In the previous articles, we learned how Fibonacci retracements give extra confirmations while trading the support & resistance levels. We also know that Fibonacci levels can be used as a confirmation tool to trade many candlestick patterns as well. Now we shall extend this discussion and understand how Fibonacci retracements can be traded using the trendlines.
Trendlines are a crucial part of technical analysis. They are primarily used to identify trends, be it up or down. Trendlines being such an important part of trading, when combined with the Fibonacci indicator, can produce trades that have the highest probability of winning. So let us see how this can be done.
Combining Fibonacci Levels & Trendlines
In the below chart, we have, firstly, identified an uptrend and drew a supporting trendline to it. The next step is to plot Fibonacci on the chart by identifying a swing low and a swing high. The marked area shows where all our trading is going to take place and the region in which we will find our swing low and swing high.
The traditional way of selecting a swing low is when the point intersects with the trendline, just as we have done in this case (below image). The swing high will be the point where the market halts and reverses for a while.
In the below chart, we have used the chosen a swing low and swing high to plot our Fibonacci indicator. In order to combine the Fibonacci with trendline, we must wait to see if the retracement from the swing high touches the 50% or 61.8% Fib level. After touching any of these levels, if the market gives a confirmation candle, it could be a perfect setup to go long. The retracement, in this case, touches the 50% level, which coincides exactly with the upward trendline. The next and final step is to look for a confirmation candle, if any.
We have gotten a confirmation sign from the market after the second green candle closes above the 23.6% Fib level (below image). Hence traders can now take risk-free positions on the ‘long’ side of the market with a stop-loss below the 61.8% Fib level and with an aggressive target above the recent high. This trade results in a risk to reward ratio of 1.5.
We should not forget that if the retracement does not take support at the 50% or 61.8% Fib level and goes further down, breaking all the levels, it could be a potential reversal sign. Thus the retracement that is coinciding with the trendline and reacting from 50% or 61.8% Fib level is the thumb of the rule of this strategy.
The above is a more widened image of the chart shows that the market continues to trend upwards, crossing our ‘take-profit’ area. To take advantage of the market’s trending nature, we can place a trailing stop-loss order to maximize our profits.
When trends start to develop in the market, one should start looking for ways to go ‘long’ or ‘short’ by using necessary technical indicators that give a better chance of a profitable trade. The Fibonacci indicator is one such powerful tool to help traders find potential entry points. We hope you understood this concept clearly. Let us know if you have any questions in the comments below. Do not forget to take the quiz before you go. Cheers![wp_quiz id=”64779″]