Archive for category: Technical analysis articles

You can’t just enter a trade based on Fib levels without having a clue where to exit.

Your account will just go up in flames and you will forever blame Fibonacci, cursing his name in Italian.

In this lesson, you’ll learn a couple of techniques to set your stops when you decide to use them trusty Fib levels.

These are simple ways to set your stop and the rationale behind each method.

Method #1: Place Stop Just Past Next Fib

The first method is to set your stop just past the next Fibonacci level.

If you were planning to enter at the 38.2% Fib level, then you would place your stop beyond the 50.0% level.

If you felt like the 50.0% level would hold, then you’d put your stop past the 61.8% level and so on and so forth. Simple, right?

Let’s take another look at that 4-hour EUR/USD chart we showed you back in the Fibonacci retracement lesson.

If you had shorted at the 50.0%, you could have placed your stop loss order just past the 61.8% Fib level.

The reasoning behind this method of setting stops is that you believed that the 50.0% level would hold as a resistance point. Therefore, if the price were to rise beyond this point, your trade idea would be invalidated.

The problem with this method of setting stops is that it is entirely dependent on you having a perfect entry.

Setting a stop just past the next Fibonacci retracement level assumes that you are really confident that the support or resistance area will hold. And, as we pointed out earlier, using drawing tools isn’t an exact science.

The market might shoot up, hit your stop, and eventually go in your direction. This is usually when we’d go to a corner, and start hitting our head on the wall.

We’re just warning you that this might happen, sometimes a few times in a row, so make sure you limit your losses quickly and let your winners run with the trend.

It might be best if you used this type of stop placement method for short-term, intraday trades.

Method #2: Place Stop Past Recent Swing High/Low

Now, if you want to be a little safer, another way to set your stops would be to place them past the recent Swing High or Swing Low.

For example, when the price is an uptrend and you’re in a long position, you can place a stop loss just below the latest Swing Low which acts as a  potential support level.

When the price is in a downtrend and you’re in a short position, you can place a stop loss just above the Swing High which acts as a potential resistance level.

This type of stop loss placement would give your trade more room to breathe and give you a better chance for the market to move in favor of your trade.

If the market price were to surpass the Swing High or Swing Low, it may indicate that a reversal of the trend is already in place.

This means that your trade idea or setup is already invalidated and that you’re too late to jump in.

Setting larger stop losses would probably be best used for longer-term, swing-type trades, and you can also incorporate this into a “scaling in” method, which you will learn later on in this course.

Of course, with a larger stop, you also have to remember to adjust your position size accordingly.

If you tend to trade the same position size, you may incur large losses, especially if you enter at one of the earlier Fib levels.

This can also lead to some unfavorable reward-to-risk ratios, as you may have a wide stop that isn’t proportional to your potential reward.

So which way is better?

The truth is, just like in combining the Fibonacci retracement tool with support and resistance, trend lines, and candlesticks to find a better entry, it would be best to use your knowledge of these tools to analyze the current environment to help you pick a good stop loss point.

As much as possible, you shouldn’t rely solely on Fibonacci levels as support and resistance points as the basis for stop loss placement.

Remember, stop loss placement isn’t a sure thing.

But if you can tilt the odds in your favor by combining multiple tools, it could help give you a better exit point, more room for your trade to breathe, and possibly a better reward-to-risk ratio trade.

In this lesson, we’re going to teach you how to combine the Fibonacci retracement tool with your knowledge of Japanese candlestick patterns that you learned in Grade 2.

 

When combining the Fibonacci retracement tool with candlestick patterns, we are actually looking for exhaustive candlesticks.

If you can tell when buying or selling pressure is exhausted, it can give you a clue of when price may continue trending.

 

We here at BabyPips.com like to call them “Fibonacci Candlesticks,” or “Fib Sticks” for short. Pretty catchy, eh? Let’s take a look at an example to make this clearer.

 

Below is a 1-hour chart of EUR/USD.

The pair seems to have been in a downtrend the past week, but the move seems to have paused for a bit.

Will there be a chance to get in on this downtrend? You know what this means. It’s time to take the Fibonacci retracement tool and get to work!

As you can see from the chart, we’ve set our Swing High at 1.3364 on March 3, with the Swing Low at 1.2523 on March 6.

Since it’s a Friday, you decided to just chill out, take an early day off, and decide when you wanna enter once you see the charts after the weekend.

Whoa! By the time you popped open your charts, you see that EUR/USD has shot up quite a bit from its Friday closing price.

While the 50.0% Fib level held for a bit, buyers eventually took the pair higher. You decide to wait and see whether the 61.8% Fib level holds.

After all, the last candle was pretty bullish! Who knows, the price just might keep shooting up!

Well, will you look at that? A long-legged doji has formed right smack on the 61.8% Fibonacci retracement level.

If you paid attention in Grade 2, you’d know that this is an “exhaustive candle.”

 

Has buying pressure died down? Is resistance at the Fibonacci retracement level holding?

It’s possible. Other traders were probably eyeing that Fib level as well.

Is it time to short? You can never know for sure (which is why risk management is so important), but the probability of a reversal looks pretty darn good!

If you had shorted right after that doji had formed, you could have made some serious profits.

Right after the doji, the price stalled for a bit before heading straight down. Take a look at all those red candles!

It seems that buyers were indeed pretty tired, which allowed sellers to jump back in and take control.

Eventually, the price went all the way back down to the Swing Low. That was a move of about 500 pips! That could’ve been your trade of the year!

 

Looking for “Fib Sticks” can be really useful, as they can signal whether a Fibonacci retracement level will hold.

If it seems that price is stalling on a Fib level, chances are that other traders may have put some orders at those levels.

This would act as more confirmation that there is indeed some resistance or support at that price.

Another nice thing about Fib Sticks is that you don’t need to place limit orders at the Fib levels.

You may have some concerns about whether the support or resistance will hold since we are looking at a “zone” and not necessarily specific levels.

This is where you can use your knowledge of candlestick formations.

You could wait for a Fib Stick to form right below or above a Fibonacci retracement level to give you more confirmation on whether you should put in an order.

If a Fib stick does form, you can just enter a trade at the market price since you now have more confirmation that level could be holding.

Well, seeing as how Fibonacci levels are used to find support and resistance levels, this also applies to Fibonacci!

Fibonacci retracements do NOT always work! They are not foolproof.

Let’s go through an example when the Fibonacci retracement tool fails.

Below is a 4-hour chart of GBP/USD.

Here, you see that the pair has been in a downtrend, so you decided to take out your Fibonacci retracement tool to help you spot a good entry point. You use the Swing High at 1.5383, with a swing low at 1.4799.

You see that the pair has been stalling at the 50.0% level for the past couple of candles.

You say to yourself, “Oh man, that 50.0% Fib level! It’s holding baby! Time to short this sucka!”

 

You short at market and start daydreaming that you’ll be driving down Rodeo Drive in your new Maserati with Scarlett Johansson (or if you’re a lady trader, Ryan Gosling) in the passenger seat…

 

Now, if you really did put an order at that level, not only would your dreams go up in smoke, but your account would take a serious hit if you didn’t manage your risk properly!

Take a look at what happened.

It turns out that that Swing Low was the bottom of the downtrend and the price began to rally above the Swing High point.

What’s the lesson here?

While Fibonacci retracement levels give you a higher probability of success, like other technical tools, they don’t always work. You don’t know if the price will reverse to the 38.2% level before resuming the trend.

Sometimes it may hit 50.0% or the 61.8% levels before turning around. Heck, sometimes the price will just ignore Mr. Fibonacci and blow past all the levels just like how Lebron James bullies his way through the lane with sheer force.

Remember, the market will not always resume its uptrend after finding temporary support or resistance, but instead continue to go past the recent Swing High or Low.

 

Another common problem in using the Fibonacci retracement tool is determining which Swing Low and Swing High to use.

People look at charts differently, look at different time frames, and have their own fundamental biases. It is likely that Stephen from Pipbuktu and the girl from Pipanema have different ideas of where the Swing High and Swing Low points should be.

The bottom line is that there is no absolute right way to do it, especially when the trend on the chart isn’t so clear. Sometimes it becomes a guessing game.

That’s why you need to hone your skills and combine the Fibonacci retracement tool with other tools in your forex toolbox to help give you a higher probability of success.

 

Fibonacci is a huge subject and there are many different Fibonacci studies with weird-sounding names but we’re going to stick to two: retracement and extension.

 

Let us first start by introducing you to the Fib man himself…Leonardo Fibonacci.

 

No, Leonardo Fibonacci isn’t some famous chef. Actually, he was a famous Italian mathematician, also known as a super-duper uber ultra geek.

He had an “Aha!” moment when he discovered a simple series of numbers that created ratios describing the natural proportions of things in the universe.

The ratios arise from the following number series: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…

This series of numbers is derived by starting with 0 followed by 1 and then adding 0 + 1 to get 1, the third number.

Then, adding the second and third numbers (1 + 1) to get 2, the fourth number, and so on.

 

After the first few numbers in the sequence, if you measure the ratio of any number to the succeeding higher number, you get .618.

 

For example, 34 divided by 55 equals .618.

If you measure the ratio between alternate numbers you get .382.

For example, 34 divided by 89 = 0.382 .

You have now just experienced the Fibonacci Sequence!

Fibonacci Sequence

A Fibonacci sequence is formed by taking 2 numbers, any 2 numbers, and adding them together to form a third number.

Then the second and third numbers are added again to form the fourth number.

And you can continue this until it’s not fun anymore.

The ratio of the last number over the second-to-the-last number is approximately equal to 1.618.

This ratio can be found in many natural objects, so this ratio is called the golden ratio.

It appears many times in geometry, art, architecture, and even on Sonic the Hedgehog.

The golden ratio is actually an irrational number, like pi, and is often denoted by the Greek letter, phi (φ).

Okay, that’s enough mumbo jumbo.

With all those numbers, you could put an elephant to sleep. We’ll just cut to the chase; these are the ratios you HAVE to know:

Fibonacci Retracement Levels

0.236, 0.382, 0.618, 0.764

Fibonacci Extension Levels

0, 0.382, 0.618, 1.000, 1.382, 1.618

You won’t really need to know how to calculate all of this. Your charting software will do all the work for you.

However, it’s always good to be familiar with the basic theory behind the indicator so you’ll have the knowledge to impress your date.

Fibonacci retracement levels work on the theory that after a big price moves in one direction, the price will retrace or return partway back to a previous price level before resuming in the original direction.

Traders use the Fibonacci retracement levels as potential support and resistance areas.

Since so many traders watch these same levels and place buy and sell orders on them to enter trades or place stops, the support and resistance levels tend to become a self-fulfilling prophecy.

Traders use the Fibonacci extension levels as profit-taking levels.

Again, since so many traders are watching these levels to place buy and sell orders to take profits, this tool tends to work more often than not due to self-fulfilling expectations.

Most charting software includes both Fibonacci retracement levels and extension level tools.

In order to apply Fibonacci levels to your charts, you’ll need to identify Swing High and Swing Low points.

A Swing High is a candlestick with at least two lower highs on both the left and right of itself.

A Swing Low is a candlestick with at least two higher lows on both the left and right of itself.

Did you get all that? Don’t worry, we’ll explain retracements, extensions, and most importantly, how to grab some pips using the Fibonacci tool in the following lessons.

To identify triple Japanese candlestick patterns, you need to look for specific formations that consist of three candlesticks in total.

These candlestick formations help traders determine how the price is likely to behave next.

Some three candlestick patterns are reversal patterns, which signal the end of the current trend and the start of a new trend in the opposite direction.

And other three candlestick patterns are continuation patterns, which signal a pause and then the continuation of the current trend.

Let’s take a look at the popular triple Japanese candlestick patterns.

Evening and Morning Stars

The Morning Star and the Evening Star are triple candlestick patterns that you can usually find at the end of a trend.

They are reversal patterns that can be recognized through three characteristics.

We’ll use the Evening Star Pattern on the right as an example of what you may see:

1. The first candlestick is a bullish candle, which is part of a recent uptrend.
2. The second candle has a small body, indicating that there could be some indecision in the market. This candle can be either bullish or bearish.
3. The third candlestick acts as a confirmation that a reversal is in place, as the candle closes beyond the midpoint of the first candle.

Three White Soldiers and Black Crows

The Three White Soldiers pattern is formed when three long bullish candles follow a DOWNTREND, signaling a reversal has occurred.

This type of triple candlestick pattern is considered as one of the most potent in-yo-face bullish signals, especially when it occurs after an extended downtrend and a short period of consolidation.

 

The first of the “three soldiers” is called the reversal candle. It either ends the downtrend or implies that the period of consolidation that followed the downtrend is over.

 

For the Three White Soldiers pattern to be considered valid, the second candlestick should be bigger than the previous candle’s body.

Also, the second candlestick should close near its high, leaving a small or non-existent upper wick.

For the Three White Soldiers pattern to be completed, the last candlestick should be at least the same size as the second candle and have a small or no shadow.

The Three Black Crows candlestick pattern is just the opposite of the Three White Soldiers.

 

It is formed when three bearish candles follow a strong UPTREND, indicating that a reversal is in the works.

The second candle’s body should be bigger than the first candle and should close at or very near its low.

Finally, the third candle should be the same size or larger than the second candle’s body with a very short or no lower shadow.

For the Three Black Crows pattern to be completed, the last candlestick should be at least the same size as the second candle and have a small or no shadow.

Three Inside Up and Down

The Three Inside Up candlestick formation is a trend-reversal pattern that is found at the bottom of a DOWNTREND.

This triple candlestick pattern indicates that the downtrend is possibly over and that a new uptrend has started.

For a valid three inside up candlestick formation, look for these properties:

1. The first candle should be found at the bottom of a downtrend and is characterized by a long bearish candlestick.
2. The second candle should at least make it up all the way up to the midpoint of the first candle.
3. The third candlestick needs to close above the first candle’s high to confirm that buyers have overpowered the strength of the downtrend.

Conversely, the Three Inside Down candlestick formation is found at the top of an UPTREND.

It means that the uptrend is possibly over and that a new downtrend has started.

A Three Inside Down candlestick formation needs to have the following characteristics:

1. The first candle should be found at the top of an uptrend and is characterized by a long bullish candlestick.
2. The second candle should make it up all the way down the midpoint of the first candle.
3. The third candlestick needs to close below the first candle’s low to confirm that sellers have overpowered the strength of the uptrend.