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

Figure 4.7
Entry signals long and short after price corrections of 61.8 percent
on 1-day high and low breakouts.
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FIBONACCI PRICE CORRECTIONS
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As mentioned, we always have to expect false breakouts. We can
integrate this into our investment strategy with a more conservative
entry rule. We buy and sell after a false breakout as soon as the pre-
vious 2-day high or the previous 2-day low is broken (see Figure 4.8).
Immediately after establishing market positions, traders need to
protect them with stop-loss rules.
Stop-Loss Rule
In working with price corrections, the stop-loss after the entry should
be the peak (on short signals) or valley (on long signals) before the
entry point.
Figure 4.9 shows the stop-loss rule of a peak /valley exit and the
immanent stop-loss risks.
Figure 4.8
Entry signals long and short after false breakouts on 2-day high and
low breakouts.
Figure 4.9
Exits on valleys (long) and peaks (short) and immanent stop-loss
risks.
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APPLICATIONS OF TRADING STRATEGIES
The size of the stop-loss changes in relation to the chosen correc-
tion level and the swing size. For example, if the swing size is 300 basis
points, the correction level is 61.8 percent, and the stop-loss is below
the previous valley, our risk is much smaller than if we enter the mar-
ket already at 38.2 percent or 50.0 percent correction level and def ine
the same stop-loss point. On the other hand, we can miss a complete
price move if the market price does not reach our correction level.
Working with the 61.8 percent correction level is preferable be-
cause we can have a small stop-loss and, therefore, less risk. The stop-
loss level is after a buy signal below the previous valley and after a
sell signal above the previous peak. After a false breakout, the high-
est high or the lowest low before the false breakout is the stop-loss level.
Trailing Stop Rule
To protect prof its, traders can work with a trailing stop as an alter-
native to prof it targets.
A trailing stop is not always the best investment strategy. After
investors get stopped out with a small trailing stop, the market price
may continue the original trend direction and they will miss the big
price move. Depending on the product and volatility, we recommend
working with a 3- to 4-day trailing stop.
Figure 4.10 covers the exit rule of a 4-day trailing stop.
The more conservative option is to work with the previous peak
or valley in prof itable territory as a trailing stop.