The Go-to Fib Level for FX Traders

06/23/2014 6:00 am EST

Focus: FOREX

Huzefa Hamid

Senior Analyst, DailyForex.com

Huzefa Hamid of DailyForex.com explains how he uses one particular Fibonacci level to spot favorable risk/reward opportunities in world currency markets.

My favorite Fibonacci level is 88.6%, and that is something I have written about many times before. To recap, the 88.6% level is derived from taking the Fibonacci "golden ratio" of 61.8% (or 0.618), square rooting it, and then square rooting it again. This gives you 0.886, or 88.6%.

When the price retraces to a Fibonacci level, all that means is that the size of the retracement as a percentage is equal to a Fibonacci percentage. For example, if the price makes a low, then moves 100 pips up to make a high, then moves back down 88.6 pips before moving back up in the original direction, then it has retraced 88.6%.

When I am using other Fib retracement levels, such as 61.8% or 38.2%, I often want to see a confluence of other factors such as a chart pattern, previous support/resistance, etc. But with the 88.6% level, if I see price bounce cleanly off it and move away, I can often take a trade on that alone, especially if it is in line with the larger trend. I have found it to be a very accurate predictor of price movement.

One Tuesday morning, I saw a nice, clean 88.6% retracement on the one-minute EUR/USD chart:

chart
Click to Enlarge

The price made a low and then went up to make a high between the two points marked with an "X"; it then retraced down 88.6% and bounced off it within a pip. (You could also have seen this on a five-minute chart.)

Notice that after the bounce, not only did the price move back to the original high, but it continued moving up for the rest of the day and didn't look back-over 150 pips from the original 88.6 level.

chart
Click to Enlarge

It is worth pointing out that the price at the 88.6% level, 1.3097, was also a previous area of support and resistance, further validating an entry.

In the following five-minute chart, I've marked 1.3097 with a red line, and looking back on the chart, you can see previous support/resistance that I've highlighted with grey boxes:

chart
Click to Enlarge

The previous support/resistance confluence is particularly useful because the previous trend on the one-minute and five-minute was down, so taking a long trade was against that short-term trend.

NEXT PAGE: The 88.6% Level Works for Short Trades, Too

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As the day unfolded, the uptrend paused and developed into a range that lasted for about 35 minutes. During that range, another 88.6% retracement occurred that presented opportunities to buy into the current uptrend and/or add to previous long positions.

chart
Click to Enlarge

The other advantage an 88.6% bounce has over 61.8% is that the price has further to travel to the previous high (in this case for a long trade), therefore giving you a better risk/reward ratio for your trade.

Typically, I place stops just below the 88.6 level or the 100.0 level. Ask yourself first, "What is the risk/reward ratio on the trade?" If your minimum target of reaching the beginning of the retracement, i.e. the zero Level on the Fib lines, cannot be reached with a decent risk/reward, then pass on the trade.

The above examples are for long trades. They work exactly the same in reverse with short trades. In those cases, the 100.0 Fib level is at the previous high, and the zero Level at a low, and you're looking for the price to move up to the 88.6% and bounce down.

Simplify your Fib retracement lines to 61.8% and 88.6% (or even just 88.6%) and start looking for these bounces.

In summary:

  1. The 88.6% Fib retracement level is one of the more powerful Fibonacci levels when it produces a bounce. You can consider a trade just on that level or with previous support/resistance (the best trades are often in line with the larger trend).
  2. The 88.6% level gives good risk/reward ratio trades when caught early. Always consider risk/reward for every trade.
  3. Bounces off 88.6% retracements often travel much further than just the previous retracement, allowing you to trail some of your position.

By Huzefa Hamid, Contributor, DailyForex.com

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