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AVOIDING A TYPICAL STOCK TRADING MISTAKE
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Trading requires constant and focused vigilance. The professional distinguishes himself by making Mistakes less often than the neophyte. He cannot hope to avoid them altogether. By studying this next example, see if you can avoid misinterpreting a situation similar to the one depicted and in so doing avoid some unnecessary losses.

This example is based on monthly data, however the same thought process it imposes can be applied to an hourly or a five minute chart.

Consider the labeling of the following US bond monthly continuation chart and the

accompanying FibNodes™ printout, which shows three reaction lows and a Focus Number of 12210.

We will be focusing on price action in the vicinity of the .382 Primary Node to see what we might learn about future price Movement. However, if you had been trading bonds from higher levels and from a shorter Time Frame chart, it would have been reasonable to assume significant D-Level support at all of the support Nodes shown. This is because all of these Nodes were created from important monthly reactions, not from a half hour chart. Ifyou look at the daily and weekly charts, you'll find at a minimum, respectable rallies in the vicinity of all ofthese price levels. Consider how this would have helped you, even on a five minute chart!

When we're analyzing whether or not a long term bull market is still intact, we look to our trend indicators on the weekly and monthly charts. We can also observe whether or not the Primary '*'.382 Node has been broken or if a major Confluence area has been penetrated. If major support has been broken, it obviously signals more weakness than if it holds. Such a break could indicate a major change in the Movement of the market. By looking at the monthly D-Level series shown in File BDMOPA2, 10423 appears to be the Primary .382 Node. In fact, it is a Fibnode generated from a Major Reaction, not the Primary Reaction low, as we will see. While the penetration of 10423 correctly forecasted lower prices, it is not nearly as serious as a break of the Node created from the Primary Reaction low.

When 10423 was penetrated, I expected a move down to the vicinity of 10013, since that was the next Fibnode support. (See the .618 retracement in Box 1). A reasonable long entry (if suppbrted by context and an appropriate entry tactic) would be in the vicinity of 10013. A reasonable stop placement area appears to be just under the.618 Fibnode at 9815, in Box 2. It would also seem reasonable to expect that closes below 9815 for a significant period of time, would indicate much lower prices, perhaps a move down to the last Fibnode support shown in box 3, all the way down to 9326!

While all this seems to be good analysis, an error is being made. What's on the screen, i.e. what we see on Chart 14-1, is not representative of what we need for adequate analysis.

When we look at the D-Level series printout that includes these reaction lows, we get a substantially different picture. Now we see that 9621 is the '*'.382 Node, not 9815! We can also see monthly Confluence between 9809 and 9815. This more complete picture and the accompanying Ftbnode series has changed the analysis significantly. For one thing the last place we would want our stop would be at, or above, the Confluence range of 9809 to 9815. We would certainly want to get below that and we're not looking for 9325 with the Primary Node of 9621 coming in substantially before that!

Now, on Chart 14-1 notice the market action around both the Confluence area, and the .382 Primary Node at 9621. Price came down to the vicinity ofthe 9815 level, supported, then broke to 9601 briefly, thus exceeding both the Confluence area and the '*'.382 Node. Since this is a monthly chart, "briefly" differs from what "briefly" would mean on a five minute chart. The Confluence area was only temporarily broken and the monthly continuation never closed below the 9815 Fibnode! The bond market merely reacted back to the '*'.382 Node, i.e. the Fibnode created from the lowest low recorded in the history

of the US bonds futures. Our conclusion, based on the proper analysis, can confidently be that the bull market remains intact and as we can see, prices returned to the old high at 122 in just a few months.

Admittedly, it's easy to say "merely reacted" back to the '*' .382 Node. If you were holding 50 contracts of bonds on the long side, it wouldn't have seemed all that "mere." What you need to understand, however, is that all this analysis must be relative to the Time Frame you are analyzing. Observing this type of action in the monthly continuation chart can produce an excellent context for your shorter Time Frame trades!

On a five minute chart I like to see a major retracement back to the Primary Node. It cleans up the rmarket and allows for an orderly move back up, perhaps to higher prices. It's no different in the higher Time Frames. I have to be sure, however, that what I think is the Primary Node is in fact the Primary Node for the Market Swing I am analyzing.

THE BROADER PICTURE:

This type of analysis is not confined to the typical financial markets we trade daily. When Orange County, California, real estate prices crashed from their highs around 1990, everyone was ready to throw in the towel. Orange County itself went into bankruptcy a few years later. Chicken Little was screaming!

Let's look at an admittedly unscientific but telling D-Level analysis. For ground rules we'll keep certain things constant, like the same type and class of home and the same general neighborhood. We'll also consider a class of home that has always had reasonably good liquidity characteristics. We're not talking lumber contracts here. We're talking the real estate equivalent of T-bonds, your 1200-1500 square foot, two or three bedroom, middle-class, love cottage.

In the early 70s, home values approximated the cost of building which was fairly constant. Inflation was reasonable. Things really started to move with values traveling almost vertically and uninterrupted into the Carter "tight money days" of the early 80s. Our generic love cottage preceding the 20% prime interest rate and 55 on the US 30 year bond futures, was about $115,000. From that high, our cottage reacted back to about $90,000. When interest rates came back within reason, the move up resumed reaching a high of about $215,000, a bit above an OP extension.

Chart 14-3 shows the ultra-simple D-Level yearly series on this slice of the southern California real estate market. With more data, we could include more reaction lows. But, this is a yearly chart and we're only looking for the major Fibnodes.

The reaction of price back to $170,000 in the early to mid 90s, only met the major .382 Node. Values stayed considerably above the .382 primary Node at $142,420. Where's the problem? Throughout the early '90s, I encouraged friends, relations, and business associates to go long Orange County real estate. Very few did - they could not see the support so apparent to someone schooled in Fibonacci Retracement analysis. This down move was just a normal correction! Those who took the speculation have some solid equity now!

It's interesting to note that the low was supported not only by the Node off the Major Reaction, but also by rental income - in other words, what the house could earn to pay a typical mortgage. When farm land crashed from inflation's highs, it also returned to an economically viable level, i.e. what the land could reasonably expect to produce. I didn't do the analysis, but I would expect the price decreased to the vicinity of the Primary Node.

Where do we go from here? The reaction down to $170,000 has given us a new place from which to calculate an expansion. I'll leave it to you to calculate the OP, but that's where I think we're going, if we can overcome the resistance Nodes (not shown), formed from the "recent" down leg.

While we're on the subject of long term charts and Major Reactions within the context of a continuing up trend, let's see the example of the Dow Jones Industrials experiencing a 500 point, one day drop and a multiple week drop of over 1,000 points. Consider the following D-Level series shown in the FibNodes™ printout on the next page and first depicted graphically in CHAPTER 11.

We just reacted back to the '*' .382 Node, which was also a Confluence area! Price stayed within the context of a normal correction.

A QUESTION

Joe, you can always go back in lime and get lower reaction lows! So what's a Primary Reaction and what isn't?

Part of the answer to your question entails bookkeeping or organization and part of it is understanding how Time Frame(s) impact your trading decisions.

While it is not true that you can always find lower reaction lows by going back further in time (the bonds saw their lows in 1981), it is true that by looking at larger Time Frames or compressing your data, it may be possible to locate deeper retracements than shown on your (default) screen. Here's how to handle this situation. Pre-calculate a Fibnode series for all Time Frames above those you are dealing with, as well as the one you are dealing with. Ifyou are an hourly player for example, have the daily, weekly, and monthly series organized. That means have a printed copy attached to a clipboard, labeled for that instrument, and readily available. The charts should be appropriately marked by use ofthe divider. You should also have these series as computer files in the software you're using. (This software should have a "paging" feature to keep your files properly organized). Each file, as well as each printed chart, can have its own Lineage Markings independent of (he higher Time Frame files. In our example ofthe bonds, I would have left the original FibNodes™ printout BDMOPA2 as it was and I would have had a quarterly or yearly file, with its own Primary and First Reaction Lineage Markings. The reason that trading the lower Time Frames is so demanding is because you must know what the Time Frames higher than those you are trading are telling you. There's a lot to keep up with! While it is extremely unlikely you'll be reaching a weekly '*'.382 Node when you're trading a five minute chart, it is not unlikely that an hourly or daily '*'.382 Node will affect your decisions. Be myopic at your own risk. Don't spend all you time looking for potholes while simultaneously ignoring the bridge that may be washed out just a little ahead.

Illustration ofthe above discussion would require copious examples and a huge amount of space. It is one of those areas best left to a classroom setting or repeated application by the individual trader.

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