Fibonacci Retracement Levels-Home Depot Chart
Fibonacci Retracement Levels and Trade Entries
One of the most common questions I get from new stock traders: “How do I know where to enter?”
In yesterday's trading lesson I outlined a strategy using average true range and well-offered candlesticks. Today's lesson offers another trading strategy built upon Fibonacci Retracement Levels.
My main criteria for new stock trades starts with order flow. I never look for entries without a clear answer to that question. So assuming we have an obvious trend, we need to start looking for a trade that makes sense. A trade that has probability and profit potential. (With acceptable risk)
Fibonacci retracement levels tell us the depth of a pull back in a recent trend. The deeper the pull back, the less likely the trend continuing. The opposite is true as well. The more shallow the pull back, the existing order flow remains intact.
This means we should look for a shallow fibonacci retracement, and then look for an entry. The key question should be: “What is a “shallow” retracement?”
I keep things simple. Use the 50 percent level as your guide.
- If your stock declines (for bullish order flow) and gives you a reversal signal before it retraces 50% of the previous rally, that gives us a trade we can enter with confidence.
- If your stock declines close to the 50% level, you can enter a new long, but with less conviction, and need to “work the order.”
- If your stock declines further than 50%, the order flow has changed and you should pass on the trade.
Using this simple 50% fibonacci level also gives you targets to set for future entries. You should set alarms so you don't miss the trade.
How to Draw Fibonacci Retracement Levels
This is far easier than most traders make it. Software makes it look like magic, but all you need is the price a recent move started, and where you believe it starts turning around.
In this chart of Home Depot, the bullish move started at roughly $180, and peaked out at roughly $207. (keeping the math simple here) To determine 50% of that move you simply subtract the two numbers, and divide by 2.
So 207 minus 180 equals 27. 27 divided by 2 equals 13.50.
So the fibonacci retracement we are looking for, the price that makes this a “good trade idea” is above $193.50. We get this price by substracting 50% of the move from the high. So 207 minus 13.50.
If you get a reversal setup in that area or even better, above that area (shallow retracement) you have an entry you can make with conviction.
This simple trading strategy should become a valued member of your trading setups. It's worked for me since I began trading in 1994.
Feel free to leave a comment if you have any questions.
Trade the News? Conflicting Headlines
Major Wall Street banks are telling clients to be ready for a sudden rip higher in the market
As stocks enjoy their best start to a year in three decades, Wall Street firms are flagging the risk of another, surprise move even higher.
And they have a playbook for clients if and when that happens.
In notes to clients this week, Morgan Stanley and Bank of America highlighted the possibility of another quick move higher. They refer to a so-called “melt up,” driven by investors late to the game looking to get in on a positive momentum shift and often a sign of a late-stage bull market.
Expect a ‘minor correction’ of 5% before stocks march higher, famed bull says
U.S. stocks followed up their impressive first quarter with another month of healthy gains in April, but the returns so far have many investors wondering how long the party can last.
Tony Dwyer, equity strategist at Canaccord Genuity, weighed in on the question in a Tuesday research note, writing that, after the S&P 500 index SPX, -0.75% has gained more than 17% year-to-date, “the tactical backdrop continues to suggest a minor correction in the near term, with any drawdown limited to 5%”