As the saying goes, "Tell me where the market has been and I will tell you where it is going to go." The first step you need to take is to draw all the uptrendlines and downtrendlines including the inner, outer and the longer term lines. This is done so that you know if the market is in an uptrend or a downtrend or whether the trendline has been broken signaling the potential end of the trend.
You also use the ADX indicator combined with the DMI indicator to determine whether the market is in a strong uptrend. Now find the latest upward rally AB in the market. Most trading software now has the Fibonacci Retracement and Extension Tool. If you are a currency trader and use MT 4 then you can easily find this essential tool in the menu.
Now, suppose you have drawn the Fibonacci Retracement and Extension Levels on the chart. Look for a candlestick pattern like the Bullish Engulfing Candlestick Pattern, Hammer or a Morning Star in the price action to form. Once this candlestick pattern appears, it heralds the reversal in price action that is about to take place. These candlestick patterns are formed at the bottom of the swing so when it form, plan to enter the trade with a stop loss slightly below the entry. This stop loss should not be very tight otherwize it will trip with small noise.
Find the projected Fibonacci Extension D (1.27%) as well as four levels of past resistance. Use a trailing stop. Hey, you are trading an uptrend. This way if the price action begins to retrace, you are not going to lose your profit. Calculate your reward to risk ratio. Reward is obtained by the number of pips between the entry and the Fibonacci Extension. Risk is the amount you are prepared to lose if the market does not do what you want it to do. If this reward to risk ratio is more than 2, enter the trade. Otherwise skip it and wait for another chance. Similarly in a downtrend, first confirm it. Draw the Fibonacci levels with the trading software taking the latest swing. In this case the Fibonacci levels will be the reverse of that in the uptrend. Calculate the reward to risk ratio. It should not be less than 2. Wait for the candlestick patterns mentioned above to make an entry. That's it! The importance of using Fibonacci levels lies in the fact the market tends to bounce at these levels. Understanding that nature exists in the market and how it works, places a trader at a great advantage!
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