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Fibonacci retracement

How to use Fibonacci retracement to improve your trading skills.


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What is Fibonacci Retracement and Why Trade With It?​

Fibonacci retracement is a technical tool used in financial markets to identify good risk-to-reward entry positions. You can think of it as a ruler to measure the relative distance of a trend wave. The market doesn't always move in one direction without pulling back. When the market is trending, there may be periods of retracement (pullback) after some price movement. During this time, the price temporarily moves against the trend, which can attract traders who see these pullbacks as opportunities to enter the trend at a potentially better price. Fibonacci retracement is an excellent tool for measuring how much the market has pulled back. You can then define the pullback ratio (for example, 61.8% or 78.6%, which are among traders' favorites) at which you want to enter the trend.

What are the benefits of trading using Fibonacci retracement with a fixed risk amount instead of fixing the lot size?​

Simply speaking, there are two main reasons. (1). Better risk control and (2). Better risk-to-reward ratio.

  • Better risk control: Your stop-loss distance and the currency you trade may vary. When you trade with a fixed lot size but different stop-loss distances or commodities, it may result in varying losses, making risk management a challenging issue. However, when you trade with a fixed risk amount, a longer stop-loss distance or a higher currency price will reduce the lot size you can trade, thereby "normalizing" the risk between each trade compared to a fixed lot size trading strategy.

  • Better risk-to-reward ratio: If you trade with a fixed risk amount, you can strategically enter your trade with a shorter stop-loss distance and potentially generate significant profits. For example, if you set the risk per trade to be $100 USD, you can buy more lots if your entry price is closer to your stop-loss. This approach can result in amplified profits compared to a fixed lot size strategy because you're buying more shares or contracts with the same risk exposure ($100 USD). When the price moves in your favor, this difference in lot size can lead to a significant increase in profits. If your stop-loss is triggered, you can still manage it to remain within your risk-per-trade level.

What is the common Fibonacci retracement ratio, and how does it affect trading​

The most common Fibonacci retracement ratios are 50%, 61.8%, and 78.6%. For a buy order, a retracement of 50% means the price has moved 50% back from the highest point to the previous lowest point. A pullback of 78.6% indicates a more significant retracement compared to the 61.8% and 50% levels. Since different traders may enter the trend at different retracement ratios, there is no simple answer to which retracement ratio is better for entering a position. However, there are a few things you need to consider:

  1. The LOWER the retracement level, the MORE FREQUENTLY the price will reach it: For example, the price is more likely to "pass by" the 50% retracement level more frequently compared to the 61.8% and 78.6% levels. This means that if you are trading with a higher retracement ratio, you may have fewer opportunities to enter the market.
  2. The HIGHER the retracement ratio, the BETTER the risk-to-reward ratio: Trading with a higher retracement ratio means you have a shorter stop-loss distance compared to a lower retracement ratio. This is because when the risk amount is fixed, you can buy more lots when the market pulls back deeper.
  3. The HIGHER the retracement ratio, the HIGHER the chance of generating excessive loss: As mentioned earlier, you can enter with a larger lot size when the price pulls back deeper. However, with a larger lot size, you may also incur a greater loss if the price penetrates your stop-loss level. This often happens because many traders set their stop-losses close to key price levels. This is why we designed a feature to slightly reduce the lot size by considering the breakthrough distance when the price breaks through your stop-loss level.
Adjust the money-to-risk-per-ticket to reduce excessive loss

Excessive loss may occur when the stop-loss distance is short (e.g., a one-bar pending order) or when trading with a small stop-loss timeframe (e.g., M1). If you consistently encounter over-loss, try slightly reducing the money-to-risk-per-ticket. For example, if you set 30 USD as your risk amount and the average loss is consistently larger than this amount, you can reduce it to 25 USD or 20 USD and test it over several attempts.