Fibonacci Arc Definition
Fibonacci Arc
Definition
Fibonacci arc is a technical analysis
indicator used to provide hidden support and resistance levels for a security.
A
fibonacci arc is constructed by first drawing a trend line between two swing
points on a chart. These two points should be between a clear peak and
trough on the chart. Once the line is drawn, key fibonacci levels are
placed on the chart at 38.2%, 50%, and 61.8% retracement levels. An arch
is then drawn at each respective level to generate the arching angles on the
price chart.
Trading with Fibonacci Arcs
Breakouts
Trading with fibonacci arcs is done by first identifying
the key fibonacci arc levels. The next step is to monitor how the stock
performs at these key levels. If the stock breaks above both a recent
price high and an arc resistance level (38.2%, 50% or 61.8%), a buy order
should be placed. Traders should then look for the next higher fibonacci
arc level to lock in profits, or sell the position outright.
Reversals
Another popular method when trading fibonacci arcs is to
look for a failure at fibonacci arc levels. Since arc levels are not
followed by many traders, these are considered "hidden" levels on the
chart. For example, a trader can wait for a break above the 61.8%
retracement level and then close back above the arc. A short position
should be entered after a move below this reversal bar.
Fibonacci Arc Trading
Example
Below is a fibonacci arc trading example, courtesy of VT
Trader. This example is on a 30-minute level over a two-day period.
Notice how a trough and peak are used on the chart to draw the trend line which
the fibonacci arcs are based upon. Then notice how as the price reacts
from the peak it sells off sharply down to the 61.8% arc retracement
level. This hidden arch level initially acted as support, but as the
EUR/USD closed below the arc level, it eventually became resistance.
Fibonacci
Arc
One thing to remember
about drawing fibonacci arcs is that it is based on the scale of your
chart. So, if a trader is using a logarithmic scale the arcs will look
differently than on linear. This is because the arcs will be extended
differently as a result of the logarithmic scale because the price is weighted
and will change as the chart moves out in the future. Whereas a linear
chart will simply reflect the price movement in a straight line fashion.
Fibonacci Arcs Trading Approach
Now
that you are familiar with fibonacci arcs, we will now dig further into how to
trade with the indicator.
After
all, it is not enough to identify patterns on the chart. You should also know
how to enter and exit trades based on signals from the indicator.
Entering Trades - Fibonacci Arcs
There
are two types of price moves, which you can attempt to catch with the fibonacci
arcs tool. These are price moves in the direction of the trend and price moves
against the trend.
Trading Fibonacci Arc Breakouts against the Trend
fibonacci
arc
The
chart above is of a bullish trend that enters a reversal phase.
You
will want to use the high and low of this pattern to create the fibonacci arcs.
On
the way down the price action breaks the 23.6%, 38.2%, 50.0%, and 61.8%
fibonacci arcs. See that after each breakout in the arcs the price decreases
further. Each of these breakouts gives you an opportunity to trade against the
primary trend.
As
you can see, this method would have worked all the way down as the stock
ultimately retraced the entire move.
Trading Bounces using Fibonacci Arcs
This
trading practice involves trade entries after the price bounces from one of the
arcs in the direction of the trend. Imagine the price breaks a trend and goes
to one of the fibonacci arcs. If you see the price bouncing from the arc,
you should trade the stock in the direction of the bounce.
Pullback
Trade - Fibonacci Arc
Above
is a classic example of a price bounce from a Fibonacci Arc.
Again,
we use the high and low of the pattern to create the fibonacci arcs.
The
price starts decreasing and it breaks the 23.6%, 38.2% and 50.0% fibonacci
arcs. Then suddenly the price action touches the 61.8% arc and creates a small
bullish candle, indicating a bounce.
We
use this bounce as an opportunity to enter the market and place a long trade.
As
you see, the price finds support at the 61.8% arc. The stock then begins to
resume its bullish move higher.
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Stop Loss - Fibonacci Arcs Trading
You
should always protect your trades with a stop loss, regarding of the method.
This same rule applies to Fibonacci arcs – no exceptions. After all, the market
will not always move in your favor.
Therefore,
you should never let the market surprise you.
Since
there are two types of entries when trading with fibonacci arcs, we will
approach two types of stop loss order positioning.
Stop Loss - Fibonacci Arc Breakouts
When
you see the price breaking a fibonacci arc, you are supposed to enter the
market in the direction of the breakout. In this manner, you are trading
against the previous trend.
To
position your stop loss, you should pick a price peak, which is located
somewhere above the broken arc.
Let’s
walk through a real-life example, to clarify the placement of the stop loss
order.
Fibonacci
Arc - Stop Loss
The
red horizontal lines on the image represent the proper location of the stop
loss orders on these potential trades. See that the second and the third trade
share the same level for a stop loss order. The reason for this is the weak
downward move after the second short signal.
The
bottom line is that you are protecting your gains as the stock moves higher in
your favor. This my friend is how you make money in the market.
Stop Loss - Fibonacci Arcs Bounces
This
time we will position the stop loss orders beyond the levels, which the price
bounced off the fibonacci arc.
Fibonacci Arc - Stop Loss for Bounce Trades
Above
you see the bounce from the 61.8% fibonacci arc we discussed a couple examples
ago. The red horizontal line represents the proper location for your stop loss
order. See that we use the small range, which the price creates in the time
before the bounce. If the price decreases to this level, it will definitely be
outside the 61.8% arc.
Profit Taking - Fibonacci Arcs
Scalping for Moves between the Arcs
This
profit approach includes trading the price moves from arc to arc. No matter if
the price has broken, or bounced from an arc, you should stay in a trade until
the price reaches the next arc.
For
example, if the price breaks through the 23.6% fibonacci arc, you should open a
trade and stay in the position until the price touches the 38.2% arc.
Trading until the Stock is Trending in
Your Favor
Some
traders are very flexible on their profit taking approach and like to let the
stock run in their favor. In this manner, they prefer to stay in the trade
until they receive a contrary trading signal from the stock.
After
all, why exit a trade, which is going more and more in your favor?
This
means you essentially ride the wave until the price goes against you.
While
this approach will yield the largest gains, the success rate will be relatively
lower.
This
is because the price will
likely reverse at some point and retest your entry.
As a responsible trader, you will need to determine which profit taking
approach works best for your personality.
I
prefer to go with the a high winning percentage.
This
is because I am a sore loser and I still get upset when things do not go my
way. Similar to the way I felt when I was 5 years old and my brother
would beat me in a game.
Hey,
don't judge me; I am what I am.
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