“Fractal Fibonacci Retracement” is a popular trading strategy that uses Fractals indicator to identify nearest swing high/low and uses Fibonacci levels to detect the retracement point.
How Fibonacci sequence works?
Fibonacci sequence is a sequence of numbers where, after 0 and 1, every number is the sum of the two previous numbers. This continues to infinity:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765….
There are some interesting relationships between these numbers that form the basis of Fibonacci numbers trading. While we cannot cover all of these relationships in this article, below are the most important ones you will need to know about when we look at Forex Fibonacci trading strategy later on:
- If you divide a number by the previous number it will approximate to 1.618. This is used as a key level in Fibonacci extensions as you’ll learn later on in the article.
- If you divide a number by the next highest number it will approximate to 0.618. This number forms the basis for 61.8% Fibonacci retracement level.
- If you divide a number by another two places higher it will approximate to 0.382. This number forms the basis for 38.2% Fibonacci retracement level.
1.618 is known as the Golden Ratio, Golden Mean, or Phi. The inverse of this is 0.618 and both numbers are found throughout nature, biology and in cosmos.
How to trade using Fibonacci retracement?
Fibonacci retracement levels help to provide price levels of support and resistance where a reversal in direction could take place and can be used to establish entry levels. The retracement levels are based on the prior move in the market:
After a big rise in price, traders will measure the move from bottom to top to find where price could retrace to before bouncing higher and continuing in the overall trend higher.
After a big fall in price, traders will measure the move from top to bottom to find where price could retrace to before correcting lower and continuing in the overall trend lower.
How Fibonacci retracement works?
In order to use Fibonacci technical analysis, a trader should identify X point which is the beginning of the trend. Then the trader should detect A point, this is the point were the trend reverses and the retracement appears. Fibonacci retracement should be applied between these two points. If the retracement is not more than 61.8% Fibonacci level (point B is not lower/higher than 61.8%) the probability that the trend will continue in its original direction is high. When point B is detected as nearest swing high/low and it is not higher/lower than 61.8% level the trader should go long during a bullish trend and go short during bearish one.
To run a back-test we have coded a complete Fibonacci Retracement trading strategy as a MetaTrader 4 Expert Advisor. During preliminary analysis we have identified that the best time frame for Fibonacci Retracement trading strategy is 1 hour (H1).
We have run a back-test of Fibonacci Retracement strategy using standard MT4 Fractals indicator to define swing High/Low. For our test as a trade exit rule we have used a Trailing Stop of 30 pips which is launched after a trade has started and is modified each new 1 pip of profit. From our point of view, such approach allows to maximize profit and minimize drawdown.
We have run the test for 2009.01.01-2019.11.11 using Every Tick modelling on EURUSD-H1, using 1:3 leverage, without reinvestment, assuming spread equals 10 ticks. These are the main parameters of Fibonacci Retracement trading strategy performance at its non-optimized state:
|ROI||# of trades||Winning ratio||Max. drawdown|
Trading data analysis
After running the initial test of a simple non-filtered strategy we perform a trading data analysis that allows to identify possible filters to use to make the strategy more profitable reducing the drawdown simultaneously.
The following charts may give some possible insights on which filters to apply (time sessions, day of week limitation, trend strength threshold, overbought/oversold conditions, volatility range) to turn this strategy profitable should you decide to use this strategy in your investment portfolio:
Fractal Fibonacci Retracement trading strategy can be used with other indicators to filter out losing trades and make entry signals more accurate. After analysing trading data we have found the following insights which have helped us to increase the profitability of Fibonacci Retracement trading strategy up tp 16% reducing it’s drawdown in 4 times:
- Trades that were opened at too high and too low values of Stochastic brought more losses when trading “Fractal Fibonacci Retracement” during 2009 – 2019. Market behavior is not stable at overbought and oversold zones. (ROI increase -5% -> 6.5%, Drawdown reduction 80% -> 29%)
- Trades that were opened at a higher value of ADX were losing when trading “Fractal Fibonacci Retracement” during 2009 – 2019. ADX shows the power of trend and the probability that current trend will reverse is higher at a higher value of ADX. (ROI increase -5% -> 9.3%, Drawdown reduction 80% -> 37%)
- Trades that were opened at too low and too high values of RVI appeared to be more losing when trading “Fractal Fibonacci Retracement” during 2009 – 2019. RVI measures the strength of a trend and the probability that current trend will reverse is higher at boundary states of RVI.(ROI increase -5% ->9.8%, Drawdown reduction 80% ->38%)
We have analysed data received from a test of Fractal Fibonacci Retracement trading strategy during 2009 — 2019 years and applied some filters such as Stochastic, ADX and RVI. As a result, the profitability of the strategy has increased from -5.15% up to 16.42% and it’s drawdown has reduced from 88.40% to 14.19% using leverage 1:3.
Reducing the drawdown more than 4 times has allowed us to increase the leverage that can be used while trading this strategy up to 1:17, which in turn, has resulted in annualized ROI increase up to 93.06%!
Reducing the drawdown has also allowed us to use risk based lot calculation. Below you can see the back-test results using $10,000 initial balance and 3% risk per trade:
|ROI||# of trades||Winning ratio||Max. drawdown|
Analyze your trading strategy!
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Disclaimer: Hypothetical or Simulated performance results have certain limitations, unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity.
Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.
Past performance is not necessarily indicative of future results. The customer is responsible for using the product at his or her own risk and “Nordman Algorithms” is not responsible for any possible losses caused by use of the product, including but not limited to losses.