The Fib Retracement Tool is one of my favourite Forex Trading Tools. You might already have free access to it within your trading platform if youre using MT4, almost all forex trading platforms and charting applications I have come across have at least the Fibonacci Retracement and Extension Tool some platforms even offer more tools like the Fibonacci Arc, Fibonacci Spiral and so on.
Before we Jump right into the meat of how you can use this Fib Retracement Tool to improve your trading skills and thus adding it to your trading tool chest I must warn you though that through your journey to becoming a Pro Forex Trader youre likely to come across a lot of misinformation and hype on the information highway, you must be very selective when it comes to choosing tools you plan to trade with.
Dont go dumping your trading strategies or system for the Latest and Greatest forex trading robot, always remember that less is definitely more when it comes to forex trading tools.
Most Forex traders tend to use the fib retracement tool the wrong way, before using the fib tool to confirm your trading decisions you must understand exactly what its does and have some tool that would help you tell what market environment youre in (Mark Up, Mark Down, Inside the Range, Accumulation or Transition Market Cycle).
Knowing these helps you in more ways than one but just to list a few, you will be able to tell which of the trades you place are trend or counter trend trades with 100% certainty thus helping you make better and more calculated risk management adjustments such as placing realistic profit and stop target 100% determined by the market when you get a little creative and add the psychological levels analysis to the mix.
What the Fib Tool Does
Charts move in cycles am sure you must have heard that before. Just have a look at a simple equity chart and you will see that theres no growth without contraction. Even if its been established that the Euro is in an uptrend therell still be dips along the move up this could be profit taking driven or it might just be caused by the many different intraday News Events.
Traders run off trying to buy low and sell high which is actually good in a way, but how do you tell if the price of a currency is low enough and a good buy or vice versa. Yes, the MACD Divergence forex trading strategy might help you with that but how many times have you seen all the indicators on your chart point to one thing only for the market to do the opposite resulting in traumatic losses?
To better illustrate to you what the fib tool does lets use an example of a long trade in a bullish trading environment in other words a Mark Up market cycle. Say the EURUSD has just formed an inverted head and shoulders chart pattern along with a positive MACD Divergence followed by an upward breach of the most significant downward sloping supply trendline by a strong bullish change of direction candle after just forming a long wicked doji candle signaling a reversal aiming to break through the 1.3150 immediate psychological resistance level with current prices at 1.3132.
The confluence of events all pointing to the fact that the selling spree might just be over with the prominent reversal indicated in more significant detail by the long wicked doji candlestick otherwise known as the gravestone doji candle representing the aggressive profit taking by savvy traders and the flood of buy orders as represented on the chart by the bullish change of direction candle signaling the domination of buyers within current market conditions.
Ill place a buy stop order at 1.3147 with a stop loss at 1.3117 and a profit target at 1.3197 and wait for the market to come to me filling my order and proving my analysis was actually worth something, these price levels are not just randomly picked; psychological levels play a vital role in the movement of prices and so I employ them into my trading methodology.
Assuming that all went well and this trade reached my specified profit target Ill pick out my fib retracement tool to forecast future areas of possible support to place another buy stop order and wait for trader consensus to prove me right again when price fills my order again, jumping right into another Buy trade in the Mark Up market cycle just confirmed by the successful fulfillment of my previous winning long position.
I use the Fibonacci Retracement Tool to forecast future levels or support and resistance as the case may warrant in an uptrend or downtrend (i.e. a Mark Up or Mark Down Market Cycle). The reasoning behind this is that if you have a 100 pip swing move to the up side, unless the prevailing condition that lead traders to believe that the value of the base currency appreciating in value have changed, the momentum behind buy trades could only increase.
So when I draw a fib retracement for our example 100 pip move on the Euro chart from 1.3100 1.3200 as travelled by the pair, price levels representing the 23.6%, 38.2%, 50%, 71.8% and 100% of the move from 1.3100 1.3200 will be drawn automatically saving me the stress of having to calculate and draw this important high probability buy trade Re entry levels manually on my chart before waiting to see which of these levels will provide a strong base of support (i.e. where sellers will be completely unable to push prices lower or where previous buyers will be completing their profit taking by closing their previous buy orders that are now in profit through executing an opposite sell order).
Just think about it for a minute, when there are no more sellers in the market wholl rule?
The answer, either the market transitions into equilibrium in prices which usually doesnt last long, or the buyers dominate and cause a rise in demand and thus bidding prices higher. To Trade successfully your trades must agree with that of the current market movers which happens to be the buyers in our example.
If you took some time to read the preceding paragraphs well enough youll notice that I look at quite a couple of factors before I consider opening a trading position as opposed to just waiting for some lagging technical indicator to call the shots for me blowing my trading capital which is what the majority of the loosing forex traders do.
Before clicking on the buy or sell button in your forex trading platform you have to have already worked out your trade like a game of chess. You should know at what price youre going to enter the market and at what price youd be getting out, what percentage of your trading capital youre staking on each and every trade you intend to take on and at what price levels youre going to be taking some profits off the table enjoying a reduced loss trade, break even trade, or a trade fully reaching your profit target. This would help make trading stress free.
The chart patterns you learn about being a part of your foundation of forex trading basics are gems youll only grow to trust and respect as you practice and improve your trading skills. Many Newbie Traders tend to drop these thinking they are the kids stuff for the more complicated trading systems with the thoughts that itll make them more money.
A profitable trading system doesnt need to be complicated, in fact I have only come to find out that through the hard way through the years that the simpler the forex trading strategy the more effective it proves to be eventually.
Try out using the fib retracement tool on a demo account with your currency trading broker of choice until you get the hang of it before moving on to adding it to your forex trading arsenal and using it for live trading on a micro account.
Hope you found this article helpful, Id love to hear your comments and answer your questions, dont forget to share this with your friends, cheers