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THE TRADERS’ MAGAZINE SINCE 1982

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JANUARY 2016

Ugly Double
Bottom Setup
Profit from bottom fishing 8

Decision Areas
In Daytrading
Identifying probable
turning points 12

Aliasing
Avoid data distortions 18

High-Volume
Breakouts
A trading strategy 26

INTERVIEW
Kevin Davey,
systems developer 32

REVIEW
n TC2000 Version 16

JANUARY 2016
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CONTENTS JANUARY 2016, Volume 34 Number 1

8 Bottom Fishing & The Ugly 30 Explore Your Options


Double Bottom Setup by Tom Gentile
by Thomas Bulkowski Got a question about options?
Profiting from bottom fishing is
notoriously difficult, but this setup INTERVIEW AT THE CLOSE
may help.
32 Developing Strategies 61 The Green Line
With Kevin Davey by Ron Jaenisch
FEATURE ARTICLE Knowing when to exit a trade
by Jayanthi Gopalakrishnan
12 Decision Areas In Daytrading Kevin J. Davey is a professional can work wonders for your trad-
by Peter Hill trader and systems developer. He ing returns. Here’s one tool that
It’s impossible to know when is the author of Building Winning can help you make that critical
the market will suddenly turn Algorithmic Trading Systems: A decision.
and move in another direction. Trader’s Journey From Data Min-
But there are tools you can apply ing To Monte Carlo Simulation To
to your charts to identify those Live Trading. An aerospace en- REVIEW
probable turning points. Here’s gineer and MBA by background, 42 • TC2000 Version 16
a simple technique any intraday Davey has been an independent Product review: Stock market
trader can use. trader for over 25 years. He placed charting software
first once and second twice in
18 Aliasing the World Cup Championship of
Futures Trading during the years DEPARTMENTS
by John F. Ehlers 2005–2007. We spoke with him
Since you are likely using sampled 6 Opening Position
about how a retail trader can trade
data when trading, there is a chance algorithmically. 7 Letters To S&C
that there could be some distortions 46 Traders’ Tips
in the data. Here’s what you can do
to avoid those distortions. 38 Failing Successfully 57 Advertisers’ Index
by Stella Osoba, CMT 57 Editorial Resource Index
22 Trading Vs. Forecasting: We’re groomed to think of losses 58 Futures Liquidity
as a sign of failure, which is why 59 Classified Advertising
What’s The Difference? trading is difficult. But experienc-
by Tyler Yell, CMT ing losses is part of a trader’s life
59 Traders’ Resource
Trading is about recognizing and is something you have to ac- 60 Books For Traders
present opportunities where cept. Here’s how to approach the
the risk-to-reward is favorable. idea in a healthy way.
Forecasting, on the other hand, is
outcome dependent. Find out how
you can use both and take advan- 40 Q&A
tage of those opportunities. by Rob Friesen
This professional trader answers
a few of your questions.
26 High-Volume Breakouts
by Ken Calhoun
In this final article in a series 45 Futures For You
we’ve been presenting on breakout by Carley Garner
trading strategies from this profes- Here’s how the futures market
sional daytrader and educator, we really works.
look at the role that volume and
price-action breakout patterns play
in confirming entry signals.
n Cover: William L. Brown
n Cover concept: Christine Morrison

Copyright © 2015 Technical Analysis, Inc. All rights reserved. Information in this publication must not be stored or reproduced in any form without written permission from the publisher. Technical Analysis
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January 2016 • Volume 34, Number 1
Opening Position
The Traders’ MagazineTM

As
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editor@traders.com

Editor in Chief Jack K. Hutson


Editor Jayanthi Gopalakrishnan
we approach another year, it may
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6 • January 2016 • Technical Analysis of Stocks & Commodities


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Maybe it’s time to try
something NEW!
IN MEMORY OF DON BRIGHT My question relates to scanning for
Editor, stocks that are trading more than one
I enjoyed reading Don Bright’s column million shares a day. Over what period
each month. He died too young. of time do the authors use to measure Winner
Thomas Bulkowski the average daily volume of one million? 13 years
(That is, two days? five days? 20 days?
THANKS FOR YOUR MAGAZINE 40 days? 60 days?) in a row!
Editor, I did a scan for one million stocks over
Your magazine is informative and a 20-day period and many of my results
touches different areas of the industry. had a current daily volume, on the day of
I especially enjoy Dirk Vandycke’s and the scan, of far below one million.
www.NeuroShell.com
Melvin Dickover’s articles and their ap- My scan for volume of over one million 301.662.7950
proach to the markets and trading. shares, using StockCharts.com, was as
Other things that I would like to read follows:
about in your magazine are the so-called SIMPLIFY IT: MOVING AVERAGE
“quant” traders and the quantitative [Daily SMA(20,Daily Volume) > CRITERIA
trading techniques and systems and 1000000] Editor,
their use. Any resources regarding this Thank you for the November 2015 article,
would be helpful. This scanned for an average daily volume “Simplify It,” by James and John Rich. As
Another thing I think could be helpful of the last 20 days that was over one an individual trader, I appreciate the way
is a column from the point of view of a million shares. they simplified the process and I liked
novice trader for those just starting out Feedback from the authors would the ideas expressed in their article.
in this business. It could be a how-to be most welcome. And thank you for A quick question for the authors:
column with the required steps for start- presenting a workable, simple trading When they are using their 50-day SMA
ing out, including advice, choosing the strategy. of the SPY to initially determine market
right hardware, platforms, and systems, William direction, what specific criteria do they
and incorporating as a business, up to Lansing, MI use to base this determination on? For
the particulars of different markets and instance, does the last 50d need to be
the best way to trade them. Author James Rich higher than the reading 10 periods prior
Thank you for your magazine and for replies: (and if so, is there a % requirement)?
the hard work you put into making the As long as you use 20 I’ve attached two sample charts [not
magazine a reality. I’m looking forward days or more, I don’t shown] (I quickly grabbed wheat charts
to reading more interesting articles. think it’s going to for this example but I would use SPY for
Mihai Arnauta make any difference, stock scanning, of course). These are
since the point is to showing the 50d trending in a direction,
SIMPLIFY IT: SCREENING AND avoid thinly traded but obviously in very different degrees
AVERAGE DAILY VOLUME stocks. Using 20 days is equal to four of trending. The downtrend of the first
Editor, trading weeks, and there’s always the is clear, but while the uptrend of the
I read with great interest James and John possibility of picking up a low-volume 50d in the second is going higher, it
Rich’s article in the November 2015 is- day or even a low-volume week, but you’ll is happening in a rather range-bound
sue of Technical Analysis of Stocks & still have stocks with enough volume to sideways market.
Commodities, “Simplify It,” on their be traded by institutions.
trading channel strategy. Continued on page 31

January 2016 • Technical Analysis of Stocks & Commodities • 7


how to improve the setup.
I’ll begin with a chart pattern I call
an ugly double bottom. In Figure 1
you see an example of this at points
AB. In a traditional double bottom,
price makes a valley, bounces, and
forms a second valley at or near the
price of the first one. In the case of an
ugly double bottom, you are looking
for a second, higher valley.
In this example, price makes a
new yearly low at A, bounces to the
horizontal blue line, and forms a
higher bottom at B. When I first tested
this pattern several years ago, I set a
minimum price difference between
bottoms of 5%. This example shows
bottom B 7% above A.
The ugly double bottom confirms
as a valid chart pattern when price
closes above the top of the pattern.
That occurs at C in Figure 1, although
it may be hard to see on the chart.
Notice how price drops to D and
then recovers. Testing shows that a
stop placed below B is not ideal, but
it will cut losses almost in half. The
tradeoff is a drop of 20 percentage
points in the win/loss ratio. I prefer
a stop below A. I’ll discuss testing
results later in this article.

Trading setup
The setup described here is easy
enough to follow. Look for an ugly
A Turn For The Better double bottom when the stock

Bottom Fishing &


makes a new yearly low. Here are
the steps.

The Ugly Double Bottom 1. Only look for stocks during a


bull market.

Setup 2. Find a stock making a new


yearly low.
3. Locate an ugly double bot-
tom where the first bottom
sets the yearly low.
Profiting from bottom fishing is notoriously difficult, but this setup may help.
4. Place an order to buy the
stock on or after the pattern
by Thomas Bulkowski
confirms.

B
Rocksweeper/Shutterstock

uy low, sell high. How many times have you tried to do that and lost money? 5. Place a stop-loss order a
Here’s a trading setup for buying stocks making new yearly lows. A shorter penny below the first bottom.
phrase for that is bottom fishing. The technique I’ll describe here is not per- 6. Use your favorite sell signal
fect. You can still lose money, perhaps a lot of it, but the setup gives you an to exit the trade.
indication of how often bottom fishing works. Perhaps you will have ideas on
8 • January 2016 • Technical Analysis of Stocks & Commodities
TRADING STRATEGIES

Step 1: Only bottom fish in a bull


market. In a bear market, price
tends to keep going down and it
busts ugly double bottoms. Testing
results reinforce that belief. The
median trade in a bull market
gained 32%, but in a bear market
it lost 20%.

Step 2: Using the yearly chart,


look for price to set a new low
for the year at the first bottom of
the ugly double bottom. I did not
test variations with the first bottom
higher in the price range, so that is
something you can explore.

Step 3: The second bottom should


be between 5% and 20% above the
first one. The larger the difference
between bottoms, the larger the

Tom Bulkowski
potential loss, but the number of
winning trades increases. I tested a
5% to 25% range and found that the
sweet spot is 10% and above. FIGURE 1: THE UGLY DOUBLE BOTTOM. An ugly double bottom appears at AB and confirms as a valid pattern at C
when price closes above the top of the pattern.
Step 4: The pattern confirms
when price closes above the top
of the pattern. That means buying at the open the next day.
However, I often use a buy stop placed a penny above the top If you were to trade the setup
of the chart pattern to get me into a trade. Using a close above
the top helps avoid one-day price spikes that would otherwise
perfectly, it wins 87% of the
trigger a premature entry. time, making an average of 48%
from winning trades.
Step 5: Placing stops. I tested two stop locations—a penny
below the first bottom and a penny below the second—triggered
on a close at or below that price. Neither stop locations work
well in my opinion. I will discuss stop placement later in this how far the bottoms should be from one another (price scale),
article. best exit technique, and so on. Then I applied the setup to the
larger group of stocks and also ran some of the tests going
Step 6: Apply a sell signal. I tested moving averages from back as far as 1990. I didn’t see any performance difference
10 to 250 days, trailing stops from 5% to 25% below a high- between in-sample and out-of-sample data that would change
water mark, and a target price exit based on the height of the the setup.
chart pattern.
Perfect trades
Testing The first question bottom fishers will want answered is how
I used 59 stocks for in-sample data and 425 for out-of-sample often will trades be stopped out? If you were to trade the
data starting January 2000 (yes, in the middle of the bear setup perfectly (using ugly double bottoms with bottoms 5%
market whose trades I discarded but logged anyway) to June to 20% apart), it wins 87% of the time, making an average
2015. Not all stocks covered the entire range. of 48% from winning trades, but incurring an average loss
To find ugly double bottoms automatically, I looked for the of 17% on losing trades. Overall, you could make an average
lowest low within a sliding window of five trading days wide. of 40% per trade.
That means finding the lowest low from five days before to To find those statistics, I used a stop-loss order placed a
five days after the bottom (11 days total) and then looking for penny below the bottom of the chart pattern, triggered on a
the next adjacent bottom. close at or below the stop price, and sold at the open the next
I used in-sample data to determine the best stop location, day. Otherwise, the stock sold when it reached the ultimate
January 2016 • Technical Analysis of Stocks & Commodities • 9
Results
1x Height 1x Height 2x Height 2x Height 2x Height 3x Height The table shown in Figure 2
illustrates how performance
Bottom Stop 1 2 1 2 1 1
varied depending on the height
Bottom Diff 5%–20% 5%–20% 5%–20% 5%–20% 10%–20% 5%–20% of the target and stop placement.
Win/Loss 75% 56% 66% 47% 68% 60% These are out-of-sample results
Avg Win 15% 15% 31% 32% 39% 46% using ugly double bottoms with
bottoms between 5% and 20%
Avg Loss -19% -11% -20% -11% -22% -20% apart (narrower than the 5% to
Avg Profit 7% 4% 14% 9% 19% 20% 25% test range). Consider the
Median Profit 12% 8% 22% -4% 32% 26% 1x height for bottom 1. I placed
a stop one penny below the first
No. of Trades 862 855 818 865 420 771
bottom of the chart pattern to
FIGURE 2: TRADING RESULTS. Here, you see the performance statistics for the ugly double bottom setup. limit losses (again, triggered only
at close and sold at the open the
next day). For the target exit, I
high. The ultimate high is the highest peak before price closes computed the height of the chart pattern, added the height to
at least 20% below that peak. This is not the same as a trailing the top of it, and then placed a sell stop at that price.
stop set 20% below a high-water mark. The exit sells at the Trades won 75% of the time. Winning trades made 15%
highest peak before the stock tumbles, so it is unrealistic. but losers lost 19%. The combined average of winning and
The 20% price swing is what many use to distinguish a bull losing trades was a gain of 7% (average) or a median of 12%.
market from a bear market. I simply applied that mechanism There were 862 trades.
to stocks. I used 867 perfect trades, so don’t expect your Since you are buying at the top of the pattern and getting
results to duplicate it in actual trading. For a more realistic stopped out at the bottom of it, the loss is large, about 20%
exit signal, I selected selling when price reached a target. The for stops placed below bottom 1. If you use bottom 2 as the
target was a multiple of the height of the ugly double bottom stop location (a penny below it), the loss drops from 19% to
added to the top of it. 11%. However, the win/loss ratio drops to 56%, so fewer trades
work. The overall profit drops from 7% to 4%, too.
I narrowed the price difference
between the two bottoms in the
ugly double bottom from 5% to
10% (second column from the
right). The results are shown in
the table in Figure 2. The win/
loss ratio climbs marginally from
66% to 68%. Losses increase
from 20% to 22% but the aver-
age and median profits rise dra-
matically, 14% to 19% and 22%
to 32%, respectively. If I were to
trade this setup, the 10% to 20%
range with a 2x height would be
my choice.
The table shows that as the
price target gets further away,
profits increase but losses stay
about the same. That makes
sense because the loss size is
determined by how tall the pat-
tern is (with a stop below the first
bottom). If you raise the stop-loss
location, then you will have more
losing trades and you will be
FIGURE 3: TRADING EXAMPLE. Here, the two bottoms are at least 10% apart but no more than 20%. The entry is
stopped out of potentially win-
triggered a penny above the top of the pattern. This ugly double bottom trade leads to a 29% gain. ning trades, decreasing profit.

10 • January 2016 • Technical Analysis of Stocks & Commodities


Tall patterns help
assure, but not
guarantee, that
the stock has
changed trend.

Here’s an example
The chart in Figure 3 shows an example
of how the ugly double bottom setup
works, using what I call the preferred
setup. The preferred setup has bottoms
at least 10% apart but no more than
20%, and entry triggers using a buy
stop placed a penny above the top of
the chart pattern.
Price makes a new yearly low at A,
at 57.55, in a bull market. At B, 64.91,
the stock makes a higher bottom. The
difference between those two bottoms
is 13%, falling within the 10% to 20%
range.
A buy stop placed a penny above the top of the pattern considered by some to be a leading expert on chart patterns.
(67.21) starts the trade at C. The exit price target is twice the He is the author of several books including Getting Started
height of the ugly double bottom, or 2 x (67.21 - 57.55) = 19.32. In Chart Patterns, Second Edition and the Evolution Of A
Add the height to the top of the pattern (or the buy price) to Trader trilogy. His website and blog, www.thepatternsite.com,
get a target of 86.53. have more than 600 articles of free information dedicated to
As the chart shows, the stock makes a strong recovery and price pattern research.
soars to D, where it sold for a 29% gain (not including com-
missions and fees). If the trade failed, it would have meant a Further reading
potential loss of almost 15%. Notice that a stop placed below B, Bulkowski, Thomas [2013]. Fundamental Analysis And
the second bottom, would have triggered on the drop to E. Position Trading: Evolution Of A Trader, John Wiley &
Sons.
That’s a wrap [2014]. Getting Started In Chart Patterns, 2d. ed.,
The ugly double bottom setup is flawed because the stop is John Wiley & Sons.
placed below the bottom of the chart pattern. This is necessary [2013]. Swing And Day Trading: Evolution Of A Trader,
because stocks making new lows tend to make lower lows. John Wiley & Sons.
Tall patterns help assure, but not guarantee, that the stock [2013]. Trading Basics: Evolution Of A Trader, John
has changed trend. When the trend changes from down to up, Wiley & Sons.
bottom fishers can profit from the rise. [2015]. “10 Selling Tips,” Technical Analysis of Stocks
Since the potential loss is large, this setup is best for inves- & Commodities, Volume 33: May.
tors, those willing to buy and hold a stock for the long term. [2015]. “Four Lessons From Three Decades Of Trad-
They are willing to risk money in the short term to boost ing,” Technical Analysis of Stocks & Commodities,
profits over the long term. Swing and position traders may Volume 33: August.
also benefit from this setup, too. • http://thepatternsite.com
Although I used the height of the chart pattern as the exit tool,
you may wish to use your own stop-loss and exit mechanisms
to perfect this setup for the markets you trade.

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
January 2016 • Technical Analysis of Stocks & Commodities • 11
12 • January 2016 • Technical Analysis of Stocks & Commodities
TRading systemS

Looking Beyond Price

Decision Areas
In Daytrading
It’s impossible to know when the market will suddenly any product in the securities markets. I’m certainly not
turn and move in another direction. But there are the first to notice this phenomenon of prices bouncing
tools you can apply to your charts to identify those around between numbers whose basis is a thousand-
probable turning points. Here’s a simple technique year-old mathematical formula, but I had not seen the
any intraday trader can use. particular analysis of intraday price activity that I found
when I started my experimentation. After watching

A
trader with a small account is in a precarious Fibonacci calculations seeming to exert great pressure
situation judging when to take a position or to on prices in the larger time frames, I had become a
stay out of the action. He is normally a person fan of this method. But it was when I looked at the
who wants to be trading in the markets, who is anxious smaller time frames that I saw I could make the power
to be involved and often thinks more of the reward of the study a safety factor in daytrading.
than the risk. This is the reason that so many people Of the hundreds of mathematical studies available
who try to scalp—that is, take intraday positions for on computer platforms that are used to access the
short periods trying to capture a few points during the stock, option, and futures markets, I had found Fibo-
day—so often come to grief. Trying to guess which nacci study to be easily the most accurate predictive
way the market will go from one minute to another is study of all. It has many devotees, which I believe is,
a perilous adventure. Often, you can be right in one in itself, the reason it is so powerful. Some have an
time frame and wrong in another, and if you’re wrong almost mystical belief in this system, thinking that
in the smaller time frame, it may be too late for you there is a metaphysical force expressing itself in the
by the time you’re justified in the longer term. way that the Fibonacci number series applies to things
With its high degree of leverage, the futures market like the formation of galaxies and the shells of turtles,
is unforgiving of mistakes. That makes it necessary the golden ratio in art, and other kinds of analysis.
for the small trader to take his position at the optimal But I think it’s enough that many traders see the ef-
moment, the one during which he will know within fects of the study and thus they use it for guidance
narrow limits whether he has made a good decision when they put in their orders to buy and sell. That is
or not. Between these boundaries is the area I call the what makes it seem as though the Fibonacci levels
“decision area” within which the trader needs to take are ordained by heaven itself.
his position or keep it or abandon it before being hurt. The determination of “value,” meaning the right
Since so many traders are not able to withstand a large price for a securities product, is the job of all market
drawdown, my task was to find a way to trade a small participants, including banks, pension funds, hedge
amount of money in such a way that profits could be funds, and the daytrader. Their opinions about the
made while taking the least possible risk. worth of things vary with changing conditions; they
are always approximate, and, to a large extent, partici-
WILLIAM L. BROWN

Enter Fibonacci pants differ according to the time frame in which they
The genesis of this project was my observation of the are observed. The time frame is the most important
effect of Fibonacci analysis on the prices of virtually factor for the daytrader, who is, by definition, out of

by Peter Hill
January 2016 • Technical Analysis of Stocks & Commodities • 13
are more enthusiastic about buying
than selling, or the opposite. The
charts are pictures of the “drama”
of the market. These images tell
a story that can be grasped im-
mediately, which reams of written
data cannot.
In Japan, in the 17th century,
charts were hand-drawn by rice
traders, and even some contem-
porary traders have drawn their
charts by hand. Those were
naturally daily charts, but with
TD AMERITRADE

the conquest of the computer in


the mid-’90s, everything changed,
FIGURE 1: A BASIC INTRADAY CHART. You can see that it’s difficult to figure out what’s going on here. Sometimes the and intraday charting came into its
buyers are winning and sometimes the sellers are winning. There’s no way to predict what’ll happen next. own. The computer does it easily,
manipulating data and putting it in
the market when it is closed and therefore unconcerned about a form that can be appreciated at a glance. The trader can use
whether it is going up or down in the longer term. He is inter- these charts to find those areas where price may be too high
ested only in the prices of things from 9:30 am until 4:15 pm or too low, that is, whether the instrument has value or not,
US Eastern Time. During these six and three-quarters hours, even on the most fleeting basis. I think charts have become
prices change in ways that may well look unpredictable to those ascendant because most people are visually oriented and like
without experience and the proper tools. the perspective that charts can provide.
The chart that I believe is best for the small trader—since
Viewing the charts we’re interested here in safety—is one that is of a very small
The security with which I am concerned, and which I will use time frame. I prefer two minutes; others like “tick” charts,
in this article, is the futures contract that tracks the S&P 500 which paint bars (or candles) according to a specified number
index. It is an instrument of interest to traders over the entire of trades. These are best for the “scalpers”—so-called because
world and it trades nearly 24 hours a day, five days a week, and of their hit-and-run style, taking a little out of the market here
on a good day, over two million contracts will be exchanged, and there—because it is the safest way to be in what could be a
making it highly liquid. Liquidity is not just an advantage for dangerous environment. There are longer-term investors here,
the daytrader; it is a necessity. The daytrader must be able to too; the two classes of market participants are there together,
jump in and out of the market without delays. Another impor- but it’s the scalpers that determine the minute-by-minute ups
tant advantage of trading in the futures market as opposed to and downs of the price action. It is the scalpers who are making
the stock market is that you do not have to own the product in their living on this price action, minute by minute, in between
order to sell it. A seller can take his position in the hope of a and sometimes using the activities of the long-term investors
decline in price, after which he can take a profit. This can also as grist for their mills. Of course, they are equally grist for the
be done in the stock market, of course, but you need the fiction mills of the long-term investors. Fair is fair.
of ownership by “borrowing” the stock in order to sell it. The Though this is an arena for long-term investors in the end,
effect is the same as long as the stock is not difficult to borrow, it’s one that could not exist without the scalpers. It is supported
but all in all, it’s easier with futures, especially in daytrading. by the scalpers in the same way that our farmers are supported
There are two basic ways of describing the financial mar- by the speculators who are willing to buy their crops before
kets. One is appropriate for longer-term investors: it concerns they have even sprouted from the ground. The farmers could
itself with the fundamentals of financial products, the analysis not remain in business without the speculators, and in the same
of the economy, monetary system, and so on. This is usually way, the investors need the scalpers to function.
applied to the equity market by people who want to find the Let’s look at a basic intraday chart in Figure 1. There’s not
best stock to own for the next 20 years. The daytrader is not much to go on here. The chart (one day in two-minute incre-
interested in the next 20 years, and he is not interested—at least ments) makes market action look like a brawl. Sometimes the
immediately—in the balance sheet and quarterly report. But he buyers are winning and sometimes the sellers. It looks like
is interested in the first effect that those things have on other there’s no way to predict what will happen next. Clearly, the
people, mainly other traders. And where others may use the chart, in and of itself, is not enough. This is where the Fibonacci
daily newspaper, or even listen to the CEO’s conference call to tool makes itself felt in the intraday environment. The tool—as
decide what’s valuable, the daytrader, along with others traders, opposed to the Fibonacci mathematical system that gave birth
uses intraday charts. The charts tell him what effect the CEO’s to it—is another invention of the last few decades: mathematical
call had on other market participants. They tell him if people studies applied in visual form to price action. The wild-looking
14 • January 2016 • Technical Analysis of Stocks & Commodities
down; instead, you have something
to go by.

What are the charts


telling you?
Now that you have the Fibonacci
levels on the chart, the next step is
to figure out what they are telling
you. In my observations I have
found that they are, sometimes
for just moments, the boundar-
ies of what we call support &
resistance. This idea may be the
most important one in the world
of trading. The trader’s idea of
FIGURE 2: ADDING FIBONACCI LINES. Here, you can see how the price often pauses at the blue lines, sometimes right support & resistance will be his
on the tick, or sometimes clustering, and then often turning to go in the other direction. reason for buying or selling or
doing nothing. When the trader
believes the price of something is at
support, he will be willing to buy,
and when it’s at resistance, he won’t
buy, and may sell instead. Support
can be defined as a level at which
buyers are willing to pay up for
the product in question, expecting
that they will be able to get more
for it in the future, even in the next
couple of minutes. Resistance, on
the other hand, comes about when
buyers are no longer willing to
pay up, and also where the sell-
ers, a little anxious, are willing
to take whatever is bid for their
holdings, generally a little less
FIGURE 3: ADDING AN INDICATOR. Here, the stochastic oscillator is used as a confirmation to the Fibonacci levels. than they would otherwise have
Meeting of price and Fibonacci levels combined with a high or low level on the stochastic gives a good indication of what held out for.
will happen next. Naturally, there are many valid
ways to determine support & re-
chart that you saw in Figure 1 can be tamed to a large degree sistance. Every trader has at least one, and I am not trying
with this tool. It clearly puts some order into the chaos of the to gainsay any other theory. But the evidence I have found
chart in Figure 1. shows that the delineations that result from the proper use of
The chart in Figure 2 has horizontal lines (blue on my charts) the Fibonacci tool become excellent estimations of support &
laid across the price activity that were calculated by the Fibonacci resistance, at which times a majority of orders moves the price
system. You can see in this chart how the price often pauses either up from support or down from resistance. Traders will
at the blue lines, sometimes right on the tick, or sometimes respond to these numbers as definitions of the high and low of
clustering, and then often turning to go in the other direction. It an area of value.
is almost as though the price was poured into an oddly shaped But is every Fibonacci line a level of support or resistance?
mold, the Fibonacci lines being its edges. There is occasional From the chart in Figure 2 you can see that price often changes
spilling over, but it is unusual for price to ignore these lines direction at the blue lines. But these numbers are not always
even at times when excitement and volatility are high. exact, and sometimes the turn is too small to be of use. You
Those Fibonacci levels are landmarks in the alien territory need something else to give you the confidence to take a posi-
that we saw in the first chart, a wasteland that gave no clues as tion, and to assure you that the change in direction you expect
to where we were or what to do. You need to have something to will have some follow-through. The thesis here is that there
judge whether the product you are trading was well or poorly is an important relationship between the price and Fibonacci
priced. With the Fibonacci levels, you don’t need to buy or levels, but this fact turns out to be insufficient by itself for ef-
sell blindly with no good idea of whether prices will go up or fective trading.
January 2016 • Technical Analysis of Stocks & Commodities • 15
Adding confirming “Calculating Fibonacci Levels” for the method of deriving these
indicators numbers.) At the open, or even earlier, we look for an indica-
The Fibonacci tool is not magi- tion of which way prices will go. Where is the Fib level? Is the
cal. What is needed is one more stochastic high or low, if either? These are the things that will
indicator that will act like a give indications of what the market wants to do.
compass at Fibonacci levels, The chart in Figure 4 shows the first two hours of activity of
telling you which way to go, the S&P emini futures contract on a recent day. (The vertical
whether it is appropriate to take lines are put in to show the connection between the stochastic
a position or not, whether to and price levels.) You can see that price opened (9:30 am Eastern
buy or sell, and whether there Time, the first of the vertical lines) up against a Fibonacci level
may be follow-through from at about 2096 and the stochastic was quite high in its range. This
the point at which you take a made for a reasonable sell of the contract, which went down to
position. It’s another of those mathematical studies made visual: 2083 before reversing for the day. There were various points at
the stochastic oscillator. There are others of this variety, but I which you could get in or out, but the possibility is clear that a
like this one. skillful trader might have captured 13 points on this contract.
Notice on the chart in Figure 3 the coincidence of price Small time frames like this have the advantage of letting the
meeting a Fibonacci level and the position, high or low, of the trader know quickly when a trade is not working as expected.
stochastic. (The ovals are drawn at the same times on the upper A large trader might use a five, or 15-minute, or even larger
and lower panels of each part of the chart. This is the coordina- time frame because he doesn’t need to worry as much about
tion you’re looking for.) the drawdown that can happen while a single bar (or candle) is
It’s clear on this chart that the meeting of price and the Fibo- being painted. If a small trader tries to use even a five-minute
nacci levels combined with a high or low level on the stochastic time frame he may find himself in trouble before he knows
gives a good indication of what will happen next. The prob- it. That, combined with the use of the Fibonacci system, is
abilities are very high that this combination will be predictive specifically geared to keep the small trader out of trouble. The
of the direction that price will go, and that there will be enough trader has what I am calling a “decision area” within which
follow-through to make the trade worthwhile. You don’t want he is safe. The large trader might be able to afford to take 15
to make a trade only to have the thing do an about-face as soon minutes to make his decision, but the little guy has sometimes
as you click the buy or sell button. Ideally, you see the price only a few moments. You want to quickly know when you are
rise along with the stochastic and then see the price meet a Fib wrong. You need to have guideposts that you respect because
level while the stochastic is high in its range. That will signal otherwise you will be tempted to think that you know better
an opportunity to sell. It’ll be the opposite for buys. than that mathematician who is long dead, and try to pit yourself
By the time the market opens, Fibonacci calculations have against the market, which is always a mistake.
been made for the day: the levels are on the chart. (See sidebar I believe that this system, simple as it is (one chart with two

Calculating Fibonacci Levels


Here’s how the Fibonacci tool is used
to create intraday levels of support &
resistance, creating some order in the
chaos. On the two-minute chart in
Sidebar Figure 1, the trader simply,
before the market opens, drags the
drawing icon labeled “Fibonacci
retracements” from the low of the
overnight session to its high (the areas
designated by the red squares). The
numbers upon which the lines are
based correspond to percentages of
the range of that overnight session
(38.2%, 50%, 62.8%, etc., up to 423%).
You then do the same thing from the
high to the low so you have numbers
SIDEBAR FIGURE 1: CALCULATING FIBONACCI LEVELS. You can prepare for any market scenario by creating
that would be appropriate to the mar- intraday levels of support & resistance.
ket going lower. This way, you’ll be
ready for anything.—P. Hill

16 • January 2016 • Technical Analysis of Stocks & Commodities


appropriate to the size of my account, never
risking more than I can afford to lose.
With these things in mind, the trader can see
what the uses of the Fibonacci levels are. They
define a place on the chart with the number
that may well be the exact point at which the
price turns. My view is that it is good to put
orders to buy or sell the Fibonacci numbers
as early as possible. Discretion has to be used
in this situation: be wary of a fast-moving
market. Each trader is competing for a place
in the queue of the exchange, which will ex-
ecute orders on the basis of the time they were
entered. If all the traders who are looking see
that 2089.75 looks like a good number to sell,
they will be putting in their orders to do so as
soon as they can. If I am late in deciding that
it would be a good deal, my order may not be
filled. My order will be left in the queue while
those ahead of me will get into the market.
Then, next time, I will have to get ahead of
FIGURE 4: TRADING THE S&P 500 EMINI FUTURES CONTRACT. At around the open, price was up
the others by using a lower number for sales
against a Fibonacci level at about 2096 and the stochastic was quite high in its range. This would have been
an indication to sell. From the chart, you can see there were several opportunities to buy and sell. and higher for buys by a tick or two, which
may work but which will make my stop-loss
more vulnerable. This may not be a terrible
problem, but it is something to consider. It is always possible
to cancel orders that look like they might be overrun because
This system, simple as it is (one there is too much volatility or the stochastic is not in the right
chart with two indicators), would position for that particular trade.
provide a way for the small trader Finally, though this is not an attempt to cover all the aspects
to function in the market without of trading, I would be remiss if I didn’t remind anyone who
wants to use this system that it is always necessary to keep an
taking a lot of risk. eye on the general conditions of the day, especially the breadth
indicators that will warn the trader of volatility and direction in
the wider market. For example, if there is a strong trend in the
indicators), would provide a way for the small trader to function downward direction, it doesn’t mean that he can’t take coun-
in the market without taking a lot of risk. I think it’s just what is tertrend trades, buying significant levels, but it does mean that
needed by so many who inhabit the chat rooms on the Internet he is in more danger doing so, and should not expect as much
waiting for gurus to tell them what to do. This can be learned from that buy trade as he would get if he were selling a good
by anyone and can give all the guidance that a guru could give, number that he could go with for a longer, and better, trade.
at least insofar as daytrading index futures is concerned. Going with the trend of the day is normally best, as usual, but
days without trend are as promising for this system as trending
The trading plan days, and possibly safer.
You can see in the chart in Figure 4 that the system does fail
at certain points, mostly when the market is volatile. However, Peter Hill was an equities trader until he made a bad specula-
these instances are so rare that a trade will be safe from any tive investment in English real estate. The loss of capital in that
serious drawdown as long as the trader always uses stop-loss deal led him to feel the need to use the higher leverage offered
orders, especially for those volatile times, and as long as the by the futures market. After investing a great deal of time and
trader respects those orders. The stop-loss order has to be un- money in learning how to trade in the futures markets, he
questionable once it has been decided generally how much the came up with a methodology to trade that offers discipline and
trader can afford to risk on a trade. In my backtesting, I’ve found reasonable expectations of what might happen in the markets.
that the price will only rarely overrun the Fibonacci level by He may be reached via email at p.healy.hill@gmail.com.
more than two points before going in the desired direction, so I
use a 10-tick, or 2½ point, stop-loss, and it is rarely hit. Taking ‡TD Ameritrade
these losses is not terrifying as long as I know that the ratio of ‡See Editorial Resource Index
wins to losses is positive, and as long as I keep my trade size
January 2016 • Technical Analysis of Stocks & Commodities • 17
Uncovering Hidden Truths

Aliasing
Since you are likely using sampled data when trading, there samples per cycle is called the Nyquist frequency. The theory
is a chance that there could be some distortions in the data. is demonstrated in Figure 1, where the shorter cycle depicted
Here’s what you can do to avoid those distortions. by the red line is sampled at a rate less than two samples per
cycle. Since there are less than two samples per cycle of the

Fred Fokkelman/Shutterstock/Digital collage: nikki morr


by John F. Ehlers real data of the red sine wave, the data is interpreted as the
phantom aliased blue sine wave. Just imagine the impact on

I
imagine that most traders consider the price data they your trading if your data is subject to aliasing!
use for analysis to be a continuous function. Nothing Mathematically, the process of sampling is multiplying a
could be further from the truth. And, depending on your sine wave at the sampling frequency with the cycles in the
trading style, the impact of this assumption can range continuous data. From your high school trigonometry class
from trivial to dramatic. The fact is that the data is sampled you may recall this equation:
data. The sample rate is once per day on daily bars, once per
hour on hourly bars, and so on. It doesn’t matter if you aver- Sine(A)*Sine(B) = 0.5*(Sine(A+B) + Sine(A-B))
age the high, low, and close; you still only have one sample
per day on daily bars. If A represents the sampling frequency and B represents the
One impact of sampled data is that it can lead to aliasing. In frequencies of the continuous data, the sampling frequency is
my youth, the old cowboy movies had a sample rate of only 16 heterodyned with the continuous data with upper and lower
frames per second, letting the eye integrate those individual sidebands. This is exactly the same process as with your AM
still photographs to produce motion, albeit with a little flicker.
Aliasing at this slow sample rate made the wagon wheels look
like they were turning backwards, and the effect was really
weird. Aliasing can also produce some weird effects on your
market data.
The theory of sampled data states that you must have at
least two samples per cycle. Otherwise, the sampled data will Figure 1: theory of sampled data. Sampling less than twice per cycle
result in aliasing. The frequency at which there are exactly two produces phantom aliased signals.

18 • January 2016 • Technical Analysis of Stocks & Commodities


TRADING TECHNIQUES

radio, where you tune your re-


ceiver to the carrier frequency and
the information is contained in the
upper and lower sidebands. Since
the sampling process is nonlinear,
aliasing can include harmonics of
the sampling frequency mixing
with different harmonics of the
data to produce a really gnarly
soup of noise superimposed on
the information contained in
the data.
Here’s the important part for
market data: there is nothing
inherent in the data to preclude
content whose period is shorter Figure 2: how does the aliased composite waveform affect your trading? Here you see that aliasing
than that of the Nyquist frequency. produces short-term volatility in the composite data.
That means you should expect the
upper sideband to be folded back
into the lower sideband, producing
a false composite signal due to
aliasing. The real question is how
badly the aliased composite wave-
form affects your trading. Figure
2 shows the closes of daily prices
of SPY as the green line, while the
red line shows the majority of the
aliased signals removed by filter-
ing in the composite waveform at
the cost of a half bar of lag.

Just how
bad is it?
To get a more quan-
titative estimate of FIGURE 3: ALIASING IMPACT. The lower sideband blue line shows the amplitude doubling every time the cycle period
aliasing effects, doubles. In this simplified model, the red line represents the aliased upper sideband amplitude simply added to the
start by making a amplitude of the blue line signal.

model of market data. It is well


established that market data is
fractal. That is, a chart using
weekly data looks exactly like
a chart using daily data if you
remove the scales. In other words,
the amplitude of the swings
in market data is proportional
to the wavelength of the cycle
components in the data. Simply
put, longer cycles have bigger
swings. Using this model, you can
extend the theoretical shape of the
market spectrum on both sides
of the Nyquist frequency. Figure
3 shows the spectrum amplitude
of the data at frequencies below
the Nyquist frequency as the blue FIGURE 4: ALIAS AMPLITUDE. The aliasing impact becomes insignificant two octaves below the Nyquist frequency.
line and, with the upper sideband
January 2016 • Technical Analysis of Stocks & Commodities • 19
basically insignificant at longer cycle periods. Other
theoretical models of the market can be created, and
these generally show that the aliasing impacts depicted
in Figures 3 & 4 are a conservative estimate.
So what does all this mean to a trader? If you are a
trend follower and are using tools like a 50-day mov-
ing average or a 200-day moving average, the cycle
periods of the data you are using is so far removed
from the Nyquist frequency that you can just ignore
the impact of aliasing. On the other hand, if your
technique involves recognizing short-term patterns
in the range of two to five bars, you should seriously
rethink your approach because aliasing produces
illusory patterns. Short-term traders using cycles or
mean reversion should take active measures to mitigate
the impacts of aliasing.

What can be done


to mitigate aliasing
FIGURE 5: frequency response of a two-bar simple moving effects?
average. here you see that a simple two-bar moving average can remove The first line of defense to avoid
much of the aliasing impact. problems associated with aliasing
is to just accept that you should
not work with cycle
periods within two
octaves of the pe-
riod of the Nyquist
frequency. For daily
data, that means
you should not ex-
pect to use cycle
periods shorter than
eight bars. Even with
this constraint you
should reduce the
swing of the com-
posite waveform by
filtering. For exam-
ple, if you wanted to
use a cycle having a
FIGURE 6: OVERSAMPLING RESULTS IN SMOOTHER EQUIVALENT FILTERED DATA. The top chart shows a four bar SuperSmoother four-bar period, you
as the red line. The bottom chart shows the equivalent 52 bar SuperSmoother using 30 minute data. The green dots show the sampled need to recognize
data in both cases. The filter output using the oversampled data is much smoother.
that the composite
signal at the Nyquist
folded back about the Nyquist frequency, the amplitude of the frequency has the same amplitude as your desired signal.
composite sidebands show as the red line. The lower sideband Therefore, it is imperative that a low-pass filter of some kind
blue line shows the amplitude doubling every time the cycle be used to reduce the amplitude of the frequency components
period doubles. In this simplified model, the red line repre- near the Nyquist frequency. A simple two-bar moving aver-
sents the aliased upper sideband amplitude simply added to age is often adequate, because this average has a theoretical
the amplitude of the blue line signal. zero of transmission at the Nyquist frequency.
The aliasing impact is better demonstrated in Figure 4, The frequency response of a two-bar simple moving
where the ratio of the composite signal plus alias is shown as average is shown in Figure 5. This is an effective way to be
a ratio to the signal in terms of decibels. The maximum im- sure that aliasing effects are removed. But when it comes
pact is at the two-bar cycle period—the period of the Nyquist to filtering, more is often better, if there is not a price to be
frequency. Two octaves below the Nyquist frequency, at the paid in terms of lag. Therefore, I also recommend using my
eight-bar cycle, the impact is less than 0.5 dB, and therefore is SuperSmoother filter set to a four-bar cutoff period.
20 • January 2016 • Technical Analysis of Stocks & Commodities
Noisy indicators
delay your analysis

If you are using short-term patterns


in the range of two to five bars, the
effect of aliasing is dramatic.
Jurik algorithms
A trader can also elect to oversample the data by using a dif- deliver low lag,
ferent sample rate. For example, there are 13 half-hour samples low noise analysis
in the trading day. So if you use 30-minute data instead of
daily data, the data of interest is nearly three octaves below
the sample rate. The top chart in Figure 6 shows a four-bar
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
SuperSmoother as the red line while the bottom chart shows Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
the equivalent 52-bar SuperSmoother using 30-minute data.
The green dots show the sampled data in both cases. The filter
Jurik Tools on live charts, on the web !
output using the oversampled data is much smoother. tinyurl.com/jurik-online
More important, oversampling enables the trader to cre-
ate a higher-fidelity waveform closer to the original Nyquist
frequency. For example, the cutoff period of the oversampled
Jurik Research
SuperSmoother filter was reduced to 26 bars, resulting in a
smoothed waveform with less lag as shown in the lower graph
of Figure 7. 2010 -- 2011 -- 2012 -- 2013
Add-In software

It may impact your trading


Market data aliasing is real, but its impact on your trading jurikres.com • 800-810-3646 • 719-686-0074
depends on your style. If you are a trend trader using relatively
long moving aver-
ages or slowly mov-
ing indicators, you
can just ignore it. On
the other hand, if you
are using short-term
patterns in the range
of two to five bars,
the effect is dramatic
and you might want
to rethink your ap-
proach. Nonetheless,
it’s a good idea to be
aware that aliasing is
real and it’s a good
idea to mitigate its
effects just by apply-
ing a simple two-bar
moving average or FIGURE 7: SMOOTHER INDICATORS WITH REDUCED LAG. Reducing the cutoff period of the oversampled SuperSmoother filter to 26
the SuperSmoother bars resulted in the smoothed waveform with less lag.
filter to the data be-
fore using any other indicator. More adventurous technicians Further reading
might want to explore oversampling using intraday data. Ehlers, John F. [2013]. Cycle Analytics For Traders, John
Wiley & Sons.
S&C Contributing Editor John Ehlers is a pioneer in the use [2015]. “Decyclers,” Technical Analysis of Stocks &
of cycles and DSP technical analysis. He is president of MESA Commodities, Volume 33: September.
Software. MESASoftware.com offers the MESA Phasor and
MESA intraday futures strategies. He is also the chief scien- ‡MESASoftware.com, ‡Stockspotter.com, ‡TradeStation
tist for StockSpotter.com, which offers stock trading signals
based on indicators and statistical techniques.
January 2016 • Technical Analysis of Stocks & Commodities • 21
Wanna Bet?

Trading Vs. Forecasting:


What’s The Difference?
Trading is about recognizing present opportunities where the number of ways to hit 21, often blind to the hundreds of ways
risk-to-reward is favorable. Forecasting, on the other hand, to go bust or have the dealer beat you, traders often think of a
is outcome dependent. Find out how you can use both and favorable outcome instead of thinking about what can go wrong.
take advantage of those opportunities. Traders who are confident in their market forecast often focus
narrowly on their outcome materializing, instead of focusing
US bill: YamabikaY/Euro bill: Whataphoto/Dao: gguy/Shutterstock/collage: J. Barrett

by Tyler Yell, CMT on the data and validating their proposed outcome.

Where forecasters get it right


M
ost of us are conditioned to make all our trading deci-
sions based on what we see on the hard right side of a and wrong
chart. When you look at a chart, price movement that Philip Tetlock, who has a new book out titled SuperFore-
occurred in the past may look like it had only one likely casters, recently brought to light a great analogy of common
outcome. But when you look at a chart in real time, you don’t forecasting personalities. He explains it well in his prior book,
know what the outcome will be. There could have been multiple Expert Political Judgment:
scenarios, and credible people will argue for price to move in
completely different paths from a specific point. The intellectually aggressive hedgehogs knew one big thing
Price charts and potential outcomes often play cruel tricks and sought, under the banner of parsimony, to expand the
on the brain. Trading, on the surface, is similar to a casino in explanatory power of that big thing to “cover” new cases;
that it informs you of the prize of a low-probability outcome the more eclectic foxes knew many little things and were
while the quantitative edge that the casino holds is purposely content to improvise ad hoc solutions to keep pace with a
hidden from you. Just as the blackjack player thinks about the rapidly changing world.
22 • January 2016 • Technical Analysis of Stocks & Commodities
FOREX FOCUS

2008 Top

Labels are from the technical forecasting methodology known as Elliott wave
a c

e/B

ii
Some people believe we’ll have
i another strong bounce off the trendline,

FXCM’s Marketscope/Trading Station II


The financial crisis at least to midline.
A
d iv?
b

iii
v/C
Many people believe we “must” hit parity (1.000) or below

FIGURE 1: WHICH WAY IS THE EUR/USD HEADING? There are often compelling views that the market will go higher or lower but only one of these forecasts
will be proven correct. Here, some traders may have reason to believe that price will have another strong bounce off the lower channel line whereas others
may feel that prices will break below that lower channel line.

Bringing this analogy to trading, you would likely be better to any one outcome but be flexible with your outlook, because
served by adding incoming data to see if your outcome is more markets appear chaotic in real time.
or less likely to come to fruition as opposed to putting your In Michael Toma’s informative book The Risk Of Trading:
head in the sand, hoping you are proven right. Mastering The Most Important Element In Financial Specu-
Another rock star in the world of nonmarket forecasting lation, he walks traders through the process of identification,
is Nate Silver, who predicted the outcome of the 2008 US assessment, control, measuring, and monitoring of trading
presidential election with far more accuracy than highly paid risks. The purpose is to show traders that when trading, there
political forecasters. He attributes his methodology of fore- is more to risk management than placing a stop-loss. Similarly,
casting to Bayes’ theorem, an algorithmic approach for which traders would likely be better served by focusing on how their
its namesake is an 18th-century pastor. Bayes’ theorem opines forecast could be nullified as opposed to validated.
that recently available evidence should be used to bring down
or bring credibility to an outcome. Nate Silver’s model used Clash of trading
individual states’ high-credibility polls in the 2008 election to & forecasting
predict the likelihood of the winner and updated his forecast When looking at the present, a new
the night of the elections as individual state outcomes were thought often creeps into your mind
being announced. as a trader. First, you think if I can
The trading equivalent to this is to look for obvious failures only figure out the future I will be
toward your desired outcome developing in real time. An able to avoid a loss and book a profit.
Elliott wave–based trader will consider invalidations of a Daniel Kahneman’s prospect theory
primary market view as casting doubt or outright invalidating from his book Thinking Fast And
his forecasts. The point here is that you should not be married Slow states that people (traders included) emotionally prefer
to avoid losses than achieve gains.
Unpacking this finding further, traders will often hold
onto forecasts and hope that it will prove true so they do
not have to take a loss. While the desire to avoid a loss is
understandable, the unwillingness to accept a loss is futile.
The desire to avoid a loss To avoid such a fallacy, you are probably better off holding
is understandable, but the your strong opinions or forecasts with consistent pessimism.
unwillingness to accept a In other words, hold your strong opinions weakly so that you
do not find yourself overrelying on an assumed outcome that
loss is futile. doesn’t take place.

January 2016 • Technical Analysis of Stocks & Commodities • 23


their well-researched views. That said, there are often com-
You can be incorrect in pelling views that the market will go higher or lower. Only
forecasting but place a good one of these forecasts will be proven correct, although in a
trade, and you can be good at sideways market, both could be correct, revealing the need
for combining risk management with forecasting.
forecasting but poor at trading.
Summary
Learning how to forecast and finding an accurate trading
method should play a separate role from learning how to trade.
Marrying the two worlds of Forecasting is outcome dependent, and the road toward the
forecasting & trading realized outcome is often full of unpredictable developments.
Businesses are fond of making a premortem prior to major Trading is about recognizing present opportunities where
projects. A premortem is an explanation of potential causes the risk–reward tradeoff is presently favorable, and taking
of failure for an important project. As you can imagine, the advantage of those opportunities. Ironically, yet importantly,
goal of the premortem is to think outside of the “hedgehog you can be incorrect in forecasting but place a good trade, and
view” so that you may act accordingly before the start of the likewise, you can be good at forecasting but poor at trading.
real project. The latter is surprisingly common.
In trading, a premortem will hopefully cause you to trade Regardless of your method of forecasting, recognizing a
smaller or use less leverage than you might have otherwise good risk–reward trade setup as per your preferential trad-
done with a more confident but likely flawed forecast. Second, ing methodology is crucial. It is best to avoid the mistake of
a premortem may help you identify where, as a trader, you may believing the market must end up at a certain juncture a week,
want to flip your bias and potentially your exposure. Either way, month, or quarter from now and overexposing your account on
optimism surprisingly has little room in a trader’s career. that hope. Rather, it is best to use a forecast as a springboard
Mark Spitznagel, the hedge fund manager and former head for entering the market and then analyzing how the market
trader for Naseem Taleb, notes in his book The Dao of Capital is reacting to your forecast to see whether or not more weight
that to survive, you must learn to “hate to win, love to lose.” As should be given to that outcome coming to fruition.
a multibillion-dollar hedge fund manager, he obviously needs Trade (as opposed to forecast) well.
profits to attract new investors. Spitznagel is driving home the
point that staying in a losing position is the quickest way out Tyler Yell, CMT, is a currency analyst and trading instructor
of the business. In addition, poor forecasting or overreliance for DailyFX.com, a forex market news and analysis site.
on your market forecasting methods is one of the quickest
ways to convince yourself to stay in a bad position. Further reading
Spitznagel, Mark [2013]. The Dao Of Capital: Austrian In-
Little bets vesting In A Distorted World, Wiley.
Many traders come to the market with a per- Tetlock, Philip E., and Dan Gardner [2015]. Superforecasting:
verted view of their likely success. In other The Art And Science Of Prediction, Crown Publishers.
words, it is common for them to look at stories Tetlock, Philip E. [2005]. Expert Political Judgment: How
on financial news networks regarding the one Good Is It? How Can We Know? Princeton University
big trade that made someone’s career like bet- Press.
ting on subprime mortgages in 2003 or betting Toma, Michael [2012]. The Risk Of Trading: Mastering The
against them in 2007. However, the one big bet Most Important Element In Financial Speculation, John
can often turn into one big loss, since few things Wiley & Sons.
unfold in a straight line. Yell, Tyler [2015]. “Gold & The Yen,” Technical Analysis of
Instead of placing one big bet, a better approach would be Stocks & Commodities, Volume 33: October.
to place multiple small bets. Sure, if your one big bet is large _____ [2015]. “Bond Markets & FX Effects,” Technical Analy-
enough and you come out on the winning side, someone may sis of Stocks & Commodities, Volume 33: August.
write a book about you, but the likelihood of that is under- ‡Marketscope/Trading Station II (FXCM)
standably small. As a trader looking for double-digit returns ‡See Editorial Resource Index
year over year, the better approach is often to manage your
downside aggressively, while strategically looking for a multi­
percentage move in the direction of a shorter-term forecast,
which of course, can still be wrong.
The chart in Figure 1 shows the EURUSD, the most heavily
traded currency pair in the spot forex market. My role at Dai-
lyFX gives me exposure to a myriad of the top-tier investment
bank (sell-side) research that makes very compelling cases for
24 • January 2016 • Technical Analysis of Stocks & Commodities
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high-volume breakout patterns when
you’re entering your trades.
A popular Wall Street professional
traders’ saying is that “traders vote
with volume, and profit with price
action.” It’s wise to wait for volume
confirmation prior to entering any
breakout trade, because you want to
have high volume serve as the “wind
beneath your wings” to support an up-
side technical price move whenever
you trade. It’s not enough to simply
buy new highs for breakout entries.
You want price to continue upward
after you enter your trade, and seeing
strong volume is one of the best ways
in which you can achieve this. Here,
then, are some high-volume breakout
patterns you can look for to help with
finding good entries.

High-volume breakouts & cups


The first volume breakout pattern
to look for is one in which volume
increases steadily near the right
side of a bullish cup, as it tests prior
resistance. You will often notice an
uptrend in the height of volume bars,
in addition to an upward sharp move
in price. The volume bar uptrend
should make a triangle-type pattern,
with the highest volume bars on the
right side.
You can see this pattern illustrated
Heighten Your Confidence in the chart of Oceaneering Interna-

High-Volume
tional, Inc. (OII) in Figure 1, in which
the cup breakout is confirmed by a

Breakouts
high-volume breakout on October 2,
2015. The volume trended up heavily
during this triangle breakout pattern.
When you’re scanning for these pat-
terns, a good entry strategy is to enter
In this final article in a series we’ve been presenting on breakout trading strategies a new swing trade anywhere from 50
from this professional daytrader and educator, we look at the role that volume and cents to a dollar above the high of the
price-action breakout patterns play in confirming entry signals. breakout pattern day on a subsequent
day (in this case, an entry near $44
by Ken Calhoun on October 5, 2015).
You may often come across these

As
many traders know, the two most important technical trading signals are high-volume breakout patterns after
price and volume. By combining price-action breakout patterns with spe- they’ve made their initial move. The
cific volume confirmation signals, you can identify strong trading entries good news is that entering above new
as they’re moving to new highs. highs on a day following this pattern
violetkalpa/Shutterstock

You can spot high-volume breakouts whenever volume increases significantly—that is fine, as long as it has remained in an
is, at least 30% higher than their average trading volume—along with a move up in uptrend following the initial volume
price. These are important because strong volume indicates institutional buying is at breakout day, as seen on the chart in
work, which can help you find good entries. In this article, I’ll show you how to find Figure 1. A simple criterion for con-
26 • January 2016 • Technical Analysis of Stocks & Commodities
CHART PATTERNS

firming a new breakout en-


try is to determine if volume
and price are both at 15-day
highs. If price alone is at a
15-day high, you may still
wish to take the trade, but
to be cautious, you should
trade a smaller share size.
If price and volume are at
15-day highs, then you can
trade a larger size.
This is an effective guide-
line for helping to decide
how many shares to trade;
you can also use volume bar
height to help you visually
see if your trade size should
be small versus large, based
on overall trading volume. If
current volume for the chart

eSignal
you’re considering is un-
changed during an uptrend, Figure 1: Cup Breakout Confirmed By High-Volume Breakout. Volume trended up heavily during the triangle
then you trade a small size. breakout pattern. A good entry strategy, in this case, would be to enter a new swing trade $0.50–$1.00 above the high of the
If, however, current (most breakout pattern on a subsequent day.
recent) volume is at least
30% higher than average, in an uptrend or other breakout
pattern, then you can consider trading a larger size.
Strong volume indicates
institutional buying is at
Volume gap continuations work, which can help you
The most common high-volume day is one in which price has find good entries.
gapped up (or down), as seen on the chart of EMC Corp. (EMC)
in Figure 2. These minor
gaps of less than one to two
points will often continue
in the direction of the gap,
often for several days. When
you see a high-volume gap
continuation pattern like
this, it’s a smart trading
idea to figure out how to
enter your trade during the
two to three days following
the gap day.
You will likely find that
these patterns make for a
primary trading strategy,
since high-volume gap
continuations tend to work
out well. Your initial, as well
as second or third, scaled-in
trades can also use volume
confirmation signals to help
you decide when to add to a
winning position. In Figure Figure 2: Gap Volume Continuation Pattern. These minor gaps, of less than one to two points, will often continue in
2, you can see that October the direction of the gap, often for several days. When you trade high-volume gap continuations, it’s important to note that the best
12, 2015, on the rightmost ones are in a clearly defined, strong, sustained uptrend.
January 2016 • Technical Analysis of Stocks & Commodities • 27
side of the chart, was also
a high-volume day. Enter-
ing on a later day, above
the high of this volume
breakout day, would also
make sense.
When you trade high-
volume gap continuations,
it’s important to note that
the best ones are in a clearly
defined, strong, sustained
uptrend. Similar to visit-
ing your eye doctor and
reporting which letters are
the clearest, in trading, it’s
important to avoid up-and-
down choppy charts, even
if they have high-volume
breakouts. Give prefer-
ence instead to charts that
exhibit price action in a
Figure 3: Inverse Head & Shoulders. High volume confirms a bullish upside breakout move. Note how much higher the tight, narrow, strongly up-
overall volume bars are on October 20, 2015 compared to the prior day, during the inverse H&S breakout during the opening trending channel like those
hour of the trading day. discussed here.

Inverse head & shoulders breakout


When you’re looking for what is Another strong pattern for day or swing trading is to enter a
worth trading, charts with volume long trade following an inverse head & shoulder (H&S) pat-
and volatility (the “two Vs”) are tern (series of three bullish cups) on high volume. You can
see how strongly this pattern works on the chart of Weight
usually the best candidates. Watchers International, Inc. (WTW) in Figure 3. The multiple
retest of resistance near $15/
share finally broke out to
new highs, once volume
increased right after 9:30
am.
Note how much higher
the overall volume bars
are on October 20, 2015
compared to the prior day,
during the inverse H&S
breakout during the open-
ing hour of the trading
day. One interesting point
to note on this chart is
how the prior day’s range
($15 - $11 = $4) was met
early in the day, as WTW
moved four points during
the early part of the day
due to high-volume buy-
ing on the open. When
you are looking for what’s
worth trading, charts with
Figure 4: High Volume Confirming 50-Period Simple Moving Average (SMA). High volume confirms an entry in
this 50-period SMA breakout chart. This pattern trended up for three weeks before pulling back, going from $33/share to $39/ volume and volatility (the
share. “two Vs”) like this one are
28 • January 2016 • Technical Analysis of Stocks & Commodities
usually the best candidates. drop, it’s time for you to tighten your trailing stop or exit the
Here are two quick technical points to keep in mind when trade altogether.
entering long inverse H&S breakouts: first, it’s best if the Here are some trading tips to keep in mind:
neckline is in a slight uptrend (as it is in Figure 3); second,
it’s best if the depth of the rightmost cup is less than $1, as in zz Use high volume as a disciplined trading guideline; do
this example. This compression pattern—one with shallow not take trades until strong volume (>30% higher than
cups—in an H&S breakout often leads to solid upside moves. usual) starts to show up on your charts.
In this example, it did a full three-point upside breakout.
From a timing standpoint, when you see these types of zz High-volume breakouts will usually trend for much
upside high-volume breakouts, a nice feature is that they’re so longer than average-volume breakouts. Capitalize on
strong you don’t have to enter early or “right on time” above this phenomenon by planning to scale in and add to
the neckline. They will often move a dollar or more before winning trades as they continue in your favor (in swing
a pullback, making them ideal for both intraday as well as trading, you may wish to add additional shares every
swing trading. two points or so).

High volume above 50-period moving average zz Selectively trade only the strongest-trending charts in
For longer-term swing trading, you can use a 90-day daily sustained uptrends; for swing trades, the prior trend
candlestick chart with the 50/100/200-period simple moving should have at least three to five days of continuous new
average (SMA) lines that are favored by institutional traders. highs on your chart prior to entering.
One high-volume breakout pattern that capitalizes on 50-pe-
riod SMA breakouts is illustrated in the chart of Best Buy Co. Keep the relationship between price action and volume
Inc. (BBY) in Figure 4. A long entry is initiated following a firmly in mind when you place your trades. See if you can spot
day in which price action trades above the 50-period SMA similar high-volume breakout charts when you scan through
on strong volume. your charts to help identify successful trading entries.
The 50-period SMA on a 90-day daily chart is a key tech-
nical indicator that, when combined with volume, can help Ken Calhoun is a producer of trading courses, live seminars,
you spot strong breakouts as they progress in an uptrend. You and video-based training systems for active traders. He is a
can see that this pattern trended up for three weeks before UCLA alumnus and is the founder of TradeMastery.com, an
pulling back, going from $33/share to $39/share. Your initial educational resource site for day and swing traders.
exit target can be set at the 200-period SMA (in this chart,
that’s the black line at $36); this one kept going up strongly Further reading
even after that exit target was hit. Calhoun, Ken [2015]. “Trading First-Hour Breakouts,” Tech-
The reason this high-volume 50-period SMA breakout nical Analysis of Stocks & Commodities, Volume 33:
pattern works is simply because professional traders use this December.
technical moving average value to make their entry decisions. [2015]. “Managing Breakout Trades,” Technical Analy-
The strong buying volume that comes in after a move above sis of Stocks & Commodities, Volume 33: November.
the 50-period SMA attracts additional buying momentum, [2015]. “Breakout Or Fakeout?” Technical Analysis of
which leads to the multiday breakout continuation. Stocks & Commodities, Volume 33: October.
[2015]. “Gap Continuation Breakouts,” Technical
Your breakout trading Analysis of Stocks & Commodities, Volume 33: Sep-
plan tember.
Think of the supply & demand involved Gopalakrishnan, Jayanthi, and Bruce R. Faber [2011]. “Trading
in trading; when volume is high and price Momentum With Ken Calhoun,” interview, Technical Anal-
continues in an uptrend, it’s because ysis of Stocks & Commodities, Volume 29: March
there’s not enough share supply at one
price point, so price increases. As long as ‡eSignal
price and volume both continue increas- ‡See Editorial Resource Index
ing in an uptrend, the breakout continues. If you see volume
drop and price move sideways in a consolidation, or start to

January 2016 • Technical Analysis of Stocks & Commodities • 29


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

TO STRADDLE OR NOT TO STRADDLE few weeks ago seemed to make a lot of that are expiring in the current week are
Why not just buy a straddle into an sense in hindsight, as option volatility trading at around 50 points when you
earnings report, attempting to profit on has risen with price. Funny thing is that combine the costs of both. That’s what
either side? most novice traders think that buying a I like to do to get a read on where this
While this sounds like a great idea, straddle and holding it through earnings stock might go after earnings. Based on
it is not always the case. This month, I makes sense, because they have seen big these numbers, option traders expect the
want to review straddles but in particular, moves happen on the stock, and have range of AMZN to be contained to 50
I want to show you when not to use one. the idea that a trade, like a straddle, points after the report. That’s about an
The straddle is a nondirectional strategy will make money on the big move. It’s 8.5% move in the stock, which is a big
in which you buy an at-the-money call not as easy as it sounds, so let’s take a anticipation for a jump after earnings. If
and put with the same strike price and more experienced approach to see if option traders are already digesting 50
expiration date. The combined cost of this indeed is a good idea ahead of this points post earnings, there would have to
this option strategy is double what it week’s earnings on AMZN (as I write be a move greater than that to the upside
would cost to simply take a side, but it’s this in early November 2015). or downside to profit on the straddle by
also a nondirectional view. This sounds The first thing I do is evaluate what Friday’s expiration.
simple and I think this covers the basics the near-term straddle is trading for, Would I buy this straddle that expires
of it. I’ll show you an example of buy- so it makes sense to look at the near only one day after the earnings an-
ing a straddle just before earnings, with options expiring in the current week nouncement? Of course not, since the
none other than one of the most popular (Figure 2). This gives me a gauge of opportunity simply isn’t there. Here’s
companies in the world, Amazon.com, how far the stock could go just after the why: First, the straddle would cost $5,000
Inc. (AMZN). report. AMZN 570 calls and 570 puts per contract to buy, which already vio-
The chart of AMZN in Figure 1 is a
great read for straddle traders. It displays 620
price along with the result of the last 600
Stock: AMZN (AMAZON.COM) O=565.27 H=570.94 L=560.31 C=570.73
Next earnings in 6 days (2015-10-22 est) 85
earnings report back in late July, and 580 SMA (200) 80
it displays volatility. The red line you 560 7-30 day ATM IV 75

see moving up and down is not a mov- 540 70


65
ing average or any popular technical
520
500 E 60
indicator. It’s the implied volatility line 480 55 7-30 day ATM IV
for the near-money options that trade
Stock

460 50
on Amazon. 440 45

Take a closer look at the chart, and you 420 40


35
400
can see that this red line, or options IV,
www.tomsoptiontools.com

380 30
moves within a range of 20–80. This is 360 Volatility on the rise 25
what I refer to as a “fear factor” line. As 340
ahead of earnings 20
the line goes down, there is less fear of 320 15

the day-to-day movement of the stock.


300 10
8

As the line goes up, so does the uncer-


-2

-1

-0

-2

-1

-2

-1

-0
05

06

07

07

08

08

09

10
-

-
15

15

15

15

15

15

15

15

tainty about the future, and of course,


20

20

20

20

20

20

20

20

Figure 1: PRICE, EARNINGS, VOLATILITY. The red line, or implied volatility, moves within a range of 20 to
option prices. If the line goes from 20 80. As the line moves down, there is less fear and as it goes up it means there is uncertainty about the future.
to 80, it means that the time value of
an option theoretically increases by a
factor of four. AMZN ATM calls and puts
A smart straddle trader would try and expiring this week
buy when volatility is low, and sell when Figure 2: calls and puts expiring in the near term. Here you see that the AMZN 570 calls and
volatility is high. Buying a straddle a 570 puts are trading at around 50 points when you combine the costs of both.

30 • January 2016 • Technical Analysis of Stocks & Commodities


Explore Your Options
lates a major rule for me. Also, because Straddles are best used in periods of
there’s only one day after earnings for Straddles are best used low volatility when you expect price to
this trade to become profitable, there’s a in periods of low volatility break but are not sure in which direction,
big chance of risk at this price. when you expect price to or if you expect a rise in volatility because
What I am talking about is called statis- break or if you expect a of impending news such as an earnings
tical probability. With options, when you report. If you’re trading it for any other
bet on the long shot, you could win more,
rise in volatility. reason, then you’re not stacking anything
but the percentage of winning becomes in your favor. Keep this in mind when the
far less. Don’t let this calculator fool you is the only way to trade. It’s just a guide next earnings season approaches!
into thinking that naked option selling and should be treated as such.

mFo original Vitali (0.03153), mFo 50 (-0.07436)


0.4
0.3
0.2
0.1
0.0
-0.1
-0.2

Continued from page 7 work when I put it


-0.3
-0.4

spX D (2,013.73, 2,020.13, 2,007.61, 2,014.89, +1.45996) 2250

Which is why I’m asking if there’s a into MetaStock. (I


2200
2150
2100

criteria they apply to the 50d to determine receive the error


2050
2000
1950
1900

if market direction is with conviction and message “symbol


1850
1800
1750
1700

more valid in establishing the base from not fou nd i n


1650
1600
1550
1500

which they then scan for the stocks? database,” so it


1450
1400
1350

Any commentary and feedback from seems like it has


1300
1250
1200
1150

the authors on this would be greatly something to do


1100
1050
1000
950

appreciated to better complete the whole with the “.DJI”


900
850
800
750

picture from their article. in the code.)


700
650
600

Thanks again, and I’m looking forward How can I use


550
500
lT bullish lT bearish lT bullish lT bullish lT bullish lT bearish lT bullish

to more insightful articles from these the indicator on


1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 X

created in metastock from Equis international

authors in the future! all my different FiguRE 1: S&P 500 WiTh READER’S TREND-FOLLOWiNg iNDiCATOR AND ViTALi
ViNceNt indexes/securi- APiRiNE’S VOLumE iNDiCATORS. In this chart, green=uptrend, blue=strong up,
red=down, black=strong down, and orange=extreme.
ties?
Author James Rich replies: UWe, Germany
If you reread the paragraph under the fits the actual data very well, if it’s
subheading “The Method,” you’ll see Author Vitali Apirine replies: smoothed to 50 days (I was able to
that I like the 20 SMA above the 50 Thank you for your inquiry. Following manage this...), one might get a better
and the 50 above the 200. When the 50 is MetaStock code to implement the view of the medium-/longer-term trend.
flattens out, the 20 has normally crossed MFO: Although not as clear in the uptrends
below it. If the 20 is above the 50, the 50 (indexes spend more time up, and need
MetaStock MFO code:
has a noticeable slope to the upside that multiple divergences), downtrends seem
has been in place since the 20 crossed {avoid division by zero} to terminate only if downtrends on his
it, or shortly thereafter. If you wanted Dvs:=if((H-Ref(l,-1))+(Ref(H,-1)- volume indicators are clearly violated.
to be a little more aggressive, you might l)=0,.00001,(H-Ref(l,-1)+(Ref(H,-1)-l))); In Figure 1 is a chart of the S&P
consider taking an initial position when mlTp:=if(H<Ref(l,-1),-1,if(l>Ref(H,-
500 with my trend-following indi-
both the 20 and 50 SMAs have turned 1),1,((H-Ref(l,-1))-(Ref(H,-1)-l))/dvs)); cator (green=uptrend, blue=strong
up (or down) but have not yet crossed up, red=down, black=strong down,
the 200. {avoid division by zero} orange=extreme!) and Apirine’s volume
Dvsv:=if(V=0,.00001,V); indicators. I definitely will add them to
mONEY FLOW OSCiLLATOR CODE my arsenal, and I’m eager to test this on
Editor, sum((mlTp*V),20)/sum(Dvsv,20); individual stocks.
Vitali Apirine’s article in the October Because of the author’s help I wanted
2015 issue, “The Money Flow Oscilla- FOLLOW-ON to share this with him, as he might be
tor,” was very interesting. Thank you very much to Vitali Apirine able to research it a little deeper and find
I’m long-term user of MetaStock, but for his fast response and the code—the something valuable for his trading!
I’m not so good at coding formulas. I code works. My first observation is that Thanks again.
wanted to try Apirine’s indicator on my it fits very well with my own simple UWe
database, but unfortunately, the code trend-following indicator.
supplied in the article doesn’t seem to Apirine’s original 20-day time frame
January 2016 • Technical Analysis of Stocks & Commodities • 31
INTERVIEW

Algorithmic Systems For The Rest Of Us

Developing Strategies
With Kevin Davey
Kevin J. Davey is a professional trader and systems developer. He
is the author of Building Winning Algorithmic Trading Systems: A
Trader’s Journey From Data Mining To Monte Carlo Simulation To
Live Trading. An aerospace engineer and MBA by background, Davey
has been an independent trader for over 25 years. Although he has had
a great deal of recent success, many of his early years of trading were
met with failure. Bloodied but not defeated, Davey spent the next few
years researching, reading, and otherwise devouring all he could about
trading. That legwork paid off in a worldwide futures trading contest,
in which Davey came in first place once and second place twice during
the years 2005–2007.
Currently, Davey trades full-time, writes for trading publications,
and divulges many of his trading practices in his Strategy Factory
workshop. He also consults with private individuals, hedge fund trad-
ers, and CTAs when he is not developing new strategies for his own
personal account.
Stocks & Commodities Editor Jayanthi Gopalakrishnan spoke with
Kevin Davey via phone on October 30, 2015 about how a retail trader The biggest challenge in the
can trade algorithmically. entire procedure was to come up
with a test process that yielded
Kevin, tell us a little bit about It probably took me 10 years
good results and prevented me
yourself and how you got or so of trading part-time, sort from having too many rules, too
interested in the financial of taking it seriously but not many parameters, and too much
markets. From what I’ve doing well and just flounder- optimization.
read about you, you have had quite an ing around, to make some
interesting journey. sense out of the markets. After
I started out the way most people start reading a few of Van Tharp’s
out—I got a piece of direct mail. This books, I become interested in system- traders make, and when those mistakes
was about 25 years ago or so, and that type algorithmic mechanical trading. keep recurring, that’s what leads people
piece of mail stated how much money I From there I went on to developing a to get frustrated with trading and quit.
could make trading commodities. That couple of systems. I was able to trade What did you learn from those mistakes
got me hooked and even though that one of those systems and win the World and how did those lessons help you in
particular method was garbage, I was Cup Championship of Futures Trading. your trading?
able to go on from there. I was hooked One year I finished second, the follow- The mistakes I made led me to realize
because I saw the potential in trading ing year I finished in first place, and the that trading is a lot more difficult than
beyond passive investing, and so I thought year after that, I finished again in second what those who sell you information
I’d give it a try. Then I just grew from place. That gave me a lot of confidence claim it to be. Trading is hard work and
there and made a ton of mistakes. I prob- because I felt like I knew what I was you have to dedicate yourself to it, even
ably did everything I possibly could do doing, at least a little bit. About a year if you’re just doing it part-time. That’s
incorrectly, such as quickly changing after that last contest I made the leap because you’re up against the profession-
systems, trading without any kind of from being a part-time trader to being als and people who trade full-time. It’s
system, averaging down, and running to a full-time one. I’ve been trading full- a zero-sum game; somebody is taking
the bank at lunchtime—this was when time ever since. money from somebody else. I learned to
I was working—to wire money just to take it a lot more seriously, and for me
avoid the margin call. All the mistakes you made are ones all I found it was best to have a methodical
32 • January 2016 • Technical Analysis of Stocks & Commodities
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step-by-step approach. The reason I say was trading three to four systems, but goals and objectives, you get trapped
“for me” is because I have a math/sci- when you’re trading more systems, you into continually trying to improve your
ence/engineering-type background, so just can’t keep track of everything. When system. There’s more to a system than
doing things with objective steps, even you have so many systems, it becomes just developing it. You need to have goals,
if the system’s good or not, or passes easier to just follow the systems without and this could include what your annual
certain criteria, made a lot more sense taking other things into consideration. return or maximum drawdown is. Many
to me. This is something I wasn’t doing For me, that was when the emotions traders who are just starting out develop-
when I started trading. I was doing a went out the window. I realized that if ing trading systems have never thought
little bit of it in the beginning, but not I decide to ignore a signal generated by of these goals. They are interested in
enough of it. one system, I should do the same with all developing something that makes a lot
That was probably what I learned signals. But it’s impossible to keep track of money with a small drawdown.
the most from my mistakes. I realized of those decisions for each system. It’s The truth is you can’t design a system
that I have to approach this problem a better just to follow the systems and do using such nonspecific goals. You have
little differently and treat it a little dif- what they indicate. What is important is to set some realistic goals. I come across
ferently. Once I did that, things started to put mechanisms in place to stop trad- people who set some ridiculously unreal-
working better and that helped me with ing if the system stops performing. Then istic goals and I can guarantee you that
the psychological aspect of trading. It it becomes completely objective. For all the steps they take to get there will in-
was always the psychology of making of my systems I have certain criteria that, volve too many rules such as overfitting,
and losing money that was difficult to if met, will indicate to me that I should curve-fitting, overoptimizing, and the
overcome. The other aspect is that even stop trading that system. system will not work going forward.
if you follow rules, you can still have Trading becomes a lot less emotional, A successful system starts with setting
those feelings of elation when you make which is nice, but you have to have con- realistic goals. Then, part of it has to do
money, and feelings of distress when fidence in your systems, and that goes with the way I do it. I look for systems
you lose money. Many people think that back to having a process for developing that are good; they don’t have to be great
automated or mechanical trading means systems. I have a process that I use, or the holy grail–type systems. Too
there are no emotions involved, but that’s and over time, I’ve proven to myself many people get hung up on that sort of
not true. There are emotions, but the that when I follow the process to create thinking. I take a different approach. I
emotions are different than those of a systems, the systems tend to work well. can probably develop 10 good systems
discretionary trader. That’s something This gives me the confidence to build and if I trade those 10 systems together,
I had to learn as well. new ones because I know most of them assuming they look at different markets,
will work. It’s similar to a feedback loop, different styles of trading, or different
Even if somebody has a trading system but once you have confidence, it’s much time frame, I can be diversified and
that’s mechanical or automated, I easier to follow it. But that comes with achieve much better performance than
would imagine there are times when experience. It’s not unusual for traders someone who trades just one system. And
the trader will allow their emotions to who are starting out to be tempted to do I’m not relying on just one strategy.
dictate what to do, especially when it something contrary to what their systems My next step, after setting goals, is to
comes to exiting the trade. Are emo- are suggesting. always look for trading ideas. You’ve got
tions always going to be there, and is to have what I call a “strategy factory,”
that something you have to accept, or You mentioned that you follow a pro- where ideas come in the door. These ideas
is it possible to get rid of them com- cess when it comes to creating a system. are your raw material and as you build
pletely? What are some of the basic steps that strategies based on these ideas, you test
I think, to an extent, emotions are you follow in that process? them. I run a lot of tests such as Monte
always going to exist. I was able to There’re a total of seven to eight steps. Carlo simulations and walk-forward test-
eliminate emotions by trading several It starts with the goals and objectives that ing. Believe it or not, a lot of the strategies
systems. For example, right now I trade you set for a strategy. If you don’t have I test don’t work well. They may work
about 80 or so strategies that are all for a short time, but my time horizon is
rule-based. Most, not all, of them are typically five to 10 years long, and the
automated. What I found was when you system I test has to give decent results
start trading—let’s say when you get during that time period. If it doesn’t, the
above five or 10 strategies—it becomes idea goes into the trash.
more difficult to overrule strategies. I’m always looking for ideas to apply
It’s impossible to make decisions on to my trading. If I run out of ideas, then
each system when there’re so many to I have nothing to test, and I’m not go-
look at. You can’t keep track of all the ing to get any strategies. I have to have
times you’re cheating or lying to your a constant flow of ideas. Once you have
system. I have done that before when I your goals and objectives and your ideas,
34 • January 2016 • Technical Analysis of Stocks & Commodities
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then it’s a matter of running some tests. I
do a few different things. I run some tests
on a limited timeframe just to get an idea
of whether the idea has any merit. Most
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a strategy, apply that strategy to a chart
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I don’t become emotionally attached to found this to be helpful. I’ve found that you can have some criteria to see if the
an idea. I know a lot of people who spend if you start trading a system soon after strategy is still performing in the same
years working on one system because you’ve finished developing it, it tends to way. That gives you more confidence to
they become attached to it and refuse fall apart right away. This is mostly due trade that system.
to admit that it’s not working. to things like overfitting, but sometimes The final step is to combine the viable
Once I find that the strategy is some- it just happens. It’s good to avoid trading strategy with other strategies to make
thing I think is viable, I do what I call systems that never work in real time. This sure you’re not doubling your risk and
incubation, which is to say I take the is an important step, and I wish I had done avoid correlation among what you’re
strategy and set it aside for a period of it with some of the systems I developed trading. Once everything is lined up,
time. I just look at it once a month and 15 years ago. I would get so excited about you go ahead and start trading your
if necessary, I’ll do some reoptimization the systems I developed that I would start strategy. But once you to start trading
because of walk-forward testing. Then, trading them the next day. it—and a lot of people don’t talk about
after a set period of time, I reevaluate My approach is different now. Obvi- this—you have to follow up by moni-
the strategy to see if it’s still holding up ously there’ll be some randomness. Noth- toring the strategies you already have,
six months after I developed it. I have ing ever performs in a straight line, but decide when to stop trading them, or
January 2016 • Technical Analysis of Stocks & Commodities • 35
maybe decide to increase your position he’s content with it. You can look at the up making an emotional heat-of-the-
size. Follow-up is extremely important. number of consecutive losing trades and moment decision. Their system is go-
One of the biggest mistakes I see people if in your history you’ve only had five ing down, they get frustrated, and then
make is that they never think their new consecutive losing trades, then perhaps finally at some point they just quit. And
system will fail. They don’t plan for their by the time you get to seven or eight, it what’s even more frustrating is after you
system failing. Instead, they plan for all might be time to quit. quit, the system turns around. That of
the money they’re going to spend when There’re a lot of different ways to course makes you angrier and you start
they make their expected profits. What decide when to quit using a system and doubting yourself. These are the types of
they should focus on is what to do if their I haven’t found one way that stands psychological games that you can play,
system fails. You don’t want your system head and shoulders above others. But so I found it best, before you start trad-
to wipe out your account, so you have what I have concluded is that having ing, to write down when you’re going to
to know when you should quit trading the exact criteria isn’t going to make a quit trading a system. Keep it somewhere
a system. I continue to do research on huge difference, but what will make a where you can see it or remember it and
aspects of trading other than developing difference is having the criteria versus if your criteria are met, then quit trading.
trading systems. One of things I have not having them. I think the best way to This helps for those who trade part-time.
been looking at lately is what criteria to approach this is to write down whatever This is how the professionals do it. They
use to stop trading a system. your criterion is before you start trading. have their risk limits, and if they exceed
That would be something along the lines them, they’re cut off or fired from their
Could you talk about that a little bit of if x happens then you’ll stop trading job. You’ve got to treat your own trading
more? When is it a good time to stop the strategy. Ideally, you share this with the same way.
trading the system, when do you change someone, whether it is a trading partner,
the size of your positions, and what type a spouse, or significant other and they’ll This process that you described is what
of an exit strategy do you apply? help hold you accountable for it. Ask them it takes to create an algorithmic trading
For position sizing, I typically use a to check in with you every six months or system. When you use the term “algo-
simple fixed fractional–type approach, so and see if the strategy ever hit the point rithmic trading,” many people tend to
which is based on my account size. I try where you said you’d quit trading it. That think it’s reserved for the institutional
not to get too clever with it. There’s a lot will hold you accountable because it’s or the high-frequency traders. But it
of different position-sizing techniques difficult to tell someone that the system sounds to me like the retail trader can
you can apply, and you can always find did hit the quitting point but you’re still also apply such a strategy. How should
one technique that’s best for one of your trading it. It’s a good mechanism to help the retail trader’s approach to develop-
systems. You may have strategy A that ensure that when you say you’re going ing an algorithmic system be different
suggests you use fixed-fractional position to quit, you do quit. A lot of people will from that of an institution’s?
sizing, strategy B might suggest some say they’ll quit when they’re down 30% What I mean when I say algorithmic
other technique, and strategy C might say but when 30% comes, and they continue systems is that the computer makes all
something else. But to me, that’s a form of to use it for another month to see how the decisions, which will tell you when
optimization, because you’re taking the it goes because in their mind, it’ll turn to buy and sell. If you automate that, the
data and then applying different things around. But what usually happens is computer will do it for you. It’s similar
to it and selecting the best one. I tend to they’re down another 20% and then they to mechanical rule-based trading. You’re
keep it simple and use fixed fractional, want to just keep going because they right in that a lot of people think algo-
and if my account size goes down into think it has to turnaround sometime. rithmic means high-frequency, and that
drawdown territory, I will cut back my You know how that goes. they have to be a hedge fund to have
position sizes. When I start trading a new The best thing to do is to have your such a system. The key for retail traders
system, I usually start with one contract. criteria defined upfront. Everybody, is to not play where the high-frequency
I always have a fear that perhaps I did myself included, has at some point not people are playing. I don’t try to scalp; any
something wrong or something isn’t quite had the criteria defined and then ended retail platform is going to have trouble
right. I let—at the beginning at least— doing that because you’ll need to have
profits dictate if I’m going to increase a platform, either a professional-type
my position size and then I switch over platform or create your own. Then, you
to a fixed-fractional method. probably need colocation equipment, and
As far as when to stop trading a system, you may even take your code and burn
it’s also system-dependent. In my trading, it onto a chip so it runs faster. For the
I use a few different things. For example, retail trader, this is not an option because
I might use two times the maximum it’s expensive and you’re fighting against
historical drawdown as a criterion. I people that have teams of statisticians
know somebody who uses half of the with PhDs and a lot of cash to support
historical drawdown as a criterion, and an infrastructure suited to trading.
36 • January 2016 • Technical Analysis of Stocks & Commodities
The retail trader is better off staying to diversify, which is
away from the institution’s domain. That probably a good thing I trade about 80 or so strategies
means more swing trading, that is, more because what that is that are all rule-based. Out of
trades that last days to weeks or even telling them is to wait
months. I do have some intraday trading until they have more those 80 strategies, I would say
systems, but oftentimes, I’ll get into a money in their ac- that maybe 50 of them are in
trade and stay in the entire day. I won’t count. Then their risk some type of trade.
get in and out of trades several times of ruin goes down and
because in the long run, the trading costs things get a lot better.
will gobble up a lot of your profits. But diversification, if anything, is like the ing for situations where there might be
In all the research & development I’ve holy grail of trading, because it’s nice to spurts of upward movement. The strategy
done, the longer-term systems, that is, trade a handful of systems knowing that might level out for a while after that if
systems based on daily bars, tend to be if one stops working, you’re not going to market conditions change. Then, it may
easier to create than systems based on lose everything. It’ll still hurt you, but go up again. I can handle those types of
one-minute bars. Yes, you have to endure there are other well-performing systems strategies because I can afford to break
drawdowns if you’re holding a position you can use. even for a while in the hope that over the
overnight or holding it longer. There’s It dawned on me a few years ago that long term, they’ll go up at times.
a higher probability of intratrade draw- if I was trading four or five systems in Out of the 80 strategies that I trade at
down, but this is where trading multiple any given year, one or two would prob- any point in time, I would say that maybe
strategies helps because they smooth ably do well, one or two would maybe 50 of them are in some type of trade, and
things out, which is something you can break even, and one would not do well. sometimes the trades cancel out. You’ll
afford to do. A retail trader can consider But I did not know which ones would have a system that’s long, and another
themselves an algorithmic trader but they do well in the next 12 months, which is one that’s short. There’ll be times when
should realize who their competition is why it was good to trade them all. You you’re just flat and that’s okay because I’ll
and try to avoid playing in the same terri- don’t want to put all your money behind still monitor the strategies individually.
tory as the high-frequency firms, because one system just because it did well the Overall, it’s not going to have an effect
you can’t compete with them. previous year, because it might not do as on my account, but that’s just part of
well next year. In my mind, diversifica- diversification.
What are the benefits of using multiple tion is really the key.
trading systems? Besides trading, do you offer courses
When you trade several strategies, When you’re saying that you have about or act as a mentor?
you’re diversifying. Instead of trading 80 strategies, do you use them in con- The main thing I do is trade full-time.
one strategy, you trade five, 10, 20, or junction, or do you use them separately After my book was released, people
however many you can. What I’ve found for different market conditions? started becoming interested in getting
in my trading experience, say in the All of the systems could trade at any a more in-depth study than what I gave
last five to six years, is that I went from time. I don’t try to discern between mar- in the book. So I hold online workshops
trading one or two strategies to the point ket conditions. I know a lot people like on strategy development about once a
where now I’m trading about 80. I look to trade some strategies when the market month. I help people build strategies and
at the volatility of my monthly returns is bullish and the concept is good. But then support them afterwards. I also do
using standard deviation and what I’ve the problem with this kind of approach some mentoring and consulting for CTAs
found is that as I increase the number of is that it depends on you having a good or people who work for hedge funds.
systems, volatility goes down. As a result, strategy for that particular market and
my returns have become a lot smoother having a good switching mechanism, or Thank you for speaking with us,
and so have my equity curves. The down- a meta-strategy that will overrule and tell Kevin.
side to diversification is that you give up you that on any given day you’ll trade
some of the upside potential. strategy A but not strategy B because Further reading
If there was a trader who was knowl- the market is bullish. You run the risk Davey, Kevin [2014]. Building Winning
edgeable about price-action trading of curve-fitting and usually what ends Algorithmic Trading Systems: A
or had one well-performing algorithm up happening is your strategy will be Trader’s Journey From Data Mining
and traded one market, it is possible too late for the bull market and you’ll to Monte Carlo Simulation to Live
that, from a performance standpoint, he still be trading your bear strategy for a Trading + website, Wiley.
could do better than somebody trading while. Although I like the idea, I don’t
10 strategies. He’d have higher upside, think it works. My strategies will trade all
but if his system breaks, then he’ll have markets and I don’t necessarily need to
more downside. It’s a tradeoff. For have performance that continually goes
those who are starting out, it’s difficult up in all types of situations. I am look-
January 2016 • Technical Analysis of Stocks & Commodities • 37
And that means embracing
failure, for failure is an es-
sential stop on the road to
mastery, and in the financial
markets, mastery is the only
road to success. To succeed
you must fail, you must fail
often, and you must fail
Osoba: strategically. This article
5.5” W, bleed L, x 6.5” H, bleed top will show the retail trader
how to approach the idea of
failing successfully.

Being wrong,
making mistakes,
failing
We all want to be right. We
want to enter a trade on a
reversal, stay with that trade
and multiply our account
countless times with little
effort. We want to be able
to brag about our successes
in the market, to tell others
how our unique brand of
smartness led us to make
that million-dollar gain
on one trade. Maybe we
dream of walking out of
our day jobs to pursue the
dream of living in a tropical
paradise, lying on a beach
with a laptop by our side to monitor
Have Faith In Yourself

Failing Successfully
our trades. We dream of watching
our accounts grow as we make trade
after successful trade. This has to
be possible, we think, for we are
smart. After all, we have succeeded
at many other things in life; maybe
We’re groomed to think of losses as a sign of failure, which is why trading is difficult. we are doctors, or lawyers, or nuclear
But experiencing losses is part of a trader’s life and is something you have to accept. physicists.
Here’s how to approach the idea in a healthy way. When we look at the charts, we can
clearly see the trends. We may think
by Stella Osoba, CMT that we have only to start and learn
a few rules to succeed. But success
To others, being wrong is a source of shame; to me, recognizing my mistakes is a source in trading is often far more elusive
of pride. Once we realize that imperfect understanding is the human condition, there is than we think it should be. Statistics
no shame in being wrong, only in failing to correct our mistakes.—George Soros show that most traders fail. Why is
this? Why is it so difficult to make

We
live in a society where the cult of success is worshipped. But what is often trading riches and why do so many
hidden are the failures that go into creating that success. Failure is often people fail trying?
JrCasas/Shutterstock

not understood and cultivated as a process that is integral to the creation


of exceptional results. Many of those who come to trading have succeeded Our unending quest
in their day jobs, and they expect success to come to them in trading in much the same for rightness
way it came in their other endeavors. But often this is not the case, for nowhere is it We go through life assuming that we
more essential to develop a strategy for building mental strength than it is in trading. are mostly right. We equate being
38 • January 2016 • Technical Analysis of Stocks & Commodities
TRADING PSYCHOLOGY

right with good, being wrong with bad. Rightness is pleasur-


able, it pumps up our egos, it enables us to feel good about
ourselves, enables us to feel confident about our place in the To succeed you must fail, you
world. When we were in school we were taught to look for the must fail often, and you must
correct answers to questions. Success was rewarded with a
passing grade. Failure was undesirable. If you failed, you felt
fail strategically.
stupid, inadequate, and you had to repeat the class. So you went
through school learning that to be respected, acknowledged,
and to succeed, you needed to be right. You needed to learn below/above which price should not go. This is the price at
about the hoops society expected you to jump through and to which you exit the trade, no matter what. This is where you
learn how to be a good hoop jumper. There were right answers set your stops, mental or otherwise.
for every subject and wrong answers for every subject. Right Once it is hit, the trade has failed and you are out. But once
was good, wrong was bad. It was that simple. You came out out, be prepared for anything to happen. Study the chart as
of school and your day job also rewarded right answers. You though you had not made the first trade and if a new setup and
play it safe because that is how the game is played and you entry forms, you should be prepared to go back into the trade
get the promotions and rise through the ranks. if your new stop will not expose you to too much risk. When
But when the work fails to be satisfying and you look studying the charts, you want to force yourself to stay in the
around for a way to make your riches, you think about trading present as much as possible. Every new bar that is formed on
and reason that the same skills that got you through school the chart carries within it information that potentially creates
exams with good grades and got you promotions on your job a new set up. Staying in the present and being prepared for all
should be enough to enable you to succeed in the financial contingencies is the only way to trade successfully.
markets. Surely, the skills of life are transferable, you reason.
And so you open a brokerage account, subscribe to a couple Cognitive biases
of newsletters, find a trading system that promises to return The reason that trading can be so
good results, and begin to trade. Failure, you reason, is not difficult is because even though it
an option. You will succeed at trading in the same manner appears to be deceptively simple, it
that you have succeeded at everything else. But reality rarely isn’t. Many of the causes of failure
follows your mental script. If you are lucky, you will fail are the result not of the trading
early. It is through mastering a skill that was never taught in system employed, but of cogni-
school—failing successfully—that you can hope to evolve into tive biases. Cognitive biases are
the kind of trader who can consistently beat the market. systematic errors in our thinking
Trading is often spoken of as a zero-sum game because what that lead us to act in predictably irrational ways. These biases
one person wins, someone else must lose. There are always are insidious because we are often not aware of them or their
two sides to a trade. Every trade must have a counterparty who influence on our thinking unless we have trained our minds
is willing to take the other side of the trade. For this reason, to be alert to our thought processes. But many trading systems
you can look at any trade and figure you have a 50% chance do not account for cognitive biases in their methods. Biases
of being on the right side of the trade. If your trading system such as the endowment effect can work against us in trading,
gives you wins 50% of the time, you can still make a lot of causing us to ascribe more value to a position because we
money trading, yet many don’t. Even the institutions with own it. This prevents us from getting out of a position when
their algorithms expect their trading systems to lose anywhere we should. Fear of failure is another bias that can prevent us
from 30% to 70% of the time, and yet they are still profitable. from entering a position when we should because we fear being
Therefore, in order to trade successfully, it is not the number wrong. Fear of regret can lead us to enter a position when it
of times you are in a losing position that determines your has moved too far from our stop, thereby increasing our risk.
ultimate success, but the ability to master what to do when Loss aversion is another bias that can cause us to hold onto
you are in a losing position. a losing position too long because we are unwilling to take a
loss. Studies have shown that, on average, we feel the pain of
It’s okay to lose a loss 1.5 to 2.5 times more than the pleasure of a gain. These
Recognizing that the inability to deal with failure success- and many other biases actively work against us to reduce our
fully is a handicap to our success as traders is perhaps the chances of success in trading.
most important lesson a trader will learn. If we expect 50% Often, when a trader has made a series of unsuccessful
or more of our trades to fail, then it is statistically possible trades, he will then go looking for a “better” trading system.
to have a series of five, maybe even 10 or more consecutive But trading is more of a psychological game. Many trading
failing trades. Preparing ourselves for failure is essential to systems work some of the time. But misapplied, trader psy-
being able to manage the stress of trading successfully. With chology will jeopardize all trading systems.
any discretionary trading system, you should have a setup and
an entry price. But you should also have in mind a price level Continued on page 41
January 2016 • Technical Analysis of Stocks & Commodities • 39
Q&A

SINCE YOU ASKED


Confused about some aspect of trading? Professional trader Rob Friesen, president
& COO of Bright Trading (www.stocktrading.com), an equity trading corporation,
answers a few of your questions. To submit a question or suggest a topic, email him
at robfriesen@brighttrading.net, or 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.
Rob Friesen

PAIR TRADING: LOOK FOR CATALYSTS relative change between the two stocks. best and worst returns; rarely is there
In the land of diminishing pair returns, Both could go up, down, converge or uniform distribution of returns.
grab some catalysts for your spreads! diverge; it all depends on which stock Trending conditions would favor
We live in an instant-fix environment. you choose as your long stock, which relative-strength pair trading rather than
If you’ve got a problem, you want an one you short, and what ratio of capital fading (going against) a directional move.
instant solution. This is often carried is applied to each. It’s fading in this environment that is like
into the trading world. You want access Pair trading can be done with equities, picking up those pennies at the risk of
to information so that your computers ETFs, options, futures, or currencies. In losing dollars. I am often asked, “Why
can crunch data and find those statistical this column, I will discuss the first two. not just trade an unhedged position if
anomalies. The computer does all the Typically, the main concept applied to you are being directional anyway?” If
work and spits out the results you are pair-related strategies is that of mean you are new to the concept of pairs, I
searching for. In this machine age, traders reversion, that is, looking for relation- can understand the skepticism, but if you
often forgo the heavy lifting implied by ships that are stretched out and revealing have experienced the benefits as well as
quality time spent researching, reflecting, anomalies. The trader would go long and the problems of pairs you can appreciate
and contemplating the current and future short as simultaneously as their trading the information I am providing.
economic landscape. Instead, they want tools can facilitate when presented with Spread traders appreciate watching
a formula or a magic pill for profits they an opportunity that usually comes in a spread number that is experienced as
think automation can provide. statistically muted or smoothed com-
I am certainly not against the com- pared to watching an individual stock.
puter age, but I do have an abundance
Traders can get much Relationship-based trading often pro-
of street smarts gained from years of better bang for their vides more information than single-
trading, working with other traders, arbitrage buck by adding stock trading. An example would be
and observing numerous statistically some additional ingredients thus: it is hard to compare an apple to
significant samples. I understand how an orange, but much easier to compare
pairs behave in good times, bad times,
to their spread trading one apple to another apple.
and most of the time. Traders will go soup. Having a long and short position
after pair opportunities, but this can at the same time can reduce event-
also end up increasing risks to their the form of an anomaly or outlier in the related risk. You want to be protected
capital. Attempting to pick up pennies in spread relationship. Once capital is ap- from market moves but take advantage
front of a steam roller, they make a dime, plied, the trader looks for the spread to of potentially better performance of
make another, and then lose a dollar. mean-revert (return to the norm). one stock over another. Even though the
I believe that traders can get much My experience, through trading, ob- VIX is hovering around 17 at the time
better bang for their arbitrage buck and servation, research, and working with of this writing, the actionable volatility
reduce some inherent problems by add- many other statistical-arbitrage (stat-arb, feels much lower. Stocks trend during
ing some additional ingredients to their or pairs) traders is that market conditions the day or even multiday with nominal
spread trading soup. For those of you play heavily into the yield and risk when retracements. Can you take advantage of
not familiar with the concept of pair a mean-reverting focus is applied. Dur- this behavior? Can pairs be optimized
trading, here is a brief explanation. Pair ing times of significant trends caused by for these market attributes?
trading is the combining of two stocks, technically driven algorithmic traders or Here are some building blocks or
one long and one short, in an effort to when the investment community is vot- ingredients of pair trades:
lower market risk and macro risk, where ing directionally due to macro influences,
the focus shifts from trading a stock in mean reversion is frustrating and can • Technical patterns on a variety of
a directional manner to relying on the result in diminished returns or outright time frames
spread price between the two. You would losses. Similarly, during seasonal trends • Technical and quantitative indica-
profit from or lose money based on the in the market, strategies have times of tors
40 • January 2016 • Technical Analysis of Stocks & Commodities
Q&A
• Persistence of short-term or long- create a combo trade. Too often, the buzz and performing better than Twitter
term performance words of correlation and cointegration • What impacted retailers such as
• Fundamental are thrown around as the sauce that is Aeropostale versus American Eagle
• Macro catalysts going to bring home the bacon. Tradi- Outfitters
{{ Currency influences tionally, there has been some merit to • Why Bank of New York Mellon
{{ Interest rate impact that analysis but there are so many more was able to outperform Franklin
{{ Political platforms ducks to line up to increase the odds of Resources
• Opportunities created from events a successful combo trade. • What is it about Costco’s business
{{ Trader enters post-event Again, money is made by the relative model that has its stock outpacing
{{ Streaks performance between your longs and that of Walmart.
{{ Seasonal tendencies shorts, so focus on what catalysts would
{{ Dividends contribute to your long position(s) slight- Can you find and exploit these types
{{ Earnings and EPS changes. ly outperforming your short position(s), of divergent big-picture opportunities
whether all your positions go up, down, again?
Besides a peer group pairing of one long or stay in a trading range. There are many more stocks that
stock against a stock short, here are some I have heard it said that if you want to have been than are, so the future will
other combinations that can be done. The write an award-winning screenplay, then be filled with winners and losers in each
combination can be: study past successful scripts. If you want peer industry. Traders can capture this
to compose a hit song, then study the potential through pairs or diversified
• Any stock long against any stock ingredients of songs that have risen in combo trades. Focus on the ingredients
short the charts. If you want to make brilliant that make up your opportunities and
• A few stocks long against a single combo trades, then study any red flags, write some rules for entry, exit, and risk
stock or ETF short ducks that lined up, and micro and macro management.
• One stock or ETF long against a few catalysts that caused peer group stocks I hope I have planted some seeds for
stocks short to separate from each other. inspiration and creativity.
• A diversified basket of longs against Think about the following:
XXX / XXXXX
a diversifiedContinued
basket of from
shorts
page PB For more information, contact Rob Fri-
• One industry or sector basket long • Why Blockbuster went to zero while esen at robfriesen@brighttrading.net.
against a different industry or sector Netflix soared
basket short. • Why Blackberry lost market share
to rivals Apple and Google
There are many ideas to draw from to • Why Facebook is monetizing mobile

OSOBA / FAILING SUCCESSFULLY trading, so give yourself permission to fail. Fail often, but fail
Continued from page 39 successfully. A failed trade is never a reflection of your skill
as a trader, but a refusal to accept failure is.
If trading is a probability game, then a failed trade cannot
be a reflection of your ability as a trader. Many, if not most, Stella Osoba is a financial writer who has written for the
trades will fail. Failure is essential to trading. The ability to Market Technician Association’s (MTA) e-newsletter Techni-
acknowledge the failure early, to not deflect or make excuses cally Speaking, their Journal Of Technical Analysis, and their
for the failure, and to exit the trade all come with humility CMT e-newsletter, as well as for TraderPlanet.com. She may
and practice. In the words of Brendan Moynihan in his book be reached via email at stellaosoba@gmail.com.
What I Learned Losing A Million Dollars, “Success can be
built upon repeated failures when the failures aren’t taken FURTHER READING
personally; likewise, failure can be built upon repeated suc- Brooks, Al [2012]. Trading Price Action Trends, John Wiley
cesses when the successes are taken personally.” & Sons.
Failure is uncomfortable, and repeated failure is many times Osoba, Stella [2015]. “Loss Aversion,” Technical Analysis of
more uncomfortable. But you must learn to embrace failure StockS & commoditieS, Volume 33: April.
however it comes and move forward from it. Failure is not a Paul, Jim, and Brendan Moynihan [2013]. What I Learned
skill that society prepares most of us for. So many will come Losing A Million Dollars, Columbia University Press.
to trading ill-equipped to handle failure. But to become a
successful trader, a mastery of the art of failing successfully
is important. Recognize that failure is an essential part of
January 2016 • Technical Analysis of Stocks & Commodities • 41
product review

TC2000 Version 16
WORDEN BROTHERS, INC. brokerage. When the finished product ex- lated trades. Multiple layouts, a feature
PO Box 1139 ceeded all of their expectations, brothers introduced in Version 12, enhances
Wilmington, NC 28402 Chris and Peter Worden and their staff the usefulness of the trading platform
Phone: 800 776-4940, felt it only fair to release the software whether you trade live or use the simu-
international: 1 919 408-0542 to the entire TC2000 family of users, lated account. With the multiple layout
Email: support@TC2000.com whether they used TC2000 Brokerage feature, you can set up a trading layout
Internet: www.TC2000.com or just continued to use the software with a window to track your portfolio,
Product: Stock market charting for analysis. a window for orders, and a window for
software trades. The windows in your layout can
Requirements: Windows-based PC, Features be pinned anywhere on the screen, hid-
or Mac with Parallels Desktop One of the many new features that first den, or left free-floating.
Price: Basic software and data services caught my attention was the simulated In your trading layout there are multiple
start at $9.99/month for the Silver edition; account component. Several platforms ways to enter orders. The detailed order
$29.99/month for TC2000 Gold; $89.99/ and standalone software programs pro- ticket is available at the top of the chart
month for Platinum. Real-time data and vide simulated accounts, but TC2000 (Figure 1) and can be set up as a template,
LiveBriefs by MT Newswires available Version 16 offers by far the most robust or even as multiple templates. An abbrevi-
for additional fees. Savings are available of any that I have tried. The feature allows ated trade window is also available and
via yearly payment options. you to establish a cash or margin account, can be set up as one or more templates. A
set the opening balance, set buy & sell buy or sell-stop order can also be estab-
by James E. Rich stops, track your daily and total profits lished using a trendline by first drawing
& losses—realized and unrealized—plus the trendline and right-clicking to bring

W
orden Brothers’ new TC2000 all the other features normally available up a dropdown menu (Figure 2) and then
Version 16 software was origi- only in live accounts. Of course, if you clicking on buy limit or sell stop, which
nally developed as a white-label go to TC2000 Brokerage and open an immediately turns the trendline into an
trading platform for TC2000 Brokerage, account, then you’ll have the option of order and displays the order box on the
Inc., the company’s new affiliated online trading in real time or executing simu- chart. When the trendline is turned into

FIGURE 1: ORDER TICKET. In the toolbar directly above the chart are buy and sell buttons that bring up a detailed order ticket that can then be saved as a template.

42 • January 2016 • Technical Analysis of Stocks & Commodities


FIGURE 2: Trendline Order ticket. By drawing a trendline and then right-clicking on the line, a dropdown box appears, allowing you to turn the trendline into a
buy limit or sell-stop order.

a sell-stop order, the line changes to a list, add the upcoming earnings date
dotted line and the abbreviated order column, sort, and there you have all the Version 16 of TC2000
box appears with your completed order. earning dates, starting with the most
Once your trading layout is established, current. In my trading, I personally don’t
gives you the option
you can create additional layouts with like to hold positions over earnings dates, of trading in real
watchlists, charts, news, and scans to use and with Version 16, I can simply take time or executing
for research and analysis. my trading portfolio, add the earnings simulated trades.
Upcoming earnings dates is another date column, sort, and I can see which
new feature and can be applied to any positions have upcoming earnings dates
watchlist. Bring up the S&P 500 watch- (Figure 3).

FIGURE 3: Earnings dates. The upcoming earnings date column can be added to any watchlist. Here, the column is added onto the positions watchlist and sorted
by date for a heads-up on pending earnings announcements.

January 2016 • Technical Analysis of Stocks & Commodities • 43


FIGURE 4: MT Newswire. The recently added newsfeed from MT Newswires offers a wide variety of news announcements on a real-time basis.

Version 16 now allows customization of videos on various subjects related to


of the chart toolbars. The top row is the trading and then go down to the bottom Worried about the
factory toolbar and cannot be edited, of the page to see the entire webinar
but now you can add a second, third, archive dating back to 2009.
learning curve with a
and fourth row with any of the buttons, Still need help? In the past, the new platform? Don’t be.
data, and so on, that suit your trading or Worden Brothers training guru, Michael More than 60 tutorial
analysis style. Thompson, put on live seminars around videos are available.
Since Bruce Faber’s review in this the country. He took a brief sabbatical
magazine of TC2000 Version 12.2 in from traveling in 2015 but plans on
2012, Worden Brothers has added a scheduling a series of live webinars in Further reading
reports button that allows you to open 2016, so keep an eye on your email if Faber, Bruce R. [2012]. “TC2000 Version
either a prebuilt fundamentals report or a you’re already a member of the TC2000 12.2 Update,” Technical Analysis of
price & volume report. Or you can create user family, or go to the website to see Stocks & Commodities, Volume
your own custom report, allowing you upcoming seminars. In addition to the 30: November.
to check the edit box to add, delete, and tutorial videos, webinar archives, and [2012]. “TC2000 Version 12,”
move fields. Recently, Worden Brothers soon-to-come live seminars, TC2000 Technical Analysis of Stocks &
added an optional service—the newsfeed has a superb support team available six Commodities, Volume 30: January.
from MT Newswires, which offers a days a week via phone or email. Rich, James E., with John B. Rich [2015].
wide variety of news announcements “Simplify It,” Technical Analysis of
on a real-time basis (Figure 4). James E. Rich has been trading for Stocks & Commodities, Volume
more than 30 years and currently 33: November.
Support trades multiple family accounts using ‡TC2000 (Worden Brothers, Inc.)
Worried about the learning curve with a a combination of technical analysis, ‡See Editorial Resource Index
new platform? Don’t be. When you click fundamental analysis, and intermarket
on the help button and then on tutorial analysis. He is the cofounder of Palm
videos, links to more than 60 videos ap- Beach Traders, an investment round-
pear. The videos average three to seven table group that meets monthly in Palm
minutes each, covering every aspect of Beach Gardens, FL to hear speakers
the program. Speaking of videos, if you and discuss various aspects of trading
want help with your trading, you can go and investing. Rich can be contacted at
to www.worden.com to view a myriad Richtrader3@gmail.com.
44 • January 2016 • Technical Analysis of Stocks & Commodities
FUTURES FOR YOU
INSIDE THE FUTURES WORLD
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 books—Currency Trading
In The Forex And Futures Markets; A Trader’s First Book On Commodities;
and Commodity Options—were published by FT Press. To submit a question,
email her at info@carleygarnertrading.com or via www.DeCarleyTrading.com.
Carley Garner
Selected questions will appear in a future issue of S&C.

Commodities: CAN PRICES GO commodity cycle. When prices are high, the commodity lose 70% from entry. An
TO ZERO? producers rush to bring product to market, emini S&P trader could lose over $70,000
Could a commodity bull with deep enough and demand tapers. Yet when prices are if prices drop 70%. These are substantial
pockets weather any storm? low, producers reign in operations while sums of money that the coolest of heads
The simple answer to that question is an demand is on the rise. Simply put, there would struggle to endure.
unequivocal yes. If you had unlimited are antagonistic forces that prevent prices Obviously, the goal of such long-term
trading capital, an unlimited time horizon, from going to zero. position trading is to go long a market
and the sense to mitigate futures market Accordingly, for a trader with the pain after it has already made a substantial
leverage, you could theoretically never tolerance, financial capital, patience, and decline. Buying into a commodity in a
lose when trading commodities. This discipline necessary to accept massive massive upswing could take both your,
theory is based on the fact that commodity drawdowns in exchange for nearly certain and your kids’, lifetimes to recover. Just
prices, although they can get very cheap, trading success, it is realistic to say that you imagine going long crude oil at $150 per
cannot go to zero. In other words, com- might never lose money trading commodi- barrel in 2008. Oil prices will probably
modities are “goods,” not “bads”; unless ties. Of course, this assumption ignores see this price again, but will it be in our
something changes dramatically in the transaction costs, the contango (rolling lifetime? Maybe not.
way we live, we will always need corn, contract months at unfavorable prices), On a side note, individual stocks, unlike
soybeans, crude oil, natural gas, and so, the slim possibility of an MF Global or commodities, have the ability to become
to some degree. PFG repeat, and the unpleasant likelihood completely worthless. Thus, if you pur-
If society finds a substitute for the of the trader dying before price recovers chase shares of a particular company with
commodities we currently use, then as from the entry price. Although commodity the mindset that it will be impossible to
the demand for such alternative resources markets tend to trade in ranges, the peaks lose if held long enough, that would be an
increases, so will the price of the substi- and valleys are sometimes seen several even bigger fallacy. In my lifetime, I’ve
tute. Eventually, consumers will migrate years, or even decades, apart. seen companies that were once staples
back to the original source. To reiterate, Naturally, none of us have the luxury in our society disappear, all the while
there will always be some value in com- of unlimited time or money. Even the putting their shareholders through the
modities. Further, the commodity markets largest funds in the world don’t have un- ringer. Remember the telephone company
go through boom and bust cycles. Even limited funds, nor do they generally have WorldCom or more recently Blockbuster
in the most trying time—think natural the discipline to pace themselves, or the video? I think we can all agree that in the
gas in the fall of 2015 or crude oil in the wherewithal to hold positions indefinitely history of the commodity markets, we’ve
summer of 2015—there is light at the end without investors withdrawing funds. never seen a market go to zero. Even if it
of the tunnel. Producers and end users With this in mind, let’s take a look at how did, there would always be potential for a
adjust their behavior according to the big the drawdowns might be in any given recovery, which also differs from individ-
state of the boom and bust cycle, only to commodity per single lot traded. Let’s as- ual stocks. If a stock becomes worthless,
trigger a repeat. For instance, when crude sume that a commodity price could lose as it is delisted, leaving shareholders with no
oil was above $100 per barrel, US shale much as 70% of its current value, which chance of recouping lost money.
oil producers were rushing to frack as is a stretch but not impossible. We’ll use So again, is it possible to construct a
much oil out of the ground as they could that as the risk of going long a long-term scenario in which a trader could ride out
with little concern for budgeting or cost position trade with unlimited financial any storm? Yes, it’s possible. Is such a
management. However, when crude oil backing. With crude oil trading at $45, strategy more feasible in commodities,
fell below $40, oil producers were aggres- the potential drawdown of going long here than it is for stocks? Yes, it is. Neverthe-
sively handing pink slips to employees with no other expectation other than prices less, it isn’t realistic.
and shutting down rigs. Each of these will eventually be higher than $45, a trader
behaviors works toward repeating the would suffer a paper loss of $31,500 should
January 2016 • Technical Analysis of Stocks & Commodities • 45
For this month’s Traders’ Tips, the focus is
James and John Rich’s article in the No-
vember 2015 issue, “Simplify It.” Here, we
present the January 2016 Traders’ Tips
code with possible implementations in var-
ious software.

The code for the following Traders’ Tips


selections is posted here:
• Traders.com  Home–S&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 is-
sue or another recent issue. The entries here are contrib-
uted by software developers or programmers for software Figure 1: TC2000. Here is a TC2000 Version 16 layout showing: 1) a chart of
that is capable of customization. SPY; 2) scans for uptrending and downtrending markets; and 3) a chart showing the
entry points for uptrends (green dots) and entry points for downtrends (red dots).

F TC2000: JANUARY 2016 TRADERS’ TIPS CODE


James and John Rich’s approach to trading with the trend, as F TRADESTATION: JANUARY 2016 TRADERS’ TIPS CODE
described in their article “Simplify It” that appeared in the In “Simplify It,” which appeared in the November 2015 issue
November 2015 issue of Technical Analysis of Stocks & of Technical Analysis of Stocks & Commodities, authors
Commodities, can easily be applied in TC2000 Version 16. James and John Rich presented a trend-following approach
In Figure 1, you see a daily SPY chart with a 50-day moving to trading that they have developed over their many years of
average (yellow line). The 50-day average is moving up, market experience. They noted that they begin by determining
signifying an overall uptrend. an opinion of the direction of the overall market. With this
Below the SPY chart are two TC2000 EasyScans: SPY information, they described the criteria for selecting candidate
in uptrend and SPY in downtrend. Since the SPY chart is stocks for trading. Finally, the authors listed their rules for
indicating an uptrend based on the 50-day moving average,
we have SPY in uptrend selected. This scan shows five stocks
for which the following conditions are true:
• Price is above its 50-day average (SMA)
• 20-day SMA of price is above the 50-day SMA of price
• 50-day SMA of price is above the 200-day SMA of
price
• 50-day average volume is greater than one million
shares
• Price has just crossed up through the eight-day moving
average of the high.

You can spacebar through the scan results to view the charts
for each symbol. Green dots mark entry points during uptrends
and red dots mark entry points during downtrends. Using the
new simulated trading feature in version 16, you can place
trades on the symbols you find interesting and see how they
perform using this approach.
If you would like a copy of this layout to use in your TC2000
software, simply send an email to support@TC2000.com and
we’ll send it to you.
—Patrick Argo Figure 2: TRADESTATION. Here are example TradeStation Scanner results
Worden Brothers, Inc. and the _RichMethod indicator and strategy applied to a daily chart of Amazon
www.TC2000.com (AMZN).

46 • January 2016 • Technical Analysis of Stocks & Commodities


entry and exit. Here, we are providing TradeStation EasyLan- xl:= L < bline;
guage code for both an indicator and strategy based on the trade:= If(el, 1, If(xl, 0, PREV));
trade = 0 AND Ref(trade = 1, -1)
authors’ work. The indicator can be used in the TradeStation
Scanner to search for candidate stocks as well as in a chart to Enter short:
visualize the results; the strategy can be used to backtest on
s1:= Security("SPY", C);
the symbols of your choice. ma1:= Mov(C, 20, S);
To download the EasyLanguage code, please visit our ma2:= Mov(C, 50, S);
TradeStation and EasyLanguage support forum. The code ma3:= Mov(C, 200, S);
dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1);
from this article can be found here: http://www.tradestation. tradeshort:= dir = -1 AND
com/TASC-2016. The ELD filename is “TASC_JAN2016. ma1 < ma2 AND ma2 < ma3;
ELD.” For more information about EasyLanguage in general, tline:= Mov(H,8,S);
bline:= Mov(L,8,S);
please see http://www.tradestation.com/EL-FAQ. es:= C < bline AND tradeshort;
The code is also shown at the Stocks & Commodities xs:= H > tline;
website at Traders.com in the Traders’ Tips area. trade:= If(es, 1, If(xs, 0, PREV));
trade = 1 AND Ref(trade = 0, -1)
A sample chart is shown in Figure 2.
This article is for informational purposes. No type of trading or Exit short:
investment recommendation, advice, or strategy is being made, given, or
in any manner provided by TradeStation Securities or its affiliates. s1:= Security("SPY", C);
ma1:= Mov(C, 20, S);
—Doug McCrary ma2:= Mov(C, 50, S);
TradeStation Securities, Inc. ma3:= Mov(C, 200, S);
www.TradeStation.com dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1);
tradeshort:= dir = -1 AND
ma1 < ma2 AND ma2 < ma3;
tline:= Mov(H,8,S);
bline:= Mov(L,8,S);
F METASTOCK: JANUARY 2016 TRADERS’ TIPS CODE es:= C < bline AND tradeshort;
xs:= H > tline;
In “Simplify It,” which appeared in the November 2015 issue trade:= If(es, 1, If(xs, 0, PREV));
of Technical Analysis of Stocks & Commodities, author trade = 0 AND Ref(trade = 1, -1)
James Rich along with brother John Rich presented a simple
trading system. The article suggested using the direction of —William Golson
MetaStock Technical Support
a 50-period SMA on the SPY to find the market trend. Then www.metastock.com
look for stocks in a trend going the same direction. From there,
channel lines are used to find the entry & exit points.
The MetaStock formulas provided here combine all those
conditions into entry & exit signals that you can put into a
system test or expert adviser in MetaStock. F eSIGNAL: JANUARY 2016 TRADERS’ TIPS CODE
For this month’s Traders’ Tip, we’ve provided a study named
Enter long:
“Simplify.efs” based on the formula described in James and
s1:= Security("SPY", C); John Rich’s article that appeared in the November 2015 issue
ma1:= Mov(C, 20, S);
ma2:= Mov(C, 50, S); of Technical Analysis of Stocks & Commodities, “Simplify
ma3:= Mov(C, 200, S);
dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1);
tradelong:= dir = 1 AND
ma1 > ma2 AND ma2 > ma3;
tline:= Mov(H,8,S);
bline:= Mov(L,8,S);
el:= C > tline AND tradelong;
xl:= L < bline;
trade:= If(el, 1, If(xl, 0, PREV));
trade = 1 AND Ref(trade = 0, -1)

Exit long:
s1:= Security("SPY", C);
ma1:= Mov(C, 20, S);
ma2:= Mov(C, 50, S);
ma3:= Mov(C, 200, S);
dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1);
tradelong:= dir = 1 AND
ma1 > ma2 AND ma2 > ma3;
tline:= Mov(H,8,S);
bline:= Mov(L,8,S); Figure 3: eSIGNAL. Here is an example of the study plotted on a daily chart of
el:= C > tline AND tradelong; HUM.

January 2016 • Technical Analysis of Stocks & Commodities • 47


have made the loading process extremely easy: simply
click on the links http://tos.mx/vTuhvW and http://tos.
mx/YQ7z0L and choose save script to thinkorswim, and
backtest in thinkScript. Choose to rename your study
and strategy “SimpleTrendChannel.” You can adjust the
parameters of this study within the edit studies window
to fine-tune your variables.
In the example in Figure 4, you see a chart of
National Oilwell Varco (NOV), with the averages
used to define strategies as well as the channels used
to trigger stops and limit orders. Beneath volume
you can see a histogram chart of profit & loss for the
charted time frame. In this example, there is a large
profit, as the green indicates.
For more on this technique, please see the Richs’
article in the November 2015 issue of Technical
Analysis of Stocks & Commodities magazine.
—thinkorswim
Figure 4: THINKORSWIM. Here is a chart of National Oilwell Varco (NOV), with the aver- A division of TD Ameritrade, Inc.
ages used to define strategies as well as the channels used to trigger stops and limit orders. A www.thinkorswim.com
histogram of profit & loss for the charted time frame is beneath volume. In this example, there
is a large profit, as the green indicates.

It.” In the article, the authors presented a simple trading method F wEALTH-LAB: JANUARY 2016 TRADERS’ TIPS CODE
based on moving averages. The WealthScript strategy we are presenting here combines
The study contains formula parameters that may be trend-detection ideas that James and John Rich had researched
configured through the edit chart window (right-click on the and presented in their November 2015 article in Stocks &
chart and select “edit chart”). A sample chart implementing Commodities, titled “Simplify It.” Users have the means to
the study is shown in Figure 3. experiment with which method of determining overall mar-
To discuss this study or download a complete copy of the ket direction works better: the one that relies on the external
formula code, please visit the EFS library discussion board symbol’s (SPY) movement used by John Rich, or the one that
forum under the forums link from the support menu at www. uses a combination of multiple moving averages as used by
esignal.com or visit our EFS KnowledgeBase at http://www. James Rich. The system’s C# code for Wealth-Lab is shown
esignal.com/support/kb/efs/. The eSignal formula script (EFS) here and can also be found at the Stocks & Commodities
is also available for copying & pasting from the Stocks & website in the Traders’ Tips area. A Wealth-Lab chart dem-
Commodities website in the Traders’ Tips area. onstrating the system is shown in Figure 5.
—Eric Lippert The method of screening for entries is so simple that it
eSignal, an Interactive Data company
800 779-6555, www.eSignal.com doesn’t require programming. For any Wealth-Lab user, it
should be pretty trivial to drag and drop the conditions in a
rule-based system (Figure 6).
Wealth-Lab 6 strategy code (C#):

using System;
F THINKORSWIM: JANUARY 2016 TRADERS’ TIPS CODE using System.Collections.Generic;
using System.Text;
In “Simplify It,” which appeared in the November 2015 issue using System.Drawing;
of Technical Analysis of Stocks & Commodities, authors using WealthLab;
James and John Rich recounted how they have been using using WealthLab.Indicators;
technical analysis since the 1960s. In that time, they have namespace WealthLab.Strategies
experimented with many different strategies, with John Rich {
even considered an authority on Elliott wave theory. They public class SimplifyIt : WealthScript
{
discuss how they have come to the conclusion that simple is private StrategyParameter paramTrendRule;
better. Thus, using only moving averages, the brothers have
public SimplifyIt()
constructed a strategy that defines trends and also has the {
granularity to include stops and limit prices. paramTrendRule = CreateParameter("SPY for trend", 1,
We have recreated their SimpleTrendChannel study and 0, 1, 1);
}
strategy using our proprietary scripting language, thinkscript. We
48 • January 2016 • Technical Analysis of Stocks & Commodities
LineStyle.Solid,1);
}

for(int bar = GetTradin-
gLoopStartBar(200); bar < Bars.
Count; bar++)
{
if (IsLastPositionActive)
{
Position p = LastPosi-
tion;
if( p.PositionType ==
PositionType.Long )
{
if( Close[bar] <
smaLo[bar] - Bars.SymbolInfo.
Tick )

SellAtMarket(bar+1, p );
Figure 5: WEALTH-LAB, EXAMPLE ENTRIES. This chart illustrates the application of the system’s rules on a daily chart }
of HUM. else
{
if( Close[bar] >
smaHi[bar] + Bars.SymbolInfo.
Tick )

CoverAtMarket(bar+1, p );
}
}
else
{
bool uptrend =
// John’s / James’ method
( useSpyFor-
Trend && (spy.Close[bar] >
spySma[bar] && spySma[bar] >
spySma[bar-1] && Close[bar] >
sma50[bar])) ||
( sma20[bar] >
sma50[bar]&& sma50[bar] >
sma200[bar]);
bool downtrend =
// John’s / James’ method
( useSpyFor-
Trend && (spy.Close[bar] <
Figure 6: WEALTH-LAB, DRAG & DROP. Users can build the system using drag & drop rules and conditions, with no spySma[bar] && spySma[bar] <
spySma[bar-1] && Close[bar] <
programming necessary.
sma50[bar])) ||
( sma20[bar] <
sma50[bar] && sma50[bar] < sma200[bar]);
protected override void Execute()
{ if( uptrend ) // market trend is up
bool useSpyForTrend = paramTrendRule.ValueInt == 1; {
Bars spy = GetExternalSymbol("SPY",true); if( SMA.Series(Volume,50)[bar] > 1000000 ) //
SMA spySma = SMA.Series(spy.Close,50); the volume criterion
SMA sma20 = SMA.Series(Close,20); if( Close[bar] > smaHi[bar] ) // the second step
SMA sma50 = SMA.Series(Close,50); BuyAtMarket(bar + 1);
SMA sma200 = SMA.Series(Close,200); }
SMA smaHi = SMA.Series(High,8); else if( downtrend ) // market trend is down
SMA smaLo = SMA.Series(Low,8); {
if( SMA.Series(Volume,50)[bar] > 1000000 ) //
//PlotSeries(PricePane,sma20,Color.Orange,WealthLab. the volume criterion
LineStyle.Solid,1); if( Close[bar] < smaLo[bar] ) // the second step
PlotSeries(PricePane,sma50,Color.Red,WealthLab. ShortAtMarket(bar + 1);
LineStyle.Solid,1); }
//PlotSeries(PricePane,sma200,Color.Blue,WealthLab. }
LineStyle.Solid,1); }
PlotSeriesFillBand(PricePane, smaHi, smaLo, Color. }
Green, Color.Transparent, LineStyle.Solid, 1); }
}
if( useSpyForTrend )
{
ChartPane spyPane = CreatePane(30,true,true); —Eugene, Wealth-Lab team
PlotSymbol(spyPane,spy,Color.Blue,Color.Red); MS123, LLC
PlotSeries(spyPane,spySma,Color.Blue,WealthLab. www.wealth-lab.com

January 2016 • Technical Analysis of Stocks & Commodities • 49


Figure 7: AMIBROKER. Here is a daily chart of Humana (HUM) with buy/sell ar- Figure 8: NEUROSHELL TRADER. This sample NeuroShell Trader chart displays the
rows generated by eight-bar simple moving average channel crossovers. method described by James and John Rich in their November 2015 article in S&C.

// MA channel breakout rules


UpperChannel = MA( High, 8 );
LowerChannel = MA( Low, 8 );

F AMIBROKER: JANUARY 2016 TRADERS’ TIPS CODE Buy = Cross( C, UpperChannel );


In “Simplify It,” which appeared in the November 2015 issue Sell = Cross( LowerChannel, C );
of Technical Analysis of Stocks & Commodities, authors Buy = ExRem( Buy, Sell );
James and John Rich presented a very simple trading method Sell = ExRem( Sell, Buy );
that involves simple moving average channel breakouts.
Plot( C, "Price", colorDefault, styleCandle );
A ready-to-use formula for AmiBroker is provided here. This
code includes trend filters mentioned in the article for your Plot( UpperChannel, "UpperChannel", colorBlue );
Plot( LowerChannel, "UpperChannel", colorBlue );
use, however, the charts presented in Richs’ article show all
channel breakouts without filtering, so the formula presented PlotShapes( Buy * shapeUpArrow, colorGreen, 0, H, -80 );
here does the same. PlotShapes( Sell * shapeDownArrow, colorRed, 0, L, -80 );
To use the formula, enter the code in the formula editor
—Tomasz Janeczko, AmiBroker.com
and press apply indicator. To backtest the system, click send www.amibroker.com
to analysis button in the formula editor and then the backtest
button in the analysis window. You may need to change the
symbol of SP500 to match your data provider’s symbology F NEUROSHELL TRADER: JANUARY 2016
(the code given here uses Yahoo symbology). TRADERS’ TIPS CODE
A sample chart is shown in Figure 7. The trading method described by James and John
Rich in their November 2015 in Technical Analysis of Stocks
AmiBroker code: & Commodities, “Simplify It,” can be easily implemented
// NOTE: the article mentions those filters with a few of NeuroShell Trader’s 800+ indicators. Simply
// yet charts presented in article don’t use them select new indicator from the insert menu and use the indicator
SP500 = Foreign("^GSPC", "C" ); wizard to create the following indicators:
UpMarket = MA( SP500, 50 ) > MA( SP500, 20 );
And3Long:
UpTrendStock = UpMarket AND Close > SMA Close,50
MA( C, 20 ) > MA( C, 50 ) AND SMA Close,20 > SMA Close,50
MA( C, 50 ) > MA( C, 200 ); SMA Close,50 > SMA Close,200

DnTrendStock = NOT UpMarket AND And3Short:


MA( C, 20 ) < MA( C, 50 ) AND Close <= SMA Close,50
MA( C, 50 ) < MA( C, 200 ); SMA Close,20 <= SMA Close,50
SMA Close,50 <= SMA Close,200
Filter = Volume > 1000000 AND
( UpTrendStock OR DnTrendStock );
To implement the method, simply select new trading strategy
from the insert menu and enter the following in the appropriate
50 • January 2016 • Technical Analysis of Stocks & Commodities
locations of the trading strategy wizard:

BUY LONG CONDITIONS: [All of which must be true]


AND3Long
CrossAbove(Close, Avg(High,8)

SELL LONG CONDITIONS: [All of which must be true]


CrossBelow(Close, Avg(Low,8))

SELL SHORT CONDITIONS: [All of which must be true]


AND3SHORT
CrossBelow(Close, Avg(Low,8))

COVER SHORT CONDITIONS: [All of which must be true]


CrossAbove(Close, Avg(High,8)

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 Figure 9: AIQ. Here is a sample equity curve of the trend-following system versus
Traders’ Tips. the NASDAQ 100 index for the period 1/2/2000 to 11/06/2015.
A sample chart is shown in Figure 8.
—Marge Sherald, Ward Systems Group, Inc.
301 662-7950, sales@wardsystems.com
www.neuroshell.com

F AIQ: JANUARY 2016 TRADERS’ TIPS CODE


The AIQ code based on James and John Rich’s article
in the November 2015 issue of Technical Analysis of
Stocks & Commodities, “Simplify It,” is provided at www.
TradersEdgeSystems.com/traderstips.htm.
The code I am providing matches the description of the
authors’ trend-following system with additional exit rules.
The long exit has an additional profit-protect exit that is not
coded, but when I ran tests, I used the built-in profit-protect
exit set to 80% protection once the profit level reaches 5%
or greater.
Figure 9 shows the equity curve for the system versus the
NASDAQ 100 index for the period 1/2/2000 to 11/06/2015.
Figure 10 shows the metrics for this same test period. The
system clearly outperformed the index.

!SIMPLIFY IT
!Author: James E. Rich with John B. Rich, TASC Nov 2015 (for
Jan 2016)
!Coded by: Richard Denning 11/1/2015 Figure 10: AIQ. Here are the metrics for the trend-following system and the test
!www.TradersEdgeSystems.com settings.

!INPUTS
mktTrendLen is 50.
IDX is "SPY". valresult(mktSMA,10).
stkLen1 is 20. !mktTrendUp if tickerRule(IDX,stkTrendUp).
stkLen2 is 50. !mtkTrendDn if tickerRule(IDX,stkTrendDn).
stkLen3 is 200.
trdBandLen is 8. !STOCK SCREEN FOR UP TRENDING STOCKS:
pctStp is 0.07. stkSMA1 is simpleavg([close],stkLen1).
minBarsSinceBandCross is 10. stkSMA2 is simpleavg([close],stkLen2).
maxBarsHold is 10. stkSMA3 is simpleavg([close],stkLen3).
stkTrendUp if [close] > stkSMA2
!MARKET DIRECTION: and stkSMA1 > stkSMA2
mktClose is TickerUDF(IDX,[close]). and stkSMA2 > stkSMA3
mktSMA is simpleavg(mktClose,mktTrendLen). and [close] > 5
mktTrendUp if mktClose > mktSMA and mktSMA > and simpleavg([volume],50) > 10000. !volume in hundreds
valresult(mktSMA,10).
mtkTrendDn if mktClose < mktSMA and mktSMA < !STOCK SCREEN FOR DOWN TRENDING STOCKS:

January 2016 • Technical Analysis of Stocks & Commodities • 51


stkTrendDn if [close] < stkSMA2 Here is the code:
and stkSMA1 < stkSMA2
and stkSMA2 < stkSMA3 'SIMPLIFY IT
and simpleavg([volume],50) > 10000. !volume in hundreds
'Author: James E Rich with John B Rich, TASC Nov 2015 (for
!TRADING BANDS: Jan 2016)
stkSMAhi is simpleavg([high],trdBandLen). 'Coded by: Richard Denning 11/1/2015
stkSMAlo is simpleavg([low],trdBandLen). 'www TradersEdgeSystems com

Buy if mktTrendUp and stkTrendUp sub SIMPLIFY(mktTrendLen,stkLen1,stkLen2,stkLen3,trdBandLe


and [close] > stkSMAhi n,pctStp,minBarsSinceBandCross,maxBarsHold,allowShorts)
and countof([close] > stkSMAhi,minBarsSinceBandCross)=1. 'mktTrendLen = 50
Short if mtkTrendDn and stkTrendDn 'IDX = "SPY"
and [close] < stkSMAlo 'stkLen1 = 20
and countof([close] < stkSMAlo,minBarsSinceBandCross)=1. 'stkLen2 = 50
'stkLen3 = 200
PD is {position days}. 'trdBandLen = 8
PEP is {position entry price}. 'pctStp = 0.07
ExitBuy if [close] < stkSMAlo * (1-pctStp). 'minBarsSinceBandCross = 10
'maxBarsHold = 10
ExitShort if [close] > stkSMAhi * (1+pctStp) 'allowShorts = 0
or (PD > maxBarsHold and [close] > PEP).
'MARKET DIRECTION:
Dim mktClose As BarArray
The code and EDS file can be downloaded from www. Dim mktSMA As BarArray
TradersEdgeSystems.com/traderstips.htm. Dim mktTrendUp As Boolean
Dim mtkTrendDn As Boolean
—Richard Denning mktClose = C Of independent1
info@TradersEdgeSystems.com mktSMA = Average(mktClose,mktTrendLen)
for AIQ Systems mktTrendUp = mktClose > mktSMA And mktSMA > mktSMA[10]
mtkTrendDn = mktClose < mktSMA And mktSMA < mktSMA[10]

'STOCK SCREEN FOR UP TRENDING STOCKS:


F TRADERSSTUDIO: JANUARY 2016 Dim stkSMA1 As BarArray
TRADERS’ TIPS CODE Dim stkSMA2 As BarArray
Dim stkSMA3 As BarArray
The TradersStudio code based on the article Dim stkTrendUp As Boolean
“Simplify It” by James and John Rich, which appeared in stkSMA1 = Average(C,stkLen1)
stkSMA2 = Average(C,stkLen2)
the November 2015 issue of Technical Analysis of Stocks & stkSMA3 = Average(C,stkLen3)
Commodities, can be found at www.TradersEdgeSystems. stkTrendUp = C>stkSMA2 And stkSMA1>stkSMA2 And
com/traderstips.htm. stkSMA2>stkSMA3 And C>5 And Average(V,50)>1000000
The following code file is contained in the download: 'STOCK SCREEN FOR DOWN TRENDING STOCKS:
Dim stkTrendDn As Boolean
• System: SIMPLIFY—Trend-following system based on au- stkTrendDn = C<stkSMA2 And stkSMA1<stkSMA2 And
thor’s description in November 2015 article, “Simplify It” stkSMA2<stkSMA3 And Average(V,50)>1000000

'TRADING BANDS:
Figure 11 shows the equity curve for the system from 2001 Dim stkSMAhi As BarArray
through 2013 trading one share per signal of the NASDAQ Dim stkSMAlo As BarArray
100 stocks. stkSMAhi = Average(H,trdBandLen)
stkSMAlo = Average(L,trdBandLen)

'ENTRY RULES:
Dim isAboveSMAhi As BarArray
isAboveSMAhi = C>stkSMAhi
If mktTrendUp And stkTrendUp And C>stkSMAhi And countof(isA
boveSMAhi,minBarsSinceBandCross,0)=1 Then
Buy("LE",1,0,Market,Day)
End If

If allowShorts=1 Then
Dim isBelowSMAlo As BarArray
isBelowSMAlo = C<stkSMAlo
If mtkTrendDn And stkTrendDn And C<stkSMAlo And countof(isB
elowSMAlo,minBarsSinceBandCross,0)=1 Then
Sell("SX",1,0,Market,Day)
End If
End If

'EXIT RULES:
Figure 11: TRADERSSTUDIO. Here is a sample equity curve for the trend-fol- If C<stkSMAlo*(1-pctStp) Then ExitLong("LXstop","",1,0,Market,
lowing trading system from 2001 through 2013 trading one share per signal of the Day)
NASDAQ 100 stocks.

52 • January 2016 • Technical Analysis of Stocks & Commodities


Figure 12: NINJATRADER. This sample chart of Humana (HUM) shows entries based on the strategy described in James & John Rich’s article “Simplify It.”

If allowShorts=1 Then Import NinjaScript and select the downloaded file. This file
If C>stkSMAhi*(1+pctStp) Or (BarsSinceEntry>maxBarsHold is for NinjaTrader Version 7.
And C>EntryPrice) Then You can review the indicator and strategy’s source code by
ExitShort("SXstop","",1,0,Market,Day)
End If selecting the menu Tools → Edit NinjaScript→ Indicator or
Dim maxProfitSS As BarArray Strategy from within the NinjaTrader Control Center window
Dim pctOfMaxProfitSS As BarArray and selecting either the SimplifyIt indicator or SimplifyIT
Dim loC As BarArray
If C<EntryPrice And C>0 And EntryPrice>0 And BarsSinceEn- strategy.
try>0 Then A sample chart implementing the strategy is shown in
'maxProfitSS=(Lowest(C,BarsSinceEntry-1)/EntryPrice)-1 Figure 12.
If BarsSinceEntry=1 Then loC=C
Else loC = Min(loC,loC[1]) —Raymond Deux & Cody Brewer
maxProfitSS=EntryPrice/loC-1 NinjaTrader, LLC
End If www.ninjatrader.com
If maxProfitSS>0 And C>0 And EntryPrice>0 Then pctOfMaxProf
itSS=(EntryPrice/C-1)/maxProfitSS
If maxProfitSS>=0.05 And pctOfMaxProfitSS<0.8 Then
ExitShort("SXprofitProtectSS","",1,0,Market,Day) F UPDATA: JANUARY 2016
End If
End If
TRADERS’ TIPS CODE
End Sub Our Traders’ Tip for this month is based on James and John
Rich’s article from the November 2015 issue of Technical
—Richard Denning Analysis of Stocks & Commodities, “Simplify It.” In the
info@TradersEdgeSystems.com article, the authors sought to develop a system for first de-
for TradersStudio termining the long, medium, and short trends of a market,
and then following the trend, with confirmation based on the
direction of the S&P 500 index ETF (SPY). Exits are a trailing
stop based on an average of the high or low.
F NINJATRADER: JANUARY 2016 TRADERS’ TIPS CODE Figure 13 demonstrates an implementation of the system,
The indicator and strategy presented in James and John Rich’s with the triple moving average filter system applied to a chart
article “Simplify It,” which appeared in the November 2015 of Humana Inc. (HUM).
issue of Technical Analysis of Stocks & Commodities, are The Updata code based on this article is in the Updata
available for download at www.ninjatrader.com/SC/Janu- library and may be downloaded by clicking the custom menu
ary2016SC.zip. and system library. Those who cannot access the library due
Once you have downloaded it, from within the NinjaTrader to a firewall may paste the code shown here into the Updata
Control Center window, select the menu File → Utilities → custom editor and save it.

January 2016 • Technical Analysis of Stocks & Commodities • 53


@LOWER=SGNL(LOW,#PERIOD4,M)
'ENTRIES
IF @AVG1>@AVG2 AND @AVG2>@AVG3 AND HASX(CLOSE,@
UPPER,UP) AND ORDERISOPEN=0 AND VOL>1000000
BUY CLOSE
@LONGSTOP=PLOW(@LOWER,#PERIOD4)
ELSEIF @AVG1<@AVG2 AND @AVG2<@AVG3 AND
HASX(CLOSE,@LOWER,DOWN) AND ORDERISOPEN=0 AND @
SPYAVG<HIST(@SPYAVG,1)
SHORT CLOSE
@SHORTSTOP=PHIGH(@UPPER,#PERIOD4)
ENDIF
'EXITS
IF ORDERISOPEN>0
IF CLOSE<@LONGSTOP
SELL @LONGSTOP
ENDIF
@LONGSTOP=MAX(PLOW(@LOWER,#PERIOD4),@LONGSTOP)
ELSEIF ORDERISOPEN<0
IF CLOSE>@SHORTSTOP
COVER @SHORTSTOP
ENDIF
@SHORTSTOP=MIN(PHIGH(@UPPER,#PERIOD4),@SHORT-
STOP)
FIGURE 13: UPDATA. Here, the triple moving average filter system is applied to
ENDIF
Humana Inc. (HUM) in daily resolution. @PLOT=@AVG1
@PLOT2=@AVG2
@PLOT3=@AVG3
DISPLAYSTYLE 5LINES @PLOT4=@UPPER
INDICATORTYPE TOOL @PLOT5=@LOWER
PLOTSTYLE LINE RGB(200,0,0) NEXT
PLOTSTYLE2 LINE RGB(0,200,0)
PLOTSTYLE3 LINE RGB(0,0,200) —Updata support team
PLOTSTYLE4 LINE RGB(100,100,100)
PLOTSTYLE5 LINE RGB(100,100,100) support@updata.co.uk, www.updata.co.uk
PARAMETER "Period 1" #PERIOD1=20
PARAMETER "Period 2" #PERIOD2=50
PARAMETER "Period 3" #PERIOD3=200
PARAMETER "Hi/Lo Avg." #PERIOD4=8 F MICROSOFT EXCEL:
PARAMETER "SPY" ~SPY=SELECT JANUARY 2016 TRADERS’ TIPS CODE
NAME "AVG[" #PERIOD1 "|" #PERIOD2 "|" #PERIOD3 "]" "" In “Simplify It,” which appeared in the November 2015 issue
@AVG1=0 of Technical Analysis of Stocks & Commodities, the team
@AVG2=0
@AVG3=0 of James and John Rich show us pieces that can be combined
@UPPER=0 to build a simple trading system.
@LOWER=0
@SPYAVG=0 The proposed system is a combination of several screen-
@LONGSTOP=0 ing rules to establish trade setups along with trigger rules to
@SHORTSTOP=0
FOR #CURDATE=#PERIOD1+#PERIOD2+#PERIOD3 TO #LASTDATE
actually enter and exit both long and short trades after a setup
@AVG1=MAVE(#PERIOD1) has been established.
@AVG2=MAVE(#PERIOD2) Since this system is based on bar close to generate signals,
@AVG3=MAVE(#PERIOD3)
@SPYAVG=SGNL(~SPY,#PERIOD2,M) the actual trade cannot logically take place on the signal bar.
@UPPER=SGNL(HIGH,#PERIOD4,M) So the long and short position shading used here begins and

FIGURE 14: EXCEL, TRADE SETUP SCREENS. This shows Humana with all trade setup screens in place.

54 • January 2016 • Technical Analysis of Stocks & Commodities


FIGURE 15: EXCEL, SCREENING RULES. What a difference removing a couple of screening rules can make!

FIGURE 16: EXCEL, Transaction Summary

ends on the bar after an entry or exit signal. sync with the stock prices, I am forcing a refresh of the index
Perhaps one could change the trigger rules to fire if any every time you request historical data for a stock symbol. So
part of the high/low span of the bar crosses the upper or lower there will be a bit of additional screen flickering and flashing,
band and then trade at a price from within that span on the but not much additional time consumed.
actual trigger day. Figures 14 & 15 approximate the data range we see in
One other usage note: To keep the SPY index prices in Figure 1 of Richs’ article. They demonstrate some of the

FIGURE 17: EXCEL, SCREEN example. Here is National Oilwell with all setup screens in force.

January 2016 • Technical Analysis of Stocks & Commodities • 55


FIGURE 18: EXCEL, TREND SCREENING. Here is the result of dropping the “index trend” screening rule.

FIGURE 19: EXCEL, SCREENING CONTROLS. Dropping another setup screening control lets in an additional trade, but it did not improve our results.

range of results based on varying the setup rules. Turning This stock is clearly in a downtrend, but the market, as
the SMA(200) versus SMA(50) rule will eliminate the losing reflected in the trend of the SPY index, is not.
short we see in Figure 2 beginning around 11/8/2014. With some trial combinations of the screening rules, we
Figure 16 shows my transaction summary tab, which lists find that the index trend screen was blocking all potential
the details of the transactions that appear on the chart. A bot- short entries.
tom line version of the transaction results is carried over to The spreadsheet file for this Traders’ Tip can be downloaded
the CalculationsAndCharts tab for quick reference. from www.traders.com in the Traders’Tips area. To successfully
Due to the way I am calculating trades, you may see a download it, follow these steps:
trade at the left of the price chart that actually started on a bar
that occurred prior to the bars displayed in the chart window. • Right-click on the Excel file link, then
In that event, you will see a partial trade documented here as • Select “save as” to place a copy of the spreadsheet
an exit with no entry. file on your hard drive.
This left edge partial trade will not be reflected in the
transaction counts, nor in the totals. If you wish to include James and John Rich have given us lots to play with here.
it, you can increase the points to plot value (cell A11) on the Enjoy!
CalculationsAndCharts tab a little bit at a time until you can —Ron McAllister
see the transaction entry bar on the chart. Excel and VBA programmer
Figures 17, 18, & 19 are the results of various combina- rpmac_xltt@sprynet.com
tions of the entry setup controls using my approximation of
Figure 2 from Richs’ article.

56 • January 2016 • Technical Analysis of Stocks & Commodities


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January 2016 • Technical Analysis of Stocks & Commodities • 57


FUTURES LIQUIDITY

T
rading liquidity is often over- very high volumes. The greatest number three-year period. Thus, all numbers in
looked as a key technical of dots indicates the greatest activity; this column have an equal dollar value.
measurement in the analysis futures with one or no dots show little Columns indicating percent margin
and selection of commodity activity and are therefore less desirable and effective percent margin provide
futures. The following explains how to for speculators. a helpful comparison for traders who
read the futures liquidity chart pub- Courtesy of CBOT wish to place their margin money ef-
lished by Technical Analysis of Stocks ficiently. The effective percent margin
& Commodities every month. is determined by dividing the margin
value ($) by the three-year price range of
Commodity futures contract dollar value, and then multiply-
The futures liquidity chart shown be- ing by one hundred.
low is intended to rank publicly traded
futures contracts in order of liquidity. Stocks
Relative contract liquidity is indicated Trading liquidity has a significant ef-
by the number of dots on the right-hand fect on the change in price of a secu-
side of the chart. rity. Theoretically, trading activity can
This liquidity ranking is produced by serve as a proxy for trading liquidity
multiplying contract point value times All futures listed are weighted equally and equals the total volume for a given
the maximum conceivable price motion under “contracts to trade for equal dol- period expressed as a percentage of the
(based on the past three years’ historical lar profit.” This is done by multiplying total number of shares outstanding. This
data) times the contract’s open interest contract value times the maximum pos- value can be thought of as the turnover
times a factor (usually 1 to 4) for low or sible change in price observed in the last rate of a firm’s shares outstanding.

Trading Liquidity: Futures


Commodity Futures Exchange % Margin Effective Contracts to Relative Contract Liquidity
% Margin Trade for Equal
Dollar Profit
E-Mini S&P 500 GBLX 3.7 11 3 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>>
10-Year T-Note CBOT 1.2 17.9 12 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
Crude Oil WTI NYMEX 12.1 6.9 1 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
5-Year T-Note CBOT 0.6 12.6 17 •••••••••••••••••••••••••••••••••••••••••••••••••
Euro FX CME 1.9 5.9 2 ••••••••••••••••••••••••••••••••••••••••••••••••
E-Mini Nasdaq 100 GBLX 2.4 5.3 2 ••••••••••••••••••••••••••••••••••••••••••••
Gold COMEX 8.5 13.3 1 ••••••••••••••••••••••••••••••••••••••
T-Bond CBOT 2.2 12.9 4 •••••••••••••••••••••••••••••••••••
Russell 2000 Mini ICEUS 3.8 11.8 3 •••••••••••••••••••••••••••••••••
Ultra T-Bond CBOT 2.8 18.7 4 ••••••••••••••••••••••••••••••••
Japanese Yen CME 2.7 5.2 2 •••••••••••••••••••••••••••••
Corn CBOT 14.9 13.4 5 •••••••••••••••••••••••••
Natural Gas NYMEX 10.5 6 2 ••••••••••••••••••
Silver COMEX 14.8 10.3 1 ••••••••••••••••
Australian Dollar CME 2.3 4.7 3 ••••••••••••
Gasoline RBOB NYMEX 11.4 7.2 1 ••••••••••••
2-Year T-Note CBOT 0.1 12.3 41 •••••••
Canadian Dollar CME 1.5 4.1 4 •••••••
DJIA mini-sized CBOTM 3.1 11.1 4 •••••••
High Grade Copper COMEX 10.2 12.3 2 •••••••
E-Mini S&P Midcap GBLX 3.1 9.4 2 ••••••
Sugar #11 ICEUS 9.8 25 16 ••••••
Soybean Meal CBOT 9.5 10.6 4 •••••
Soybeans CBOT 10.7 11.9 3 •••••
Wheat CBOT 13.4 16.3 5 •••••
British Pound CME 1.4 10.8 8 ••••
Platinum NYMEX 9.1 8.6 2 ••••
Soybean Oil CBOT 10.3 10.8 6 ••••
CBOE S&P 500 VIX CFE 7 9.6 8 •••
Coffee ICEUS 11.7 11.7 2 •••
Hard Red Wheat KCBT 10.9 10.8 4 ••• CBOT Chicago Board of Trade, Division of CME
Lean Hogs CME 6.5 4.5 3 ••• CFE CBOE Futures Exchange
Swiss Franc CME 1.8 7.1 3 ••• CME Chicago Mercantile Exchange
U.S. Dollar Index ICEUS 1.3 6.3 5 •••
COMEX Commodity Exchange, Inc. CME Group
Crude Oil Brent (F) NYMEX 11.2 6.6 1 ••
GBLX Chicago Mercantile Exchange - Globex
Eurodollar CME 0.1 60.1 181 ••
ICE-EU Intercontinental Exchange-Futures - Europe
Live Cattle CME 2.6 8.3 6 ••
Mexican Peso CME 7.4 18.4 8 •• ICE-US Intercontinental Exchange-Futures - US
Cotton #2 ICEUS 8 13.8 6 • KCBT Kansas City Board of Trade
New Zealand Dollar CME 2.7 7.5 4 • MGEX Minneapolis Grain Exchange
Palladium NYMEX 9.8 13.8 3 • NYMEX New York Mercantile Exchange
Spring Wheat MGEX 13 14.6 5 •
30-Day Fed Funds CBOT 0 85.6 424
Canola WCE 5.8 14.5 27
Class III Milk CME 5.7 9.5 6 1601
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 easi-
or 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
when compared to others in the same column. Contract Liquidity” is the number of contracts to trade times total open interest times a
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
as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price 1 or exp –2
In 5000
Excursion).

58 • January 2016 • Technical Analysis of Stocks & Commodities


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Trading systems can help take the subjective interpre- Product Company
tation out of trading decisions by providing automated
buy and sell signals based on preprogrammed rules. 1. AbleTrend AbleSys Corporation
Trading systems are usually computer programs but
2. FXCM Trading Platform Forex Capital Markets LLC
can also be a real-time service issuing signals or a set
of published rules to follow. They can rely on one or 3. Forex System Selector Forex Capital Markets LLC
more trading disciplines, such as artificial intelligence,
Gann analysis, astrology, indicator sets, or custom rules. 4. Profitunity Trading Group Profitunity Trading Group
The product information you’ll find at our website for trading systems 5. Sure-Fire Trading Systems VectorVest, Inc.
will help answer questions such as: What indicators does the system
utilize? What markets are followed by the trading system? Are additional 6. GorillaTrades GorillaTrades, Inc.
applications required to use the trading system? What types of customer 7. Bulls ’n Bears Red Light,
support are offered? What are the primary features of the trading system? Gecko Software, Inc.
Green Light System
While we are unable to present track records or rankings in the listing,
we hope this resource will be a starting place for finding out more about 8. Andromeda Trading System Petros Development Corp.
some of the available systems and finding the right trading system for
your trading. 9. BWT Precision Indicators Blue Wave Trading R&D
In addition to the trading systems listing at Traders.com, you’ll also find 10. BWT Precision Auto Trader Blue Wave Trading R&D
listings of other trading-related products and services such as brokerages,
data services, courses and seminars, software, and more. We hope this
These are the 10 trading systems clicked on most often on the Traders’ Resource website. Each entry
is listed in order of clicks received. This is not an editorial rating or ranking. For more information on
will help you learn about products to help in your trading endeavors. specific products and services, try checking store.Traders.com for archived S&C product reviews.

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.

January 2016 • Technical Analysis of Stocks & Commodities • 59


The following selection of book descriptions represents into the limelight with the 2007 near collapse of the global financial market.
a sampling of recent book releases in the investing field. This book provides thorough, practical guidance toward processing the
Books described here may be from some of the major book trade, and the risks & rewards it entails.
publishers as well as some independent book publishers.
www.wiley.com
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. Financial Risk Management: Applica-
tions In Market, Credit, Asset And Li-
ability Management And Firmwide Risk
Trading Psychology 2.0: From Best (576 pages, $95 hardcover, $$61.99 ebook,
Practices To Best Processes (448 pages, October 2015, ISBN 978-1-119-13551-7) by
$60 hardcover, $39.99 ebook, September Jimmy Skoglund & Wei Chen, published by
2015, ISBN 978-1-118-93681-8) by Brett N. Wiley. This book presents an in-depth look
Steenbarger, published by Wiley. at banking risk on a global scale, including
Trading Psychology 2.0 is a guide to apply- comprehensive examination of the US Com-
ing the science of psychology to the art of prehensive Capital Analysis and Review and
trading. Veteran trading psychologist and the European Banking Authority stress tests.
bestselling author Brett Steenbarger offers Written by experts in global banking risk products and management, this
advice and techniques to help interested book provides up-to-date information and insight into risk management.
traders better understand the markets, with The discussion begins with an overview of methods for computing and
practical takeaways that can be implemented managing a variety of risks, then moves into a review of the economic
immediately. Steenbarger draws on his own experience in psychology and foundation of modern risk management and the growing importance of
statistical modeling as an active trader to offer insights into the practical model risk management. Market risk, portfolio credit risk, counterparty
aspect of trading psychology. Academic research is made understandable credit risk, liquidity risk, profitability analysis, stress testing, and others
using examples, illustrations, and case studies to make it meaningful for are dissected and examined, helping the reader to develop strategies
practical traders. Interactive features include a blog offering ever-expanding to construct a robust risk management system. The book takes readers
content and a Twitter feed for quick tips. There are also contributions from basic market risk analysis to major recent advances in financial risk
from market bloggers, authors, and experts for fresh perspectives to the disciplines seen in the banking industry. The quantitative methodologies are
topic. Studying the market from the perspective of human behavior gives developed with business case discussions and examples illustrating how
traders insight into how human behavior drives market behavior. Trading they are used in practice. Chapters devoted to firmwide risk and stress test-
psychology is equally relevant to daytraders and active investors, market ing cross-reference the different methodologies developed for the specific
makers and portfolio managers, and traders in all different markets. This risk areas and explain how they work together at firmwide level. Since risk
book seeks to act as a personal trading coach in print, accessible 24/7 no regulations have driven a lot of the recent practices, the book also relates
matter what the market is doing. to the current global regulations in the financial risk areas.
www.wiley.com www.wiley.com

The Trade Lifecycle: Behind The Scenes Financial Planning Competency Hand-
Of The Trading Process, second edition book, second edition (944 pages, $175
+ website (416 pages, $70 hardcover, $45.99 hardcover, August 2015, ISBN 978-1-119-
ebook, October 2015, ISBN 978-1-118-99946- 09466-1) from the CFP Board, published
2) by Robert P. Baker, published by Wiley. by Wiley. This is a reference for those at any
The Trade Lifecycle catalogs and details the stage of certification and is also a resource
various types of trades, including the inherent for practitioners looking to better serve their
cashflows and risk exposures of each. Now clients. The book contains over 90 chapters
in its second edition, this guide includes new for practitioners, students, and faculty. There
coverage of traded products, credit valua- is a US edition and an international edition.
tion adjustment, regulation, and the role of The revised text includes an in-depth review of
information technology. The author teaches how to dissect a trade into its the major content areas associated with financial planning including estate
component parts, track it from preconception to maturity, and learn how it planning, taxation, investments, principles of communication, and more. This
affects each business function of a financial institution. You will become edition includes new content on connections diagrams, new case studies,
familiar with the full extent of legal, operational, liquidity, credit, and market and instructional videos, and a new section devoted to the interdisciplinary
risks to which it is exposed. Case studies of real projects cover topics nature of financial planning. The reference seeks to provide insights from
such as forex exotics, commodity counterparty risk, equity settlement, fields like psychology, behavioral finance, communication, and marriage
bond management, and global derivatives initiatives, while the companion & family therapy to help the reader better connect with their clients and
website features additional video training on specific topics to help the perform to the highest expectations as a financial planner.
reader build a strong background in this fundamental aspect of finance. www.wiley.com
Trade processing and settlement combined with control of risk was thrust
60 • January 2015 • Technical Analysis of Stocks & Commodities
AT THE CLOSE

Sell With Confidence

The Green Line


Knowing when to exit a trade can work wonders for your Average (DJIA) you see in Figure 1 and mentioned that a
trading returns. Here’s one tool that can help you make that year ago I posted a video that suggested the DJIA was near
critical decision. a topping area. In the chart of the DJIA in Figure 1 a mega-
horn pattern is in play and price is near the green line. The
by Ron Jaenisch technician who first identified the pattern and coined the term
mega horn wrote that it was more reliable for finding highs

It
was a very hot day in September and I was at a pri- than lows. The green line is the far parallel of an Andrews
vate lunch meeting with the CEO and CFO of a legal pitchfork. The pitchfork is drawn using the recent three large
consulting company. They were making the rounds to pivots. Most charting software has the ability to draw this
encourage well-heeled investors to consider investing line. The Andrews line was originally written about in this
in their company. Their stock had a high market cap but a low magazine by Tom French.
daily turnover, which for most money managers, is a criterion Over the years I found that price often finds strong resis-
that brings up a caution flag. tance at the green line. This is something I taught to money
I decided to use the opportunity to practice presenting a small managers in Vienna years ago. Figure 2 shows the weekly
piece of what I was working on, one of the many automated scale of the DJIA and you can see that price did reverse near
techniques used by the technical analysis software that was the green line.
muellek josef/Shutterstock

being built for a family office consortium. I showed them several other charts such as the daily chart
I decided to present them with credible evidence that I had of Apple Inc. (AAPL) that you see in Figure 3. Once again
technology that is used by the money managers of the ultra- I pointed out that prices had made a top at the green line.
wealthy in Vienna to know when to sell. This may sound like Interestingly, a similar scenario took place in AAPL in 2012
a tall tale, but I taught technical analysis to Vienna money (Figure 4) in that prices reversed near the green line. However,
managers several years back. I didn’t include this chart in my presentation.
First I showed them the chart of the Dow Jones Industrial
January 2016 • Technical Analysis of Stocks & Commodities • 61
AT THE CLOSE

FIGURE 2: STRONG RESISTANCE. On this weekly chart of the DJIA you can see
that price reversed at the green line.
qcharts.com

Price often finds strong


FIGURE 1: MEGAHORN PATTERN. On this daily chart of the Dow Jones Industrial
Average (DJIA), price is approaching the green line. resistance at the green line,
which is the far parallel of
Conclusion an Andrews pitchfork.
I have come across several charts that show prices reversing at
the green line. I’ve seen it enough times that I am convinced the
green line is a reliable tool that lets me know when to sell. and futures, using the techniques. He can be reached through
Andrewscourse.com.
Ron Jaenisch spent time with Dr. Alan Andrews learning
his techniques. Jaenisch has been authorized by Andrews to Further reading
teach the Andrews techniques via a course that now includes French, Thomas E. [1985]. “Median Line Market Analysis,”
videos. In 2015 Jaenisch was part of an international team Technical Analysis of Stocks & Commodities, Volume
that built software that automatically trades forex, stocks, 3: April.

FIGURE 3: A TOP IN APPLE INC. (AAPL). Here in the daily chart of AAPL is FIGURE 4: AND IT HAS HAPPENED BEFORE. Interestingly, a similar scenario
another instance of prices reversing at the green line. occurred in the chart of AAPL in 2012.

62 • January 2016 • Technical Analysis of Stocks & Commodities


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Dear Friends:

There is a famous story I have heard a time ago: On a beautiful late spring
afternoon, twenty-five years ago, two young men graduated from the same college.
They were very much alike, these two young men. Both had been better than
average students, both were personable and both – as young college graduates are
– were filled with ambitious dreams for the future.

Recently, these two men returned to college for their 25th reunion.

They were still very much alike. Both were happily married. Both had two
children. And both, it turned out, had gone to work for the same international
manufacturing company after graduation, and were still there.

But there was a difference. One of the men was manager of a small department of
that company. The other was its president.

What Made The Difference

Have you ever wondered, as I have, what makes this kind of difference in people’s
lives? It isn’t always a native intelligence, talent, or dedication. It isn’t that one
person wants success and the other doesn’t.

The difference lies in what each person knows and how he or she makes use of that
knowledge.

And that is why I am writing to you and to people like you about LibTA, the
Technical Analysis Library. For that is the whole purpose of our Library: To give
its members knowledge – knowledge that they can use in trading and life.

Each day, The Library’s posts include a broad range of information of interest and
significance to business-minded people, no matter where it comes from. Not just
markets and finance, but anything and everything in the whole, fast-moving world
of trading. The LibTA gives you all the resources you need — when you need it.

Knowledge Is Power

From Technical Analysis and cryptos to options and stock markets, from investing
to Forex, there are almost 1000 books and dozens of hours in audio and video-
courses at your fingertips.

Our goal is to share knowledge and help investors and traders to become proficient
and succeed in the market.
If you have never heard about the LibTA, you cannot imagine how useful it can be
to you. You will want to find out immediately if it can do for you what it is doing
for its thousands of members. Just access it here: https://t.me/libTA

A Money-Saving Channel

Everything in our channel is free and it will always be. Our courses & books are
meant for those who seek knowledge but cannot afford to buy on the author's
website or on Amazon. However, if you like the course or book, and can afford it,
please support the Author by purchasing it.

About those two college classmates I mention at the beginning of this letter: they
were graduated from college together and together got started in the business
world. So what made their lives in business different?

Knowledge. Useful knowledge. And its application.

An Investment In Success

I can't promise you that success will be instantly yours if you start reading and
watching our courses and books. But I can guarantee that you will find our Library
always interesting, always reliable, and always useful.

Sincerely,
~ LibTA Team

PS: If you feel, as we do, that this is a fair and reasonable proposition, and you
share our ideals, help LibTA. For as little as 0.003 BTC you can support the project
and make a difference – and it only takes a minute. Thank you.

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