How To Trade The Forex Market Using Fibonnaci

 

Fibonacci is a huge subject in the world of trading. We have different Fibonacci ratios ranging from Fibonacci Retracement, Fibonacci Extension, Fibonacci Fan, Fibonacci Arcs, Fibonacci Time zones. But for the sake of simplicity, we would be dealing with just the retracement. 

A lot of traders use the Fibonacci retracement levels as potential support and resistance areas. Since so many traders watch these levels in order to place buy and sell orders, this makes the support and resistance levels tend to become a self-fulfilling prophecy.

Most charting software comes with the Fibonacci retracement level tool. In order to apply Fibonacci levels to your charts, you'll need to identify Swing High and Swing Low points.

 

Fibonacci Retracement

The first thing you should know about the Fibonacci tool is that it works best when the market is trending. 

The idea is to buy on a retracement at a Fibonacci support level when the market is trending up, and to sell on a retracement at a Fibonacci resistance level when the market is trending down. 

In order to find these retracement levels, you have to find the recent significant Swing Highs and Swings Lows.

In order to plot it in a downtrend, you would have to click on the Swing High and drag the cursor to the most recent Swing Low and for an uptrend, you would do the opposite. Click on the Swing Low and drag the cursor to the most recent Swing High. 

Let's take a look at some examples of how to apply Fibonacci retracements levels in the markets. 

Uptrend Scenario.

Here we plotted the Fibonacci retracement Levels by clicking on the Swing Low and dragging the cursor to the Swing High. The software now shows you the retracement levels which are 

As you can see from the chart, the retracement levels were 23.6%, 38.2%, 50.0%, 61.8% and 76.4%. 

Now, the expectation is this pair retraces from the recent high, it will find support at one of those Fibonacci levels because traders will be placing buy orders at these levels as the price pulls back. 

Let's take a look at what happened afterward in the image below.

Price eventually pulled back right through the 23.6% level and continued to move down until it tested the 38.2% level but was unable to close below it. The market resumed its upward move and broke through the swing high. Clearly, buying at the 38.2% Fibonacci level would have been a profitable trade!

Downtrend Scenario

Here we plotted the Fibonacci retracement levels by clicking on the Swing High and dragging the cursor to the Swing Low. The software now shows you the retracement levels.

The expectation for a downtrend is that if price retraces from this low, it will encounter resistance at one of the Fibonacci levels because traders will be ready with sell orders there.

Let's take a look at what happened next. 

Price started moving up after the low and broke the 23.6% level into the 38.2% level, then made a slight break there and did as if it wants to come up but eventually went down breaking the 38.2% into 50.0% and broke that level also.

Finally, it was held at the 61.8% level and started an upward move from there which saw the price moving back to the lowest point and breaking past the 0.0% going further down. Clearly a very profitable trade there.

In these two examples, we see that price have a way of pausing at each level making it temporary support or resistance before breaking through that level or retracing back from that level. Because of all the people who use the Fibonacci tool, those levels become self-fulfilling support and resistance levels. 

One thing you should take note of is that price won't always bounce from these levels. They should be looked at as areas of interest.

There is a clause you should always remember about using the Fibonacci tool. The clause is simple; fib level fails at times also just like every other support and resistance indicator. So let’s take a look at scenarios when it fails.

When Fibonacci Fails

Their golden rule of support and resistance with other forms of trading indicators is that they hold at times and they fail at times.  This is why traders need to think in terms of probabilities.

Now, let's go through an example when the Fibonacci retracement tool fails.

The image below is that of a pair that had seen a downward trend. The Fibonacci approach to this is to look for a possible retracement when this pair starts heading up so we can get in on a good level and follow it back down hoping that one of the fib levels will act as a resistance to the uptrend.

So we bring out our Fibonacci tool and draw in from the high of the swing to the low of it like you can see on the chart.   

You can see on the chart that price first made a slight stop on the 23.6% then broke up to the 50.0% level. It dropped down a little bit from there then pushed up above the 61.8% level and we see it go up to the 100.0% and broke it upwards without even considering that level.

Assuming we placed a sell order at 23.6% or 50.0% level because of the way price behaved at those levels, we would have ended up with losing trades. It wasn’t a wrong decision; the price just didn’t respect those levels in this scenario.

The reason for this is because; traders look at charts differently, look at different time frames, and have their own fundamental biases. So a level that might appear as resistance on a smaller timeframe might actually be a support on a larger or a different timeframe.

That's why you need to hone your skills and combine the Fibonacci indicator with other indicators in your Forex toolbox to help give you a higher probability of success.  You can’t rely on only one indicator.

Click here to go to the next lesson.

Click here to go to the previous lesson

Go back to the indicator list.

How To Trade The Forex Market Using Average Directional Index

 

The Average Directional Index, or ADX for short, is another example of an oscillator. It fluctuates from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend. 

Unlike the stochastic, ADX doesn't determine whether the trend is bullish or bearish. Rather, it merely measures the strength of the current trend. Because of that, ADX is typically used to identify whether the market is ranging or starting a new trend. 

Take a look at these neat charts we've pulled up:

In this first example, ADX lingered below 20 within the spaces colored blue. Price just couldn’t move aside of the ranging formation. The ADX readings below the 20 is doing a great job letting us know there is no trend in sight.

However, in the next color red section, you can see that the ADX below climbed above 50, signaling that a strong trend could be waiting in the wings.

And true to that, we can see a beautiful downtrend with so many profits to pick from.  Perfectly obeying the readings of the ADX signaling strength in price movement

Now, let's look at another example:

With a perfect similarity to the initial example we treated, ADX lingered around the 20 levels for quite a while. At that time, the price on the chart was also ranging. After a while, ADX rose above 50 and the price also broke out from the range and headed upwards. 

It’s obvious we can see an uptrend when the ADX went to the 50 level. That’s an amazing profit to lock into your trading wallet.

Now the little twist to ADX unlike other oscillators is the fact that it doesn’t exactly tell you whether it's a buy or a sell. What it does tell you is whether it'd be okay to jump in an ongoing trend or not. 

Once ADX starts dropping below 50 again, it could mean that the uptrend or downtrend is starting to weaken and that it might be a good time to lock in profits. 

                                                   

                                                       How to Trade Using ADX

One way to trade using ADX is to wait for breakouts first before deciding to go long or short. ADX can be used as confirmation whether the pair could possibly continue in its current trend or not. 

Another way is to combine ADX with another indicator, particularly one that identifies whether the pair is headed downwards or upwards. 

ADX can also be used to determine when one should close a trade early. 

For instance, when ADX starts to slide below 50, it indicates that the current trend is losing steam. From then on, the pair could possibly move sideways, so you might want to lock in those pips before that happens.

Click here to go to the next lesson. 

Click here to go to the previous lesson

Go back to the indicator list.

How To Trade The Forex Market Using Relative Strenght Index

 

Relative Strength Index (RSI) shares similarities with other oscillators because it is designed to identify overbought and oversold conditions in the market. It is also scaled from 0 to 100. Typically, readings below 30 indicate oversold, while readings over 70 indicate overbought. 

How to Trade Using RSI

The RSI can be used just like other oscillators. Its primary purpose is to pick the potential tops and bottoms price movement. This is determined by using its overbought and oversold readings

We take a look at the chart below to see RSI in action.

Going through the chart above, you can see price trading up in the red rectangle. While price was moving in that direction, RSI moved above the 70 line signaling an overbought which also means we are running out of buyers in that uptrend move. Eventually, you can see that price fell at the oversold reading of RSI.

The reverse scenario took place at the rectangle marked blue. RSI gave an oversold reading as it touched the 30 level. Shortly after, the market ran out of sellers and price made a move for the upside. This is an indicator that when RSI is on the extreme, we should be getting set for a possible reversal move.

 

Determining the Trend using RSI

RSI is a very popular tool because it can also be used to confirm trend formations. RSI is one of the most widely used trading indicators by professional traders just like stochastic and MACD.

One of its beauty is the fact that it can be used to determine if a trend is forming in the market. As traders, we want to always be on the side of the trend and join the move.

Aside the overbought and oversold levels of 70 and 30, a reading of 50 crossing to the upside or to the downside can be of great use to gauge the start of a trend. The 50 line is not highlighted on the indicator software by default; you have to manually put it there by yourself.

If you are looking at a possible uptrend, then make sure the RSI is above 50. If you are looking at a possible downtrend, then make sure the RSI is below 50.

You can see as the crossing of RSI on the 50 confirmed a trend. This also applies if we looking for a downtrend.

Click here to go to the next lesson.

Click here to go to the previous lesson

Go back to the indicator list.

How To Use Stochastic Indicator In Forex Trading

 

The Stochastic is another indicator that helps us determine where a trend might be ending. The stochastic has two lines that cross each other to give a sell or a buy signal.

By definition, a Stochastic is an oscillator that measures overbought and oversold conditions in the market. In a market trending up, prices close near the high, and in a market trending down, prices close near the low.  

 

How to Trade Using the Stochastic

The Stochastic is scaled from 0 to 100 and like earlier established, it tells us when it thinks the market is probably overbought or oversold.

When the Stochastic lines are above 80 (the overbought dotted line in the chart above), then it means the market is overbought. When the Stochastic lines are below 20 (the oversold dotted line), then it means that the market is oversold. 

As a rule of thumb, we buy when the market is oversold, and we sell when the market is overbought. 

Looking at the chart above, you can see that the Stochastic showed overbought when it crossed that dotted line above, based on this, if you sold the pair from there, your decision would be accepted as good because after then, the price started going down, in other words when the price is overbought, sooner or later a reversal move will take place.

The same is true when stochastic shows an oversold reading.  If you bought the pair after an oversold reading, chances are high you would catch the bull run that proceeds after the oversold reading. The chart above explains it. 

Click here to go to the next lesson.

Click here to go to the previous lesson

Go back to the indicator list. 

How To Trade The Forex Market Using Parabolic SAR

 

One indicator that can help us determine where a trend might be ending is the Parabolic SAR (Stop And Reversal). A Parabolic SAR places dots, or points, on a chart that indicate potential reversals in price movement.

Although it is important to be able to identify new trends, it is equally important to be able to identify where a trend ends. A well-timed exit is as important as a well timed entry. 

How to Trade Using Parabolic SAR

The nice thing about the Parabolic SAR is that it is really simple to use. Trading with this indicator is about the simplest approach you can have in your world of trading.

Basically, when the dots are below the candles, it is a buy signal; and when the dots are above the candles, it is a sell signal. 

The image above is quite simple and that’s basically what parabolic is all about. 

When the first dot appears below the price, it assumes that the price is going up and when the first dot appears above the price, it assumes that the price is going down. With this established, this tool is best used in markets that are trending, and that have long rallies and downturns. 

This indicator would not favor your trade decisions when it’s used in a choppy market where the price movement is sideways.

Using Parabolic SAR to exit trades

 You can also use Parabolic SAR to help you determine whether you should close your trade or not. 

Check out how the Parabolic SAR worked as an exit signal in the chart below.

When the green dot appeared at the spot(parabolic SAR) the arrow pointed at in the image above, the circled price level (candle) indicates when we are supposed to sell that pair, and when the other green dot(parabolic SAR) came up under the price, that was the spot to exit that sell position.

If we kept holding on to that sell position after that green dot (parabolic SAR) had appeared under price hoping the price will continue going down, all the profits we have accrued will be eroded because the trend reversed and moved against us from there. 

Click here to go to the next lesson.

Click here to go to the previous lesson

Go back to the indicator list.