A Gold-Rush Style Boom
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"It's been the opportunity of a lifetime."
"It's unexpected. A blessing."
That's just a few of the things being said about a gold-rush-style boom generating "overnight millionaires" across the country.
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| Tuesday, December 23, 2014 | Issue #2443 | |
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Technical Tuesday: Using Key Price Points to Buy
on the Pullback Christopher Rowe, Technical Strategist, The Oxford Club
 How frustrating is it to hear market pundits say "buy it on a pullback" without hearing the actual price at which to buy?
But can you blame them for omitting the price?
On one hand, they want to give you an idea of where to buy, but on the other they know you'll hold their feet to the fire if they weren't exactly right. Nobody can be expected to know the future, especially when the outcome is based on the mood of millions of investors.
But it is possible to gain a good estimate of where prices may find support or resistance using Fibonacci retracements. This pattern is one of many analytical methods derived from Fibonacci ratios.
Today I'll give you the basic understanding of Fibonacci retracements to identify price levels that are likely to be good entry and exit points.
Fibonacci Retracements
When a security makes a major advance (in an uptrend) or decline (in a downtrend), it makes a strong move in the major direction, followed by a smaller pullback in the opposite direction. It then resumes the major direction with another strong move, and so on.
The question is: How big will the pullback be, before the major trend resumes?
Let's focus on the most popular Fibonacci retracement levels, which are 61.8% and 38.2%.
Below is a chart of the iShares 20+ Year Treasury Bond ETF (NYSE: TLT). It tracks the results of an index composed of U.S. Treasury bonds with remaining maturities greater than 20 years.
I used this because I think, unlike stocks, people feel Treasury prices are more likely to move based on fundamentals of the global economy as opposed to technical behavior.
Let's assume, in late August 2014, we wanted to enter TLT on a pullback. The first thing we would do is go back and find a major low and then connect it to a major high (dashed line).
Using our Fibonacci retracement tool, we start with the major low of $101.19 at the beginning of 2014 and connect it to the August 2014 high of $119.37.
Once we plot the move, the tool automatically creates the horizontal lines you see, which include the two major retracement levels discussed (61.8% and 38.2%) as well as some retracement levels not mentioned yet.
We tracked an $18.18 move. After reaching the high of $119.37, TLT retraced $6.64 (or 36.52%) of that move when it pulled back to $112.73.
This was very close to the 38.2% Fibonacci retracement level, and "very close" is the best that we can hope for. Keep in mind, Fibonacci retracements are rough approximations of where investors look for a reversal.
Let's track another move, from that September 2014 low we just focused on to the following October 2014 high.
But pause here and notice we are measuring moves based on intraday lows and highs. This is an important distinction because the intraday high in October was $127.68 while the closing high was $122.53 - a big difference.
This time, we are tracking a 14.95-point move, from $112.73 to $127.68. The second major Fibonacci level we discussed was reached. TLT pulled back to $118.21 intraday so it retraced $9.47, or 63.33% of its $14.95 advance.
What the Pundits Are Really Thinking
Those market pundits may tell you to expect a move back to a particular price point before a reversal occurs. But they always have a secondary, lower price point where they'd expect a reversal to happen if their first price point didn't act as a support level.
Often, the 38.2% retracement level is the first expected support level, a 50% retracement level is the second expected support level and 61.8% is the third. While 50% is an extremely popular retracement level, it's not a Fibonacci level.
Considering TLT made such a huge move to the October high, a larger retracement is a reasonable expectation.
Why does this work?
Most of the volume traded in the stock market is automatic trading, triggered by computers using mathematic equations. If lots of computer programs focus on the same levels as potential reversal points to buy, it becomes a self-fulfilling prophecy.
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It Works Both Ways
We focused on continuing trends thus far, but look at what happens when we track a move from the major high in May 2013 to the low at the turn of the year.
If, in the beginning of 2014, we drew the line from the high to the low, the Fibonacci retracement levels seen above are created. I matched the arrow's colors to their respective retracement levels.
But in addition to that, I added black arrows to point out how the major and the secondary levels also acted as key support levels.
The secondary levels of 23.6% and 78.6% can assist anyone looking to time their trading.
They key word here is "assist." Fibonacci levels should be used in conjunction with other technical indicators and fundamental factors for finding key price points. Technical analysis is an art, not a science, so be sure to use these levels as rough approximations.
Most charting services provide this popular tool for finding likely reversal points. I hope this article helps you improve your entry and exit points going forward.
Good investing,
Chris | |
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Beyond strong fundamentals, insider action at a company is also telling. In the past quarter, insiders have purchased 25.76% of this company's stock. Readers of Investment U's premium edition are learning about it today. Learn how to join them by clicking here. | |
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I often argue that the mainstream media is far too pessimistic. This causes investors to miss worthwhile investment opportunities... or avoid equities entirely. But how about when the news is genuinely bad? Read On... | |
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