Fibonacci continued: the over-extended candle
In my first Fibonacci article I looked at the strong directional move as a basis for plotting retracement lines. In this article I’ll consider the other key market move to identify: the over-extended candle. In this case what we’re looking for is a significant candle movement, something ‘out of the ordinary’. This can be attributed to data, news or just a strong period of technical buying and selling.
As these triggers are specifically used in day trading we have to make sure we’re identifying over-extended candles on the correct timeframe. This for me is always on the 15-minute and hourly charts. Only around big data such as the NFP, the FOMC or other significant releases would you ever want to use the lower timeframe of 5-minute charts.
Over the years I have found no 100% reliable way of actually putting a label on an over-extended candle. I usually have to rely on plain sight. You can try using Bollinger bands, the ATR (average trading range) and other such oscillators to help, but usually it just ‘looks out of the ordinary’.
Here is the EUR/USD on the 15m chart:
Some of the points I would use to quantify this as ‘out the ordinary’:
- The market is trending down
- The market tried to push down very aggressively but this is rejected
- The candle of interest does not close at the high
These three points suggest to me that something of interest is happening to the EUR/USD right now and I should try to see if I can profit from this trade. The most logical thing I can do is to take the high and the low of the candle (that which I know has happened) and then draw a Fibonacci retracement. This way I can use the 50% as a future pivot (to tell me that which I don’t know).
In my experience 80% of the time if I have identified the over-extended candle correctly it will retrace to the 50%. This is a very high-edge strategy. In this case it takes three 15-minute candle closes to retrace back to the 50%. As the trend was down, this was a good trade to short.
Here is a current H1 gold chart:
On this chart we can identify two over-extended candles. One bullish green candle and one bullish red candle. What we know is:
- The first up candle retraced to the 50%
- The second candle was the opposite of the first; we have had a reversal
- The second candle does not attempt to get back to the first 50% pivot
This means that whatever sent gold up is no longer valid and sellers are controlling the direction.
We can then use the past, that which we know, to predict the future. We can do this from the 15-minute chart.
Here is gold in a zoomed-in view:
See how the first up candle’s rejection has sent the market aggressively down. The second red over-extended candle’s 50% is now acting as resistance. This all points to gold now making new lows from here.
By combining hourly and 15-minute over-extended candles and the key 50% retracement you can quickly build up an accurate framework of what a market is trying achieve from its technical movement.
Again, in my experience 80% of the time the 50% is hit – if you identify the correct candle. Try it for yourself.
Chief Market Strategist
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