Trading What I See

Trendlines are often the key for choosing which Fibonacci extension or retracement is going to prove significant. I traded trendlines and parallel channels for many years before I discovered Fibonacci, and using them together has made my trading much more accurate.

To understand today’s chart, remember that retracements can be a portion of the original move, or greater than that move. The first is call an internal retracement, and the second an external retracement. Let’s start with the white labels.

Yesterday we moved from “X” to “A” and then retraced to point “B” at the close. The pullback to “B” was a 50% internal retracement of the first move. Today we made a gap upwards and reversed at point “C.” The distance from “B” to “C” was 162% of the distance from “A” to “B.” It was larger than the A-B move, so it is an external retracement.

External retracements often reverse at 127% or 162% of the original moves. Sometimes you can tell that one Fib level is not going to stop price because there is no pause. Today you could also tell by drawing a parallel trend channel.

The first yellow trendline was drawn as soon as the pivot at “B” was obvious. And immediately afterwards, the parallel was drawn from point “A.” The fact that the 162% retracement occurred exactly when we hit that trendline made it an obvious point for a reversal. Add an overbought Stochastic and you have three reasons for expecting at least a temporary top there.

Another Fibonacci measurement that I use often is the extension. Instead of comparing moves in opposite directions, extensions examine the relationship between two consecutive moves in the same direction. Look at the labels in blue.

The distance between the white “C” and the blue “A” is exactly matched by the distance from blue “B” to “C.” This is a Fibonacci extension, and will usually be either 0.618, 1.00, or 1.618 of the first move. In this case it is 100%, or a Measured Move. How do we know which one to expect? Draw some parallel lines.

As soon as the blue “B” pivot is obvious, you should draw the upper yellow trendline, followed by the parallel line. Once again, price reverses when it reaches the conjunction of the 100% Fib and the parallel. Again it happens as the Stochastic becomes oversold.

Does this always work? Of course not. This afternoon’s trading didn’t have any Fib relationships that I really liked, but look at the parallel trendlines. Three times in one day it shows the limits of a move. That’s tradable information.

For the best book on really explaining trendlines and channels, see below.

Edwards and Magee: Technical Analysis of Stock Trends