Trading the Stock Indices with Fibonacci Price Clusters
Many traders are already familiar with using Fibonacci price retracements for possible support or resistance decisions in the market. They may be less familiar with the concept of Fibonacci price extensions and projections. We can take Fibonacci price analysis a step further by taking a combination of these retracements, extensions and projections to create what is called a Fibonacci price cluster. These clusters can define a relatively low risk high probability trade setup.
Fibonacci Price Cluster
A Fibonacci Price Cluster is the coincidence of at least three Fibonacci price relationships that come together within a relatively tight range. A cluster can define a key support or resistance decision in a market and also define your risk extremely well on a trade setup.
First, to find a price cluster, we will run all the Fibonacci price relationships from the key swing highs and lows on a particular chart. We will be using the price relationships mentioned in the first paragraph which are retracements, extensions and price projections.
The ratios most often used in this analysis are .382, 50, .618, .786, 1.00, 1.272 and 1.618.
Let’s recap some terminology
Price Retracements are measurements of prior lows to highs or highs to lows using the ratios of.382, 50, .618 and .786 which define possible support or resistance.
Price Extensions are measurements of prior lows to highs or highs to lows using the ratios of 1.272 and 1.618 which define possible support or resistance.
Price Projections are measurements which compare swings in the same direction using the ratios of 100% and 1.618 which define possible support or resistance. This is where we take prior low to high swings that will be projected from a disconnected low or a prior high to low swing which will be projected from a disconnected high.
The following price cluster example will illustrate each of these Fibonacci price relationships. Let’s walk through a setup on a 3-minute chart in the E-mini S&P contract.
Figure 1 is a simple illustration of the 3-minute chart which was the raw material for the trade setup. Since this chart pattern of lower lows and lower highs is considered to be bearish, I wanted to set up the sell side for a trade entry in the direction of the trend of this chart. If you trade in the direction of the trend, you are following the path of least resistance.
(All chart prices are rounded to the closest futures price)
Figure 1
(Courtesy of DynamicTraders.com)
In Figure 2, I ran a price retracement of a prior high to low swing (1329.50 high to the 1320.50 low) for possible resistance. For this particular example we are interested in the .382 retracement which came in at 1324.00.
Figure 2
(Courtesy of DynamicTraders.com)
In the next chart (figure 3) I ran the retracements of another high to low swing (1326.50 high to the 1320.50 low) In this example the .618 retracement closely overlaps the .382 retracement example in figure 2 coming in at 1324.25.
Figure 3
(Courtesy of DynamicTraders.com)
In the next chart (Figure 4), you are looking at an example of two price projections of prior low to high swings (1326.00 low to the 1329.50 high and 1323.00 to the 1326.50) which were then projected from the low made at 1320.50. You will only see one projection level on the chart however, because both of these swings were equal at 3.50 S&P points.
These projections came in at the 1324.00 level. In this case I only used the 1.0 projection for what I call a symmetry projection where the swings being compared would be similar or equal.
Figure 4
(Courtesy of DynamicTraders.com)
This next chart (figure 5) illustrates the price extensions of a high to low (1323.25 high to the 1320.75 low). For this price cluster example the 1.272 extension at 1324.00 also overlapped all our prior price relationships.
Figure 5
(Courtesy of DynamicTraders.com)
When you look at all the price relationships together, you can see where a clustering of these levels show up on the next chart (figure 6). Here we are looking at a confluence of price relationships that came in between the 1324.00-1324.25 area.
They included a .382 retracement, a .618 retracement, a 1.272 extension and two 100% price projections. This became our price cluster decision.
Figure 6
(Courtesy of DynamicTraders.com)
When a price cluster zone is tested we want to see if this area will stall the market and offer us a trading opportunity. If it does stall, we then look for a trigger entry that tells us to enter the market.
In this case the actual high was made at 1324.00 which was followed by an 8.50 point decline. Since price did stall in this case, the next step would be to go to your trigger chart and look for an entry. This is illustrated on the next chart.
Figure 7
(Courtesy of DynamicTraders.com)
Most of my traders like to use a tick chart such as 55, 89 or 144 ticks per bar, as it will generally trigger an entry that is relatively close to the price cluster zone. For this example I used a 55 tick chart along with a TTM squeeze trigger.
A squeeze entry fired off where the arrow in figure 7 comes in. The low of this bar was 1322.50 so if you executed the trade immediately your entry price would have been 1322.50 or better. Either a standard price stop can be used or it can be placed just above the high made prior to the actual sell trigger which would be 1324.50 in this case.
As far as money management is concerned, after the initial stop is placed, my traders like to use multiples of 3 lots. They would exit the 1st third of this trade at +4 ticks, the 2nd third at +8 ticks. They would then attempt to keep what is called a runner. This is where they would let the 3rd unit of the trade run until the market takes you out with a trailing stop.
Depending on the exact entry and the type of trailing stop that would have been used in this case, this trade should have yielded at least 4 – 5 S&P points on the last third of this particular trade.
Figure 8
(Courtesy of DynamicTraders.com)
Carolyn Boroden is a Commodity Trading Advisor and Technical Analyst that has been involved in the trading industry for over 20 years. Her background includes working on the major trading floors including the Chicago Mercantile Exchange, the CBOT, NYFE and COMEX. For more information, go to www.FibonacciQueen.com.