Trading What I See

After a slight continuation of Friday afternoon’s drop, the Russell 2000 began a laborous climb to precisely the 50% retracement level. From the looks of the action, there must have been a lot of people watching that number, for the market made three unsuccessful attempts to push through the 732 area.

If you were drawing trendlines on this short-term movement, you ended up with a rectangle, a chart pattern with a flat top and bottom. Notice the drop in volume during the pattern — this is typical of rectangles.

You could also consider this rectangle as just another congestion area. See how the upper and lower trendlines match the high and low of the first candlestick? There were 27 consecutive bars whose range was completely contained within that first bar. That is really congestion.

Unless a rectangle has a lot of room between its top and bottom, it is safer to wait for a breakout — or better yet, a breakout and a pullback, which occurrs over half the time. Today the direction was down, making the rectangle into a reversal pattern. The pullback actually moved back into the pattern for several bars, which caused me some concern, but the ultimate move was certainly worth the worry.

There was a second entry on a pullback to the short moving average. I took that trade, but was stopped out for a small loss when I moved my trailing stop too close. The final bottom occurred at a typical Fibonacci number. When a move is decelerating, the second impulse is often 0.618 times the length of the first. Perfect time for an exit.