The Geometry Continues
You’ve probably noticed that recently I seem to be showing a slightly larger picture of market action. Actually I try to look at this every day, but since right now I can’t follow the market in real time (and may not be able to for another month), the larger picture is what I see first. And it has been providing interesting information.
On Thursday I pointed out the Trader Vic 2B Top. They don’t always work out, but since they allow a close stop, I never ignore them. They are, of course, a specialized instance of the Spring patterns I like to trade. Since the pattern took over a day to form, it was a warning that the larger trend had probably changed to down.
Friday and today completed what is called a Downside Triangle with a downside break after about four hours of trading. Triangles of any type usually break with a strong price surge, and today was no exception. One thing I watch for in all patterns, but particularly in triangles, are internal Fibonacci measurements. The better the Fib setup, the more likely the triangle is to work as expected.
I have three peaks numbered in the chart representing the three rallys making up the triangle. The second rally is 62% of the first, and the third rally is 62% of the second. That type of symetrical pattern seems to make the breakout more likely to reach its minimum target. In this case the target is the parallel to the upper edge of the triangle which we hit near the close.
The triangle itself is made up of an A-B-C pattern which has passed the two first logical Fibonacci targets. Notice how it tried to bounce at 100% and 162%. If it continues, the next target will be 262% which usually creates a bottom. And if it develops into any kind of panic move it could drop to 426%. Check out a longer term chart and you’ll find old congestion near these levels.
Which doesn’t mean we won’t turn around tomorrow morning. Fibonacci targets are not predictions, but if you’ve read this commentary for very long you are aware of how often they work out.
The Third Direction
Yesterday’s Trader Vic 2B setup turned out to be at least a temporary top, but as I said, there are always three ways the market can go, and it chose sideways. But it certainly did so in an interesting manner.
Two of the three darker trendlines shown were on the chart from yesterday, and are parallel. The third and forth trendlines added today are also parallel to the others. This situation happens more often than you would expect — another reason to retain old trendlines.
We gapped down past the bottom of yesterday’s channel and pulled back up to touch the broken trendline just as we hit the 50% retracement level. That would have made a nice short entry as we traced out the shape of an A-B-C pattern. I don’t have it marked as such because it didn’t stop at a normal Fibonacci level. But in addition to the Fib measurements I always mark in the Support and Resistance levels. It’s how price acts when these locations are reached that determines whether you should take action.
After reversing at 7:45 the market created a new parallel channel with an A-B-C Measured Move, with “C” being equal to “A.” And this occurred just as the entire retracement hit the 62% Fibonacci retracement level from yesterday’s high and reached the top of the new channel. And if that wasn’t enough, the top had a nice Stochastic divergence.
There have been many nice setups, but this week’s entire range has only been 15.40 points. Maybe next week the market will chose one of the other two directions.
2B or Not 2B
Today I’m showing three days of data to illustrate two different points — a Trader Vic 2B SETUP and a nice example of what I call an Internal Trendline.
An Internal Trendline is just a trendline that was providing support and that when broken, starts acting as resistance as price keeps moving in the same direction. It’s another example of why I treat trendlines exactly the same as support and resistance levels.
Many treat a trendline break as a trend reversal, but the market always has three choices; up, down, or sideways. And after this trendline break the market decided it had further to go on the upside and it did so by using the trendline as a ceiling. This is just an extension of the more common example of price making a single pullback to a broken resistance level. It also explains why I try to leave trendlines on my charts as long as possible.
The market opened with a small gap down and reversed. This has been the pattern all week, so naturally the market did a double reverse and continued down into a nice Fibonacci cluster. We made a 62% pullback from Tuesday’s low that matched a 89% pullback from Wednesday’s low.
This was accompanied by a divergence in the Stochastic and one more thing that is not so obvious. When price breaks a trendline, there is often a significant bounce when it moves an equal distance in the opposite direction. The distance from “B” to the trendline is only three ticks less than the distance from “A” to the trendline. Not safely tradable by itself, but another confirmation of a potential bottom.
Price then rose to test the underside of the longer trendline, made a 50% retracement that bounced from a parallel channel bottom, and finally went to the top of that channel to create a double top. That top is also the 62% Fibonacci target for a large A-B-C marked in blue.
Even more interesting is that this sequence has created a Trader Vic 2B setup. These occur when price breaks a well-established trendline and then makes a strong pullback to a slightly higher high that fails. “C” is 1.2 points above “B.”
I’m 350 miles from my trading library so I can’t look up the figures, but Trader Vic says this setup has a very high probability of marking a trend reversal. But before you get too excited, remember — the market at any time can always choose from three different directions.
For More Information:
Victor Sperandeo: Trader Vic - Methods of a Wall Street Master Recycled Lines
Yesterday you saw how having two days of data available pointed out some pivots. Exactly the same thing happened today. And our good friend the 127% external Fibonacci retracement showed up again.
For those that just found this site, an external retracement is when a pullback extends beyond the starting pivot. Most people know about the 38%, 50%, and 62% pullbacks, but when price actually moves beyond the starting point, Fibonacci reversals still keep appearing. The first turning point past 100% is 127%.
The opening price gapped above yesterday’s resistance, and on the second three-minute bar we reached the 127% level. And when we shot back down through the resistance line it created a Spring reversal.
As will often happen we had a pullback to that same line. That would have made a much safer entry for a short sale by allowing a closer initial stop. The next reversal was at the trendline from yesterday’s data which was hit just as we retraced a Fibonacci 89%.
Many of you know I don’t like to trade between converging trendlines, but not everyone has that bias. In this case the bottom entry would have made a nice trade as it moved to the upper converging trendline just as it made another 127% external retracement. I can’t justify calling this a WEDGE pattern, since the volume doesn’t fit, so I guess it’s just wait for tomorrow.
Trendlines and Clusters
Today is another example of the importance of leaving trendlines on the screen. And, of course, using Fibonacci measurements that include more than just today’s data.
We began with a small pop above the controling trendline from yesterday. Trendlines, when tested several times, work just like any other support or resistance levels — they can be hard to break, but when broken they tend to resist penetration from the other direction.
And, like S&R levels, when price breaks through a trendline, it is supposed to continue - not to reverse. A pullback to the trendline is common, but re-crossing a trendline can be a reversal signal.
In this case price reversed at the resistance of the previous pivot. It is also just over a 127% external retracement (not shown) of yesterday’s final drop. Remember that I consider anywhere between 127% and 162% as a potential reversal zone.
As soon as we went back through the blue trendline it was time to label the chart with the first two letters of a large A-B-C. The three most likely reversal levels for the “C” move are 62%, 100%, and 162%. When you are trying to pick tops or bottoms, it is useful to look for internal measurements — in other words an a-b-c inside a larger move, and that is what we got.
Price looked as though it were going to reverse at the red line I’ve marked Support. That would have made the larger (Red) A-B-C turn at 62%, but that level only held for two bars before continuing downward. By the time we approached the low of the day the labeling was obvious, but in real time it is much more difficult.
If price had turned up from the support line the larger move would have been 62%, and there was a slight bounce there. The next likely turning point was 100%, and again the market tried to stage a rally. This is why I never use the Fibonacci levels themselves for entry. At each potential turning point I watch price closely for indications of an actual turn, using candlesticks, moving averages, divergences, and anything else I observe at the time.
Finally when the smaller A-B-C hit 62% and the larger A-B-C reached 162% we got a Fibonacci Cluster and the market reversed. Another thing I noticed at that level was that we had just duplicated the distance I have marked with Support and Resistance labels. It is not a rectangle, but after spending years working with pattern recognition I sometimes look for targets even when the original “pattern” doesn’t fit the rules.
From the bottom we made another A-B-C to the upside. Notice that the trendline from yesterday reversed the market. The “B” move retraced exactly 50% (forgot to mark it), and the final rise again stopped at 62%. That tends to happen often on sideways days.
On more item that is seldom presented in Technical Analysis books appears at the end of the day. By 10:30 (Pacific time) we had a strongly defined downtrend line (Blue), and then the market started ignoring it. This is usually one of the earliest signs of congestion, and an indication that not trading might be the best choice.
Trendlines and Patterns
The charts may look a little different (haven’t rebuilt my templates yet), but the same old trendlines and A-B-C patterns keep giving trading signals.
As happens so frequently we made a small gap in one direction and quickly reversed. The question was “How far will we go?” I’m always looking for a potential reversal at a 127% external retracement of the last move, and if we pass that, I watch carefully at the 162% retracement. That’s where we put in the top for the day.
If we get above the 162% retracement I assume the trend has reversed, but today was just a sidways movement. From the peak the market set up a down-channel, and if you were really comfortable with trendlines you could have caught it quite early. Notice the first two trendline touches on the line I have marked “Parallel.” If you drew in a trendline using those bottoms, you could have drawn the top red line. If you didn’t, we still retraced right to the 62% Fibonacci level at the Black point “B.”
Everyone should have then drawn the top Red trendline, which gave a nice target for the second move down.
This move down (to point “C”) was a Measured Move — a distance equal to the first drop. There is also a small a-b-c (not marked) within that last move, and in that case “c” equals 62% of “a.” That makes the bottom marked with a Red “A” a Fibonacci cluster — 100% of “A” on the larger move and 62% of “a” on the smaller one. Add a divergence in the Stochastic and those are the type of signals that are most likely to be correct. In this case I would only consider it as an exit, but these multiple signals will often give good entries.
The pullback to the large Red “B” was again a 62% retracement of the entire downmove. It would have been nicer to see a Stochastic divergence there, but the market never makes it that easy. The following drop was the fastest move of the day, but it still stopped at an exact Fibonnaci 100% level for the second Measured Move of the day. The move to the Red “C” was an exact match for the move to the Red “A.”
The afternoon push upwards was stopped at the Blue trendline (you did draw that after the pivot at Red “B” was created — right?) The trick to this kind of trading is to draw all the trendlines and all the Fibonacci levels and then carefully observe how price reacts when those points are reached. And then to go back after the market has closed to find all the levels you missed in real time. The longer you do this, the fewer setups you’ll miss. Fortunately you don’t have to catch them all to keep ahead of the game.
