This is a guest post by Ahmad Hassam
Most breakouts tend to fail. It is impossible to know which breakout will succeed and which breakout will fail. But you have to be in it to win it. As a trend trader, you have to take every trade. However, using Fibonacci can optimize your few wins and minimize many losses.
When you spot the breakout candle, enter the market with half of your trade size. If the price continues in your favor as you had anticipated add 1/4th of the trade size at 138.2% of the initial move. And if the momentum continues in the direction that you had wanted and anticipated, add the final 1/4th of the trade size at 162.8% of the move.
In nutshell, you will be using Fibonacci Projection Levels, you will carefully increase position size as the price action continues in your favor. Let’s make it clear with an example. Suppose you are trading the EURUSD pair. Suppose the length of the breakout candle is 100 pips and it closes on the high of 1.2300. You intend to trade one standard lot (100,000 units).
Enter the market with half lot (50,000 units) at 1.2300. Your stop loss will be at the 38.2 Fibonacci Retracement Level which comes out to be close to 40 pips below the 1.2300 entry ( 1.2260). If the price retraces to this level, the case for the momentum based trade becomes weak and the probability of success diminished. If the price makes a retracement, you lose 40 points. Since, you intended to trade only one lot, you lose in reality only 20 pips.
If the price continues to trend in the direction favoring you, you will add 1/4 lot (25,000) units more at 1.2338 level. This comes to be equal to 138.2% Fibonacci Projection Level. Your average price comes out to be 1.2312. You can now tighten the stop to 1.2298 level.
Now, if the price continues to move in the direction that you want, you can add the final 1/4 lot at 1.2363 which the 162.8% Fib Projection Level. So, your average cost now stands at 1.2325. If the price continues to move in the direction that favors you and reaches the target of 1.2400, your reward will be 75 pips and your risk will be 25 pips. Giving you an excellent reward to risk ratio of 3:1.
This approach minimizes risk by committing only half of the capital at the beginning of the trade. By using Fibonacci Projection Levels, you gradually add 50% more capital that slightly increases the cost from 1.2300 to 1.2325 while at the same time confirming the breakout making the trade more likely to become profitable.