ when making individual trading decisions. The ideal strategy for any trend trader is to be able to buy on the pullbacks during an upward trend and the short, sharp rallies during a downward trend. These are known as short-term corrections and the larger moves in the opposing direction can be seen as trend retracements. However, the difficulty if often knowing when to enter and if a trend is simply correcting, or forming a more substantial retracement.

What appears to be going up, will almost always come down

Fortunately, traders can effectively use forex tools such as Fibonacci ratios in order to anticipate where a trend is likely to retrace after a sustained move up or down on any timeframe. There is an old adage that once you are able to spot a trend in the forex markets, it is highly likely to be coming to an end. We all know, however that market prices do not move up and down in straight lines but will tend to move higher and lower to forge a visual pattern of the general market sentiment over any given period of time. When trend comes to an end it will almost always move in the opposing direction before attempting to continue to a newer high or low, as correction traders consider this as a good opportunity to enter if the trend is going to continue. Similarly, depending on how far the price retraces following a recent high or low many traders place orders at the powerful retracement levels in order to make short term gains even if the trend does not continue.

Applying the most popular Fibonacci ratios

The most powerful retracement levels of any trend can be considered the 38.2%, 50% and 61.8% levels. These are simply the degree of retracement from the recent swing high and low of a trend. Although the 50% level is not strictly a Fibonacci level, it has become highly influential for traders using forex charts and attracts a lot of trading orders which in turn creates a good deal of price action. Many traders will place orders in the direction of the previous trend at the 38.3% level, and the popularity of this level allow both scalpers and short term day traders plenty of opportunities to make a handful of pips as price tries again to bounce of this level and resume the trend.

How to execute a Fibonacci retracement strategy

Applying the Fibonacci levels to a forex chart is easy but planning the trade is somewhat harder. For the more adventurous, the higher risk trade would be to place an order at the level and enter as soon as price touches this. With orders placed at subsequent levels, traders can ensure that they can run the profitable bounces and close any losing positions as quickly as possible. For those who trade more conservatively and want a higher-probability entry, waiting for an additional entry signal at any of these levels will often result in a successful short-term trade. A bullish candlestick or reversal pattern will often indicate that the retracement is acting as solid support or resistance for at least several bars of profitable trading and exits can be taken at the Fibonacci level immediately above this.