Candlesticks, Fibonacci, and Chart Pattern Trading Tools : a synergistic Strategy to Enhance Profits and Reduce Risk

FIBONACCI ANALYSIS
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• 38.2 percent is the result of the division 0.618
÷
1.618.
• 50.0 percent is the transformed ratio 1.000.
• 61.8 percent is the result of the immediate ratio 1.000
÷
1.618.
Figure 3.5 shows the different risk prof iles when trading alter-
native percentages of corrections with stop-loss protection.
Forecasting the exact size of a correction is an empirical prob-
lem. Investing after a correction of just 38.2 percent might be too
early, whereas waiting for a correction of 61.8 percent might result in
completely missing a strong trend. But no matter what corrections are
considered, traders should focus on the PHI-related sizes.
Price Extensions in 3-Wave Patterns
Price extensions are exuberant price movements that result from run-
away markets, opening gaps, or limit moves, up or down, at high volatil-
ity. Most extensions occur when unexpected news, such as weather
information, crop reports, or interest rate announcements by the Fed-
eral Reserve Board, reverse major market trends within seconds.
When news runs counter to investors’ expectations, market situ-
ations emerge with strong trading potential. However, investors can
only take advantage of these situations if they follow sensible, def in-
itive rules in carrying out analysis. Extensive market moves can be
very dangerous for investors who get caught by surprise with a wrong
position in the marketplace.
Figure 3.5
Different stop-loss risk profiles on investments into a correction of
38.2 percent and a correction of 61.8 percent.
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BASIC PRINCIPLES OF TRADING STRATEGIES
Extensions take place primarily in the third wave of a 3-wave
price pattern. In a regular 3-wave pattern in an uptrend, the correc-
tion does not go lower than the bottom of wave 1. In extensions out of a
bear trap formation of irregular bottoms, the correction can go lower
than the low of the f irst impulse wave (opposite in a bull trap). The two
basic chart formations for price extensions are illustrated in Figure 3.6.
Exploring price extensions means investing against major trend
directions. Working with extensions also suggests that an investor is
looking for quick prof its by taking advantage of imbalances in the
marketplace. Therefore, it is important to know in advance not only
when to enter a position, but also when to exit it. Entry rule, stop-
loss rule, and prof it target always must be integrated to achieve long-
term investment strategies that are consistently prof itable.
Three consecutive analytical steps are needed to calculate price
targets in price extensions of the third wave out of a 3-wave chart
formation:
1. A minimum swing size has to be def ined for the sizes from peak
to valley (or valley to peak) of the first impulse wave of the 3-wave
pattern.
2. The swing size has to be multiplied by the Fibonacci ratio 1.618.