Knowing where to enter or exit profits is probably just as critical as knowing where to position your stop loss. You can’t just initiate a trade based on Fib levels and not know where to exit.
Your account will burn, and you will always blame Fibonacci, cursing his name in Italian.
In this course, you’ll learn a couple of ways for setting your stops when using your trusted Fib levels.
These are basic methods for stopping, as well as the reasoning behind them.
Method #1: Place Stop Just Past Next Fib
The first strategy involves placing your stop just beyond the next Fibonacci level.
If you were going to enter at the 38.2% Fib level, your stop would be above the 50.0% level.
If you thought the 50.0% level would hold, you’d move your stop beyond the 61.8% level, and so on. Isn’t it simple?
Let’s revisit the 4-hour EUR/USD chart we showed you in the Fibonacci retracement lesson.
You could have put your stop loss order just past the 61.8% Fib level if you had shorted at 50.0%.
The idea behind this stop-loss approach is that you anticipated the 50.0% level would act as a resistance point. As a result, if the price rose above this level, your trade suggestion would be rendered void.
The issue with this method of stopping is that it is entirely reliant on you having a perfect entry.
Setting a stop just past the next Fibonacci retracement level assumes that the support or resistance area will hold. And, as previously stated, using sketching tools isn’t an exact science.
The market may rise, hit your stop, and then fall in your favor. This is usually when we go around a corner and start banging our heads on the wall. We’re simply telling you that this may occur, perhaps several times in a row, so limit your losses promptly and let your winnings run with the trend.
This type of stop placement approach may be best suited for short-term, intraday trades.
Method #2: Place Stop Past Recent Swing High/Low
If you want to be a little more cautious, you can set your stops past the most recent Swing High or Swing Low.
For example, if the price is in an uptrend and you’re long, you can set a stop loss slightly below the most recent Swing Low, which works as a potential support level.
When the price is in a downtrend and you’re short, you can set a stop loss right above the Swing High, which serves as a possible resistance level.
This form of stop loss placement would provide your trade more breathing room and a better probability of the market moving in your favor.
If the market price exceeds the Swing High or Swing Low, it may suggest that a trend reversal is already underway.
This signifies that your trade idea or setup is already invalid, and you’re too late to enter.
Setting greater stop losses is probably preferable for longer-term, swing-type trades, and you can also include this into a “scaling in” strategy, which you will learn later in this course.
Of course, with a larger stop, you must also remember to change your position size proportionately.
If you consistently trade the same position size, you could suffer significant losses, especially if you begin at one of the earlier Fib levels.
This might also result in unfavorable reward-to-risk ratios because you may have a wide stop that isn’t proportional to your prospective gain.
So which way is better?
The truth is that, just as you would use the Fibonacci retracement tool in conjunction with support and resistance, trend lines, and candlesticks to locate a better entry, you should utilize your knowledge of these tools to examine the present environment to assist you pick a suitable stop loss point.
You should avoid using Fibonacci levels as support and resistance points for stop loss placement as much as feasible.
Keep in mind that setting a stop loss is not a definite thing.
However, integrating various tools can help you tilt the odds in your favor, giving you a better exit point, more breathing room for your transaction, and possibly a better reward-to-risk ratio trade.
Next Lesson: What Are Moving Averages?