Sunday, December 07, 2008

Simple Analysis to Understand Fibonacci

The purpose of this post is to review a couple of charts with and without Fibonacci lines so that traders can get a better understanding of the usefulness of Fibonacci as a trading tool.

The first chart is the 15 minute BTU with support/resistance gap openings and congestion zones mapped out.

The second chart is the same BTU chart with the Fibonacci retracement and extensions added. The trade in question was Thursday December 4th. Susan shorted on a break of the coiled spring (price/vol. contraction), partialed at the 50% level and closed at the ORL which lines up with 62% Fib. level. She re-entered after price consolidated at the PDL (previous day low) and exit at the 50% Fib. extension level.

The key take away here is that if the Fibonacci lines are drawn as per Trader-X guidelines (#1) in this setup, the Fibonacci retracement zones (38%-62%) correspond to key S/R, congestion areas. Those are areas where price could typically find support and consolidate or retrace. If you're trading in the retracement zone, you have to manage the trade closely. Once price moves away from the retracement zone, and assuming the setup is good, it is more likely to move to the next level because there's nothing in the way.

Fibonacci lines are a mathematical tool to help traders with entries and exits. It's much easier to map out Fibonacci lines than all of the actual S/R, gaps and congestion zones. The math, which is not my forte, has an uncanny way of lining up with the key spots.

In addition to the guidelines set out by Trader-X, I have a few of my own. Long time readers know that when I trade chart patterns, I like to place Fib. extension lines from the high/low of the pattern to the base. For example on a C&H, I extend from the low of the cup to the base of the handle and target 100% extension. That's based on textbook measured moves of chart patterns.

The chart below of ABX (TSX) is a 3 PP base - box play. In this type of setup, I prefer to place my Fib. lines from previous day high to the pivot point base rather than the ORL. Why? Because the base has been forming over several days and is thus more significant than the open.

Here again I've mapped out the real S/R zones and Fibonacci. They're almost identical. I traded ABX on Friday as depicted below. On the first test of the R-zone, it held as resistance and price moved to the 100% extension. I had planned to short again if and when it broke out of the retracement zone to the downside around 2:30, but that didn't happen and I moved on to something else.

This post has been selected for Dinosaur Trader's annual Best Stock Market Blog series coming soon!


Jim said...

Hey Jamie,

Excellent post!

anarco said...

Thanks for doing this great post Jamie!

Jamie said...

Thanks guys!

Susan said...

Thank you Jamie for this excellent post. Very informative for me.

I have a few questions on a double top trade and how you would have traded that. It's DUG (Dec. 5) on a 5 min. chart. It formed a double top around 11.35 at the 50% fib. extension. Would you have traded this ETF based on the chart at around 11.35 (irrespective of how the market was moving). If no, why? If yes, where would you have entered, what would have been your targets at the time of entry.

Also, if the 11.35 candle on the 5 min. chart was a doji or a hanging man - would that have affected your entry point? Any thing that I should remember while taking these setups?

Also, at 10.55, I wanted to draw fib. retracement lines for DUG. I drew from previous day low (from where the leg up started) to the day's high at that time. Is this correct or it should have been the previous day close to the day's high at that point?

Jamie, I know you answer each and every comment and questions on your blog but please feel free not to answer any of my post/s or answer them whenever you have time.

Thank you.


Jamie said...


I would not have taken that trade. I don't really see a double top here, it's much too subtle. The second top is higher than the first and up to that point this stock is on a path of higher highs and higher lows. Volume is higher on green bars than red. More evidence is needed before committing money to this trade.

Just draw your fibs like #2 in the Trader-X guidelines.

Eventually, it forms a bear flag on the retest of the R-zone and you can short it there. I would partial out at ORH and get stopped out, but you can re-enter after the second bear flag breaks below ORH. Use Fib retracement as target. No need to redraw the fibs. in this case.

I'm going to post the chart below.

Also, preference to 15 minute timeframe over 5 min. for newer traders. Candlestick reversal patterns more meaningful on the longer timeframe IMO.

Trader-X said...

I had to chime in with everyone else and say Great Post!

Very informative. How often would you say your C&H patterns reach 100% vs. say the more conservative Fib Extension that I use? Have you ever considered covering half your position at that point and letting the rest ride...or is that (100%) target reached a high percentage of time?

Jamie said...

Thanks X,

Trading with the market, the success ratio is quite high (approx 80%). I do take partials when trading against the market or when price stalls at the R-zone. Generally speaking, the successful patterns print almost all bars the same color, so its usually a fast trade. You will feel it in the first 10-15 minutes and that will guide you whether or not to partial out.