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COPYRIGHT HARMONICTRADER.COM, L.L.C. 2004

The Harmonic Trader (Excerpt 1)

By Scott M. Carney

Library of Congress
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From a Declaration of Principles Jointly Adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.

Copyright Scott M. Carney, 1999

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Excerpt 1

Bullish .618 Retracement

The bullish .618 is an important retracement area for a stock that is selling off. When I see a sharp sell-off in a stock that has completed a nice rally, the .618 retracement is the first area that I examine for a potential reversal.

During a decline, I will wait for the stock to approach the .618 area and observe the price action. If the sell-off is extreme, as indicated by a warning sign, I will wait one price bar before executing a trade at the .618 retracement area. However, if a stock finds support in this area, exhibited by a reversal price bar, I will buy at the .618

It does take some time to be able to decipher the price action accurately at the Fibonacci numbers. However, if you study the major declines like the following examples, you will learn how the market provides clues regarding the nature of the price action.

The first chart illustrates a bullish .618 retracement nicely. Amazon.com is an excellent example of an incredibly volatile stock that possessed very harmonic price action.

It is amazing that this stock rallied almost 800% in five months and then retraced almost exactly to the .618 of this move. In fact, after selling off more than 120 points, AMZN reversed on the same day it hit the .618.

I want to take a moment and explain the means of calculating the Fibonacci retracement. The September low at 21 5/8 (Pt. X) was subtracted from the January 1999 high at 199 1/8 (Pt. A). The difference between the high and the low was 177 1/2 (199.125-21.625=177.5). I multiplied 177 1/2 by 0.618, which was equivalent to 109.695. I subtracted this amount, approximated at 109 11/16, from the stock's high at 199 1/8 (199.125-109.6875=89.43). This calculation approximates to 89 7/16.

The stock bottomed at 84 1/4 (Pt. B) and rallied sharply. Although the stock possessed a bearish price bar on the day it hit the .618 retracement, the next day clearly exhibited a reversal price bar, as the stock gapped up on the open and closed above the previous day’s high.

The following enlarged chart shows the price action of Amazon.com at the .618 retracement. It is important to notice how the stock began a new uptrend after hitting the retracement.

In such an extreme sell-off like this one, it is prudent to wait one price bar to confirm the reversal. In this case, Amazon sold off over 100 points in a very short time. So, I believe these circumstances require some additional caution.

Although the price action formed a bearish price bar on the day it hit the .618 retracement, the following day confirmed the reversal, as the stock gapped up on the open and closed above the previous day's high. In fact, Amazon.com rallied up seven days in a row without breaking the previous day's low. Such price action is very significant after reversing off a Fibonacci retracement. This chart reveals an ideal reversal, as the stock bounced on the day it hit the .618 and exhibited a bullish continuation of higher highs, lows and closes.