What Are Fibonacci Retracements?
Fibonacci Retracements (also known as Fibonacci Ratios) is a popular trading method that is used by traders all over the world to plot trading entries, exits, and potential profit targets.
Fibonacci Retracements are most commonly illustrated by mathematical ratios that are plotted vertically on a chart to help traders identify high probability trading setups. These mathematical ratios are a direct product of something known as “The Fibonacci Sequence”, a theory made famous by a mathematician called Leonardo Fibonacci, in which he claimed that certain mathematical patterns exist in all things (humans, animals, architecture, nature, etc). You can click here to learn more about him. Within the context of trading markets, the
most popular Fibonacci Retracements levels are 38.2%, 50%, and 61.8%, and so lets use the S&P 500 market (Symbol for stocks: SPY | symbol for futures: ES) as an example on a hypothetical bullish trade. Say the market rallies 200 points (10%), from a level of 2450 to a level of 2550. Those traders who are looking to get long the market will be waiting for a Retracement pullback at 38%, 50%, and 62% of the amount that the market rallied (in this example, 200 points).
As a note of caution, while Fibonacci Retracements are considered predictive in nature…they also subscribe to the typically crowd mentality: If enough traders in the world believe in its value, then all of them will act at exactly the same time and force a Market reaction at these levels. In addition, price will rarely ever touch exactly 38%, 50%, or 62%…and in many cases will either stop short just prior to those levels, or will break those levels, chop around for a bit, and only then continue in the original direction.
In this article, I’m going to show you my take on Fibonacci Retracements, and illustrate how I use the concept of Retracements to capture a 90% win rate and earn massive profits in the market.
THE POWER OF RETRACEMENTS
In the day trading industry, market participants can generally be broken up into 2 categories: The Momentum Trader and The Pullback Trader.
While Momentum Trading can be profitable, these types of momentum trading markets are generally associated with bubbles and price distortions (think Bitcoin). A better option, and the sure and steady path to profitability, and the key to ensuring long term success as a day trader, resides firmly in Trading The Retracement.
All financially traded instruments, whether Stocks, or Futures, or Forex currencies, all have one thing in common: The Trend.
If you’ve ever looked closely at a chart, you’ll notice that, although price spent the majority of the day trending in one direction, almost EVERY SINGLE TIME the market had short Retracements before continuing the direction of the prevailing Trend.
Here are some examples:
You can see that these color coded bars require absolutely no Trading Indicators, which is a concept known as Naked Trading – the ability to trade based on pure Price Action.
For BUY trading setups, simply look for the first Green Bar that finishes printing after any string of continuous Red Bars. This is your indication that a potential monster trade may be about to start. For reference purposes, this Bar can be called the Starting Bar.
The High of this Starting Bar and the Low of this Starting Bar now become a more sophisticated / accurate version of our original Fibonacci Retracement levels, and now becomes our Retracement zone that we are looking for price to pullback into. Click here to watch our Youtube video on exactly the perfect trade setup to look for.
For SELL trading setups, also known as short trades, simply work the colors in the other direction. Look for the first Red Starting Bar that prints and set up your modified Fibonacci Retracement zones – the bar high and the bar low. Then look for Short trades whenever price rallies back into the zone.
LET THE TREND SHOW YOU THE PATH TO PROFITS
Fibonacci Retracements are a useful way, especially when modified, to capture the starting point of a new trend in the market. Studies have shown that market price action performs a Retracement an astonishing 90% of the time before continuing in the the direction of the prevailing trend.
Having an effective Retracement trading strategy, along with proper risk management tools, can offer many traders the opportunity to always be on the right side of the trade. And the best part about this strategy is that there are no messy, cluttered, confusing indicators on your chart.