One Tool to Quickly Improve Your Trading
In this video, I break down how I like using Fibonacci Retracements to identify entry points (the trigger zone) and take profit levels when in trades.
Fibonacci Retracements
I am back with a brand new trading video and in this one, I’m going to cover a simple way to help you identify the best place to take profit when in a trade, and you can even use it to help you enter a trade.
We are talking about Fibonacci Retracements. This is a popular tool among technical traders, and there are quite a few different ways people use them, so let me cover the basics first.
What is Fibonacci?
In mathematics, Fibonacci numbers form a sequence where each number is the sum of the two preceding ones, starting from 0 and 1.
Fibonacci sequences also appear in nature, like the arrangement of leaves on a stem, pine cones, etc.
Now for trading, it’s often used to measure the vertical distance between a peak and a trough, and then the Fibonacci tool divides the vertical distance by key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%, and 100%.
This can then help you identify possible areas of support and resistance.
Luckily, just about every charting platform has the Fibonacci Retracements tool for you to use.
Before You Start
So like anything else, this isn’t some magical tool or indicator that will automatically make you a profitable trader. You’ll want to use Fibonacci retracements in addition to other forms of analysis.
Before you enter a trade based on Fibonacci levels, visually look to the left on the chart and find previous areas of support and resistance… you might also want to look at the S&P and see if it’s also looking strong, and so on and so forth.
Trading the Opening Range
The most common way I use Fibonacci is to measure the opening range. Let me pull up Docusign’s chart from this morning. After the first 30 minutes of the market open, I will find the highest point… click with the Fibonacci drawing tool, and click on the lowest point. This automatically plots out specific levels… but I’m only interested in a few, so let me show you which ones I have enabled. I have the 0 line, 1, -0.618, -0.272, 0.618, 0.5, 1.272, and 1.618.
Now oftentimes, I will find a stock that had a nice run at market open, and then enter on a pullback. So you could add a moving average to do this – like the 9 EMA… wait for it to come back down to this line, and enter there. That’s fine. You could also use the Fibonacci trigger zone like this orange zone here which is between 0.5 and 0.618. Ideally, we want to see the price come down to 0.5 and then work it’s way back up.
Now that we have our range mapped out with the Fibonacci retracement tool, let’s look for an entry. Okay, so we hit our 0.5, and even broke below it. We’re still waiting to enter. Okay, we can see the stock isn’t doing a whole lot – kind of chopping around this zone. I’ll draw a trendline over the top and look for it to break.
Okay, so we broke out of the downtrend, so we could enter on this next candle. So our first take profit level is the 1.272 level, and our stop-loss I want to put just below these recent lows. If the stock isn’t moving how I am expecting it to, we can cut the trade there for a small loss. This gives us a 2.19 to 1 risk/reward ratio. Let’s see how this would play out. Oooh, it came pretty close to our stop-loss, but it started picking up strength, and about an hour later we are at our first take-profit level. Here we can decide to exit completely, or start to scale out of the trade. If the market and this particular stock is still looking strong, we can hold some of our position with the 1.618 target as our final take-profit, which is a 3.4 to 1 risk/reward ratio. We can see we did hit the 1.618 level which, you know, definitely doesn’t happen every time.
So that was a pretty good example of this strategy. We take the 30-minute opening range, use fibs to divide the distance and provide us with targets. Then we wait for the stock to come into our trigger zone… I often find a lot of times stocks will chop around this zone for awhile, so I’m usually patient on my entry. I want to see it breaking above any downtrend, and if there is still strength in the overall market and this particular ticker, I will enter and keep my stop loss just below recent levels of demand. My first take profit is 1-2-7-2 and my final take profit target is the 1-6-1-8 level.
While I didn’t catch the Docusign trade, I did take a Facebook trade. Now I didn’t really have a good entry because I didn’t wait for a better pull-back or for the 30-minute opening range to develop. So this trade turned red on me pretty quick. My stop-loss was just under this market area of support… and with options, I’m using mental stop-losses, so we can see it pretty much came down and tapped that level, but then we had a nice green candle pushing it back up.
Because my entry wasn’t so great, I ended up holding it a bit past my first target since it blew through it, re-tested it, and had another big green candle up. So I ended up exiting completely in between these two fib levels.
This wasn’t a huge win, but still a decent trade and the fib levels help give me these take profit levels.
Facebook actually had a great day and continued running far past my fib levels, and even re-testing the 1-6-1-8.
Bearish Example
We can also use this same concept for a downtrending stock – maybe we see that Nvidia had a weak close the day prior and we’d like to buy put options on it.
Again, let’s map out our 30-minute opening range. Several times, the price wicks into our trigger zone, so we could enter a trade here. Our stop-loss would be just above these wicks outside of our zone, and -0.272 is our first take profit level, which gives us a 3 to 1 risk/reward ratio. We hit our target less than an hour later and again, we can exit completely or if we think there is still more downside left, we can hold a partial position with -0.618 as our final take profit level, which is over 7 to 1 risk/reward ratio.
That worked out really nicely… almost too nicely. So let’s just look at a few examples that don’t work out so perfectly.
When It Doesn’t Work
AAPL
Here’s an example of a strong opening from Apple. Mapped out with fib levels, now we just want to enter when it hits our trigger zone. Well, it had no time for us, and continued on with us just sitting in its glorious, designed in California dust. This is where, if you were entering on something like a 9 EMA pullback, you could’ve gotten in on the trade, but trading using the fib trigger zone would’ve left you behind.
SQ
So here’s Square. The first 30-minutes don’t look so great. It gapped down to open and just looks… weak. We map out the first 30 minutes with fib levels… and maybe buy puts when it hits our trigger zone. Well, boom, we got stopped out almost immediately. Square decided to reverse and run the other way, where, if we were in call options, well these fib levels would’ve been great. That’s why I usually like to wait and see how price interacts with the trigger zone before entering a trade.
ABNB
Another time when I when I’d probably hold off on this strategy is when there isn’t clear strength or clear weakness… when a stock is just chopping around. Here is Airbnb with our opening range. Looks kind of weak, but if you thought strength was building and decided to go long when it came into the trigger zone, well you might’ve thought you made the right call, but this massive candle would’ve knocked you out fast. And, look at it hitting our bottom fib level just about perfectly.
Recap
So let’s recap exactly how to implement this strategy in your trading:
Identify the stock you want to trade
30 minutes after market open, use the Fibonacci retracement tool to map out your levels
For a bull position, you want to see a strong opening; For a bear position, a weak opening
If price action is choppy, leave it alone until there’s a clear direction
Stop-loss just outside trigger zone
Start scaling out of the trade at 1.272
Second take profit level at 1.618
Final Thoughts
Again, there isn’t one bulletproof tool – just another thing you can add to your technical analysis arsenal. This has helped me a lot with my trading though – many times I wouldn’t have such a concrete take profit level and just exit whenever I was happy enough with the percent return, but there are so many times where I paper-handed a trade, sold it too soon, and then watched it come up and hit my fib targets, so I definitely recommend you trying it out for yourself. There are so many times where the fib levels work so uncannily well, you might as well see how it can help you.
I hope you found this video to be helpful and if you could, go ahead and tweak that thumbs up button, subscribe if you haven’t already, and I’ll see you in the next one.