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Trading 38.2% Retracements

The importance of the 38.2 retracement level

When it comes to Fibonacci retracement levels, there were so many theories that have been written that the trader is confused and really one starts to have doubts about what to do with the whole Fibonacci sequence: Elliott theory is based on the golden ratios (61.8% retracement), Gartley is looking at above 80% retracement levels, and the list can go on so easily. So what to do and which retracement level is the most important one?

Buying opportunities in the 38.2 area

Recent GBP/USD 4-hour chart illustrates good buying opportunities in the 38.2 retracement level area,
which started with the contracting triangle, seen in the lower left of the screen.

Elliott waves theory trading

Everybody is looking at the 61.8% level and they are right as this is one of the most important retracement levels. In terms of Elliott waves, the classical third wave should start anywhere between the 50%-61.8% retracement level (which, by the way, tends not to be true most of the times, but this would be the subject of another article most likely) and the distinction between the zigzags and the flats should be made by using the same level: 61.8%. Do we miss something from the whole Fibonacci sequence if we look only at the 61.8% retracement level? The answer is yes, we are missing the importance of the 38.2% retracement level.

Any five waves impulsive move should have the fourth wave retracing into the 38.2% level and it should be considered that fourth waves types rarely travel beyond the fifty percent level. So if you are trading with Elliott waves theory and looking at a possible fourth wave type that is going beyond the 50% level, just remember that this is not common and try to evaluate your whole structure again.

Trade at the 38.2% level

Instead, what should be interesting to see is to try to buy (in the case of a bullish trend) or to sell (in the case of a bearish trend) the 38.2% level, with a stop loss at the 50% retracement level. Based on the fact that MOST of the times price is not exceeding the 50% level on the fourth wave, then this stop loss should hold MOST of the times.

The target for such a trade should not be new highs/lows for the price to make, but 70% of the length of the fourth wave, measured from the end of the third wave to the end of the fourth wave (if the fourth wave is ending with a contracting triangle then the end of the triangle should be the end of the wave, not the absolute highs/lows there). Why 70%? Because we want to avoid a possible fifth wave failure (remember, we are trading this in an impulsive move) and the minimum conditions for a fifth wave to be considered a failure is the 70% retracement level when compared with the previous fourth wave).

This strategy works best when you are having an impulsive move and the third wave is extended. The chart above shows you the recent GBP/USD four hour chart. By the time price broke out of that contracting triangle on the lower left of the screen, the third wave started, then the move started to be corrected, in the end the correction to resemble an irregular flat. And so, the 38.2% retracement level was a good buying area in this case and the stop loss in the 50% level held nicely. Target? 70% as measured by the time the flat is done, and the trade is profitable.

Remember, good Forex books are very useful for every trader. There is always room for improvement, so do not hesitate on taking a book from forex-library.com and improving your performance!

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