We will look more closely at market action between horizontal price zones next. Ford Motor Company (F) is displayed in a weekly chart in Figure 6.9. This chart will help us look more carefully at the price internals within a chart. This is something very few people do until they have traded a long time.
FIGURE 6.9 Ford Motor Company Weekly Chart—Price Internals
Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software
Remember, if we want to create levels of resistance over a current market price, the start of all ranges will always be from a price low, and then sequential bar highs will end the ranges. Near the price low bottom a level marked start shows where all the selected ranges that were subdivided begin. The actual price low is not used as a key reversal is present, and the market close and open does not fall under the defined start line. There are four ranges in this chart and all four end at strong bars marked at levels a, b, c, and d. None of the endings of the ranges are at major swing highs. This will be the case most of the time.
I know these ranges are correct for several reasons within the market data. When the ranges are subdivided into the ratios 38.2 percent, 50.0 percent, and 61.8 percent, four confluence zones develop in tight bands marked m, n, o, and p. One of the confluence zones, n, is reinforced with three Fibonacci ratios within this zone. Confluence zones with multiple ratios, developed from gaps, or extremely strong bars all have a higher weighting than two ratios from lesser points. In this chart, confluence zones n and p are of greatest importance.
Starting from the pivots marked 1 and 2, the move into pivot 1 manages to push through confluence zone p, but fails at minor resistance under pivot 1. Then when the market falls back and makes a new challenge it fails at pivot 2, right at confluence zone p. We know these ranges are being respected by this market. In other words, we have found the price grid this market is using to develop future swings.
The market falls and then uses pivots 3 and 4 in a very similar manner as pivots 1 and 2. But the market is much weaker, and a third wave decline begins from pivot 4. The market makes a hard fast break through levels n and m. These confluence zones are all levels of resistance. We defined the ranges from the same start at the bottom of the data. Do not use them as support. If we wanted to know support, we would have started all the ranges from a high.
If you sold short into confluence zone m, stops would have to be at least over zone n. You cannot place stops between zones. (Assume you will be filled at the next zone.) To create a risk-to-reward ratio, you would use the range dp that ends at level d with the midpoint confluence zone at p to create an equality swing. The measured range is then projected down from confluence zone p. You would find the target was precise at the chart lows. If you sold level m, the risk-to-reward ratio of 1 : 3 would be present using the price projection technique just described. If that was the criteria to establish a trade, it is important not to change the strategy. Your profit would have been banked before the start of the market move towards pivot 5.
From the market low, a strong rebound develops directly to the first confluence zone at m. This is common market action. Then a pullback follows that resumes the move up towards pivot 5. While pivot 5 blew through the confluence zone at n and through a minor level of resistance just above it, the price data failed to reach confluence zone o. This is very significant because the key reversal at pivot 5 had no interference or reason to stop before confluence zone o. It is a sign the brief uptrend is exhausted. The market pulls back and then moves up into confluence zone n at pivot 6. While confluence zone n is exceeded, the key reversal fails at the minor level of resistance and then immediately falls back to confluence zone m. This is why making these minor levels of resistance or support a soft gray or faded color in the background can be of value. It is also important to notice bar opens or closes do not occur over confluence zone n near pivot 6.
Pivot 7 fails under confluence zone n. The market pulls back and fails at pivot 8. This is a weekly chart. Your oscillators will warn you the market has the strength to create the swing up into pivot 9 in the weekly time horizon, but the monthly chart will tell you the swing up is corrective. Always use two different time periods to make an opinion on how a market will respond to a confluence zone. In this weekly chart, Ford fails at confluence zone 9 without exceeding it. A decline then follows, and you should be able to read pivots 10 and 11, including the small matching shoulder to the right side of 11 under zone n. Notice how the price data moved between zones m and n from pivots 7 to 10. All of this price data action confirms the market is working within the grid created within this chart.
In the next example in Figure 6.10, we will examine a 1-week chart for CBOT Wheat Futures to mix up the market examples. Wheat offers an ideal example of how markets that form very strong rallies will break hard when they correct. These markets will create wide empty spreads between the developing confluence zones. The target zone was level m. It is possible the confluence zone at level m is only the midpoint of this rally. You can use the box method described and measure the range from d to m. Then project the same range up from m. That is a big move, so you would further subdivide the projected box range from m to a new high into the Fibonacci ratios.
FIGURE 6.10 CBOT Wheat Futures 1-Week Chart
Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software
The high was used to start the ranges that end at levels a, b, c, and d. The reason the high was used is the most recent price bar is higher than the bar behind the key reversal market top. So all levels of resistance have been broken, and only the market top remains. The range ending at b is an important gap discussed early in this book. Always use gaps in this manner to define the ending of one of the selected ranges. You should also notice that the close of the bar after b is near the high two bars behind b that precedes the key reversal just behind b. Confluence zone m held the market decline from the high, but the spread and empty void between m and n means this was not the place to go 100 percent long. You might consider a 30 percent long position for a long horizon trader. When the market tests 770 1/8, add 50 percent. This is the second bar past the low at m that tests a single support line viewed as minor support. This would be a safer entry than at the pivot low on m. Then, as the market runs past the high of the bar that tested the zone at m, the final 20 percent might be scaled into the long horizon position. Each leg should be treated as its own position and not averaged. Therefore, each traunch has its own risk-to-reward ratio and stop loss trigger. As the confluence zone at m can be viewed as the midpoint from which to make future Fibonacci expansion targets, it can be said this market will definitely exceed the current high. Know where you would be wrong to hold such a bullish opinion. If the market breaks the confluence zone at m, before reaching the equality swing projected, a new market study must be made. You would also make this evaluation while you were out of the market and flat.
The next market example has been chosen deliberately because of its price complexity. Figure 6.11 is a 5-week bar chart of the 30-Year U.S. Treasury Bond futures. This market is choppy in nature as it is defining a rising wedge that develops many back-and-fill swings.
The start is important for defining the ranges in this chart. The swing into the actual market high has nearly been fully retraced. Take the most current swing high because it has broken all resistance levels behind it by nearly defining a full retracement and double top. It is not a double top, but it tried hard to create one before falling to pivot 1. Truncate the spike and set the starting level where numerous bars have failed. There are six ranges and the lows that define the endings have been labeled a through f. This time I have not labeled the zones so you can examine the placement on your own. But use the zone nearest pivots 2 and 3 to set your eye for what you should define as a confluence zone. It does not matter if it is a 1-minute chart or a semiannual chart; the look and feel of a confluence zone within any chart will be similar. As you study pivots 1 through 9, con
sider the market’s reaction to these past swings. If the market respected these levels in the past, you have set the correct grid for the future. The horizontal lines were not extended to the right. This is a working chart for this market, and where they end on the right was the current bar when they were created. Then pivot 1 fell into a support area that would be clearer if the Fibonacci zones were extended. This chart cannot be used to create resistance unless you develop Fibonacci expansion targets or drop down to a shorter time horizon to use pivot 1 as the start of a range. It would be better to create expansion targets. (We will review this technique in the gold market in the next example.)
FIGURE 6.11 30-Year U.S. Treasury Bond Futures—5-Week Chart
Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software
The zone near pivots 2, 3, and 7 is clearly important for any expansion work developed. The next zone would be just above the label a. If you can duplicate these zones on your own in a monthly chart, you are doing extremely well. The key to selecting the ranges in such a chart is to end the first range at the highest price low first. Then scan downwards through the data to sequential lows. Do not jump down to the extreme low because you will not be able to see the internals for all the other ranges you need to consider. By now you have seen I rarely use the price low. When the ranges are subdivided, you may not want to see the secondary minor levels. The solution is to use a horizontal line to mark the widths of the confluence zones and then remove all the Fibonacci subdivisions. The upper and lower boundaries of confluence zones are essential, as you will need the zone width for trading strategy. When you can delete the other calculations leaving just the confluence zones, they can be used for additional analysis techniques. A few of these applications follow in the last two charts.
Figure 6.12 is a 2-month chart of COMEX Gold futures. The three different Fibonacci expansion projections made in this chart define a confluence target at n, o, and p. The current market highs are currently just short of confluence zone n. The price data consolidated for several months under the confluence zone that formed at m. The respect shown to this resistance area is marked 1, which means this zone will be an important marker for future market swings. Take a look at the oscillator. The Composite Index2 has diverged from price highs, but we are justified in asking if target zone n or o is the more probable target. Adding to our concern is seeing the oscillator pressing under its own two moving averages as the shorter-period average crosses down through the slower moving average. The market is clearly overbought, but be very careful about zone n. Time analysis shows zone p will be realized before a larger correction develops.
FIGURE 6.12 COMEX Gold Futures
Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software
Both target zones n and o in Figure 6.12 are confluence zones containing Fibonacci expansion projections. But zone n is not as strong a confluence zone compared to o. The zone at level o has much greater weighting because it includes an equality swing target of range B derived from the range marked A. Range A begins where the strongest start of the rally ignites upwards and ends after the market showed months of respect to the target confluence zone at m. Please do not ever forget that the most significant points, or milestones, the market will give us are gaps and points that mark the start of strong forceful moves. This is true if you are working with intraday or longer-horizon charts. In this case, the start of range A is the start of a third-of-third rally, using Elliott terminology. In other words, it is always the point at which the market has everyone on the same side. The shorts have to get out, the early longs want to add to their positions, and the laggards are desperate to jump in. In declines, the same sentiment occurs at these market junctures. Only the Elliott Wave Principle gives us the language to map and discuss milestones of market sentiment, making this methodology a valuable addition. Level n should be viewed as minor resistance, and level o as major resistance where a corrective pullback or pause could occur before the trend resumes upwards.
In the last two chapters you will learn why various Fibonacci confluence zones like levels n, o, and p are not of equal weighting or importance. Before long you will ask, “Which zone is more significant to the one that began the entire price move?” That is when you will know you are ready to do more than just create the confluence zones. When you start asking which zone is the most important, you are beginning to study how these confluence zones relate to one another. In Chapters 7 and 8 we will look at how proportion is evaluated so we can solve problems involving ratios. Fibonacci analysis is really just a subset within a larger field of analysis that is new to the industry involving harmonic intervals. But do not move to this level of study until you are proficient in working with confluence zones by themselves.
The Hong Kong WEB on the NYSE (EWH) is displayed in a 2-week chart in Figure 6.13. Figure B.2 in Appendix B is the same chart before the Gann fan angles where added, if you want to examine how the Fibonacci confluence zones were created without the clutter. Gann angles radiate forward in an upwards or declining direction with a specific slope. When a line is created with a growth rate from a price pivot point with one unit of price relative to one unit of time, it creates a 1-by-1 trend line at a 45-degree angle. The precise angles that define a complete Gann Fan are 3.75°, 7.5°, 15°, 26.25°, 45°, 63.75°, 75°, 82.5°, and 86.25°. Figure 6.13 displays a few Gann angles to demonstrate that many technical tools perform with greater accuracy when you use the same pivots that create range extremes for confluence zones. In Figure 6.13 the intersection of two Gann angles from different confluence zones define a major market pivot high. This is not a final top, but accurately warns that this market is at an important level of resistance. Notice how the market fell to the first confluence zone near 19.90.
If you are new to these methods, your hands are full learning the basics, and you need to practice in many different market charts. Use old data at first so you can scan forward to see how accurate you are becoming. Listed in Appendix B are a few common errors traders I’ve taught encounter; the aim of that appendix is to make you aware of these common difficulties. Although you might find it difficult to look at the smaller details within a chart, you need to recognize that developing an ability to do this is absolutely essential. The traders I’ve worked with who struggle at first generally make broad-stroke assumptions far too quickly and have never allowed themselves to look at the rich source of directional information forming within the internal price structure. The internal structure will not get in your way of making a decision; it will increase your probability of being right.
FIGURE 6.13 Hong Kong WEB (EWH) 2-Week Chart
Connie Brown, www.aeroinvest.com. Source: Copyright © 2008 Market Analyst Software
There will come a point in your trading when you are amazed at how the market respects confluence zones within any time horizon. These methods will become fluid and effortless with practice. It will not matter what market you are asked to consider. I once found an exact pivot deemed impossible for the Thai bhat/lira currency cross. I just used these methods and switched the chicken track data to a line chart to make the calculations. The methodology and logic tree does not change and is a sound approach for any market you may wish to trade. The caution is to never study one time horizon or one market alone. Always find the correlated, or inversely correlated, market to help guide you. If one market blows through a zone, it is an early warning about another.
We are ready to dig deeper to explore how these confluence zones relate to one another. Some of you may leave at this point, and I wish you trading success and the patience to learn these methods. They have defined a career that built my home and supported a dream. I am grateful to Joe DiNapoli who first introduced the concept of Fibonacci confluence to me many years ago. But then I took the idea of confluence to an entirely different level and with experience new methods began to emerge. For over ten years people in the industry have asked me to write this particular book. I
guess I never felt ready before now because it takes years of experience to finally feel you have the confidence and security to reveal what others do not discuss. There is no “bs” within these pages, just an open record of what has been proven to be a working method that I know has held up over years in the most volatile of markets and over changing times. Let other methods give you permission to act upon the target zone. Don’t read indicators alone. If you are looking for more behind these methods, the final chapters will give you insight into how the confluence zones relate to one another. You will discover that the proportions between zones are harmonic. This opens a different kind of chart analysis, and it is interesting how life comes full circle. The discovery of harmonic relationships between confluence zones brings us back to the Pythagorean doctrine that all things are connected by harmonic proportions. I believe this to be true now. For the few brave enough to read on, we are ready for those final discussions. For those who need more time to digest the methods described, my best wishes to you for trading success, and may success bring you peace.
CHAPTER NOTES
1 Using a 34-degree progression is very similar to what is known as an ingress cycle, where a planet crosses a house cusp. Ingress studies are recommended, but a Fibonacci number has been deliberately selected so those of you more familiar with astrology will broaden your research to include astronomical progressions using the Fibonacci number series for angle analysis in addition to your other work.
2 The Composite Index Oscillator formula I released in Breakthroughs in Technical Analysis (Bloomberg Press, 2007). You will find more about this oscillator and how it is used to warn when RSI is failing to detect a market reversal in my book Technical Analysis for the Trading Professional (McGraw-Hill, 1999).
Fibonacci Analysis Page 11