Study the following charts. These are the Referendum moves but work for extended and strong, thin moves as well due to the volume mechanics which I will explain at the end. The reason I say don’t but do, is because it’s best to trade the retrace.
Enter blindly on big moves that reject the 50% level. To plot the fib, you take the open of the candle at the start of the big move and end it at the wick of the end of the big move. You can use discretion if the move is close enough to the 50% level of the move (or if it breaks it and still rejects it). Optimum entry is a close exactly on the 50% level.
Stops are placed at the next fib level above if buying or below if selling (the 61.8% level or the 38.2% level).
Take profit is at the return to the range of the move, i.e the newly generated support level at the wick of the end of the big move. You can then use discretion to add to your position, or move stops to just above the first take profit level.
Why does this work?
Volume is key here. I shall explain in terms of the histogram (volume profile) on the side. Price ends up bouncing at areas of high volume as there are resting orders, people taking profits and new entrants into the market (trading at higher volume areas is cheaper for big participants – less slippage due to there being more participants at these levels). On the flip side, the 50% level almost always has a big void of low volume. Price can slip through this, but when there is very limited volume to trade into and when the trend is very strong in one way (made apparent by the big thin move), price tends to continue with the trend.
Here are the stats on the strategy taken on a daily & H4
time frame over 15 months:
The Sharpe Ratio could be better, but the strategy can be optimised further. The frequency of trades ranged between 1-4 per month.
Try it out and see how it works. It’s pretty simple which I quite like.
(Article originally written in August 2016).