There are times when a pullback can retrace beyond the original starting
point and exceed 100 percent of the initial wave or trend. So a Fibonacci
extension is essentially a correction that exceeds the low of the initial
trend. Technicians will use the 100 percent, 1.272 percent, and 1.618 per
cent ratios to target a pullback level. This state of correction can be
con sidered a double bottom at the 100 percent pullback level; and when we
see that correction exceed the low of point A, we see raids on stops. By
using the extension tool, you may have a great spot to place your stop
orders and keep stop-loss orders out of harm's way by using the hidden, or
invisible, support and resistance levels, as determined by the Fibonacci
extension technique. As you can see in Figure 6.2, prices penetrate below
the low as indicated at point A. Let's say you went long; you could
determine a dollar amount risk factor based on these Fibonacci extension
levels or use them as add-on points of entry. FIBONACCI PROJECTIONS
A Fibonacci projection is simply the determining of a potential price ob
jective and is a vital component in Elliott wave theory. It is an
excellent confirmation tool to identify potential trend-exhaustion turning
points. Figure 6.3 shows how to determine a bullish upside objective by
measuring the range of the wave, or the swing, as it is also called.
Multiply that sum by the corresponding ratios, which are 0.618 percent;
1.00 percent; 1.618 per cent; 2.618 percent; and, for extreme moves, 3.618
percent. In a bullish trend, add that figure to the low, or point C, which
is the correction low; this will give you the projected extension price
objective.
Figure 6.4 shows how to use the Fibonacci ratios to determine bearish
price projections. If point C is a correction, take the measurement of A -
B, multiply that amount by the corresponding Fibonacci ratio, and subtract
that figure from point B, which will give you a downside price objective,
or the targeted support level of point C.
As you examine Figure 6.5, which is a spot euro FX, you will see how to
effectively use the Fibonacci tool. If in a given time period that the
pivot point analysis or pivot support or resistance numbers have hit you
are look ing for further clues as to price direction or support or
resistance levels within the pivot numbers, Fibonacci will be your
greatest tool. Once we in dicate what the established low is at point A,
as the market rallies, we see a top, which is formed by a doji. All that
is needed is to figure what the pos sible support or targeted low will be
on the correction. Point C is the exact 50 percent retracement on the
pullback. One of the most important ele ments to watch here is this: If
the support holds and is a valid spot to buy the retracement, then you
want the market to continue to close above the support numbers. That is
exactly what happens here.
Let's see how we would use the Fibonacci extension method to estab lish an
upside price objective. Take a look at Figure 6.6: The first step is to
establish the low, shown on the euro currency chart as point A. Then as
the peak, or top, is determined at point B, we would extend that distance
by
1.618 percent or 2.00 percent. If the market respects a 50 percent
pullback and begins to resume the uptrend, using a Fibonacci extension
tool will help alert you to a profit target. As I stated before, I like to
think that a mar
ket that is in sync with the Fibonacci ratio numbers stays in sync with Fi
bonacci price objections. In this chart, the pullback was 50 percent of A
B move, and the market held the Fibonacci extension resistance targets.
Fibonacci works with day trading to determine support and resistance
levels within the pivot point areas as well as to help forecast the
projected ranges. Figure 6.7 is a euro currency chart that shows the daily
pivot lines with the 0.38 percent retracement level. The Fibonacci
correction tool can be used as a way to identify whether the trend will
reverse or continue. Let's study the chart in Figure 6.7. The market is
already on a downtrend; if you missed the sell signal at the very top,
when do you join the trend and sell or look for a buying opportunity? As
the market establishes a bottom, as indicated at point B, using the
Fibonacci tool, we see the correction levels indicating resistance at the
38 percent, 50 percent, and 618 percent re tracement areas. Point C stops
dead on a dime at the 38 percent level.
In fact, that reversal triggers a sell signal using the pivot point moving
average method; and as you can see, the market resumes the downtrend. The
arrows illustrate a sell signal as the market closes below a prior low and
below the moving averages. It was the rejection of the Fibonacci 38
percent resistance that helped confirm a trading opportunity. If you take
a short position at the 0.38 percent rejection level, you should use an
initial stop-close-only above the high at point C and then adjust the
stop-loss accordingly. This means we change from a mental stop-close-only
to a hard stop; then, depending on whether you scale out of a portion of
your position, you adjust your stop according to how many lots you have
left on.
Here is how you can put Fibonacci correction levels to good use while
integrating them with pivot point support and resistance numbers. This is
a technique that is more in line with what day traders will encounter on a
more frequent basis. Figure 6.8 shows a 15-minute chart on the Aussie
dollar. As you can see, the market moved into a bullish trend mode early,
only to stall at the projected pivot resistance level. The high of the
session is formed by a doji, which indicates indecision. No call to action
is made just yet; as a system or rule-based trader, you need to wait until
there is confir mation of a breakdown of either support or a conditional
change in prices by a series of lower highs, lower closes than opens,
lower lows, and closes below prior lows. Most important, you want
confirmation of a sell signal when the market closes below the low of the
doji.
The trigger to sell would be on that candle's close or the next time pe
riod's open. The stop would be placed initially as a stop-close-only above
the high of the doji. Immediately, we see instant gratification as prices
plunge. But as what can normally occur is an upside correction that takes
place, in this example, the correction takes the form of a consolidation
period that lasts nearly one hour and forty-five minutes. This period of
inde cision can create havoc, doubt, and uncertainty; and your mind can
start to play tricks on you.
This is the consolidation period that generates indecision. At this point,
you have a good setup, prices have violated support, resistance has held,
and there is a high-probability pattern that you recognize that generates
re liable price action, namely the low close doji sell signal. But you are
faced with these internal forces that may cause you to exit a well-defined
trade. After all, you have a risk factor and a potential reward objective
already mapped out. However, this consolidation period is creating more
and more doubt about whether you should stay in the trade. Here is when
you need to take advantage of the time the market is in the pause period
and go to work. You now have a distinguishable high and a low made. Using
the Fibonacci ratios, you determine the correction levels. As such, you
have iden tified that the 50 percent and the 0.618 percent Fibonacci
retracement levels are holding the market down.
Armed with this information, you will not be surprised or forced to react
emotionally when prices rebound but do not penetrate above these levels.
As Figure 6.8 shows, the correction hits the 0.618 percent retrace ment
level as defined by point C and almost immediately prices collapse. The
market rewards the disciplined and patient trader, as such Fibonacci
correction levels will help you to identify what I consider pattern traps.
What generally occurs in order for the market to finally fall out of bed,
like it does as shown in Figure 6.8, is a period of time to consolidate
and attract buyers. It is within this congestion period, when it fails to
support and prices breach below the lows, that traders are forced to sell
like mad. This setup was a textbook sell signal as this book has taught
you from the be ginning. There was little to no heat to take on the trade.
It did require pa tience and discipline to see the trade through. But this
is how the Fibonacci tool can work in your favor. Use the Fibonacci tool
to help you uncover the hidden resistance levels within a newly defined
trend and stay on the right side of the market longer.
I prefer pivot points, but the fact is that no single tool is the holy
grail. There are many instances where Fibonacci studies outperform pivot
point analysis to help target price-measurement objectives. There will be
times when the daily pivot numbers will not come into play as they will be
too far away from the current market price or the market will blow right
past them, for example, if a prior trading session has an unusually
small-range day and then, during the following session, a major report or
event wreaks havoc on the market. With an increase in volatility, we can
assume that there might be an expanded range and that the pivot support or
resistance numbers may not be as effective. This is where you can harness
the predictive power of the Fibonacci correction or extension technique to
help uncover hidden value areas.
In Figure 6.9, using the Fibonacci extension tool, once we have the high
identified, as shown at point A, we need to look for a low point, or a re
actionary low, as it is called. As the chart shows, the price action blows
right past the daily predicted pivot point support level and forms point
B. The market now goes into another consolidation phase, in which we can
see the pivot support level now acting as a resistance level as prices
hold at point C. By using the Fibonacci extension tool, we can determine
how far the market can decline. The first objective is the 1.618 percent
extension and the next level is the 2.00 percent objective—point D on the
chart. This technique really does help you determine a good profit target
objective when all else fails.
The reason why this is a valuable tool is fairly obvious: If you are scale
trading and peeling off positions and milking the trade by trailing stops
on portions of your positions, the Fibonacci tool gives you profit target
levels so you let the trade run. All that is needed is to manage the trade
set orders to cover shorts at these hidden target levels. This book comes
with a Fi bonacci calculator that includes the correction and extension
tool. I believe that if you are new to trading and do not have a charting
software package that includes this feature, you will find the CD
extremely helpful. Once you determine the calculations, you can simply use
a drawing tool on your charts with the figures. I have included a
simulated demonstration on the CD as well.
SUMMARY
Fibonacci analysis is not complicated when using the numbers as a tool to
determine retracement levels for intraday trading. I find that pivot
points on the various time frames, such as daily, weekly, and monthly,
work more effectively more times than not; so for me, Fibonacci is doing
double the work for longer-term analysis. However, with the software like
Genesis, it certainly does not hurt to use Fibonacci analysis; and it
works extreme ly effectively for day trading corrections on
strong-trending days. The narrow-range days, where pivot analysis will be
ineffective for the most part, will occur but not that frequently; but
when these narrow-range days occur, I believe you will be glad you know
how to use and apply Fibonacci calculations. |