(prepared by Mark Braun)
How many times have we asked ourselves, "How much can I expect from this trade? Where can I place a logical profit target without asking too much of the market, or too little?"
An understanding of the geometry of price and time, plus practical Fibonacci and Gann techniques, can help you set profit targets before you enter a trade. These targets have the benefit of being self adaptive; they're based on recent market activity and not just an arbitrary number which may have no bearing on what the market is willing to give you at this point in time.
Most of us are familiar with the use of Fibonacci retracements to find support or resistance areas prior to entering a trade. Figure 6.4 shows the 15-minute GBP chart that demonstrates this principle.
The support zone on the chart is a cluster of three Fibonacci ratios established by taking several prior lows and connecting them to the highest high on the chart. These overlaps, or clusters, provide excellent support areas for long entries when combined with a momentum based indicator. They can also help to keep you in a trade by indicating a likely turning point in the market. I use the CCI (Commodity Channel Index) indicator, which in this case was confirming a return to upwards momentum as the market approached the Fibonacci support cluster.
But did you know that you can also use Fibonacci tools to project where a swing is likely to terminate or pause?
Wouldn't it be helpful in setting targets if you had this information?
We call these 'Fibonacci Extensions". An extension is a retracement which is larger than the swing being measured. Commonly used Fibonacci retracement values such as .618 and .786 are great for measuring support and resistance when you're looking at pullbacks. A retracement, since it is a fraction of a prior swing, must by nature land between a previous high and low.
But what if you're making a new high on the timeframe you're using for trading?
Just as those retracement values represent likely turning points on pullbacks, the extension values of 1.272 and 1.618 are great for showing when the market might say "okay, that's enough for now".
Figure 6.5. shows the same chart as Figure 6.4, but with extension targets.
By setting a retracement tool to the values of 1.272 and 1.618, we're able to put that question to the market directly, "If the rally resumes, where is it likely to terminate or at least pause again?" In the case of a rally, connect a prior high (Point A) with the current low (Point B) to project those extensions above. As you can see, the market rallied to within a couple of pips of the first level. The CCI also showed substantial divergence, indicating a loss of upside momentum. An excellent place to take profits!
Let's discuss now Figure 6.6, which shows a 15-minute CHF chart.
Extensions can often help pinpoint the end of a major move before any other signs of reversal. On the left of this chart, you can see that the market was in a downtrend. In this case, by taking the prior low to the high after it with the retracement tool (again set to 1.272 and 1.618), we were able to forecast where this possible "U-Turn" had a high probability of pause or termination. As you can see, in this case it was termination of the decline! Note that the only price points necessary to project this extension were the prior low and high. Support was in place well before the market traded near that price. The example on the right of the chart shows a long trade. I've omitted the Fibonacci support in order to keep the chart clear. When the lower CCI, longer term, crossed above its zero line and price crossed above the moving average it indicated a return to upwards momentum (see the black circles). This would be a good entry. At that point, connect a prior high to the current low to project the extensions above. Price rocketed through the first extension. A test and rejection of the second level while the CCI began to hook downward indicates a good place to take at least partial profits. If there were another entry signal, the partial could be put back on. In this example, the worst-case exit on the balance would be when that longer term CCI proved unable to maintain the +100 line. At this point it would be prudent to exit the balance of the position. But even waiting that long on covering the balance, a part of the position returned the most profit possible on the entire swing!
This next example (Figure 6.7), a 60-minute USD/CHF chart, shows a particularly powerful pattern.
When a market is coming to the end of a trend, it will often make a series of smaller swings into new highs or lows. In the case of this rally, it was possible to plot several "U-Turns" with the extensions as projected by a retracement tool.
Each time the market made a new high and low, the retracement tool was used (from high to low) to project the extensions above. They overlapped, which is common near the end of a major trend.
Also, a Fibonacci Timing tool was applied to the same pivots to discover whether these highs and lows were cyclic in nature. A strong cycle is indicated by a near overlap, within one bar, of three Fibonacci time relationships. The center of that overlap is at 0700 hours near the top of the chart, since there were also timing factors at 0600 and 0800. With an overlap of both price and time factors, there's a very high probability of the market reversing or pulling back substantially if price meets the extensions during the timing overlap. That's exactly what happened in the example above. Combined with the very visible CCI divergences, it's an excellent place to cover a long position, maximizing profits from even a longer term trade.
These overlaps in both price and time can be found in any market, on any timeframe. By all means, experiment with tools in your charting package. You'll be amazed at what you'll find when you look for those "U-Turns"!
If you would like to become an expert at trading using these techniques, see Mark's trading seminars at his website: http:// www.mjbraun.net
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