Common, Costly Fibonacci Mistakes

04/16/2012 3:55 pm EST

Focus: STRATEGIES

Anne-Marie Baiynd

President and CEO, TheTradingBook.com

Applying Fibonacci in non-trending markets is an all-too-common error, says Anne-Marie Baiynd, but when used properly, Fibonacci works well in all markets and time frames.

My guest today is Anne-Marie Baiynd. Anne-Marie, Fibonacci is very popular, but are traders using it the right way?

A lot of times, we don’t use them the right way. Fibonaccis are meant to be supplements to market movement and wave action.

Many times, we just slap them on and look at a chart and go, “OK, I need to go high to low,” and we don’t think about that wave action, but it’s also a matter of trend.

Remember, unless you are selling options that involve time decay, your goal is to get into a stock at one level and have it move to another level for you to get out, and you can’t do that without trending. So many of us use Fibonacci, but what we have is sort of a flat environment.

So really as commonplace as it is, that 50-period moving average, that 20-period moving average, that 30, those sorts of things are critical to look at. I like to say that if it’s at two o’clock or three o’clock on the hands of a clock, or four o’clock and five o’clock, you’ve got great momentum.

You can slap up your Fib there and wait for it to come into support and then move forward, but if you’re meandering around three o’clock, that’s not a good place to use Fibs, because you’ll be bouncing from one Fib back down to the other and then sitting in a tight range.

Is there a specific type of time frame where you like to use Fibonacci? One that you think it’s most effective with?

The great thing about Fibs is they work wherever. The thing is, have you got the patience to wait for it to come to the level?

When we’re trading, one of the biggest things is we see the set-up, but we can’t wait for it. It really takes away our confidence in the Fibs if we jump on in and then have to wait around, but it doesn’t matter what time frame you use.

Really, if you could trade it, you could slap Fibs up on a one-minute time frame. You really wouldn’t want to unless you’re buying a million shares of something, but it works, and so the key element there is what is your comfort level?

How well do you trade a five minute? How well do you trade a 15 minute? Do you have that “analysis paralysis” event that occurs, and if it’s like that, you need that longer time frame, but the Fibs will work no matter where it is.

Everybody wants to hit the 61.8 level perfectly and bounce off, but it’s rarely that. Do we look at it as more of a zone, or do I want it to come as close to that thing as possible before I decide?

That’s a terrific question. Here’s what happens: we do want it to come to that 61.8. Very often it does, but remember, there’s always someone there waiting to stop out the guy who gets into the trade early if trading the reversal off of that 61.8.

It is a zone, in a sense. There is a space that you come to where it’s a little bit above or it’s a little bit below, or traders are setting up to argue there so that somebody wins and it becomes a tug of war.

You have to wait and look to see if a range is developing, or if everybody pretty much has said, “Nope, we’re going to sell it here,” and of course, you’ll see that ‘V’ shape or you’ll see that rounded/flat shape if they’re arguing.

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