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

Figure 4.10
Long and short positions protected with trailing stop exits on 4-day
low and high breakouts.
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FIBONACCI PRICE CORRECTIONS
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Practical Applications of Price Corrections
Working with corrections requires accuracy and discipline. The
chances for profits are very high in products with a big swing size and
volatility such as in the S&P 500 Index, the Nasdaq 100 Index, the
Dax 30 Index, and the DJ EuroStoxx 50 Index. Cash currencies such
as the U.S. Dollar against the Japanese Yen or the Euro against the
U.S. Dollar also may present opportunities.
But a big swing size in a product we want to trade is not enough.
High volume is at least as important. If the volume in the product is too
small, the slippage and commission may make trading unprof itable.
Before working with corrections, traders need to determine the
swing size and correction level that they want to work with. Only then
can we determine whether a product has naturally big or small swings
and has a high or low volatility.
There is no perfect rule to determine these parameters, because
every product is different. But eyeballing daily historical data for
about a 3-year period can provide a good indication. As a rule of
thumb, a product should not have more than 15 to 20 peaks or val-
leys over a 12-month period.
In the DJ EuroStoxx 50 Index shown in Figure 4.11, a swing size
of 300 basis points is a good size to work with. In the S&P 500 Index,
a swing size of at least 80 ticks is needed (a move from 1,000.00 to
1,080.00). In the Japanese Yen cash currency, a swing size of 180 ticks
(a move from 110.00 to 111.80) is appropriate.
Determining whether we are in an uptrend or a downtrend also
can be a problem while working with corrections. The status of the
market has to be addressed f irst; otherwise, investors will never be
able to decide in what direction to invest.
As long as the market price continues to make new lows and the
swing size is bigger than our predetermined swing size based on his-
torical test runs, we will always sell if the correction level reaches
61.8 percent. If the market makes new highs, we receive buy signals
whenever a trend correction of 61.8 percent occurs. But we will never
know in advance whether we invest:
• Into a correction of an impulse wave in a downtrend.
• Into an impulse wave in an uptrend.
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