Trading What I See

After opening with a small gap above yesterday’s high, the market immediately reversed on the first one minute bar and closed the gap (not shown.) That looked like a Spring setup, but there was no confirmation — no Fibonacci level or divergence for the top.

The next two minutes reversed the reversal, and then the market topped out at the 127% Fibonacci external retracement. For those new to the site, that’s a measurement that retraces more than 100% of the previous move, shown on this chart with white arrows early in the morning and again in the afternoon.

Any time the market exceeds a previous pivot you should mark off the 127% and 162% external retracements, since these are the two most likely levels for a quick reversal. If we exceed 162% that’s a good indication that the move will continue for a while.

The turn at the high created another Spring setup as we broke through yesterday’s resistance but immediately reversed. This time the reversal occurred at 127% so there were two reasons to enter a short sale. If you missed that entry, the pullback at “B” was at a 50% retracement of the early decline. I like to enter after Dunnigan blue reversal bars if there is another good reason, since that often acts much like the Spring setup.

An A-B-C pattern (shown in blue) will often turn at 62%, 100%, or 162%. The two bar hesitation at 7:30 was at 62%, but there was no actual bounce. We went through 100% without a pause, and finally made the low of the day at 162%. Nice morning trading.

For the next four hours I can’t find an entry I like. I expect early pullbacks to be 50% or greater, but it never happened. I have a nice parallel trend channel marked in yellow, but without an entry you can’t trade it.

But it does point out the afternoon top, which is also a 162% external retracement and another refusal to move upwards after again breaking yesterday’s high. Not as clear as the morning reversal, but I would still consider it a Spring.

You might take a look at the daily chart before tomorrow’s open. We’re back at the high of a rectangle that has lasted over a month. For longer term traders tomorrow might be decision time.

Last Tuesday’s commentary left price just under a downtrend line (shown today in yellow) on the 45 minute chart. Since that level had also completed a potential A-B-C with “C” pausing at 62% of “A”, it was looking much like a top.

After pointing that out, my next sentence was “Of course a breakout tomorrow morning would change this pattern …” The magic of Fibonacci and trendlines is how often they work, not that they can predict the market. Part of successful trading is the ability to quickly adapt to new information. On the shortened trading day Wednesday price pushed through both the trendline and the Fib level. But look what happened next.

As soon as price exceeds a pivot point, you want to draw an external retracement measurement to show the 127% and 162% Fib levels. That’s where to start looking for the next potential reversal. And that’s where we closed on the three bars that eSignal shows occurring on the 4th. That doesn’t predict the downturn this morning — it just means it shouldn’t have come as a surprise.

As I have said many times, where there are two pullbacks in a move, the first one will usually be large (most often 62%) and the second one small (38%.) Today the second pullback turned right at the 38% Fibonacci level AND bounced off the support of the broken trendline. An obvious place for a turn.

On my three minute trading chart you can see the market made a nice A-B-C=100% Measured Move that hit the bottom of a parallel channel (in yellow). That gives today’s low two measurements from a 45 minute chart combined with two more from the trading chart. When multiple time frames agree on direction, you have a high probability trade.

Of course there are often more potential Fib and channel trades than I point out (or sometimes even see) that are available during the trading day. In Tuesday’s comments John explains how he used the $Tick reading combined with the magenta channel this morning to execute a nice short sale starting at “X” on the chart. Nice trade, John.

Setups are easier to trade when they occur at pre-determined locations. That’s why I mark off specific Fibonacci measurements as soon as a move extends beyond 162% of the first major pullback in a trend. Sometimes these levels will be ignored — but surprisingly often they correspond to pivots in the price action.

This morning provided a good example. In yesterday’s chart I had marked the next logical Fib level of 423%, and that’s where the market tried to stabilize. There was no assurance we would turn there, but look what happened between 6:45 and 7:00. The second bottom was a Fibonacci 127% external retracement of the bounce, and at the same time there was a divergence with the Stochastic oscillator.

That’s a nice buy setup, and since we had reached the 423% Fib level, my expectation was for a reasonable move. I first started watching for this level after reading Tony Plummer’s book Forecasting Financial Markets some years ago. He calls these levels Natural Reversal Points.

The concept involves market moves being influenced by the momentum of the next larger wave. Plummer considers a 262% external retracement of the first major pullback to be a “normal” move. As he says in his book:

…when a higher level trend counteracts the impulse wave, then the appropriate ratio for calculating the subsequent objective is 1.618; while if the higher level trend complements the impulse wave, then the appropriate ratio is 4.236…

And it worked again today. The Plummer book has the best explanations of Fibonacci relationships I have read. It is highly recommended, and is now out in an expanded version.

Where does that leave us now? The bounce continued for the rest of the day, but notice that the second major pulse reversed at 127% of the first pullback. And as price rose during the trading session, the volume contracted making the converging blue trendlines start looking very much like a WEDGE.

Nothing definite here, but it’s not really encouraging for any upside movement in the very short term.

Tony Plummer’s Forecasting Financial Markets

After a well structured five wave move like we had yesterday, a reversal of some sort is common. Not required, but certainly not a surprise. So when the market created a Spring setup at the open, the first red bar could be an entry for a short sale.

The Russell tried again to break above yesterday’s high, but didn’t exceed the first pivot — the most logical place for a stop. From there the market kept getting weaker all day long.

Since Spring setups can catch a lot of breakout players on the wrong side of the market, you will usually get at least an A-B-C move against the previous trend. After the 8:00 pullback price moved right to the parallel trendline just beyond where “C” would equal 100% of “A.” But then price couldn’t get back to the top of the channel.

Of course you couldn’t predict that in advance, but by the time we had reached the blue “X” on the chart, just by drawing trendlines and their parallels after each new pivot gave you a potential short entry at the top of the new channel. How much of the next move you could capture depends entirely upon your money management technique.

Over the past few weeks I’ve been pointing out Fibonacci external retracement measurements based on the first major pullback in a larger move (marked in white.) I look for reversal points at 127% and 162%. However if we get beyond the 162% level the most common turning point is 262%. As you can see, price didn’t even hesitate at that level.

What comes after 262%? In a runaway move there will often be at least a good bounce at 423%, and many times that will end the move. No — that is not a prediction. And no, I’m not carrying a position overnight. But I’ve already marked the 837.50 level on my trading chart for tomorrow — just in case.

You’ve probably noticed that I try to point out turns that have multiple indications, since these setups are more likely to work out as expected. If three signals or indicators point to the same result, there could be three times as many other traders pushing price in your direction. Not everyone is looking for the same setups.

Today is an example of multiple versus individual signals. At the bottom marked “A” there were three reasons to expect a reversal at almost exactly the same point. At “B” there were also three potential reversal signals. But at today’s close I can see at least four different levels where a reversal would fit my trading style. And they are not the same.

At “A” we were making a double bottom with the pivot from June 8th. At the same time we finished an external retracement of 162% times the rise to “X.” That is often a Fibonacci turn measurement. And if you’ve learned how to use continuation gaps as a measuring tool, the distance from “X” to the center of the gap was exactly the same as the distance from the center of the gap to “A”. (For a refresher, see Trading Gaps from early April.)

Not only did the center of the gap mark the half-way point — it also provided resistance to the three-bar pullback after the gap. Each of those rising bars had less volume, so just from a chart-reading standpoint the first red bar could be an entry for a short sale.

At point “B” there was a 62% retracement of the entire move down from “X” just as we hit a trendline draw through the first pullback after the top. On June 4th I pointed out how forgotten trendlines drawn across first pullbacks will often mark later reversals — but you will only see them if you leave old trendlines on your charts.

Not shown (except for the Fibonacci level marked at the top) is an internal First Pullback Fib measurement. The top at “B” is at the “normal” 262% external retracement. That makes three reasons to suspect a reversal.

Contrast these pivots with the situation at the close. We have just hit the 127% external retracement of the rise from “A” to “B.” But if we fall a little farther, we’ll get to the yellow parallel. And if that doesn’t hold, there is always the long blue trendline that could turn prices upward. But before we get there it’s always possible that we’ll turn when “C”=100% of “A.”

Waiting for too much confirmation misses trades. But would you rather take a position at “A” and “B”, or take a chance at what will eventually become “C.” As soon as you see a potential setup, start looking for other indications of a turn. On good moves, it’s surprising how often there will be more than one reason to trade.

First Pullback measurements are always external retracements (see yesterday), but they are Fibonacci ratios that few seem to follow. You can mark the Fib levels for the next potential turn as soon a reversal pivot forms following the first significant pullback.

Today each of the major reversals turned at one of these levels (all shown with white lines and arrows.) The 7:30 bottom turned at 127% just as it reached the continuation of a trendline from one of yesterday’s pivots. It also had a Stochastic divergence, and lead to the best move of the day.

That mid-day rally also ended in the same manner, but this time at the 262% external retracement of the first major pullback. This is what I consider a “normal” move. Once again the turn also had confirmation from a trendline at the top of a channel.

After making the high of the day we had another move down. For the third time, the actual reversal near the close was a 262% external retracement of the first good pullback.

This doesn’t work every time, but that’s the case with all support and resistance or Fibonacci levels. They give you an area where turns are more likely to take place. It’s up to your trading plan to give you entries to take advantage of them.

Getting acceptable Fibonacci measurements at futures contract rollover can sometimes be problematic. For longer measurements, do you use the old contract or the new? There is always a gap at rollover, so the measurements won’t be the same.

Yesterday I had a nice 423% external retracement marked on the 15 minute chart for a potential reversal. Today, using the new contract, that measurement is off by about a point and a half. On the 32 point move that was being measured, that comes out to just under five percent.

My solution, for what it’s worth, is to try to base my new contract trading on very short term measurements until the weekend. You decide whether that potential reversal worked or not.

Today we started with a quick double fake-out — up, down, and then the rally. The move created a Spring entry combined with a 127% retracement of the quick upmove. After moving to what would later be labeled “A” there was a 50% pullback which eventually turned into a double bottom.

A trade at the first bottom probably would have been a loss (unless you left your stop below the pivot.) The second bottom (perhaps a re-entry) lead to a nice rally. Both the parallel trendline and the Measured Move pointed out the top at “C.”

Using the “First Pullback” measurement technique that I’ve illustrated several times this week (white lines), today’s top was at a 262% external retracement. The four external retracements I watch for are 127%, 162%, 262%, and 423%.

A fake-out reversal usually comes at 127%. A general reversal zone exists between 127% and 162%. When we pass 162% I watch for a normal move to 262% (as happened today.) And if there is a very strong move, there is often a reversal at 423% as shown yesterday.

Has this move topped? There wasn’t a divergence or a 127% move from the previous peak. But we did turn inside the reversal zone. And we have reached 262%. Not enough agreement to give me any type of bias. As usual, I’ll wait for Monday’s open and see what the charts say then.