The importance of the 38.2 retracement
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?
|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
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 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.
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