If you use Fibonacci retracement on a regular basis, this article is for you, because for all their simplicity and convenience, Fibonacci levels have one tricky element that every trader who uses them has to figure out. How do you decide where to start measuring your Fibonacci retracement? If you start from the wrong point, it has implications for how useful your Fibonacci level is. So is there a trick to getting the right Fibonacci levels? Yes there is, and it involves the Parabolic SAR, the lesser known brother of the Relative Strength indicator.
How Parabolic SAR Can Help You
The Parabolic SAR is an index developed by the same mastermind who brought us the Relative Strength indicator: J Welles Wilder. It is commonly used as an effective tool for trailing stop losses. However, the Parabolic SAR also has another very good use: it is very effective at identifying pivots. As seen in the weekly chart below, as the Parabolic SAR switched from being above the price (a bearish sign) to being below the price (a bullish sign), the pair – in this case, the EUR/USD – reached a pivot. And, of course, the converse is true – when the Parabolic SAR switches from being below the price to above it, this is also a pivot.
So why is this indication so valuable for Fibonacci? Basically, a trend lies between two pivots of opposite direction. If we know where it started (the first Parabolic SAR conversion) and where it ended (the next Parabolic SAR conversion), we know exactly where to stretch the Fibonacci, making it much more accurate.
A Practical Example of Fibonacci
Once again, let’s look at our pair, the EUR/USD. In the first example, we tried to stretch the Fibonacci from the top to bottom. The Fibonacci levels that we got haven’t really been helpful for us in spotting key resistances and support levels. It actually captured two different bearish waves and this has caused the Fibonacci position to be off. In the second example, we used the second convergence of the Parabolic SAR as a starting point for stretching our Fibonacci because this is the wave relevant for us.
We then used the following Parabolic SAR convergence that signals the end of the second wave as the end of our Fibonacci, or the 1 level. The Parabolic SAR marks where to start our Fibonacci retracement and where to end our stretch of Fibonacci. The improvement in accuracy of the Fibonacci is evident. This essentially means that our Fibonacci levels are much more reliable and can now be trusted as resistance and support levels.
Things You Need to Know
As you have probably guessed, there are some pitfalls you need to watch for/avoid before you implement this useful combination. The Parabolic SAR tends to be more effective on a weekly interval than, let’s say, daily or even hourly. So if you use this method on an hourly or daily basis, don’t expect the same level of accuracy. This probably means that this technical of Parabolic SAR and Fibonacci is best suited for swing traders.