Top 4 Fibonacci Retracement Mistakes to Avoid

Source: FX Intellicharts

But, if we take an appearance at the short term, the image looks much various.

1. Don't Mix Fibonacci Reference Points

Source: FX Intellicharts

Now the possibility comes to life as the price action evaluates our Fibonacci retracement level at 111.40 on January 30.

Top 4 Fibonacci Retracement Mistakes to Avoid

Source: FX Intellicharts

In Figure 6, we try to apply Fibonacci to an intraday step in the CAD/JPY exchange rate chart (over a three-minute duration).

Source: FX Intellicharts

Top 4 Fibonacci Retracement Mistakes to Avoid

Figure 2, on the other hand, shows disparity.

Source: FX Intellicharts

But, if we take a look at the brief term, the picture looks a lot different.

Key Takeaways

  • Every foreign exchange trader will use Fibonacci retracements at some point in their trading career.
  • When fitting Fibonacci retracements to price action, it's always good to keep your reference points consistent.
  • New traders often try to measure significant moves and pullbacks in the short term without keeping the bigger picture in mind.
  • Fibonacci can provide reliable trade setups, but not without confirmation.
  • Day trading the foreign exchange market is exciting, but there is a lot of volatility.

2. Don't Ignore Long-Term Trends

Source: FX Intellicharts

After a run-up in the currency set, we can see a possible brief chance in the five-minute timeframe (Figure 4).

Top 4 Fibonacci Retracement Mistakes to Avoid

Source: FX Intellicharts

Now the chance comes active as the rate activity evaluates our Fibonacci retracement level at 111.40 on January 30.

Source: FX Intellicharts

Top 4 Fibonacci Retracement Mistakes to Avoid

In Figure 6, we attempt to use Fibonacci to an intraday relocation in the CAD/JPY exchange rate chart (over a three-minute timeframe).

Source: FX Intellicharts

After a run-up in the currency pair, we can see a potential short opportunity in the five-minute timeframe (Figure 4). This is the trap. By not keeping to the longer term view, the short seller applies Fibonacci from the 2.1215 spike high to the 2.1024 spike low (February 11), leading to a short position at 2.1097, or the 38% Fibonacci level.

This short trade does net the trader a handsome 50-pip profit, but it comes at the expense of the following 400-pip advance. The better plan would have been to enter a long position in the GBP/NZD pair at the short-term support of 2.1050.

Keeping in mind the bigger picture will not only help you pick your trade opportunities, but will also prevent the trade from fighting the trend.

3. Don't Rely on Fibonacci Alone

Fibonacci can provide reliable trade setups, but not without confirmation.

Applying additional technical tools like MACD or stochastic oscillators will support the trade opportunity and increase the likelihood of a good trade. Without these methods to act as confirmation, a trader has little more than hope for a positive outcome.

In Figure 5, we see a retracement off a medium-term move higher in the euro/Japanese yen currency pair. Beginning on January 10, 2011, the EUR/JPY exchange rate rose to a high of 113.94 over almost two weeks. Applying our Fibonacci retracement sequence, we arrive at a 38.2% retracement level of 111.42 (from the 113.94 top). Following the retracement lower, we notice the stochastic oscillator is also confirming the momentum lower.

Top 4 Fibonacci Retracement Mistakes to Avoid

Figure 5: The stochastic oscillator confirms a trend in the EUR/JPY pair.

Source: FX Intellicharts

Now the opportunity comes alive as the price action tests our Fibonacci retracement level at 111.40 on January 30. Seeing this as an opportunity to go long, we confirm the price point with stochastic, which shows an oversold signal. A trader taking this position would have profited by almost 1.4%, or 160 pips, as the price bounced off the 111.40 and traded as high as 113 over the next couple of days.

4. Don't Use Fibonacci Over Short Intervals.

Day trading the foreign exchange market is exciting, but there is a lot of volatility.

For this reason, applying Fibonacci retracements over a short timeframe is ineffective. The shorter the timeframe, the less reliable the retracements levels. Volatility can, and will, skew support and resistance levels, making it very difficult for the trader to really pick and choose what levels can be traded. Not to mention in the short term, spikes and whipsaws are very common. These dynamics can make it especially difficult to place stops or take profit points as retracements can create narrow and tight confluences. Just check out the Canadian dollar/Japanese yen example below.

Top 4 Fibonacci Retracement Mistakes to Avoid

Figure 6: Fibonacci is applied to an intraday move in the CAD/JPY pair over a three-minute time frame.

Source: FX Intellicharts

In Figure 6, we attempt to apply Fibonacci to an intraday move in the CAD/JPY exchange rate chart (over a three-minute timeframe). Here, volatility is high. This causes longer wicks in the price action, creating the potential for misanalysis of certain support levels. It also doesn't help that our Fibonacci levels are separated by a mere six pips on average, increasing the likelihood of being stopped out.

Remember, as with any other statistical study, the more data used, the stronger the analysis. Sticking to longer timeframes when applying Fibonacci sequences can improve the reliability of each price level.

The Bottom Line

As with any specialty, it takes time and practice to become better at using Fibonacci retracements in forex trading. Don't allow yourself to become frustrated—the long-term rewards definitely outweigh the costs. Follow the simple rules of applying Fibonacci retracements and learn from these common mistakes to help you analyze profitable opportunities in the currency markets. 

Tip: For investors’ reference only, it does not constitute investment advice. Financial investment products have high risks and are not suitable for every investor. If necessary, please consult a professional consultant.