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Tuesday, October 28, 2008

Fibonacci lines, indicators, and the Holy Grail

"There IS a Holy Grail - between 1995 and 2001, I must have found it a thousand times." - Trader-X, 2006

I said the above in an interview I did a few years back. What I was implying was that we have all thought at one time or another we found the Holy Grail...only to be disappointed an hour, a day, or a month later.

In my opinion, there is not a Holy Grail in the sense of a single indicator or setup; there is only understanding price action and how to read charts...and that to me is the true Holy Grail.

You can utilize different tools to help understand price action and how to read charts - there is no shortage of indicators and it seems new ones come along on a regular basis. I use candlestick charts and support/resistance in the form of Fibonacci, pivot lines, previous swing highs/lows, and to a lesser extent moving averages.

Before I proceed any further, it is important to reiterate a point I stated in what readers say is one of my most popular and insightful posts (they are few and far between!) - "Chasing success":

...most people jump from indicator to indicator, timeframe to timeframe, method to method. They will use something for a few days, hit a bump, and move on to something different all together. One day the holy grail is a XX period moving average, the next day it is MACD or an oscillator. One day it is a 30-minute chart, the next day it is a 5-minute chart. One day it is buying the break of the first inside bar, the next day it is a pullback from the high.

I call this "chasing success".

Attempting to decide how to plot Fibonacci lines can easily turn into chasing success. The amazing thing about how you plot Fibonacci lines (and use all indicators for that matter), is that no matter what you choose to do any method will yield startlingly accurate results some of the time. But that amazing aspect is also why so many traders fail - some of the time is not all of the time. If a trader lacks patience, it will lead to them bouncing around from one method to another, looking for the next trade...chasing success.

Below I list the ways I have plotted Fibonacci lines over the past ten years. When talking about Fibonacci, I always give credit to TRADEthemove.com*. After reading their work, it sparked my thinking and that is what led to me developing my methodology.

On a side note, that is how I approach my market studies - I never read a book or a blog looking for the "answer", I always read looking for information that will help me develop the answer for myself (feel free to substitute "Holy Grail" for "answer"). It is highly unlikely that you will take what someone else does, replicate it, and achieve the same results. Instead - study what other people do and integrate what you find useful from their style into your own strategy. Once you start doing this, you quit searching for Gurus and Holy Grails and begin focusing on real success for you - developing your own methodology.

Back to plotting Fibonacci lines - below I outline the various methods I have used over the past ten years. I encourage you to study them on your own, and over the next week I will try to post an example of each. The point of this exercise is to show price action and how it reacts at various levels. Once you have an understanding of that, you can hone in on what appeals to you and start crafting your own methodology.

1.) Plot lines over the previous day's high/low. This is probably the most common technique, and usually provides decent support and resistance levels for the current day's action.
2.) Plot lines over the previous day's high/low to the opening day's low/high. This is what I use the majority of the time as it takes into consideration the current day's open. I have tweaks for certain situations - for example, a gap that is still in the previous day's range (does not gap above/below the previous day's high/low) may dictate I only plot lines over the previous day's high/low and ignore the open.
3.) Plot lines over the previous two (or three) day's high/low. This technique allows you to catch bigger moves, and can be used in conjunction with #1 and #2 if price blows past your initial target.
4.) Plot lines over the current day's first 15- (or 30-) minute high/low. This technique works for scalping on shorter timeframes. You will be surprised to see how price for the rest of the day reacts to support/resistance based on the opening range.

These comprise the core techniques I have used. Again, I encourage you to study them on your own; you can also experiment with tweaks based on these four - for example, plotting lines over five days for a "swing trade" type approach, or using swing highs/lows as opposed to fixed times.

Check back over the next few days for examples, and don't forget to vote.

Edit - examples (check back later for more):
1.) Bear Market rallies can be violent...
2.) ABB - 102908
4.) From the Equity Watchlist:
> Nordstrom

Trader Jamie was also kind enough to provide a few examples on his [most excellent] blog.

*TRADEthemove.com periodically advertises on this site, and contributes to "Good Karma". It is important to note they advertise here because I mentioned and recommended them over the years (as opposed to them approaching me to advertise and me subsequently endorsing them).



Roger said...

This is an amazing post. I have a lot of work to do. Thank you for sharing.

zuwu said...

thanks for sharing so much with us. I m looking forward to learning alot from your blog.

Anonymous said...

Ditto on the thanks. Great post.

TonyB said...


Can't say how happy I am that you're blogging again. BEST trading blog on the web. Thanks for sharing man.


Fred N. said...

This is very helpful. Thanks for so freely sharing.

bl said...

Thanks for the great Fib post. I also notice the 2:22 EST rally/sell off time just after a 1:30-2:30 sell off/rally time and time again. And of course the fomc mtg ends at 2:10 per usual.

Anonymous said...

Great to have you back in the blogging world.


Anonymous said...

Thank you for this piece. It was very helpful as I'm new to Fib. You addressed some fundamentals that many ignore. Thank you again!