Trading Basics: Evolution of a Trader

FIBONACCI RETRACE STOP: DEAL OR DUD?

Most of you probably know about the Fibonacci number sequence, how it came about, how to calculate it, and how nature makes use of it. If not, then that is too bad because I am not going to discuss any of that either. The book, Candlesticks, Fibonacci, and Chart Pattern Trading Tools (Wiley 2003), by Robert Fischer and Jens Fischer, gives an entertaining introduction to the subject.

The idea behind a Fib retrace stop is that price will turn after retracing 38, 50, or 62 percent of the prior rise. This type of stop comes in handy during a long straight-line run when the closest minor low would be too far away to park a stop underneath. Although I refer to the percentages as Fibonacci numbers, they are mathematical derivations from the Fibonacci number sequence.

Figure 3.3 shows several examples. Let us discuss the ABC move (I chose the BC decline because it is proportional to the AB rise). Point A has a low of 43.10 and B has a high of 55.48, for a height of 12.38 (55.48 – 43.10). Applying the 38, 50, and 62 percent retrace values, we get 50.78, 49.29, and 47.80, respectively, which are shown on the chart. The first value, 50.78, is found by taking 38 percent of the 12.38 height to get 4.70, which is then subtracted from the high price: 55.48 – (12.38 × 38 percent) = 50.78. The same logic applies to the 50 and 62 percent retrace values.

Figure 3.3 A Fibonacci stop below C would work well.

Move AD retraces 50 percent before moving higher. The ...