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Figure 1

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As you see above, NFLX was in a downtrend in 2008 and made a closing low of $17.94 in October. A month later, it made a higher low of $18.60 (line c). On December 8, NFLX surpassed the previous peaks (line b), suggesting that a bottom might be in place. Given the gloomy outlook for the economy and the plunging stock prices at the time, however, buying anything may have been tough.

A stronger signal was given at the end of December when the downtrend from the April highs, line a, was broken at point 1. NFLX opened the following day at $28.27. Traders who went long on the opening may have used a stop under the recent lows at $26.82, while investors could have used Fibonacci analysis to determine their stop.

The rally from the lowest low ($17.94) to the close on the day the downtrend was broken ($28.66) was a difference of $10.72 ($28.66-$17.94). The most common Fibonacci ratios are 0.382, 0.50 and 0.618, which allows us to calculate the key Fibonacci support levels.

1. 38.2% Support: $28.66 - (0.382 x $10.72) = $24.56
2. 50% Support: $28.66 - (0.50 x $10.72) = $23.30
3. 61.8% Support: $28.66 - (0.618 x $10.72) = $22.03

As a result, those who went long on the trend line break could have used a stop either under the 38.2% support at $24.56, or under the 50% support at $23.30. Because of the trend line break, a stop under the 38.2% support would have been wide enough so that if the breakout was legitimate, any pullbacks should be shallow.   

I always give the stop some room under the Fibonacci level because others are also watching these levels. As a rule of thumb, you could use 0.5% of the stock price under the support, which in this example would be $28.66 x .005 = $.14. Thus, a stop at $24.42 ($24.56 - $.14) would have been fine.

Of course, buyers would have had to be watching NFLX very closely to observe this breakout, which might be unrealistic. Three days later, NFLX closed at $31.94 as it had gained over 10% in just three days, which was more likely to get your attention.

The rally stalled in early January when NFLX traded sideways after testing the upper Starc band. This suggested a pullback was likely. The insert on the chart shows the rally from point 2 ($26.82) to point 3 ($33.15) and the ensuing decline more closely. The 38.2%, 50%, and 61.8% levels are each labeled on the chart. The 61.8% retracement (on a closing basis) (point 4) was at $29.44, which was exceeded intraday, but not on a closing basis, on both January 14 and 15.

Typically, I would look to buy just above the 50% support or possibly between the 50% and 61.8% support levels. This would have been between $30.15 and $29.44 in this case. An initial stop under the December swing lows at $26.82 would have been good, as this was also under the 38.2% retracement support calculated from the October lows.

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