Trading with Fibonacci Arc
Trading based on Fibonacci numbers is something that is widely used in the financial markets. The Fibonacci numbers have always been a mystery among some traders. These are nothing but mathematical values that are derived.
Among the various ways that Fibonacci numbers are used, they are most commonly found in finding the retracement of a wave, or in projecting the extension of the waves based on Fibonacci numbers.
A less common way of trading with the markets is the use of Fibonacci arcs.
There is a bit of complexity involved when trading with the Fibonacci arcs. One of the main reasons behind this is that it can become very subjective for the trader. Because arcs are basically circles one trader can assess the markets differently compared to the other.
So, what are Fibonacci arcs and how can they be used in trading? In this article, we explain what are Fibonacci arcs and how to plot them. Bear in mind that Fibonacci arcs are very subjective. It is not recommended that you use the Fibonacci arcs to trade blindly. Some amount of practice and familiarity is required in order to trade successfully with the Fibonacci arcs.
Traders in general tend to have a fascination for the Fibonacci levels. Some call it a mystery but in reality Fibonacci levels are a self fulfilling prophecy. Due to the fact that they are widely used, the price levels as seen by the Fibonacci levels become areas of interest for traders.
As a result, you can often expect price to react when it reaches one of the Fibonacci levels. Thus, there is no mystery involved but rather the fact that the method is widely used. Among the various methods of Fibonacci based analysis, the Fibonacci retracement and the Fibonacci extension tools are most common.
The Fibonacci arcs which we will explain in this article is one of the less commonly used tools when it comes to technical analysis based on Fibonacci retracement levels.
What are Fibonacci arcs?
As the name suggests, Fibonacci arcs are half circles that are projected outside from the line that connects the high and low of price wave. A price wave is nothing but the period where a strong trend is formed. In such phases, there are little to no pullbacks.
The Fibonacci arcs belong to the time series family of tools under the Fibonacci based technical indicators. These indicators which also account for time series aim to project the potential price points at a future time.
This might be appealing for some traders, but it is more a matter of a hit and a miss. There are no studies that prove the accuracy of the Fibonacci time series methods. Still, it is not surprising that quite a few traders try to use the Fibonacci arcs in order to estimate where price will be at a future point in time.
The basic purpose of using the Fibonacci arcs is to predict where prices can retrace or extend to.
With Fibonacci arcs, due to the fact that they are circles, the resistance and support areas span across price levels. The arcs intersect at the key Fibonacci levels of 38.2%, 23.6%, 61.8% and so on.
When price retreats into one of these levels, based on the price’s proximity to the Fibonacci arcs, traders can anticipate potential reversal in the price. One of the features unique to trading with Fibonacci arcs is that they also give the trader a sense of price and time.
Below is an example of a typical Fibonacci arc plotted on the price.
Fibonacci Arcs Example
In the above example, the Fibonacci arcs are plotted after connecting the swing high and the swing low points. After the Fibonacci arcs are formed when you connect the highs and lows, the arcs give a potential retracement levels that price can retrace to.
You can see that after plotting the swing low, price starts to retrace. Eventually, price retraces close to the 61.8% Fibonacci arc where we see a retracement in price and the previous downtrend is resumed.
The Fibonacci area where price reversed is nothing but the dynamic resistance area. But one might argue how come the previous resistance levels near 38.2% did not see a reversal in price.
The same concepts that apply to generic support and resistance levels also holds true with Fibonacci arcs as well. In the above example, price retraces, breaking past the potential resistance levels and rallies to the 61.8% Fibonacci level before reversing.
The arc lines also serve as potential areas of support and resistance . For example, after price retreats from the rally to 61.8%, you can see how price initially bounces off the 50% Fibonacci level before resuming the downtrend.
Using the general concept of Fibonacci retracements, traders can also use multiple Fibonacci arcs to measure short term retracements and trade near cluster areas.
How to use the Fibonacci arcs?
Fibonacci arcs are used to identify areas of support and resistance . Because Fibonacci levels are basically used for retracements and extensions, the arcs provide potential areas of reversals by means of projecting the support and resistance levels.
The first step in using the Fibonacci arcs is to identify a swing high and a swing low. These levels can be seen by a strong move in price. The basic idea is that once you identify the swing high and low points, you will then need to use the Fibonacci arc tool to connect these two points. In doing so, you are preemptively expecting to see a correction to the direction from the previous swing. Now comes the question of how far will price reverse or retrace, the previous swing direction.
This is where the Fibonacci arcs come into play by projecting the arcs based on the Fibonacci levels. Because the arcs cover a wide span, you can also estimate when price could hit the retracement levels.
Fibonacci Retracement levels with Fibonacci Arcs
In the next chart above, you can see that we plotted the Fibonacci arcs by connecting the swing high and swing low. During this swing, price action moved higher after forming a swing point low.
When the swing is completed, the Fibonacci arcs automatically project the arcs based at the key Fibonacci levels. From there on, the trader simply anticipates potential areas of retracements.
An important point to mention is that when there is an upswing, the Fibonacci arcs present levels of potential support. Likewise, when there is a downswing, the Fibonacci arcs present potential areas of resistance.
These support and resistance levels are areas where price could possibly reverse direction and resume the previous trend. But this is not always set in tone. The Fibonacci method of analyzing the markets simply project the areas of reversals. Just because you see these reversal levels doesn’t mean that price must reverse.
There are many instances when price breaks past the potential support and resistance levels and continues to move in the new direction.
Going back to the above chart, you can see that the Fibonacci arcs show these levels. Price indeed initially bounces off these arcs but sooner than later, price reverses direction and continues to fall.
Key points to remember when drawing the Fibonacci arcs
Fibonacci arcs can be a bit confusing compared to other Fibonacci retracement or extension tools which are more straightforward. Therefore, it is ideal if the trader follows the below set of guidelines.
- When there is an upswing, you will plot the Fibonacci arcs in the opposite direction. Therefore, your starting point will be the swing high and you will plot the Fibonacci arc to the swing low.
- Once the two main points are connected, the arcs are automatically plotted. Depending on the trading or the charting platform that you use, you will be able to configure the Fibonacci levels.
- Some traders prefer to use all the Fibonacci levels, starting from 23.6% all the way through to 78.6% level. This is a matter of personal choice. Remember that your charts can get too cluttered if you use too many Fibonacci levels.
- Once the arcs are set up, you can expect at which point in time will price make a reversal or at the very least touch one of the Fibonacci arcs.
- The Fibonacci arcs basically project into the future. Thus, you can use this as a guideline and make a rough estimate of when price will be testing one of these Fibonacci arcs.
Following this, you can follow the general rules of Fibonacci. Depending on whether the retracement was successful or not, you can then trade in the direction of the reversal or the retracement of the previous swing wave.
It is not recommended that you use the Fibonacci arcs in isolation. Remember that the Fibonacci arcs are merely potential levels of support and resistance with the added knowledge about time as well.
Therefore, you should also be using existing method such as oscillators or trend following tools in order to determine if the Fibonacci retracement is valid or not.
Trading with Fibonacci arcs
There are many different ways that you can trade with the Fibonacci arcs. For one, traders tend to use the Fibonacci arc bounce. In this method, traders wait for a bounce to occur at one of the arcs.
When price bounces off the arcs, a short term trade is set up in the direction of the bounce.
You will often find various articles on Fibonacci arcs showing how to trade these bounces successfully.
But remember that these set ups are shown in hindsight and therefore, it might look easy to trade the Fibonacci arc bounces. In reality, it can be a completely different ballgame altogether. As mentioned previously, there is no guarantee that price will be able to maintain the direction after the bounce in price.
Fibonacci Arc Bounce
In the above chart, we have such an example. For example, in the first instance, we see that there was a modest retracement when price reaches the first Fibonacci arc. Following this, one might take a short position and expect price to drop to the lower Fibonacci arc.
But this is not the case. Notice how price reverses the decline mid-way and continues to rise higher. Looking further out to the right side of the chart, you can see that there were multiple bounces on the outer arcs. Here, one might be tempted to take a long position
The first two attempts would have been unsuccessful. Price initially bounces only to post a lower low. Following this, there is another attempt to bounce but price declines once again to the Fibonacci arcs.
It is only after two failed attempts that price manages to maintain the bounce and pushes to new highs. Unless you were astute in your trading positions, there is a high chance that many traders would have given up just before the final bounce occurred and the price trend was maintained.
What are the drawbacks of using Fibonacci arcs?
One of the main concepts of technical analysis is to keep it simple. In this aspect, the Fibonacci arc is not the ideal trading tool to be used. Due to the fact that it takes up almost your entire price chart, it can get difficult to properly trade with the Fibonacci arcs.
Another point which we pointed out earlier is that the Fibonacci arcs extend into the future. Because of the curvature of the arcs, traders can view this differently. Thus, for a tool that brings about so much of subjectivity it can be a bit confusing to trade with the Fibonacci arcs.
A common way to use Fibonacci methods is to use them as a cluster. This mean, plotting the Fibonacci retracement levels across different swing points. Over time, when you see a cluster of Fibonacci levels, you can expect those levels to exhibit strong areas of reversal.
This is how regular Fibonacci tools such as the Fibonacci retracement or the Fibonacci extension tools are used. Using these tools don’t quite clutter your chart that much. But with Fibonacci arcs, it is a different story. Because each swing measure has a full arc in itself, using two or three such arcs can make price analysis very confusing.
Fibonacci Arc Clutter
The above chart gives one such example. What we did was simply measure the different swing points using the Fibonacci arcs. You can see that price action gets really confusing. Also, there is no clear indication of where the potential support and resistance levels are formed.
To put this in perspective, look at the next chart below. Here we only use the regular Fibonacci retracement tools. We connect the same swing high and low points in price.
Fibonacci Retracement tools
In the above method, you can see how simple the technical analysis looks. There is a clear cluster of Fibonacci levels which basically indicate that this is a strong area of support where price action is likely to retrace too.
Comparing the above chart to the Fibonacci arc, you can see how different the two approaches are. Yet, some traders prefer to use the Fibonacci arcs. There is no right or wrong approach to technical analysis.
So, if you feel that the Fibonacci arcs offer you a better perspective of the markets, then you should probably be using this approach. However, if you are a new trader and contemplating which Fibonacci tool to use, you should weigh the pros and cons of this.
Using too many Fibonacci arcs can easily make you lose the perspective and price action gets hidden behind the fancy arcs which defeats the purpose of technical analysis in the first place.
Trading with moving averages and Fibonacci arcs
Having outlined the drawbacks, long term swing traders can make use of the Fibonacci arcs by using it with an existing trading system. For example, you can use the two moving average method along with Fibonacci arcs to spot potential areas of take profit or stop loss levels.
Fibonacci arcs with a moving average system
In the above example, we use a 200-day moving average and a 50-day moving average. We already know that trends are assessed based on the short term moving average and its relation to the long term moving average.
In the above example, we use the previous swing point and plot the Fibonacci arcs. Once the set up is ready, we can then expect to see which price points offer potential areas of bounce or a reversal.
As you can see in the chart, once price forms a top, it starts to drop. The declines fall within the arc area of 50% and 61.8% retracement level. This is nothing but the potential support area that has held.
Following the drop, the price action starts to move higher. You can see that while price managed to move within the 50% and 61.8% area, this same level now starts to act as resistance.
After prices move steadily, you can see that there has been a temporary top formed, following which price starts to fall strongly once again.
There are of course different ways to trade this. For one, after the Fibonacci arcs are formed, you can expect price to test one of the lower levels. Thus, setting a long order near one of the arcs can signal a potential rebound in price.
But in the above chart example, you can see that prices dipped a lot lower and almost came close to the outer Fibonacci arc. Thus, traders need to be very familiar with using the Fibonacci arcs in order to make a successful trade based from this method of analysis of the markets.
Some traders also look at the Fibonacci arcs as a way to project potential price area that can be reached within the specified period of time. This is due to the nature of the arcs. There are no proven studies that price tends to reach the levels within the specific time frame that the arcs project.
Fibonacci arcs tools on MT4
The Fibonacci arcs can be found on the MT4 trading platform. However, the way the arcs are plotted are quite different. For one, the take the shape of an ellipse. This is quite different to how the arcs are formed.
The Fibonacci arcs are not that commonly used. This explains the reason why that the Fibonacci arc drawing tool is not one of the default tools that are shipped with a trading or a charting platform that are widely used.
You will most likely have to use one of the custom indicators as far as the MT4 trading platform is concerned. This explains the reason why that Fibonacci arcs are not that popular when it comes to analyzing the markets.
Fibonacci arcs – Conclusion
In conclusion, the Fibonacci arcs are one of the few technical tools that are not very popular. The reason behind this is because there can be a lot of subjectivity involved. While it is easy to explain price action in hindsight, it can be quite a task to trade in real time especially based on where price could bounce.
One of the unique features of using the Fibonacci based tools is that some of them are also based on timeseries. This makes it somewhat appealing. Traders basically try to predict where price will trade at a given point in time in the future.
While this has its appeal, predicting the price action with accuracy is something that is not consistent. Therefore, traders need to apply their own due diligence if they want to make use of trading with the Fibonacci arc tool.
While you might come across a lot of trading strategies based off the Fibonacci arcs, be wary of the fact that these are only examples after price has evolved. It makes it easy and also gives a false sense of security for the trader that the Fibonacci arcs are a great way to trade the markets.