In the previous article, we learnt how exactly to trade using the Fibonacci levels. There are many other ways through which Fib levels can be traded. Some of them include trading these levels using S&R, Trendlines, and even candlestick patterns. Before learning all of these ways, we must know that these levels are not guaranteed and cannot be traded stand-alone. So in this article, let’s discuss why one should be very careful while trading Fibonacci retracements.
Fibonacci Levels Will Not Be Respected Always
Every technical level ultimately breaks at a certain point in time, and that is the case with Fibonacci levels as well. In the previous article, we had learnt that Fibonacci levels also act as potential support and resistance areas. So these levels do break just as how S&R levels break. Therefore we must keep in mind that these levels are not foolproof.
Let’s understand this with the help of an example. But before that, make sure to read our article on ‘How to trade Fib retracements’ to understand this better. You can find that lesson here.
In the price chart below, we can see an initial big move to the downside. So basically, here we must wait for the retracement, and that retracement must touch the Fibo levels. Let’s see what happens in the next step.
We saw the retracement (below chart) of the downward move, and we have placed the Fib levels from swing high to swing low since it is a downtrend.
Then we can see the retracement reaching the 50% Fib level and holding there. Ideally, at this point, the retracement must stop, and the market’s original downtrend should continue. Also, we should be placing our ‘sell’ trades as the Red confirmation candle can clearly be seen.
But, to our surprise, we observe that the price did not respect our strategy, and the market shot up to the north, violating all the Fibonacci levels, as shown in the below chart.
While Fibonacci retracement levels give us a high probability of the trade working in our favor, like any other technical analysis tool, they don’t always work. One can never be entirely certain that the price will respect the 50% or 38.2% or any Fibonacci level for that matter.
If you are an experienced technical trader, you wouldn’t have placed a sell trade in the above scenario. It was clear that the sellers are losing momentum. The formation of a bearish Doji candle at the bottom (below chart) is another confirmation of a trend reversal.
So we should be looking at the bigger picture, or we should take the help of any other technical tools to confirm the signals generated by the Fibonacci levels. Never completely depend on them.
Apart from the things that we discussed above, there is another issue while using these Fib ratios, which is determining the appropriate swing low and swing high. Everyone looks at charts differently. They trade at different time frames and have their own fundamental reason for buying or selling the currency pair.
Swing high for one trader might likely be different than swing high for another. And when the Fib ratios are placed incorrectly, of course, the trading signals generated won’t be accurate. Also, the prerequisite for Fibonacci trading is trending markets. When the market is in a consolidation or moving sideways, it is obviously not possible to trade with these ratios.
We hope you understood this lesson well. If you find this complicated or if you have any questions, please let us know in the comments below. Cheers.