The Fibonacci retracement tool can be an extremely useful tool for deciding buying and selling points, as discussed in the TA-7 tutorial. However, it is important to known some of the common mistakes that traders are prone to make when using this tool and how to avoid them, which is what I am going to discuss in this tutorial.
1. Fibonacci reference points – do not mix them!
When fitting Fibonacci retracements to price action, it’s always good to keep your reference points consistent. So, if you are referencing the lowest price of a trend through the close of a session or the body of the candle, the best high price should be available within the body of a candle at the top of a trend: candle body to candle body; wick to wick.
When you use the retracement tool, you have to choose a low point and a high point on the graph, which is what we call a reference point. So if you choose the lowest point of a trend through the close of a session or body of the candle, the highest point should also be chosen within the body of a candle at the top of a trend – candle body to candle body or wick to wick.
If you mix the reference points, so for example if you go from a candle wick to the body of a candle, this can often lead to inaccurate analysis.
You can see in the image below that the reference points were inaccurately chosen, as neither the lowest point nor the highest point are at the end of the wick.
2. Don’t ignore long-term trends.
When you measure significant moves, up or down, in the short-term, it is very important to look at the bigger picture – the general trend. The general trend represents a framework within which the value of the coin can vary significantly but nevertheless, the general trend can still give you a rough idea of the direction in which the asset is set. If you apply the retracement tool and you take into account the general trend, you are more likely to be correct when establishing the momentum and setting up your orders.
You can see in the image below, that the general trend is going upwards. In order to establish a trend, you need 3 contact points on the candles at least. In the image below, there are 4 contact points for the trend line. Applying the retracement tool, we can now see that the coin had a support level 38.2% Fib level so going long on this coin would have proven to be quite beneficial.
One of the biggest reasons why your retracement tool needs to be aligned with a general trend is because you don’t want to be fighting the general trend, which is a powerful indicator. Maybe your Fibonacci shows signs of a pullback but if the general trend is going upwards, you need to take that into account.
3. Don’t rely on Fibonacci alone.
This is a general rule that applies to any financial tool or indicator – do not solely rely on only one of them. Fibonacci retracement tool is a highly valuable tool, but applying additional tools such as MACD or stochastic oscillators can provide further proof to your decision and increase the likelihood of being right.
4. Don’t use Fibonacci over short intervals.
Using Fibonacci over short intervals (a few hours, for example) can be inaccurate because there is much volatility in price, especially in the cryptocurrency market. Generally speaking, the shorter the time frame, the less reliable the retracement levels are.
The dynamics of day trading is built in such a way that it can be difficult to find and establish accurate trends and also to place stop-loss orders or take profit points because the volatility can create narrow and tight confluences.
Try and apply the retracement levels over a longer period of time to assess the trend more accurately.