The Trading Levels are based on the golden ratio of .618 applied to price. In the previous article we talked about trade management along with viewing whole numbers as psychological levels where traders tend to enter and exit trades. This article will elaborate on what these numbers are we have coined the term ‘Trading Levels'.Leonardo Fibonacci
The slightly under recognized 13th Century mathematician Leonardo Fibonacci, noticed in nature recurring patterns that could be identified mathematically now known as the Fibonacci sequence of numbers 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 and so on. This numerical sequence is the sum of any two adjacent numbers in the sequence that forms the next higher number in the sequence: 1 plus 1 equals 2, 1 plus 2 equals 3, 2 plus 3 equals 5, 3 plus 5 equals 8 and so on. The ratio of any two consecutive numbers in the sequence approximates 1.618 or its inverse .618, known as the golden ratio or golden mean. This ratio is also a natural part of the Elliot Wave Theory which Robert Prechter outlines superbly in his book The Elliott Wave Principle, the bible on Ralph Elliott's price behavior theories of the 1930s.
Nearly people encounter Elliott quite complicated if in fact it's quite unfussy, and on only three rules. (It's my belief that in general traders find it difficult to follow their own trading rules let alone another's. It's a major cause why nearly traders offer their money to the professionals the rich get richer! Ask over whatsoever professional trader and they will happily explain to you that a little discipline towards their own trading rules goes a very long way.
What are Trading Levels?
We view the Fibonacci sequence simply as ‘Price' that is, 1 becomes 1 cent, 2 becomes 2 cents, 3 becomes 3 cents and so on, 5 cents, 8 cents, 13 cents, 21 cents, 34 cents, 55 cents 89 cents. The second aspect to understand is that the sequence expands by the power of 10, that is, 1 cent expands by the power of 10 and becomes 10 cents, 10 cents then becomes 100 cents or $1. Then $10 then $100 then 1000 and 10,000. High numbers like this can be used with Indices such as the Dow Jones which is currently trading at Trading Level 1 (10,000). Its previous support or Trading Level 8 (8,000) also comes into play. These are our Trading Levels and are levels of sustain and resistance in mere terms. The same principle applies to each number in the series eg. 2 becomes 2 cents (expand by the power of 10) becomes 20 cents, then $2, $20, 200, 2000 and so on, (where zinc is currently trading). The Fibonacci sequence and the expanding by the power of 10 will start to look like this: 1, 2, 3, 5, 8, 10, 13, 20, 21, 30, 34, 50, 55, 80, 89, 100, and so on. Remembering that these numbers are immediately ‘trading levels', and that whatsoever of these levels can be cents, dollars or points. The reason they work is because they have a relationship to one another and that is the golden ratio as you can see in nature itself.
Are selected levels further important than others?
Yes. More than likely 10 will have more presence over its neighboring numbers 8 and 13 as will 20 to 21 and 30 over 34, 50 over 55 and so on. As a guideline, if there has been a large correction at $10 (Trading Level 1) then there will most likely be a smaller or minor correction a the next level being $13 (Trading Level 13) so the next major correction will be at $20 (Trading Level 2). In even additional detail still for the budding Elliott observers, the guideline of alteration comes into play within wave 2 and 4 - if wave 2 is simple and sideways at trading level 1 ($10) then we can expect wave 4 to be sharp and complex. BNB is an example of that. You also commence to notice that a five wave structure of one degree will happen between the Trading Levels, making Elliott even easier. I am talking about this operating in stocks that are in cents, dollars and indices, the three charts below show you this operating.
How to use them?
Corrections can occur at these Trading Levels. Corrections are where traders can lose money and caution is warranted in avoiding being trapped in a trading pattern you don't understand. Once the correction is completed - there are many ways to work this out - then the market will continue to move. I prefer to buy into new highs and sell into new lows, volume pending. The other obvious point here is not to buy before these levels, as you will probably be moving into a profit taking correction. You need to be patient and wait until the market has rested back above a trading level and then enter once new highs are confirmed. Also a large sideways correction at a Trading Level is a good foundation for a healthy run to the next Trading Level. The Trading Levels will become more apparent once you draw the horizontal line on your chart at the appropriate levels. You will also begin to notice that there are smaller Trading Levels between two Trading Levels - it is at the 50% level that there will be the largest minor correction. This is basic to be aware of as you can move your trailing stop down under the monthly bar to ride out the storm in the tea cup.
The Trading Levels are the discovery of www.ka-ching.com.au and used as part of its 12 month trading email service on what, whenever and how we trade. The trading levels are also taught in the CMC 2 Pro Trading Course held monthly in most states.
In the next article, we will have a closer look at the constructional phases of the trade set-up and entry signal at the trading levels, the how, when and why to enter and how to place that initial stop loss under the volume for safety.
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