Most of the comments in this post are written on the charts. You’re welcome to download and save them to refer back to them periodically when you need a reminder about the importance of patience in trading! Lack of patience and over-trading is likely one of the biggest causes of losing money in trading. You’ll see many references to HB (Half Back) or the Fib retracement zone. HB is the 50% retracement of a price move and beyond that level is the 61.8% retracement of a move. Those 2 levels combine to form the Fib zone and, after you read this post, you’ll get a better idea of why that zone is so important in anticipating where a trading opportunity may present itself in the future. Let’s get started!
The first few charts below deal with identifying the prior and current trend. That’s not as difficult as it might seem. If you haven’t seen any of my posts or tweets before you may be shocked to see how ‘zoomed-in’ my charts are in many cases. That’s because many of the price action clues are hidden in plain sight if only you’d look closely enough! Later in the post I’ll examine the patterns that show up when the chart contains many candles, sometimes hundreds, on a chart but, for now, let’s get up-close and personal with the SPX daily chart.
As price moves in a direction there’s no way to know when it will change it’s mind and move in another direction so we let the price action tell us if it’s bullish or bearish using the IF/THEN method of price action analysis.
For many (most) traders, patience is the rarest commodity! It’s hard to watch price progressing in the direction you expected without you adding to the size of your position. The temptation to get short or long is often greatest just before the move reverses direction!
The Fib extension tool helps target an ongoing move in price. When the Fib extension target lines up with the Fib retracement level of a prior move then that target level becomes even more important and a price reaction there becomes more likely.
Below the analysis switches the bigger picture view where the longer-term patterns and levels appear.
Trendlines are followed by many trades but they are less than an exact science. Some connect the extreme levels of a candlestick, some connect the bodies and others try to draw the lines so it touches the greatest number of points. So while they are valuable to pay attention to you should know that they are less exact than Fib levels in many cases.
Many times traders are focused on one trendline and sometimes fail to see another, potentially more important, trendline developing.
If SPX falls to the 3700 area you’ll likely hear some traders anticipating a head and shoulders pattern forming and using that pattern to project much higher prices.
Combining trendlines with Fib levels can add context to a potential time and price target.
Finally, I hope the chart below puts all of what you’ve seen in the charts above into a context where you’ll more clearly see where the current opportunities lie. Was Friday’s 3943 low a good opportunity to get short? With the 61.8% Fib support level of the prior rally at 3929, probably not. Would a rally to 4069 be a good area to get short? Absolutely since both the 61.8% Fib resistance of the current (still-developing) downtrend lines up with the declining upper band of the 8-day SMA. What if the 3929 levels fails to provide support? Then 3843 is the likely next lower target. So should I short it IF price drops below 3929? If I do and that move fails to follow thru lower and then moves back above 3929 I would’ve just shorted in the hole only to see price rip higher! That doesn’t mean that will happen, only that it could happen. And that’s where the patience comes in. There are times where it just doesn’t pay to initiate a new position. Price is already in the body of the move and there aren’t great opportunities to trade long or short. Sit those areas out!!! Only initiate trades in good locations and then reduce your risk (through Delta Hedging strategies that I demonstrate throughout this blog) when price reaches an important level of support or resistance. Choose whether you want to be strictly a trade with trend trader or whether you like to counter-trend trade also. Make that choice for yourself, don’t let the market decide that for you!
I hope this post was helpful. I appreciate any feedback, good or bad, because it lets me know whether or not these posts are helping you to understand the points I’m trying to make. Let me know down below! Also, if you’d like more information on how I interpret price action you’ll find it in the Understanding Price Action post.
One final point. This post is about interpreting price action and setting targets for price retracements and extensions. It doesn’t deal with the option strategies that can profit from trading that price action. In the previous post I discuss the use of a Triple Put Calendar strategy to attempt to profit from a choppy decline in price that doesn’t take much Delta (directional) risk. Click on the the link to check out the Fun with Calendars post. Make sure to read and understand the last paragraph of the post since it explains why I chose the Triple Calendar strategy to deal with the current price environment!
great post