This is the third article in our Fibonacci Ratio series. If you haven’t already we suggest that you check out the first article about the Fibonacci Application. In the previous two articles, we covered the background of Fibonacci Ratios, or the “Fibs”, how they are calculated, and how to use and read them on a chart. Ralph Nelson Elliott and W. D. Gann used these ratios in their various analyses to predict future pricing behavior with uncanny accuracy.
Forex traders use the Fibonacci application to anticipate key support and resistance levels for both upward and downward trends in order to prepare various long and short position trades and to place various stops along the way. As with any technical indicator, a Fibonacci chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding Fibonacci indicator signals must be developed over time. In the example below, let’s develop a simple trading system based on Fibonacci signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “Green” circles on the above chart illustrate optimal entry and exit points that can be discerned from using Fibonacci analysis. The subsequent trend is also a classic Elliott impulse and corrective wave pattern that can assist one in choosing positions.
A simple trading system would then be:
- Determine your entry point after the first Fibonacci support level is crossed and then re-confirmed;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” below your entry point;
- Determine your exit point after the 61.8% Fibonacci line is crossed, and then re-enter at this level, waiting to exit once more after the 100% line is crossed (Do remember to set a stop-loss for the second trade).
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded two profitable trades of 35 “pips” apiece, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, Fibonacci Ratio Technical Analysis will provide you with an “edge”.
That concludes our series on the Fibonacci Indicator. For further reading please visit our Forex Indicators section.
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Please also have a look at the Bollinger Band indicator.