Filed under: Blog, Quant Trading | Tags: Fibonacci Trading, Knowledge Guide
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Improving the Odds of Reversal in A Trend
With some practice and some back-testing you can find which types of fractal waves offer the best opportunities for counter-trend trades. However, we can often improve our entry timing and further possibility of a reversal by using other Fibonacci lines in confluence to form resistance around certain levels.
The more confluence and cluster of fib lines around a general price zone the bigger chance of reversal point. These types of trades can offer excellent risk to reward. So following on from the previous example we can change our chart time frame to a 15 minute chart to look for more extension zones (I like to first look at bigger picture on higher time-frames and then start to look to shorter time-frames to find smaller waves).
Notes from looking at the second chart image:
For any new daytrader or potential algorithmic trader we can see from this post that we can pretty much start with a simple hypothesis and then work on the same hypothesis from a different angle. Then we can see that by modifying risk/reward for the strategy we can change a losing strategy into a winning one.
If you wanted to continue with this particular strategy you could figure out and design filters where you expect this system to fail.
Why We Would Not Trade This Strategy
- I find a small swing high to swing low within the current trend - particularly the first waves always has a Fib 2.0 extensions or 200% of the minor swing high to swing low point (this is outlined in the image as first minor wave within the trend and we have Fib 2.0 extension value at 210.37).
- The only other minor wave we have is a small one at 210.42 and is labelled second minor wave. Its Fib 2.0 extension is exactly at level 212.12.
- Now we have a decent sell zone created (the shaded rectangle has become the sell zone).
- Back-testing this type of strategy has given me best results when we have at least 2 minor waves within the trend which then line up with the fib extension from the major wave. In this case our sell zone is from: 210.39 to 212.12. The main aim is to find a trading edge using Fibonacci levels as your methodology.
- Before we enter our short trade we want to wait for that second minor swing wave 2 in the trend to begin before entering so we take the best entry point at 212.01.
- This confluence of fib extensions often lead to quick counter-trend trades which can be made with very small stops and decent rewards. Try creating some rules to a Fibonacci strategy and then test different stops and targets to create your own algorithm. The beauty about algorithmic trading is that we can test hundreds of ideas quickly and ensure that our final strategy has a proven positive expectancy
Please don’t think Fib Extensions will work every single time, even if there is a major confluence sell zone going on it does not mean price will stop magically and reverse. You want to create a system around finding these sell zones and then finding good place to put stops and targets (both should dynamically change to the current market price). You can easily create low risk high payoff strategy around price exhaustion (Fib confluence zones).
Fib extensions are levels which many traders look at for profit taking or counter-trading, it somewhat becomes a self-fulfilling prophecy on why they work.
However, do not just apply Fib extensions wherever and whenever, try to keep them relevant to at least the 60 min chart. Looking to far out can sometime lead to values which just don’t work. The best thing to do is back-test ideas around Fib extensions and attempt to create counter-trend strategies – that way you can create an algorithm which gives the best desired results and quantifies what works and what does not.
The most important aspect of finding the correct methodology of using Fibonacci levels is back-testing your strategies. Algorithmic Trading is very important in today's markets.