Using Fibonacci Analysis - Part Three (stops)

We've now discussed finding entry points, setting stops, and projecting initial profit targets in the previous lesson. I’ve found that it’s usually harder to decide what to do with the trade once you have entered it. Especially when the trade moves as you expected it would. Is it appropriate and possible to adjust stops and project price targets once initial projections have been met?Stop losses I find Fibonacci retracements invaluable when trying to answer these questions. In this section we will talk about adjusting stops and projecting price targets beyond initial estimates. Stop Losses Risk control is critical for survival in the forex. One of the most popular methods for risk control (on a trade-by-trade basis) is the stop loss. In the last section we talked about how to set an initial stop. But once the market begins to move, it may make sense to adjust those stops. In this example we will repeat the steps from the previous lesson but look at a specific scenario for moving your stop. 1. The Fibonacci retracement was drawn from the top to the bottom of the trend from early to mid November (1). Because the trend was down, you would have been looking for short opportunities. 2. Following the bottom in November, prices rebounded to the 38.2%% retracement level at 229.00 and then bounced down to continue the trend. The move up to the retracement level is what creates the opportunity to short the market as the trend continues to the downside. An opportunity for a trade could have been found with a limit order (automatic order at a certain price) to short this pair midway between the 38.2% retracement level and the 23.6% retracement level (2) at 227.50. This would be placed in anticipation of the potential bounce down off resistance at the 38.2 level. In the last lesson, we discussed using the midpoint between two Fibonacci levels as a good entry point following a support or resistance bounce. 3. At the same time that a limit order to short the pair was filled, a stop order for risk control should also be entered. In the last section we discussed placing the stop on the other side of the Fibonacci level that prices bounced off about a third of the way towards the next Fibonacci level. In this example, prices bounced off the 38.2% retracement level at 229.00, and the next Fibonacci level is the 50% at 231.50. Therefore, the stop would be placed at 229.83 (3). GBP/JPY Daily Chart [IMG]http://www.pfxglobal.com/beta/images/john/02262008gbpjpy1smal.png[/IMG] In steps 1-3 we talked about the initial trade setup. So far we have used the information from the last section to establish a short position on the GBP/JPY based on the Fibonacci levels. In the next few steps we will talk about how this trade worked out and how we adjusted the stops. 4. Following the entry at 227.50, prices almost immediately fell to the next Fibonacci level of 23.6%. This was in line with the original forecast. But don’t get antsy and adjust your stop yet. We recommend you wait until the next Fibonacci level has been reached. In this case, the 0% level was not reached before the trade was stopped out on Dec 12th. This is a good example of how even the best analysis, predicted correctly, will sometimes not always work out. But the good news is there’s another good setup around the bend. 5. The stop in December was bitter-sweet since, prices immediately moved back below the 38.2% retracement level, proving the analysis is correct. That move would have triggered another trade because prices are again bouncing off the 38.2% retracement level with an identical setup to the trade constructed in steps 1-3. 6. Prices followed the trend and hit the 0% line on 12/31 which was a trigger to reevaluate the stop loss. A good rule of thumb here is to move the stop down a full “level” to rest just above the 23.6% retracement level. This pattern can continue to be repeated as prices exceed lower benchmarks, however, it is important to leave plenty of room between current prices and the stop loss or you may find yourself right on direction but wrong on the whipsaw. Always remember: Tightening your stops reduces your downside exposure but increases the chances for a whipsaw. To see the rest of this article and a video, click here: [url]http://www.learningmarkets.com/index.php/200901131264/Forex/Forex-Technicals/using-fibonacci-analysis-part-three.html[/url]