Combining Fibonacci Retracements with The Williams Percent Range Indicator

A powerful combination of algorithms, art, architecture, biology, finance, music, mathematics and momentum.

Combining Fibonacci Retracement Levels with the Williams %R (Percent Range) indicator can offer a powerful strategy for online traders to identify potential market reversals, entry and exit points, and manage risk effectively. This strategy is structured to cater to traders of varying experience levels, from beginners to advanced. It will cover foundational concepts, intermediate strategies, and advanced applications of Fibonacci and Williams %R in trading.

Module 1: Introduction to Fibonacci

Fibonacci numbers and the Golden Ratio permeate various fields, from the natural world and biology to art, architecture, finance, music, and more. Their ubiquitous presence in these diverse areas highlights their significance in understanding patterns, growth, harmony, and the fundamental structures of both nature and human creations.

1. Nature and Biology

Fibonacci numbers frequently appear in natural growth patterns, which is why they are often associated with organic development and natural beauty:

• Plant Growth: The arrangement of leaves around a stem (phyllotaxis), the branching of trees, the arrangement of petals in flowers, and the fruit sprouts of a pineapple often follow Fibonacci sequences. For example, sunflower seed arrangements and pinecone scales display spiral patterns that correspond to Fibonacci numbers.

• Animal Physiology: Fibonacci numbers are also evident in the growth patterns of animals. The breeding patterns of rabbits (as originally described by Fibonacci in his famous problem), the spiral shells of snails and nautiluses, and even the arrangement of a hawk’s feathers display patterns associated with the Fibonacci sequence.

• Human Anatomy: The Fibonacci sequence appears in various aspects of human anatomy. For example, the number of bones in each section of the human hand (from wrist to fingertip) follows a Fibonacci pattern: 2, 3, 5. Even the proportions of the human body—such as the length of the forearm relative to the hand—can approximate the Golden Ratio, derived from Fibonacci numbers.

2. Mathematics and Geometry

• Number Theory: Fibonacci numbers are an integral part of number theory. They have unique properties and relationships with other mathematical sequences and are used to explore concepts such as divisibility, prime numbers, and irrational numbers.

• Spirals and Geometry: Fibonacci numbers are used to construct Fibonacci spirals, which closely approximate the Golden Spiral—a logarithmic spiral that appears in galaxies, hurricanes, and even some shells. This is visually linked to the Golden Ratio, approximately 1.618, which is derived from the ratio of successive Fibonacci numbers.

3. Art and Architecture

• Golden Ratio in Design: The Golden Ratio, which is closely related to Fibonacci numbers, has been used in art and architecture for centuries to create visually pleasing and harmonious compositions. The Parthenon in Greece, Leonardo da Vinci's "Vitruvian Man," and various Renaissance artworks are believed to incorporate the Golden Ratio for aesthetic appeal.

• Modern Design and Photography: Contemporary artists, architects, and graphic designers often use the Golden Ratio and Fibonacci grids to create balanced and aesthetically pleasing compositions. In photography, the "rule of thirds" is a simplified application of the Golden Ratio to frame subjects in a visually appealing way.

4. Finance and Trading

• Technical Analysis: Fibonacci numbers are applied in financial markets to predict potential price reversals or continuation points. Fibonacci retracement levels (23.6%, 38.2%, 50%, 61.8%, and 100%) are widely used by traders to identify support and resistance levels in price movements. Fibonacci extensions (161.8%, 261.8%, etc.) help in setting profit targets and anticipating potential breakout points.

5. Physics and Engineering

• Wave Patterns and Quantum Mechanics: The Fibonacci sequence appears in wave theory, optics, and quantum mechanics. It is used to study wave patterns, fractals, and oscillations. The Fibonacci sequence can describe the harmonics and interference patterns found in wave mechanics.

• Engineering Structures: Certain structural designs and frameworks, especially those based on natural forms, use Fibonacci sequences to optimize strength, weight distribution, and aesthetic balance.

6. Music and Rhythm

• Musical Composition: Fibonacci numbers are found in the timing and rhythm of music. For instance, the scales in Western music, the timing of note sequences, and the structure of musical compositions often reflect Fibonacci patterns, providing a natural rhythm that resonates with listeners.

• Harmonics and Sound Waves: The harmonic series in music theory also reflects Fibonacci-like properties, contributing to the creation of scales, chords, and harmonic progressions.

Module 2: Plotting Fibonacci Levels on a Price Chart

Plotting Fibonacci levels on a price chart is a powerful method for identifying potential reversal zones and making more informed trading decisions. By mastering this technique and combining it with other indicators like Williams %R, traders can enhance their ability to predict market movements and manage risk more effectively.

1. Understanding Fibonacci Retracement Levels

Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur. These levels are derived from the Fibonacci sequence, and the most commonly used retracement levels are 23.6%, 38.2%, 50%, 61.8%, and 100%.

• 23.6%, 38.2%, and 61.8%: These are key levels derived from Fibonacci ratios, calculated by dividing one number in the sequence by another (e.g., 21/89 ≈ 23.6%).

• 50%: This level is not a Fibonacci ratio but is commonly used as a psychological retracement level.

• 100%: Represents a full retracement back to the starting point of the prior move.

These levels are used to estimate possible reversal points when the market price retraces (moves against the current trend) before continuing in the original direction.

2. Steps to Plot Fibonacci Levels on a Price Chart

Plotting Fibonacci levels on a price chart is straightforward but requires a proper understanding of price swings and trend identification:

Step 1: Identify a Significant Price Move

• Uptrend (Bullish Market): Look for a significant price movement from a swing low (the lowest point reached by the price before an upward movement) to a swing high (the highest point reached by the price before a downward movement begins).

• Downtrend (Bearish Market): Identify a significant price move from a swing high to a swing low.

Step 2: Select the Fibonacci Retracement Tool

• Most trading platforms and charting software, such as MetaTrader, have a built-in Fibonacci retracement tool.

• Select the tool and click on the chart at the swing low (for an uptrend) or swing high (for a downtrend).

Step 3: Draw the Fibonacci Levels

• Drag the tool from the swing low to the swing high (in an uptrend) or from the swing high to the swing low (in a downtrend). The tool will automatically plot horizontal lines corresponding to the key Fibonacci retracement levels: 23.6%, 38.2%, 50%, 61.8%, 78.6% and 100%.

Step 4: Analyse the Price Chart

• The Fibonacci retracement levels will act as potential support (in an uptrend) or resistance (in a downtrend) zones where the price might reverse.

• Look for confirmation signals, such as candlestick patterns, volume spikes, or other indicators (e.g., Williams %R, RSI) at these levels to validate potential trade setups.

3. Interpreting Fibonacci Levels

Once the Fibonacci levels are plotted on the chart, traders look for the following:

• Support Levels (in an Uptrend): These are levels where the price may find support as it retraces downward from a swing high. If the price bounces off these levels, it may indicate a good buying opportunity.

• Resistance Levels (in a Downtrend): These are levels where the price may face resistance as it retraces upward from a swing low. If the price reverses at these levels, it could present a potential selling opportunity.

• Key Levels (38.2%, 50%, 61.8%): These levels are considered more significant. The 61.8% level, often referred to as the "Golden Ratio," is particularly important, as price tends to respect this level more frequently.

• Breakouts: If the price breaks through a Fibonacci level with strong momentum, it may signal a continuation of the trend rather than a reversal. Traders might look to enter in the direction of the breakout.

4. Practical Example

Imagine a stock that has been in an uptrend from a low of $50 to a high of $100:

• Identify the Swing Low and Swing High: The swing low is $50, and the swing high is $100.

• Plot Fibonacci Levels: Using the Fibonacci retracement tool, plot from $50 to $100. The chart will display levels at $61.80 (61.8%), $73.60 (38.2%), etc.

• Interpret the Levels: If the stock retraces to $73.60 and starts to reverse, traders might look for buying signals like bullish candlesticks or other indicators confirming a reversal. Conversely, a drop below $61.80 could signal a deeper correction or trend reversal.

Let’s take a look at the XAUUSD (Gold) chart below:

The chart above displays the weekly timeframe to demonstrate the effectiveness and precision of Fibonacci retracement levels across different timeframes. The 200-period moving average clearly indicates that XAUUSD has been in an overall uptrend since the end of 2018. This suggests we should look for downward retracements to identify potential entry points aligned with the prevailing uptrend. The swing low is visible on the left side of the chart, occurring in August 2018, while the swing high is marked two years later in August 2020.

It's crucial to understand that markets always move in waves. These waves consist of specific movements known as impulses and retracements. In trading, especially in technical analysis, understanding impulses and retracements is key to analysing price movements in financial markets. These concepts help traders pinpoint potential entry and exit points within a trend. The approach involves plotting the initial impulse and subsequent retracement to identify potential entry points for the next impulse, enabling traders to capitalise on that leg of the wave.

Impulses

An impulse (also known as an impulsive move) is a strong and swift price movement in the direction of the prevailing trend. Impulse moves are characterized by high momentum, larger price ranges, and increased trading volume. They occur when there is a strong market consensus, driving the price sharply in one direction.

• In an uptrend, impulses are the strong upward price movements that push the price to new highs.

• In a downtrend, impulses are the sharp downward movements that drive the price to new lows.

Key Characteristics of Impulses:

• High momentum and strong price action.

• Longer candlesticks (if using candlestick charts).

• Often accompanied by higher trading volume.

• Indicates strong buying or selling pressure.

Retracements

A retracement is a temporary reversal in the price movement that goes against the prevailing trend. Retracements are typically seen as short-term corrections or pullbacks within a larger trend. They are natural and healthy parts of a trending market, allowing for the market to consolidate and gather strength for the next impulse move.

• In an uptrend, a retracement would be a brief downward movement or pullback before the price resumes its upward trajectory.

• In a downtrend, a retracement would be a short-lived upward movement or pullback before the price continues to decline.

Key Characteristics of Retracements:

• Lower momentum compared to impulses.

• Smaller candlesticks (if using candlestick charts).

• Often accompanied by lower trading volume.

• Indicates a pause or consolidation in the trend rather than a reversal.

As shown on the chart, the first impulse extends from the swing low to the swing high. This initial leg marks the beginning of a new trend and is part of the setup; however, it is not the leg we aim to trade. The levels defined by this move will be used to plot the Fibonacci retracement tool, which helps identify potential reversal points for the start of the second impulse—the leg we intend to trade.

To apply the Fibonacci retracement tool, we position the 100% level at the swing low and the 0% level at the swing high. This action plots the key retracement levels to the downside: 23.6%, 38.2%, 50%, 61.8% and 78.6%. These levels represent potential reversal points where the second impulse to the upside could begin. The key question now is how to determine which of these levels will serve as the actual reversal point.

Module 3: Understanding The Williams Percent Range

The Williams Percent Range, commonly known as Williams %R, is a momentum indicator that helps traders identify potential overbought and oversold conditions in the market. Developed by Larry Williams in the late 1970s, this technical analysis tool measures the level of the closing price relative to the high-low range over a specified period. This indicator is especially useful for spotting possible reversal points, allowing traders to enter or exit positions with greater confidence.

What is the Williams Percent Range (Williams %R)?

The Williams %R is a bounded oscillator that moves between a range of -100 to 0. Unlike other momentum indicators like the Relative Strength Index (RSI), Williams %R uses a negative scale. The closer the value is to 0, the more overbought the asset is considered; the closer it is to -100, the more oversold it is.

The formula for calculating Williams %R is as follows:

Where:

• Highest High is the highest price over the look-back period.

• Lowest Low is the lowest price over the same period.

• Close is the most recent closing price.

The typical look-back period for Williams %R is 14 periods, but traders may adjust this based on their trading style and the asset being analysed. After many tests and trials, I have come to the conclusion that 40 periods is best suited to my trading style.

How Does Williams %R Work?

Williams %R essentially shows the current closing price's relative position within the chosen period's high-low range. When the indicator is above -20, it suggests that the market is in an overbought condition; when it is below -80, it indicates an oversold condition. However, being overbought or oversold does not necessarily mean an immediate reversal will occur. It is an early warning sign that a change in the trend may be forthcoming.

Applying Williams %R to Identify Possible Reversal Points

Traders use the Williams %R indicator to identify potential reversal points in the market by analysing overbought and oversold levels, divergences, and crossovers. Here’s how:

1. Identifying Overbought and Oversold Levels

• Overbought Levels (-20 to 0): When the Williams %R moves above -20, it suggests that the asset is overbought, and a bearish reversal could be imminent. In such a scenario, traders may look to take profits on long positions or consider initiating short positions.

• Oversold Levels (-80 to -100): When the Williams %R drops below -80, it indicates that the asset is oversold, signalling a potential bullish reversal. Traders may look for buying opportunities or consider closing short positions.

It is essential to note that overbought or oversold conditions can persist for extended periods in strong trends. Therefore, traders should use additional confirmation tools or indicators before making trading decisions solely based on Williams %R. Below is an illustration of how the Williams %R oscillates.

2. Using Divergence for Reversal Signals

• Bullish Divergence: A bullish divergence occurs when the price makes a lower low, but the Williams %R forms a higher low. This divergence suggests that bearish momentum is weakening, and a bullish reversal could be on the horizon. Traders often use this signal to enter long positions.

• Bearish Divergence: A bearish divergence occurs when the price makes a higher high, but the Williams %R forms a lower high. This divergence indicates that bullish momentum is fading, signalling a potential bearish reversal. Traders often use this as a signal to enter short positions.

Divergence can be a powerful tool for identifying reversal points, especially when combined with other technical analysis tools such as trendlines, support and resistance levels, or candlestick patterns.

Below is an example of Bearish Divergence, where the price printed a higher high and the Williams %R printed a lower high, indicating a potential bearish reversal. 

3. Crossovers and Confirmations with Other Indicators

• Traders often use Williams %R in conjunction with other technical indicators to improve the accuracy of their predictions. For instance, a crossover strategy using moving averages or the MACD can provide confirmation of a potential trend reversal identified by Williams %R.

• For example, if the Williams %R indicates an oversold condition and a moving average crossover occurs, it could strengthen the case for entering a long position.

4. Williams %R in Range-Bound Markets

• In range-bound or sideways markets, Williams %R can be particularly effective for identifying reversal points near support and resistance levels. When the price is oscillating within a range, traders can use Williams %R to time their entries and exits by buying near support (oversold level) and selling near resistance (overbought level).

Below is an example of the accuracy of the Williams %R indicator in identifying potential reversal points within a range bound market. The green vertical lines indicate possible bullish reversal points where the Williams %R was indicating an oversold area. The red vertical lines indicate possible bearish reversal points where the Williams %R was indicating an overbought area.

The key to implementing this accurately is to wait for the candle close of the timeframe you are assessing before determining entry levels. Note that the price made definitive moves at every plotted vertical line and is an excellent indicator for possible reversal points. 

Best Practices for Using Williams %R

• Combine with Other Indicators: While Williams %R is a valuable tool, relying solely on it can lead to false signals. Combining it with other indicators, such as RSI, MACD, or Bollinger Bands, can provide more robust signals.

• Use Multiple Timeframes: Analysing Williams %R across multiple timeframes can help confirm signals and avoid entering trades based on noise or short-term fluctuations. For example, if both the daily and weekly Williams %R indicate an oversold condition, it strengthens the likelihood of a bullish reversal.

• Wait for Confirmation: Entering a trade solely based on overbought or oversold readings can be risky. Always wait for confirmation from price action, such as a candlestick pattern or a break of a trendline, before making a trade.

• Set Stop Losses: As with any trading strategy, always use stop losses to manage risk. The market can remain overbought or oversold longer than expected, and having a stop-loss strategy helps protect your capital.

Module 4: Free Trading Strategy

Williams Percent Range Meets Fibonacci: A Powerful Strategy for Identifying High-Probability Trade Setups

Individually, Williams %R and Fibonacci retracement levels are powerful tools. However, when combined, they provide a more comprehensive approach to identifying reliable reversal points. Here’s how traders can effectively use both indicators together:

1. Confirming Overbought and Oversold Conditions with Fibonacci Levels

While Williams %R helps identify overbought and oversold conditions, Fibonacci retracement levels offer specific price levels where reversals are more likely to occur. When Williams %R indicates that an asset is overbought (above -20), and the price reaches a key Fibonacci retracement level (e.g., 61.8%), it signals a high-probability reversal point. Similarly, when Williams %R shows oversold conditions (below -80) and the price aligns with a Fibonacci support level (e.g., 38.2%), a bullish reversal could be imminent.

This combination provides traders with a clearer signal to enter or exit trades, as both the momentum (Williams %R) and key price levels (Fibonacci retracements) are aligned.

2. Divergence and Confluence as Strong Reversal Signals

Another powerful strategy is to look for divergences between price and Williams %R at critical Fibonacci retracement levels:

• Bullish Divergence: If the price forms a lower low, but the Williams %R forms a higher low near a Fibonacci retracement level, it indicates weakening bearish momentum. This confluence suggests a potential bullish reversal, providing a strong buy signal.

• Bearish Divergence: Conversely, if the price makes a higher high, but the Williams %R forms a lower high near a Fibonacci resistance level, it signals weakening bullish momentum. This confluence indicates a possible bearish reversal, making it a strong sell signal.

Using divergence in conjunction with Fibonacci retracement levels adds another layer of confirmation, enhancing the reliability of reversal predictions.

3. Timing Entry and Exit Points with Precision

Combining Williams %R and Fibonacci retracement levels allows traders to time their entry and exit points more precisely. For example, suppose an asset is in an uptrend, and the price retraces to the 50% Fibonacci level while Williams %R drops below -80 (indicating oversold conditions). In that case, a trader might consider entering a long position, anticipating the continuation of the uptrend.

Similarly, if the price rallies to the 61.8% Fibonacci level during a downtrend and Williams %R moves above -20 (indicating overbought conditions), it could be an ideal point to enter a short position.

Below is an example of a bullish reversal that took place on XAUUSD (gold).

Consider the following steps and criteria before looking for possible entries:

• XAUUSD is in an uptrend

• First impulse formed between the swing low and swing high

• Price testing Fibonacci retracement levels while the Williams %R indicates oversold conditions

The green vertical lines indicate points on the chart where the price was testing Fibonacci retracement levels while the Williams %R was indicating oversold conditions. The possible reversal points are indicated with numbers 1, 2 and 3. Note that points 1 and 2 occurred at the 38,2% Fibonacci retracement level. While this is a common retracement level and reversal point, it is considered a shallow retracement and may produce either a false signal or smaller moves in the direction of the underlying trend, as seen above.

The 50% and especially the 61,8% Fibonacci retracement levels are considered more significant and can indicate higher confidence in a possible reversal point. When combined with an oversold or overbought indication from the Williams %R, this produces a reliable trade setup. Note how the price bounced on the 50% Fibonacci retracement level three times while the Williams %R was in oversold territory and then rallied to the target of the second impulse. This trade would have been highly profitable for experienced traders who were patient and applied this combination of confluence and knowledge to make a potential risk to reward ratio of more than 1:10.

4. Filtering False Signals

Both Williams %R and Fibonacci retracement levels can occasionally produce false signals. However, when used together, they can help filter out noise. For example, if Williams %R indicates an overbought condition, but the price has not reached a significant Fibonacci level, it might be wise to wait for further confirmation before entering a trade. This approach reduces the risk of entering trades based on false signals, improving overall trading accuracy.

5. Combining with Other Technical Tools for Enhanced Confirmation

To further strengthen the signals from Williams %R and Fibonacci retracement levels, traders can use additional technical analysis tools such as moving averages, trendlines, or candlestick patterns. For instance, a bullish reversal at a Fibonacci level with an oversold Williams %R could be further confirmed by a bullish candlestick pattern (e.g., a Hammer or Engulfing pattern). Combining multiple tools provides a more comprehensive analysis, leading to better-informed trading decisions.

Best Practices for Using Williams %R and Fibonacci Retracement Levels

• Always Use Stop Losses: No trading strategy is foolproof. Always set stop losses to manage risk, as markets can behave unpredictably.

• Consider Multiple Timeframes: Analysing multiple timeframes can provide additional confirmation. For example, a bullish reversal signal on both the daily and weekly charts can increase the probability of a successful trade.

• Be Aware of Market Context: Always consider broader market conditions, such as economic news, geopolitical events, and overall market sentiment, as these can affect price movements and override technical signals.

• Practice Patience and Discipline: Wait for confluence between Williams %R and Fibonacci retracement levels to increase the likelihood of successful trades. Avoid chasing trades based solely on one indicator.