So why does Fibonacci work in the Forex market?

Because Fibonacci ratios are a deeply ingrained part of the Forex culture. Big banks, hedge funds, and individual traders alike all pay close attention to these ratios, and frequently place their orders at Fibonacci retracement levels.

If enough orders accumulate at a particular level, the combined power of these orders can actually change the direction of the exchange rate when that level is achieved. This is the essence of the self-fulfilling prophecy that we discussed in last week's newletter.

If my assumption is correct that Fibonacci works in the Forex market not because of magic but due to a self-fulfilling prophecy, then there are certain conclusions that we can extrapolate from this premise:

Fibonacci Is More Effective on Longer-Term Charts
If we truly believe that Fibonacci is a self-fulfilling prophecy, then we should live by the credo, "the more, the merrier." In other words, the more orders that are placed at a particular level, the more likely it becomes that the level will hold as support or resistance.

What can improve the chances that there will be a large quantity of orders at a particular Fib level? Visibility is the key. If the other players can't see the Fib level, they can't place their orders accordingly.

For example, if a Fibonacci level forms on a five-minute chart during the Asian trading session, any opportunity to place a trade based on this retracement is likely to come and go before European and American traders have wiped the sleep from their eyes. Since many of these traders will never observe this opportunity, there will be fewer orders placed at that level. This makes it less likely that the level will hold when the price reaches that area.

However, if the same scenario occurs on the daily chart, traders all around the world will have the time and the opportunity to place their orders accordingly. Since Forex is truly an international market, with traders located on every part of the globe, this aspect of Fibonacci trading takes on added significance.

Fibonacci Is More Effective on Commonly Used Retracement Levels
The most commonly used Fibonacci ratios are 38.2%, 50%, and 61.8%. However, 23.6%, 78.6% and 100% are also legitimate Fib levels. Some traders even use Fibonacci "extensions" that go beyond 100%, such as a 161.8% retracement. There are also Fibonacci Arcs, Fibonacci Fans, and Fibonacci Time Zones.

Which of these techniques will be the most effective? If we truly believe that a sizable quantity of orders (or a quantity of sizable orders) will make the difference, then we must give more weight to the levels that garner the most attention - the 38.2%, 50%, and 61.8% levels. In Fibonacci, as in many aspects of trading, sometimes it's better to keep things simple.

Improving your trading by thinking less

Analysis paralysis. We’ll all heard of it. Have we all experienced it? I know I have.

My personal tendency in all aspects of life is to be very analytic. That has some nice advantages, but it also as some nasty drawbacks at times as well. I’ve been told on more than one occasion that I think too much, and while it was not normally meant to be a deragatory thing, it is indicative. I do think alot, and probably would be considered by many an intellectual - for better or worse.

The "worse" part is something I became aware of many years ago, early in my professional career as an analyst. My job required me to product commentary quite frequently. It was actually too frequently in many respects because I found that by being forced to revisit the price action I wasn’t able to allow the market moves I had previously outlined to properly develop. I was instead coming up with new analysis at each point, often to the detriment of producing quality trading ideas.

This is something which has from time to time carried over into my trading as well. There have been spells where I have allowed myself to get sucked way into the fine details of things. Sometimes I catch myself before much damage is done, but often it ends up becoming a hindsight sort of thing. Basically, the more I think about trading, the less well I tend to do, which is definitely part of why I’ve tended to perform better taking longer-term positions where the decision-making is more spread out and less at risk of turning into over-thinking.

The funny aspect to this whole situation is a bit of a paradox. I find that my gut generally gives me the right read, but if I consciously check my gut it nullifies things. In other words, I can’t think about what my gut is telling me. I just have to accept it’s influence when it chooses to speak up.

And by the way, the gut thing is something I definitely believe to be reflective of experience. It’s not something people are just born with. It’s a question of having seen the patterns of how the markets move many, many times such that your waking mind doesn’t even have to register them at all. This tends to go along the lines with how expertise comes from frequency of repetition, not time.

My point in sharing these things is to encourage you to look at your own work in the market to see whether you might be over-thinking things to your detriment at times.


Sources :

1. John Forman - The Essentials of Trading author (Improving your trading by thinking less)