One of the most commonly used terms used by Technical Analysis traders in the Forex market is “Fibonacci,” or the “Fibonacci Retracement.” Despite its prevalence, many still view strategies developed with Fibonacci tools with skepticism because, it could be argued, the numbers used in its calculations have nothing to do with the underlying markets that are being traded. Is there any special reason why the EUR/USD should find support at a 61.8% Fibonacci level, especially when considering the possibility that only a minority of the market is watching (and actually placing orders) at that level?

In this article, I will argue that even though I agree with the idea that there is no direct relationship between the Fibonacci sequence and any of the commonly traded asset markets, traders still can (and do) place trades based on these levels and can achieve consistent gains when these levels are viewed in terms of what they actually are: approximate stalling points within a much larger trend. What becomes confusing and problematic (and results in losses) for many new traders is that Fibonacci is viewed in terms that are too exact, rather than in the context of what is happening in the larger trend. Trades based on Fibonacci levels are contrarian in nature (as we are looking for reversal points) and because of this additional flexibility is required when fighting against the market’s momentum.

With this in mind, we will look at a specific strategy to put these ideas into practice. Using a 4-hour chart, we will plot a 100-period EMA alongside a 150-period SMA. For indicators, we will use a 14-period daily RSI and against all of this we will plot the Fibonacci retracements of a significant bullish or bearish move. These levels will match the 0.382, 0.50 and 0.618 levels (which are the areas most commonly watched) and in addition to this, we will plot a 0.250 retracement as well as a 0.750 retracement level.

For our stop loss, we will set our levels at 2 percent (or less) of our entire trading account value but this can then be adjusted to align against significant support or resistance levels in this region. Profit targets are more flexible, as we will bring our stop loss to break even once the position is showing reaches the 0.750 retracement (for long positions) or the 0.250 retracement (for short positions). Trailing stops will then be used and we will close the position on a rejection of the support/resistance levels of the larger Fibonacci move.

In our trade, the main focus is the Fibonacci zone that is seen between the 0.382 retracement and the 0.618 retracement level within our impulsive Fibonacci move. This is our “price zone” and is our major concern in the trade. Our rules for trade entries will require the following: our shorter term moving average will show a positive cross in an uptrend or a negative cross in a downtrend. In an uptrend, we need to see the RSI reading below 50 while in a downtrend we will need to see a reading below 50. This helps us identify levels where markets are becoming over-extended.

Once a major Fibonacci move has been identified on a visual basis, we will wait for prices to enter into the “price zone.” The trigger signal is a close (using candlestick charts) and once this occurs, our parameters are set. The most important thing to remember is that trades cannot be entered “in anticipation” of these criteria being met. This is how traders get caught on the wrong side before the real moves occur. Fibonacci strategies can only work (over the long term) if specific risk to reward ratios are met. “Incorrect” entries are the most problematic obstacle for this type of position and this can be avoided as long as we honor our our original trading parameters.

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