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Trading the Jam way

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Juno Beach
 
Trading Experience: Advanced
Platform: Ninja and TS
Broker/Data: Optimus Futures / Matt
Favorite Futures: multiple
 
JamTheTrader's Avatar
 
Posts: 135 since Sep 2009

Trading with Fibonacci

THE FIBONACCI SUMMATION SERIES
It is a well publicized fact that the Fibonacci summation series appears throughout our lives. It is in flowers, trees, plants, microorganisms, natural science, the ocean, the human body, and many other things around us that we take for granted on a daily basis. The Fibonacci summation series is as follows 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610 and so forth, to keep going just add the last number and the previous number to get the next number in the summation series. The series itself is asymptotic by nature and therefore moves toward a constant ratio slower as the number gets higher but can never quite reach the constant ratio no matter how far we go. If you divide a number in the series by its preceding number you will find that the answer always oscillates around an irrational number 1.61803398875 alternating higher and lower each time. In trading we round this number off to 1.618. The ratio 1.618 in geometry is known as phi. Entire books have been written about this subject.
You will also hear the ratio 1.618 called the “Divine Proportion” or “The Golden Mean”. I would encourage you to Google the subject or go to your local book store and read further if you are so inclined. For our purposes in trading, we are concerned with the ratio’s surrounding the summation series and not the summation series itself.

Fibonacci Retracements
Retracements are defined as a move in the opposite direction of the trend in the time frame that you are analyzing, recapturing a portion of the move. Retracements are the most commonly used Fibonacci tool in trading and therefore hold the most weigh out of all of our Fibonacci Tools. Floor traders use the 50% ratio and almost all
publications about trading mention it somewhere. For this reason it would be prudent for us to pay close attention when prices approach one of these ratios, either as a place to reverse the markets or at least slow them down temporarily. Ratios involved and most important ratios
•38.2%
•50%
•61.8%
•78.6%


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In the example above left, our market moves up to form a pivot at the top to which we would apply our retracement tool and plot our ratios. In the example on the right our market is moving down and finally slows and forms a pivot at the bottom. At this point we would plot our ratios. Each charting platform has a different place for this, in NinjaTrader you can get this by hitting your F8 key, then clicking on the bottom pivot and pulling it to the top of the pivot and clicking again which sets it in place.

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In the above chart , prices start moving up from point A and finally form a pivot at point B. We simply pull our Fibs from point A to point B and plot our standard ratio’s 38.2, 50, 61.8%. Notice that our prices stop and turn right on the 50% ratio. At this turning point we would then go to our smaller time frame and look for trade setups
and entries.

Retracements can be great patterns to not only take note of, but for defining a set of trading rules and trading them. We already know that retracements are the most popular Fibonacci study that is looked at by traders around the word. In this section we will define a set of rules, a basic money management plan using 2 contracts, as well as look at some confirmation techniques and apply these rules to trading. While Fib retracements can be very profitable, I would recommend using multiple tools for confirmation and not just a fib retracement by itself. Lets define some very basic rules for entry, exit, and some simple money management rules.

• We will use three time frames for analysis
a. 20 Range bar chart for support and resistance HTR = Higher Time Frame
b. 10 Range bar chart for area and direction MTR = Medium Time Frame
c. 5 Range bar chart for entry ETR = Entry Time Frame

• We will look at our 20 Range bar chart first to determine overall direction, and, if we have any longer term support or resistance in front of our trade. Once this is
analyzed, we will take notes and move to the 10R for analysis.

• Determine you direction on your 10R chart and look for fib retracements, once you have a
set up, move to your smaller timeframe chart and look for entries.

• Move to the 5 Range and look for entries

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As you can see here in our 20 Range chart we have an area of resistance that in the overnight session stopped at a 61.8% retracement up, which now became resistance for the market as we start our trading session. The two areas to start thinking about shorts are at 2 and 3 labeled on the chart. Things to take note of as we get started in the morning.

• Triple top at the 61.8% retracement that cant even get all the way back to the first top labeled 1, 2 and 3 accordingly. This type of topping action denotes weakness
and lack of momentum. No momentum indicators are needed to tell you what the price action is telling you at this point.

• Lower low pivot at label 4 gives us another clue that our next leg up may have a lower top
than the previous top.

So we can say with confidence that our area shows a high potential for a reversal to the down side. At this point we go to our medium time frame and analyze with a little more of a detailed view.

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After we have determined that our HTF chart is giving us reversal signals to watch for, we can then go to our MTF chart and analyze. In the chart above you will notice that we have a defined triple top from 2 through 3. This MTF offers us a little better detail than our HTF and gives better clues as we analyze and look for our high probability trades. So, what do we need after determining that our HTF and our MTF are at areas to turn the markets? Confirmation! I like using breaks of trend lines along with my fib retracements for confirmation that we are heading in our direction after an area is hit. In my opinion this is the best way to catch trades from strong areas because many times the markets can gain steam and move very fast without any major pullback once the rest of the world sees it and starts jumping in the trade. Just one word of caution here, you should never just jump in trades without a complete and proven trading plan that you can follow and that you trust because you have done all of your necessary homework.

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Notice in the above chart, at the right edge, our trend line has been broken. At this point we will go to our entry chart and look for our entry signal.

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At the right edge, you will notice that we retraced 61.8% of the move down after breaking a trend line and pulling back to it as well. If you go back and compare the our MTF chart on the previous page with this entry chart, you will see where we broke out and how the two charts correlate. Lets define some entry rules.

• HTF has been analyzed and at areas for a trade
• MTF has been analyzed and gave us a signal to look at our ETF (entry time frame)
• We now look for a pullback and reversal bar on our ETF denoted by our three arrows

So, where should we put our “initial” stop loss? There are several schools of thought on this

• Stop should go behind the previous pivot
• Stop should go behind the entry bar
• Fixed stop loss by number of pips/ticks
• Fixed money stop
• Use an indicator to dictate your stop (in my opinion this is the worst of all and holds little merit unless you are a system writer with an always in system, as indicators
are easy to automated.

There are complete studies on this subject alone, and we will not have the time to give you a full understanding and appreciation for the strengths and weaknesses of each listed. The stops that I use and we will use in this book here forward are entry bar stops. While entry bar stops can cause a few more whipsaws, once you get your entries perfected they will provide the best overall reward to risk ratios.

In the chart above and for every example going forward we will only enter after a pullback and a bar
close in our direction and all initial stops will be 2 pips/ticks behind our entry bar.

• We enter on the close of the bar with three arrows above it with 2 contracts
• Initial Stop is set 2 ticks above the entry bar
• We will use an area to take profits on the first contract and trail the second by pivots.

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We will grab our milk money or take profits on ˝ our positions when hitting an area that could hold the market. In this case it is a double bottom. After profits are taken, we will trail the second half behind pivots. At this point you should not take a complete loss on the trade, if the market moves back up with strength, keep your stop smaller than original. A good place to move the stop is a bar close above your entry piece. If the bar hits your entry price but does not close at or above then you
would simple stay in.

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In the chart above at the right edge you will notice that we get a pullback above our entry price, but the bar turns back around and closes below the actual entry so we will stay in the trade to avoid exiting prematurely. After this bar closes back down and continues in our direction, we will then move our stop two ticks behind the new pivot. At this point we would expect the bottom to finally break and head to the down side. We will not always get such a deep pullback and in that case we still trail
our stop behind any future pivots.

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Our trade takes back off in our direction as expected, but never guaranteed. Considering that we have already taken our money contract out, with this contract we can shoot for the home run, trail all the way down, and extract as much as it will give us. So the logical question here is why this setup is such a high probability? Well for starters, we have traders at other timeframes taking trades based on the HTF, the MTF and the ETM independently using the same analysis that we just used. These traders will all have a different set of rules for entry, exit and money management, but we all have one thing in common, pure technical analysis. Perhaps this can be best explained by using pure crowd behavior. If you have ever taken any Psychology classes than this should make even more sense, if not, then just take my word for it, when multiple traders come together, with the same analysis techniques that the majority use, then we are going to have movement in market that reflects
this analysis. Is this 100% guaranteed? No, but you don’t need anywhere near 100% winning trades to make money, in face one could very well argue with proper money management techniques, your win to loss ratio could be well under half and you can still make a very good living trading.

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In the above chart you will notice that we have another leg down and new pivot. At this point we will move our stop down and behind the new pivot by 1 to 2 ticks.

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And we finally get our exit signal. Lets sum up the trade
• First exit +10 ticks
• Second exit +48 ticks
• For a net total of 29 ticks on the trade (10+48)/2
As you can see trading pullbacks can be quite profitable. However, you must first understand that no trading system or style is ever going to be 100% correct all of the
time. Remember, we are dealing with human emotions and not absolutes, people do change their minds and therefore you should always have your protective stops in
place. And remember, always take some profits so you can get paid for your work. Don’t every let the market come back and take you out one you are in a decent profit position.

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