In this article we are going to explain a trading system based on Fibonacci retracements and the weighted moving average (WMA), which can be used in any market and in most time frames. Therefore, it requires a basic knowledge of Fibonacci tools, although nothing complex.
Fibonacci tools can be found in the vast majority of trading platforms, such as Metatrader 4, so this system can be used on any platform that the trader chooses.
If you do not have knowledge about Fibonacci indicators, you can consult the following article: Fibonacci in Forex Trading
Basically, it is a technical trading system that focuses on opening positions in the trend direction, using Fibonacci retracements as price zones to enter the market. In other words, it is a trend following system. The WMA moving average is used to determine the best time to open positions.
As always, it is recommended to test this system on a demo account before using it for trading in a real account.
Why is it convenient to use a trading system?
When a trader chooses to use small time frames (like 10 minutes, 15 minutes, 30 minutes, even 1 hour), the risks of being wrong are always greater than with the longer time frames.
Therefore, it is very important to have a really good trading system that can point us to the best entry points with the highest chances of success and, more importantly, it should be able to tell us exactly where we can exit without constantly monitoring the price action. Also note that the more many traders look at the price charts, the more they tend to have mixed feelings about the success of a current open trade.
Now without further introduction, we are going to explain what this system consists of.
Fibonacci Retracement Trading System Setup and Indicators
- Recommended markets: This trading methodology can be applied in any market, including Forex, precious metals and stock indices, among others.
- Recommended time frames: The system can be used in any time frame, from 5 minutes (M5) to 4 hours (H4). Minor time frames like M1 are too erratic to generate good results.
- Recommended market periods: It is recommended to use this trading system for trading during the market sessions of the United States (New York) and Europe (London), where the directional movements of the assets are stronger and can generate strong trends.
- System indicators: The technical indicators used by this system are
- Fibonacci retracement tool.
- 1 weighted moving average (WMA) of 5 periods.
Rules of the trading system
The rules of this system are quite simple and easy to use. However, it is necessary for the trader to know how to use the Fibonacci retracement tool. To display the Fibonacci levels of an uptrend or downtrend movement, you should do the following:
- Analyze the price swings on the chart. Find the most recent swing high and the most recent swing low, which will be swing point A and swing point B of the Fibonacci Retracement Tool.
- Extend the Fibonacci tool from point A to point B. To find out in which direction to extend the tool (up or down) just watch and follow the trend.
- Once we extend the Fibonacci Retracement Tool between the high and low (or vice versa) of a trend, the retracement levels are plotted automatically.
- The retracements that the tool should show and that will be used in the entry signals are 38.2% and 61.8%.
After plotting the retracement levels, we observe how the price action behaves and wait for the conditions to be met to open new trades.
Buy trades
To open a buy position, the following conditions must be met:
- The trend of the analyzed price movement must be bullish.
- From the level of point B the price should make a bearish retracement.
- The price must touch at least the Fibonacci retracement of 38.2%.
- The price must touch the 5-period WMA.
- The price should not go below the 61.8% Fibonacci retracement. This means that the price should not close below the 61.8% retracement line. The price can reach and even temporarily exceed this price level, but the level must resist the ‘attack’.
- Position opening: When the previous conditions are met, we can open a buy position once a candlestick closes clearly above the WMA 5.
- Stop loss: The stop loss can be placed 4-5 pips below the Fibonacci retracement of 61.8%.
- Take Profit: If the market starts to move in the same direction as the trade, we can close the buy position with profit when the price reaches the Fibonacci extension of 161.8% derived from point A.
Sell trades
To open a sell position, the following conditions must be met:
- The trend of the analyzed price movement must be bearish.
- From the level of point B the price must make a bullish retracement.
- The price must touch at least the Fibonacci retracement of 38.2%.
- The price must touch the 5-period WMA.
- The price should not break above the 61.8% Fibonacci retracement. This means that the price should not close above the 61.8% retracement line. The price can reach and even temporarily exceed this price level, but the level must resist the ‘attack’.
- Position opening: When all the above conditions are met, we can open a sell position once a candle closes clearly below the WMA 5
- Stop loss: The stop loss can be placed 4-5 pips above the Fibonacci retracement of 61.8%.
- Take profit: If the market starts to move in the same direction as the trade, we can close the sell position with profit when the price reaches the Fibonacci extension of 161.8% derived from point A.
Fibonacci Retracement Trading System Example
In the previous image we have a 15-minute price chart of the EUR/USD currency pair where this trading system has been implemented and where a sell trade has been carried out. In this case, we have a clear downtrend where we have applied the Fibonacci retracements between oscillation points A and B (on the left side of the chart). We must remember that the price movements that developed beyond A and B occurred after applying the Fibonacci retracements to the AB movement.
Once we plot the Fibonacci retracements we wait for the price to make a bullish retracement from point B and reach at least the 38.2% retracement and the WMA 5. This occurred a few candlesticks later. Now we wait for the price to start to decline and resume the downtrend. Once the price closes below the WMA 5, we open a sell position, with a stop loss placed above the 61.8% retracement.
As the market begins to move in the trade direction, we let the trade run and set a profit target at the 161.8% extension measured from point A. The price continued to fall strongly and hit our profit target, closing the trade with a profit. As we see, the price continued to fall even more, but it is better not to be greedy.
