Forex is a highly volatile market.   he exchange rate can move 150 points or more in a matter of minutes, especially if there is major announcement or central bank intervention. For example, when Alan Greenspan made a comment and around the same tme the Japanese Government intervened in the market, the affected currencies moved significantly.

One must use a mental stop loss or enter a stop loss or risk losing most or of one’s capital. Immediately entering the “market at order”, a stop loss must be placed. It is a pre-calculated price where you plan to exit the trade if the market moves against you. It forces you to folow an exit strategy getng you out of the market at around the nominated exit price. If possible, it is wise to place the stop loss just above or below a resistance or support line.

A stop loss should never exceed your maximum exposure amounts. One should never increase your stop oss after you have entered a trade and established your stop price.

RISK TO REWARD RAIOS are important and should be calculated.

A risk reward ratio of 1:1.5 is recommended.

Risk. 30 pips to make a profit of 45 pips or risk 40 pips to make 60 pips.

The best location for placing stops is:

15 pips above the last swing high for a SHORT trade and

10 pips below the last swing low for a   LONG trade.

An alternative place for a stop loss would be just past the next Fibonacci level, e .g buy at 61.8% retracement and place the stop loss below 78.6% retracement.

It is stl important to apply the above calculations for your risk/reward. If stops exceed the risk/reward calculations, seriously consider not entering the trade.

Moving Stops

It is important to protect your profit. One way is to use a moving stop loss. When the trade becomes profitable, you move the stop loss to reduce your risk.

If the Stop Loss is 40 pips with 1:1.5 risk reward ratio, you are risking 40pips to make 60pips profit.

• When the market moves 10 pips in your favour, move the Stop Loss 10 pips. Your Stop Loss wil now be reduced to 30 pips.

• Continue reducing the stop loss each tme the market moves another 10 pips in your favour. Your stop can eventually be moved to your entry point and give you a “free” trade.

• When the market reaches 75% of your original target for profit, begin progressively tghtening the distance of your stop from the current market price.

• If there is no sign of a market reversal, take off your lmit order and continue to use the moving stop technique to protect profits and ride the trend.

• If there is strong evidence of a market reversal, close your posion with a market order and consider opening a new posion going in the new direction. You wil need plenty of practice to do this lve. We know that after a big rally there is always a consoldation which is basically a retracement to a Fibonacci level.

You need to have a stop that does not folow the market too closely. The noise or whipsaw in the market can be 20 – 30 pips or more and wil take out stops that are too small. It is suggested that stops should be at least 30 to 40 points in most cases, especially in the early part of a trade. However, the best posion for stops is above and below points of resistance or support as mentioned above.

Convergence is when the coincidence of 2 or more Fibonacci price relationships comes together with a relatively tight range.

For example, a Fibonacci convergence is where a 38.2% off one high and 50% off another and a 61.8% off another, converging on the same area of the chart. A Fibonacci extension can converge with a Fibonacci retracement creating a bounce.

Two Fibonacci retracements have been drawn on the chart above from two different low ponts. Three cluster points are drawn:

A - where the 61.8% and 32.8% retracements concide.

B - where the 38.2% and 23.6% retracements concide.

C - where the 61.8% and 100% retracements coincide.

Trade Examples:

Example 1.

GBPUSD 30 min chart.

In the chart above, we have a classc ABCD pattern where the entry point is at point C, a 76.4% retracement and a Morning Star Candlestck Pattern.

The point C was at 76.4% and not 61.8% (76.4% is popular on the GBPUSD), but by waitng for the candlestck pattern i.e. the Morning Star we found confirmation of the reversal and a good trade to point D the 161.8% projection.

Note also the point C was close to a Double Bottom with point E and formed a Higher Low Pattern with point 1

Example 2

GBP/USD 4hr

Looking at the GBPUSD 4 hour chart we have the two trade examples:

1.   Entry at Point B on the Bull Engulfing candle with a Target Exit at the 61.8% retracement of the move A to B

2.   The ABCD pattern with entry at C being the 61.8 % retracement of the move A to B confirmed by the double bottom at pont C or the Bull Engulfing candle above C.   he trade exits are at 161.8 % projection at D or the 261.8% at E. Either exit gave very good trades. Note there is a Fibonacci convergence at point E.

Note that point D also forms a Double Top with point A. This convergence of the Double   op and the 161.8% projection increases the relabilty of the exit point.

Example 3

GBP/USD 4hr

Again using the ABCD pattern another good long term trade with entry from the 61.8% retracement confirmed by a Higher Low Chart Pattern.

Exit at point D the 161.8% Projection of the move from point A to point B…

Example 4

GBPUSD 4 Hour

In this example, the candlestck pattern is a Bearish Rejection Pattern which is a convergence of candles at a resistance lne, a 50% retracement. Note how the currency pair was rejected at this level.

The first target point 161.8% of the move from point A to point B at D provided a small support where the price pulled back a small way before continuing down.   his was caused by traders exitng the trade at and around that point.

Example 5

EUR/JPY 30 minutes

This example is a trade off the 30 minute chart. Note how the currency pair set up by retracing to pont C which happened to be a 50% retracement point before continuing short.   his could also be called a “bull trap” as a trader could have entered long at B, only to find the trade rapidly reversed. It is important to watch the price action on and around the major Fibonacci levels. Because the trend was down, good traders would have waited for the reversal at C before placing short trades.

Note how the strong short move stopped close to the 161.8% projection of the move from point A to point B. This is where most of the traders took their profits, causing a pullback.

Example 6

GBPUSD 30 minute

The Fibonacci levels are a very powerful tool in trading forex. They can be traded in isolation or in combination with other signals, for example candlestcks, indicators or chart patterns. In this book we wil use confirmation signals for entry and exit points. 

Buy setups include bullish engulfing candlestck, morning star, tweezer bottom, double bottom and a break of the high of an inside bar. Sell setups include bearish engulfing candlestck, evening star, tweezer top, double top and a break of the low of an inside bar

The methodology wil be demonstrated using real examples using charts and explanations.

One can apply these methods on any tme frame from 5min charts through to weekly charts.

When puttng Fibonacci levels on the charts, one must look back on each tme frame for significant highs and lows.   his may involve looking back days and even weeks.   here are traders trading all the different

me frames so Fibonacci lnes drawn on weekly or monthly charts wil affect the market. Convergence of different Fibonacci levels may occur from levels placed on the different tme frame charts. Where convergence occurs, the levels become more significant. It is important to look for convergence with Support and Resistance Levels and Trendlines

Candlestck patterns are most relable near Fibonacci levels and other support and resistance lnes. Candlestcks are also good for signaling the end of a retracement.

Double tops and double bottoms often appear at Fibonacci levels e.g. 61.8% retracement or the 1.382% extension.

Example of a Sell setup a lot more here short trades

Example of a Buy setup and a lot more >> long tardes

Fibonacci Extensions, Expansions or Projections,

Target point D (Profit Objective) and retracement pont C can be calculated by measuring the number of pips from point A to point B    and multplying by the factors below:           

Most charting software has these extensions available so calculations are not needed.

For a retracement, left click on point A, drag the lne to point B, then release the mouse. For an extension (projection), left click on point B, hold, and drag the lne to point A and release.

Commonly, 61.8% retracements go to at least the 161.8% projection. Sometmes the 100%, 200% and 261.8% extensions come into play.

A lot of money has been made using the ABCD (also called 1234) patterns using retracements to enter and extensions to exit. Enter near point C and exit at point D.

The best way to determine whether a move is a pullback (retracement) or not is to determine whether the price is moving in the direction of the main trend. If the price is moving against the main trend watch for reversals at the 38.2%, 50%, 61.8% or 78.6% Fibonacci Lines. Sometmes the price wil consoldate at one or each of the levels before continuing. Hence it is important to wait for a confirmation signal before re-entering in the reverse direction.

The chart below ilustrates this. In the move down from A the GBPUSD consoldated at B the 38.2% retracement. Note there is no reversal signal here and that the GBPUSD then continued retracing until it reached the 61.8% level. Here there is a Morning Star Candlestck Pattern and a Support lne providing a reversal signal at point C and convergence with 61.8% retracement.

1 , 1 , 2 , 3 , 5 , 8 , 13 , 21 , 34 , 55 , 89 , 144 ,…

The numbers are calculated simply by adding the two previous numbers together.

E.g. 3 + 5 = 8
         5 + 8 = 13
        8 + 13 =21
         etc.

In forex, the Fibonacci ratios are used extensively to calculate targets for exit points and entry points for trades. These Fibonacci levels are relable as a large number of professional traders use them, and when this happens the traders, in mass, drive the prices to these levels.

Let’s look at how the ratios are derived

Take four sequential Fibonacci numbers

Eg        13,21,34,55

By dividing one number with another we get the ratios.

13/21 = 0.618           or        61.8%
34/55 = 0.618          or        61.8%

34/21 = 1.618          or         161.8%
55/34 = 1.618          or         161.8%

21/55 = 0.382         or         38.2%
13/34 = 0.382        or           38.2%

The square root of 0.618 = 0.786
And the square root of 1.618 = 1.27

In Forex trading the key Fibonacci ratios are

0.382 38.2%

0.50 50%

0.618 61.8%

0.786 78.6%   (76.4% is used on Metatrader charts 38.2 x 2 = 76.4% and 1- 34/144 = 0.764) (Price often bounces off an exact 76.4% retracement level and 76.4 is being mentioned by various forex brokers)
1.382  138.2%

1.618  161.8%

2.618  261.8%

On my blog You can find a lot of examples that this numbers works very well. Why? It’s simply the biggest traders use this numbers and it couse the moves.