Video Trading Strategies: How to Trade Retracements

Video Trading Strategies: How to Trade Retracements

Video Trading Strategies How to Trade Retracements

We delve deep into using retracements and Fibonacci numbers

Trading retracements is a very popular strategy, as it lets you take advantage of getting in at the right time on a trend that already has some momentum. But how you can tell if there’s a retracement? Or a trend for that matter?

These are the million dollar questions, aren’t they. Trends aren’t actually that hard to spot on charts, once you have a little bit of experience, although they might look different for the varying instruments – steeper and prolonged for less traded currency pairs, or long and gradual for the more traded and popular indexes like the Dow Jones.

The tricky part is making the difference between the moment these trends are over or if they are just catching their breath before going on. These two scenarios are respectively called reversals and retracements.

Trend reversals are defined as the moment when a prolonged movement in one direction has finally run its course and goes the opposite way. We’ll be dissecting reversals and how to trade them in our next video tutorial so we’ll leave it at that for now.

Retracements are the small moves against the course of a trend (otherwise known as price corrections) and can be attributed to profit taking by short-term traders, the “random walk” theory or simply more people deciding to go the other way. If the latter were to prevail then we get a reversal and we need to set a stop loss. If the trend continues, we need a take profit level. But where to place them?

You could go with your gut feeling by looking only at the chart, but a more prudent approach would be to use Fibonacci number sequence instead.

Their origins can actually be traced back to India, where mathematicians developed the sequence as early as 200 B.C., but in the West, they’ve come to be known as Fibonacci numbers, named after one of the aliases of the Italian mathematician Leonardo Bonacci.

The sequence of the numbers is simply explained as a sequence starting with 0 and 1 and the number in the sequence after them is the sum of the previous two. So it usually looks like 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 etc. The different numbers form  different relations and distances between each other and can be found in nature, although it is not universally observed. Just like in markets.

Fibonacci retracements can be useful on many occasions when it comes to charts. There is no universal filter to identify a situation when they would be most suitable, but some argue that they are more practical when looking at markets that have recently (relative to the timeframe you are using) experienced a large move.

This is the staging point of using the Fibonacci retracements. It involves picking the most recent high and low point which serve as reference points for the algorithm to form the indication levels.

As seen in the video, the most important levels are 0%, 23.6%, 38.2%, 61.8% and 100%. They form the respective support and resistance levels that serve as triggers for the different types of trades. One useful thing to do at this point is to jump out of the whole Fibonacci and retracement idea and simply confirm the levels have previously been tested and did infact act as barriers.

The usual advice for setting stop-loss and take profit levels is to place them slightly above or below the respective levels. If we’re looking at a downward trend, then we place the stop loss at or above the closest Fibonacci level that is above the current price.

The assumption is of course that the trend will continue, so this gives more confidence that a new high or low will be achieved, aiming to extend the profit. This is where your personal risk tolerance comes into play – you might place the take profit level at two levels away, or more.

As one of the most widely used technical indicators, Fibonacci numbers do carry a certain level of psychological weight, meaning traders act on them automatically, without considering other factors. But in the end the most crucial point is to use them when they can confirm a retracement with the generated levels – this can provide confidence that the future support and resistance levels drawn by the tool will also be true and the strategy would be successful.

Any questions about this trading strategy? Let us know in the comment section and we’ll get back to you.

3 thoughts on “Video Trading Strategies: How to Trade Retracements

  1. Well explained concepts, although I was a little confused by your explanation of where to take profits according to fibo extensions – how do you choose which extensions correspond to which retracement levels?

    1. The Fibonacci extensions correspond to retracement levels making it all very simple. For example, if you decide to enter at the 38.2% line, you could take profit at the corresponding extension level at 138.2% and if you enter at 50-61.8% a good take profit is the corresponding extension level at 161.8%.

      These would also depend on your risk tolerance – if you want to aim at a small, but hopefully more certain profit – then you take profit at the closest extension. If you’re aiming at a longer run then you take profit further away. It’s always worthwhile to actively monitor the market and see how it’s behaving when it’s around the respective levels so that you can make a better decision.

  2. Today’s news calendar for the US trading session is relatively quiet, but we do have some events this week that could spur on some market movement and you will want to make note of those on your own financial calendars throughout the entire week, going all the way into Friday with US non-farm payrolls.

    All right, let’s get started here with the US Dollar versus the Swiss Franc [USDCHF]. We’re looking at the daily timeframe. In the live, daily Trade Room, we’ve been discussing this downward-facing channel here. The two red trend lines that you see here on my chart. Downward-facing channel. Throughout the past couple of weeks, we’ve been studying the rising within that pattern.

    Previously, along the blue trend lines, we saw it find a low along the bottom and rise all the way to the top. In a recent pattern, we saw it find a low, but not making it all the way – quite all the way – to the top of the pattern, and now falling back down towards the mid-0.9500s. Of course that doesn’t mean we have turned all the way back down and we’re going to see it go all the way back down to the bottom, but definitely something to take note of is the fact that we have not completed the pattern this time so far and moved all the way to the top of the range.

    If it starts to go bullish again, we would of course look to target back to the top of the range, but currently, last week, the market was clearly bearish here for the USDCHF. Of course like I said, we have news events all this week that could change everything that we’re looking at here on this currency, but definitely, at least at this current point, we have a bearish momentum built into the market.

    Let’s go ahead and zoom in a little bit here on the daily timeframe. Five days in a row it’s been going down. Doesn’t mean it has to continue down, but definitely something that you would take note of. If you’re looking to sell in this direction, there’s two reasons to sell it. I think, first off, you would look for it to come back up here into this pink zone, close to the 0.9600-level, if you’re looking to go short. I don’t think at the current moment it’s a good idea to go short because we’re clearly into the support level, into the mid to upper-0.9500s, the green-shaded area.

    So, currently the green-shaded area is our support. If you’re looking to go short again, it either needs to go up to the pink zone or break through this green-shaded area, and then we could look for it to tackle the next support, which is down here at the purple-shaded area. If we start to see some evidence of reversal, maybe a break above the pink zone, we might look for the bullish action to return, but currently bearish, and I think that’s probably the direction at least for the first part of this week that we’ll continue to focus our efforts on.

    Down here to the four-hour timeframe. You could see it’s kind of stuck right now between the pink and the green-shaded area. So, what I would expect that we’re looking for is a breakout of this congestion that we’re in right now. Above it, may start to signal the upside again for the USDCHF. Below it, as it is right now, and getting below the green-shaded area, further movement down towards the 0.9500-level would likely be expected. So, watching for a breakout of this congestion will probably be your key to direction for the USDCHF this week.

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