Today (2009.04.28) had many textbook setups that gave some great learning opportunities in the ES. This is a very long post, but I feel it contains some valuable information! Note: all times shown in charts are CST and are using a 987T chart.
Below shows the market action near the regular trading hours open. We can draw a fork from the lows and using the first pullback that gave us a full high to low swing on the stochastic. Market then confirmed this fork by bouncing off the lower line of the fork (circled), so we have higher confidence that we can trust this fork to work in the future.
We are looking to short this rally (sell on strength, buy on weakness). We take a fibonacci extension of the first leg up (purple arrow near bottom left) and see where this extension crosses the top of our fork (circled areas).
The first two circles had their price levels hit, but did not come in at the right time of the fork. The third circle had price come in right at that 1.618 level (853.75) and the top of the fork at the same time. This is a good setup for a scalp. I say scalp, since the trend is still upwards and we don't have a "counter-trend" setup in our indicators (
as discussed in this article).
As mentioned above, the trade setup for a nice ~2pt scalp and did not give us a big trend reversal. However, the stochastic is giving us a sign that a trend reversal is forming. In other words, there was a "False Bar" up, a stochastic pullback that had a ~50% pullback, but not fully to oversold. We will watch this leg up for signs of a reversal.
As an aside, if we wanted to look for a target of this scalp, we could look to the very last wave (in the same direction) to give us a heads up. If we take a fib extension of the previous pullback (smaller red arrow on the left), then apply it to the current pullback, we see that we went exactly 1.618 (851.50) of this distance. A general rule of thumb is that if a pullback is a very small one (2-4 pts, like in this case) then the fib extension will most likely be 1.618 or greater. Medium (4-6pts), then 1.272 or 1.618. Large (>6pts), then 1.0 or 1.272. This is, of course, not always the case.
Another way to measure this pullback is to look at the first pullback before the big rise up the fork (bottom, left, red arrow). In this case, the pullbacks are exactly the same. To the tick! It's a good idea to make many of these types of measurements and see where levels overlap. The more they overlap (confluence), then the stronger the support or resistance will be.
The leg up (labeled "A") gave us a new high with divergence in the oscillator (green histogram below with red line showing divergence). Since we had a pullback (labeled "B"), we take a fib extension to see where leg "C" will come in and THIS will be our place to short for a larger move. You would think that it is preferable to also hit the top of the fork, but since we are seeing (and wanting) a weakening market, it typically doesn't. Again, this type of counter-trend setup is discussed in
this article.
This extension marked the very top of this move (to the tick!) and began to fall. Since we stopped at the 1.0 level (858.50), it means wave "C" was 100% of wave "A" (they were equal). The oscillator continued to show divergence with this new high and the stochastic quickly started turning over.
Now that we started falling, we need to take a look at some targets. The first leg down gives us our first indication. We take a fib extension of this leg (left, purple down arrow) and see price come in at the 1.0 and 1.272 levels (identified by blue arrows). The stochastic is also showing signs of divergence with that new low, so this might be a good time to take some profits (or exit all together). Plus, at this point we are in "chop-time" or the "mid-day doldrums", so that's added reason to be defensive.
If that divergence turns into something, where could it potentially go? We first add a fork (as shown below). We then take a fib extension from the most recent pullback (small, left purple arrow). We take note where these levels cross our fork.
The first area caused some conjestion, but not enough to make it continue the fall. Note, the next level up is at 857.75.
Now that we have our first pullback in this move up, we can take a fib extension from it (both purple arrows are the same height). Note the 100% level is right at 857.75, the top of our fork, and the level we noted above!
As expected, right in the area, price fell off.
Since we are in the middle of "chop-time", it is a dangerous time to trade. However, there is still some method to the madness, as price bounced around in this fork. For context, the circled area was the first sell mentioned in the above chart.
Below is the same chart as above that has the addition of a new fork and the formation of triangle with a slight upward bias (the bottom line has a steeper upward slope compared to the descending line). Also, note the stochastic has a similar wedge formation. Finally, notice how the bottom line of new fork crosses the top line of the old fork right where price meets it.
And then the pop! Ususally when you see a wedge like that forming, it is building energy and has a pretty substantial breakout of that wedge (as shown below).
Below is one way to identify where this rally would go and a good place to short once again. The stochastic didn't start to show any divergence until it reached this 1.618 extension level. The fib extension is an extension of the first red arrow. The choice of how to draw the fork is a tricky one.
As the sale continued, we retraced to where the median line and the 1.272 level crossed (see second circled area). This would be a 2nd opportunity to get in if you missed the first entry to short.
This pullback also gives us an opportunity to take a fib extension and look for some targets (see first purple arrow hidden by the price movement). You can see we re-entered the fork from earlier (dark blue lines), so we have to be aware where these fib levels cross this fork. These levels act as an additional level of support. You can see the market reacted at each of these fib levels (pointed out by the blue arrows).
The final minutes of the day just bounced around in the bottom half of the fork and never really fell below that 2.0 fib extension (851). However, those final minutes seem to be forming a descending wedge, so I wouldn't be surprised if market continues to fall when the market re-opens.
I hope you found this information helpful. Good hunting traders!
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