Tag: Fibonacci Extensions

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Forex Daily Topic Forex Fibonacci Forex Price-Action Strategies

Generating Trading Signals Using Fibonacci Tools

Introduction

Introduction

Introduction

In our previous educational article, we reviewed how the identification of double top and double bottom formations could provide a trading setup, which, according to its technical configuration, returns a risk to reward ratio equivalent to 1:1.

In this educational article, we’ll review the use of Fibonacci retracements and extensions to generate trading signals.

Trading the Market Corrections

Trading based on corrective movements has its origin in the idea that when the price action makes an impulsive move, the market develops a corrective movement before continuing to develop a new motive move.

This method’s risk derives from the possibility of false breakouts, which, depending on the primary trend, could be a “bearish trap” or “bullish trap.”

Considering that there is a broad range of Fibonacci ratios, Fischer & Fischer propose filtering the trading volume using the 61.8% level as a conservative level. The use of 61.8% provides the technical trader the possibility to invest risking a reduced part of its capital.

As a second entry filter criteria, traders could use the swing size average of the asset under analysis. Considering that every financial asset holds a different personality and volatility, this filter demands the technical trader to develop statistical backtesting to understand the asset’s inherent volatility under study.

Trade Setup

Entry Setup: Considering that the entry rule requires a unique Fibonacci level, the entry will occur once the price touches and closes above (or below) the level 61.8%. This criterion could help shield the technical investor against a potential false breakout.

Stop-Loss: The trade invalidation level will be set above/below the last peak/valley preceding the entry-level. The benefit of trading using the 61.8% level as the point of market entry is the reduced risk compared with other typical Fibonacci levels, such as 38.2% or 50%.

Trailing Stop as Profit Protector: This method by itself doesn’t make the use of a profit target level. As an alternative, the use of a trailing stop could help protect profits with a trailing criterion of the last peak or valley. The disadvantage of this method is that, constrained by the volatility observed in the real market, it is unlikely that the resulting risk to reward ratio goes beyond a mere 1:1.

Trading the Market Progress

As the Elliott Wave Theory states, the price tends to advance in three or five waves. This method uses Fibonacci extensions to define target levels.

In general, when the price action develops a price movement on strong momentum and, then, its correction doesn’t violate the starting level of the initial move, it means the market is not building a bullish or bearish trap; thus, it is likely the action will continue progressing in the direction of the first move.

Entry Rule:  In the same way as in the case of a price correction setup, the entry should be set when the price retraces and closes, starting a new impulsive move. This condition doesn’t require that the price retraces to the 61.8% level of the initial movement.

Stop-Loss: The invalidation level of the trade setup should be located below the last peak or valley preceding the entry-level.

Profit Target (Three Movements Case): When the price evolves following a three-move sequence, the profit target should be set at 161.8% of the projection of the first sequence, as illustrated in the next figure.

Profit Target (Five Movements Case): This scenario considers two options. The first one is when the progress happens in the third segment and the second one when the price action has completed the third move and could be initiating its fifth movement. These scenarios are illustrated in the following figure.

Conclusions

In this educational article, we reviewed two cases in which to use as Fibonacci retracements as the extensions tool. Both methods presented in this article offer specific risks. The use of the corrections method provides a reduced risk to the technical trader, due to the trailing stop use criterion, this doesn’t mean that it could deliver a risk to reward ratio of over 1:1.

On the other hand, the use of the Fibonacci extensions, according to Fischer & Fischer, always means to invest against the trend. However, a combination of both methods could provide an opportunity to enter in favor of the market direction.

To reduce the noise and risk in the investment process, the technical trader must evaluate the performance strategy developing statistical backtesting with historical data before risking real money.

Suggested Readings

  • Fischer, R., Fischer J.; Candlesticks, Fibonacci, and Chart Patterns Trading Tools; John Wiley & Sons; 1st Edition (2003).

 

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Forex Basic Strategies

Identifying & Trading The Bullish & Bearish Gartley Pattern

Introduction

Introduction

Introduction

We have discussed three of the most used Harmonic patterns in the previous strategy articles, and they are AB=CD, Butterfly, and Bat patterns. In today’s article, let’s learn how to trade one of the oldest Harmonic patterns – The Gartley. Trading harmonic patterns is one of the most challenging ways to trade but equally rewarding. There are traders across the world who highly believe in these patterns because of their accuracy in identifying trading signals, and the high RRR trades they offer.

The Gartley is one of the most commonly used harmonic patterns as it works very well on all the timeframes. IT is also one such pattern that frequently appears on the price charts. H.M Gartley introduced this pattern in his book ‘Profits in the Stock Market’ in the year 1935.

This pattern is also known as the Gartley 222 pattern because H.M Gartley introduced this pattern in the 222nd page of his book. There are both bearish and bullish Gartley patterns, and they appear depending on the underlying trend of the market. The Gartley pattern is made up of 5 pivot points; let’s see what these points are in the below section.

5 Pivot Points of The Garley Pattern

Just like other harmonic patterns, H.M Gartley used five letters to distinguish the five separate moves and impulses of the Gartley pattern.

  • The letter X represents the start of the trend.
  • The letter A represents the end of the trend.
  • The letter B represents the first pullback of the trend.
  • The letter C represents the pullback of the pullback.
  • The letter D represents the target of the letter C.

Gartley Pattern Rules

‘X-A’ – This is the very first move of the pattern. The wave XA doesn’t fit any criteria, so it is nothing but a bullish or bearish move in the market.

‘A-B’ – The Second move AB should approximately be at the 61.8% level of the first XA move. So if the XA move is bearish, the AB move should reverse the price action and reach the 61.8% Fib retracement level of the XA.

‘B-C’ – The goal of the BC move is to reverse the AB move. Also, the BC move should end either at 88.6% or 38.2% Fibonacci retracement level of XA.

‘C-D’ – The CD move is the reversal of the BC move. So if the BC move is 38.2% of the AB, CD move should respond at 127.2% level of BC. If BC move is at the 88.6% level of the AB move, the CD move should be at the 161.8% Fib extension level of BC.

‘A-D’ – This is the last but most crucial move of the Gartley pattern. Once the CD move is over, the next step is to measure the AD move. The Last AD move will show us the validity of the Gartley Pattern on the price chart. The pattern is said to be valid if this move takes a retracement approximately at the 78.6% Fib level of the XA move.

Below is the pictographic representation of the Gartley Pattern

 Gartley Pattern Trading Strategy 

Trading The Bullish Gartley Pattern

In the below NZD/USD weekly chart, we can see that the market is in a clear uptrend. We have then found the swing high and swing low, which is marked by the point X & Point A. We then have four swing-high & swing-low points on the price chart that binds together to form the Gartley harmonic pattern.

Always remember that every swing high and low must validate the Fibs ratios of the Gartley pattern. These levels can be approximate as we can never trade the market if we keep waiting for the perfect set-up. There are indicators out there where the Fibonacci levels are present in them by default. We generally use TradingView, and in this charting software, the below-used indicator can be found in the toolbox, which is present on the left-hand side.

Please refer to the marked region in the chart below. The first XA leg is formed just like a random bullish move in the market. The second AB move is a bearish retracement, and it is at the 61.8% Fib level of the XA move. Furthermore, the BC is a bullish move again, and it follows the 88.6% Fib level of the AB move. The CD leg is the last bearish move, and it is respecting the 161.8% Fib level of BC.

Now we have identified the bullish Gartley pattern on the price chart. We can take our long positions as soon as the CD move ends at the 161.8% level. The next and most crucial step of our strategy is to find the potential placement of our stop-loss. The ideal region to place the stop-loss is just below point X. If the price action breaks the point X, it automatically invalidates the Gartley pattern.

However, stop-loss placement depends on what kind of trader you are. Some aggressive traders place stop-losses just below the entry while some use wider stops. We suggest you follow the rules of the strategy and use point X as an ideal stop-loss placement.

B, C & A points can be considered as ideal areas for taking your profits. We suggest you go for higher targets in the case of the formation of a perfect Gartley pattern. Overall, placing a ‘take-profit‘ order depends on your previous trading experience also. Because, if you come across any ideal candlestick patterns in your favor while your trade is performing, you can extend your profits. We can also combine this pattern with other reliable technical indicators to load more positions in our trades.

Trading The Bearish Gartley Pattern

Below is the EUR/GBP four-hour chart in which we have identified the bearish Gartley pattern. In the highlighted region, we can see the formation of the bearish XA leg like a random bearish move. The second leg is AB – a bullish retracement stopping at the 61.8% level of the XA move. Furthermore, the BC move is bearish again, and it respects the 88.6% Fibs level of the AB move. CD is the final bullish move, and it is respecting the 161.8% Fibs level of BC.

As soon as the price action completes the CD move, we can be assured that the Gartley pattern is formed on our price chart. We can also see the formation of a Red confirmation candle indicating us to go short in this Forex pair. We have taken our short positions at point D and placed our stop-loss just above point X.

We have three targets in total, and they are points B, C, and A. Within a few hours, the price action hits the B point, which was our first target. Moreover, the price pulled back at point C, but we were safe in our trade as our stop-loss was placed above point X. Our final target was at point A, which is achieved within four days.

Conclusion

The Gartley pattern is wholly based on mathematical formulas and Fibonacci ratios. Remember to take the trades only when all the mentioned Fib levels are respected. If you have no experience with harmonic patterns, you must master this pattern on a demo account first and then use them on the live markets. We are saying this because it requires a lot of patience and practice to identify and trade these patterns.

We hope you understood how to identify and trade the Gartley Harmonic Pattern. If you have any questions, let us know in the comments below. Cheers!

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Forex Basic Strategies

Trading The Bullish & Bearish Bat Pattern Like A Pro

Introduction

Introduction

Introduction

We have learned the importance of Harmonic patterns in our previous articles. We also understood a couple of interesting harmonic patterns – The Butterfly & AB=CD. In this article, let’s understand what a ‘Bat’ pattern is, and how to make money trading this pattern. The Bat pattern is a part of the Harmonic group, and ‘Scott Carney’ discovered this pattern in the year 2001. Out of all the patterns present in the harmonic group, Bat pattern has the highest accuracy. This pattern can be extremely profitable when traded correctly.

It works very well on all the timeframes but try not to trade it in smaller timeframes because the price in these timeframes tends to reverse quickly. The Bat pattern comes in both bullish and bearish variations and is made up of five swing points X, A, B, C, and D. In a downtrend, the appearance of a bullish Bat pattern indicates a bullish reversal. In an uptrend, the appearance of a bearish Bat pattern indicates a bearish reversal.

One of the critical characteristics of the Bat pattern is the power, speed, and strength of the reversal that occurs after the appearance of this pattern on the price chart. Fibonacci ratios are the core strength of any harmonic pattern, and thanks to the advanced technology for providing the Fibs ratios to the Bat pattern to increase its accuracy.

Bat Pattern Rules

Just like most of the harmonic patterns, the Bat pattern is a four-leg reversal pattern that follows specific Fib ratios. A proper Bat pattern needs to fulfill the below criteria.

‘X-A’ – In its bullish form, the first XA move of the Bat pattern could be any random upward move on the price chart.

‘A-B’ – For a Bat pattern to get validated, the AB leg’s minimum retracement should be 38.2% of XA leg or maximum of 50% Fib levels. Scott Carney suggests that the retracement at 50% Fibs levels increase the accuracy of the signal generated.

‘B-C’ – The BC move can retrace up to a minimum of 38.2% Fib level of AB and a maximum of 88.6%.

‘C-D’ – CD is the last move that confirms the Bat pattern. This move should be at 88.6% Fibs retracement of XA leg, or it should be between 161.8% or 261.8% Fibs extension of the AB leg.

For a bearish Bat pattern, point X should be at a significant high. Conversely, for a bullish Bat pattern, point X should be at a significant low.

Below is the pictographic representation of the Bat Harmonic Chart Pattern.

Bat Pattern Trading Strategy

Trading The Bullish Bat Pattern

In the below USD/CHF four hours chart, we can see the formation of a bullish Bat pattern. These days, on most of the trading platforms, we can find all the harmonic tools which are combined with Fib levels. These tools get extremely handy when we need to quickly confirm the pattern. We use TradingView charts, and the harmonic pattern tool can be found in the left-side toolbar.

Coming to the strategy, our starting point X was at 0.9840 from where the move has started. The price action started to counter the trend from 0.9984. Let’s consider this as our point A, and the XA is nothing but a random bullish move in the market. Now we located our first swing high, so the next step is to count the market wave movement. The AB move retraces at 38.2% of the XA move, and the BC move goes up again and retraces at 88.6% of AB. Furthermore, the market prints the last move of the pattern, which is at 88.6% level of the XA move. So now we have got all the four touch patterns for a bullish Bat pattern on the price chart.

While back-testing, we found the market blasting to the north whenever the CD move finishes at 88.6% level. This is the reason why we took the buy entry as soon as the price-action completes the CD move. Overall it was an excellent risk-reward ratio trade. Also, when the CD move touches the 88.6% Fib level, it always provides a decent risk-reward ratio. The stop-loss is placed below the ‘X,’ and take-profit can either be placed at A or C points.

Trading The Bearish Bat Pattern

Both the bearish and bullish Bat patterns have the same rules. The only difference is that it appears inversely. So in this strategy, let’s trade the bearish Bat pattern with at most accuracy.

In the below NZD/USD daily chart, we have identified a bearish Bat pattern. The very first move has started from point X and ends at point A. This can be considered as a random bearish move. The price action has then reversed back and retraced at 38.2% level of the XA move forming the AB move. The market then goes into the counter direction and forms a BC leg, which is also retraced at 38.2% Fib level of the AB leg. The last leg was the CD move, and it finished close to the 88.6% Fibs level.

These swing highs and lows confirm the formation of a bearish Bat pattern on the price chart. So when the price action prints a bearish confirmation candle, we went short in this pair. Scott Carney described the points B, C and A as the first, second, and third target respectively. We can book profit at any of these points, or we can hold for deeper targets depending on the market situation.

In this particular trade, we didn’t book profits at B or C after seeing the momentum of the price. We were sure that the price could easily reach the last target. The price action did hold at point C for a longer time, which indicates that this trade might not work. Any armature trader would have panicked and closed their trades at breakeven.

But, as mentioned, whenever an ‘almost perfect’ Bat pattern is formed, the trade will definitely work. We must be patient and confident enough to stick to the strategy. Stop-loss placement is crucial, and one thumb rule while trading harmonic patterns is to place the stop-loss just below point X.

Conclusion

In short, harmonic patterns imply that the trends can be subdivided into smaller or larger waves using which the future price direction can be predicted. These harmonic patterns only work if the fibs ratios are aligned with the pattern. Some traders do not believe the authenticity of harmonic patterns, but we assure you that you can trade these patterns confidently. This ends the discussion on the Bat pattern. Remember that this pattern provides accurate entries as well as good RRR trades compared to other harmonic patterns. In the upcoming articles, let’s discuss Gartley and Crab patterns, which are equally important to learn.

We hope you find this article informative. In case of any questions, please let us know in the comments below. Cheers!

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Forex Course

68. Using Fibonacci Retracements To Place Appropriate Stop-Loss

Introduction

Introduction

Introduction

Until now, we have paired the Fibonacci levels with various technical tools to find appropriate trading opportunities. Some of them include support/resistance, trendlines, and even candlestick patterns. In the previous lesson, we also saw how to place appropriate ‘take-profit’ orders to maximize our profits. The uses of the Fibonacci levels do not end here. There is another incredible application of these levels, and that is to find the appropriate ‘stop-loss’ levels. ‘

As a trader, one should always use the ‘Stop-Loss’ orde as they are critical to avoid the risk of bearing huge losses. In some adverse situations, if this order is not used, it would result in a complete drain of trading capital where we can have the risk of losing everything in a single trade. Placing an appropriate stop-loss ensures that we do not expose ourselves to the unbearable risk.

However, placing the stop-loss order randomly might expose us to the risk of getting stopped out very early. So the proper placement of this order is crucial, and it can be hard for traders who aren’t experienced enough. So the Fibonacci tool can be a great help for us in determining accurate stop-loss levels.

Using Fibonacci Levels To Place Appropriate Stop-Loss Orders

In the below chart, we see a big initial move to the upside on which the Fibonacci levels are plotted using the Swing low and Swing high. Using the ‘Fibonacci strategy,’ we can notice a retracement that has reacted fairly well from the 61.8% Fib level, and now if the next candle is green, this could be a confirmation for us to go ‘long.’

We notice in the below chart that the next candle appears to be Green, and now with that confirmation, we can place our ‘buy’ trades with appropriate ‘stop-loss’ and ‘take profit.’ The traditional way of using a stop-loss order is to place it 50 pips away from the point of entry. Most of the novice traders use this method even today. This is said to be a layman’s approach with no suitable reasoning. When we use such methods, there is a high chance of we getting stopped out before the trade moves in our favor.

The below chart shows that how placing a 50 pip stop-loss can prove to be dangerous. We can see the stop-loss getting triggered by the immediate next candle after the entry was made.

Now let’s see how to place the stop-loss order using Fibonacci levels. The strategy is to place the stop-loss at the Fib level, which is below the Fib level from where the retracement reacts and gives a confirmation candle. Taking the above example, since the retracement touched the 61.8% Fib ratio and gave a confirmation candle, the stop-loss will be placed at the 78.6% Fib ratio. This seems to be very simple, yet most traders are not aware of this.

In the above chart, we can see how the price just misses our stop-loss placed at the 78.6 Fib level and later directly went to our take-profit. This shows the precision of stop-loss placement, which was established using the Fibonacci levels.

Conclusion

We must understand that stop-loss determination is a crucial step and has to be calculated mathematically using any reliable technical indicators. Indicators like Fibonacci have a mathematical approach in determining these levels. Make sure to use these levels before going to place your stop-loss levels next and let us know how they have worked for you. Cheers!

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Forex Basic Strategies

Learning To Trade The Bullish & Bearish ‘Butterfly’ Harmonic Pattern

Introduction

Introduction

Introduction

Harmonic patterns have always been popular among a set of traders around the world. So it is essential to learn them to have an edge over the market. There are two different types of Harmonic Patterns. The first type is external, and the second is internal. External Harmonic patterns include Butterfly and crab patterns. Whereas the internal Harmonic patterns include Gartley and Bat patterns. In today’s article, let’s discuss how to trade the Butterfly pattern profitably.

The Butterfly is both a bullish and bearish reversal pattern that falls into the category of the Harmonic group. It is developed by H.M Gartley. Scott Carney and Larry Pesavento then fine-tuned the pattern by adding the Fibs ratios. This harmonic pattern is composed of four legs, and they are marked as ‘X-A,’ ‘A-B,’ ‘B-C,’ and ‘C-D.’ The Butterfly pattern mostly appears at the end of the trend indicating a trend reversal.

By identifying this pattern on the price charts, traders can enter a trade anticipating a potential market reversal. The Butterfly structure on the chart resembles the letter’M’ in a downward trend. Conversely, in an uptrend, the pattern looks like a ‘W.’

Butterfly Pattern Rules

To confirm the appearance of the Butterfly pattern, the rules below must be met. Remember to accept the pattern even if the levels are closer to these Fib ratios. If we stick these levels only, we might be missing on well-performing trades as the setups with the exact Fib levels hardly occur.

‘X-A’ – This is the initial move of the Butterfly pattern, and in a downtrend, this leg is formed when the price drops sharply from point X to A. Likewise, in an uptrend, this leg is formed when price moves up swiftly from X to A.

‘A-B’ – The B point should retrace 78.6% of X-A leg.

‘B-C’ – The B-C move should retrace 38.2% or 88.6% of the A-B move.

‘C-D’ – The C-D move is the final and most crucial move of the pattern. If the B-C is 88.6% of the A-B, then the C-D must be reached the 261.8% extension of BC. On the other hand, if the B-C is 38.2% of A-B, then the C-D must reach the 161.8% extension of B-C.

A pictographic representation of the same is shown below.

How To Trade The Butterfly Pattern

Trading The Bullish Butterfly Pattern

The below picture is a 30-minute chart of the USD/JPY Forex pair. We have identified the Butterfly pattern and plotted Fib levels on to that. As we can see, the first X-A leg started as a random bullish move on the price chart. The second A-B bearish move retraces close to the 78.6% of the X-A move.

Furthermore, the B-C moves reach close to 88.6% of the A-B move. The last C-D bullish move reaches almost close to the161.8% of the B-C movement. So after the appearance of all the four legs, we confirm the formation of the Bullish Butterfly Pattern. Now let’s how we are going to trade this pattern.

Once the price action completes the CD move, we must wait for 2 to 3 bullish candles to take a buy entry in the USD/JPY pair. We must enter the market right after the appearance of the Green confirmation candles. As we can see in the above image, the market blasted to the north right after the appearance of confirmation candles.

Always remember that we are dealing with probabilities and not certainty while trading. So as technical traders, we must adjust according to the market sentiment. The ideal way is to exit our positions when the price approaches the level of point A. But in this particular trade, the market shows excessive volatility as we can see the appearance of a ‘three white soldiers’ candlestick pattern. As per our learnings, we know when this pattern appears, the trend is going to continue.

So we must place deeper targets in this Forex pair. That’s the reason why we didn’t book any partial profits and closed our whole position at a significant resistance area. So in any given trade, always decide your risk-management according to the market situation. Furthermore, we put the stop loss just below the X point, which is the safest position to set a stop-loss. Because, if the price breaks this point, directly it invalidates the Butterfly pattern.

Trading The Bearish Butterfly Pattern

The below image represents the 240-min chart of the GBP/USD Forex pair. We have identified the formation of a Bearish Butterfly pattern in this chart. In a downtrend, the first X-A leg started as a random bearish movement in the market. The A-B leg is a bullish move that retraces close to the 78.6% of the X-A leg. Then the third B-C movement is the bearish move again, and it retraces close to the 38.2% of the A-B move. Then finally, the C-D move happened, which completes the formation of the Bearish Butterfly Pattern.

As we can see in the above picture, the last leg retraces to the upside, and it was close to the 161.8% extension of the BC move. When the price action completes the C-D leg, it prints a couple of red confirmation candles indicating a potential market reversal. Hence in this pair, we took a sell at D point, and the stop-loss placement was just above the D point. We didn’t book any partial profit at point B or C; instead, we closed our whole position at our final target, which is point A.

When and When Not to Trade The Butterfly Pattern?

The good thing about Harmonic patterns is that they work very well in all the types of markets. They also work wonderfully in every market condition. We believe you have clearly understood that the Butterfly is a reversal pattern. We must use all of our previous learnings to win a trade. For instance, if a bullish Butterfly pattern is formed in a strong downtrend, try to avoid trading that pattern. This is because it is difficult for a single pattern to completely reverse the market trend.

If the market was in an uptrend, which is now turning into a dying channel, and if we identify a bearish Butterfly pattern on the price chart, the probability of it being an accurate trading signal is more. Sometimes we can observe the market printing a pattern within the pattern. This also increases the likelihood of our trades. For instance, we can see the formation of a ‘Three White Soldiers’ pattern (below chart) in one of the examples we discussed.

This example is not in the context of trading the Harmonic pattern as a whole but in the context of placing our take-profit orders while trading Harmonic patterns.

Alternative to Harmonic Patterns?

It is a bit difficult for new traders to learn and implement the Harmonic patterns on their trades. So, in the beginning, new traders can also use other forms of technical analysis tools to trade the market. These harmonic patterns are used by most of the professional traders in the industry as they provide an excellent risk to reward ratio. But once you gain some experience, you can try trading harmonic patterns on the demo account, and if you are confident enough, you can apply them to the live charts.

In the end, price action trading is the only tool which can be considered as a complete alternative to the harmonic pattern trading. But a large part of the traders in the industry does not know how to use price action alone to trade the market. So for them, candlestick pattern trading combined with technical indicators is the best method to trade. Overall, yes, there is an alternative to harmonic pattern trading. However, most of the traders in the market aren’t aware of it.

Bottom Line

The one main benefit of identifying and trading the Butterfly pattern is that it helps the traders to identify the top and bottom of the price action so that they can ride the whole trend. The Butterfly pattern is the easiest one in the harmonic group, which provides highly profitable trading signals. The Fibonacci extension levels are an integral part of trading the Butterfly pattern. If the Fib ratios are not attached to your pattern, make sure to add the fibs manually to your price chart so that you can visualize the pattern correctly. Best of luck!