In the past lessons, we’ve paired the Fibonacci retracement levels with multiple technical tools, such as Trendlines, Support and Resistance, and Candlestick Patterns.
This proves how Fib levels can be a powerful and versatile tool when analyzing the market. For this lesson, we’ll be using more than two concepts!
We’ll learn how to use the Fibonacci tool to place stop-less orders accurately, but to do so, we also must identify Support and Resistance Levels.
Let’s Review Stop-Loss Orders
If you’re not paying close attention, the forex market’s volatility can cause you critical losses!
Every moment the market changes can affect your position, one way to limit your losses is through a stop-loss order.
Instead of reacting to sudden trend reversals, a stop-loss order is a proactive approach to hedge risk.
A stop-loss (SL) order is a type of forex order that can mitigate potential losses. SL orders are placed below or above the entry price, depending on how much loss you’re willing to take for that position.
A stop-loss order to sell means the traders instruct a broker to sell a security below a specified price. A stop-loss order to buy means the broker should purchase above the current price.
Advantages of a Stop-Loss Order
An SL order protects your position when the market moves against it. It is an effective risk management strategy to keep you from rapidly losing money.
The SL order can also help with emotional trading and avoid impulsive decisions. Through an SL order, you already have a predefined exit point if the market moves against you.
Additionally, you don’t have to monitor the market at all times because of automated executions.
It is highly advised that traders use a stop-loss order for every trade that they make.
Disadvantages of a Stop-Loss Order
A potential disadvantage of the stop-loss orders is that orders are triggered even by short-term fluctuations. This can be inconvenient for volatile markets where prices can surge or plunge in short periods.
Meanwhile, frequent triggers of stop-loss orders can lead to high commission costs is the stop-loss is set to close to current price levels.
Lastly, relying on stop-loss orders can give you a false sense of security. It’s important to combine them with other risk management strategies!
Using Fibonacci Retracement for Stop-Loss Placement
Traders typically place stop-loss orders near key Fibonacci retracement levels.
Fibonacci retracement levels:
- 23.6%
- 38.2%
- 50.0%
- 61.8%
- 78.6% (depending on market volatility).
These levels represent potential reversal points in the price movements! The idea is that after a strong trend (bullish or bearish), prices often retrace to previous Fib levels before continuing the trend.
Identify the Trend
The first step is to identify if there is a clear upward or downward trend in the market.
Consider the scenario:
You're a scalp trader who just opened a long position. However, you saw that prices have just started to go up when you opened your platform.
Let’s take a look at this 20-minute price chart for USDJPY.
We can say that the price is moving upward. But around 10:50, prices are starting to reverse.
Additionally, two shooting star candlesticks indicate that the price might continue to go down.
Since you want to open a short position, you want to place your stop-loss order at the highest price point with the lowest possible loss.
But how do you identify where to place it? Let’s plot the Fibonacci levels next!
Plot Fibonacci Levels
Since the trend is going upward, we can plot the Fibonacci retracement tool from the swing low to the swing high.
We’ve plotted it using the example below.
Great! Now we have our Fibonacci Retracement levels on our price chart.
We can see that prices are starting to reverse a little from their uptrend. Now would actually be a good time to execute your short position!
However, you want to wait it out a little bit because of the hammer candlesticks that dominate the chart.
But! You still don’t want to risk too much money by waiting for a surge in price. But what is the most optimal price to limit losses?
Looking at the chart, the previous resistance levels were at the 50% Fib level.
Question: Will you place a stop order below, above, or at the 50% Fib level?
We know that previous resistance levels are highly likely to become support.
So, we’ll place a stop-loss order below it. Chances are, prices will retrace back to the 50% Fib level. If we put a stop-loss order there, our trade will exit. We would lose the opportunity to wait for a higher price!
Let’s see what happened:
Awesome! The prices didn’t actually reach our stop-loss price, but phew that was close!
Prices continued to surge upward, and you got to open your short position at the 154.08 mark!
Remember
Using the Fibonacci Retracement Levels to place stop-loss orders is a useful tool for judging the optimal price point for stop-loss orders.
Placing stop-loss orders is like a “just in case” strategy. However, you should still be very strategic about it, because it could trigger your trade and limit your opportunities.
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