With the markets drifting along today, lets take a stab at explaining some questions about retracement brackets. One of the most common questions is where do you anchor the bracket to? Lets walk through an example, using a chart of Veritas as an example. Hypothetically, if you bought Vertias when it broke the downtrend and wanted to know how high it could climb, which point would you want to anchor the bracket to on the below chart?
Veritas Daily Chart
The decision of which point to use depends on your trading time frame. If you're Warren Buffet and you believe Veritas is going to be higher a year from now, I would anchor the bracket to point 1. If you have a shorter time frame, a couple of days to a couple of weeks, I would use point 4. Lets use point 4, and place the second anchor at the April low, point A. Point A would be the second anchor point regardless of which high you chose.
Veritas Daily Chart with Bracket
Our first test was the 38.2% level at $65.41. Veritas failed to get above this resistance level on its first try, but succeeded on its second try. Now VRTS is having trouble getting above 50% at $73.94. So how reliable are these levels? Like any indicator you have to try them out, and develop your own confidence levels. The percentages are based on Leonardo Fibonacci 13th century book, Liber Abaci. This obviously wasn't a stock trading book, and deals with relationships between consecutive numbers. Not being a math major, I'll just assume he knew what he was talking about. What will give me more confidence, is when levels "make sense." Take the 61.8% level for instance. This matches up perfectly with the previous high on 2/15. The more you use these brackets, the more you find these "coincidences."