The Fibonacci breakout strategy uses the Fibonacci indicator to identify support and resistance levels that a trader or investor can use for entry, exit, and stop placement. I think the Fibonacci gets overlooked by some traders because they believe it may be too complicated to use. However, this is not the case once you take some time to practice how to draw Fibonacci levels. The Fibonacci indicator is available in most trading platforms free of charge and all you need to do is connect the high and low points on your charts. It will then automatically draw the relevant Fibonacci levels which can be on important price levels. These levels can then be used for trading reversals or the Fibonacci breakout strategy.
What is the Fibonacci indicator?
The Fibonacci indicator can be used for trading breakouts and reversals. Fibonacci retracements measure the pullbacks within a trend, while Fibonacci extensions measure the impulse waves in the direction of the trend. The indicator is useful because it can be drawn between any two significant price points, such as a high and a low.
What are the Fibonacci levels?
The Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. While not officially a Fibonacci ratio, 50% is also used although it is not derived from the Fibonacci numbers. The most commonly used Fibonacci extension levels are 38.2% and 61.8%. Price can sometimes react more around these levels but all of them are still important and worth paying attention to.
What is the Fibonacci breakout strategy?
Fibonacci levels are often used as part of a forex trend trading strategy. Forex traders can look for a retracement taking place within a currency pair trend and look to enter in the direction of this trend when there is a breakout of the Fibonacci levels.
If price is trending is trending downwards, you could look to time the entry when price breaches the next Fibonacci level of support. If price is trending upwards, you could look to enter when price breaches the next Fibonacci level of resistance.
You do not need to draw support and resistance levels as the Fibonacci indicator can do this for you. However, you will need to be able to spot the relevant swing high and swing lows from which you will draw the Fibonacci extensions. Once you know how to do this, you can identify potential key levels of support and resistance where price is likely to react in some way.
How do you trade Fibonacci breakouts?
You just need to draw Fibonacci retracements correctly by identifying the trend direction and using the appropriate high/low and vice versa. You can apply multiple time frame analysis with additional Fibonacci retracements but make sure you don’t end up with too many lines on your chart as this can be overwhelming.
I think it can be useful to use some other technical indicators to help identify the overall trend direction and filter out ranging market conditions. This could be anything from a moving average to the MACD, or combination of indicators. I would always keep an eye on price action around any potential breakout to see how price reacts. This can help to filter some false breakouts compared to jumping in right away.
You could still trade Fibonacci breakouts in a range bound market by waiting for price to breakout from any of the Fibonacci levels. However, if there is no clear trend prior to the breakout, then you might find there are more false signals. We could instead wait for the breakout to happen and then look to enter in a pullback to the Fibonacci level.
Fibonacci retracement vs extension
Fibonacci extensions show where the price may go following a retracement and can be used to spot Fibonacci breakouts. The Fibonacci retracement levels indicate how deep a retracement could be when the price is moving down from resistance or up from support.
If used correctly, both Fibonacci retracements and extensions can help traders to identify upcoming support and resistance levels based on past price action. I just like to confirm Fibonacci signals with other indicators and price action analysis.
Fibonacci chart timeframes
You can use any chart timeframe to draw your Fibonacci breakout levels. I personally like to look at the 1-hour charts and above. This is because I think there can be too much market noise on the lower chart timeframes which can cause an increase in false signals. Trading on the longer-term chart timeframes also means less time spent watching the charts.
If you do want to day trade on the lower-term timeframes, you might want to also mark the Fibonacci levels on the long-term timeframes for extra confirmation. This could help prevent trading against the overall trend and give you extra confirmation on your trades.
- Draw Fibonacci retracement from low to high points
- Wait for price to pullback before breaking out above resistance
- MACD histogram should be above MACD signal line
- Use Fib levels as profit and stop loss targets (optional)
You can see from the EUR/USD 1-hour chart below that the price is trending upwards which gave us 2 obvious points to use for the Fibonacci levels. We then saw price pullback from resistance before the Fibonacci breakout. This was confirmed with the MACD crossover showing bullish momentum and candlestick patterns such as the inverted hammer formation. We could have used the latest swing low as a stop loss point which is around 50 pips and the 161.78% fib level as the first target at around 100 pips. We could then move the stop loss to break even and try to catch the next fib levels as the trend continues.
- Draw Fibonacci retracement from high to low points
- Wait for price to pullback before breaking out below support
- MACD histogram should be below MACD signal line
- Use Fib levels as profit and stop loss targets (optional)
In the EUR/USD 1-hour chart below, you can see that all of the conditions for a sell trade have been met. There is a Fibonacci breakout to the downside and the MACD is showing a downtrend. We have bearish price action including doji candlestick patterns showing market indecision followed by consecutive red candles. If we used the 61.8% fib level for the stop loss, it would have been around 50 pips. That’s not bad when you consider this downtrend went on for over 220 pips. We could have taken profits at the 161.8% fib level or just shy of the 261.8 level.
Fibonacci breakout strategy Pros & Cons
- Can catch some big breakouts
- Gives entry and exit points
- Can be used in trending and ranging markets
- Automatically calculates support/resistance levels
- Works on any currency pair or other financial instrument
- Can use multiple Fibonacci levels on different timeframes
- Fibonacci indicator is free to use
- Takes time to learn how to correctly draw Fib lines
- Market highs and lows can be open to interpretation
- There will be lots of false Fibonacci breakout signals
- Need to time entry and exit into the market
- Require good money management
Conclusion: does the Fibonacci breakout strategy work?
Yes, I think forex trading with Fibonacci breakouts can be very powerful when done correctly. Once you have drawn the Fibonacci levels on your chart, you can have a clear picture of potential support and resistance levels which can be used for breakout and reversal trades.
However, it does require the trader to take some initiative as you will need to filter buy and sell signals with your own additional market analysis. Not to mention, as with any forex strategy you will need excellent money management and trading discipline. This can be the difference between a winning and losing strategy.
I think a forex demo account can be a good way to get some practice with drawing support and resistance using the Fibonacci indicator. You can get a demo account from most forex brokers. This will allow you to practice your forex trading strategies without needing to take any unnecessary risk. Once you start to see some consistent results, you could always make the switch to a real forex trading account.
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