Use Fibonacci Levels to Pick Your Spots

The Nightmare on Wall Street continues, and it's not a dream. I would not be surprised to see the SEC step in and impose some kind of temporary restriction on algorithmic trading, similar to the banning of short-selling in financial stocks in September 2008, to restore equilibrium to the market. The debate that followed would center on whether high-frequency trading is a capitalist tool or a monkey wrench in the machinery. (My opinion is that it is a hindrance to the efficient movement of the market and a restriction in and of itself. Those who say it adds liquidity are the dreamers; those who simply hope the horror will end need to wake up.) Over the past several trading sessions, I have cautioned the average trader about getting in front of this market, and specifically about trading a snapback rally. There have been some special situations, however, like the Annaly Capital setup I mentioned yesterday. Another special strategy -- one that goes against the technical tactic of buying into strength and momentum -- is to look for entry points on a full-scale fear-driven capitulation move. Apparently, the carnage over the past two weeks has not crossed the severe pain threshold for many, but one true blow-off could trigger panic-selling. At that point stabilization and recovery is a real possibility, and the stocks that will benefit the most will be previous market leaders. This is different from guessing the bottom of an eroding market, and smarter money and smarter heads will look to re-enter at a much cheaper price. The market will tell us what that extreme level was but, unfortunately, it will be after the fact and after price has bounced. I use Fibonacci retracement levels to project potential target prices. Normally those levels are established after a move higher or lower and they are retested on pullbacks or recoveries, but we can project them forward using key support or resistance levels. The weekly chart of the S&P 500 index shows the strong advance off the 2009 low to this year's high. I consider the neckline breakout of the inverse head-and-shoulders pattern in July 2009 to be the start of the rally. If, in July 2009, you used the March low as a base and the inverse H&S neckline as the first or 62% Fibonacci retracement level and projected the remaining levels higher -- remember, these levels are being constructed backward and into the future -- the series would have identified important future support and resistance levels, and you would have nailed the 2011 top in price. Projecting downward off last May's top and using the 38% retracement level of the move from the 2009 low to the 2011 high as the potential 50% level of the current decline, the next level of support is in the 1045 area, or 6% below yesterday's close. S&P 500 -- Weekly Source: StockCharts.com View Chart » Interestingly, one of the best-performing stocks in 2011 was the ratings agency Moody's Corporation (MCO). The next level of support on its weekly chart is the 50% retracement of the move from the 2010 low to the 2011 high, a 6% drop from its most recent close. The projected 50% retracement level, which uses previous levels as markers, is in the $26.44 area, or a 9% decline. Moody's (MCO) -- Weekly Source: StockCharts.com View Chart » Plotting Fibonacci retracements in advance and being alert to these levels during an acute panic selloff could offer good entry points for previously healthy stocks that will be the first to recover. The strategy is speculative but offers some structure to a market without many technical waypoints.

Use Fibonacci Levels to Pick Your Spots

This tool will help identify possible key levels in an otherwise uncertain market.

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