Trading What I See

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.

Whenever I enter a position, after setting a protective stop loss I begin looking for my first exit level. My compromise between getting out too early and holding a position too long is to trade multiple contracts.

Sometimes finding a logical point to take some profits can be difficult. I don’t automatically exit at Fib or support/resistance levels, but use them as areas to watch price closely for reversal indications. And sometimes I’ll use points that others may not consider “correct.”

After a nice Spring setup just after the open (complete with a Stochastic divergence), price re-visited a resistance area created yesterday, making a third reversal at exactly the same level. Although there is only a single bottom pivot, I’ll probably start to treat this area as a potential rectangle.

A “correct” rectangle will have at least two pivots at both top and bottom, but notice what happens when the bottom support breaks. There is an immediate pullback to that support, just as often happens with a “real” rectangle. If you’re willing to trade “almost” patterns, that pullback was a nice entry for a short sale.

For those not familiar with the quote used as today’s title, here is a more complete version:

If it walks like a duck and quacks like a duck, you can be reasonably sure it is a duck.

For my trading the same thing applies to rectangles, triangles, and many other patterns. If it acts like a rectangle, I’ll certainly mark off a rectangle measurement for a target even though it doesn’t meet all the normal requirements.

And that rectangle target is where we got a nice reversal today. We eventually moved somewhat lower, but first targets don’t necessarily mean the end of a move. But they are certainly good places to take partial profits.

One of the most difficult things about discretionary trading is deciding how much leeway to give patterns and levels. If you are just starting out, my suggestion is to require very strict adherence to the “rules”, but after you have analyzed thousands of charts you’ll begin to see more “almost” patterns and discover that they often work.

Yesterday I didn’t mark an A-B-C for the downside triangle and its target because the previous day’s low seemed to form a strong support. So today the market started out by breaking that support and reversing right at a Fibonacci 162% extension for the A-B-C, and then gave a nice Spring setup.

The magenta “B” is a Fibonacci 78% retracement (not marked). Notice how it stalls at the level of the yellow “B” from yesterday. A nice combination of both price and Fibonacci resistance.

We ended the day at a Fibonacci cluster from two time frames. The larger magenta A-B-C is a 100% extension, while the smaller yellow A-B-C is a 162% extension. In addition, that level is the target for two external Fibonacci retracements. It is a 262% retracement of this morning’s move to magenta “B”, and a 127% external retracement of the second rally to yellow “X.”

Just because we have a nice Fibonacci cluster here, don’t assume this is the bottom. We are still inside a Daily rectangle, and have a way to go before testing the bottom support.

Even better, don’t assume anything. Look for setups that make sense to you and let the market gurus make their predictions. Taking good looking setups in either direction is what makes money in the market.

On May 1st I titled an entry “Time and Target” with an illustration of how a triangle will often give you a price level and a time projection. Most of my trading deals with recognizing recurring setups in the market, and with slight differences we had almost the same pattern today.

We started with a small surge to the upside, breaking through yesterday’s high and reversing. When a market breaks through resistance and can’t continue, it will often create a Spring setup. The next hour retraced yesterday’s final rally and stalled at a support level that was already on the chart. For a while it looked as though we were finished for the day.

The first pullback was 50% for a second logical short entry, but then the market couldn’t seem to break down. The key was to look at the volume. The combination of volume and price action forms the same downside triangle we saw on May 1st. Shortly after 10 (Pacific time) we broke lower on increasing volume. As often happens, there was a pullback to the broken support followed by a move to the triangle target. Another nice short sale entry with a close protective stop.

The first target is a line drawn parallel to the opposite side of the triangle (magenta.) And often this level is reached just when the two trendlines that create the triangle cross. Trading with Technical Analysis is just recognizing setups you’ve seen before, but doing it in time to take action.

For pattern analysis I still think the best book is one many call the “Bible” of Technical Analysis. Check out the link below.

Edwards and Magee: Technical Analysis of Stock Trends

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.

Trading gaps requires two different approaches, partly depending upon where price opens. Recently I’ve pointed out a number of occasions where price would open at a 127% external retracement of a previous move and then immediately reverse. That wasn’t the situation today.

Today we opened slightly above the 162% external retracement of yesterday’s last decline. It is between 127% and 162% that I watch carefully for reversal signals. Once we pass the higher measurement it usually means that price will continue for a while. Before I show how today’s continuation and final top made trading sense, let’s talk about yesterday.

On the 15 minute timeframe I was watching a large triangle break to the upside. I didn’t mention it on the site because there was no increase in volume with the breakout. As I’ve said many times, an upside breakout without a volume increase will often fail. But just because they often fail doesn’t mean that some won’t work out. You must decide which is more important to you — never missing a “good” trade or having a higher percentage of winners.

When we opened with a nice gap this morning I wasn’t thinking of triangles, but of gap statistics. I hope those of you that have been reading this commentary for a while (or have read the more than 150 days of archived analysis) were thinking of the Victor Sperandeo quote I first posted last November after a similar gap.

If there is a gap, and it is going to reverse, it will do so 10 to 15 minutes after the opening 95 percent of the time.

In that post I also mentioned how to find a logical target for specific measuring gaps such as we had this morning. It was certainly nice that both the measuring method and the triangle target were at the same level, because that’s precisely where the rally stopped.

The easiest way to find the primary target for a triangle is to draw a parallel trendline to the edge of the triangle. This creates a trend channel, and these channels are often where price finds serious resistance.

The gap measuring method says that a continuation gap occurs approximately half-way through a rally or decline. You’ll notice that this measuring gap met the requirements.

A third reason for profit taking at that level was the pivot high on March 22nd. Today’s high was within a point of that chart resistance. We then spent the rest of the day creating a small rectangle.

Of course this all assumes you got into the trade by remembering Trader Vic’s statistics. His book is an excellent trading resource — see below.

Victor Sperandeo: Trader Vic - Methods of a Wall Street Master

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.