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Fibonacci, Trendlines, Divergences — Recipe For Reversal

10/08/09 01:56:40 PM
by Donald W. Pendergast, Jr.

Not every intraday trade setup works out this well, but the technical dynamics leading up to it are worth a second look.

Security:   Gold, GC
Position:   N/A

Most new traders get frustrated when they attempt to analyze a chart using only one kind of indicator or trading technique. Even worse, if they try to actually make a trade using a singular technical interpretation of market action, their trading results are usually disappointing. Here's one way to combine multiple technical interpretations into a viable trading strategy that can actually make money over time.

FIGURE 1: GOLD, THREE MINUTES. Price momentum and price–money flow divergences are reliable early warnings of potential trend reversals — on any chart, and in any time frame. Using Fibonacci support/resistance levels and trendline breaks can also help time such divergence setups.
Graphic provided by: Interactive Brokers TWS 3-minute chart.
Figure 1 is the three-minute chart for COMEX December 2009 gold. Gold made a strong run higher right out the gate this morning (October 6, 2009), tacking on a gain of about $11 in an hour and a half of trading action. While this is great news for those following the epic breakout in progress on gold's monthly chart, it also provided a healthy technical backdrop for this amazing intraday setup that printed a few hours after the initial run higher. A savvy intraday trader would most likely stretch a Fibonacci retracement grid between the morning low (1032.50) and the early morning high (1045), looking for possible low-risk long reentry points at key Fibonacci levels.

After placing the grid, the trader would note the approximate price levels of the 38%, 50%, 62%, and 79% Fibonacci retracement lines and then thoroughly evaluate the technical landscape on any touches of such levels on a pullback move from the morning's high. Since the intraday method that I follow relies mostly on money flow, intraday pivot points (not a major factor today, as price stayed above resistance level #2 [R2] for the entire session), momentum, moving averages, and average true range (ATR), it was little surprise to see at least several of these technical factors come into play as prices began a leisurely four-hour period of retracement and/or consolidation.

Note how each key Fibonacci level that was actually touched acted as significant support as the decline played out; the 38% level (top horizontal blue line on chart) was particularly strong, holding back the decline on two (see point 1a on chart) consecutive tests. Volatility (measured by the ATR — see the yellow indicator line below the price chart) was steadily declining during those two tests (see point 2 on chart) of support, but the Chaikin money flow (CMF)(34) (blue indicator line at bottom of chart) was not supportive of a significant reversal at that time.

Waiting a little longer, the Fibonacci 50% retracement also acted as support (see point 1b on chart) on one occasion, allowing quick scalpers to make a handle or two between 10:15 and 10:40 Pacific time (PT). This rally attempt quickly failed, however, causing a sharp drop down to another key Fibonacci support level, the venerable 62% retracement (see point 1c on chart). After hitting this level (near 1037.25) at about 11:10 PT, volatility began to drop off dramatically even as the money flow line continued to confirm that a bullish price-momentum reversal was likely in the works (see point 3 on chart).

Soon afterward, gold broke above a minor downtrend line (see point 4 on chart), a final retest of the Fibonacci 62% level proved successful (see point 5 on chart), and then price shot higher on a wide-range three-minute bar that not only took out a minor swing high, but also allowed price to actually reverse above the prior Fibonacci 50% level (see the X at point 6 on chart). Price continued to follow through, even taking out the Fibonacci 38% level on its way toward completing a reversal gain of about six points in just 45 minutes. Even nicer for gold bulls, prices closed near the high prices of today's session, at 1043.

Does every Fibonacci/volatility/divergence setup like this always yield equally profitable results? Of course not, but you'd be surprised at how often they produce a swing move worthy of engagement. Setups like this usually offer a very attractive risk-to-reward ratio (RR), especially when the stock or futures contact traded is also in a confirmed uptrend on its higher time frames. Gold certainly qualifies in that regard, making a setup like this nearly irresistible to experienced traders. In addition, you may experience better results when using both the 20- and 50-period exponential moving averages (EMAs) when trading a template similar to this; they were omitted for the sake of clarity on this particular chart.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address:

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Date: 10/12/09Rank: 4Comment: 

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