TECHNICAL ANALYSIS

Carolyn Boroden shows how to use Fibonacci price relationships and the clustering of Fibonacci relationships to identify low risk trade setups
CAROLYN BORODEN

How to Trade Forex using Fibonacci Price Relationships

M
ost traders who use technical analysis are familiar with using single Fibonacci price relationships (such as price retracements) to help define potential support and resistance points in a market. However, many traders are less familiar with the concept of clustering Fibonacci price relationships to identify high probability, relatively low risk trade setups. In this article, I will explain what this trade setup is, and then provide examples to show how you might use this strategy in your trading. When Fibonacci price clusters are used as a trading strategy, a setup or possible trading opportunity occurs when the analyst sees a coincidence of at least three Fibonacci price relationships coming together within a relatively tight price range on the chart. This coincidence of price relationships defines a key price support or resistance zone for a potential trade entry. Fibonacci price retracements, price extensions and price projections are made from key swing highs and lows that are obvious on the chart being analyzed. There is a bit of an art to selecting the key highs and lows that are relevant for creating these clusters, but the examples should give you a good idea where you can start. To make projections, we use the ratios defined by the Fibonacci number series. The generally used ratios are: .382, .50, .618, .786, 1.00, 1.272 and 1.618. At times, .236, 2.618 and 4.236 are used as ratios to confirm other levels. Note that these same key ratios can be applied directly to the time axis of the market to identify times when the market is more likely to reverse trend. This may be the subject of a future article.

Figure 1

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TECHNICAL ANALYSIS
Lets look at some examples of individual Fibonacci price relationships before looking at an example of a price cluster. First, we will look at price retracements that many technical traders should already be familiar with. When running retracements, the measure is taken from a low to a high swing looking for possible support or it is taken from a high to low swing looking for possible resistance. To define possible support or resistance, we are measuring the length of the swing and then allowing our trading program to proportion this prior swing by the ratios of .382, .50, .618 and .786. When the market pulls back to these ratios of the prior swing, we watch for possible support or resistance. Figure 1 shows an example of price retracement on a daily JPY chart. All of the charts in this article are provided courtesy of the Dynamic Trader software. Here we are measuring a prior low to high from the May 17, 2006 low to the October 13, 2006 high. By clicking on the low and then the high of this swing, the program ran the potential retracement levels for possible support of this swing as JPY started to pull back from the October 13, 2006 high. Note: In this case, the 50% retracement level provided support from where the rally resumed. Now, lets take a look at an example of a price extension, which is also measured from a prior swing low to high or high to low to project possible support or resistance in a particular market. However, rather than retracing a prior swing, we use the Fibonacci ratios that EXTEND beyond 100% of that prior swing by using the ratios of 1.272 and 1.618. Figure 2, is a daily chart of the Euro. Here, we measured a prior high made on December 6, 2006 to the low made on January 12, 2007 and ran the extension ratios looking for possible resistance to the rally from the January low. In this example, the extension drawn from 1.272 offered no resistance, though the market did terminate the rally within a couple of pips of the 1.618 extension of that prior swing. Last, we want to look at price projections of prior swings. The price projection tool Figure 3 that I use in the Dynamic Trader program is the alternate price projection, or APP. It is typically considered an extension tool in other well-known programs. Bottom line, projections are made so prior swings in the market can be compared with current swings in the same direction. For this reason, we need a price tool that can project using three points on a chart. The ratios that I use for projections are 1.0 and 1.618. Figure 3 is an example of a projection on a daily chart of CHF. First, I selected the August 21, 2006 low to the August 25, 2006 high and projected the 1.0 and 1.618 ratios upward from the low on August 31, 2006 looking for possible resistance at either of the projection points. In this case, the high at 1.2623 was 6 pips above the 1.618 projection of 12617 while the 1.0 projection was essentially ignored. Keep in mind when running these levels that you will not always see a

Figure 2

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level perfectly hit. However, as long as it is not violated by a huge margin, it is still good to watch these levels/areas for possible market reversal. In Figure 4, I am sharing an example of a symmetry projection on a daily CAD chart. My definition of symmetry is similarity or equality with a prior swing in the market. Since the market was trending up, I was comparing the decline from the January 11, 2007 high with a prior corrective decline that was made between December 18 and December 20, 2006. Since many corrective moves tend to be of similar size, using the 1.0 setting of the projection tool to compare these swings helps me set up an entry in the market in the direction of the main trend. Notice that the prior high to low swing was 160 points. This projects possible support in the area of 1.1644. The actual low for the move was at 1.1646 or 158 points from the prior high made on January 11, 2007. Now that we have looked at these individual price relationships, lets look at an example of how you can look at a clustering of price relationships to identify a standout price decision zone in the market. Single Fibonacci price relationships can still turn a market, though I find when these price relationships come together within a relatively tight range, they identify the standout support or resistance in a market. Lets review an example of a Fibonacci price cluster in the Euro. By the middle of August 2007, it seemed that a relatively important high was in place in the Euro from late July. As a technician, you would likely be playing the short side of this market in August and reaping the benefits. Something else you would likely want to know as an analyst is when this move to the downside is likely to terminate. In Figure 5, you are looking at the daily chart in the Euro in the month of August. Would you dare to try to catch a falling knife looking at this chart pattern? No sane trader steps in front of a freight train like this without a reason. Figure 6 illustrates the price cluster zone that developed in this market that could have

Figure 4

Figure 5 given a heads up that the decline could be terminating soon. In the price range between 1.3320 and 1.3359, there was a rather healthy price cluster in the Euro that included the coincidence of at least six price relationships. This clustering of relationships warned us of the potential termination of the decline in the Euro market. These relationships were: .236 retracement 1.1639 low to 1.3852 high = 1.3330 .382 retracement 1.2459 low to 1.3852 high = 1.3320 .50 retracement 1.2866 low to 1.3852 high = 1.3359 1.0projection 1.2323 high to 1.1827 low from 1.3852 high =1.3356

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This particular example of a price cluster zone included only price retracements and projections. There were no price extensions. Note that a price cluster can include the coincidence of any of these three types of price relationships. It can be three retracements or a retracement, an extension and a projection. It can also be more than three price relationships. Lets say a price cluster zone includes six price relationships as in the Euro example. This does not mean that the zone is any more likely to hold. It just means that this is an important decision area in the market. If such a large zone holds, it is likely to produce a tradable reaction. If this same type of zone is violated, it votes for a continuation and possible acceleration of the trend until the next meaningful price decision is met and tested. Carolyn Boroden is a commodity trading advisor and technical analyst specializing in Fibonacci time and price analysis. Her focus is on the synchronicity or confluences of both price and time relationships that set up relatively low risk, high probability trading setups. Ms. Boroden has been involved in the trading industry since 1978. Her background includes working on the major trading floors including the Chicago Mercantile Exchange, the Chicago Board of Trade, NYFE, and COMEX. Ms. Boroden taught a segment of the Chicago Commodity Boot Camp seminars for four years on advanced trading techniques using Fibonacci ratios on both the time and price axis of the market. She has been a featured speaker on Fibonacci analysis for venues such as the Market Technicians Association, the Online Trading Expo, TradingMarkets, and Cornerstone Investments Group. Ms. Boroden currently runs an intraday trading advisory/chatroom service which includes end of day video updates focusing on Stock Index Futures. She mentors individuals on her analysis technique and also conducts group seminars on this same technique. Her first book is to be published and released by McGraw-Hill in January 2008. Its title is Fibonacci Trading, How to Master the Time and Price Advantage. Carolyn can be reached at CB1618@aol.com or via her website www.fibonacciqueen. com

Figure 6

Figure 7 1.0projection 1.2980 high to 1.2459 low from 1.3852 high = 1.3331 1.0projection 1.3369 high to 1.2866 low from 1.3852 high = 1.3349 Even though this price cluster zone was identified early, it is still not a good idea to step in front of the proverbial freight train. First, we would see if the decline stalled or stopped around this key price decision zone. Then, we would look to see if there was a price reversal trigger to enter the market on the buy side. Figure 7 illustrates the result of the price cluster setup. The actual low was made at 1.3361, which was just two pips above the high end of the zone and as they say this was close enough for government work. As of the submission of this article, the Euro has rallied 917 pips from the price cluster low.

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