Where is the market going to? Using Technical Analysis, the only way we can answer that question is to know where it has come from. Many years ago there was that famous book called a Random Walk down Wall Street.

There were, and I am sure still are, those who have no time for TA and believe either

a) that price moves at random and there is no valid way of predicting the future or

b) that market players manipulate price to where they want it to go.  

The reality of trading is that as there are so many market participants who will have similar aims and so patterns will emerge negating the random walk theory. At any one time there will a mix of long term holders and short term speculators, those who need to sell and need to buy. Once this mix of traders is balanced then price settles to a range, once it imbalances, then trends develop until the supply demand balance returns.

There is perhaps greater truth in market manipulation. How often have you read a stock upgrade or downgrade only to find price moves in the opposite direction as the main players in the stock sell into buying strength on the upgrade news and the reverse of a downgrade, resulting in an up move once the initial selling subsides.

Trends make the Money !

Traders need trends but trends have a habit of rarely moving cleanly from one area of price action to the next. A process of backing and filling takes place caused by profit takers and opportunists looking for counter trend rallies or corrections. These moves also shake out weak traders from the main trend and then allow stronger players to add in to positions as the rallies or corrections revert back to the main trend. There are several ways of looking at trends and finding the optimum entry and exit points and Fibonacci provides some excellent clues to where price is now, where it has been and where might it go next.

Fibonacci is based on the number sequence 1-2-3-5-8-13 and so on to infiniti. Leonardo Fibonacci discovered the sequence way back in the twelfth century, he carried out research that linked the sequence to many naturally occurring phenomena. By dividing one number by the next the ratios of 0.681 and it’s reciprocal 1.618 are found. Many believe these ratios have mystical significance as they are found in calculations relating to the ancient pyramids and throughout nature in sea shells, petals, and the relationship between the lengths of bones in the body and so on.

So is 0.618 the answer to the universe and everything within or is it just a self fulfilling prophecy - when applied to the markets?

I subscribe to the latter as mysticism, astrology and the like don’t sit easily with me. If there are thousands of traders out there who are following Fib then I want to follow what they are doing. Maybe certain markets follow Fib purely because the majority of players are fixated on it just as a fashionable analysis technique of the time. It is and has been, very widely followed, particularly in the Forex market but there was a time when very few traders had even heard of Fibonacci. However, if it works for me, and it does, then I’m a Fib trader and I’ll use it. 

The ratios

 The standard Fib ratios are 0.618, 0.382 (usually expressed as percentages, 61.8% and 38.2%) and the Gann ratio of 50%, which is often stated incorrectly as a Fib ratio. I also use the so called 'Secret Ratios' that apply to the Forex markets in particular but I'm sure you will forgive for not revealing all just yet.

 

The basic theory works by considering to where price might pull back as the major trend undergoes a correction or rally. These counter trend moves occur for a variety of reasons from traders booking profits along the way of a big move to other players deciding the main trend has turned, to short term counter trend traders catching what can sometimes be explosive snap back moves from an overbought or oversold market. These ‘jobbing’ trades are used by funds where the major holding is with the longer term trend and counter trend trading provides protection and profits as the correction takes its course.

Fig one shows a simple Fib Grid with a counter trend move that turns at the 78.6% line. Stock traders tend to be of the opinion that for the main trend to continue, the turn should occur no later than the 61.8% retracement. They would consider the major trend has run out of steam if that was breached and a reversal highly likely that would ultimately be signalled when the previous high, above 100% was taken out.

In my experience playing in the Forex market, this is not so. Retracements are often very deep with turns occurring at the higher Fibs, and often reaching the 88.7% level before turning tail and resuming the main trend. Indeed there are some specific chart patterns that play out in the Forex market that confirm themselves by turning at 78.6% or 88.7%, but more on those in a later article.

Fig one

There are also some specific chart patterns that play out in the Forex market and others that confirm themselves by turning at some specific and important Fibonacci levels - these patterns are beyond the scope of this article and you can learn exactly how to trade these advance patterns in my full course.

So just how can Fib retracements be used to make money?

 There are several and these include: 

1. Entering a trade on a Fib pull back once a trend is established.

2. Using multiple, or a confluence of Fib retracements, to confirm future support and resistance areas for targets and future trades.

3. Project future swing extensions based on the last swing.

4. Combine retracements with extensions to give trade target areas and entries for limit orders.

5. Find future time based targets for significant highs and lows.

6. Trade specific chart patterns including the Gartley and BAT.

 Fibonacci pull back entries are the standard ones and just require a trend to be in place. At some point price will stop moving higher or lower and retrace so here are the rules: 

1. Wait for price action to stop and start moving back against the trend.

2. Set the Fib grid between the last swing high and the just formed, swing low.

3. Wait for price to turn back in the direction of the main trend as it bounces off the Fib retracement line.

 

 

Trade One

 The down trend is in place and, as soon as the first bounce starts, place the FibGrid^TM between the last high (A) and the current swing low (B). As price moves away from the Fib line at C, enter a sell short trade with a stop above the 38.2% Fib line. 

Trade Two

 As price moves lower than D there is another Fib retracement opportunity as D is 50% of the last swing (it's not marked up but confirm it by checking with a ruler and calculator – or with the FibGrid^TM)

 Trade Three

 The next trade entry occurs at F, again enter the short sell as price moves back in the direction of the main trend.

 As you can see, Fib entries occur a good many times here and this pair, the AUDUSD, works very well using the Fib retracement technique.

 The FibGrid^TM is an overlay that you can place on any chart or image that you have on your screen and is not dependent on your charts. This is the tool I use every day and the full series of Fibonacci Trading Videos, together with the Fib and Click grid in now available here: www.fibgrid.com

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Both the Gartley and BAT patterns are amongst the most powerful and accurate chart patterns and these occur time and again in all markets, for a limited time you will find out exactly how to trade these patterns with the Fib Grid.

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