Forex Blog

 

Fibonacci is used many ways, but how many of you ever use it to determine the balance point between long and short? Fibonacci can be used to help identify reversal points in the market as they are unfolding and help give us one more tools in our inventory; to give you that ever so hard to keep edge in trading. Reversal signals are key in keeping pace with market sentiment. There are ways that we can use the Fibonacci tool as an aid in seeing these reversal points and to be able to look past its levels as merely support and resistance points. Used properly the Fibonacci tool can give you that looking glass that measures overall market sentiment. A simple observation is all that’s needed with the application of the Fibonacci tool to measure the balance between a long and short market sentiment. One day to the next can give us the direction that the market is most likely to take the following day along with a few basic rules of using the Fibonacci tool.

Rule 1 - When the market is trending we look for price to reach the 138 extension the next day in the direction it’s trending the current day. A failure to reach the 138 extension is a sign there is a loss of momentum and the potential exist for the market to reverse.

 

Rule 2 - When the market retraces more than 61.8% level of the previous day, it’s a signal the market has the potential to reverse direction. Sentiment is changing.

 

If we apply these basic rules now we use the Fibonacci tool now to determine the direction of the following day. Trending up we look to buy dips. Trending down we look to sell rally’s. We’ll measure each day from the high and low made during each day as a strict rule…no Intraday fib strategy here for this. We’ll start with the market trending Figure1.

 

 

Starting here on this Friday we find the market reaches the 138 extension on the following Monday (which from now well refer to as T1)…..short for Target 1. A touch on T1 is a sign of trending in the market and we look for this to continue into the next day. We move up the tool now the Monday and measure it from high to low to find the next trending short target. In Figure 2 we look to see if the trending short continues.

 

 

Actually yes the trending continues and even accelerates by surpassing T1. We move up our fib tool now to Tuesday and we look for this to continue unless one of the rules stated before comes into play. In Figure 3 we see something different.

 

 

Wednesday’s action fails to reach T1. Not only that, but before the market continues short late in the trading day, what happens? We see the market retrace more than 61.8% of the previous days range. 

Moving up our tool now and knowing to start looking for that reversal in sentiment. In Figure 4 we move up our tool and look for price action to catch up to the possible reversal in market sentiment.

 

 

What we find is the sentiment short is not going to give up easy, but what fails to happen?…..Is T1 met. No it isn’t…reread the rules stated above. Trending failed to continue on a last push short.

If we advance and continue what we are seeing is reversal signals can materialize now and price action catches up to us to confirm our signals seen in sentiment. 

 

 

Looks as if we were right on the money once again and now price action is confirming a reversal in sentiment but we were seeing it days before the indicator traders. If the trending is to continue now we're looking to buy dips in price. Figure 6 gives us a wrinkle to think about. The market doesn’t reach T1 and we see price fail, the bounce were looking for does not occur. What doest it mean when T1 is not met the following day after a trending signal was given on the previous day…reread the rules. No one said anything about how long trending from one day to the next can last. Sometimes its 3 weeks sometimes it’s only for one day.

 

It's your turn now in Figure 8 there are no notes. Can you  read market sentiment and tell what it will be the following day. Don’t cheat and look ahead at the answer, it’s a trick question.

 

 

The answer is there was a loss of momentum to the short trending now, but the market has remained on the short side, no reversal signal given yet. In figure 9 what’s one of the things that can happen after a large fast movement in price?

 

 

We have two days in a row and now the market is staying on the long side. Again no progress or trending signals. What is the market doing when its not trending ? We get ranging.

Now here is another wrinkle for you. What would happen if you get a day that reaches T1, but after that price gives a reversal signal? You go with what you know and the old saying “what have you done for me lately.”  What happened most recent (lately) is the reversal signal. So we go with the reversal signal; remember nothing says how long a pair will trend with out reversing and we have a reversal signal given last.

Figure 10 is a perfect example of this.

 

 

The reversal is confirmed and now we're getting a trending signal. We switch gears and are looking to buy dips and taking long opportunities. As long as the trending signals continue we continue with that direction until we see our 2 simple rules in price action. Figure 11 we see the continuation.

 

 

We're going to advance in time a couple of days somewhat here to the current day that hasn’t unfolded yet, but with what you know of the current day what’s the market sentiment?

 

 

This gives you solid trading framework to start pulling profits out of the market and you are many steps ahead of indicator based traders; thus have an edge to exploit.  In the Trade Kings Club we go into more detail on entries/exits as well as extended strategies. You can also come over to the public forum and discuss or ask questions related to Fibonacci Trading in Forex.

 

Practice this on your favorite pair and two more things remember where your learned it at and from whom! I hope you've gained some valuable insight from this lesson and best of luck on your upcoming trades. 

- Jeff