Counter trend trading the Fibonacci bounce

Hi all,

I would welcome any opinion on the idea of trading the bounces off of Fibonacci Extension levels. I know that the ‘Trend is your friend’ and this strategy would involve counter trend trading and is therefore risky. However, if you create tight stops and take profit wisely you can limit the risk.

Forex trading institutions are the forex market movers and use Fibonacci Extension levels to take profits to some degree. If you therefore plot your extensions accurately you will notice that there is often a bounce at these levels. The bounce may be considerable or very small so profit targets may vary.

The tricky part is knowing on which of the extension levels a bounce will occur; the 1st, 2nd, 3rd level, a combination or none at all.

So we need some clues that will help us determine the most likely level that a decent bounce will occur on. If we can narrow it down, we can then use appropriate stops and targets to be successful over time as the odds will be on our side.

Has anyone tried this method? All ideas welcome.

This is part of my trading method. I only trade counter trend if theres a reversal candle formation at or close to the natural fib. extension from the previous ABCD pattern of daily or weekly time frames. Normally when this occur the market often times formed a crown/H&S on a lower time frame which would be the ideal entry.

Thanks for the reply. This is a great way of timing a reversal. Would you consider trading a bounce for smaller gains, knowing that there may be some reaction at an extension level, with a tight stop incase momentum negates any reaction? These trades would not necessarily be at the end of the 5th wave.

Studying the EUR/USD I have noticed that if you have plotted a swing correctly, there is a very high probability of a bounce (small or large) occuring at the 1st and 2nd extension levels. This is obviously institutions reducing their positions. Targets and stops could be set in such a way as to create a successful ratio of profit and loss. I am sure there are more clues that could tell us on which extension levels those bounces are more likely to occur and increase our odds? This is regarding bounces throughout the wave. We definately have some indications at the end of the wave as you described.

The gains will be based on how far away the trend line is for the over all trend of a particular time frame.

The projected extension would be base on how far the price retrace before it continues the trend. Eg. for a 382 retrace I would target the 161 extension. However I’m a believer in candle patterns so thats why I would wait for a reversal formation at the projected extension before considering a bounce.

Heres an example. On the daily EU chart we have a retracement just below a 618, the projected extension is at the 161. As the market approaches the 161 it formed an engulfing bearish candle, at this point I would be looking for another retracement to the now establish up trend line.

After that reversal candle formation is formed on the daily at the fib. extension the lower time frames more than often will form a H&S as shown below on the 4H and the 1H. Entering these H&S at the right tip is very profitable. The vertical dotted line was drawn after the bearish engulfing daily candle.

Thanks for that cadarkitek. I can see that candle patterns give us big indications of when a retracement or reversal may occur.

Do you think you could apply this strategy to smaller time frames, such as using a 15 min chart to establish your fibonacci levels and using 5 min and 1 min charts to identify candle patterns? Does the reliability of fib levels and candle patterns diminish the smaller the time frame you use? If smaller time frames could be used we would find more trading opportunites through the day.

Thanks again for your input.

It should work on any time frame but I’m not sure how reliable it would be on the 15m-5m, you can give it a try on demo. I wouldn’t say fibs are less accurate on lower time frames but its always good to view higher time frames to get an overall direction.

Heres a live example on the AU chart. The daily shows the market at the 161 extension after a retrace to the 382 followed by bearish reversal CF.

The 1H already crowns and now it forms an evening star at the test of a broken up trend line. Entry would be after the ES formation.

Corby this one works out well today, over a 100pips gain with a less than 50 SL nice R/R ratio.

Yes, that was a nice setup. I do really like the 1:2 risk reward ratio over the long term as there is less pressure on each trade. I have been using this ratio with Fibonacci levels on a 15 min chart, with the help of other time frames. I have found that there is usually an equal number of winning trades to losing trades which means that I am usually up at the end of the day.

Would you always favour a ratio with a reward that is twice that (or more) of the risk?

Yes I favor a high R/R, I started out at minimum 1:1.5, I now go for 1:2 or higher if the entry shows the potential of going the distance. I also use other exit strategies to scale of a trade should the market show signs of reversing.

Just showing you here that the counter trend trading of the Fibonacci bounce works on just about any chart. You will see on the gold chart posted below there were several trade opportunities.