Trading What I See

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

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.

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

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.

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.