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Common Misuses of Fibonacci
"Learn how to spot the most common mistakes traders make with Fibonacci tools, how to avoid them, and how you can be more effective and consistent in your trading."
Wikilix Team
Educational Content Team
Have you ever drawn Fibonacci levels on your chart and had the price completely ignore the levels? Don't feel bad, you are not alone! While Fibonacci tools can be used by traders with success, it is clear that not many know how to apply them effectively. This often leads to poor applications of Fibonacci extensions and retracements, resulting in rescue signals, broken trade setups, and dealing with frustrating losses.
In this article, we will discuss the most common mistakes, recommend uses of Fibonacci tools, and how to avoid them. Once you finish gaining this week's valuable reading, you will have a much clearer understanding of how to develop a working knowledge of Fibonacci levels and improve your consistency in your trading.
A notable example of misapplying Fibonacci levels is using them on price swings that are not significant. Using Fibonacci tools is most effective when applied to clear, intense price swings or extreme highs and lows, as these help define a larger price trend.
Why Is This An Issue?
• By using it on lesser price movements, you create fuzzy levels and unreliable measures.
• You could be taking setups that have little technical value.
How Do You Correct It?
When drawing your Fibonacci levels, the skewed highs and lows should be prominent on the chart. Like all things in trading, the larger the price action, the greater your Fibonacci levels will be.
Not considering the overall trend is another common issue with using Fibonacci levels. At times, a trader using Fibonacci retracements may disregard the overall setup of the trend. In other words, the trader aims to identify price reversals against both the market direction and the minor trend, as well as complete leg reversals based on minor level retracement. Why This Is a Problem
• Your probability of success by doing the opposite of the dominant trend will be less.
• Price action is more likely to respect Fibonacci levels in the direction of the trend than the opposite.
How to Fix It
Always start by analyzing the dominant trend of the higher time frames, and then use Fibonacci levels to find pullbacks in that trend, and avoid calling tops or bottoms indiscriminately.
Some traders make the mistake of drawing Fibonacci retracements on different time frames or with overlapping swings, resulting in messy charts filled with dozens of lines. You can then be met with analysis paralysis.
Why This Is a Problem
• With so many levels, it is often tough to find the most critical zones.
• Conflicting signals can cause you to hesitate or make erroneous decisions.
How to Fix It
Keep your charts clean! Keep your withdrawals in check and focus on the most recent swing that is significant enough for you to trade unnoticed to help you avoid clutter.
Fibonacci levels are zones of interest, not actual points of reversal. Many traders use Fibonacci levels as a definitive point of reversal, assuming the price will reverse when it hits 61.8% or 50%. This leads them to enter trades prematurely because they didn't get confirmation.
Why This Is a Problem
• The markets will blast through greasy low Fibonacci levels and act like the level doesn't exist.
• Entering unthinkingly leads to unnecessary losses.
How to Fix It
Take the time to use Fibonacci levels with confirmation signals such as patterns on candlesticks, trendlines, support/resistance zones, and spikes of volume. Confluence makes it more reliable.
Fibonacci levels are only meaningful when they meet previous support or resistance zones. If you decide to ignore this critical element, you will reduce the precision of your analysis.
Why is it an Issue
• A Fibonacci retracement at 50% will have no meaning if there is no market memory attached
• Someone who is strictly using Fibonacci alone could give you mistaken impressions or expectation levels
How to Fix
The first step is to identify the key support and resistance zones. Once these are marked, you can proceed to place your Fibonacci retracements. In areas where the Fibonacci confluence zones meet your support or resistance, your findings will be higher probability areas of interest.
Traders often misapply Fibonacci extensions when setting unrealistic target profits. For example, chasing the 261.8% extension in a weak market may result in missing out on taking profits at lower levels.
Why is it an Issue
• Chasing levels far away in low-immediate strength markets can be a struggle.
• Believing there is only one target and ignoring the market conditions is not proper.
How to Fix
Use Fibonacci extensions with a level of intelligence. First, start with a closer level such as 127.2% and 161.8%. Then take that into account while you are artificially scaling out of the trade rather than simply probing towards a large, ridiculous target.
Many traders only look at Fibonacci levels from one timeframe. Let's say you are tracking a retracement level from the 15-minute timeframe, and you identify a strong retracement level. Great, but if you encounter significant resistance, you may want to reconsider that level as a strong signal. Why This Is a Problem
• Trading against higher timeframe structures means a decrease in win probabilities
• Not seeing the larger context, and this causes many unexpected reversals
How to fix it
Mark your Fibonacci levels on higher timeframes, such as daily and 4-hour4-hour, and also on lower timeframes. Then, drop down to the lower timeframes and enter at those levels.
The whole magic with Fibonacci lies in the confluence of other technical signals with Fibonacci levels. Entirely relying on Fibonacci levels, without using confirming factors, is one of the most common misuses of Fibonacci.
Examples of Confluence Tools
• Fibonacci levels with Trendline levels
• Moving averages that align with retracement zones
• RSI or MACD divergences that support a reversal
You can never have too many indicators pointing to the same price level, and the more you have all aligned, the greater the probability that a strong market reaction will occur.
Fibonacci tools are made for trending markets. When using Fibonacci in sideways markets or choppy markets, you are likely to create many meaningless levels.
Why This Is a Problem
• The significance of a retracement and extension is skewed as there is no clear direction.
• Trading a Fibonacci level in a range can make for lots of stop-outs or my favourite term, "whipsaws".
How to Fix It
Look for a trending market first, and ensure it is not consolidating before you start the coding of Fibonacci levels. You want to look for a strong move without any sideways movement to have a clear direction.
In volatile markets, such as some cryptocurrencies and commodities, change can occur quickly. The market will usually push past the Fibonacci level before it reverses back; so having rigid expectations in volatile markets will cause you to miss out.
How to Fix It
Be loose. In volatile markets, allow for more buffer zones around the Fibonacci levels you have identified. If you get paired up with real-time price action, you can more accurately position your trades.
When used correctly, Fibonacci tools can be potent, but they are not going to fix every problem. Like many traders, they will often incorrectly apply Fibonacci by forcing setups, overlooking the broader context, and disregarding the advice to use them in conjunction with confluence.
The key point is that Fibonacci levels serve as a guideline, not a guarantee. When used with trend analysis, support/resistance, candlestick patterns, and multiple time frames, they are significantly more dependable!
Suppose you make the necessary adjustments to the above mistakes and focus on using Fibonacci when it is in confluence. In that case, you will use Fibonacci levels the way professionals do - strategically, intentionally, and effectively.
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