Trading What I See

For the last week I’ve been pointing out how important the Fibonacci A-B-C pattern is for finding turning points in the market. It almost looks as though the Russell 2000 wanted to emphasize the issue with today’s trading.

Yesterday I showed how the larger A-B-C pattern had just reached the 100% measurement (with a reminder that it “does NOT necessarily mean we will bounce on tomorrow’s open.“) But that was a logical level to be watching for a bounce.

We opened with a small pop to the upside and reversed to break yesterday’s low. Are we going lower? We’re still at the large 100% A-B-C shown yesterday, and if you check the measurements using the drop to the close as a smaller A-B-C, the market reversed at 162%. That low was also a 127% external retracement of the “A” to “B” move while setting up a nice divergence with the Stochastic.

That would be enough to take a long position at today’s bottom, but to give some added assurance, the entire formation set up a Wyckoff Spring reversal that I mention from time to time. That always translates into a close initial stop.

Measure another A-B-C move to today’s top, and we turn down at 162%. Add some more A-B-C patterns and the market has created a nice rectangle that contained prices for the rest of the day.

Many of you are probably wondering whether the A-B-C pattern is just an Elliott Wave correction. There is actually a theory that Elliott had it wrong, and that most market movement (even Elliott’s five waves) can really be explained by a better understanding of the Up-Down-Up pattern that I call an A-B-C.

I won’t take sides in that argument, but I often get Elliott counts wrong while A-B-Cs never change their structure. I developed much of this method from Tony Plummer’s book Forecasting Financial Markets. He recently came out with a new edition. Check out the link shown below.

Tony Plummer’s Forecasting Financial Markets

Last Thursday I pointed out a trade using the A-B-C Fibonacci pattern. Yesterday the market repeated that action. These patterns occur in all timeframes, and often you will see patterns inside of patterns inside of patterns. In today’s 15 minute chart you can see three levels of A-B-C.

The basic pattern consists of a move (A), a retracement (B), and a continuation (C) that usually stops at either 62%, 100%, or 162% of the original move. My interpretation of what is likely to happen after the A-B-C completes is based on which level turns the market.

If wave “C” is only 62% of “A” the market move was not very strong, and a good reversal is likely. If wave “C” turns at 100% of “A”, the market is in balance. But if wave “C” is 162% or larger, there is a good chance that the entire move is not over.

Today’s chart shows three A-B-C patterns, all starting at the top marked with the multiple “X” symbols. The pattern in blue was yesterday, as price broke downward from a long rectangle. The pullback into the close became the “B” wave of a larger pattern (yellow.)

If including a gap in the middle of a pattern makes it hard to follow, consider doing as I do — consult a chart that includes the trading outside of market hours. You’ll find that there really isn’t a gap — trading occurred during that empty area. It just happened between 4:15pm and 9:30am (Eastern time), so it doesn’t show on “regular” charts.

The yellow wave “C” didn’t stop at 100%, so there was a warning that more downside action was a strong possibility. And that brings us to the green wave “B”, which on a 3 minute chart contained a very small a-b-c, with “c” stopping at 62%. If you saw the larger pattern, that created a potential entry for the afternoon drop. If not, there was a downside triangle that could have been used for the short sale.

Where are we now? The large green A-B-C pattern has just reached the 100% mark. That does NOT necessarily mean we will bounce on tomorrow’s open. You can’t classify an A-B-C pattern until a pivot has occurred. But the market has been struggling for the last two weeks, and with the severity of today’s drop my assumption is we are finally seeing a long overdue correction.

Friday I pointed out a rectangle pattern on the 15 minute chart, and today we broke down through its bottom. Trading patterns such as rectangles or triangles involves recognizing repeating structures in the market — so does trading Fibonacci setups.

Usually the repetition is one of style, but today we saw an extremely close duplicate of the market moves from last Thursday (see Multiple Reasons.) After reading this commentary scroll down and look. You’ll see that I have marked the two charts in almost exactly the same way.

We started with a little pop into resistance, and then made a decline that covered all of Friday’s range. Bouncing from the bottom, the market made a small a-b-c move with the “c” move equaling 62% of “a.” Just like Thursday, there was a nice Stochastic divergence on a shorter time frame (not shown - see Thursday.) Once again this trade, if successful, will break out of a consolidation range.

As the market continues down, there is a Measured Move where the larger “C” equals the earlier “A.” The only real difference between today and Thursday was that this A-B-C took about 90 minute longer. Make a close comparison between these two days, and memorize this pattern. I think you’ll find the exercise quite profitable.

My Web Hosting company has been having technical problems this weekend. They now say everything is fixed. If you are still having trouble with anything on the site, please leave a comment.

Lowell

Yesterday closed with a Test of Top in the Russell 2000, and today opened with a failure of that test. Nothing serious — just another inside day, but when a market makes new highs and can’t continue there is a serious threat we may head in the opposite direction.

The first chart today is the 15 minute timeframe, and it shows a large rectangle formation. This gives a good picture of how much congestion there has been in this shortened trading week. Criss-crossing moving averages are another good indication that trading opportunities will be hard to find.

With no reasonable trade setups today, lets review two types of retracement patterns that, under better conditions, I watch for potential entries. The first, marked in yellow, is a normal Fibonacci retracement. This is the one most people recognize, where the market pulls back to give traders a second chance at entering a change of trend. It is often 62% of the original move, but other Fib numbers will occur.

The retracement marked in magenta is less well known. It has several names, but I like to call it an external retracement. This is a retracement that goes farther than the original move, and will often reverse direction at 127% of the first move.

Neither of these are automatic trades, but since they can be drawn long before price reaches them, they give lots of time to look for confirming signals. The two levels also work well together, since a purchase at the 62% level can often use the 127% level as a first target.

You can see how that would have played out today — if we hadn’t been in congestion. If someone is new to Fibonacci measurement, these are the two levels I would have them watch first.

Even though I still think we are in congestion, I found a trade this morning that was hard to resist. When I find a setup that has multiple reasons for an entry and allows a very close stop, it fits into my trading plan.

We started the day with a small pop to the upside, made a quick pullback, and then moved up to the session high at point “X.” We turned down at a 127% external retracement of the previous decline (15 minute chart — not shown). This is a very common turning point, but moving back into congestion doesn’t suggest a trade to me. But what happened next created a nice setup.

The bounce from point “A” couldn’t get through yesterday’s high (green line), and on the second try it was completing a small a-b-c (up-down-up) pattern. The measurement on the second upthrust was exactly 0.618 times the first up movement. That Fib ratio is the most likely to turn into a tradable move.

Some other reasons: a previous day’s high, low, or close will often create important support or resistance, and price is stalling in the area of the high and close. Moving averages will do the same thing, and we are hitting the 13 period (white) moving average, which has turned down.

All of this makes point “B” an obvious short sale setup. Now I’ll start looking for a place for my initial stop. As soon as we turn down I can use the pivot at “B”, the white moving average, or yesterday’s high — all will give me a reasonable risk/reward ratio even if we only drop as far as point “A.”

I’m showing something new on today’s chart — a faster Stochastic. I normally watch a 14 period Stochastic, since so many charting programs use that as a default. I want to be aware of what many other traders are watching. But when I’m looking for divergences in a very short timeframe, I’ll switch to a 5 period Stochastic. And you’ll notice that at point “B” there is a very clear divergence.

Multiple reasons for an entry with a close stop. And the eventual target is a Measured Move — the distance from “B” to “C” exactly matches the distance from “X” to “A.”

The next three hours were sideways, and it ended by forming a nice rectangle. Some might complain that the three bottoms didn’t line up exactly, but I like the pattern structure. What I didn’t like was we are going back into congestion again, and there was no pullback. Until we actually get some momentum behind these pokes into new high territory I’ll continue to be overly cautions in my trade selection.

Yesterday’s 16 point range raised hopes that the market was finally moving again. The rectangle (magenta) created during the day should have acted as support if we were to move higher. Instead we gapped completely through the rectangle and then went sideways for the rest of the day.

There were Fibonacci retracements that I’m sure some traded, but here is why I ignored them. The first drop was to a Fib 38% retracement of yesterday’s entire range. But notice that the moving averages are flat rather than rising. Normally a 38% retracement happens late in a move, and the moving averages have a wide separation. In fact price is usually still well above the moving averages.

Then there is the simple matter of pivots. An uptrend will have higher highs and higher lows, and the opening price created a lower low. Not a good sign.

We pulled back up to the moving averages, and if they had both been declining it might have been an acceptable short entry. But the long MA is very flat, making the entire structure look like congestion.

When we dropped again, price stopped at a 127% external retracement of yesterday’s last rally, and it even had a nice Stochastic divergence. But where are we going? Right back into the congestion area.

The final drop of the day again stopped at a normal Fib retracement, this time 62%. If you look at the larger picture we have sideways moving averages, sideways moving prices. That means low probability trades.

When I think we are in a trend I’m looking for excuses to take trades. But when I have doubts about the trending action, I’m doing the reverse — looking for reasons to watch. Today I watched.