Monthly Archives: February 2011

6.18 Reasons Why Fibonacci Is An Illusion

Some people are not going to like this article. That’s fine though. We may just have to agree to disagree in the end, because this is an argument that has been going on forever on trading forums without ever finding any common ground.

Of course… my side of the argument is the right one… but some people just don’t seem able to see that.  🙂

I’m talking of course about Fibonacci levels, and their use in trading.

This discussion has come about as a result of a recent email by a YTC Newsletter reader, as follows:

Excerpt from Email:

Hi Lance,

Just a chart of today’s price action in EUR/USD.

From this H1 chart, we can see how well trend lines works, also that 61.8% retracements works and that S/R in charts works. Three good reasons to take this trade in my opinion, with very low risk and great rewards.

Since London closed high up and the Asian session traded far lower, to the traders in London this might just be seen as a large gap for them, just my thought on the subject and an idea for exit target.

How come you do not find trend lines and Fibonacci levels useful in your trading, if I understand you correctly?

I do not know of any tools that are so exact as trend lines and second are Fib-levels, chart S/R work also very well and is usually found close to major Fib-levels.

Chart Attachment:

Response:

Let’s consider fibonacci levels… why don’t I believe in fibonacci levels as having some predictive ability to identify turning points?

Reason 1:

(more…)

What Is Wrong With This Entry?

The following is an excerpt from an email Q&A session, which offers a great lesson for us all to share – the importance of correctly assessing the bias.

Email excerpt:

…My problem is I get stopped out again and again most of the time before price goes in my direction. I have a 20 EMA on my charts and it seems that price bounces off it most of the time to retest the lows. I have thought about waiting for strength to enter the market and attempt entry only on the first retracement, but as per your teachings on fading weakness that’s normally too late to enter after strength (even if it is on the lower timeframe?)

Am I wrong in searching for answers in my entry timing? Should I rather be looking at making my momentum reads more accurate? Or is it my momentum reads on the lower timeframe that takes place inside my entry formations that need attention?

I attach an example of a Eur trade that illustrates my problem. It is a breakout failure that I wanted to trade. After the third attempt at the lows it took off in my intended direction without me after I took two losses attempting to enter. I did not enter this third attempt since I then doubted it would continue higher.

Any ideas on what I can focus on to improve my entry timing?

Your guidance is greatly appreciated

Regards

Stan

Attached images:

5 min chart: (click on the image to open a larger copy in your browser)

1 min chart: (click on the image to open a larger copy in your browser)

Response:

Hi Stan,

Great question.

Accepting that I have only one trade sequence to use in assessing your current challenges, hopefully the following response will prove worthy of such a great question, and provide you with some insights for the way forward.

My immediate thoughts on seeing your chart is that… you don’t have an entry problem.

You have a problem identifying the bias (the likely path for future price action, or the future trend direction, or whatever other term you like), and possibly a reentry (psych) problem.

Let’s look at bias first.

Why do I say this is a bias problem, rather than an entry problem? Because if your assessment of bias is right, you can be quite imperfect with your entry and still have opportunity to profit. Whereas if your assessment of bias is wrong, even a most technically perfect entry will still place you in threat of a drawdown and likely loss.

Here’s an example demonstrating what I mean by this…

Let’s move now to your example.

We’ll begin by blanking out all other price action and examining the quality of your entries.(Note: my candles look slightly different to yours, which is just the pip or two difference between your spot forex broker and the fx futures. The concepts discussed are still applicable though).

From a technical perspective, both entries are very similar in technique. And both are a great method of entering the market at a point of short-term bullish sentiment, which was evidenced by price rallying for the following couple of candles.

Had such an entry technique been used with a clear bullish bias, it would likely have secured you an early low-risk entry into a high probability move, as bullish sentiment and orderflow carried your trade through to greater profits.

The problem then is not entry (which you’re already good at)… but when to make your entry decision.

And this is a problem of assessing the bias for future price action, or the path of least resistance (there’s too many names for this concept!!!).

Let’s look at the market at the time of your entry attempts, through your higher timeframe 5 min chart.

You correctly identified slowing momentum, as price broke the support in the vicinity of 1.3470.

The question then is, where is price likely to go from here. Weakness is clearly displayed after the point of breakout, but is that likely to lead to a reversal long? Or is a rally more likely to bring in more selling, leading to a continuation lower?

Your analysis clearly expected a breakout failure and reversal.

Your entry technique expertly picked a point at which short-term orderflow would be bullish, getting your trade off to a good start. Continuation higher though (eventually forming a reversal), will require fresh bullish orderflow. This will require a wider following… with other timeframe participants also switching to a bullish sentiment.

Your assessment of bias will then depend on whether you feel that a push higher will bring in sufficient new bulls, or cause sufficient numbers of shorts to cover their position, to overcome any new selling.

Let’s see how any pullback might look to traders of the 5 or 15 min charts.

So, is a rally likely to lead to wider bullish support?

No.

Given the bullish pressure that’s occurring at or below 1.3470, and the likely bearish pressure that will occur above, and in the absence of any external event which changes the supply/demand dynamics of the market, I’d expect that price would most likely settle into a period of sideways consolidation.

(Of course… it did eventually end up meeting your expectations… but that’s for another reason discussed towards the end of the article.)

My expectation is for sideways ranging action. The higher probability trades would be the short entries at the top of consolidation. Longs (if taken) would be managed very aggressively.

What would give me confidence in the long direction? I typically will require either a confirmation of change of trend, or some evidence of strength in the long direction and weakness in the bearish direction.

Until then… trust the trend.  (YTC PAT readers… refer to the "future trend – simplified" bonus video which discusses this a little more)

This is exactly the scenario you mentioned in your email ("I have thought about waiting for strength to enter the market and attempt entry only on the first retracement, but as per your teachings on fading weakness that’s normally too late to enter after strength (even if it is on the lower timeframe ?)"). I’m not sure why you thought I don’t recommend that. Identify strength in the bullish direction. Fade the weakness on the pullback. It’s a great plan.

(Side note: Momentum analysis is much more important on your trading timeframe (5-min), as demonstrated above. In your example charts you have not referred to this chart at all, instead focusing solely on the lower timeframe entry chart. Consider whether your focus is too much on the lower timeframe.)

Does this mean your attempted breakout failure trades (long) were invalid?

No. The breakout did occur and price did show weakness in the bearish direction.

Your entries are valid. I may well have taken them myself.

However, given the context within which they occurred they should either have been treated as a higher risk scalp back to value, or passed entirely, with preference given to pullback entries short (BPB trades, for YTC PAT readers) as the short-term bullish move failed. And… if we do discover that price rallies higher with strength and we missed the move, so be it. Reassess your bias and look for the next opportunity; watch for a weaker pullback and an entry long.

A couple of points to wrap up.

1. Re-entry… I mentioned that as a potential problem as well, given your comment that you didn’t have the confidence to take your third entry after the first two produced losses.

Confidence in re-entry is a whole subject on its own, but in this example we’ve highlighted the importance of recognising when a trade is lower probability (due to being against the larger bias), and managing it aggressively. Both your long entries offered sufficient potential to exit a portion with a small scalp profit, with the remainder scratched on premise failure for close to breakeven. At worst case, these two trades should not have produced much of a loss at all. Certainly, they should not have hit their stop with a full position.

Through active management, risk can be contained, reducing the fear of subsequent entries. Of course, experience is a vital factor here as well.

2. Why did the market rally? It’s nothing to do with technical patterns. There was an external event which changed the supply/demand dynamics of the market. In this case, it was the open of trading in London at 08:00 GMT. The open of a new session provides a whole new source of orderflow, and can often change the nature of the price action.

So, to summarise (and relate it to the important concepts of trade review and deliberate practice)…

I would suggest that your entries were excellent, if your assessment was for a change to a bullish bias and rally. Recognising the trend you’re fighting though, your trades should have been managed more aggressively.

However, the fact that price continued to push lower, stopping out both trades, shows you failed to correctly assess the wider bearish sentiment within the market.

The bias for this market was not for higher prices.

Higher probability options were through waiting for a pullback to fail, allowing re-entry short.

This is the benefit of post-trade (or session) reviews. Learning is a result of assessing the gap between what you expected to occur and what did occur. Review your charts post-trade from this perspective.

And if possible, re-trade the sequence in a simulator, using a market replay feature. Where were the signs that bearish strength was stronger than expected? How could you have seen this in the live market, and how should you have reacted?

Improvement comes through reinforcing the lessons found in our post-trade and post-session reviews.

Cheers,

Lance Beggs

A final bit for YTC PAT readers (I’ll keep it short… I promise)

You’ll
note that Stan’s expectation for a reversal comes as a result of the sixth principle. Strength was shown on approach to the S/R barrier, and it did result in the breakout. Weakness was then evident post-breakout, leading to an expectation for breakout failure and reversal back through the area of S/R. However, it’s important to note that this does not automatically mean we get a complete reversal of trend and a bullish rally. The expectation was met… price did rally (albeit only a short distance). Subsequent expectations depend on the following signs of strength and weakness. You may recall this discussed in the "future trend – simplified" video, where we discuss the fact that the trend is trusted until evidence of it breaking, or evidence of strength against the trend. In this case, you’ll note the lack of strength shown in the rally after both of his entries. This then leads to a further expectation of failure of the rally (potential breakout pullbacks). The market was in a bit of a stalemate at this point. Bullish orderflow from below; bearish orderflow from above. It wasn’t till the introduction of new orderflow at the start of the UK session, that clear direction was provided.

What Was That? (EUR/JPY, Jan 28th, 2011)

The following was a reader email, regarding some specific price action on Jan 29th, 2011, in the EUR/JPY:

Question:

I have question for you. I have attached a 5 min chart on Friday as a JPEG file.

Note the candlestick in the circle which is very long and sudden up and down. Also the shadow extends outside of the narrow band, which I’ve drawn as a green line.

How do you react to this kind of market? It is very pain in the XXX.

Regards, M.

Attached image:

Response:

(more…)