As described in detail in Chapter 5, the basic structure of PHI-ellipses is always the same, even though they can be thinner or thicker, shorter or longer depending on the market situation. The strength of PHI-ellipses is that they can be dynamically adjusted to any price move, as long as the required peaks or valleys are available.
There are two ways to work with PHI-ellipses. The first way is to analyze a trending market. If the market is going down, we are looking for a buy signal. If the market is going up, we try to find a sell signal. In short: We are looking for turning points countertrend to the market action. The second option is working with PHI-ellipses that are placed horizontally on the chart. In these cases, we are looking for breakouts either up or down out of the PHI-ellipse. In other words: We get trading signals in the direction of the market trend.
We can draw PHI-ellipses if we have at least three points, the starting point and one point on either side of the PHI-ellipse.
Because PHI-ellipses can only be drawn after a 3-wave price swing (two impulse waves and one corrective wave), the second impulse wave has to be at least as long as the first impulse wave.
In most cases, the longer the PHI-ellipse, the stronger is the price correction if we analyze the end of the market swing correctly. This is why products like the S&P 500 Index, Nasdaq 100 Index, Dax 30 Index, DJ EuroStoxx 50 Index, cash currencies, or financial futures with high volatility and big price swings can be best traded with the PHI-ellipse.
Once the first PHI-ellipse can be drawn based on a 3-swing price pattern, we still might not have found the final form of the PHI-ellipse. Although we have chosen the starting point and two side points correctly, the final form might be longer or shorter, thicker or thinner. To solve this problem, we combine PHI-ellipses with 3-point chart patterns and candlestick patterns. We can also anticipate the final point of the PHI-ellipse with support and resistance lines, or with Fibonacci correction levels and extension levels.
We have explained Fibonacci ratios, candlestick charts, and 3-point chart patterns in detail in the previous chapters to help interested traders find suitable combinations for entry rules that lead to higher profits at controlled risk.
The following examples are typical of profitable combinations of PHI-ellipses, candlestick patterns, and 3-point chart patterns. The selected charts can only be reworked by using the free WINPHI program that accompanies this book. Traders who want to test our strategies online and/or intend to develop their own strategies based on our recommendations can find an excellent analysis platform at www .fibotrader.com.
Our first example of a PHI-ellipse trade countertrend in combination with candlestick charting and regular chart patterns is on the S&P 500 Index between May 2002 and November 2002 (see Figure 6.29).
After the first impulse wave from point 0 to point 1 and the correction from point 1 to point 2 are finished, we can draw a PHI-ellipse as soon as the market price in wave 3 (the second impulse wave) goes higher than point 1. The PHI-ellipse has its starting point at 0 and its two side points at 1 and 2.
While the market price moves higher, we try to find the final point of the PHI-ellipse. The first sign that the price move is slowing down becomes obvious when the market price moves out of the PHI-ellipse.
The sell signal can be analyzed as follows:
• The market price moves out of the PHI-ellipse.
• A wedge chart pattern confirms the end of the market trend.
• A candlestick engulfing pattern confirms the sell signal when the market price breaks out of the support line of the wedge formation.
• The profit target is set to 50 percent of the total swing from the starting point 0 of the PHI-ellipse to the highest high of the market movement.
• The stop-loss is placed at the peak before the short entry.
The strong price movement to the downside leads to a solid profit on the position. A buy signal in the S&P 500 Index shows up just two months later (see Figure 6.30).
We start the PHI-ellipse at point 0. The two side points of the PHI-ellipse are at valley 1 and peak 2. Our primary goal is to define a market entry long once the final point of the PHI-ellipse is reached and the market moves out of the PHI-ellipse.
We conduct the analysis according to the following parameters:
• A candlestick engulfing pattern confirms the trend change after the breakout of the PHI-ellipse.
• A 2-day high breakout after the double bottom formation confirms the trend reversal additionally.
• The first profit target is at the resistance line at 875.00. The second profit target is marked by the resistance line at 925.00. After the breakout of the trading range between 875.00 and 925.00, doubling the size of the trading range leads to a third profit target at 976.00.
• The stop-loss point is at the valley before the buy signal.
Figure 6.31 provides us with a third trading example, this time on the Japanese Yen cash currency between March and November 2002.
The buy signal stems from a breakout out of a symmetrical triangle, which is also the beginning of wave 3 (the second impulse wave) of the market move. While the market moves higher, the sell signal is based on the following rules:
• Point 3 (in Figure 6.31) marks the final point of the PHI-ellipse. The market trend stops at the resistance line. A symmetrical triangle is formed that has its apex almost at the high of the PHI-ellipse.
• We sell short when the support line of the symmetrical triangle and the outside line of the PHI-ellipse are broken. The profit target is at 50 percent of the swing size from point 0 to point 3.
• The stop-loss is placed at the peak before the sell signal.
Finally, the Deutsche Telekom stock provides a striking chart example of trading tools in combination (see Figure 6.32).
The most interesting trading signal on the Deutsche Telekom chart is the fourth one, the long entry EL4. The buy signal is based on a clear set of rules:
• A perfect PHI-ellipse can be drawn circumventing the market move from points B to D.
• We find a double bottom formation at point D (the second bottom is located at point A).
• Point D is also the head of an (inverted) head and shoulder formation.
• We enter the market long on a breakout of the outside line of the PHI-ellipse, which at the same time is a breakout of the peak between the head and the right shoulder of the head and shoulder chart formation.
• The profit target is triggered at the resistance line, which is defined as the parallel line to the support line running from point A to point D.
• The stop-loss is placed at the most recent valley before the long market entry.
The countertrend trading signals based on PHI-ellipses in various combinations with candlestick patterns and/or regular chart patterns have come out perfectly.
It is just a small step to turn the approach upside down and analyze market entries at the final points of PHI-ellipses in the direction of the main trend.
PHI-Ellipses in the Main Trend Direction
At least as important as countertrend PHI-ellipses are those PHI-ellipses that can be traded in the direction of the main trend.
All PHI-ellipses that trade with the direction of the trend have an almost horizontal position. Sideward patterns are often difficult to detect, and these horizontal PHI-ellipses are valuable because they make such patterns visible.
The goal in trading horizontal PHI-ellipses is to participate in small price swings with a high number of profitable trades at controlled risk. However, many traders discover that this kind of trading demands higher discipline to execute the trading signals because higher slippage and commissions can take away much of the profit potential.
In general, what makes PHI-ellipses relevant trading tools for sideward markets is that they can be adjusted dynamically to different sideward patterns. This is where most traders lack a trading tool. The PHI-ellipse shows not only how far a sideward market might go, but also where the stop-loss level and the profit targets are. We have designed stop-loss and profit taking rules by ourselves, and there is no reason other traders cannot come up with profitable solutions that suit their personal needs.
We provide a few chart examples to illustrate how to apply horizontal PHI-ellipses in a profitable manner. We start with the S&P 500 Index between May and November 2002 (see Figure 6.33).
The PHI-ellipse in Figure 6.33 surrounds a chart pattern that shows a significant peak at 965.00 and two significant valleys at
875.00 and 868.00. Basic requirements for a countertrend PHI-ellipse are a starting point and two side points. In contrast, since we lack a starting point on horizontal PHI-ellipses, basic requirements for PHI-ellipses in the direction of the main trend are peaks and valleys on the upper border, lower border, or median line of the PHI-ellipse.
The most important factor to watch while working with horizontal PHI-ellipses is that the PHI-ellipse is locked in, meaning that it cannot be moved higher or lower any more. It is the constellation of peaks and valleys that gives stability to a horizontal PHI-ellipse. In our S&P 500 Index example, we get overall stability through the two peaks in the middle that touch the median line of the PHI-ellipse.
A sell signal is filled in the S&P 500 Index once the support line of the PHI-ellipse is broken. The profit target is twice the distance between the peak at 965.00 and the valley at 868.00. The new resistance line is identical with the low of the price movement at 771.00 points (where we take our profit). The stop-loss is placed at the peak before the sell signal.
A couple of horizontal PHI-ellipses can also be seen in Figure 6.32. Long entry EL4 was discussed earlier; the two short entries ES1 and ES3 and the long entry EL2 are the ones that we focus on in this section.
The first short entry is based on a PHI-ellipse locked in with three peaks on the upper side, one peak and one valley on the median line, and one valley at the lower side of the PHI-ellipse. Incorporated in the PHI-ellipse movement is also a symmetrical triangle. When the valley at the border of the PHI-ellipse is broken, we get filled on our sell signal. The profit target is reached at twice the width of the PHI-ellipse. The stop-loss is placed at the peak prior to the sell signal.
The first long entry is based on a very small PHI-ellipse. Although most traders might think such a small PHI-ellipse would not be significant enough for trading, it demonstrates that PHI-ellipses can be dynamically adjusted to bigger and smaller price moves.
The PHI-ellipse in question gets its stability from two peaks on the upper border and two valleys on the lower border. The buy signal is executed when the upper border of the PHI-ellipse is broken. The profit target is twice the total width of the PHI-ellipse. The stop-loss is at the valley before the market entry.
The PHI-ellipse on which the second short entry is based gets its stability from two peaks touching its upper border, two peaks touching the median line, and one valley touching the lower border. The peak/ valley configuration gives a unique form to the PHI-ellipse; any other ellipse would not completely surround the market move.
The sell signal is filled on a sharp breakout of the PHI-ellipse to the downside. The profit target is twice the total width of the PHI-ellipse. The stop-loss point is at the peak before the short entry.
To help readers follow our explanation and description of trading signals most easily, Figure 6.34 shows the Deutsche Telekom chart again.
Before we discuss PHI-ellipses in combination with candlesticks and/or 3-point chart patterns on an intraday basis, we want to present a final striking example of horizontal PHI-ellipses as a tool to invest short-term in the direction of the main trend. The product in this example is the stock of U.S. chipmaker Intel over almost two years between December 2000 and November 2002, as shown in Figure 6.35.
Five sample trades show up on the chart, four short trades and one long trade.
The first short trade is based on a PHI-ellipse that has four peaks on its upper border and four valleys on its lower border. The sell signal is executed when the lowest valley is broken. The profit target is calculated by doubling the total width of the PHI-ellipse. The stop-loss is placed at the peak before the sell signal.
The second short trade is based on a rare example of a PHI-ellipse with one peak in the middle on the top border, three valleys touching the median line, and three valleys on the lower border. The sell signal is filled when the lowest valley is broken. Shortly after the short entry, the market price reverses, but does not trigger the stop-loss point at the peak before the sell signal. The profit target is reached after three months at the target price, precalculated by doubling the total width of the horizontal PHI-ellipse.
To generate the third short signal, we can identify three peaks on the upper border of he PHI-ellipse, a peak and a valley touching the median line, and one valley on the lower border. Once the valley on the lower border is broken, we get a sell signal. The stop-loss is placed at the peak before the sell signal. The profit target is calculated by doubling the width of the PHI-ellipse.
The last of the four short signals is based on two peaks on the upper border, two valleys on the lower border, and a single peak touching the median line of the PHI-ellipse. We get a sell signal on a breakout of the lowest valley. The stop-loss point is at the peak before the sell signal. In this case, the profit target is not reached. The stop-loss is not triggered, either, so the position is reversed as soon as the only long signal in our Intel example shows up.
The long sample entry is based on a PHI-ellipse with a steep slope to the upside. As explained in Chapter 5, we can get a buy signal on a breakout of the PHI-ellipse to the upside if we use an entry rule saying that we buy at the high of the day at which market pricing breaks out of the PHI-ellipse.
As our selected examples have made clear, horizontal PHI-ellipses are ideal tools for short-term investments in the direction of the main trend on a daily basis. Moreover, horizontal PHI-ellipses are also the link between daily chart analysis and intraday analysis.
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