Fibs for Forex

02/15/2013 12:16 pm EST

Focus: FOREX

Huzefa Hamid

Senior Analyst, DailyForex.com

Fibonacci retracements are very valuable finds for forex traders and Huzefa Hamid explains why the 88.6% reversal is key.

Most traders are familiar with Fibonacci that can be used on any market, and specifically the forex market, is what we're talking about today with Huzefa Hamid from the TheForexRoom.com.  So Huzefa, talk about something you like to use, a Fib reversal.  What is that?

Hi Tim.  Okay, so the Fib reversal is basically a Fibonacci retracement, and Fib retracements have been around for decades, hundreds of years.  It's a very, very basic tool and it's a very hand-drawn tool.  You can't systemize it too much.  You have to pick your swing highs and your swing lows.  Now the Fib reversal that I use in particular and that we're using in our room is the 88.6% reversals and that number is derived from the golden ratio itself. 

So if you take the golden ratio of 61.8%, the standard Fib level, you square root it and you get an 0.786, you square root 0.618 and you get 0.786 and you square it again and you get 0.886 or 88.6%.  We've found just through experience that we can use that Fib reversal pattern itself, by itself, without having too much confluence on other things.  Whereas, the 61.8% is a great reversal, but it's not enough to get it into the market by itself.  So if you see 61.8% bounce, that's good.  It's telling you something, but by itself it may not be enough of a signal to go into the market.  The 88.6% if we see a clean bounce, it's a fantastic tool.

You mentioned the clean bounce.  I know that a lot of Fibonacci traders initially have trouble wanting that to come exactly to that line and bounce off of it.  Is it more of a zone?  How close do we need it to get to be a valid signal?

Pretty close.  I like to have it within a few pips.  Obviously it depends on the type of chart you're using.  If you're using weekly charts, you're looking at about within 10, 20, 30 pips and then it's a fair bounce.  If it's on an hourly chart or less, you're talking about less than 5 pips.  It should be within that range.  If you see say a stronger reversal bar, 7 pips away from that bar and it's a strong reversal bar, then you can take that as a valid bounce. 

I have a great chart example.  It's a dollar Swiss example.  On a weekly chart every year, there was an 88.6% bounce that I took and it was within 0.5 of a pip over a 1000 pip range, that 88.6% hit it.  Zooming to the daily, it bounced solely in the offering.  So it was a fabulous, fabulous bounce and a lot of people missed it.

The last thing is drawing that swing high and swing low, between which one is always a tough thing for a new Fib trader.  Are there any rules that you know of to find the right low to draw it to and to the right high?

The first thing I do is to tell traders to get out of candlesticks and go into bar mode because candlesticks give you sometimes far too much information when you're looking for swing highs and swing lows, and you can get distracted within the kind of inter-period pullbacks.  So go into candlesticks, zoom out.  It's really an art.  You need to spend some screen time over weeks, and maybe months, just getting used to looking at bars.  Have a template where it's just price.  Take off all your indicators, take off the stochastics or whatever else you might be using and just look at the price and these things should start popping out at you. If you can't see it, start being old fashioned.  Print out your chart, flip it over, turn it around and see if you can see the same bearish backing as a bullish backing and that kind of thing.

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