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

FIBONACCI PRICE CORRECTIONS
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market moves of false breakouts for bull trap and bear trap chart
patterns.
Traders can base trading signals on false breakouts if they know
how to separate the different types of breakouts. We discuss this topic
in more detail later on when we talk about entry rules.
Size of Corrections
The most common approach for working with corrections in research
and practical trading is to relate the size of the corrections to a per-
centage of the prior impulse move.
In our analysis, we concentrate on 61.8 percent, which is directly
related to a ratio out of the Fibonacci summation series. A price cor-
rection of 61.8 percent is the result of division (1.000
÷
1.618).
Forecasting the exact size of a correction is an empirical problem.
Investing after a correction of just 38.2 percent might be too early,
whereas waiting for a correction of 61.8 percent might mean missing
a strong trend completely. We concentrate on 61.8 percent and keep the
investment risk very small by placing a well-def ined close stop-loss.
The best way to work with corrections is to combine the percent-
age of corrections with the swing size as a second parameter. Each
product has a typical swing pattern that traders can identify with a
computer simulation. This pattern should be part of the investment
strategy. To get the best real-time results, the investor needs to iden-
tify and test it on historical data.
Figure 4.6
False breakouts to the downside and to the upside.
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APPLICATIONS OF TRADING STRATEGIES
The swing size depends on the product. The swing sizes between
daily data and intraday data on the same product can be very different.
The smaller the swing sizes are, the more noise there is in the price
data and the more diff icult it will be to f ilter out the product’s typical
swing size.
For example, if 150 basis points cover the swing size in the cash
currency Japanese Yen every day, correction levels of 38.2 percent,
50.0 percent, or 61.8 percent might be too small to work with. On the
other hand, a correction level of 38.2 percent might be the best to work
with if, in the same product, we measure a price swing of 1,000 points
over a longer period. It might take weeks before the market price has
a correction of 382 basis points.
Entry Rules
The main reason to work with an entry rule is to get an additional
conf irmation of trend changes. Working with entry rules also means
working with a compromise because we always invest a little later
than if we had entered the market as soon as a correction price 
target was reached. By giving up a little bit of the prof it potential,
we gain a safety net to avoid getting stopped out and whipsawed 
so often.
Because we work only with a 61.8 percent correction level in our
strategy, we need just one entry rule. We buy or sell—after the correc-
tion level of 61.8 percent has been reached—when the previous day’s
high or low is broken.
Figure 4.7 shows market entries to the long and short side.