Trend or countertrend

You can use Fibonacci ratios regardless of whether you enter a position expecting immediate continuation or if you’re trading on a pullback. Because trend trading is usually a more common technique for most traders, let’s look at that approach first.

Say you spot a strong breakout on an hourly chart of the Euro/U.S. dollar rate (EUR/USD). Although it’s impossible to be sure the move will follow through, a trend trader would go long in anticipation of further upside price movement.

To trade this setup, you could use the following technique: Enter only half your total trade size on the breakout, add a quarter more if the trade goes your way at 138.2 percent of the initial breakout move, and enter the final quarter at 161.8 percent of the move.

For example, if the high of the breakout bar was 1.3250, the length of the breakout candle was 100 pips and you wanted to commit a total of 20 mini lots (requiring approximately $2,000 in margin) to the trade, you would do the following:

1. Buy 10 lots at 1.3250 (initial level).

2. Buy 5 lots at 1.3288 (the low of the breakout bar plus 138.2 percent of the length of the bar).

3. Buy 5 lots at 1.3311 (the low of the breakout bar plus 161.8 percent of the length of bar). Average cost = 1.3275.

4. Place a sell stop-loss order at 1.3150 (low of the breakout bar).

This strategy is known as “pressing the trade” and is a variation of an idea in Josh Lukeman’s book The Market Maker’s Edge (McGraw-Hill, 2003).

This concept has several advantages. First, it minimizes risk by committing only half the capital at the beginning of the trade. In this case, if the trade moves against the position, you would lose only $1,000 instead of the full $2,000 investment. On the other hand, if the trade becomes profitable, you would add 50 percent more capital to the trade without significantly increasing your average cost.