In the previous lessons, we understood how Fibonacci levels could be combined with trendlines to generate confirmation signals. After discussing many applications of the Fibonacci indicator, we are now ready to explore some complex strategies using these levels. In this lesson, we will be discussing how the Fibonacci levels can be used with Japanese candlestick patterns.
The candlestick patterns are an intrinsic part of trading, and we cannot ignore them. We have learned many candlestick patterns in the previous lessons, and you can find them starting from here. We have also learned that these patterns can not be used stand-alone, and we should be using any reliable indicators to confirm the signals generated by these patterns. So we will be using Fibonacci retracements to confirm the opportunities generated by the chart patterns.
For the explanation purpose, let’s discuss one of the most reliable candlestick patterns – Dark Cloud Cover. To know more about this pattern, you can refer to the second part of this article. We will be trading the market today by combining both Fibonacci levels and the Dark Cloud Cover pattern.
Strategy – Dark Cloud Cover Pattern + Fibonacci Levels
For explaining the strategy, we considered a downtrend, on which we will be plotting our Fibonacci indicator and later evaluate its retracement. The below chart shows the same with a trading region in which we will be identifying our swing high and swing low. We will also see if the retracement shown in the chart is going to react at the important Fib levels.
In the below chart, we can see the market has moved down quite swiftly from the swing high to swing low. This shows the strength of the underlying downtrend. Trading a retracement of a strong and big move on any side is always preferable. The next step is to plot the Fibonacci levels on the chart.
After the Fibonacci indicator is rightly plotted as shown in the below chart, let’s see what happens at the important Fibonacci levels, such as 50% or 61.8% level. In the chart below, we see that the last Red candle of the retracement exactly touches the 50% level and closes midway of the previous Green candle.
These two candles together remind us of one of the very well known candlestick patterns – The Dark Cloud Cover. More importantly, this pattern is formed exactly at the 50% Fib level. So if we get a confirmation to the downside, it could result in a perfect setup to go short on this pair.
In the above picture, we can clearly see the formation of a bearish confirmation candle. So we can confidently take short positions in the market by placing a stop-loss near the 61.8% level with a target below the recent low.
The above chart shows how the trade works in our favor by hitting our pre-determined ‘take profit.’ We can see that, right after the entry was made, the market moves so fast in the direction of the trend producing continuous red candles. This shows the accuracy of candlestick patterns when combined with indicators like Fibonacci. Since the market is still in a strong downtrend, aggressive traders can take profit at the second or third swing low of the trend, after crossing the initial ‘take-profit.’
From the previous articles, we have seen how the Fibonacci tool can be used with support resistance levels, trendlines, and now even candlestick patterns. By this, we can be assured that the Fibonacci tool is potent and should never be underestimated. Instead, we recommend you to widen its usage in technical analysis to identify more accurate trading opportunities.