Perhaps the best thing about trading the futures markets is the ability for participants to profit from trends. Strong moves in price offer beneficial risk versus reward ratios and provide an opportunity to realize extraordinary profits. One way in which active traders pursue profits via trend trading strategies is through automated Fibonacci trading.
In this article, we’ll take a closer look at Fibonacci technical analysis and how to use Fibonacci retracement to enter a trade.
Viewing the Fibonacci Retracement from a Market Perspective
Credited to Leonardo of Pisa in the late-12th century, the Fibonacci sequence is a mathematical formula with boundless applications. It is comprised of the following progression of numbers: 0, 1, 1, 2, 3, 5, 8, 13, 21, on to infinity. The pattern is simple, as each number in the sequence is the sum of the previous two integers.
More involved is the golden ratio (1.618033), which represents the proportionality of one Fibonacci number to another. Accordingly, Fibonacci sequence trading involves various technical tools, including Fibonacci retracements, extensions, and expansions.
So what are Fibonacci retracements? Simply put, they are a set of measurements derived from the golden ratio that may be used to place price action into a manageable context. This is accomplished by measuring the distance from a periodic high to a low and then applying the specific retracement ratios to the aggregate value. Typically, calculations are done automatically via a simple retracement calculator.
Here are the ratios included in a standard set of automated Fibonacci trading retracements:
- 23.6%
- 38.2%
- 61.8%
In addition to these values, traders often add the 50 percent and 78.6 percent retracements to their calculations. Though not technically a part of the golden ratio, the Fib levels 78.6 percent and 50 percent come standard within the functionality of the best Fibonacci trading software suites.
Fibonacci Live Trading: Understanding How to Apply Retracements to Trending Markets
Trend trading is a strategy that aims to secure profit from the momentum driving a directional move in price. To be a successful trend trader, you must be able to do two things:
- Identify trends in a timely fashion.
- Select ideal market entry and exit points.
Of course, these two tasks are much easier said than done. However, there’s good news: Using Fibonacci in trading and applying automated Fibonacci trading tools can make each function vastly easier.
For instance, a trend may be deemed active or concluded when the following characteristics are exhibited in conjunction with retracement levels:
- Active: A market is considered to be trending when a pullback from a directional move in price (from peak to trough or vice versa) fails to extend above or below the Fibonacci 38.2 percent retracement or 61.8 percent retracement levels. In a similar vein, the Fibonacci retracement 50 rule states that a security’s price gives back between 50 percent and 67 percent before resuming the broader uptrend.
- Concluded: In the event that price penetrates the 61.8 percent retracement level, the prevailing trend is deemed over. The market is then primed to enter either a rotational phase or an outright reversal. Once again, correctly evaluating price action with regard to each retracement level is the key to successful Fibonacci financial analysis.
Here are a few ways that Fibonacci price action is commonly viewed when trading golden ratio levels on trending markets:
- Market entry: Getting in on a trend can be a challenge. In many cases, traders arrive too late and end up buying the market’s periodic top or selling an intermediate-term bottom. However, by entering a trend after a pullback has occurred, you can improve your trade’s location. Common values that traders use for this market entry technique are the 38.2 percent and 61.8 percent retracements.
- Risk management: Because retracements are viewed as potential areas of support and resistance, they are useful in the placement of stop-loss orders. Closing an open position once a trend proves exhausted is a good way to avoid losses due to market reversal.
- Counter-trend strategies: In the event that a trend is deemed finished, an opposing position may be taken. This type of approach is especially valuable in reversal and rotational strategies.
The beauty of Fibonacci tools is that they may be easily applied in live market conditions. Most software trading platforms offer automated Fibonacci trading indicators that feature drag-and-drop functionality.
However, a word of warning: Capitalizing on the power of free Fibonacci trading software involves judgment. Accurate calculations rely on the proper time frame, wave count, and ideal peak-trough values being chosen. Ultimately, learning how to apply Fibonacci technical analysis properly requires time, experience, and additional education.
Getting Started with Automated Fibonacci Trading
Although Fibonacci retracements are powerful analytical devices, they are not the only technical tool out there. Like most other indicators or studies, retracements are best used within the framework of a comprehensive trading plan.
For information on Fibonacci tools and more, download our free e-book Basic Training for Futures Traders. You’ll find tips on futures trading essentials from industry professionals and active traders and learn techniques to become a disciplined trader.
This blog was originally published March 18th, 2019 and has been updated for accuracy and comprehensiveness.
