First off, I don't claim to be a "guru" on fibonacci levels. Like any other trading technique, a new trader needs to do their own homework and see exactly how the market reacts to various fibonacci levels (from this point forward, I am going to abbreviate the fibonacci word by "fib" because to type fibonacci out every time would lengthen this article by half again).
I am not going to look at any other indicators (like moving averages, or other technical indicators). In my full trading plan, those indicators play an important part of deciding if I take a trade or not. In another words, just because you have reached some of the fib levels I am going to talk about in this article, DO NOT take a trade unless other criteria have been met. Fib levels, while important, are not a be all, end all, stand alone strategy.
The 61.8% Fib Level
When I first started trading, many of the trading books and manuals that I studied recommended using the 38.20% (38%) fib level, and the 50% fib level to analyze support/resistance areas. While I have found those to be somewhat useful, there are other levels that I have found to really give a trader a better edge in making decisions on where support/resistance areas are. The first of these levels is the 61.8% (61%) fib level. Most charting platforms have a fib tool built in. In Tradestation, the fib tool is very easy to use. Let's assume that the market opened (point 1), moved down and bounced off of a certain level (point 2) and then began to rally back up to point 1. The price stops there and begins a pullback. Using your fib tool, click on point 1 and then on point 2 and release. Your fib levels will then be marked. It is important to see how the price reacts to the 40%, 50% and ultimately the 61% fib level. The market can turn and go in the other direction at any of these levels. My research has shown that the larger the pullback (specifically the 61% fib level), the better chance that the market will turn around and go in the other direction. I have seen many times that the market will pause at the 61% fib level, almost as if it is trying to make up it's mind if its going to stop there, or head on in the original direction it was headed. I urge you to start watching the 61% fib level and see how many times that level holds the price in.
The 127% Fib Level
If the 61% fib level described above is broken, then the next two fib levels come into play. The second fib level that my testing shows is worthy of mention is the 127% external fib level. Usually (but not always), once the 61% fib level is crossed, the market will travel to the 127% external fib area. An interesting point is that many traders don't acknowledge or use the external fibs to determine possible stopping areas. I am amazed at how many times the market turns on a dime at this level.
The 161% Fib Level
Another level that I think needs to be addressed is the 161% external fib level. If the 127% fib level doesn't hold the price in, the next stopping point is the 161% fib level. This level also seems to stop a trend in its tracks.
How To Use Fib Levels
In my opinion, there are two ways to use fib levels. If I am looking to enter a trade and the 61% fib level is right above/below my entry, I will pass on the trade and wait for a set-up without that area to compete with. Secondly, if the 61% fib level has been broken, I know that there is a reasonable chance for the price to go to the 127% or 161% fib extension area.
Conclusion
As you began to work with fibs, understand that these areas are just that, areas. That means that when the price approaches a fib level, it can go past that level by a few ticks or more and still be a valid fib level. I hope that if you are serious about learning how to day trade, you put fibs in your tackle-box as a tool to help evaluate strong support and resistance levels. Charts describing the above set-ups and more free commentary are available on my blog. I hope that Fib levels help you be able to: Catch a whopper!!
Regards,
Ron Lewis