Back in
Grade 1, we said that support and resistance levels eventually break. Well,
seeing as how Fibonacci levels are used to find support and resistance levels,
this also applies to Fibonacci!
Now,
let's go through an example when the Fibonacci retracement tool fails.
Below is
a 4-hour chart of GBP/USD.
Here, you
see that the pair has been in downtrend, so you decided to take out your
Fibonacci tool to help you spot a good entry point. You use the Swing High at
1.5383, with a swing low at 1.4799.
You see
that the pair has been stalling at the 50.0% level for the past couple of
candles.
You say
to yourself, "Oh man, that 50.0% Fib level! It's holding baby! Time to
short this sucka!"
You short
at market and start day dreaming that you'll be driving down Rodeo Drive in
your new Maserati with Scarlett Johansson (or if you're a lady trader, Robert
Pattinson) in the passenger seat...
Now, if
you really did put an order at that level, not only would your dreams go up in
smoke, but your account would take a serious hit if you didn't manage your risk
properly!
Take a
look at what happened.
It turns
out that that Swing Low was the bottom of the downtrend and market began to
rally above the Swing High point.
What's
the lesson here?
While
Fibonacci levels give you a higher probability of success, like other technical
tools, they don't always work. You don't know if price will reverse to the
38.2% level before resuming the trend.
Sometimes
it may hit 50.0% or the 61.8% levels before turning around. Heck, sometimes
price will just ignore Mr. Fibonacci and blow past all the levels just like how
Lebron James bullies his way through the lane with sheer force.
Remember,
the market will not always resume its uptrend after finding temporary support
or resistance, but instead continue to go past the recent Swing High or Low.
Another common problem in using the Fibonacci tool is determining which Swing Low and Swing High to use.
People
look at charts differently, look at different time frames, and have their own
fundamental biases. It is likely that Stephen from Pipbuktu and the girl from
Pipanema have different ideas of where the Swing High and Swing Low points
should be.
The bottom
line is that there is no absolute right way to do it, especially when the trend
on the chart isn't so clear. Sometimes it becomes a guessing game.
That's
why you need to hone your skills and combine the Fibonacci tool with other
tools in your forex toolbox to help give you a higher probability of success.
In the
next lesson, we'll show you how to use the Fibonacci tool in combination with
other forms of support and resistance levels and candlesticks.
