When Forex Volatility Ignites, The “Fibs” May Be the Only Tool That Works

There are many currency traders that will gladly welcome the passing of the current year into the history books. Volatility can be a catalyst for opportunistic trading strategies when the actions of the market follow some rule of order, but 2011 brought more chaos than orderly market fluctuations. The uncertainty in Europe and the constant barrage of contrary pronouncements from every official and pundit in the region created an overly sensitive market that would bolt to and fro at the slightest hint of a problem. Volatility was the result, but the accompanying “whip-saw” actions, most notably observed in our forex markets, made trading a hazardous exercise at best.

Many forex traders rushed for the exits and sat on the sidelines for much of the year, licking their wounds when their trusted trading strategies no longer yielded the expected returns. Even professional traders moved more cautiously and self-adjusted, knowing from experience that choppy markets require a special touch to avoid the hated “long losing streak”. These markets have a tendency to eliminate all stop-loss orders before making a decisive move in one direction or another. Picking optimum entry and exit points are key, but broadening your risk tolerance level is perhaps more important if your plan is to bring the success you desire.

When market action turns erratic, the one “tool” that can bring order to the chaos is the Fibonacci line study. Often referred to as “using the Fibs”, many experienced traders rely solely on the predicted levels of support and resistance that this tool produces, even when the going gets rough. The following diagram is but one example:

The chart relates the pricing behavior for the Euro on 5-minute intervals on a Friday. A single piece of news has jolted the trading into a steep angle of ascent. A “jolt” of this severity usually results in increased volatility, as well, as noted by the “Average True Range”, or “ATR”, indicator. Adroit traders will quickly add the red Fibonacci lines and execute a limit order beneath the “zero” baseline. After three “tests”, the anticipated quick descent ensues. At this point, how deep will the drop be and what retracements can be expected? The “Fibs” highlight optimum entry and exit points, the “blue” circles” amidst the chaotic price swings that could produce more fear than logical thinking.

With today’s technology and sophisticated trading software, the above tasks can be achieved with a few clicks. Patience and a tolerance for risk will determine your eventual outcomes, but your trading plan will have deliberate steps that will guide your decision-making process and prevent your mind from undermining your ability to score under these trying circumstances.

It is sometimes hard to believe that many of the advances in technical theory came when computers were only a dream in someone’s mind. The names of Elliott and Gann are often associated with much of this early research into the wave-like properties of our financial markets. These founding fathers studied all types of lines and angles in pricing charts of the day and attempted to correlate many natural laws in physics with the forces at work in our markets. Many insights were gained, but none has been more profound than these simple Fibonacci ratios and how prevalent they appear in any type of pricing behavior.

It was Albert Einstein that once said, “Make everything as simple as possible, but not simpler.” Trading can be a “90/10” exercise where 10% of your trades yield 90% of your gains. Einstein might have “used the Fibs” to achieve this simple objective.

Tom Cleveland is a writer and investment analyst for ForexTraders.com, an online resource for the foreign exchange market and forex news. He has over 30 years of experience in executive management, corporate governance and business development, having served as CFO for various Visa International entities from 1980 until his retirement in 1999. Tom’s writing on business issues has appeared in the NY Daily News and Business Insider among others.

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