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Trade Ideas, Trading Strategies
Analyzing a Forex Fibonacci Retracement Strategy
Last Updated on May 5, 2023 by Mark Ursell
Fibonacci retracements look great on charts, but how useful are they for forex traders? Are they helpful for finding entry levels, and can they be 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 historical data to test various Fibonacci levels to see what works well and what does not.
Fibonacci Retracements
The chart displays Fibonacci levels, highlighting the key levels at 23.6%, 38.2%, 50%, and 61.8%.
Traders often use Fibonacci levels to assess the strength of a retracement against the major trend.
Many traders expect the price to react at these levels, which often provides a favorable opportunity to enter a trade in the direction of the major trend.
How to Draw Fibonacci Retracement Levels
On a price chart, you can draw Fibonacci levels in various ways, which often leads to confusion when deciding where to position the retracement levels.
If the market is trending upward, I want to enter a long trade. In this case, I draw the Fibonacci retracements from a significant low to a significant high.
A significant high or low will have plenty of blank space to the left.
The swing low in the chart above was the 2020 Covid Crash low and the swing high occurred in September 2020.
The more significant the high and low points, the most important the Fibonacci retracement levels will be.
Analyzing a Fibonacci Retracement Strategy
Traders spend a lot of time drawing and studying Fibonacci levels on their charts. However, there is not much hard evidence about the success rate of Fibonacci retracement entries. In particular, I want to know which fib levels work best.
Backtest Model
My analysis was carried out using a Tradinformed Excel Backtest Model.
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Strategy
The trading strategy used a 200-period moving average to identify the dominant trend. I entered Long trades above the moving average and short trades 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 the analysis, I looked at the EUR/USD on the daily timeframe and I used data from 1989 to 2015.
Stop-Loss and Profit Target
Stop-losses and profit targets have a big effect 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 period.
I carried out two 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. In addition, 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 don’t 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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