Elite CurrenSea has offered multiple posts in the recent weeks on the topic of Fibonacci. Slowly but surely we expect to discuss progressively more difficulty angles of the Fibonacci concept. Today our mission continues with a focus on how to use the Fibonacci tool.
The Fibonacci tool is a very diverse tool because it can be applied in numerous situations such as:
The list is quite long, but it does not include defining the trend. There are other tools and indicators that do a better job for this purpose like moving averages and trend channels.
As you can see Fibonacci is one of the most powerful tools available for my own personal Forex trading. Fibs are very handy because they can provide a lot of information from support and resistance levels to potential entry levels, from potential target levels to stop loss levels. All that information is provided in one simple tool so no wonder that traders like Fibonacci.
One of the techniques for applying Fibonacci to the chart is by using it as a method to distinguish heavy and important support and resistance spots on the chart.
Fibonacci levels are engrained in very fabric and DNA of the market. Knowing where the key levels are on the chart is critical in understanding market structure and avoiding setups that are doomed to fail.
One of the great ways how to use Fibonacci is by ‘filtering’ out setups, which means skipping a trade because of less desirable factors on the charts. Ultimately this can help the ‘bottom line’ (profitability) of traders as they are ignoring setups that do not offer positive expectancy in the long-term.
In which case would a trader NOT take a setup?
In essence traders want to avoid trading close to a major Fibonacci level, simply because price could ‘respect’ it and turn on a dime into the opposite direction.
Traders want to be cautious with taking longs when a strong Fibonacci number is just above it – or be careful with short setups when a key level is below it.
If price is too close to the main Fibonacci levels then traders should decide to skip the setup, which means “filtering out” the potential trade.
The reason is simple: most Fibonacci levels will act as a stand away (although not necessarily all of them). I therefore always expect price to respect and stop at major Fibonacci levels.
I plan my trade assuming that price will respect each and every of my important Fib levels. I will not be become discouraged if occasionally I miss a profitable setup because of this filtering process.
When deciding to filter a setup, I focus on the critical balance of reward potential in comparison with the expected risk. A trader is not worth the risk when the turnaround spot is too close, especially when the reward to risk ratio (R:R) is less than 1:1.
Traders must choose which Fibonacci levels they consider to be of major importance because otherwise too many potential Fibs can be identified and eventually they might block all trades.
As a general rule Fibonacci levels on higher time frames such as the daily, weekly and monthly could be considered for critical levels.
My typical approach however looks at the time frame chart which is 1 higher than my trend chart.
This means that my strategy that uses the 4 hour chart for determining the trend will use the daily chart as the filter chart.
This ratio is valid for all times frames (1 higher than trend).When I use a strategy that employs the daily chart, then I will look for a relevant Fibonacci level on 1 time frame higher which is the weekly chart.
In most cases I only use 1, or max 2, Fibonacci levels to determine potential filters.
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