Using stops with Fibonacci determines potential support and resistance areas for strategic stop placement.
Fibonacci retracement levels can provide a trader with the knowledge of where to place stops. By placing Fibonacci lines over a price chart and extending the lines further than the current price a trader can locate future support and resistance levels and have a better idea on where to place stops.
Using Stops with Fibonacci:
Potential retracement areas can be located by inserting Fibonacci lines over a price chart and extending the lines further than the current market price. Retracement levels tend to show potential resistance and support levels. Where a price is below a retracement level and the current trend is upwards then the subsequent Fibonacci level could be considered a resistance level. Conversely if the price is above a retracement level and the current trend is downwards then the subsequent Fibonacci level could be considered as a support level.
Many forex traders use the Fibonacci lines as guidelines as to where to place their stops losses. When a trader is holding a long position the stop should be placed just below the next potential support level. In most cases this will be the 50% retracement level and as you can see from the above chart the price retraces to just above the 50% level before moving higher again. Having a stop just below the 50% level prevents the stop from being triggered too soon.
If a trader has a short position the stop should be placed just above the next potential resistance level. The price is likely to retrace to the resistance level but unlikely to break through it therefore a stop loss is unlikely to be broken.
How to use Fibonacci retracement and apply the data for setting a stop loss?
Assume that a trader had a Euro short position at 1.4926 as indicated by the Fibonacci 100% retracement on the EUR/USD daily chart below.
Once the price was lower than the 61.8% level the 100% level becomes a resistance level and the trader should set a stop loss just above it. As the price declines further the potential resistance level becomes the 61.8%, the 50% and then the 38.2% levels. Notice how the price retraces firstly just above the 61.8% level, then it retraces to the 50% level and finally to the 38.2% level before the downward trend dies out at around 1.4000 and reverses.
Stop losses moved down to just above each of these levels would not only have been an insurance against a big loss but also locked in more potential profit as each resistance level was left behind. The locked in profit at 61.8% is 371 pips, at 50% is 483 pips and 38.2% is 593 pips.
In conclusion using Fibonacci retracements as stop loss guidelines to support and resistance levels enables a trader to reduce potential losses and lock in potential profits.
Investors: Have you ever considered taking into account social indicators? Now, eToro Openbook enables you to follow real time traders and their trades. Learn from their failures and imitate their successes! Sign up with eToro Openbook today.
