Trading What I See

Sometimes the obvious Fibonacci targets don’t work the way you expect. That’s the time to remind yourself that the objective is to make money — not to be correct.

The market opened without much volume and tried to break out above yesterday’s high. To be convincing, breakouts need volume, and without it the reversal wasn’t all that surprising. A breakout that immediately reverses is called a Spring, and I find a tradable example several times a week.

Whenever I see a reversal I anticipate an A-B-C move, so the bounce up from “A” was not a reason to exit. And the turn down from “B” was logical. It was a 50% retracement and occurred at the yellow trendline that was drawn from two earlier peaks. But that’s where things got interesting.

As soon as we turned down from “B” it was time to draw the yellow parallel as a target for the first profit taking level. Since it matched yesterday’s close I expected a turn there. But it wasn’t at a Fibonacci measurement. And there was no Stochastic divergence. Maybe it would be worthwhile to keep part of the position.

When the second hit of the parallel trendline matched the 100% Fib extension I again thought we would bounce, but we didn’t even slow down. Time to draw the next Fib target at 162%. As you can see, we didn’t stop there either.

Now for something you won’t find in many technical analysis books — look at the purple trendline. That is drawn as an exact parallel to the yellow trendlines, but starts at the next pivot I could find. When the market is creating parallel channels and then breaks outside, a surprising number of times price will stop at another parallel to the original channel.

I don’t ever initiate a trade at this point, but in this case you are looking for an exit to retain as much profit as possible. I also found another Fib measurement that pointed to the bottom. The original A-B-C didn’t stop at a good level, but if you will examine the “C” leg it is also a smaller a-b-c. And that purple “C” is the 162% extension of the smaller pattern.

This example is why I always try to trade in multiple contracts. The first half I will exit at a target — the second half with a trailing stop. And when I see a potential reversal, instead of exiting, I just move the trailing stop very close to the price.

After the bottom the market created another nice channel. Unfortunately I can’t see any good entries. But finally at 11:30 we made another reversal with three indications that it might happen. We had retraced 62% of the morning’s drop, we were hitting the top of a well-defined channel, and also running into resistance from a previous pivot.

Another A-B-C that was a Measured Move, and also matched a 62% retracement of the rally, created the last pivot bottom of the day. More lines than usual, but this is what my charts often look like before I clean them up as posts to the blog.

Today we had more A-B-C patterns, but instead of marking them on the chart I’ve drawn in the pullbacks that made up the “B” sections. Often pullbacks will repeat the size of the previous retracement, giving you a price level to watch for an entry. Since these reversal points will usually be Fibonacci levels, checking the actual points moved can act as a type of confirmation.

We began with a gap to the 127% external retracement of yesterday’s afternoon decline. That level is often a reversal point as we’ve seen many times recently. Then we followed a stair-step pattern all the way to today’s low.

Each of the pullbacks retraced the same amount, and in doing so they set up a parallel trend channel that held until the last hour of trading.

You can’t tell how long this type of movement will continue, but if you look carefully at the volume bars, each pullback came on decreasing volume until we reached the last bottom. The increase in volume as we bounced from yesterday’s low was a good indication that the step-wise pattern had probably ended.

Single Fibonacci levels often mark turns in the market, but it’s always more reassuring to have multiple reasons to consider a trade. If several Fib measurements line up at nearly the same price it’s called a Fibonacci Cluster.

Today started with a gap below yesterday’s range, with an immediate pullback to yesterday’s low where it met resistance. This was also a 38% Fibonacci retracement of the move from the previous close. Notice that the volume decreased on the pullback. An entry could either be a short-term trendline break, or the break of the faster moving average.

Then there was a quick drop into a Fibonacci cluster. When you are trading clusters you don’t know whether price is ignoring them until the farthest level is broken. This means that if you enter at the highest level, your stop should really be placed under the final Fib point. This is why I want a Fibonacci cluster to have the levels very close together.

In this case there were three Fibonacci measurements. I’ve placed the three arrows showing where they fall. The highest level was a Measured Move, where “C” was equal to “A.” Next came the 262% external retracement of the A-B move, and the actual turn was at a 38% retracement of the rally from the March 14th bottom. The three levels were within 1 1/2 points of each other.

But in this case the Fib range wasn’t an issue — there was no reversal green bar until after the bottom Fib. That was my preferred entry. The Stochastic divergence gave some additional support to the trade.

The move up made another A-B-C Measured Move, and again the Stochastic diverged from price. The yellow “C” is actually another Fibonacci cluster. I’ve left off two of the measurements to make the chart easier to read. It is an exact 78% pullback of the original drop, and there is a smaller Measured Move inside the “B” leg. The up-down-up action of “B” is another perfect a-b-c.

The market must have been making up for the lack of signals yesterday, because it finished with a third A-B-C, and once again there was more than one measurement to show the turn. It was a 62% retracement of the mid-day rally, and the A-B-C stopped at 162%. The only minor flaw in the pattern was that Stochastics waited for a second bottom before giving the divergence.

After nice signals yesterday, the market wouldn’t cooperate today. We continued yesterday’s closing decline, but none of the turning points matched the Fib levels I was watching.

The first pullback didn’t even reach 38%, and the final decline reversed before reaching a 62% A-B-C. By the end of the lunch hour I though we had a reasonable triangle forming (in yellow), but the upside breakout had no volume increase so I didn’t trust it.

The reversal about 10:30 (Pacific time) was the only good Fibonacci turn of the day. It completed an A-B-C at the 62% level which also matched a 38% retracement of the morning drop. But by that time the moving averages were definitely sideways, so I didn’t even consider a trade.

About the only thing today shows is an example of not forcing trades when the signals aren’t there. We have a fairly well-defined rectangle with this afternoon’s sideways action, so perhaps we’ll get a tradable breakout and pullback in the morning.

The market often will reverse direction when it gets new information. What continues to amaze me is how often those reversals occur right at chart points that correspond to support and resistance, trendlines, Fibonacci, or High-Low-Close levels. Today I’ve turned off volume and moving averages because I’ve left so many lines on the chart.

We had a slow start this morning as traders waited for the New Home Sales report. When the report was released, the market had just reached a 127% external retracement of Friday’s last decline. Any time you exceed a previous peak its important to have this 127% level marked, since this will often be the turning point.

These 127% levels often appear as a Spring formation where price breaks to a new high or low and is unable to continue. When this occurs along with a Stochastic divergence you have multiple indications of a potential trade. Then it just depends upon your entry technique. If you get a trigger, you have a trade.

When the numbers were worse than expected, the market dropped down to the day’s low where it created exactly the same pattern in the opposite direction. There was a low, a pullback, and 127% external retracement of the bounce. Again there was a good Stochastic divergence with price.

A high percentage of market movements occur in three pulses and I often mark them as A-B-C. The first move off the low stalled at the resistance of the previous pivot (A), retraced 38% (B), and then completed a Measured Move to point “C” which is the same length as “A.”

Before we got there I had drawn the blue trendline from the bottom to point “B” and the parallel trendline extending from point “A.” In addition to hitting the parallel trendline, there is the resistance of yesterday’s low (red line.) There was also another Stochastic divergence, making four reasons to look for another reversal.

The question was whether to exit or actually reverse to a short sale. Personally I thought we were going further down. But whether in a trade or just waiting for an entry I keep drawing my trendlines and Fib projections while watching for signals.

We broke the blue trendline, but stopped at the 50% retracement from the bottom. That was a logical place for a bounce, but there was no evidence of an actual reversal. As soon as the blue trendline broke, I drew in the yellow top trendline and its parallel. That’s where the market reversed again — yellow parallel, 2nd touch of the 50% retracement with a double bottom, and another Stochastic divergence.

That was enough to eliminate my downward bias, but certainly not enough to expect much higher prices. So although I didn’t trade after lunch hour, notice that the top reversal came at a parallel trendline combined with hitting yesterday’s close and a 78% retracement of the morning drop. Lots of signals today. How many you were able to take depends on your trading style.

I don’t think today needs very much comment, but an example of a trading tip appeared during the first few bars this morning. Candlestick extensions above and below the day’s open and close have various names. Some call them wicks, some call them tails.

See how noticeable they are during the early trading. When a number of very long tails appear in both directions on consecutive bars, they are an early indication of market indecision and often lead to false moves or sideways action. When I see them, I am hesitant to trade. And today that served me well.

About the only good thing from a trader’s standpoint is that volatility runs in cycles. Excluding the explosive move after the Fed announcement, the last few days have been very flat. Either we will get some movement soon or I’ve mis-read the calendar and summer is here already.

I ended the last post saying that I’d be willing to take a trade in either direction, but neglected to mention the third posibility — sideways again. Perhaps all that excitement yesterday was just short covering after all.

We started the morning with a small gap, and went right to what is often a turning point — the 127% external retracement of the last move. This also created a Spring setup when price couldn’t hold the breakout above yesterday’s high.

An overbought Stochastic combined with a slight divergence gave the short entry, but there was not much continuation as we formed an A-B-C ending at the 62% Fibonacci level.

The combination of a narrow range during the first hour and criss-crossing moving averages kept me out of any additional trades. As sometimes happens, the market started oscillating around the center point of the day’s first move, and ended up almost exactly at yesterday’s close.