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Schrdingers Cat
Finding information in
market data

Filtering Price

Introducing a new zigzag



Predicting The VIX

By reordering the data


10 Selling Tips

Knowing when is when 30


Technical analyst
Boon Chin Low


n Haguro Method
n MetaStock XIV
MAY 2015



MAY 2015

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MAY 2015, Volume 33 Number 6

8 Schrdingers Cat

by John F. Ehlers
What information is contained in
market data? Can you develop an
indicator or trading system that
can extract this information to
provide an edge in trading? Heres
a look.



12 Filtering Price Movement

by Giorgos E. Siligardos
Here is an alternative to the classic
zigzag indicator, which may prove
useful to visual technical analysts
and chart pattern researchers.

22 Mean Reversion And

The S&P 500

by Stephen Beatson
It is generally believed that markets tend to mean-revert. But this
is true for some markets more than
others. Heres an in-depth look
at how the S&P 500 responds to
mean reversion.

25 Futures For You

by Carley Garner
Heres how the futures market
really works.

26 Predicting The VIX

By Reordering Data

by Stephen Butts
In recent years, the CBOE Volatility Index (VIX) has increased in
importance and use as an indicator
of market direction. This article
demonstrates how the direction
of tomorrows change in the VIX
might be determined by restructuring readily available market data.

30 10 Selling Tips

by Thomas Bulkowski
Do you spend as much time deciding to sell as deciding to buy? Here
are 10 tips to make deciding when
to sell easier.


34 TA For The Longer Term

With Boon Chin Low

by Jayanthi Gopalakrishnan
BC Low has been a teacher and
practitioner of technical analysis since the 1980s. He is one of
Singapores earliest practitioners to
attain the Chartered Market Technician credential. At Singapore
Polytechnic, he created and taught
two modules of Technical Analysis and Trading, the only formal
course on technical analysis in Singapore. He was a technical analyst
for Merrill Lynch Bank, where he
provided currency views to dealers,
private bankers, and institutional
clients. Currently, he continues to
trade his own equity. We asked him
about how longer-term investors
can apply technical analysis.

42 Haguro Method
Product review: MetaStock add-on
based on the Haguro method
46 MetaStock XIV
Product review: Trading and charting platform


Opening Position
Letters To S&C
Traders Glossary
Trade News & Products
Traders Tips
Futures Liquidity
Advertisers Index
Editorial Resource Index
Books For Traders
Classified Advertising
Traders Resource

41 Explore Your Options

by Tom Gentile
Got a question about options?


60 Gambling, Speculating,

& Investing

by Stella Osoba
What do these terms mean as
applied to the participant in the financial markets? Lets have a look
to try to come up with some clear

29 Q&A

by Don Bright
This professional trader answers
a few of your questions.

This article is the basis for

TIPS Traders Tips this month.

n Cover: Jose Cruz

n Cover concept: Christine Morrison

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ill they, or wont they, and if so, when?

All eyes were on the policy statement
released by the Fed on March 18. The takeaway
from it was that the word patient was not
used, implying that there is a chance that we
will see a rate hike this year. And rate hikes
means that the economy is improving, or that
is what we are led to believe. Immediately after
the Fed released their statement suggesting
they may start raising interest rates sometime
in 2015, it was almost as if there was a huge
sigh of relief. Stocks moved higher, commodities moved higher, treasuries moved
lower, and the US dollar moved lower.


you take a moment to analyze what really moves the markets, youll find
that its a lot more than interest rates. Fundamental analysts focus on valuations such as price/earnings ratios, debt-to-equity ratios, EBITDA, and so on,
but as technical analysts, we need to look at indicators such as market breadth,
advances over declines, and investor sentiment using variables such as TRIN,
TICK, and VIX. Keeping an eye on these variables can be used as a barometer
to gauge the strength of the market and whether investors are risk averse. Any
divergence between the movement of the broader markets and these barometers
or a lack of confirmation from all these variables should be considered as a sign
to tread cautiously. At the moment there seems to be too much uncertainty in the
markets together with too much optimism. The two dont mix well and thats a
cause for concern.
Were too focused on the central banks and placing importance on their choice
of words. First, it was irrational exuberance, then patience, and now reasonably
confident. According to the recent statement released by the Fed, its inflation,
unemployment, and wages that will indicate how well the economy is doing and
ultimately be the deciding factor for raising interest rates. But other indicators such
as credit spreads, treasury yields, performance of commodities, and performance
of the manufacturing/service sector give much earlier signals of the underlying
economic fundamentals. But getting a real gauge of the economy is no easy task,
especially when its been stimulated by funds from the central banks. I seriously
doubt well be seeing any interest rate hikes in the next FOMC meeting. We have
to patiently wait to see when and if it will happen this year.

6 May 2015 Technical Analysis of Stocks & Commodities

Jayanthi Gopalakrishnan,

Miami Downtown Richard Cavalleri/Shutterstock



The editors of S&C invite readers to submit their opinions and information on subjects
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Tell us about it. Without a source of new ideas and subjects coming from our readers,
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Email your correspondence to Editor@Traders.com or address your correspondence
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letters become the property of Technical Analysis, Inc. Letter-writers must include their full
name and address for verification. Letters may be edited for length or clarity. The opinions
expressed in this column do not necessarily represent those of the magazine.Editor

I just read Dave Clines
February 2015 article in
Stocks & Commodities , Candlesticks,
Condensed, and found
it quite interesting. I had
never thought of using the approach he
describes. Its a nice way to create pattern signatures. I took a course through
Coursera on quantitative analysis by
Tucker Balch and used Python during
the course. One of the exercises was
to analyze historical events based on
price movements. Adding a candlestick
signature could be used as an extension
to this.
I have also done some basic simulations of crossing EMAs in Excel. When
I went to download the Python code
associated with Clines article from
Traders.com, I read that Cline had also
done some work in Excel and wondered
if he is willing to share a version of the
Excel file referred to there.
Author Dave Cline replies:
I can provide the Excel spreadsheet,
although its not much, really. I can also
provide the Access.MDB file into which
I dumped the Excel data for grouping/
consolidation. You can get these files
from the following link:
Youll find that some of the problems with
the compressed candles approach are:

1. You really need two, three, or four

sequential patterns to make the results discrete enough
2. Then you need tons of data to build
the dataset to get enough patterns to
make their numbers significant.
And those two items fight each other.
Fortunately, on Quantopian.com, you
can use 200 instruments going back to
about 2003 to build the source database
of patterns.
Thanks for your inquiry.
I was interested in the article
by Dave Cline in the February 2015 issue (Candlesticks, Condensed), so I
decided to see if I could replicate his
work. A summary of results follows and
the relevant spreadsheet is attached [not
shown]. I would be interested in Clines
comments. I have also written code in
I analyzed 53 years (19622014) of
S&P 500 index weekly candlesticks with
reference to the past 10 weeks, and each
candle was assigned a three-letter code
for the body, upper shadow, and lower
shadow, as follows:

A means +2 SD
(standard deviations)
B means +1 SD
C means normal
D means -1 SD
E means -2 SD

My analysis showed minimal predictive significance, as SD was usually wider

than the gap between zero and the percentage gain for the following week.
May 2015

The exceptions were limited to patterns that were only seen once over
the reference interval (SD = 0) and the
BDE seen twice
CCE seen twice
CEA seen twice
DEB seen twice
EEC seen 5 times
EBD seen 3 times

1.43% SD=0.01
1.02% SD=0.64
-1.25% SD=0.3
-1.33% SD=0.03
-1.62% SD=1.34
-1.79% SD=1.37

My conclusion: Single weekly candlesticks were of no value in predicting the

following weeks market action for the
S&P 500 index.
John Rathbun
Asheville, NC
Author Dave Cline replies:
Interesting translation into a StdDevbased variation. The compression
technique already is fairly lossy; are you
sure youre not losing any additional
information by this technique?
Also, youve got 2,751 samples, which
I would suggest is a somewhat limited
set to work with.
As you can probably surmise, and
I think I alluded to this in my article,
single candles have nearly zero predictive information within them. But
in sequences, they may provide small
probability benefits. Unfortunately, you
need tens or hundreds of thousands of
sequence samples to build up statistically significant sets. So I would suggest
building pairs of candles as patterns. For
instance, what is the average return on
the CDC-CBA sequence (if it exists)?
When I built and tested this mechanism, I ran 10 years of daily data on
all the S&P securities through it. I used
three-candle sequences. I've also tried
two years of hourly data of the same.
Within those tests, I could find significant
sequences that tested out-of-sample to
about one half of their in-sample return.
So I think there's value, if tiny and hard
to see, in the technique. To me, its just
one more layer of probability to add to
a list of filters when scanning thousands
of instruments for possible trades.
Thanks for reading and going through
the trouble of testing the theory. It means
a lot to me.
Technical Analysis of Stocks & Commodities 7

Random With Memory

Schrdingers Cat
What information is contained in market data? Can you develop an indicator or trading
system that can extract this information to provide an edge in trading? Heres a look.

by John F. Ehlers

he purpose of technical analysis is to discern what information is contained in market

data and, if you are clever enough, to develop an indicator or trading system that extracts
this information to provide an edge in trading. On the other hand, there are those who
believe in the efficient market hypothesis: that all the information about the markets is known
and the effects are purely random due to the law of large numbers of traders. The discussion
goes downhill from there.
One of my favorite theoretical descriptions of market activity is the drunkards walk. When
the random variable is position, the partial differential equation solution is called the diffusion
equation, and it describes random motion like a particle of smoke in a smoke plume. When
the random variable is momentum, then the partial differential equation solution is called the
wave equation. Taken together, the drunkards walk describes physical phenomena like the
meandering of a river, which can be random (trending) or cyclical. Unfortunately, there is no
closed solution for the differential equations that can lead to an indicator, because they require

8 May 2015 Technical Analysis of Stocks & Commodities

Measuring synthe-

sized market data

Synthesizing market data is
one thing, and measuring its
characteristics is quite another. The problem is similar to
that of the Schrdingers cat
thought experiment: Merely
measuring the outcome determines the outcome itself.
Heres the problem: When


boundary value solutions

and there is no definable
In another physical area,
Peter Swerling noted that
the radar echoes returned
from flying aircraft were
noise-like. The echoes would
vary from pulse to pulse and
from one antenna sweep to
another. The explanation is
that there was a total average
power returned, but the total
power was the summation
of components that were
bounced off the fuselage,
wings, rudder, and so on,
and the changing aspect of
the aircraft caused the summation of these components
to look like noise. When
building deception jammers
for radars, I simulated the
Swerling noise by using the
received radar pulse plus an
exponential moving average
(EMA) of past pulses. This
jamming signal was a remarkably good replica of the real
radar echo. This kind signal is
called random with memory,
and its consistent with other
phenomena described by the
Hurst coefficient. Synthesizing market data using a random number generator and
an EMA is simple to do and
could be an interesting way to
examine the nature of market
data. Knowing the nature of
the data can therefore lead to
the generation of an indicator
that possibly can give us a
trading edge.


the market is modeled as

a random variable with
memory, the memory is
provided by a filter such
as an EMA. However,
when measuring the frequency content of market
data with any technique
such as a Fourier transform or a contiguous
bank of bandpass filters,
they all have filters with
memory as part of the
analysis technique. Thus, FIGURE 1: MEASURED SPECTRUM OF THE SPDR S&P 500 OVER THE LAST YEAR. The dominant cycle period was between 20 and 25
measuring a truly ran- bars in the fall of 2012, was on the order of 15 bars during most of the uptrend, and was an ill-defined longer cycle period most recently.
dom set of data would
involve the memory being provided by the measurement daily data). The spectrum shows that there is not much cyclic
technique, and the entire process would become self-fulfilling. activity, and the dominant cycle is mostly near a 10-bar cycle
Measuring the frequency content of synthesized data must due to aliasing noise.
avoid the use of filters.
The next experiment is to see the effects of adding memory
Interfering with the synthesis of market data is minimized to the random data. For example, Figure 3 shows the data
through the use of an autocorrelation periodogram. This and spectrum when the memory low-pass filter has a critiprocess first creates the autocorrelation of the data, a process cal period of 20 bars. Not unexpectedly, the data is much
that is basically without filters. Then, a Fourier transform of smoother than in Figure 2. Also, the dominant cycle period
the autocorrelation function is taken to extract the frequency in the measured spectrum is near a 20-bar period most of
content of the data. On a related note, the autocorrelation the time.
periodogram is now my preferred method of frequency meaContinuing with the experiment, the memory of the low-pass
surement of market data because it mitigates the effects of filter is changed to have a critical period of 40 bars (Figure 4).
spectral dilation.
In this case, the data is smoother across the graph. Further,
Figure 1 shows what the measured spectrum of real market the measured dominant cycle period has increased.
data looks like. The data is approximately one years worth
of daily bars of the SPDR S&P 500 (SPY). The measured So what does it all mean?
spectrum is shown below the price bars as a heatmap. The Dealing with random data is tricky because you can never
strength of the cycle amplitude is shown in colors ranging reproduce your results. The best you can do is infer characfrom white hot through red hot to ice cold. The period of the teristics from your measurements. The first observation is that
measured cycles is indicated on the vertical scale from zero market cycles are ephemeralthey come and go, and the cycle
through 48-bar periods. Figure 1 shows that the dominant periods of the dominant cycle can often change rapidly.
cycle period was between
20 and 25 bars in the fall
of 2012; was on the order
of 15 bars during most of
the uptrend; and was an
ill-defined longer cycle
period most recently.
Now that you are familiar with displays of
market spectra, lets
turn your attention to the
measurement of purely
random data with no
memory, as shown in
Figure 2. The random
data is shown as the green
ragged line over approximately 250 samples FIGURE 2: MEASURED SPECTRUM OF PURELY RANDOM DATA WITH NO MEMORY. The spectrum shows that there is not much
(essentially one year of cyclic activity, and the dominant cycle is mostly near a 10-bar cycle due to aliasing noise.
May 2015

Technical Analysis of Stocks & Commodities 9

FIGURE 3: MEASURED SPECTRUM OF RANDOM DATA WITH MEMORY HAVING A 20-BAR CRITICAL PERIOD. The dominant cycle period in the measured spectrum is near
a 20-bar period most of the time.

Market cycles are ephemeral

they come and go, and the cycle
periods of the dominant cycle
can often change rapidly.
Synthesizing market data as random with memory does
gain some credibility because the resulting measured spectra
look similar to real market data. Further, the characteristics
of the synthesized data can be controlled simply by varying
the critical period of the memory component of the synthesized data. Credible replicas of market data can therefore be
created simply by making the critical period of the memory

time variable across the chart.

But most of all, you can gain the edge in your trading that
you sought in the first place. Knowing that market cycles are
ephemeral, you can quickly jump on them with predictive
filters when they appear. You can get an idea of how this works
by looking at the trade setup analyzer on www.StockSpotter.
com. A trade setup occurs when the MESA cycle indicator is
at or near a cycle trough and the MESA momentum indicator
is declining or is at a minimum.
S&C Contributing Editor John Ehlers is a pioneer in the use of
cycles and DSP techniques in technical analysis. He is president of MESA Software. MESASoftware.com offers the MESA
Phasor and MESA intraday futures strategies. He is also the
chief scientist for StockSpotter.com, which offers stock trading
signals based on indicators and statistical techniques.


Ehlers, John [2013].
Cycle Analytics For
Traders, Wiley &
[2014]. The
Quotient Tra nsform, Technical
Analysis of Stocks
& C ommodities,
Volume 32: August.
graph and the measured dominant cycle period has increased.

10 May 2015 Technical Analysis of Stocks & Commodities

See Editorial Resource Index


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12 May 2015 Technical Analysis of Stocks & Commodities


For Your Digital Eyes Only

Price Movement
Here is an alternative to the classic zigzag indicator, which may prove useful to visual technical
analysts and chart pattern researchers.

Applied Micro Devices






hen there is need for algorithmic iden12.5

tification of price swings in a chart,
there is a word that always comes to
mind for technical analysts: zigzag. The zigzag
indicator is based on the concept from Arthur
Merills 1977 book Filtered Waves, Basic
Theory: A Tool For Stock Market Analysis. It
filters price movements below a cutoff level,
that is, a threshold. The threshold is either in
Zigzag (20%)
point terms or in percentage terms. If you were,
for example, using a threshold of x points, the
Zigzag (20%)
zigzag would disregard all price movements
T2 4.0
less than x points. If, on the other hand, you
2014 Feb Mar
used a threshold of x percent, the zigzag would
Figure 1: the dynamic nature of the zigzags last legs. The red zigzag in this daily chart
disregard all price movements of magnitude of Applied Micro Devices, Inc. (AMD) is based on a percentage threshold of 20% and it uses data up to
less than x percent. When plotted, the zigzag date T1. The blue zigzag is based again on the 20% percentage threshold but it uses data up to date
T2. In other words, the red zigzag is a snapshot from the history of the blue one. Notice how the last
is shown as a crooked line connecting peaks two legs of the red zigzag changed when price information from T1 and later were taken into account to
the blue zigzag. This chart was created in MetaStock, which plots the zigzag in a way such that
and troughs. The line segments of the zigzag create
its last two legs are dynamic. In other versions of zigzag, only the last legs are dynamic.
are commonly referred to as its legs.
Notwithstanding that the zigzag identifies promi- are dynamic and usually change significantly as new
nent peaks and troughs, it doesnt filter the price data comes in. Consequently, the historical values
swings the same way a technicians eye would. In this of the zigzag are based on hindsight. So if youre
article, I will introduce you to a more natural way of using the zigzag in the same way that you use other
filtering the price, which is accomplished via what are classic technical indicators such as moving averages,
called perceptually important points. This alternative relative strength index (RSI), stochastics, and so
to the classic zigzag indicator is closer to the way a on, then zigzag wont be of much use. However, it
can be useful if its used to identify prominent price
human perceives the movement of price.
swings on a chart. Simply put, there is no way to
know when the current price movement will pass the
Limitations of the zigzag
The zigzag is accused of a serious drawback: Its last cutoff threshold before that happens (see Figure 1 for
two legs (or, depending on the software, its last leg) an example). In effect, the zigzag is a static tool that
by Giorgos E. Siligardos
May 2015

Technical Analysis of Stocks & Commodities 13

Figure 2: not all points identified by the zigzag are visually prominent.
The zigzag always tries to find and accent prominent price swings based on how high or
low these swings go, but this makes it quite stiff. In this iconic example, the zigzag would
disregard point 2 just because point 1 is a bit lower. From a visual perspective, however,
point 2 was more important than point 1 since it was the pivot that sparked a swift and
strong uptrend.

tries to mimicoften in a clumsy waythe eye of the analyst

when it looks at a snapshot of a chart. It does so from a more
mathematically rigid point of view, concentrating on the major
swings of price (as defined by the cutoff threshold).
It must come as no surprise then that for the chart pattern


CBS Corp. CL B

Zigzag (20%)
J A S O N D 2007

A M J J A S O N D 2008


A M J J A S O N D 2009

analyst, the dynamic nature of the zigzags last legs is not a

drawback but a merit. For example, in his November 2003
Stocks & Commodities article The Zigzag Trend Indicator,
Spyros Raftopoulos introduced an interesting binary indicator
that he called zigzag trend. The zigzag trend is essentially the
zigzag without its dynamic feature, so its strong point is that it
can be used and treated the same way as other common trend
indicators such as the MACD, with the additional benefit of a
low number of whipsaws. From a pattern analysts standpoint,
however, the absence of dynamic parts makes it completely
incapable of identifying visually prominent peaks and troughs
in a snapshot of a chart.
A more substantial drawback of the zigzag as a tool to represent a chartists perception could be its dependence on the
threshold parameter. In other words, you cant use the same
cutoff threshold for all charts. A 20% threshold for long-term
daily charts of stocks does a pretty good job most of the time,
but it might be inefficient for short-term daily charts. So the
analyst must first see the chart and then define the threshold
that will give the zigzag the opportunity to identify the major
swings. That initially negates the usefulness of the zigzag as a
representative of the human eye when there is need for identification of major swings in thousands of charts. This is not a
serious drawback, however, since there is a simple (albeit not
perfect) workaround: You can take the range of values in a chart
(highest value minus lowest value) and then define the
threshold as a percentage of that range.
So what are the essential limitations of the zigzag
from a chartists point of view? One limitation is that
it focuses exclusively on prominent price swings (peak
to trough and trough to peak). More precisely, although
it indeed identifies meaningful pivots in price, it often
misses other pivots that are even more important regarding
their role in the visual comprehension of the movement
of the price (Figure 2). Also, its bias toward only price
swings makes it incapable of perceiving special cases
where connection of peaks to peaks or troughs to troughs
describes the price behavior in a better way (see Figure
3). Another important limitation of the zigzag has to do
with the way it summarizes and ranks information on a
chart. More precisely, you cant force the zigzag to summarize the price action into a specific number of swings.
For example, you cant tell the zigzag to filter the price
action and condense it into, say, four swings (legs). You
will know the total number of the zigzags legs only after
it has filtered the price.

Figure 3: the zigzag always connects peaks with troughs. The zigzag has a unilateral
way to filter price movements. It always connects peaks with troughs. This means that it is blind
regarding changes in the strength of directional movements and so misses important information
with respect to the visual perspective of a price trend. In this daily chart of CBS Corp., the 20%
threshold zigzag (in blue color) is unable to see the visual importance of points 2 and 3 although
they clearly mark changes in the severity of the downtrend. It considered point 4 as significant, but
that is not visually prominent. The pink crooked line gives a much better sight of the price movement
from point 1 to point 5.

14 May 2015 Technical Analysis of Stocks & Commodities

Meet the PIPs method

An alternative method of filtering price fluctuations is

one that is based on the idea of perceptually important
points, or PIPs. While roots of this method trace back to
1973, it was mainly introduced in 2001 by F.L. Chung et
al. in their academic research paper Flexible Time Series Pattern Matching Based On Perceptually Important
Points. The PIPs method makes it feasible to construct a
modified version of the classic zigzag indicator that will




overcome the limitations I mentioned
earlier because its filtering process is
much closer to the way a technicians
eye scans a chart. This doesnt mean
dx(Y,Z) = d1+d2
that this new method should wholly
replace the classic zigzag. It is just a
different method serving a different
purpose. The PIPs method is more
appropriate for representing price Figure 4: the tHree flavors of distance of one point from A PAIr of two points. Three ways to define
the distance of a point X from a pair of points Y, Z have been proposed in the literature: The Euclidian, the vertical, and the
movement from a visual standpoint. perpendicular.
In brief, while the zigzag starts from
the left of a chart and creates legs as
it moves to the right, the PIPs method identifies important points based
on a holistic approach: All price data is indirectly taken into account
Identifying the third PIP
for the identification of each and every leg.

The concept of distance

Before diving into the details of PIPs, it is necessary to define the concept
of the distance of one point with respect to two other points. Let X, Y,
and Z be three points in a timeprice chart in this order: Y, then X, then
Z. In their 2008 paper Representing Financial Time Series Based On
Data Point Importance, Tak-chung Fu et al. proposed three ways to
define the concept of distance dX(Y,Z) of X from points Y and Z:

Euclidian distance: dX(Y,Z) is defined as the distance of X

from Y plus the distance of X from Z.
Vertical distance: If is the straight line connecting the points
Y and Z, then dX(Y,Z) is defined as the vertical distance of X
from .

Identifying the fourth PIP

Perpendicular distance: If is again the straight line that

connects the points Y and Z, then dX(Y,Z) is defined as the
perpendicular distance of X from .

In Figure 4 you can see pictorial examples for these three flavors
of distance.

Identifying the PIPs

Consider a set of points in a timeprice chart that are derived by the

values of an indicator such as the MACD or the closing price of a stock.
A point from this set will be considered perceptually important when
it dominates all other points in terms of importance in the perception
of the visual shape that these points create.
Thats a loose definition, I know, so let me define the PIPs via a
formal inductive procedure using the vertical kind of distance (refer
to Figure 5 for a visual aid).
Step 1: The first two PIPs are the first and last points in the chart.
Name them A and B, respectively. I call these PIPs marginal for
obvious reasons. All the other PIPs will be called internal.
Step 2: To find the third PIP, calculate the vertical distances of
all points of the set from the couple A, B (that is, calculate
all dX(A,B) where X runs all points of the set). The point X,
which produces the maximum distance, is the third PIP. Let

Identifying the fifth PIP

Figure 5: identifying PERCEPTUALLY IMPORTANT POINTS (PIPs) USING THE VERTICAL DISTANCE. The first two PIPs are the first and last points
(A and B). From there on, to designate a point as perceptually important, you
go through a procedure that takes into account all price data in the chart. More
precisely, you go through calculations of vertical distances involving all data in
the chart and lines connecting previously identified PIPs.
May 2015

Technical Analysis of Stocks & Commodities 15

this point be C. There are now three PIPs that appear

in this time order in the chart: ACB.
Step 3: Using the same previous idea, run through all set
points between A and C and calculate their vertical
distances from the couple A, C. Also run through all
set points between C and B and calculate their vertical
distances from the couple C, B. The maximum distance
found from these two runs marks point D, which is
the fourth PIP.
Step 4: Say that D is between A and C. For the fifth PIP
you make three runs of vertical distance calculations:
one from A to D, one from D to C, and one from C to
B. The maximum distance found marks the fifth PIP
(E in Figure 5).
Next steps: You can repeat this procedure to find as many
PIPs as you like (a new PIP for every step). The procedure stops when you have identified your desired
number of PIPs or when the maximum distance in
a step is zero (as this would mean that no additional
information is gained by identifying new PIPs). Of
course, there is always a natural limit to the number
of PIPs you can identifyand that limit is the total
number of points in the chart.

and, voilyou have a new zigzag-like indicator. (Note that

the number of legs equals the number of PIPs minus one.) I call
this indicator zzTOP. The zz part of the name comes from it
being a generalized kind of zigzag andwhat can I saythe
TOP part comes because I am listening to ZZ Tops hit song
Legs as I write this article.
The zzTOP indicator requires three arguments (parameters).
These are: indicator, LegsNo, and scale. Lets look at them
in detail.
Unlike the classic zigzag, the zzTOP doesnt rely on cutoff
thresholds, so it can be directly applied successfully to any
kind of indicator. The indicator parameter is therefore the
indicator upon which you want the zzTOP to be applied.
It can be the closing price line, the MACD, the RSI, or
any indicator you can think of.

This is a numeric parameter (a positive integer greater than
or equal to 1) that defines the total number of legs you want
the zzTOP indicator to have. The number of PIPs equals this
number plus 1. For example, a value of 20 for this parameter
indicates that you want the zzTOP to have exactly 20 legs
(or equivalently, you are interested in 21 PIPs).

As you probably noticed, the inductive procedure used to

identify the PIPs has an additional benefit: The PIPs are automatically ranked in descending order of perceptual importance. The
mathematically inclined, however, might have already found a
possible problem with this procedure: What if there is not one
and only one maximum distance among the vertical distances
you calculate for a step? This is rare but it can happen. In this
occasion, there will be more than one finalist for the next PIP
designation, so you either designate all of them as PIPs or, when
you need to select only one of them because you want only one
PIP, you need a selection convention regarding which one to
designate as the next PIP.
As a simple solution for the second case, I opt for the finalist,
which lies in the right-most side of the chart. In other words, I
focus on the most recent data. You could use other methods of
selection, but I believe this is the simplest and most efficient
for our purpose.
A similar procedure could be used to identify PIPs using
Euclidian or perpendicular distance. But what is the most appropriate distance to use? A study of various examples shows
that from a visual point of view, the Euclidian distance identifies
terrible PIPs. Further, the vertical and perpendicular distances
produce exactly the same PIPs in most of the real cases. In effect, you can use only the vertical distance and disregard the
other two. The indicator I will present uses the vertical distance
and the selection convention discussed earlier.

The zzTOP indicator

Now that you know how to calculate PIPs in an indicators plot,

you can connect them using straight line segments to create legs
16 May 2015 Technical Analysis of Stocks & Commodities

Ball Corp.


zzTop (Close,5,L)


zzTop (Close,20,L)





Figure 6: zztop performance in the daily chart of ball corp. (BLL). The
zzTOP indicator is a nice way to approximate the price action via a predefined number of
linear legs. The more legs that are used, the closer the approximation.

This parameter refers to the scaling
of the y-axis of the chart, and it has a
significant effect on the performance
of the zzTOP. The scale parameter
can take two values: A (arithmetic)
and L (logarithmic). If you want
the zzTOP to filter the movements
of the indicator parameter as seen
in an arithmetic scale, then you set
this parameter to A. This instructs
the zzTOP indicator to apply its PIPs
identification algorithm to the indicator itself. If, however, the indicator is
positive and you want the zzTOP to
filter its movements as seen in a semilogarithmic scale (in such a scale,
the y-axis is logarithmically scaled,
whereas the x axis is arithmetically
scaled), then you set this parameter
to L. This latter case is equivalent
to first taking the natural logarithm
of the indicator, then applying the
zzTOP with a scale parameter of
A, and then applying the exp()
function in the result.
As an example, zzTOP(close, 30, L)
refers to the zzTOP indicator applied on
the semilogarithmic chart of the closing
price of a security demanding that the
zzTOP must have exactly 30 legs. Similarly, zzTOP(MACD, 20,A) refers to the
zzTOP applied on an arithmetic chart of
MACD and demanding that the zzTOP
must have exactly 20 legs.
It is important to note again that while
the zigzag scans the price series from left
to right using a number (the threshold) to
classify a price swing as important, the
zzTOP uses information from all loaded
data in a chart every time it identifies
a new internal PIP. This is invaluable
from the point of visual comprehension
of a chart, but it comes at a price: The
zzTOP is much more prone to changing
many of its legs when new price data
is added to the chart.

Chart examples

It is now time to go through some chart

examples. In Figure 6 you can see how the
zzTOP(close,5,L) and zzTOP(close,20,L)
perform in the same chart. The former
scans all prices shown in the chart, finds
six PIPS, and summarizes the price action
May 2015

Technical Analysis of Stocks & Commodities 17

ASML (daily)


zzTop (Close,20,L)

Zigzag (20%)
1995 1996




2000 2001














Figure 7: zztop and zigzag vis vis. The upper and lower daily charts of ASML Holding (ASML) are the same. The
zzTOP(close,20,L) indicator is overlaid in the upper chart, whereas in the lower chart, the zigzag identifies peaks & troughs based
on a percentage threshold of 20%. From a visual standpoint, the zzTOP indicator can effectively render the essentials of the price
movement using much fewer legs than the zigzag (see its performance between late 1999 and late 2001). This is mainly because
of two reasons: First, it is allowed to connect peaks to peaks and troughs to troughs, and second, it takes into account all price data
for the calculation of each leg. The zigzag on the other hand doesnt look at all price data every time it creates a leg. It processes
the data strictly from left to right and it can only change its last two legs during the identification procedure.

into only five legs. The latter finds 15 more PIPs and summarizes the price action into 20
legs. Note that the zzTOP doesnt have to connect only peaks with troughs. It can also
connect peaks to peaks or troughs to troughs and thus it is more flexible in summarizing
and expressing the price movement quirks. In this regard, the choice of zz in the name
zzTOP is perfectly suited because the zzTOP is not limited to only zigzagsit can do
zigzigs and zagzags too.
In Figure 7 you can see how the zzTOP(close,20,L) differs from the classic zigzag in-

For the chart pattern analyst, the dynamic nature of

the zigzags last legs is not a drawback but a merit.

Baxter Intl. Inc.

zzTop (Close,20,L)


zzTop (Close,20,L)


Period 1
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Period 2
Figure 8: zztop usually changes dramatically when new data IS added. That zzTOP identifies an internal PIP
taking into account all previously identified PIPs, and that the first and last prices in the chart are always the first two PIPs means
that all internal PIPs (and consequently all legs) are indirectly affected by the first and last prices of the chart. So as new data is
added to a chart, all the legs of the zzTOP face the danger of change. As more and more data is added, all of its legs will finally
change, since the number of legs is constant. This feature of the zzTOP is clearly seen in the daily chart of Baxter International
Inc. (BAX), where the zzTOP(close,20,L) is applied to price data for two periods. The red zzTOP is applied to price data for period
1 and the blue zzTOP is applied to price data for period 2.

18 May 2015 Technical Analysis of Stocks & Commodities

dicator with a percentage threshold

of 20%. Note especially the period
from the end of 1999 until the end of
2001. The zzTOP clearly depicts the
price movement in a better way than
the zigzag does in terms of visual
clarity, using just a few legs.
Figure 8 shows how the zzTOP
may change when you put new
data in a chart. Period 2 starts at
the beginning of 1983 and ends
at the beginning of 2000, whereas
period 1 starts at the beginning of
1983 and ends near the summer of
2009. The zzTOP indicator in blue
is applied in period 2 only (that is,
it doesnt look outside period 2) and
identifies 20 legs for that period.
The zzTOP indicator in red is applied in period 1 and summarizes
the price action into 20 legs for the
entire period. Both zzTOPs have
the same parameters except for
the time period upon which they
are applied. It is obvious that new
data can have a significant effect
on the performance of zzTOP not
only because of the restriction in the
number of legs it is allowed to present but also because its algorithm
identifies all internal PIPs, starting
from the marginal ones (the first and
last prices in the chart). In effect, all
internal PIPsand consequently all
legsare affected by the first and
last prices in the chart.
In Figure 9 you can see why the
scale parameter is important. In the
top chart you see the weekly price
of Caterpillar Inc. (CAT) with the
20-leg zzTOP based on the closing
price using arithmetic as its scale
parameter. In the lower chart you see
the same weekly chart of CAT with
the same 20-leg zzTOP indicator,
but this time, the scale parameter
is logarithmic. The upper chart is
arithmetic, whereas the lower one is
semilogarithmic. It is clear that the
scale parameter is there to ensure
that the zzTOP sees the chart the
same way a chartist would do with
his eyes. In the upper chart (the
arithmetic one), the price movement
before the year 2000 is seen as almost horizontal by the human eye.

Caterpillar Inc.

Thats because after 2000, the prices

advanced significantly. In effect,
the swings of the price after 2000
overshadow those before 2000 from
an arithmetic perspective and the
arithmetic-scale zzTOP correctly
focuses on the price swings after
2000 because thats what a human
eye would naturally do.
In the lower chart, though, the
semilogarithmic scale makes it possible to see things from a percentage
perspective, so the price swings before 2000 are visually more prominent now. The logarithmic-scale
zzTOP in the lower chart correctly
identifies the 20 most noticeable
price swings the same way a human
eye would.
Most chartists use semilogarithmic charts to plot the prices of trading
instruments, so an arithmetic-scale
zzTOP is practically useless when
applied to the price charts (especially
the long-term ones). The charts of
common technical indicators (such
as stochastics, MACD, and RSI) are
nonetheless always arithmetic, so the
ability of zzTOP to adapt to scale
differences can be useful. In Figure
10 you can see how the arithmeticscale zzTOP performs in a weekly
chart of Archer Daniels Midland
Co. (ADM).


Arithmetic scale
zzTop (Close,20,A)


Semilogarithmic scale
zzTop (Close,20,L)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Figure 9: arithmetic vS. logarithmic scale. The scale parameter of the zzTOP determines the way the zzTOP sees
the price. The A (arithmetic) scale parameter instructs the zzTOP to see the price from an arithmetically scaled y-axis whereas
the L (logarithmic) scale parameter instructs it to see the price from a logarithmically scaled y-axis. The results can be strikingly
different for these two cases as it is seen in this weekly chart of Caterpillar Inc. (CAT).

The zzTOP doesnt rely on cutoff thresholds so it can be

directly applied successfully to any kind of indicator.
Archer Daniels Midland Co.

zzTop (Close,20,L)


zzTop (MACD,20,A)
2000 2001














The zzTOP requires you to state how Figure 10: identifying the swings of macd in a weekly chart of archer daniels Midland co. (ADM). The
zzTOP indicator performs pretty well when applied in indicators without the need to define filtering thresholds.
many legs you are interested in. The
opportunity to a priori define the
number of legs gives you tremendous freedom, but sometimes closer the zzTOPauto line must be to the indicator plot and
you may want the indicator to choose how many legs to identify thus the more legs will be needed.
Consider, for example:
based on a goodness of fit level that you desire. In other words,
you might be interested in a hybrid between the zzTOP and the
zigzag. This can be accomplished by requiring the zzTOP indicator to keep finding PIPs and to create legs up to a predefined
proximity level (an equivalent to the threshold of the zigzag). and say that the highest value of the indicator is 200 and its
lowest value is 40. The range of the indicator is therefore
I named this automated version of zzTOP the zzTOPauto.
The zzTOPauto indicator has the same indicator and scale R=200-40=160. Since the proximity parameter is 20, you are
parameters as the zzTOP does, but instead of LegsNo, it has interested in the required number of legs such that the vertia proximity parameter. So zzTOPauto(close,10,L), for ex- cal distances between the values of the indicator and the legs
ample, refers to the zzTOPauto applied to the closing price are less than 20% of 160 (which equals 32). In other words, a
of a security on a semilogarithmic chart with a proximity of proximity of 20 means that you want the zzTOPauto to keep
10. Proximity is a positive number up to 100 and represents a finding PIPs and to keep creating legs up to the point where the
percentage of the range of values of the indicator parameter. indicators values will not divert more than 20% of R from the
Its purpose is to give the zzTOPauto a level of goodness of fit zzTOPautos plot. Of course, for logarithmic-scale zzTOPauto,
you are interested in. Note that the lower the proximity, the the range of the indicator must be measured in a way that will
May 2015

Technical Analysis of Stocks & Commodities 19


Boston Scientific

perform the backtesting, the typical

technical analysis software loads
all historical data, then calculates
the values of indicators, and then
uses these calculated values to
simulate the backtesting. This is
zzTOPauto (Close,10,L)
fine for common indicators such as
MACD and RSI, but for dynamic
indicators like zigzag, zzTOP, and
zzTOPauto (which change their
Figure 11: performance of zztopauto with a proximity parameter of 10 in a daily chart of boston
scientific inc. (BSX). The zzTOPauto indicator in this chart did a great job in outlining the price movements of BSX. Using
historical values when new data
a higher proximity parameter would result in fewer legs for the zzTOPauto, whereas a lower proximity parameter would result
comes in), this approach produces
in more legs.
erroneously prettifying results.
As a consequence, the zzTOP and
take into account the visual idiosyncrasy of the semilogarithmic zzTOPauto indicators must not be used for backtesting in the
charts. More precisely, for the logarithmic-scale zzTOPauto, the typical software program using the softwares built-in backtestrange of the indicator is measured using the logarithms of the ing feature. You can, however, use these indicators in a static
indicator values instead of the values themselves. In Figure 11 fashion as a digital substitution for your eyes when you want
you can see how the zzTOPauto (close,10,L) did a great job in your software to scan thousands of charts.
outlining the price movements of Boston Scientific Inc. (BSX).
Coding the zzTOP and zzTOPauto indicators requires some
Using a higher proximity parameter would result in fewer legs time and effort. For software whose formula language lacks
for the zzTOPauto, whereas a lower proximity parameter would looping capabilities (like MetaStock, for example), the zzTOP
result in more legs.
and zzTOPauto must be coded using a versatile programming
language, embedded inside a dynamic link library (DLL) file,
Coding and usage
and then be called by the software as external functions from
The correct way to perform backtesting is the DLL. To plot the zzTOP and zzTOPauto indicators in
to recalculate the values of all indicators MetaStock, I created a DLL (named zzTOPindicators.dll)
involved whenever a new bar is taken into thats available for download from the Article Code area of
account. But that would require too many www.traders.com, or from http://traders.com/files/zzTOPindicalculations. To decrease the time needed to cators.zip directly. In the sidebar ZZTOP And ZZTOPauto
Indicators In Metastock, you can find information on how
to download and use it.

Readers can download my zzTOPindicators.dll file as a .zip archive

from http://traders.com/files/zzTOPindicators.zip or from the Article
Code of the Technical Analysis of Stocks & Commodities website,
www.traders.com. After downloading, you will need to expand
the .zip file and place a copy of it in MetaStocks external function
DLLs folder (usually located at C:\Program Files\Equis\MetaStock\
External Function DLLs).
The zzTOP and zzTOPauto indicators can be called by the following code:
ExtFml( "zzTOPindicators.zzTOP",Indicator ,LegsNo ,Scale)


respectively. For example, the code:

ExtFml( "zzTOPindicators.zzTOPauto",CLOSE ,15 ,L )

calls the zzTOPauto indicator for the close price in a semilogarithmic

scale with a proximity of 15.
G. Siligardos
20 May 2015 Technical Analysis of Stocks & Commodities

Rock & roll

The zigzags way of filtering fluctuations, although simple, is

not always appropriate for capturing the visual representation of
price behavior. The zzTOP and zzTOPauto indicators presented
in this article offer an alternative way to transfer your visual
perception to your software. Perhaps, if you go through thousands of charts, chances are you will encounter cases where the
zzTOPs will miss a few points that your eye would consider as
visually important; however, that would generally be rare. So if
you are not pleased with the way the zigzag indicator perceives
the price movements in a chart, then get ready to rock and let
the zzTOPs do their magic.
Giorgos Siligardos holds a PhD in mathematics and a market
maker certificate in derivatives from the Athens Exchange. He
is a financial software developer, coauthor of academic books
in finance, and a frequent contributor to Technical Analysis of
Stocks & Commodities magazine. He has also been a research
and teaching fellow to the University of Crete as well as a
teaching fellow to the Department of Finance and Insurance
at the Technological Educational Institute of Crete for many
years teaching math and financial courses and supervising
masters dissertations. His academic website is http://www.tem.


uoc.gr/~siligard and his current views on

the markets can be found in http://marketcalchas.blogspot.gr/. He may be reached
at siligard@tem.uoc.gr.
The DLL file mentioned in this article is
available from http://traders.com/files/
zzTOPindicators.zip as a downloadable zip
archive as well as from the Subscriber Area
at our website, www.Traders.com, in the
Article Code area.
See our Traders Tips section beginning on
page 50 for commentary on implementation
of Siligardos technique in various technical
analysis programs. Accompanying program
code can be found in the Traders Tips area
at Traders.com.

Further reading

Chung, F.L., and TC Fu, R. Luk, and V.

Ng [2001]. Flexible time series pattern matching based on perceptually
important points, International Joint
Conference On Artificial Intelligence
Workshop On Learning From Temporal And Spatial Data (pp. 17).
Douglas, D., and T. Peucker [1973].
Algorithms For The Reduction Of
The Number Of Points Required To
Represent A Digitized Line Or Its Caricature, The Canadian Cartographer,
Vol. 10, No. 2, pp. 112122.
Fu, Tak-chung, and Fu-lai Chung, Robert Luk, and Chak-man Ng [2008].
Representing Financial Time Series
Based On Data Point Importance,
Engineering Applications Of Artificial Intelligence, Vol. 21, Issue 2, pp.
277300, March.
Merrill, Arthur A. [1977]. Filtered Waves,
Basic Theory: A Tool For Stock Market
Theory, Technical Trends.
Phetchanchai, Chawalsak, and Ali Selamat,
Amjad Rehman, and Tanzila Saba
[2010]. Index Financial Time Series
Based On Zigzag: Perceptually Important Points, Journal Of Computer
Science, Vol. 6, No. 12, pp 1,38995.
Raftopoulos, Spyros [2003]. The Zigzag
Trend Indicator, Technical Analysis
of Stocks & Commodities, Volume
21: November.

See Traders Glossary for definition

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inclusive. The settlement will provide $625,000 to
pay claims from Persons who bought, sold, or
otherwise traded the referenced futures contracts at
any time from July 8, 2008 through July 15, 2008.
If you qualify, you may send in a Proof of Claim
form to potentially get benefits, or you can exclude
yourself from the settlement, or object to it.

Settlement Agreement, available at the

settlement website, describes all of the details
about the proposed settlement.
The exact amount each qualifying
Settlement Class member will receive from
the Settlement Fund cannot be calculated
until (1) the Court approves the settlement;
(2) certain amounts identified in the full
Settlement Agreement are deducted from the
Settlement Fund; and (3) the number of
participating Class members and the amount of
their Allowed Claims are determined.

The United States District Court for the Northern

The number of claimants who send in claims
District of Illinois (219 South Dearborn Street,
varies widely from case to case. If less than
Chicago, IL 60604) authorized this notice. Before
100% of the Settlement Class sends in a Proof of
any money is paid, the Court will hold a Fairness
Claim form, you could get more money.
Hearing to decide whether to approve the settlement.
How Do You Ask For a Payment?
Whos Included?
If you are a Settlement Class member, you
You are a Settlement Class member if you
may seek to participate in the Settlement by
purchased, sold, or otherwise traded July and/or
submitting a Proof of Claim to the Settlement
September 2008 CBOT Rough Rice futures contracts
Administrator at the address below, postmarked
from July 8, 2008 through July 15, 2008, inclusive.
no later than November 9, 2015. You may
Excluded from the Settlement Class are (i) the Released
obtain a Proof of Claim on the settlement
Parties (as defined in Section 1(k) of the Settlement
website or by calling the toll-free number
Agreement), and (ii) any Opt-Outs (as defined in
referenced above. If you are a Settlement Class
Paragraph 7 of the Settlement Agreement).
member but do not file a Proof of Claim, you
Contact your futures broker or futures will still be bound by the releases set forth in the
commission merchant to see if you purchased, Settlement Agreement if the Court enters an
sold or otherwise traded the referenced contracts. order approving the Settlement Agreement.
If youre not sure you are included, you can get
What Are Your Other Options?
more information, including the Settlement
If you dont want to be legally bound by
Agreement, Mailed Notice, Plan of Allocation,
the settlement, you must exclude yourself
Proof of Claim and other important documents,
by July 21, 2015, or you wont be able to sue, or
at www.ricefuturessettlement.com (settlement
continue to sue, Defendants about the legal claims
website) or by calling toll free 800-918-8964.
in this case. If you exclude yourself, you cant get
Whats This About?
money from this settlement. If you stay in the
The lawsuit claims, among other things, that on settlement, you may object to it by August 3, 2015.
July 11, 2008, Defendants held 100% of the reported All objections to or requests to be excluded from
open interest in the CBOT Rough Rice futures the settlement must be made in accordance with
contract expiring in July 2008 and that Defendants, the instructions set forth in the formal Mailed
by July 11, 2008, had made large purchases in the Notice.
The Mailed Notice available at
rice cash market with the purpose and intent of www.ricefuturessettlement.com explains how to
limiting the amount of rice that would be available exclude yourself or object.
for delivery against the July 2008 CBOT Rough
The Court will hold a Fairness Hearing in this
Rice futures contracts. Plaintiffs also alleged that case (In re: Rough Rice Commodity Litigation,
Defendants uneconomically stood for delivery on Case No. 11-cv-00618) on August 25, 2015, to
their July 2008 position during the Settlement Class consider whether to approve the settlement and a
Period. Defendants deny any wrongdoing that request by the lawyers representing all
Plaintiffs allege in the lawsuit and maintain that
Settlement Class members (Lovell Stewart
they have complied with their legal obligations.
Halebian Jacobson LLP and Lowey Dannenberg
The Court did not decide which side is right. Cohen & Hart, P.C.,) for an award of attorneys
But both sides agreed to the settlement to resolve fees of no more than one-third (i.e., 33 1/3%) of
the case and get benefits to potentially affected the Settlement Fund for investigating the facts,
market participants. The two sides disagree on litigating the case, and negotiating the
how much money could have been won if the settlement, and for reimbursement of their costs
Plaintiffs had won at trial.
and expenses in the amount of no more than
approximately $50,000.00.
What Does the Settlement Provide?
Under the settlement, Defendants agreed to
create a $625,000 Settlement Fund. If the Court
approves the settlement, potential Settlement
Class members who qualify and send in valid
Proof of Claim forms will receive a share of the
Settlement Fund, after it is reduced by the
payment of certain fees and expenses. The

May 2015

You may ask to appear at the Fairness Hearing,

but you dont have to. For more information, call
toll free 800-918-8964, visit the website
www.ricefuturessettlement.com, or write to In
re: Rough Rice Commodity Litigation
Settlement, c/o A.B. Data, Ltd., PO Box 170500,
Milwaukee, WI 53217-8091.

Technical Analysis of Stocks & Commodities 21

Different strokes

Mean Reversion
And The S&P 500
It is generally believed that markets tend to mean-revert. But this is true for some markets more
than others. Heres an in-depth look at how the S&P 500 responds to mean reversion.
by Stephen Beatson

ean reversion is not a universal phenomenon; some markets have a tendency toward
mean reversion, while others dont. This has led a number of analysts and traders to
look upon mean reversion with some degree of suspicion. If mean reversion has a solid
statistical foundation, should it not be applicable to all markets all the time?


Equity ($)




Equity curve







Figure 1: EQUITY CURVE. Here you see the results of buying the S&P 500 index at a 10-day low and selling 10 days later
(19702013). The green line shows the strategys strong and persistent edge.

22 May 2015 Technical Analysis of Stocks & Commodities

Buy on the close if the

index closes at a 10-day

Sell on the close 10

days later

$100,000 per trade, no

allowance for commissions or slippage

Figure 1 shows the resulting

equity curve. During the
19702013 period, the strategys win rate was 60.52%

ShredDEd bills: mary981/Arrow: tomwa/collage: JOAN BARreTT

Rhythm Of The Markets

The simple truth is that

some markets respond well
to mean-reversion strategies,
and others dont. There are
several possible explanations
for this, including what factors drive the instruments
price (macro economics,
earnings, news, and so on);
the number of market participants; the ability to take
short positions; the volumes
involved; and the average
volatility of the instrument
in question.
It is generally believed that
commodity time series respond better to continuationtype systems (trend-following,
breakout, and so on) than to
mean-reversion systems. The
same applies to currency
pairs, which are understood
to exhibit long- and short-term
trending tendencies. The US
stock market daily time series,
on the other hand, has consistently demonstrated a strong
propensity toward mean reversion. In this article, I will
try to determine whether this
has always been the case. The
focus here will be on long-side
mean reversion, that is, on a
securitys prices tendency to
move upward after a shortterm decline.
I looked at the S&P 500
index from 19702013 and applied the following strategy:

During both bull and bear

markets, a short-term fall in
the S&P 500 is more likely to
be followed by a bounce than
by a continued drop.
and the profit factor (total profits/total losses) was 1.71. This
indicates that when the index hit a 10-day low, a trader with
a long position was generally better off holding his position
and exiting 10 days later.
The equity curves regular upward slope is quite remarkable.
Of course, some of this tendency must be assigned to directional
bias after all, the S&P 500 went up in value almost 20 fold
over the period, so you would expect the equity curve of this
long-only strategy to display a positive edge. However, the upward slope is also stubbornly present throughout the past two
decades (19942013) that saw some extreme rises and falls in
stock market prices.
Thus, the data suggests that during both bull and bear markets,
a short-term fall in the S&P 500 is more likely to be followed
by a bounce than by a continued drop, at least in the first few
days that follow. In other words, buying price dips and selling
at mean reversion would have been a simple and profitable
strategy over the past 50 years.
To further understand the nature of this short-term meanreversion cycle, I used the same strategy but applied a much
shorter two-day holding period, as follows:
Buy on the close if the
index closes at a 10-day


Sell on the close two

days later


$100,000 per trade, no

allowance for commissions or slippage

Figure 2 shows the resulting

equity curve for the two-day
holding period. What you
see here is a very different
chart. The downward sloping
red line indicates that from
19701987, the S&P 500
exhibited a strong tendency
toward short-term continuation, or follow-through that
is, a 10-day low in the index
had a strong tendency to be

Where Order Flow

Meets Price Velocity

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the elusive Convict
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followed by further selling, at least in the short term (two
days). From 1987 to date, however, and quite consistently for
the past three decades, the exact opposite appears to have
happened: A 10-day low was generally followed by a quick




Equity ($)





Equity curve


Black Monday






Figure 2: EQUITY CURVE OF A SHORTER HOLDING PERIOD. Here you see the results of buying the S&P 500 index at a 10-day
low and selling two days later (19702013). The strategy had a negative edge until late 1987, then a fairly consistent positive edge
May 2015

Technical Analysis of Stocks & Commodities 23




1/4 965
1/4 67
1/4 969
1/4 971
1/4 73
1/4 975
1/4 77
1/4 979
1/4 81
1/4 983
1/4 85
1/4 987
1/4 89
1/4 991
1/4 93
1/4 995
1/4 97
1/4 999
1/4 001
1/4 03
1/4 005
1/4 07
1/4 009
1/4 11

occurring intraday instead of

interday. That meant that price
stability could be reached before
the end of the trading session,
allowing opportunistic buyers
to step in the following morning,
pushing prices back up toward
the mean.
The third likely explanation for
the US stock markets short-term
mean-reverting tendency is the
pervasiveness of short selling.
Short selling, in its many forms,
has been around for a long time
and was certainly very much
alive in the 1960s and 1970s.
But it was only in the 1980s that
shorting on electronic platforms
became widely available. This
rise in the collective power of
the shorts has exacerbated the
short-rally effect, which is one
FIGURE 3: RISING VOLUMES. Stock market volumes have grown exponentially since the early 1960s, reaching their peaks
of the main ingredients of mean
in the fourth quarter of 2008.
reversion. Essentially, when an
instruments price is falling,
bounce, or reversion. And the inflection point of the equity short sellers must buy to cover and take their profits. This
curve occurred on a specific date, which was October 19, 1987, buying interest drives prices back up toward the mean. So
also known as Black Monday.
the greater the short interest, the stronger is the pressure for
falling prices to revert back upward.
Why the change?
Finally, we must also consider the advent of strategy-driven
There are arguably four main reasons for this fundamental automated trading systems and high-frequency traders (HFTs).
change in the US stock markets short-term profile from trend- These have, ironically, brought considerable short-term
ing to mean reverting. The first lies in the extraordinary rise rationality to the marketplace. Trading systems designed to
in the volume of stock market transactions over the past 50 recognize panic selling step in to oversold situations and buy
years, as reflected in Figure 3. Buy & hold investing that was into market overreactions. This serves to discourage followthe hallmark of most of the 1900s has made way for active through and favors mean reversion.
investing, short-term trading, and hedging. Financial products
that were intended as vehicles for investment have become
Stay the course
tools for speculation. This is the case for just about every
We have seen that the S&P 500 index has
financial instrument available in the electronic marketplace.
exhibited short-term long-side mean reverThis increased volume has brought about an unprecedented
sion for at least the past half century. Whats
level of liquidity to the marketplace, allowing buyers and
more, this tendency has been prevalent in
sellers to find each other more efficiently, thereby slowing the
bullish and bearish periods. We have also
runaway trains associated with illiquid markets.
seen what appears to be a quickening in the
A second possible explanation is that until the mid-1980s,
way the market responds to falling prices.
stop-loss orders were often executed on the day following
Reversion cycles that in the 1970s and 1980s
the stop being hit. That is, if a stop-loss level was touched
took several days now occur within a much
on Monday, the broker would execute the sale at the open on
shorter time frame. Traders recognizing
Tuesday morning. These sell orders would serve to compound
this phenomenon should be able to profit by
the downward effect, resulting in more stops being hit, and
using mean-reversion strategies that exploit
more sell orders being generated on Wednesday morning. The
this edge.
downward spiral would continue until value investors stepped
in and confidence was restored. The big change occurred in the Stephen Beatson is an investment consultant based in Paris,
mid-1980s with the advent of automated systems that allowed France and is founder of the educational site TheMechanistop-losses to be executed instantly when hit. The multiday calTrader.com.
price erosion process I described was suddenly compressed,
24 May 2015 Technical Analysis of Stocks & Commodities


Want to find out how the futures markets really work? Carley Garner is the senior
strategist for DeCarley Trading, a division of Zaner Group, where she also works
as a broker. She authors widely distributed e-newsletters; for your free subscription, visit www.DeCarleyTrading.com. Her booksCurrency Trading In The Forex
And Futures Markets; A Traders First Book On Commodities; and Commodity
Optionswere published by FT Press. To submit a question, post your question at
http://Message-Boards.Traders.com. Answers will be posted there, and selected
questions will appear in a future issue of S&C.


What impact will the CMEs pit closure
have on the average trader?
In early 2015, the Chicago Mercantile
Exchange (CME) announced that it
would be closing pit trading for all futures
contracts in its Chicago and New York
operations, with the exception of the
full-sized S&P 500 contract and most
of its option pits.
The S&P 500 futures contract was
the only product that had never been
moved to the screen. While all other
CME futures products traded in both an
electronic version and open-outcry version side-by-side, execution in the big
S&P has always been strictly open outcry.
Because of this, many traders moved
their speculation from the original S&P
contract into the electronically executed
emini S&P 500 futures (ES) to avoid the
delays and slippage that sometimes came
with pit-traded execution.
If you are young or new to the trading
community, you might not be aware of
what trading pits are or about the practice of open-outcry execution. In short,
the pits are designated circular areas in
which exchange members buy and sell
futures contracts through hand gestures
known as arb. Although the transactions
are dictated by hand movements, they are
accompanied by aggressive voices, and in
some cases, a degree of physicality. The
process of open-outcry trade execution
is often referred to as organized chaos.
If you havent seen the movie Trading
Places starring Eddie Murphy and Dan
Aykroyd (one of the greatest movies of
all time, in my opinion!), you should; it
manages to capture the essence of pit
trading in all of its glory. As another one
to mention, the documentary Floored
directed by James Allen Smith tells a

candid story of the ups and downs experienced by those on the CME trading
floors in Chicago.
As I mentioned, along with the fullsize S&P 500 futures, the option pits
will continue operation. This is because
the complexity of option trading hasnt
translated to the screens as well as
futures contracts have. Simple long &
short calls & puts can easily be executed
via an electronic platform, but in some
circumstances, those trading multileg
option spreads in high volume still find
benefits in using an open-outcry execution broker. This is expected to be the case
for the foreseeable future. Nonetheless,

Although the closure of

the futures trading pits
officially marks the end
of an era, there will be
little to no impact on the
average retail trader.
the writing is on the wall: Eventually,
the option pits will likely go the way of
the futures pits.
Although the closure of the futures
trading pits officially marks the end of
an era, there will be little to no impact
on the average retail trader. At the
time the CME Group announced the
pit closure, roughly 1% of all executed
futures contracts on the exchange were
traded in the pits. In other words, nearly
all of CME Group trades are executed
electronically; thus, most of us wont
even notice the change.
However, there will certainly be
casualties. For starters, all of those
working on the trading floor (executing
brokers, order clerks, and so on) will be
May 2015

Carley Garner

out of a job. Even though the numbers

of these individuals has dwindled over
the years, there are still hundreds that
will be affected. In addition, those who
made a living disseminating order flow
information (such as which banks and
hedge funds were buying or selling in
the pits), are finding they no longer have
a place on the trading floor.
Moreover, despite the clear advantages of electronic trade matching such
as transparency, speed of execution
and fill reporting, and fill quality (less
slippage), the disadvantages are often
overlooked. For instance, up until now,
when the exchange, or even brokerage
firms, experienced technology issues, it
was possible to route orders to the pit for
execution. These types of events dont
occur frequently, but they do happen. In
the absence of an alternative means of
execution, it only takes a single instance
of halted trades to dramatically affect
the integrity of the markets and work
against orderly trading.
In the aftermath of side-by-side trading
(simultaneous futures markets trading)
we are left with some residual chaos
when it comes to identifying products in
a trading platform or on a quote board.
This is because when electronic trading was first introduced, the exchange,
platform vendors, and brokerage firms
opted to identify the electronically executed contract with a different symbol
than the open-outcry version. This was
because at the time, electronic trading
hadnt fully developed. Consequently, it
was important that traders had the ability
to choose which venue to route trades to.
For example, the open outcry version of
crude oil has always been denoted by
Continued on page 62

Technical Analysis of Stocks & Commodities 25

are likely to come from today and

previous days.

The Road Ahead

Predicting The VIX

By Reordering Data
In recent years, the CBOE Volatility Index (VIX) has increased in importance and use
as an indicator of market direction. This article demonstrates how the direction of
tomorrows change in the VIX might be determined by restructuring readily available
market data.


by Stephen Butts

usually presented, financial data is ordered in a time series: The data runs from
left to right or top to bottom by increasing values of days, months, years, and so
on. The data may be altered (with a moving average, lagged values, the log, or
square taken, and so forth), but in most cases, data is envisioned and laid out according
to the arrow of time. Patterns are then observed or discovered in this time-based framework, and this makes great sense: The factor that may produce tomorrows market moves

26 May 2015 Technical Analysis of Stocks & Commodities

But ordering data in just one way
limits us. If there are patterns in
the data that are not related to the
one-directional march of time,
we may miss them. This article
seeks to explore one of many
possible orderings of data from
a well-studied, readily-available
financial derivativethe volatility index (VIX). My objective
is to see if I can discover useful
relationships that are hidden in a
time series view.
Ill begin with a small sample of
VIX index data from the 30 days
of trading between December 16,
1996 and January 28, 1997 (Figure
1). I arrange this data with the date
in column 1, the closing value for
each of the 30 days in column 2,
and the next days change in the
closing value in column 3.
For example, the VIX closed at
19.27 on January 14, 1997 and I put
the difference between this close
and that for the following day, 0.13,
into column 3 for January 14, not
for January 15. I then sort all three
columns together by descending
value of the VIX close and add
another column containing each
days cumulative sum of the next
days change (see Figure 2). Note
that after the sorting, the dates are
no longer in ascending order, and
that the cumulative change in the
VIX is calculated based on the new
order of the 30 days. For the sake
of brevity, hereafter we will refer
to the change in the closing value
of the VIX between a given trading
day and the trading day immediately after as the delta, and to the
cumulative value of the delta when it
is ordered according to the scheme
above as the cumulative delta.
The chart in Figure 3 presents a
graph of the descending VIX and
the cumulative delta from Figure
2, and it shows a pattern: While
the closing VIX values have been




sorted to descend steadily from their

highest value to their lowest (the 30
days are no longer in calendar order),
the cumulative delta values (that is,
the next days changes in the VIX)
generally, but with several detours,
drift down to a low point (-6.84)
somewhere around the middle of
the chart, and then change direction
and move upward (with detours) to
the last point in the chart. The low
point for the cumulative delta occurs on day 15 of this re-sorted data
(December 18, 1996) with a closing
VIX value for that day of 19.42.
To the left of and including this
low point, more cumulative deltas
fall (10) than rise (five), and the
sum of the deltas for these (-9.93)
is larger in a negative direction than
the sum of the rises (3.09) is in a
positive direction.
So for every day in this 30-day
period where the closing value of the
VIX is greater than or equal to the
Figure 2: closing vix sorted by descending vix. Here,
VIX value on the day of the lowest Figure 1: closing vix sorted by date
(december 16, 1996january 1997). The
the VIX close is sorted in descending order and a column containing
point in column 5 of Figure 2, you data is arranged by date, closing value, and next
each days cumulative sum of the next days change is added.
would be correct 10 times out of 15 if days change.
you were to predict that tomorrows
VIX will be lower than todays. And for every day when the 1990, for every day with a closing VIX greater or equal to
closing value of the VIX is less than the VIX value on the day the VIX on the day with the lowest value for the cumulative
of the lowest point in column 3, you would be correct 11 times next days change in the VIX (delta), there is a higher-thanout of 15 if you were to predict that tomorrows VIX will be average probability that the next days VIX will drop. And
higher than todays. In other words, if you knew the closing the reverse is true for all the days when the closing VIX is
VIX for every day in the table and the value of the VIX on the less than the VIX on the day with the lowest value for the
day having the low point of the cumulative deltas, you would cumulative delta.
predict correctly for 21 of the 30
days for a total of 16.64 points,
and incorrectly for nine days for
-4.72 points, leaving you 11.92
points ahead. Needless to say,
this is a far better performance
than the simple 30-day change
in the VIX itself, which results
in a drop of just 1.76 points over
the period.
This general pattern for the
reordered data is true for most
of the 30-day periods since the
VIX has existed. The low point
for the cumulative delta is rarely
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
in the exact center of the chart
as in the example in Figure 3,
Days in order of descending VIX
and often is skewed well to the FIGURE 3: DESCENDING VIX WITH CUMULATIVE CHANGE IN TOMORROWS VIX. While the closing VIX values have been
left or the right. However, in all sorted to descend steadily from their highest value to their lowest, the cumulative delta values generally drift down to a low point
30-day periods since January around the middle of the chart.
Value of closing VIX

VIX cumulative change

May 2015

Technical Analysis of Stocks & Commodities 27



for each 30 days would give a fair

estimate of the VIX at the low point.
In fact, both of them do: If you sub400.00
stitute the mean VIX value (which
Maximum drawdown
you know for all days, including
= 59.57 points
today) for the observed VIX at each
low point in the historical data, the
predictions for the next days VIX
change are correct for 3,078 (54%)
of the days and produce 652 points
on the VIX. The chart in Figure 4
shows the cumulative points gained
over the 23 years in this case; note
that the maximum drawdown for
FIGURE 4: cumulative vix outcome by year using mean prediction. The maximum drawdown for the entire the entire run is less than 60 points.
run is less than 60 points.
Using the median is almost as good,
producing 617 points.
How well does this method work?
Predicting the direction of tomorrows VIX with an advanThe historical database I used for the VIX comprises every tage of 652 points in 23 years may not sound like much until
trading day from January 29, 1990 to December 31, 2012 and you consider the alternatives. If you were simply to predict
there are 5,749 overlapping 30-day periods in this span. If for each day over the 23 years that tomorrows VIX would
you predict whether the next days VIX change is up or down always rise or always fall, you would be right about 47.6% of
for the 30th day in each period as per the method discussed, the time for rising and 52.4% for falling, for a grand total of
3,686 of the total 5,713 predictions (that is, 65%; for 36 days, only 1.91 points. A 1,000-trial Monte Carlo simulation of
the VIX change is zero) are correct for a net gain of 2,571 random predictions for each day in the 23 years shows that
VIX index points for the 23 years studied.
you would have achieved a gain of more than 300 points just
But you want to predict not just the following days VIX for eight times in 1,000 tries (thats 23,000 years), and that you
some dates in the past, but tomorrows VIX today, in real time. would gain a maximum of 361 points just once.
Since you want tomorrows change in the VIX, you should
begin with the 30 trading day period ending today, and then What will tomorrow bring?
reorder the data as mentioned. Then find which day has the In fact, you may get a more accurate estimate of the VIX value
lowest cumulative delta, and note the VIX value on that day. needed from the historical data by using more sophisticated
However, remember that for each day in the period, you need statistical methods than simply calculating the mean. With a
to have the next days change in the VIX, and of course, you least-squares approach using multiple variables, I have been
dont know tomorrows number today. Thus, you can reorder able to achieve close to a 900-point gain over the period (I
the data by sorting them into descending order by each days leave an exploration of this to readers as an exercise, and if
VIX, but you cannot calculate the cumulative change values you can do better, I invite you to share your method with other
because the latest one is missing.
readers of this magazine).
The only way to overcome this problem is to bypass it. You
I hope that the information I have presented here will give
need the value of the VIX on the day when the cumulative delta traders a small but useful advantage in predicting short-term
is the lowest for the last 30 days. Without knowing the data moves in the VIX, and encourage all analysts to take another
from the last day you can use various means to estimate that look at how time-series market data might be rearranged to
VIX value. For example, you know from historical analysis produce interesting insights.
that the low points for the cumulative VIX changes tend to
cluster somewhere near the middle of the sorted VIX values Stephen Butts has a PhD in political science. He has worked
for each period. Perhaps the mean or the median VIX value as a statistical and methodological consultant and teacher at
Columbia University, the Bureau of Applied Social Research
in New York, and the University of Wisconsin-Madison. He
may be reached via email at sjbutts@yahoo.com.
Cumulative VIX


The factor that may produce

tomorrows market moves are
likely to come from today and
previous days.

28 May 2015 Technical Analysis of Stocks & Commodities

Further reading

Gardner, Trent [2012]. Using VIX To Forecast The S&P

500, Technical Analysis of Stocks & Commodities,
Volume 30: July.

Confused about some aspect of trading? Professional trader Don Bright of Bright
Trading (www.stocktrading.com), an equity trading corporation, answers a few of
your questions. To submit a question, post your question to our website at http://
Message-Boards.Traders.com. Answers will be posted there, and selected questions
will appear in a future issue of S&C.
Don Bright of Bright Trading


Mr. Bright, thanks for all the information over the years. Your columns have
been very helpful. I have been hearing/
reading about the possibility of changing from the penny tick size in trading.
I have to admit that Im not sure what
this even means. Are exchanges going
to make changes? Will traders benefit
from these changes? Does this mean
the end to subpennies? (Ive read some
of your past columns on the topic of
subpennies.) Are these changes coming
soon?Ted A.
Thanks, Ted, for the nice words.
Always glad to help. Please keep the
questions coming.
To address your question, what youre
referring to is the Tick Size Pilot Program
(SEC File No. 4-657). Tick size here
refers to expanding the minimum tick to
five cents (or similar) for certain smallercap securities. Remember, we old guys
traded with 1/8th tick sizes and what was
called teenies (12.4 cents and 6.25
cents as the minimum tick size). This
was before subpenny denominations and
high-frequency trading and other such
activities came to be, and before penny
jumping practices came to be, although
some firms did engage in leaning on
another order, placing their order a teenie higher, thus limiting their losses to
the 6.25 cents.
These minimum price increments
have an impact on displayed liquidity
and transaction costs. Since the markets
adopted decimalization, there have
been changes in market structure, the
way people trade, and the roles market
participants played. How will expanding
the minimum tick size for certain stocks
help market participants?

The Securities And Exchange Commission (SEC) has been taking public
comments regarding this pilot program.
We at Bright Trading submitted a comment letter to the SEC on it, prepared
by Dennis Dick, CFA (a trader at
Bright Trading and a trader lobbyist).
Ill summarize and reiterate some of
our submitted comments here. (Note:
This information and the link to our
comment letter represent the opinion of
Bright Trading, and may not be shared
by all traders.)
One of our concerns is the lack of interest in the small- and mid-capitalization
companies. We believe this is primarily
due to a lack of liquidity caused by the
discouragement of limit-order traders.
As we see it, many small-capitalization
companies trade with very wide spreads,

The dominance of
the penny-jumping
program discourages
other participants
from providing
which should be attractive for market
makers to trade because of the potential
profit opportunity from the wide spread.
However, algorithmic penny-jumping
programs appear to dominate these securities, discouraging other participants
from providing liquidity.
Heres an example: Assume stock
XYZ is trading with a spread of $25.00
x $25.20. If a market participant places a
bid at $25.01 to tighten the spread, the algorithmic penny-jumping program will
automatically bid $25.02. If the original
May 2015

participant raises their bid to $25.03, the

algorithmic program will raise its bid to
$25.04. If the original participant cancels
their bid, the algorithmic penny-jumping
program cancels its bid as well, and the
best bid returns to $25.00. The pennyjumping technique is designed to battle
for the top of the order queue, so as to be
the first to interact with incoming marketable order flow, giving it the best chance
to capture the spread. The dominance
of this penny-jumping activity discourages other participants from providing
liquidity, which keeps the spread on these
securities artificially wide.
We believe the tick size pilot will help
address this issue. Firms will not want to
risk 500% more slippage than they face
with penny ticks.
Another major concern of ours is
brokerdealer internalization (that is,
when the broker takes the other side
of trade versus open market trading).
We write in our comments that The
biggest issue that our traders cite is
their inability to get filled on their limit
orders, even when they are at the top
of the order queue. This is primarily
due to over-the-counter (OTC) market
makers intercepting marketable order
flow that would otherwise interact with
the traders displayed limit order. In an
earlier public comment letter that we
submitted to the SEC in June 2010, we
cited this issue and recommended that
the SEC require an OTC market maker
internalizing a retail order to provide
meaningful price improvement over the
displayed quote.
We commend the SEC in attempting
to address this issue in the tick size pilot
program but believe an exception in one
Continued on page 45

Technical Analysis of Stocks & Commodities 29

Psst, Heres A Secret

10 Selling Tips

Do you spend as much time deciding to sell as deciding to buy?

Here are 10 tips to make deciding when to sell easier.

by Thomas Bulkowski

Landscape: blue67 sign/sign pole: vipman

he stock of Ferro Corporation (FOE) has flatlined like a dead animal

since November 2013. It is now 2015, and I have more than doubled
my money. Should I sell?
Every trader or investor must answer that type of question for their own
investments. In this article, Ill discuss 10 selling tips to help you find your

Tip #1: Use stops. This has to top the list of selling techniques because it
makes the process simple. If you use a stop-loss order, you can quit worrying about when to sell. The order will take care of that. All you have to
do is locate the stop in the right place. Stop placement is an art beyond this
article, but if you are having difficulty, use a volatility stop.
I learned about volatility stops from Perry Kaufmans book A Short Course
In Technical Trading. The idea behind a volatility stop is to place a stop far
enough away from the current price to avoid being stopped out on normal

30 May 2015 Technical Analysis of Stocks & Commodities

price movement. A volatility stop works well

when no other stop locations are nearby.
To use a volatility stop, compute the high-low
difference of price each day for the last month
(about 21 price bars). Average the result and
multiply by 2 to get the volatility. Subtract the
volatility from the current low price to get the
stop price. Trail the stop upward as price rises.
This type of stop is similar to a chandelier stop,
but Kaufmans stop performs better.
I found that a multiplier of 2 works best for
my trades, but you may prefer 1.5 or another
number. If the stop price, in percentage terms,
is too far away from the current price, then skip
the trade and find a less volatile stock.
The computation need not be a painful experience. One way to do it is to go to http://finance.
yahoo.com (Figure 1), type in the stock symbol,
and on the left, youll see a link to historical
prices. I show that circled in red in Figure 1.
Click on that link and download the prices
into a spreadsheet. On the same Yahoo page,
the link for a spreadsheet download is located
below the price grid. Subtract the high price
from the low and use the average() worksheet
function to get the volatility. I am providing a
sample spreadsheet at http://traders.com/files/
VolStop.xls.zip that does this math for you. All
you have to do is paste in a months worth of
price quotes from Yahoo.
Tip #2: Sell at a target price. When the stock
reaches a price target, sell. You should have the
target (and a stop-loss) price picked out before
trading the stock.
Consider placing the target just below overhead
resistance, such as at a prior peak or valley, or at a
round number (double
or triple zeros such as
$9.00 or $10.00 are
good for daytraders),
or at some other price
target. If using a round
number, consider selling a few cents below
the target, like 8.93
and 9.95. You want
to beat the crowd to
the exit.
If you are using
chart patterns as the
entry signal, take the FIGURE 1: HISTORICAL PRICES.
height of the chart Downloading historical prices can be
done easily given that there are sevpattern and add it to eral resources available from which
the breakout price to do so. Here you see an example
to get a target. That using Yahoo! Finance.

method works about 70% to 80% of the time, depending on

the chart pattern. You can cut the height in half for a closer
target that will work close to 90% of the time. In Figure 2
you see such an example.
A double-bottom chart pattern appears at AB and it confirms as a valid pattern when price closes above C, which
is the highest peak between the two bottoms. C is also the
breakout price.
The height from C ($24.50) to the lower of the two bottoms,
A ($21.67), is 2.83. Add the height to the breakout price (C)
to get a target of $27.33. Line D shows the target. For double
bottoms, this method works 68% of the time. Using half the
height boosts the success rate to 86%. Line D is also where
overhead resistance begins (between the two red lines). Thus,
the target and overhead resistance merge to form a good sell
Target selling is most useful for swing and daytraders because time is money (that is, they want to keep their money
in stocks climbing the fastest). Position traders looking for a
trend change (a drop of at least 20%) should avoid using this
approach. Thats because, as the chart shows, selling at the price
of line D limits profit since the stock can continue higher.
Tip #3: Sell after an adverse breakout. If you see a chart
pattern and buy into it before the breakout, sometimes the
breakout is opposite of what you had planned. In that case, sell
immediately. This applies to any approach you use to buy a
stock. If the stock moves in a surprising direction (down when
you expected it to rise), then you need to sell your position.
This tip is especially useful during earnings season. A stock
suffering a hit in earnings will get slammed by the market. For
any trading style other than buy & hold, sell immediately. Otherwise, the stock is likely to be whacked
again in three or six months time.

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Avoid buying or owning countertrend stocks by checking
whether they drop when the market makes a big move higher.
If so, and if they do that for several days in a month, consider
selling those holdings. The days need not be consecutive, but if


Tom Bulkowski

Tip #4: Watch for countertrend moves.

Last year I was planning to add a stock to
my portfolio, but when I checked its price,
I saw that the stock price was dropping
when the Dow Jones Industrial Average
was soaring. That drop in the stock was
a countertrend move.
You may have heard the phrase a rising tide lifts all boats, but this boat had
a hole in it. I avoided the stock and saved
myself from drowning.
I did a study on stocks that made
countertrend moves. I compared stocks
that dropped when the index made a
significant move upward (at least 1%).
Stocks that dropped underperformed
the index for at least three months and
underperformed the trend followers
(those stocks that followed the index
higher) for a year. You can find a link
to this research in the further reading

Noisy indicators
delay your analysis

FIGURE 2: APPLYING CHART PATTERNS TO MAKE SELL DECISIONS. In this case, take the height of the chart
pattern and add it to the breakout price to get a target.
May 2015

Technical Analysis of Stocks & Commodities 31


If you wake up in the early hours

of the night and your first thought
is of trading, thats a clue you
have unresolved issues.
the countertrend moves occur too frequently, you will be able
to do better by selecting a stock that follows the uptrend.
Tip #5: Obey indicator sell signals. If you are a system trader,
when your system issues a sell order, obey it. If you try to finesse
the exit by waiting, that could cause you more grief because
youre creating a bad habit.
Imagine that you delay selling and the stock climbs further.
By holding on longer, you are rewarded. The next time this
scenario unfolds, you do the same thing and make more money.
By delaying selling and winning, you create a bad habit that is
like a bomb waiting to explode. Eventually, the same scenario
will unfold, youll hold on, and boom! The stock will plummet,
giving you a huge loss.
If your system is flawed such that it gives sell signals too early,
then thats fine. Indicator testing can identify this problem. Im
not talking about living with a flawed system. Im talking about
ignoring trading signals.
If you are going to use a system, then trust it and obey it.
If you dont trust the system, then research its operation to
identify its weaknesses and become confident that the system
works. Then avoid trading when those weaknesses are apparent (say, during bear markets or during the afternoon session
when volume tapers off).
Tip #6: Worried about a trade? I remember planning to daytrade Intel (INTC) by
shorting 2,000 shares of the stock at the
open. I went to bed and worried about
the trade. Why? Because the position
size was double what I normally used.
So I got up and reduced the size of the
trade. That turned out to be a good idea
because the trade lost money (I was right
in the direction, but was flushed out when
the stock spiked upward within minutes
of the open).
A friend of mine had a similar problem.
She was having difficulty sleeping through
the night because of worries about her position in a mining stock. My advice to her
was to cut the position size until her worries
disappeared. If the stock still bothered her,
then she should sell it completely.
If you wake up in the early hours of the
night and your first thought is of trading,
then that is a good clue you have unresolved
issues. This is especially true if sleepless-

ness happens repeatedly. Do what it takes to eliminate that

stress by making adjustments such as reducing your trading
and investing more or moving into cash for a while. Or perhaps
its time for a vacation.
Tip #7: Sell when the market says youre wrong. Keep that
phrase in mind when looking at your losing positions. If the
stock did not act as you expected it to, then sell.
I like to have a diversified portfolio by owning several
securities and diversifying by trading style. I may have some
stocks that I am swing trading, some that I am position trading, and some that I am buying & holding.
The buy & hold stocks do not require much attention. That
inattention can lead to problems when a cyclical stock goes
out of favor. Perhaps the reasons for ownership have changed.
If the company sells a division that removes a source of big
profits, the stock could suffer, and its time to sell.
What sometimes happens is that Ill buy a stock and itll act
like I expected it to for a few weeks by moving higher. As soon
as my focus turns elsewhere, the stock drops. The decline is
not an in-your-face plunge of 50% in one session. Rather, the
stock eases lower day by day, eating away the meager profit it
once enjoyed. Soon, the position is losing money. The market
is telling me I made a mistake. The transition from profit to
loss is a wake-up calla sell signal. Obey it.
Tip #8: Price drops 10% from a high. A financial consultant
I know told me that she uses a 10% rule to sell her blue-chip
A blue-chip stock is a low-volatility, high-quality, highvolume security priced above $5. If it drops by 5% from a
peak, it piques her interest. She will look at the fundamentals

FIGURE 3. PRICE BREAKS SUPPORT. When a stock breaks support, as in the case of Ferro Corp. (FOE) in this
weekly chart, consider selling it.

32 May 2015 Technical Analysis of Stocks & Commodities

and try to understand the reason for the

decline. If the market is dropping as part
of a bullish move higher (a retrace in an
uptrend), for example, she will ignore
the temporary slump.
If the drop turns into a 10% decline
from the peak, she will sell at least half, but
most often, the entire position will go.
Tip #9: Market relative strength. If
you manage money for a living, either
privately with your own portfolio or
professionally by steering a hedge fund,
your goal is to beat the competition. The
competition is the market indexes.
One way to do that is to find stocks that
are outperforming the market. Heres
what you do. Divide the closing stock
price each day by the corresponding
close in the S&P index (or the index
of your choice, like the utility index
for a utility stock, as an example). You
should see one line on the chart. If the
line slopes upward, your stock is outperforming the index. If it trends lower,
the stock is performing less well.
This technique is what I call market
relative strength since you are comparing the stocks performance to the overall market. Sell stocks that are underperforming the market. I apply a moving average to the line (22 days
is what I use) to smooth out the bumps so I can see the overall
trend. The direction of the trend is whats most important. Ideally, you want to have a portfolio of stocks that are climbing
faster than the market.
Tip #10: Price breaks support. I mentioned this stock (Figure
3, weekly scale) at the beginning of this article. The stock hit
bottom at A in November 2012 and then it went on a tear.
The stock climbed in a stairstep fashion until it bumped up
against a ceiling. It slid horizontally for months, resting on
a new floor at $12.
After such a big gain from the low at $2.38, I expected it
to take an extended break. My hope was that the stock would
continue higher, resuming the stairstep move up.
When the stock poked its tail through support at C, it was
not an automatic sale. I know that these types of false signals
happen from time to time when the smart money tries to
shake out the uninformed. I monitored the stock closely and
decided to hold on. Fortunately, the stock recovered but still
continued moving sideways.
Then the stock pushed through support at D and congested
just below $12. It sat there for about two weeks. Again, I sat
and waited just in case the move was trying to shake me out of
a winning position. However, with the stock resting below support, it pushed me closer to the exit. I just needed a shove.
The push came when the stock dropped 5% in one day but

closed slightly above the open. I decided to sell the following

day. After buying the stock at $4.93, I sold it at $11.53 for a
gain of 134%.
The point of this anecdote is a simple one. When a stock breaks
support, consider selling it. In Ferros case, it was time to let it
go, so I sold. Timely selling is what this game is all about.
S&C Contributing Writer Thomas Bulkowski (who may be
reached via email at tbul@hotmail.com) is a private investor
and trader with more than 30 years of market experience and
considered by some to be a leading expert on chart patterns.
He is the author of several books including Getting Started
In Chart Patterns, Second Edition and The Evolution Of A
Trader trilogy. His website and blog, www.thepatternsite.com,
have more than 600 articles of free information dedicated to
price pattern research.
The spreadsheet file mentioned in this article is downloadable
from http://traders.com/files/VolStop.xls.zip as well as from the
Subscriber Area at our website, www.Traders.com, in the Article
Code area.

Further reading

Kaufman, Perry [2003]. Short Course In Technical Trading,

Wiley & Sons.
http://thepatternsite.com/CounterTrends.html (note this URL
is case-sensitive)

May 2015

Technical Analysis of Stocks & Commodities 33


Knowledge, Patience, Discipline

TA For The Longer

Term With
Boon Chin Low

What led to your being interested in technical analysis?

It was 1986 when I began
trading in Japanese commodities that I started in technical
analysis. There was little by
way of fundamentals, so charts were the
only thing that made sense. Technical
analysis was on the cusp of a new era in
Singapore, spurred by the publication
of John Murphys first book, Technical
Analysis Of The Futures Markets, in
1986. Still, it was tough trading commodities with huge paper charts, handdrawn candlestick bars, and trendlines,
plus moving averages calculated manually. I began to feverishly learn technical
analysis from as many sources as I could.
When I joined Merrill Lynch Singapore
in 1989 as a technical analyst, I had my
first encounter with technical analysis
software, CompuTrac. From then on, I
was hooked on TA!

Understanding the relationship

between the different time frames
helps the investor to know how the
bigger time frame trends change.

Thats interesting. You know, the premiere issue of this magazine was distributed at a CompuTrac seminar. From
your experience, do you think technical
analysis taught you things about the
market that you may not have known if
you hadnt applied technical analysis?
Certainly. Technical analysis taught me
that all markets can be reduced to the common denominator of price. And as Charles
Dow said more than 100 years ago, charts
show that markets move in trends. With
technical analysis, it is possible to forecast
market direction, something much needed
by all investors and traders.
What I hope to add to this premise
through my book Integrating Technical
Analysis For The Investor is that it is also
possible to forecast farther into the future
with the consistent application of technical analysis into the larger time frame
charts such as weekly, monthly, quarterly,
and even longer time frames.

34 May 2015 Technical Analysis of Stocks & Commodities

Applying technical analysis for investing or on longer time frames is contradictory to what most people do. Do
you combine technical analysis with
fundamental analysis and if so, how?
I think the reason technical analysis
has not been used for the longer time
frame is because there has not been
sufficient focus on using it that way.
Technicians tend to be traders and not
investors. So the use of technical analysis
tended to be skewed towards the shorter
time frame. And in recent times, time
frames have gotten even shorter.
But there is no reason for technical
analysis not to work in the longer time
frameit is, after all, still about price, albeit on a longer time frame. And investors
should discover that technical analysis
works just as well in those time frames.
Some mental adjustment is needed to get
used to the larger dimensions in time and
space, but it can be done.

Singapore skyline: joyful/Shutterstock

BC Low has been a teacher and practitioner of technical analysis

since the 1980s. He is one of Singapores earliest practitioners to
attain the Chartered Market Technician credential from the Market
Technicians Association, which is based in New York.
From 1991 to 2011, Low was a senior lecturer at Singapore
Polytechnic, where he introduced education in technical analysis to
the curriculum. He created and taught two modules of Technical
Analysis and Trading, the only formal course on technical analysis
in Singapore.
Low has been active in the Singapore Technical Analysts & Traders Society (STATS) since the 1990s. He launched the Certificate
in Technical Analysis (CTA) through STATS in 2004; he launched
the societys Diploma in Technical Analysis (DTA) in 2010. Prior to
his work at Singapore Polytechnic, Low was a technical analyst for
Merrill Lynch Bank, where he provided currency views to dealers,
private bankers, and institutional clients. Currently, he continues to
trade his own equity. His recent book release is Integrating Technical
Analysis For The Investor.
S tocks & Commodities Editor Jayanthi Gopalakrishnan
communicated with him via email in early March 2015 to find out more
about how longer-term investors can apply technical analysis.

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As far as possible, I try to avoid fundamental analysis. But once I am given
a fundamental view, I will look at my
charts to evaluate the outlook based on
the fundamental analysis and see if the
fundamental view is supported by the
technical view on the longer time frames.

If the fundamental view is divergent with

my technical views, naturally I will not
act on the fundamental view.
You integrate trend, price, and timing.
How do you determine if a trend is just
beginning or is close to maturing?
The end of one trend may signal the
start of a new trend; that is, the end of
a downtrend may imply the start of an
uptrend. There are indicators that help
investors ascertain the timing of the start
and end of a trend. One of my favorites is
the combination of a 10- and 40-period
exponential moving average (EMA).
In the simplest terms, the crossing
of the 10 EMA above or below the 40
EMA can be interpreted as the start of
an uptrend or downtrend, respectively.
I have used this combination for all
markets and all time frames, and it has
proved to be invaluable.
That sounds simple enough. You also
look at price patterns. What patterns do
you look at and how are they helpful?
My view is that trends change as a
result of changing fundamentals. But
as we know, economic fundaments do
not normally change overnight. As such,
larger reversal patterns will reflect such
changes in fundaments better than the
minor patterns will.

Calls may be monitored because these are uncertain times.

36 May 2015 Technical Analysis of Stocks & Commodities

Historically, I observed that while

reversal patternssuch as double tops
or bottoms, or head & shouldersdo not
occur frequently, trends do change all
the time. So there is a need for reliable
indicators of trend change other than
price patterns.
My use of price patterns is to have them
play a confirmation role. Once you can
establish that a trend is possibly reversing
with another indicator, you can look out
for price patterns to confirm the impending change. I find that breakaway gaps
have done very well in this respect, as
have certain candlestick patterns.
I have used this approach of using
price patterns as a confirmation tool
for many years in various markets, and
it has worked well. It places the horse
before the cart, so to speak, rather than
the other way around.
What time frame charts do you look at
when you do your analysis?
I look at time frames from daily all the
way to the quarterly. Sometimes, I even
look at the yearly chart just for a very
big picture view, but that is rare and I do
that only for exceptional circumstances.
Typically, the daily and weekly charts
are the staples; I prefer to use the weekly
chart, as it filters the noise of the daily
chart and provides earlier signals than
the monthly. As the monthly chart is
only evaluated at the end of the calendar
month, its impact will be slower, but it is
still a necessary tool for investors.
My interest in the longer time frames
led me to the important discovery
that technical signals are consistent in
whichever time frame they are used. If,
for example, the crossing of two moving
averages signals an uptrend in the daily
chart, the same is true in the weekly,
monthly, and other charts. The difference is that the time and price scales will
be increasingly larger. Because of this
consistency in technical signals across
all time frames, it is possible to achieve
longer-term views of markets. This consistency has in fact been proved with charts
dating back several decades such as in the
Dow Jones Industrial Average.
One important issue in using more
than one time frame is to understand the
relationship between the different time

frames at any one point in time. If the

monthly, weekly, and daily trends are at
odds with each other, how is the investor to make sense of it and invest? This
relationship has not been well defined in
the past. The hope is that my book will
provide investors with a clear explanation of this relationship so that they can
invest better.
Understanding the relationship between the different time frames also
helps the investor to know how the bigger
time frame trends changeit involves
the progressive changing of the shorter
time frame trends, causing the bigger
time frame trend to eventually change.
This process, described in my book, can
help investors to fathom out the likely
change or continuation in the long-term
trend of markets such as gold, crude oil,
and the US stock indexes.
What are some of your favorite indicators?
Despite my constant refrain for investors not to look for the holy grail in
indicators, my most important indicator
is the 10 & 40 EMA combinations, as I
mentioned earlier. It has a proven track
record and is unique in being able to perform more than one important function
well, and that is to forecast future trends,
to monitor the process of a change in
trend, and to provide important support
or resistance levels in a trending market.
Few other indicators can achieve that
much that well.
The other indicator I like a lot is
George Lanes classic stochastic oscillator, because of its ability to signal quick
turns in the market under certain market
conditions. However, I recommend that
investors understand the specific role that
stochastics is equipped to play, and not
expect it to perform more than it can. A
sprinter is not a marathon runner, and
vice versa.


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Trading is about probability. How does
applying TA for the longer time frame
improve your odds of success?
Ill start with Charles Dows axiom
that markets move in trends. If you look
at the longer time frame charts, the trends
are more clearly discernible because the
short-term gyrations are filtered out. However, as you get into the shorter time frame,
say, daily or intraday, the shorter-term
gyrations complicate the view of the trend.
This greater shorter-term uncertainty
increases the probability of making the
wrong decision or lowers the probability
May 2015

of making the right decision.

Most people will think that trading for
the longer term is more forgiving. Is it,
or do you still have to have as much
discipline to gain the higher returns?
The use of the longer time frames
gives the investor expanded space to
place the stops in return for catching the
bigger returns from longer-term moves.
If the investor focuses on the long term,
the day-to-day market gyrations may
not impact the bigger trend. Because of
that, you can be misled into thinking

Technical Analysis of Stocks & Commodities 37

that discipline can be more relaxed,

but that should not happen. Key market
levels of longer-term charts should still
be identified and earmarked for action
even though they may be further away.
In other words, the same discipline is
needed for the longer time frame as it
is for the shorter.
How much of an influence does fundamental analysis have on your investment decisions?
While trends are underpinned by
market fundaments, technicals, in my
opinion, pinpoint the timing of trends
more clearly and visibly. I find that
technical signals tend to front-run the
fundamentals, such that when the news
finally appears, good technical signals
would have already been triggered and
the move is well underway.
In fact, when I am given a fundamental
view of a market, I immediately refer to
my charts to evaluate the fundamental
What are the important factors to
be mindful of when managing your
There are many factors to bear in
mind, but since I am advocating the use
of technical analysis for investing long

term, I wish to emphasize that investors

should not neglect their positions just
because they are long term. Investors,
like everyone else, lead busy liveswork,
family, and social. So when a position
is profitable, they tend to just let it run
and take no action. But as markets move
in trends, they eventually turn bearish
and wipe out what was previously a
profitable position. This is one of the
more common and serious errors in
investinginvestors do not plan the exit
of their positions enough.
In my experience, investors are more
focused about entering the market, but
not so much in exiting. Investors must
monitor their investments regularly; and
while identifying a good time and price to
exit a position may not be easy, neglecting
the positions is not an option.
From your book, it appears as if you
use indicators and patterns that are in
the public domain. Do you rely on these
tools or do you come up with your own
indicators or tools?
In my practice of technical analysis the
past 30 years, I have focused on achieving better interpretation and integration
of indicators rather than creating new
indicators. There are enough good indicators out there, so why not understand

them better and make more effective

use of them?
The three basic needs of an investor or
trader are to correctly define the trend,
and based on the trend, the optimum
timing and price to enter and exit the
market. This means assembling a tool
box of effective trend, timing, and price
indicators, and then integrating them for
the best outcomes. However, the investor
should also be aware that his technical
tool box is a dynamic one and he should
constantly look out for better indicators
over time.
Having said that, I innovated on J.
Welles Wilders famous indicator, the
directional movement index (DMI), a
few years ago by creating three clusters
each of the ADX, +DI and DI lines.
[Editors note: For an explainer on the
ADX indicator, see sidebar The ADX.]
I named my indicator DMI clusters and
its function is to identify the timing of
the highest or lowest bar in a trend. For
example, on the weekly chart of the
NASDAQ Composite in Figure 1, you
see how the market top is signaled by
the ADX cluster peak at 90 and the 3X
-DI cluster bottom at 5.
I have since used it for five years
with very good outcomes. In fact, you
published my article Identify The Start

Directional Movement -DI (15.0000), Directional Movement -DI (12.0000) Directional Movement -DI (8.00000)
- DI < 5
- DI < 5
Directional Movement ADX (71.0000) Directional Movement ADX (43.0000) Directional Movement ADX (56.0000)

3X ADX cluster turning

down around 90


- DI < 5


3X ADX cluster turning

down around 90

USA - Nasdaq 100 index (2,821.03, 2,823.34, 2,780.24, 2,784.89, -40.2202

Market top

Market top


Market top





Dec 2010




Dec 2011




Dec 2012





FIGURE 1: MARKET TOP. On this weekly chart of the NASDAQ Composite, the market top is signaled by the ADX cluster peak at 90 and the 3x DI cluster bottom at 5.

38 May 2015 Technical Analysis of Stocks & Commodities

Of A Trend With DMI on this topic in

the November 2012 issue of Technical
Analysis of Stocks & Commodities.
Yes, we did. [Readers can find that
article in our article archives at our
website, www.traders.com.] Would you
say that technical analysis has gained
more respect than when you started using
it in the 1980s?
Yes, TA is better understood today
than when I started 30 years ago. There
must be hundreds of books on the subject
of technical analysis alone. Its use has
expanded from end-of-day to intraday
markets, from off-line to online and to
more markets globally than ever before.
There are also many more technical indicators and approaches today compared
to the past.
Despite the proliferation in the application of TA among trading professionals, I still feel that TA is still not well
understood by the investor community.
By nature, technical analysis tends to be
numeric or quantitative, and as such, it is

Key market levels of longer-term charts

should still be identified and earmarked for
action even though they may be further away.
suited to individuals who are comfortable
with numbers. Investors not inclined that
way still feel more comfortable with the
intuitive logic of fundamental analysis.
This is why I have written my book
in a concise manner so that it can be
understood by investors. My hope is that
with this book, the lay investor can make
better and more profitable decisions in
their investments.
Thank you for sharing your thoughts,

Stocks & Commodities, Volume

29: April.
Low, BC [2014]. Integrating Technical
Analysis For The Investor, Technical
Analysis Consultancy.
[2012]. Identify The Start Of A
Trend With DMI, Technical Analysis
of Stocks & Commodities, Volume
30: November.
[2010]. Trading, Time Frames,
And Trends, Technical Analysis of
Stocks & Commodities, Volume
28: September.

Further reading

Gopalakrishnan, Jayanthi, and Bruce

Faber [2011]. Then And Now With
Tim Slater, Technical Analysis of

The calculation of the average directional movement (ADX) indicator
is built on the intuitive notion that a trend is a series of price ranges
extending in a consistent direction.
In sidebar Figure 1, example A, the second days trading range is
higher than the first days trading range, indicating positive directional
movement. In example B, the second days trading range is below the
first days trading range, an indication of negative directional movement.
Example C is more complicated because the second days range is both
lower and higher than the first days range.
Directional movement is only considered to be up, down, or not
present. Therefore, the larger part of the days range extending beyond
the previous days range is used to identify directional movement. In
example C, the largest part of the second day is higher; consequently,
the directional movement is positive. In example D, the largest part of
the second days range is lower so that the directional movement is
negative. In example E, the second days range is within the first days
range so the directional movement is zero.
Directional movement for the ADX is expressed as a function of true
range (TR). True range is the largest of the following:

Directional Movement Examples







1 The difference between todays high and todays low

2 The difference between todays high and yesterdays close

3 The difference between todays low and yesterdays close.
In the Excel 4.0 spreadsheet (sidebar Figure 2), the first calculation
for ADX is the true range value. This is performed in column E. The
formula for cell E3 is:


Next, column F determines the positive directional movement or

returns zero if there is no positive directional movement. The formula
for cell F3 is:
May 2015

Technical Analysis of Stocks & Commodities 39


Column G calculates the negative directional movement or returns
zero if there is no negative directional movement. The formula for
cell G3 is:
The daily calculations are volatile and so the data needs to be
smoothed. First, sum the last 14 periods for TR, +DM and DM. The
formula for summing the TR is in cell H16:
The formula for summing the +DM is in cell I16:
The formula for summing the -DM is in cell J16:
The smoothing formula for the TR14 column begins at cell H17:
The smoothing formula subtracts 1/14th of yesterdays TR14 from yes
terdays TR14 and then adds todays TR value.The rounding((truncating
function is used to calculate the indicator as close as possible to the
developer of the ADXs original form of calculation (which was done
by hand).
The smoothing formula for the +DM14 column begins at cell I17:

to calculate the ratios of +DM and DM to TR. The ratios are called the
+directional indicator (+DI) and directional indicator (DI). The formula
for the +DI column begins at cell K16:
The formula for the +DI column begins at cell L16:
The INT (integer function) is used because the original developer
dropped the values after the decimal in the original work on the ADX
indicator. The next step is to calculate the absolute value of the differ
ence between the +DI and the DI. This is done in column M and the
formula for cell M16:
The next column calculates the sum of the +DI and DI. The formula
for cell N16:
The next step is to calculate the DX, which is the ratio of the ab
solute value of the difference between the +DI and the DI divided by
the sum of the +DI and the DI. This is done in column O. The formula
for cell O16:


The final step is smoothing the DX to arrive at the value of the

ADX. First, average the last 14 days of DX values. The formula for
cell P28:

The smoothing formula subtracts 1/14th of yesterdays +DM14 from

yesterdays +DM14 and then adds todays +DM value. The smoothing
formula for the -DM14 column begins at cell J17:

The smoothing process uses yesterdays ADX value multiplied by

13, and then add todays DX value. Finally, divide this sum by 14. The
formula for cell P29:



The smoothing formula subtracts 1/14th of yesterdays DM14 value

from yesterdays DM14 and then adds todays DM value. Now we
have a 14-day smoothed sum of TR, +DM and DM. The next step is
40 May 2015 Technical Analysis of Stocks & Commodities

Readers can find a copy of this ADX spreadsheet file at our website, www.
traders.com, in the Article Code area in the May 2015 issue listing.

Explore Your Options

Got a question about options? Tom Gentile started his trading career on the floor
of the American Stock Exchange in 1994. He has appeared on many financial TV
and radio shows, as well as hosting a weekly talk show himself, and has co-authored
many books on the markets. He can be found at www.tomgentile.com. To submit a
question for Tom Gentile, post it to our website at http://Message-Boards.Traders.
com. Answers will be posted there, and selected questions will appear in a future
issue of S&C.
Tom Gentile

Which way will oil and energy prices go
as we head into the spring and summer
months, and how can you trade these
As spring creeps up on us, so does
the winter thaw out of the Northeast.
For much of the winter season, record
amounts of snowfall blanketed the northeastern part of the United States, with
some storms so fierce, they were given
names such as Pandora and Thor.
Those poor Noreasters, as I like to
call them, are happy that the winter
season of 20142015 is finally behind
them. So much so that cabin fever is
in full effect from North Carolina up to
Maine. People are eager to get out and
travel, and this should bode well for oil
and gas demand.
This year presents us with different
problems that were not around last season. For instance, there is a much greater
supply of oil worldwide, so perhaps prices
will shift up and down more on the
economy and off of international growth
than before. The move in oil over the last
year presents risks that were unseen in
years, no matter how much the demand
for oil might occur this summer. How
can a trader capitalize on this potential
opportunity with minimal risk?
If theres one thing that oil markets are
yielding these days, its uncertainty. All
of this uncertainty about the future price
of oil has option premiums exploding this
year versus last year. Looking at the chart
in Figure 1, this tells an option trader that
premiums on USO options look to be
three times higher than at this time last
year. Thats like seeing your car insurance go up triple for the same coverage.
Good for the insurance salesman, bad
for you. The one thing we dont want
to do as option traders is buy expensive

options. So whats a trader to do, when

opportunities present themselves in a
market such as oil and energy?
Become the insurance salesman
The best way to capitalize on this opportunity is to become an option seller.
Selling options increases your probability
of being right over time, but the risks if you
are wrong increase as well, and in some
cases can be unlimited risk. So how do
insurance companies stay in business after
a hurricane blows through and everyone

starts calling in claims? Easy. They cut

their losses by reinsuring with a bigger
company. So for instance, lets say that
ABC insurance sells $50 million in home
insurance and they want to hedge their
risk. What they do is perhaps reinsure so
that if claims go over $100 million, they
are covered from that point on. Their risk
is between $50 and $100 million, but no
more. You want to do the same thing
with options. In Figure 2 is an example
Continued on page 45

Figure 1: exploding option premiums. Premiums on USO options look to be three times higher than
this time last year.

Figure 2: hedging your risks. Here youre selling the 16 puts and hedging the 14 puts for a combined credit
of 0.50 or $50 per spread. A credit spread has limited reward and risk. The risk is that USO drops in value, causing
the price of puts to rise. The most you can lose is the difference between strikes minus the credit received.
May 2015

Technical Analysis of Stocks & Commodities 41


product review

Haguro Method
90 South 400 West, Suite 620
Salt Lake City, UT 84101
Phone: Sales 800 508 9180,
support 801 265 9998
Email: sales@metastock.com,
Product: MetaStock add-on
based on the Haguro method
System requirements: Windows 7 and above, 2.4GHz
or higher, 4GB RAM, 1.6GB
disk space
Price: Free


by S&C Staff

he Haguro method ofprice

analysis was written about
by Seiki Shimizu in his
book The Japanese Chart
Of Charts, and we published
13an article
12 10on the
14 method
Gary Burton in the April 2015
issue of Technical Analysis of
Stocks & Commodities. The
method has now been adapted
as a MetaStock add-on, which
is available to MetaStock users
at no additional cost. You can
download the add-on from www.
metastock.com/haguro. Burton,
director of the Australian School
of Technical Analysis, had translated Shimizus work, and Jeff
Gibby, Business Development
Manager for MetaStock, saw a
presentation by Burton on the
method while attending a conference in Australia. Since Gibby
manages the development of
new software for MetaStock and
also trades the market himself,
Gibby is well-qualified to evaluate new methods and strategies.
What he saw in the Haguro
method was unique, he thought,
and could be a potentially profitable method to use.



Here, we see the open

& close below the
midpoint of the line.




This example shows

the open & close above
the midpoint of the line.




Figure 1: Candlestick Versus Midpoint. Candlestick patterns are

given a specific number to identify them. There are two groups with eight
patterns in each. One group will be based on bodies where the close is
greater than the open (the green candle on the left). The other group uses
candlesticks where the body is red (that is, close<open). Within each group,
specific patterns are based on the relationship of the body to the midpoint.




Figure 2: Identifying Numbers for Up Candle Bodies. Again, the

reference to line means range. The middle point is the midpoint calculated
as explained in the text of this article.











Figure 3: Identifying Numbers For Down Candle Bodies.

These down candle bodies versus midpoint have been put in the same
order as those in Figure 2. Note that the Haguro numbering is no longer in
ascending order.

42 May 2015 Technical Analysis of Stocks & Commodities

Given that the Haguro method is

Japanese in origin, it shouldnt
come as a surprise that it employs
candlesticks. The current encoding of the method is designed
to work with weekly charts.
There may be a daily strategy
worked out somewhere, but its
not simply a matter of changing periodicity. For example,
when using weekly charts, gaps
and other events are just about
There are two parts to this
strategy. The first part looks at
where the candle is relative to
the midpoint of range, and the
second looks at where the close
of the week is relative to the last
peak or valley of a 7% zigzag.
Theres no user manual that tells
you how to trade this strategy,
but there is a video available on
YouTube titled Trading The
Haguro MethodJeff Gibby
that you can take a look at.

Range midpoint

and candlestick
body position
Well tackle the first part using
charts from the video for some
of the explanation. The relationship of the body to a midpoint
and whether the body is green
(close>open) or red (close<open)
(Figure 1) will determine the
identifying pattern number
(Figure 2 for green bodies and
Figure 3 for red bodies). Calculating the midpoint is simple:
Its just (high+low)/2. But which
midpoint do you use? Do you
use this weeks midpoint, the
one from the previous week, or
one from another week? You
use the midpoint for the week
with the largest range, which

you determine by comparing the current week to the previous week and the
weeks before that.
To give you an idea of how these
patterns are employed with a price chart,
well consider two patterns: number 3
(see Figure 2) and number 16 (Figure
3). The number 3 pattern is frequently
found in reversals. Pattern 16 is one that
covers the middle of the range. According
to Burton, the strong trading period is
one where the range and body are visibly larger than in preceding weeks. It
is considered to be the soldier guarding
the area going forward, and the weakest
part of the soldier is the midriff, which, if
pierced, will result in certain death.
There are eight occurrences of pattern
16 in Figure 4, with the first three being
pointed out. As you can see in Figure
4, the midpoint acts as resistance on
the left-hand portion of the price chart.
Later on, the midpoint acts as support.
Also shown in Figure 4 is an example
of pattern 3 in action; note that pattern
3 is part of a trend and that it precedes a
trend reversal typically by two or three
weeks. Finally, Figure 4 shows the two
indicators that are part of the Haguro
method, namely Haguro - % in range
zigzag and Haguro range. In this case,
the nearest zigzag peak or value (based
on a 7% zigzag) was used as a reference
point to calculate the percentage between
the valley or peak and this weeks closing
price. The number 3 pattern has the most
significance if it occurs when the market
is overextended because of the indicator
above the price chart exceeding 7%.
As youve probably figured out by
now, the pattern numbers do matter. To
help with this, there is a template as part
of the add-on. In Figure 5 you see the
same weekly chart of GM but with the
Haguro template applied. The template
labels every candle with its identifying
number. The dark line with horizontal
segments represents the midpoint.
The number 2 pattern is considered
a strong buy pattern and is seen as the
second candle in April in Figures 4 and 5
(also seen as the point where the midpoint
changes from resistance to support). But
you dont have to memorize each of the
patterns and what they mean. All you
have to do is to add expert commentary

The pattern you are looking for is no. 16 (see Figure 3)

AND the candle body and range are visibly larger than
those of the preceding weeks, and thus the midpoint goes
through the middle of the body

No. 3 pattern
(see Figure 2)

FIGURE 4: WEEKLY CHART OF GM (General Motors). Here you see the two indicators of the Haguro method. In the
price chart, a black line with horizontal segments goes through the candles and is the midpoint calculation. The candles with
the greatest range dictate the value of the midpoint. Above the price chart in an inner chart window is an indicator designed
to show normal versus extreme behavior. Note that the number 16 pattern appears eight times on this price chart.

The strategy looks at where the candle is

relative to the midpoint of range and where
the close of the week is relative to the last
peak or valley of a 7% zigzag.

Figure 5: Weekly GM (General Motors). Applying the Haguro template to the price chart makes it easy to see the
patterns. Every candle is labeled with its identifying number. The dark line with horizontal segments is the midpoint. In the
first week of March (center of chart) the candle is labeled as 12 because there is no upper candle wick. But given its wide
range, its a player in dictating price movement. The midpoint serves as resistance & support. In the earlier weeks on the
left, the midpoint line acts as resistance, but in the middle of chart (April 2014), the midpoint acts as support.
May 2015

Technical Analysis of Stocks & Commodities 43

to your chart (Figure 6). When you do,

youll get an explanation of whatever
candle is identified by the commentary
(seen as text to the right of the price
chart in Figure 6). Not surprisingly, the
commentary will tell you that the pattern is more significant if it is occurring
when the 7% Haguro range indicator is
showing a value above or below 7%. The
indicator is displayed above the price
chart in Figure 6.
In this particular example, the commentary included this text: The range of
this stock has extended more than 7%.
This is again a reference to the indicator
at the top of the chart and it identifies the
percentage change in price as measured
from the last 7% zigzag peak or valley
that is greater than (+) 7%.

Other features

Two additional explorations are part of

the add-on. The user manual for this addon is the video available on YouTube that
was mentioned toward the beginning of
this review. One thing to keep in mind,
to avoid confusion, is that Burton often
uses the terms longer line or shorter line
to refer to range.


What a deal. This add-on makes use of

many great features of MetaStock such
as expert advisories and explorations.
MetaStocks user interface is straight-

A PrioriKnown ahead of time.

Average Directional Movement Index (ADX)
Indicator developed by J. Welles Wilder to
measure market trend intensity.
Average true rangeA moving average of
the true range.
Back-restingA strategy is tested or optimized on historical data and then the
strategy is applied to new data to see if
the results are consistent.
Candlestick chartsA charting method,
originally from Japan, in which the high
and low are plotted as a single line and are
referred to as shadows. The price range
between the open and the close is plotted
as a narrow rectangle and is referred to as
the body. If the close is above the open,
the body is white. If the close is below the

This caret is controlled

by arrows at the top of
the commentary

Figure 6: Weekly GM (General Motors). Starting with the price chart shown in Figure 5, two changes have been
made. Most apparent is the addition of expert advisory commentary on the right. A black caret on the price chart points
to the candle being described. You can control placement of the caret by using the arrows at the top of the commentary.
Each pattern is explained for you.

forward and robust. Gibby did the coding, and the formula language he used
is clever and short. To use this add-on,
you need MetaStock. If you dont already
use MetaStock and are looking for a
charting platform, consider that it has
been the recipient of numerous Readers
Choice Awards in this magazine and is
a top-notch program. Technical support
is extremely capable and free.

Further reading

open, the body is black.

Chandelier exitA stop order calculated
based on either the highest high or the
close and some multiple of average true
DrawdownThe reduction in account equity
as a result of a trade or series of trades.
Dynamic link library Refers to a group of
small programs that can be used (called)
by your main program while running
under Windows.
Efficient market theoryAll known information is already discounted by the market
and reflected in the price due to market participants acting upon the information.
Fast Fourier transformA method by which
to decompose data into a sum of sinusoids
of varying cycle length, with each cycle

being a fraction of a common fundamental

cycle length.
Market makerA broker or bank continually
prepared to make a two-way price to purchase or sell for a security or currency.
Moving average convergence/divergence
(MACD)The crossing of two exponentially smoothed moving averages that are
plotted above and below a zero line. The
crossover, movement through the zero
line, and divergences generate buy and
sell signals.
Volatility indexA widely used measure of
market risk. Sometimes referred to as the
investor fear gauge.

44 May 2015 Technical Analysis of Stocks & Commodities

Burton, Gary [2015]. Candlesticks And

The Haguro Method, Technical
Analysis of Stocks & Commodities,
Volume 33: April.
Shimizu, Seiki [1990]. The Japanese
Chart Of Charts [English translation],
Shroff Publishers.

Explore Your Options


Continued from page 41

using USO.
USO as of this writing sits just above
$18. You believe the price will be above
$16 by summer, but want to be covered in
case you are wrong. You create a credit
spread using puts, selling the 16 puts
and buying the 14 puts for a combined
credit of 0.50 or $50 per spread. This is
the most that you can receive, if USO is
above $16 by mid-July. What are your
costs and risks of this type of spread?
A credit spread, as this is, has limited
reward and risk. The reward is limited
by the amount of money received, as you
make money when the spread drops in
value to zero. So whats the risk? The
risk is that USO drops in value, causing
the prices of puts to rise, so much so
that the 16 and 14 puts are deep in-themoney. The good news is that because
of the purchase of the 14 puts, the most
that can be lost is the difference between
strikes, minus the credit received.
Lets dive into this a bit deeper. Looking at Figure 3, this chart shows what
could happen if the price of USO were
to rise, fall, or stay the same over time.
Figure 3 clearly shows where the price

FIGURE 3: PLAYING THE NUMBERS. Oil has a 68% chance of being above the sell price of $16, and a 95%
chance of being above $14 by mid-July. You have a 68% chance of keeping the full amount collected ($50 per
spread) and a 5% chance you will lose $150 per spread.

of USO is on the left, as well as where

you dont want it to go. Statistically, oil
has a 68% chance of being above the
sell price of $16, and a 95% chance of
being above $14 by mid-July. This means
theres a 68% chance of keeping the full
amount collected ($50 per spread) and
you have a 5% chance that you will lose
$150 per spread.
This is exactly how insurance companies workthey play the numbers,

spread their risk around different areas,

and most important, they reinsure in
risky demographics, where premiums are
highest. Do yourself a favor: If you are
going to sell option premiums, do what
the insurance companies do. They have
been in business a long time, and they
will be here long after we are gone!

orders. This discourages participants

from placing passive limit orders on the
exchanges, which, at certain levels, may
impair public price discovery.
Further, we are concerned about the
so-called dark markets (that is, nondisplayed bids & offers) in the marketplace. Because of this, we recommend
that one of the tests be modied to
restrict brokerdealer internalization
to see if market quality improves in the
underlying securities.
The pilot program is currently sched-

uled to begin in May 2015 and is expected

to run for 12 months. Thus, it will be a
while before changes are implemented.
Readers can view our complete comment
letter at http://www.sec.gov/comments
/4-657/4657-82.pdf or can read more
about the pilot program itself at the
SECs website.
I will be interested to see the data
that the SEC starts to gather on the pilot
program later this year. Ill return to this
topic then.


Continued from page 29

of the programs terms hurt the case for

price improvement, and we address this
in our submitted comments.
We strongly believe that the lack of displayed liquidity in the small-cap space is
primarily due to the rise in off-exchange
trading and brokerdealer internalization. Displayed market makers are setting the price but not getting the reward
of getting the execution on their limit

May 2015

Technical Analysis of Stocks & Commodities 45

product review

MetaStock XIV
90 South 400 West, Suite 620
Salt Lake City, UT 84101
Phone: sales 800 508 9180
Email: sales@MetaStock.com,

Product: Trading platform

System requirements: Windows 7
and above, 4GB RAM, 1.6GB disk
space; see website for specifics
Price: Daily charts, $499; real-time,

by S&C Staff

etaStock has had a devoted

following since its early
days and continues to have
one. Its a terrific product that has only
gotten better. In this version, navigation
is more robust, the Forecaster tool has
been enhanced, and theres a new trading
system thats part of version 14, just to
name a few of the changes. Well start
by looking at the power console.

Power console

FIGURE 1: POWER CONSOLE SCREEN. On the far left are tabs you can use to select one of four major categories. For this screen capture, the major category chart was selected, but explore, system test, and forecaster are
alternative choices. To the right of the tabs is a split screen, with the left-hand portion being an instrument (that is,
equities) tree structure and the right being chart options, such as the number of records to load and whether or
not to use a template. At the top of the instrument tree for this screen capture, it reads Instruments 1 of 359972.
This means one instrument out of a possible 359,972 has been selected. Using the tree structure and looking for a
1 of type of statement, the next class of items is public online data lists, followed by equities North America,
and then US ETF. From the list of ETFs, we selected the symbol QQQ.O.

FIGURE 2: PUBLIC LIST EDITOR. Choose an item from the left and then an action using the buttons in the
middle to add, remove, or remove all from the list on the right. If you dont like the order of the items in this newly
created list, select one and move it up or down using the move up and move down buttons on the right. You can
create a header to name your list. Use a button on the right or pick a header from the left-hand list of equities and
add it to items on the right.

46 May 2015 Technical Analysis of Stocks & Commodities

In Figure 1 you see the new look of the

power console. If you are familiar with
MetaStock, the first thing youll notice
is the split screen. On one side is a tree
structure that lets you find the instrument
you want to use in your analysis. The
advantage of the tree structure is you can
start with a broad class of securities and
then use subclasses to narrow your search
to view only your pertinent subclass of
equities. Since the charts tab on the left
was chosen, the right side of the screen
lets you choose chart periodicity, use of
a template, how many records you want
to load, and more. Its not obvious from
the screenshot for Figure 1, but you can
resize the power console screen. In earlier
versions, it was a fixed size.
At the very top of the tree list shown
in Figure 1 is the word instrument. If you
right-click on it, you will be prompted
with a screen that asks if you want to
manage your public online data list
or build a custom list. If your focus is
going to be North American instruments,
it might make sense to pare down the
tree a bit. Lets say you select manage
public lists You get a screen similar
to what you see in Figure 2. Its simple
to use. All you have to do is scroll down
the list on the left, and use the buttons in
middle, that is, add, remove, and remove
all, and create a list of items you want to
see. Give this newly formed list a name
by using the header button. Then, the
next time you use the charts tab in the

power console, youll see just the list

you have created.
Other bells and whistles have been
added to this revised power console
interface, but one worth noting is that
you can now open a chart using a
template with several different periods.
For example, if you have a template
that has three charts with monthly,
weekly, and daily periodicities, you
can open that three-chart layout from
the power console. Prior to version 14,
if you opened that kind of template,
the software would have selected one
of the periodicities and used it for all
of the charts. Speaking of periodicity,
you can now create bars using ticks.
The interface defaults to a selection of
Fibonacci numbers. All of this is well
and good, but what will really tickle the
trader is the Forecaster.


This ingenious, clever feature unique to

MetaStock has been made better. Heres
the idea: Suppose you wanted to know
what a price would do after a technical
event such as a Bollinger Band upward
breakout. Ideally, you would like to
see some sort of depiction of the probability of price change after this event
has occurred. When you say after, it
could range anywhere from a few days
up to 90 days. What Forecaster does is
find out, on a purely statistical basis, if
price moved in the direction you thought
it would, based on the technical event
that occurred.
MetaStock has over 70 events you can
choose from. If you are not exactly sure
what a specific event is, you can click on
the event and get a short and complete
textual description. In version 14, in
addition to adding six new events and
more ways to sort the results, MetaStock
has added the ability to draw your own
pattern and have the software match it
against a price series.
There are a couple of ways to go about
doing this. You start from the power
console, select the Forecaster tab, and
follow an instrument from the tree.
You are now in the Forecaster, which
has its own window separate from the
MetaStock XIV window. Heres where
you are going to make a decision about

FIGURE 3: Forecaster Price and Volume Chart. The title above the price series chart displays the symbol and
the last event used from the library. The gray highlighted square overlaying the price series is the result of clicking & dragging a special mouse icon created when you choose user-defined pattern select in the upper right-hand corner. As soon
as you click a second time, the area where you want to base your pattern is created and the dialog screen overlaying the
price appears asking you if you are done with the selection portion of the price chart with the pattern you want.

which way you want to go. You can

draw the pattern free-hand, or you can
start with the price series youve chosen
and locate the pattern you want. Lets try
the latter because it illustrates some of
the steps you would go through if you
choose the path of starting with a freehand drawing and then seeing how well

it fits a price series.

In the Forecaster window there are
two tabs: forecast analysis and event
recognizer library. Choose the former
and then choose the price, volume, and
event markers tab to arrive at a chart with
your selected price series. Clicking on a
button in the upper right allows you to

Figure 4: Price Pattern Editor. The top portion reflects the pattern you identified in the price series defined in
Figure 3 by clicking & dragging the mouse cursor over the area of interest in the price series. Circles connect straight-line
segments. The circles correspond to closing prices from your price series, and only the closing prices that require a change
in direction. You can use your mouse to alter the shape of the pattern, you can decide how many price bars you want in the
pattern, the sensitivity, and your cloud focus. Theres a button on the lower-left corner of the circle and line diagram that
allows you to get the pattern quick test, which is displayed in the bottom portion with green and red segments.
May 2015

Technical Analysis of Stocks & Commodities 47

Figure 5: Forecast Cloud. This forecast cloud shows the probability (shown as different colors, for example, blue is about a 50% probability) on a grid that uses
price percentage for the y-axis and bars after the event for the x-axis. The thermometer on the right is a scale showing which color corresponds to which probability.

use your mouse in a click & drag fashion

to identify the portion of the price series
you want for your pattern (Figure 3).
In Figure 3 you see a dialog screen
overlaying the price series. In that dialog
screen is this question: Do you want
to capture the selected price formation
as a user-defined pattern? If you select
the yes button on the right, itll result
in the upper portion of the screen you
see in Figure 4. The series of straight
lines drawn between the circles is a
representation of the pattern you located
in Figure 3. You can take your cursor
and move the circles to draw a slightly
different pattern or you can create a new
one. You can now name your pattern to
save it in the event library. Next, you
can click on the button pattern quick
test, which will display what you see in
the bottom portion of Figure 4.
The quick test allows you to scroll
your price series underneath your pattern
to see how well it fits other parts of the
price series. This makes perfect sense
since you have the ability to alter the
shape of your pattern using the circle and
line diagram that is displayed above the
pattern quick test. When you get to the
point where you are satisfied with the

pattern, you can easily save it in the event

recognizer library, which is one of the
first tabs you could have chosen from the
Forecaster window. Once saved, you can
select the pattern and request the software
to find out how well it did in actual use
by selecting the tab that lets you see the
forecast cloud (Figure 5).
You get to make a couple of important
inputs from the screen shown in Figure 4.
One of these is pattern match sensitivity.
You have three choices: high, medium, or
low. The idea behind these three choices
is to give the user the ability to say how
closely they want to have the pattern
match a part of the price series. If you
select low sensitivity, youll have more
events but the match may not be too close
to what youre looking for. You could go
to the opposite extreme and select high
sensitivity, in which case youll probably
get fewer events but with a much better
match. A key element in this process is
that a cloud will not be drawn if there are
fewer than three events. In other words,
your pattern must match some part of the
price series at least three times. Thus, a
key result is in the heading of Figure 5,
which states that the cloud is based on
the most recent 14 events.

Navigation is more robust, the Forecaster

tool has been enhanced, and there is a
new trading system in this version.
48 May 2015 Technical Analysis of Stocks & Commodities


Another feature of MetaStock XIV is

the LCI trading system. It is so robust
that it will take a second review to cover
it sufficiently. Suffice it to say, it is a
system based on support & resistance
using support & resistance calculations
and Fibonacci levels.
You can find a number of webinars on
YouTube that will help you understand
how to use the Forecaster feature and
the LCI system. There is also friendly
and knowledgeable support available at
no extra cost.


With navigation made easier and more

features added to the Forecaster, this
new iteration has made an outstanding
product even better.

Further reading

Gopalakrishnan, Jayanthi [2013].

Charting The Future With Scott
Brown (interview with CEO of
MetaStock), Technical Analysis of
Stocks & Commodities, Volume
31: October.
S&C Staff [2013]. MetaStock 12,
product review, Technical Analysis
of Stocks & Commodities, Volume
31: January.
S&C Staff [2014]. MetaStock XIII,
Technical Analysis of Stocks &
Commodities, Volume 32: March.


NeuroShell Trader has announced
new payment options. Users can now
choose from several lease plans as well
as monthly plans for purchasing the
software. NeuroShell Trader helps users to quickly build, optimize, and test
trading systems without having to write
any code. Its features can help the user
to develop trading systems with traditional indicators and rules combined
with genetic optimization and neural
network predictions. With the goal of
saving the user time, the program offers
creation of trading systems and predictive models for multiple instruments in
one pass. NeuroShell Trader works with
stocks, forex, futures, and commodities,
and the user can perform cross-market
analysis by combining datastreams in
predictive models.



CBOE Holdings announced it entered
into a licensing agreement with London Stock Exchange Group (LSEG)
to develop and list options based on
more than two dozen FTSE and Russell
indexes. Under the agreement, cashsettled options on these indices will
now be available to trade in the United
States on the Chicago Board Options
Exchange (CBOE). In addition, as part
of the agreement, CBOE and LSEG
will collaborate on new index options
products and investor education.



Fidelity Investments has announced a
financial app for the new Apple Watch,
which is planned to debut on April 24,
2015. The Fidelity Mobile app for Apple
Watch gives users an overview of global
markets as well as alerts on stocks and
investments in real time right on the
users wrist. The watch app connects
to the users iPhone for more in-depth
research and the ability to go from trade
alert to placing trades.
Fidelity states it has a goal to make
financial expertise broadly accessible.
It has $5.0 trillion in assets under
administration, including managed assets
of $2.0 trillion. Its customers include
individual investors as well as businesses
for which Fidelity manages employee
benefit programs. Fidelity also provides
technology solutions to advisory firms.

natural gas, and US power, which will

launch sometime in 2015.
TT also announced an agreement to
partner with Fundamental Analytics,
a provider of charting and analytics
software for energy and agricultural
markets. This will allow TT clients
to access Fundamental Analytics
fundamental data and price behavior
information through a web-based
interface. This analytics package allows
users to merge fundamental data with
price data and to identify cyclical
patterns, anomalies, and correlations for
outright contracts as well as spreads.


TradeGuider has launched a new generation of its Volume Spread Analysis
software at www.vsaforforex.com.
TradeGuider 4.5 scans multiple charts
in multiple time frames to help identify
high-probability, low-risk VSA trade
setups. It sends the user an email and/or
audible alert when a setup is found.



Trading Technologies International
(TT), a global provider of professional
trading software, and Nasdaq announced
that TT will introduce connectivity to
Nasdaq Futures (NFX), the exchange
groups US-based designated contract
market (DCM) through both its TT and
X_TRADER platforms. Through NFX,
Nasdaq will expand its commodities
business with futures and options on
key energy benchmarks including oil,
May 2015

www.VSAforforex.com, TradeGuider.com

Technical Analysis of Stocks & Commodities 49

For this months Traders Tips,

the focus is Giorgos Siligardos'
article in this issue, Filtering
Price Movement. Here, we present the May 2015 Traders Tips
code with possible implementations in various software.
Code for MetaStock is already provided by Siligardos
in his article, which S&C subscribers will find in the Subscriber Area of our website:

Traders.com HomeS&C Magazine

S&C Article Code

The code for the Traders Tips section is posted here:

Traders.com HomeS&C Magazine

Traders Tips

(Or from Traders.com, scroll down to the current articles

section and click on the Traders Tips tab.)
The Traders Tips section is provided to help the reader
implement a selected technique from an article in this issue or another recent issue. The entries here are contributed by software developers or programmers for software
that is capable of customization.


In Filtering Price Movement in this issue, author Giorgos
Siligardos describes a process to analyze historical market
data. He begins by describing a concept that he refers to as
perceptually important points (PIPs), which he uses to identify
price extremes. From these, he creates an indicator he calls
zzTOP that identifies these points and then connects them
using trendlines.
For convenience, were providing the code for a TradeStation indicator based on the authors description.
Indicator: _zzTop
using elsystem;
using elsystem.collections ;
using elsystem.drawingobjects ;
using elsystem.drawing ;
int Iterations( 3 );
Vector BarData ( NULL ), // Bar DTP
Vector Segments ( NULL ); // of Rounds of Pairs
method void CreateTL ( DTPoint Begin_DTP,
DTPoint End_DTP )
variables: TrendLine New_TL ;
New_TL = TrendLine.Create( Begin_DTP, End_DTP ) ;
New_TL.ExtLeft = false ;
New_TL.ExtRight = false ;
New_TL.Persist = true ;
New_TL.Color = Color.Aquamarine ;
DrawingObjects.Add( New_TL ) ;
end ;

50 May 2015 Technical Analysis of Stocks & Commodities

Figure 1: TRADESTATION. Here, the zzTop indicator is applied to an intraday

chart of IBM.
method void LoadBarDataVector ()
if BarData <> NULL then
DTPoint.Create( BarDateTime, Close ) astype DTPoint ) ;
end ;
method DTPoint BisectPairs ( Vector DTPPair )
variables: DTPoint BegDTP, DTPoint EndDTP,
DTPoint MidDTP,
int BarDataStartIndex, int BarDataEndIndex,
int BarDataCnt,
int HighDiffIndex, double HighDiff,
int Count, double TL_Val ;
HighDiffIndex = 0 ;
HighDiff = -999999 ;

BegDTP = DTPPair.Items[0] astype DTPoint ;
EndDTP = DTPPair.Items[1] astype DTPoint ;

for Count = 0 to BarData.Count - 1
if (BarData.Items[Count] astype DTPoint).DateTimeOfBar =
BegDTP.DateTimeOfBar then
BarDataStartIndex = Count ;
if (BarData.Items[Count] astype DTPoint).DateTimeOfBar =
EndDTP.DateTimeOfBar then
BarDataEndIndex = Count ;
end ;

BarDataCnt = BarDataEndIndex - BarDataStartIndex ;
if BarDataCnt = 0
then BarDataCnt +=1 ;
for Count = BarDataStartIndex to BarDataEndIndex
// Find TL Value
TL_Val = (BarData.Items[BarDataStartIndex]
astype DTPoint).Price astype double +
(( BarData.Items[BarDataEndIndex] astype DTPoint).
Price astype double (BarData.Items[BarDataStartIndex] astype DTPoint).
Price astype double )

* ( ( Count ) / BarDataCnt ) ;
if AbsValue( TL_Val - (BarData.Items[Count] astype DTPoint).
Price astype double ) > HighDiff then
HighDiff = AbsValue( TL_Val (BarData.Items[Count] astype DTPoint).Price astype
double ) ;
HighDiffIndex = Count ;
end ;
end ;
MidDTP = BarData.Items[HighDiffIndex] astype DTPoint ;
return MidDTP ;
method void findDiffBisect( )
variables: Vector RecursRound, Vector NewRound,
Vector NewPairR, Vector NewPairL,
int Count, bool OKToUse,
DTPoint BegDTP, DTPoint EndDTP, DTPoint MidDTP ;
NewRound = new Vector ;
RecursRound = new Vector ;
OKToUse = false ;
RecursRound = segments.Items[Segments.Count -1] astype
Vector ;
for Count = 0 to RecursRound.Count -1
MidDTP = BisectPairs( RecursRound.Items[Count]
astype Vector ) ;
NewPairL = new Vector ;
NewPairL.Push_Back( (RecursRound.Items[Count]
astype Vector).Items[0] astype DTPoint ) ;
NewPairL.Push_Back( MidDTP astype DTPoint ) ;
NewRound.Push_Back( NewPairL astype Vector ) ;
NewPairR = new Vector ;
NewPairR.Push_Back( MidDTP astype DTPoint ) ;
NewPairR.Push_Back( (RecursRound.Items[Count]
astype Vector).Items[1] astype DTPoint ) ;
NewRound.Push_Back( NewPairR astype Vector ) ;
end ;
end ;
Segments.push_back( NewRound ) ;
end ;
method void SeedSegmentsVector()
variables: Vector RecursRound, Vector Pair ;
Pair = new Vector ;
RecursRound = new Vector ;
Pair.Push_Back( BarData.Items[0] astype DTPoint ) ;
Pair.Push_Back( BarData.Items[BarData.Count -1] astype
DTPoint ) ;
RecursRound.Push_Back( Pair astype Vector ) ;
Segments.Push_Back( RecursRound astype Vector ) ;
end ;

ClearPrintLog ;
BarData = new Vector ;
Segments = new Vector ;
end ;

if BarStatus( DataNum + 1 ) = 2
LoadBarDataVector () ;


once ( LastBarOnChartEx )
SeedSegmentsVector( ) ;
For Value1 = 1 to Iterations
findDiffBisect( ) ;
end ;
DrawAllTLs( ) ;
end ;

To download the EasyLanguage code, please visit our

TradeStation and EasyLanguage support forum. The code
can be found here: http://www.tradestation.com/TASC2015. The ELD filename is _TASC_ModifiedTrueRange.
ELD. For more information about EasyLanguage in general, please see http://www.tradestation.com/EL-FAQ.
A sample chart is shown in Figure 1.

This article is for informational purposes. No type of trading

or investment recommendation, advice, or strategy is being made,
given, or in any manner provided by TradeStation Securities or its
Doug McCrary
TradeStation Securities, Inc.


For this months Traders Tip, weve provided the formulas
zzTOP.efs and zzTOPauto.efs based on the formulas described
in Giorgos Siligardos article in this issue, Filtering Price
The studies contain formula parameters to set the desired
period and price, which may be configured through the edit
chart window (right-click on the chart and select edit chart)

method void DrawAllTLs( )

variables: Vector RecursRound, Vector Pair, int Count ;
Pair = new Vector ;
RecursRound = new Vector ;
RecursRound = Segments.Items[Segments.Count -1] astype
vector ;
Print( "TLStart" ) ;
for Count = 0 to RecursRound.Count -1
Pair = RecursRound.Items[Count] astype Vector ;
CreateTL( Pair.Items[0] astype DTPoint, Pair.Items[1]
astype DTPoint );
end ;
end ;

Figure 2: eSIGNAL. Here is an example of the study implemented on a chart of

Boston Scientific Corp. (BSX).
May 2015 Technical Analysis of

Stocks & Commodities 51

to set the desired period and price. A sample chart is shown

in Figure 2.
To discuss these studies or download a complete copy
of the formulas code, please visit the EFS Library Discussion Board forum under the forums link from the support
menu at www.esignal.com or visit our EFS KnowledgeBase
at http://www.esignal.com/support/kb/efs/. The eSignal formula scripts (EFS) are also available for copying & pasting
from the Stocks & Commodities website at Traders.com
in the Traders Tips area.
Eric Lippert
eSignal, an Interactive Data company
800 779-6555, www.eSignal.com


In Filtering Price Movement in this issue, author Giorgos
Siligardos takes a fresh look at the old technical analysis tool
zigzag. He discusses the limitations of a traditional zigzag
indicator and introduces concepts to strengthen it.
We have recreated his zzTOP study using our proprietary
scripting language thinkscript. We have made the loading
process extremely easy: Simply click on the link http://tos.
mx/npjeNL and choose save script to thinkorswim, then
choose to rename your study to zzTOP. You can adjust the
parameters of these within the edit studies window to finetune your variables.
In the example in Figure 3, we have added a 10-leg strategy version of the zzTOP on a thinkorswim chart of Ball
Corp. (BLL). Refer to Siligardos article for a detailed description of the strategy.

A division of TD Ameritrade, Inc.

Figure 4: WEALTH-LAB. Wealth-Labs zzTOPauto routine automatically adjusts

for the chart panes log or arithmetic scale.


Weve implemented the perceptually important points (PIPs)
method introduced by Giorgos Siligardos in his article in this
issue, Filtering Price Movement, in a script study. The script
uses a recursive call to find the PIP having the maximum absolute value of the vertical distance from the line connecting
two PIPs previously found. The price movement plot is based
on a user-specified percentage.
As suggested by the articles author, for a DataSeries plotted
in the arithmetic scale, the minimum vertical distance required
to find a PIP is the percentage of the DataSeries entire range,
whereas a fixed vertical distance in a logarithmic plot is
inherently represented equally by the same percentage. For
example, on a log chart, the distance between 1 and 10 is the
same as that between 10 and 100 (or for any other 1,000%
price change).
Finally, note that due to the manner in which the indicator
is constructed, the zzTOP indicator must not be used for
backtesting, but rather could be useful for digitally scanning
numerous charts for patterns.
The Wealth-Lab code listing is shown at Traders.com in
the Traders Tips area.
See Figure 4 for an example chart.
Robert Sucher
Wealth-Lab, www.wealth-lab.com

Figure 3: THINKORSWIM. This example chart shows a 10-leg version of the

zzTOP study on a daily chart of Ball Corp. (BLL).

52 May 2015 Technical Analysis of Stocks & Commodities


In Filtering Price Movement in this issue, author Giorgos
Siligardos presents a new zigzag-style indicator for visual
identification of price patterns, which he calls zzTOP. Using
AmiBrokers formula language (AFL), its possible to write

if ( pips[ i ] )
x1 = i;
if ( x1 > x0 )
curdist = 0;
newpip = FindMiddlePIP( data, x0, x1, "curdist" );
if ( newpip != -1 AND curdist > maxdist )
maxdist = curdist;
if ( oldpip != -1 )
pips[ oldpip ] = 0; // remove smaller one

Figure 5: AMIBROKER. Here is a sample chart showing the zzTop indicator applied
on ASML daily data, replicating the chart from Siligardos article in this issue.

code directly in AmiBroker in a short and concise way without

having to use an external DLL and/or external languages. The
code listing follows.
An example of the zzTOP indicator as implemented on an
AmiBroker chart of ASML Holdings is shown in Figure 5.
AmiBroker code listing
SetBarsRequired( sbrAll, 0 );
function FindMiddlePIP( data, x0, x1, curdist )
bi = BarIndex();
y0 = data[ x0 ];
y1 = data[ x1 ];
line = y0 + ( y1 - y0 ) * ( bi - x0 ) / ( x1 - x0 );
distance = abs( data - line );
maxbars = HHVBars( distance, x1 - x0 );
pipbar = Nz( x1 - maxbars[ x1 ], -1 );
if ( pipbar != -1 )
VarSet( curdist, distance[ pipbar ] );

return pipbar;

LogMode = ParamToggle( "Mode", "Linear|Logarithmic", 0 );

MaxLegs = Param( "MaxLegs", 20, 4, 35 );
data = Close;
// one leg first - from start to end
legs = 1;
pips = 0;
pips[ 0 ] = 1;
pips[ BarCount - 1 ] = 1;
if ( LogMode ) data = log( Data );
for ( ; legs < maxlegs; legs++ )
x0 = 0;
x1 = -1;
oldpip = -1;
maxdist = 0;
for ( i = 0; i < BarCount; i++ )


pips[ newpip ] = 1;
oldpip = newpip;

x0 = x1; // next leg

x1 = -1; //

// draw lines connecting pip points

x0 = 0;
x1 = -1;
zzline = Null;
for ( i = 0; i < BarCount; i++ )
if ( pips[ i ] )
x1 = i;
line = LineArray( x0, data[ x0 ], x1, data[ x1 ] );
zzline = IIf( NOT IsNull( line ), line, zzline );
x0 = x1;
if ( LogMode )
zzline = exp( zzline );
Plot( zzline, "zzTop", colorRed, styleThick );
Plot( C, "Price", colorDefault );

Tomasz Janeczko, AmiBroker.com


The PIPs (perceptually important points) method
described by Giorgos Siligardos in his article in this issue,
Filtering Price Movement, can be easily implemented in
NeuroShell Trader using NeuroShell Traders ability to call
external dynamic linked libraries (DLLs). Dynamic linked
libraries can be written in C, C++, Power Basic, or Delphi.
After writing the indicator code in your preferred compiler
and creating a DLL, you can insert the resulting indicators
as follows:
1. Select new indicator from the insert menu
2. Choose the External Program & Library Calls category
3. Select the appropriate External DLL Call indicator
May 2015 Technical Analysis of

Stocks & Commodities 53

Figure 6: NEUROSHELL TRADER. This NeuroShell Trader chart shows the zzTOP
indicator applied to the closing price and the zzTOPauto indicator applied to an
MACD indicator.

FIGURE 7: EXCEL, User Controls. Here you see the controls implemented in
the spreadsheet for the zigzag, zzTOP, and zzTOPauto indicators.

4. Set up the parameters to match your DLL

5. Select the finished button.

Traders Tips.
A sample chart is shown in Figure 6.

As noted by Siligardos in his article, these indicators

change their historical values when new data comes in and
thus should not be used for backtesting or automated trading, and instead should only be used as a digital substitution
for your eyes when scanning charts.
Users of NeuroShell Trader can go to the Stocks & Commodities section of the NeuroShell Trader free technical
support website to download a copy of this or any previous


In Filtering Price Movement in this issue, author Giorgos
Siligardos shows us a tool that lets us determine the level of
price swing detail that we wish to pay attention to.

Marge Sherald, Ward Systems Group, Inc.

301 662-7950, sales@wardsystems.com

FIGURE 8: EXCEL, zzTOP Interval Controls. Slider controls allow you to immediately see the effects of changing the starting and ending points for the
zzTOP indicator.

54 May 2015 Technical Analysis of Stocks & Commodities

FIGURE 9: EXCEL, ZigZag and All. Here, the interval is the full chart and we can see how the zzTOP indicators stack up against a standard zigzag over the same

Much like zooming in on a map from satellite level down

to neighborhood level, the closer we get, the more fine detail we can see. What he calls perceptually important points
(PIPs) can do that for us. When we ask for only a few PIPs,
we are highlighting the large (high-level) moves and ignoring the small ones. As we ask for more points, we are, in
effect, zooming in to highlight the ever-finer details.
The zigzag indicator I will use here was excerpted from
the spreadsheet I built for my June 2013 Traders Tips submission (which readers can find in the Traders Tips archive
at Traders.com). I am using that indicator as a starting point
since Siligardos article in this issue compares the behaviors
of his zzTOP indicators to the traditional zigzag.
My implemention of the zzTOP indicator in Excel has
three user controls (see Figure 7):
Type in the number of legs you want to see

Click on the checkbox to toggle between arithmetic or

logarithmic calculation modes

Click one or more times on the gray button to select the

pricing column to use in calculation of the indicator.
This tumbler button includes a hybrid choice of Hi:Lo
In the Hi:Lo Combo mode, both the high and low of a bar
are tested when selecting candidate points. This behavior is
similar in concept to the standard zigzag and can produce a
very choppy zzTOP indicator.
The zzTOPauto version of the indicator swaps the specific
number of legs for a proximity test, but otherwise, the controls behave the same way.
To be able to see the effects of changing the starting and
ending points for the zzTOP indicators, I have provided the
ability to specify the interval of interest via slider controls
(Figure 8). These can be used to step the left and right edges
of the computation interval in or out and immediately see
what happens to the indicator.

Use the checkboxes to select the indicator or indicators

you wish to display as a way to control chart clutter.
In Figure 9, the interval is the full chart and we can see
how the zzTOP indicators stack up against a standard zigzag
over the same interval.

Additional uses for PIPs

(perceptually important points)

In 2010, while Google and I were looking for discussions of

pattern matching in time series data, I came across an interesting masters thesis written in 2008 titled Novel Pattern
Matching Methods For Stock Data Analysis by Zhang Zhe,
City University of Hong Kong. Its a fairly accessible read
and proposes a three-step process for locating and identifying patterns such as head & shoulders in a time series stream.
Interested readers can access a free PDF of the paper at:
The spreadsheet file for this Traders Tip can be downloaded from www.traders.com in the Traders Tips area. To
successfully download it, follow these steps:
Right-click on the Excel file link (PIP_Filters.xlsm),

Select save as to place a copy of the spreadsheet file

on your hard drive.
Ron McAllister
Excel and VBA programmer

May 2015 Technical Analysis of

Stocks & Commodities 55


rading liquidity is often overlooked as a key technical

measurement in the analysis
and selection of commodity
futures. The following explains how to
read the futures liquidity chart published by Technical Analysis of Stocks
& Commodities every month.

very high volumes. The greatest number

of dots indicates the greatest activity;
futures with one or no dots show little
activity and are therefore less desirable
for speculators.
Courtesy of CBOT

Commodity futures

The futures liquidity chart shown below is intended to rank publicly traded
futures contracts in order of liquidity.
Relative contract liquidity is indicated
by the number of dots on the right-hand
side of the chart.
This liquidity ranking is produced by
multiplying contract point value times
the maximum conceivable price motion
(based on the past three years historical
data) times the contracts open interest
times a factor (usually 1 to 4) for low or

three-year period. Thus, all numbers in

this column have an equal dollar value.
Columns indicating percent margin
and effective percent margin provide
a helpful comparison for traders who
wish to place their margin money efficiently. The effective percent margin
is determined by dividing the margin
value ($) by the three-year price range of
contract dollar value, and then multiplying by one hundred.


All futures listed are weighted equally

under contracts to trade for equal dollar profit. This is done by multiplying
contract value times the maximum possible change in price observed in the last

Trading liquidity has a significant effect on the change in price of a security. Theoretically, trading activity can
serve as a proxy for trading liquidity
and equals the total volume for a given
period expressed as a percentage of the
total number of shares outstanding. This
value can be thought of as the turnover
rate of a firms shares outstanding.

Trading Liquidity: Futures

Commodity Futures
Exchange % Margin
Contracts to
Relative Contract Liquidity

% Margin Trade for Equal

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Chicago Mercantile Exchange
Hard Red Wheat

Commodity Exchange, Inc. CME Group
Mexican Peso

Chicago Mercantile Exchange - Globex

Intercontinental Exchange-Futures - Europe

Intercontinental Exchange-Futures - US
Ultra T-Bond

Kansas City Board of Trade
2-Year T-Note
Minneapolis Grain Exchange
30-Day Fed Funds
New York Mercantile Exchange
5-Year T-Note
Class III Milk


Trading Liquidity: Futures is a reference chart for speculators. It compares markets Relative Contract Liquidity places commodities in descending order according to
according to their per-contract potential for profit and how easily contracts can be bought how easily all of their contracts can be traded. Commodities at the top of the list are easior sold (i.e., trading liquidity). Each is a proportional measure and is meaningful only est to buy and sell; commodities at the bottom of the list are the most difficult. Relative
Contract Liquidity is the number of contracts to trade times total open interest times a
when compared to others in the same column.
The number in the Contracts to Trade for Equal Dollar Profit column shows how volume factor, which is the greater of:
many contracts of one commodity must be traded to obtain the same potential return
In volume
1 or exp
as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price
In 5000

56 May 2015 Technical Analysis of Stocks & Commodities

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list is also printed above along with the corresponding page number for each ad.
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May 2015

Technical Analysis of Stocks & Commodities 57

The following selection of book descriptions represents a sampling of recent book

releases in the investing field. Books described here may be from some of the major book publishers as well as some independent book publishers. These are not
critical reviews or editorial evaluations, but rather a brief look at the book marketplace to help keep readers up to date on new or recent book offerings.

21st Century Point And

Figure (200 pages, 45
hardcover, 2015, ISBN
9780857194428) by Jeremy du Plessis, published
by Harriman House Press.
From the author of The Definitive Guide To Point And
Figure, this book seeks to
bring point & figure charting into the modern age. Point & figure has
been around for more than 130 years; while
the basic principles of the technique have
remained unchanged, those working with
point & figure can try to push the boundaries of how it is used in order to make it more
effective and useful. Some analysts believe
that the lack of a time element on point &
figure charts means that time-based tools
and indicators cant be used with them,
or that the lack of a volume component
means that the importance of individual
columns cant be determined. However, in
his new book, du Plessis shows that neither is the case, and that with some lateral
thinking, a host of other techniques can be
added to point & figure charts and analysis.
Finally, the author introduces a point & figurebased oscillator that can also be used
on time-based charts. All topics are illustrated with color charts.

Beat The Crowd: How

You Can Out-Invest
The Herd By Thinking
Differently (308 pages, $29.95 hardcover, March 2015, ISBN
by Kenneth L. Fisher & Elisabeth Dellinger, published by
Wiley. This book is presented as a contrarians guide to investing, with explanations
of how a true contrarian investor thinks and
acts, and why it can work. The author explains why the crowd often goes astray,
and how the investor can stay on track. He

explains how headlines affect the market, and which noise (including talking
heads in the media) and fads investors should tune out. He teaches simple tricks to think differently, which may
help the investor to get it right more often than not. He addresses how far
ahead an investor should look. A successful investment strategy requires information, preparation, brainpower, and
some luck, according to the author, and in
this book he presents a tactical approach
based on going against the grain.

Trading As A Business: The Methods

And Rules I've Used To Beat The Markets For 40 Years (168 pages, $60 softcover, $39.99 ebook,
January 2015, ISBN
by Dick Diamond,
published by Wiley.
This book seeks to
provide a behindthe-scenes look at
how the author says
he became a successful independent trader. The book discusses Diamonds methods for analyzing the market and timing
trades, including his 80%/20% strategy
and his six statistics that he believes are
critical for determining where the stock
market is headed. The book outlines what
Diamond believes it takes to become an
independent trader who can make money
over the long haul.

A Traders Guide To Financial Astrology:

Forecasting Market Cycles Using Planetary And Lunar Movements (240 pages, $90 softcover, $58.99 ebook, January
2015, ISBN 978-1-118-36939-5) by Larry
Pasavento and Shane Smoleny, published by Wiley. This book is a guide to
trading market cycles based on astrological data. Cowritten by well-known technical
analyst Larry Pasavento, the book states a

58 May 2015 Technical Analysis of Stocks & Commodities

connection between
the movements of
planets and the volatility of the market.
The book presents
Pasaventos information in the context of
one hundred years of
historical data, and he instructs the reader
to spot correlations from the past, then refers to planetary and lunar data for the next
five years to help readers shape their own
strategy. The book covers the principles of
astrological forecasting as applied to the financial markets, explaining what to watch
for and how to interpret planetary and lunar activity, and offers guidance on everyday practical application. For traders who
have always wanted to know what to do
when Mercury is in retrograde or the moon
is new, this market educator offers his instruction.

Fundamentals Of
Actua rial M athe matics, 3rd ed. (552
pages, $85 hardcover, $ 68.99 ebook,
January 2015, ISBN
by S. David Promislow, published by
Wiley. This book covers both the deterministic and stochastic models of life contingencies, risk theory, credibility theory, multistate models, and an introduction to modern mathematical finance. This third edition
restructures the material to fit into modern
computational methods and provides several spreadsheet examples throughout. It
includes new chapters covering stochastic investments returns and universal life
insurance. Elements of option pricing and
the Black-Scholes formula are introduced.
It also covers the syllabus for the Institute
of Actuaries subject CT5.

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Technical Analysis of Stocks & Commodities 59


Place Your Bets

What do these terms mean as applied to the participant in

the financial markets? Lets have a look to try to come up
with some clear definitions.

ernard Baruch, the famed American financier and investor, often repeated the following quotation, which he
attributed to Sir Ernest Cassel, good friend and banker
to King Edward V11:

When as a young and unknown man I started to be successful I

was referred to as a gambler. My operations increased in scope
and volume. Then I was known as a speculator. The sphere of my
activities continued to expand and presently I was known as a
banker. Actually I had been doing the same thing all the time.

Much the same could be said today for gambling, speculating,

and investing. When you start off, your operations are small
and people call you a gambler. As your operations grow, they
call you a speculator, and then when your operations are of
a decent size, you achieve a level of respectability and you
become known as an investor. What do these terms really
mean when applied to market participants? Can we arrive at
some clear definitions and remove some of the ambiguities
embedded in the common usage of these terms?

Is stock trading gambling?

For the novice player, gambling is a high-risk play on the

outcome of an event characterized by recklessness and in-

tense emotions. For example, we can agree that betting in the

Powerball lottery with a 1-in-175 million chance of winning
is gambling. Betting on a favorite team to win the Super Bowl
or on a favorite horse or jockey is similarly a high-risk play.
We have no control over the outcome and the odds are not in
our favor. But the stakes are usually low, and the thrill of the
experience compensates for the ridiculously low odds of winning. Now, when you bring that same mindset to the financial
markets in general or to the stock market in particular, you
are condemned to bet blindly, make high-risk bets characterized by recklessness and intense emotions, and our results are
unlikely to be any different from those of the novice gambler
hoping for luck in the Powerball lottery or on the races. But in
gambling, as in speculating and investing, there is a minority
of participants who consider themselves professionals and
who win consistently. What is it that this minority does that
sets them apart from the majority? I will attempt to answer
this question later on in this article.

Can you improve the odds by speculating?

If gambling is characterized by high risk, recklessness, and

intense emotions, what then is the commonly held view of
speculating? To most people, it is no more respectable than
gambling. In some corners of the investing world, speculating is viewed as dishonorable, seedy, and unwholesome. It
is the province of oily traders trying to wrest out a fast buck
from the markets, staring in darkened dens at screens lit up
by red and green flashing lights. It is no more reputable than

by Stella Osoba
60 May 2015 Technical Analysis of Stocks & Commodities

medieval backgammon scene: carmina boranus/wooden board: Lonely Walker/ collage: nikki Morr

Gambling, Speculating, & Investing

Your most important consideration
when taking a position is how much
you can afford to lose, not how
much you hope to win.

gambling, and no one with an ounce of honor would dare

admit in polite society to being a speculator. And yet in 1938,
John Maynard Keynes said the following: A speculator is
one who runs risks of which he is aware, and an investor is
one who runs risks of which he is unaware. It is also true
that Keynes often referred to himself as a speculator. So what
exactly is speculating? Speculators buy or sell with the idea of
disposing of the asset for a profit in the future. But isnt that
what investors do? How then are they different? It could be
that a speculator, knowing that he is involved in a high-risk
trade, studies the market, and devises specific rules based on
particular strategies to enter and exit the market. As Jesse
Livermore, the well-known speculator, once said:
Speculators in stock markets have lost money. But I believe it
is a safe statement that the money lost by speculation alone is
small compared with the gigantic sums lost by so-called investors who have let their investments ride. From my viewpoint,
the investors are big gamblers. They make a bet, stay with
it, and if it goes wrong, they lose it all. The speculator might
buy at the same time. But if he is an intelligent speculator, he
will recognizeif he keeps recordsthe danger signal warning him all is not well. He will, by acting promptly, hold his
losses to a minimum and await a more favorable opportunity
to reenter the market.

In other words, what Jesse Livermore seems to be saying is

that a speculator is one who enters the market with clear rules
delineating the trade, which tell him under what conditions to
hold the trade and when to exit for a profit or loss.

What does investing mean?

Of the three terms, investing seems to be considered the most

respectable among lay people. No one is abashed to refer to
themselves as an investor. It appears that investing is what
you must aspire to in order to achieve respectability. So how
then can we define investing? For far too many people, investing is a byword for buy & hold. The Business Dictionary
describes the investor as one whose primary objectives are
the preservation of the original investment, a steady income,
and capital appreciation. In this sense, the investor is seen
as more prudent than either the gambler, who is described as
one whose risk of loss is out of proportion to the rewards, or
to the speculator, who is defined as one who takes high risks
for high rewards. Because of this aura of respectability, which
common usage has attached to the idea of investing, lay people
aspire to investing and substitute buy & hold and fundamental

analysis as proxies for the investor. But holding a security

indefinitely will not protect an investment from catastrophic
losses, nor will it guarantee gains. Fundamental data will not
tell you when to enter a position. That a company has good
fundamentals is no guarantee that the price of the security
will rise and not go sideways or even fall. A speculator has
no less interest in preserving capital than the investor does.
In fact, the speculator and gambler might have more reason
to try to preserve the original capital because thats how they
stay in the game. Moreover, being risk-averse does not guarantee the investor a steady income. The stock market is risky
and everyone who participates in it has to learn to embrace
a level of risk.
Less than 100 years ago, all stock trading was seen as
speculating. In fact, in England, the Universities and College
Estates Act of 1925 (The Trustees Act) made it onerous and
nearly impossible to invest any of the endowment money of
the colleges of Oxford and Cambridge in the stock market
because stocks were seen as too risky and the colleges funds
were supposed to be managed conservatively. Speculators
took positions in the stock market, not investors. It was John
Maynard Keynes who in the early 1920s succeeded in persuading the Fellows at Kings College, Cambridge, to be the
first university college in England to put part of its funds in
the stock market. Keynes also showed that it was possible to
speculate and invest in the stock market successfully.

Think like a statistician

Gambling, speculating, and investing

are, at their core, disciplines that rely on
somewhat basically interchangeable skill
sets. This is what the professional knows
but the public does not. And this is why
it is so difficult to come up with definitions that sufficiently differentiate each
term. To succeed at gambling, speculating, or investing, you
need to be in control of your emotions and have a firm grasp
of probabilities. Whether you are a professional gambler in
Las Vegas or a billion-dollar hedge fund manager on Wall
Street, you know that you do not have to be right all the time
to be successful. Given this, you know you must have clear
entry & exit rules, and you must also become an excellent
risk manager.
Unlike with the general public, your most important consideration when taking a position is how much you can afford to
lose, not how much you hope to win. In games of uncertainty,
you are guided by your knowledge of human nature (yours
and others) and chance. In order to win, you have to have a
firm understanding of what your opponent is likely to do, what
you will do, and what your odds of winning are. You have
to know about risk, understand what it is, and master the art
of managing it. It is not a coincidence that many gambling
terms such as risk of ruin, the Kelly criterion, Monte Carlo
simulation, and theory of runs are also used by speculators
and investors. Investment firms that manage billions of dollars
recruit quants to build models based on statistical inference
May 2015

Technical Analysis of Stocks & Commodities 61

to make best guesses on the outcome of market events. Statistical inference can be thought of as gambling theory applied
to the world around us.

Whats your priority?

To stay in the game, you must make it your business to preserve

capital. This is your number-one priority, no matter what label
you apply to your dealings. And you must also make it your
business to master the language of probabilities. You must
have clear rules that will dictate what you will do when you
are wrong. The thrill is not to be found in the playing of the
game as the novice expects; rather, its in the staying in the
game. That is what allows the rewards to come. So gamble,
speculate, investcall it what you may; the professional knows

the rules of the game and has evolved the temperament and
skill to stick with it and succeed.
Stella Osoba is a financial writer who has written for the
Market Technician Associations (MTA) e-newsletter Technically Speaking, their Journal Of Technical Analysis, and their
CMT e-newsletter, as well as for TraderPlanet.com. She may
be reached via email at stellaosoba@gmail.com.

Further reading

Osoba, Stella [2015]. Does Technical Analysis Work?

Technical Analysis of Stocks & Commodities, Volume
33: February.



Continued from page 25

CL but the electronic contract was

often ECL or GCL, where the E
refers to electronic and the G refers
to Globex, which is CME Groups electronic exchange. The letters E and G
represent the same method of execution;
there is no difference between the two
other than the preference of the trading
platform vendor or quote service. Logic

suggests that all platforms and brokers

should come together to determine a
single symbol to identify each product,
but I doubt that will be the case. As it
stands, some platforms already use the
open-outcry symbol for electronic execution, so there is little uniformity.
Louis Winthorpe III, the character played
by Aykroyd in Trading Places, described
the futures trading pits as the last bas-

tion of pure capitalism. When the pits

die, a little piece of the hearts and minds
of industry veterans will die with them.
And yet, weve known all along this was
an inevitable and necessary step in the
progression toward market efficiency.
Today I mourn the death of tradition, but
I embrace the future of the industry Ive
dedicated my career to. Change is hard,
but it doesnt have to be bad.


Advisory services are all

over the place, as our listing at
Traders.com shows. You have
plenty of choices and price
points to consider.
One key factor is whether
the outfit youre checking out is a Registered
Investment Advisor (RIA) or a registered
Commodity Trading Advisor (CTA). Though
it doesnt weed out the undependable advice,
the act of registration puts the person or persons under the governments scrutiny. In this
listing, filled in by the companies themselves,
youll find those who have RIA and/or CTA
certifications as well as those who are nonregistered advisories.
If its trading advice you seek, then track
records are essential, preferably records
monitored by third parties. References
should also be checked, and if publications

are involved, back issues should be

scanned. Even then, a lengthy observation period following the advisors rationale and recommendations is prudent.
Commit money to trades only when you
are ready to follow the advice thoroughly:
youll only have yourself to blame if you
cherry-pick trades and come up with
results differing from the advisors.

These are the 10 advisory services clicked

on most often on the Traders Resource
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clicks received. This is not an editorial rating,
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The information in Traders Resource is the most accurate at the time of posting and is subject to change. Because the vendors posting to Traders Resource are responsible for their own listing, Technical Analysis, Inc. declines any and all liability
for any representations made by the businesses and individuals listed. Nor can Technical Analysis, Inc. endorse any business or individual listed on Traders Resource. Technical Analysis, Inc. makes no warranties, express or implied, as to the
accuracy and reliability of claims herein. You agree to release Technical Analysis, Inc., together with its respective employees, agents, officers, directors and shareholders, from any and all liability and obligations whatsoever in connection with or
arising from your use of Traders Resource. If at any time you are not happy with the information posted to Traders Resource or object to any material within Traders Resource, your sole remedy is to cease using it. This list is updated frequently.
If you are aware of a business that should be listed, please email us at Editor@Traders.com.

62 May 2015 Technical Analysis of StockS
tocks & c

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