Three Classic Tools to a Three Step Setup

And that's because the motives and emotions that rule the market have not changed. Fear and greed rule...and probably always will. Because of this fact, I purposely sought out books written in the early 1900s because the "crutch" of television and computers were not available to these traders. In my opinion, these books focus on price and chart patterns more than books written in the latter part of the century. Price and chart patterns are the most direct way to measure market emotion.

Analyzing price and chart action using the "classic" tools is a tried and true formula. That's not to say indicators are not powerful assets—you know that I use a set of Moving Averages, aka the "Wave,"

as well as the Commodity Channel Index (CCI) to add depth to my analysis. Let's focus on the three tools that start my analysis of any market: Trendlines, support and resistance lines, minor highs and lows, and Fibonacci levels.

While what we are about to discuss will show how a three-step setup works in the Forex market, it can and does work on everything from stocks to E-Minis, intraday, and end-of-day. Remember that your trading style will dictate how you will use each of these tools for your entry strategy. Many times after you analyze the chart, you will see that one style is better suited than another in the current market environment. For example, because the market is already trading in an

Chart 18.1

established trend, you may focus on swing trading. Perhaps you missed a momentum trade; in that case the three-step analysis will help you set up a swing trade.

Let's begin. First, if you haven't done your prep work please go back and do it! If you have already, great! Step one is drawing major and minor trendlines. Many first-time traders enter positions without respecting the support and resistance of major and minor trendlines. Knowing where the trend is heading is a simple but key point that can begin with the Wave, but eventually you and I must draw trendlines, support, and resistance lines to pinpoint the price levels that we will watch.

The trendlines in Ch 18.1 show multiple downtrends. While the major downtrend line is a thicker line, it is important to note the minor downtrends marked by the thin lines. We can also see a horizontal support level. Trendlines, support, and resistance are all related and are all the building blocks of chart patterns. If you find these levels, you will also find any relevant charting patterns because most, if not all, chart patterns are made up of some combinations of trendlines, support, and resistance levels. The next step is to locate the "swings" by finding the minor high and low patterns on the chart (Ch 18.2).

Minor highs and minors lows are helpful because they are an easy way of identifying the swings in the market. (See Chap. 10, Fibonacci Levels.) Our goal is to find an accurate way to methodically locate the most recent and relevant swing high and swing low from which we can draw Fibonacci levels. Drawing the Fibonacci levels is step three.

Since we know how to locate the minor highs and minor lows on the chart, we can accurately draw the most relevant Fibonacci retracements and exten

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i. 'i.i sions (Ch 18,3). The result is a set of levels that will offer support and resistance until the next major rally or decline. The analysis shows us that the 0.618 and .786 Fibonacci level acted as resistance. The 1.000 level was briefly support before prices fell through the 1.272 and 1.618 levels. While the 1.886 level wasn't hit, prices did stop just above it. The most recent few candles show that the 1.618 level is currently resistance.

Each one of these steps unveils an important piece of the analysis puzzle. Trendlines without Fibonacci levels would only show the trend yet would not reveal all relevant support and resistance levels. Fibonacci levels without trendlines would not show potential trendline breaks and the current strength or weakness of the market. Putting these two tools together yields the two most important facets of

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