TD Double Retracement

TD DOUBLE RETRACEMENT

Regardless whether a retracement breakout is described as qualified or disqualified, if two retracement levels are traversed within one price bar period, usually the market experiences a price reaction. Since price must travel a sizable distance to exceed these two retracement levels within one price bar, TD Double Retracement identifies potential levels of price exhaustion. It is important that subsequent to the recording of the opening price that the two retracement levels are exceeded. In other

Figure 7.15. The standard TD Relative Retracements are presented in this chart. As you can see, these levels coincided with market turning points.

Figure 7.16. This chart shows how TD Relative Retracements can be applied to markets intraday. In this example, a triple retracement preceded a price reversal to the upside. The move upside was in turn contained by a disqualified 61.8 percent retracement level.

Figure 7.17. The 60-minute chart of Merck (MRK) identifies the 0.382 and the 0.618 TD Relative Retracements levels, both projected from the low coming in on December 15.

Figure 7.18. In each of these examples, the price bar from which the TD Relative Retracements were calculated are identified with asterisks. In both cases, these retracements were disqualified because none of the four qualifiers were met.

Figure 7.19. This chart illustrates several examples where TD Relative Retracements occurred. In some cases TD Double and Triple Retracements reversed the trend and produce sizable intraday profit opportunities for option traders. Again, asterisks identify the reference price bar from which the retracements are projected.

Figure 7.20. TD Relative Retracements show two disqualified and one qualified breakout. In the case of the two disqualified breakouts, price reversed its trend sharply and created sizable profits intraday.

words, to record a TD Double Retracement indication upside, the current bar’s open must be less than two TD Relative Retracement levels and then must exceed both of them. Conversely, to record a TD Double Retracement indication downside, the current bar’s open must be greater than two TD Relative Retracement levels and then must exceed both of them to the downside. Should the price opening exceed one or both of the retracement levels, this would not fulfill the double retracement requirement since both retracement breakouts must occur after the opening of the market.

An important consideration that does not affect individual security markets but does impact most cash market indices is the manner in which the opening price levels are established. For example, a number of exchanges use the previous trading day’s closing price less any adjustments for dividend payouts or stock splits as the opening price level instead of averaging the opening price of all the index components. Another practice of various exchanges is to survey the various             components of an index after the first 5 or 10 minutes of trading and then use that calculated value as its official opening price. Although the latter practice is an improvement over using the prior trading day’s closing price as an opening-level proxy, many times not all the individual securities are open within the first 5 or 10 minutes of trading and, as a result, the opening is not a true representation of what has taken place in the market. Therefore, applying the TD Double Retracement indicator to identify price exhaustion zones is suspect in the case of some cash indices. The openings for stocks and futures indices, on the other hand, are actual market trades and can be used when applying TD Double Retracement.

TD Double Retracement opportunities upside require an opening below both the 38.2 and the 61.8 percent retracement levels or an opening below both the 61.8 percent and magnet price retracement levels. Although a combination of magnet price and 138.2 percent double retracements, as well as combinations of other 100 percent- plus double retracement levels could be applied, we prefer to rely upon those retracement levels that include combinations of only 38.2 percent, 61.8 percent, and the magnet price levels, as these three retracement levels are of the greatest significance. On the other hand, TD Double Retracement opportunities downside require an opening above both retracement levels and then a decline below both to establish a likely downside price exhaustion level. Once again a combination of the retracement ratios 38.2 percent, 61.8 percent, and the magnet price is preferable to, and more significant than, the 100 percent-plus ratio combinations.

In some rare instances, instead of opening and then traversing two retracement levels in one price bar, three retracement levels may be crossed in one retracement price bar. Obviously, by definition, two retracements occur before three retracements. Most often, in the rare instances when triple retracements occur, the TD Double Retracement will work for a period of time; however, the pressure will prove overwhelming and the market will continue to its triple retracement level where the move should be exhausted. Consequently, if a position were taken because two retracements had been exceeded, then additional trading can occur at the triple retracement level since that level should most definitely coincide with price exhaustion. A trader may elect to forego TD Double Retracements and concentrate upon only the triple retracement exhaustion price levels. This latter proposition occurs much less frequently than the TD Double Retracements but the degree of coincidence with market-exhaustion low-risk trading opportunities is enhanced considerably.

Figure 7.21 shows the trading activity of Digital River. Not only did a TD Double Retracement occur the day of the sharp move upside, but a third retracement was exceeded as well. Regardless, if a put option had been purchased above the second retracement level, by the close that trading day, price had declined sufficiently to produce a sizable profit. Note that the third retracement level over the same price period was only one point above the TD Double Retracement level.

Figure 7.22 displays the Natural Gas March 1999 futures contract. The 38.2 percent retracement level was preceded by a down close thereby qualifying the breakout upside for a low-risk intraday entry. However, the following trading day’s breakouts above both the magnet and the 61.8 percent levels were disqualified since the previous trading day recorded a strong up close. Additionally, that same trading day recorded a TD Double Retracement. The fact that the market failed to reverse downside the day of the disqualified TD Double Retracement was a surprise but, as so often happens when an immediate response fails to appear, the next trading day the market opened lower and proceeded to decline below both retracement levels.

Absolute Retracements

While TD Relative Retracements can be utilized to obtain price objective levels upside or downside, they cannot be applied to those instances in which either the price of a security or a market is at a multi month high—which has not been exceeded upside for over 12 months or a low which has not been exceeded down side for over 12 months—or an all-time low or high. In the case of a multi month or all-time low, there exists no prior low which can be used as a reference price level to identify an intermediate high. Similarly, in the case of a multi month or all-time high, there exists no prior high which can be used as a reference price level to identify an intermediate low. Without being able to relate a recent low to a prior low or a recent high to a prior high, TD Absolute Retracement is a viable alternative method. A high can be multiplied by 61.8 or 38.2 percent to arrive at downside price objectives. Conversely, a low can be multiplied by 138.2, 161.8 ,223.6, 361.8, 461.8 percent, and so forth to arrive at likely upside retracement levels. Once again, the same qualifiers which can be utilized with TD Relative Retracements can be applied to TD Absolute Retracements as well.

TD Absolute Retracements are especially effective in predicting support levels for newly listed securities. It is not uncommon for recent public stock offerings and

Figure 7.21. This example illustrate TD Double Retracements (and TD Triple Retracement). Since the triple retracements level was within a point of the double retracement level, two profitable entry opportunities presented themselves for an option day trader (put buyer).

Figure 7.22. The response to exceeding the TD Double Retracements level in the example was deferred for a day. If a trader had restricted him or herself to existing at the close, the trade would have been slightly  unprofitable; however, by postponing exit until the following day, it evolved into a profitable trade.

recently listed New York Stock Exchange securities to decline from their peak price levels 61.8 and 38.2 percent. This tendency is also apparent at the conclusion of bear market declines as well. Whenever a market records a multi month or all- time price high and then commences a downside correction, TD Absolute Retracement can be used by multiplying the price peak itself by the ratios 61.8 and 38.2 percent to arrive at potential downside price support levels.

Figures 7.23 through 7.28 demonstrate how TD Absolute Retracements can identify price support and potential intraday price reversal levels. Figure 7.23 demonstrates how a trader can apply TD Absolute Retracement to a likely price reversal level. By multiplying the Egghead (EGGS) price peak of 40, recorded during the Internet craze, by 38.2 percent, TD Absolute Retracement identifies downside price support. The price objective low was hit almost precisely on the third trading day following the high and was succeeded by a sharp price rally over the next few days. Subsequently, this daily price low on December 3 provided a level from which to project a series of upside TD Relative Retracements. The initial 0.382 level upside was disqualified since it failed to meet any of the four qualifiers, and therefore price reversed. The magnet level was not disqualified, but it did cause price to reverse intraday due to a TD Double Retracement indication (although this is not indicated on the chart. The 0.382 level should be extended until a qualified breakout above that level is recorded; this would not have occurred until December 24, when price also rallied to the magnet level). Even though both retracement levels were qualified individually, as a result of the low-risk TD Double Retracement indication, a low-risk put-buying opportunity around the magnet level would have been presented.

Highly volatile stocks and recently released new issues often decline to their respective TD Absolute Retracements and then record bold and steep retracements. We randomly selected two Internet-related stocks, CMGI and Lycos, to demonstrate the movement off of these levels intraday into the close of trading. For example, CMGI (Fig. 7.24) rallied from below 96 to 131 at the close of trading upon breaking this TD Absolute Retracement level; while Lycos (Fig. 7.25) rallied from below 90 to 105 at the close of trading upon exceeding the TD Absolute Retracement level to the downside. Figure 7.26 applies TD Absolute Retracements to a daily price chart for Morgan Stanley Dean Witter (MWD) in order to time entry intraday. In this example, the market declined below 42M and then rebounded sharply intraday. Figure 7.27, MindSpring, and Fig. 7.28, Cyberian Outpost, also illustrate the effectiveness of TD Absolute Retracements. In almost all of these examples, a trader’s profit would have increased had he or she held the position beyond the current price bar’s close. With an indicator as powerful as TD Absolute Retracements, traders should always evaluate their trading positions and stance prior to that trading day’s close to determine whether to remain in the trade.

Figure 7.23. By multiplying the Egghead price peak of 40 by 38.2 percent, TD Absolute Retracements identifies downside price support.

Figure 7.24. This chart of (CMGI) displays what commonly happens when price trades for the first time to the TD Absolute Retracement Level. In this case, price rallied the same trading day over 35 points into the close.

Figure 7.25

Figure 7.26. Chart A presents Morgan Stanley Dean Witter (MWD) and TD Absolute Retracement. It is not common to have major trend reversals coincide with TD Absolute Retracement Levels. Chart B shows a magnification of the low of Chart A, and how price recorded a reversal the exact day of the TD Absolute Retracement level.

Figure 7.26 (continued).

Figure 7.27. MindSpring (MSPG) illustrates how price slightly exceeded the retracement level at the opening of trading but then immediately rallied the same trading day over 33 percent (25+ points). This would have been a great trading opportunity for an option trader.

Figure 7.28. This chart of Cyberian Outpost (COOL) once again demonstrate the ability of TD Absolute Retracements to predict levels of price support. In this case, the market recorded its low and closed at the retracement level. The next trading day, it rallied over 15 percent, and in the ensuing four trading days rallied an additional 50 percent plus.

Each of these examples demonstrated instances in which the market held these important retracement levels. These highly volatile stocks also provide an excellent opportunity for option trading, as an individual can participate in these lucrative yet risky markets while at the same time effectively containing one’s losses. An established trend accelerates once these retracement lines are violated, but our preferred method of operation is to anticipate trend reversals with the help of the four retracement qualifiers.