How to Use Fibonacci Levels in Trading
08/14/2009 12:01 am EST
The SPY (S&P 500) ETF gave us a few examples of how to use simple Fibonacci retracements for specific purposes of price targeting and trade entry. Let's take a look at the one-minute chart to see what we can learn.
When price made its initial large downswing from the $98.40 highs to the $97.34 lows, one could have entered long as price began to rise off the lows, breaking above the $97.50 highs off of a positive tick divergence (not shown here) and doji on the five-minute chart.
How would you set your target, or what price would you play for?
Drawing a specific Fibonacci retracement grid from the highs to the lows could help answer that question.
First, let me say you would place a stop a slight distance—not too close but not to far—from the $97.34 swing lows. The resulting 38.2%, 50.0%, and 61.8% Fibonacci retracements of the large morning downswing come in at $97.75, $97.87, and $98.00 respectively, and all of them could serve as logical price targets.
The 38.2% would be a conservative upside target, the 50.0% would serve as a moderate target, and the 61.8% would serve as an aggressive price target. Your risk tolerance and trading tactics would determine what target to play for and how to size your position, but that is for another article!
The 61.8% target would serve as a "maximum," or "best-case scenario" target (as observed when putting on the trade). Notice how price retraced (rallied) all the way up to this level, found resistance as expected (blowing through the 38% and 50% retracements with ease, which gave clues that odds shifted further upside to come) and did retrace at the $98.00 zone (which corresponded with "round number" confluence resistance).
Not only was this a trade exit (long) target, but it could have served as a short sale entry, particularly since we formed an internal tick divergence and bearish reversal candles (on the five-minute chart) at the $98.00 level.
The logic is the same on the second blue Fibonacci grid I've drawn, only we're looking for where the price will likely find support, and thus, a target (exit) to cover our short sale.
By Corey Rosenbloom of AfraidToTrade.com