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Trade Ideas
Analyzing a Forex Fibonacci Retracement Strategy
Fibonacci retracements look great on charts but how useful are they for forex traders? I wanted to know whether they are helpful and if they can be used as part of a profitable trading strategy.
In this article I analyze how effective and profitable a fibonacci trading strategy is in the EUR/USD forex market. I use historic data to test a range of fibonacci levels to see what works well and what does not.
Fibonacci Retracements
Fibonacci levels are shown on the chart. The key levels are 23.6%, 38.2%, 50% and 61.8%.
Fibonacci levels are often used to judge the strength of a retracement against the major trend.
The price is expected to show a reaction at these levels and they can provide a good opportunity to enter a trade in the direction of the major trend.
How to Draw Fibonacci Retracement Levels
In a price chart there are usually many different ways to draw a fibonacci levels. It can be confusing to decide where to place the retracement levels.
If market is in an uptrend I want to enter a long trade. In this case I draw the fibonacci retracements from a significant low to significant high. A significant high or low will have plenty of blank space to the left.
Looking again at the fibonacci levels we can see that the high point is the highest for 161 days. The low point is the lowest for 82 Days.
Generally speaking, the more significant the high and low points, the most important the fibonacci retracement levels will be.
Analyzing Fibonacci Retracement Entries
A lot of people spend time drawing and studying fibonacci levels onto their charts. However, there is not much hard evidence about the success of fibonacci retracement entries. Furthermore, I want to know which fib levels work best.
Backtest Model
The analysis was carried out using a Tradinformed Backtest Model. These models use Excel and are capable of testing a wide range of trading strategies.
Strategy
The trading strategy used a 200 period moving average to identify the dominant trend. Long trades were entered above the moving average and short trades were entered below.
Long trades were entered when the market had retraced to the downside and short trades were taken when market had retraced to the upside.
Data and Timeframe
In this analysis I looked at the EUR/USD on the daily timeframe. I used data from 1989 to 2015.
Stop-Loss and Profit Target
Stop-losses and profit targets have a big affect on the profitability of a trading strategy. In this test I set the stop-loss and profit target based as a multiple of the ATR. The ATR allows the system to react by increasing the stop-loss and profit targets during times of volatility. It is also useful when the test is being carried out over a long time period.
I carried out 2 tests to see whether a different profit target would change the results. The tests were:
Test 1: Stop-Loss 5*ATR; Profit Target 5*ATR
Test 2: Stop-Loss 5*ATR; Profit Target 10*ATR
Video
Watch the associated video for more detail about setting fibonacci retracement levels.
Results
Test 1
| Retracement Level | 23.6% | 38.2% | 50.0% | 61.8% |
|---|---|---|---|---|
| Gross Winning Trades | $371,162 | $285,701 | $148,090 | $71,680 |
| Gross Losing Trades | $-270,513 | $-153,918 | $-100,635 | $-75,231 |
| Net Profit | $100,649 | $131,783 | $47,455 | $-3,551 |
| Profit Factor | 1.37 | 1.86 | 1.47 | 0.95 |
| Winning Trade | 57 | 43 | 26 | 14 |
| Losing Trades | 63 | 31 | 18 | 14 |
| Win Percentage | 48% | 58% | 59% | 50% |
| Largest Winning Trade | $10,082 | $11,618 | $7,391 | $5,479 |
| Largest Losing Trade | $-10,586 | $-12,199 | $-7,761 | $-5,753 |
| Max Drawdown | 23.1% | 23.4% | 26.2% | 22.9% |
| Average Profit Per Trade | $839 | $1,781 | $1,079 | $-127 |
Test 2
| Retracement Level | 23.60% | 38.20% | 50.00% | 61.80% |
|---|---|---|---|---|
| Gross Winning Trades | $528,064 | $397,876 | $226,135 | $131,841 |
| Gross Losing Trades | $-292,513 | $-155,765 | $-126,233 | $-92,856 |
| Net Profit | $235,551 | $242,111 | $99,903 | $38,985 |
| Profit Factor | 1.81 | 2.55 | 1.79 | 1.42 |
| Winning Trade | 37 | 26 | 18 | 11 |
| Losing Trades | 54 | 28 | 17 | 14 |
| Win Percentage | 41% | 48% | 51% | 44% |
| Largest Winning Trade | $30,505 | $33,911 | $19,722 | $14,844 |
| Largest Losing Trade | $-16,362 | $-18,006 | $-10,847 | $-8,164 |
| Max Drawdown | 22.5% | 25.8% | 25.4% | 25.8% |
| Average Profit Per Trade | $2,588 | $4,484 | $2,854 | $1,559 |
Conclusions
The results show that test 1 and test 2 had similar results. The order of profitability was the same in both test 1 and test 2.
Both tests show that the 38.2% retracement level yielded the most profit in the 2 scenarios. The 61.8% level was the least profitable. There was a surprisingly large difference between these 2 levels. This suggests that the most profitable trades are made when the price has a shallower retracement. Once the price has retraced to 50% and beyond the chance of a continuation trade is much lower. This information could be useful in predicting when the price is more likely to become stuck in a range or reverse.
There is an interesting difference between the 23.6% retracement and the 38.2% retracement. The 23.6% has many more trades but they tend to be less profitable. This suggests that patient traders should wait until the 38.2% level has been reached. Active traders may want to enter at the 23.6% level to ensure they do not miss a move.
More Trading Strategies
If you are interested in backtesting and analyzing trading strategies check out the page on Trading Strategies for lots more research and trading ideas.
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