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Mastering the Currency Market Figure 5-29 Fifty Percent Retracement Level Holds in USDJPY of thumb, the smaller the retracement, the stronger the original move. For example, a 0.382 percent retracement after a move generally indicates a stronger likelihood of a continuation of the original move beyond its previous high or low compared with a 0.618 retracement. It’s also important to note the distance of the previous retracement, as often that measurement becomes a characteristic and thus repeats itself. As always, it’s very important to have enough information in the form of time on the chart to avoid being caught measuring retracements of a minor move or retracements of a retracement and miss the long-term trend or the big picture. Figure 5-30 shows how USDJPY falls into a pattern of 0.382 percent retracements as it gives us three in a row. It is not 116 S u p p o rt a n d R e s i s ta n c e Figure 5-30 Three 0.382 Percent Retracements in a Row uncommon to see price movement break down so cleanly into measured retracements. This type of predictability, however, generally is found only in very liquid—that is, very heavily traded—securities, currencies, and commodities. Figure 5-31 shows GBPUSD completing a perfect 50 percent retracement on a 60-minute chart just ahead of a powerful rally after the U.S. nonfarm payroll news release on June 6, 2008. Figure 5-32 shows the intersection of a 0.618 percent retracement and a bull trendline hold on a 240-minute chart, followed by a powerful rally that quickly reversed the previous session’s sell-off and confirmed the long-term uptrend. Also note the sizable change-of-direction candle that kicked off the up move. In Figure 5-33 we’ve included a 60-minute chart of the same 117 Mastering the Currency Market Figure 5-31 Fifty Percent Retracement on a 60-Minute GBPUSD Chart after an Economic Release Figure 5-32 A 0.618 Percent Retracement on a 240-Minute USDJPY Chart 118 S u p p o rt a n d R e s i s ta n c e period to highlight the same buy trigger on the next lower time frame. Figure 5-33 shows the same day we just examined, but on the next lower time frame. Here we again see a change-ofdirection candle, this time on the 60-minute chart. Of course we don’t know at the time that this intersection of a trendline and a 0.618 percent retracement will hold, but when we see the change-of-direction candle put in the double bottom here, just below 104, we don’t think, we buy. Although Fibonacci retracements are more of a countertrend tool in that they measure primarily corrective price behavior, Fibonacci extensions are a trending tool because they are Figure 5-33 Intersection of Bull Trendline and 0.618 Percent Retracement in a USDJPY Chart 119 Mastering the Currency Market projecting, or forecasting, targets ahead of the market. An extension would be taken by observing a market move followed by a retracement, measuring the original move, and then taking the same height and extrapolating it up or down from the depth or height of the retracement back in the direction of the longer-term trend by a multiple of 0.618, 1, or 1.618; one also could use any other multiple. To simplify it, we often are looking for a move to repeat itself, or extend 100 percent of itself. This means that if a stock went from 1 to 2 and then back to 1.5, a 100 percent extension of that original move, as measured from the bottom of the retracement or correction at 1.5, would be a move to 2.5. Figure 5-34 Textbook Extensions on a Daily GBPUSD Chart 120 S u p p o rt a n d R e s i s ta n c e Figure 5-34 shows a USDJPY chart in which we’ve measured the June-August sell-off and used the height of that move when taken from the September-October retracement to measure down and give us a target for the next leg lower. We also get a third leg down in February-March, which happens to bottom just below the 1.618 extension given to us from the first leg from the previous summer. Extensions are often effective, just as retracements and other support and resistance levels are, because traders know about them and heed them. For our analysis and trading, we need to know when and where there are significant levels on the chart so that we can take a closer look at price behavior in the short-term time frames at those price levels. Figure 5-35 A 100 Percent Extension on a Daily USDJPY Chart 121 Mastering the Currency Market Figure 5-35 shows an example of a price move, in this case a rally, followed by a second rally several weeks later of nearly identical height and time. This is a classic case of market symmetry. Note the pattern of higher lows and then the two equal lows in May, which would also be called a double bottom. A double bottom is a classic chart formation that will be covered in the next part of this book. This is a very interesting chart. Note how in early June there was a close above the old May high, or a market “breakout,” and USDJPY quickly extended its move to replicate the earlier rally. Studying charts like this during off-market hours in a relaxed environment is great experience for market students. Figure 5-36 A 161.8 Percent Extension on a Daily GBPUSD Chart 122 S u p p o rt a n d R e s i s ta n c e Figure 5-36 shows a late summer rally in 2007 in GBPUSD and then a sharp correction lower by approximately 66 percent of the up move into mid-September, which provides a retracement from which to draw an extension higher. In this case the market pulls up short of the 100 percent extension in early October and proceeds to move sideways for much of the month before slipping higher toward the end of the month. The second close above the 100 percent extension proves to be a “breakout” above both that level and the isolated high back in July, and we get a very fast rally, or a climax rally, up to the 1.618 extension level. Figure 5-37 A 100 Percent Extension on a Daily GBPUSD Chart 123 Mastering the Currency Market The extensions we see most are the 100 percent measurements, and Figure 5-37 shows one on the daily GBPUSD chart after a brief sideways correction in late February-early March 2008. We have seen how important support and resistance levels are to markets and traders. We see support and resistance in the form of previous daily highs and lows and the trendlines created by them, pivot points on all time frames, and retracement and extension levels. As you can see, there are plenty of levels for traders to be concerned about on a chart, but the most important thing to remember is that we don’t respect the level unless the market does that first. Although you may be concerned about having so many lines on your chart, you can relax because as you will see, the markets will tell you which lines are significant. Technical analysis is, after all, an art and is based on the assumption that “the charts tell us everything the market knows about itself.” It’s up to us to stay loose and keep an open mind so that we can see what the market is telling us. 124 C H A P T E R 6 Chart Patterns N ow that we understand how a chart is constructed and how price action identifies significant support and resistance levels, we will discuss chart patterns, which are formations created by multiple support and resistance points and trendlines. Whether we know it or not, pattern-recognition skills play a big part in our lives and those of the people around us. To talk about price patterns on financial charts, we also must cover price volume, which is the total number of actual securities or contracts traded for a particular bar or candle; it tells us whether the trader participation rate is high or low relative to what it has been and whether volume is increasing or decreasing. The candle pattern gives us the length of a price movement, and the volume tells us the size of the participation rate. For securities, commodities, and currency analysis, volume is of particular importance at the potential inflection points in the chart patterns where the trend shifts. Volume is displayed at the bottom of the chart in a histogram and is used to confirm direction. If a breakout, or penetration of an important price level, occurs on rising volume, it is considered more viable; if it occurs 125