I received an e-mail this morning from a reader who is frustated … he has cut his overnight holds to zero as the market goes through its wild swings. However, he finds that he can't get involved in Day Trading on stocks that he normally trades (GS, AAPL etc…).
I didn't get involved in either of these today due in large part to not trusting a low volume holiday session. I told him I would post how I use Fibonacci grids in teaching my students in playing Continuation Patterns.
GS 1-Minute Charts
GS has a small gap lower this am and then basically went straight up. what is a trader to do? Well I point out on this chart that a trader hawking this stock and familiar with my Opening Range trade strategies could have started a long position at the top of the Opening Range with the plan to add on a pull-back for the move off of the top line. This blog is not about Opening Range trade strategies so I will skip that discussion.
For Continuation Pattern's traders are looking for a lower-risk strategy to get involved with a strong trending stock/ETF. I recommend using a simple, repeatable mathematical way to do that. I find that it takes a lot of the guess work out of the trade and definitely reduces the emotional aspect of trying to jump on to a strong trending stock.
First thing you do is WAIT … wait for that first pull-back and then strap on your Fibonacci Grid.
As noted, strap on your Grid and move the anchor as price makes newer lows on the retracement. Note how price wasn't going back to the Opening Range, so those taking that Opening Range trade are happy here as price consolidates at higher levels.
Once we have the Grid in place you watch price … I concentrate firstly on the 61.8% level. My experience is that if price can get above the 61.8% level shortly after finding a low in price then it is likely a good Continuation Pattern candidate and will likely make another move higher and take out the HOD.
What I want to see is price finding support at the 61.8% and showing that it can get above the 78.6% level. Students of mine know that this is somewhat similar of how I play Contraction Patterns and Key Reversal Patterns … it is but there is a subtle difference for Continuation Patterns. With Continuation Patterns, you seldom get a break of the Pattern and then retest with patterns that "work". What I mean is that if price breaks above the HOD (the break level for the Continuation Pattern), it is going to go to new highs and keep trying to move higher. I generally will have my stops in the same area to start with as I do with Contraction Patterns, Key Reversals etc … that is I use a level around 50% between the 38.2% level and the break-down price … in the GS case it would have been $90.08. After the breaking of the Pattern's high, I would begin moving it … first to 38.2%, then to the 61.8% level etc as price moves higher. Stops are personal decisions, but vital in risk management.
Back to the GS example …
So as noted, price showed that the 61.8% level was ok and that it was willing to get above the 78.6% level (into the GAP). Now this is where having experience with this type of trade makes it so much easier. Many traders would have a hard time buying GS here this am as it was acting so strong and the fact that it is liable to be whippy first thing in the trading day.
However, I put my trust in how I trade Continuation Patterns … if I see all the normal things I like to see in the set-up, I take emotion out and will either buy at the market in the GAP area or if that area is a bit large choose a limit order to do my work. My normal limit order is about 1/2 between the 78.6% and the break price. Why 1/2? Why not? I try to take emotion out of trading these Patterns and I have just found that level is as good as any other. I want to make my trading strategies as repeatable as possible, therefore I have a strategy that I use and I avoid having to make "new" decisions every time I look at one of these Patterns. Some people may call that being lazy but it works for me.
So if you had experience on Continuation Patterns you would have been long GS before it broke the Pattern … remember, we are not expecting it to return into the Pattern. If it does, we probably are going to get stopped at the 61.8% level.
Stop and take a look at this type of trade … traders would have gone long at say $90.53 with a stop at $90.08 (1/2 way between the 38.2% level and the break down level). In terms of targets, I find with Continuation Patterns it is best to take 1/3 to 1/2 of your position off at the grid's first target ($91.00). Again, some traders like to set limit orders a couple of cents in front of these levels since the computers know these levels and often step in front of them. In the GS example, that first target is rather close to the Pattern so I would be happy to take only 1/3 off at $90.98 for a first profit of $0.45/share. Once price hits my first target, I would have my stop on the remainder at the top of the Pattern's Grid ($90.60) … that would lock in at least a break-even or small profit on the remainder.
My primary target on this trade would be the Grid's 2nd target … I would take another 1/3 off and raise my stop to the first target's level. I would normally use this strategy for Continuation Patterns that occur early in a strong trend. If it was a Continuation Pattern that was occurring in an already extended move, I would have likely taken 1/2 at the first target and then the last half at the 2nd target and been happy. Again, I go into detail with my strategies on other blogs/student lessons, so I encourage readers to review these for more details.
So price actually made a retest of that first break … not what I would normally like to see. It did however respect the $90.31 low of the swing inside the Grid and then quickly bounce back outside the Grid. I would now recommend that traders move their stops to around that 61.8% level, locking in a small loss in a worst case scenario.
So we would have been filled on our limit order in front of the Grid's first target, and we should have raised out stop to the top of the Grid. due to the negative divergence in volume here (VZO indicator), I would plan to take the remainder of the trade off at the next target – in front of the Grid's 2nd target.
Also, due to the negative divergence in the VZO, I would be more attentive in trailing my stop as price approaches the 2nd target … there is no guarantee that price will make it to that level so if traders leave their stop at the Grid top too long they may end up missing any real profit potential on that last 2/3rd position. For example, as price gets 50% of the way to the target, I would have raised my stop to just below the 1st target level ($91.00), so that when/if failed to hit the second target I should at least get another $0.40/share or so, making the whole trade worth about $0.43/share.
If you kept your stop at the Grid high, and price corrected hard into you, you would have averaged $0.45/share on a 1/3rd and then $0.07/share on 2/3rds for a blend of $0.1967/share. Keep your eye on Continuation Patterns once you see some cracks in the internals.
So the machines did what they often do … they reversed right in front of the Grid's target. If the prepared trader had his limit order at $0.02 or so in front he would have been filled most likely. In a worst case scenario, he could have hit the market as price pulled back or relied on his stop at the $91.00 level to bail him out.
Pretty much a text book Continuation Pattern trade …
The blog is getting pretty long so I will post a new one on the weekend for students on AAPL … it is an example of a Continuation Pattern that started later in a trend and it is an example of a trend going lower. All of these Patterns can be traded the same way, they just present themselves a little differently each time. My goal is to lather, rinse, repeat for all my trading.
Cheers and have a great weekend … Leaf_West (http://blog.tradingwithleafwest.com/)
P.s., remember the Morning Outlook and Afternoon Trading Plan are going to be e-mailed to readers starting on Monday. E-mail me if you want to be included.