In my last article on DailyForex here I wrote about the importance of a much overlooked chart pattern, the “Triangle”, and how it can produce accurate trades with excellent risk/reward ratios.
Here, we’re going to look at this concept tied in with a Fibonacci retracement level that I love, the 88.6 Fib percentage. To recap, the Fibonacci Golden ratio is 61.8%. If you square root that percentage, and square root it again, you get 0.886, or 88.6%. I often use a bounce off the 88.6% Fib level as a trade entry.
Let’s dive right in and look at an example. This is a live trade that I took on the GBP/USD on a 15-minute chart.
The following chart is the point at which I saw the trade developing:
My logic was this: The price moved from a high to a low (marked by the 100% and 0% lines) and then moved back up to the 88.6% level (highlighted by the small blue line). The price bounced off that level to the exact pip. I felt the price would continue moving down and extend the previous down-move past the 0% level.
I could have entered a short position immediately but the nearest place for a stop was around 45 pips away (above the previous high); whilst the profit-target was over 80 pips giving an okay risk/reward, I felt I could get a tighter stop-loss on a consolidation. So instead I waited for a pull back or a consolidation (such as a triangle) to plan the trade from. The risk with waiting is missing the trade entirely as the price could just rocket down and not consolidate at all.
Getting into the trade
When I checked the chart again, I noticed a triangle consolidation that the price had just broken out from and decided this made a good entry point. I used a 25 pip stop that was just above the triangle. In the following chart, I’ve marked just the initial high as Point X, the low as Point 1, and the 88.6% level as Point 2 (and removed the other Fib levels for clarity). And the triangle pattern is marked with the red lines.
Getting out of the trade
My target was a 100% extension of Wave 1. This means you take the size of Wave 1, i.e. from Point X to Point 1, and measure 100% of that size from Point 2. That gave me a target of about 80 pips away from my entry. This was a risk/reward ratio of over 1:3 which I think is very acceptable.
When it hit the target, it broke it by 1-2 pips before rebounding and going through it firmly. See the following chart.
1. A Fib level can often produce a good setup, but if you don’t see it quick enough, you may miss the trade or have to accept a wide stop
2. The triangle pattern can give you a tighter entry and therefore a better high risk/reward
3. In Forex, the pips made only makes sense when you compare it to the pips you risked!