THE TRADERS’ MAGAZINE SINCE 1982

www.traders.com AUGUST 2015

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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4 • January 2016 • Technical Analysis of Stocks & Commodities

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 January 2016 • Volume 34, Number 1
Opening Position
The Traders’ MagazineTM

As
EDITORIAL
editor@traders.com

Editor in Chief Jack K. Hutson

Editor Jayanthi Gopalakrishnan
we approach another year, it may
Production Manager Karen E. Wasserman be a good time to reflect on what
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Contributing Editors John Ehlers,
Anthony W. Warren, Ph.D.
Did you meet your goals? Did you follow
Contributing Writers Thomas Bulkowski, Martin Pring,
your strategies as you intended to? For the
Barbara Star, Markos Katsanos most part, 2015 was a strong year in the
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6 • January 2016 • Technical Analysis of Stocks & Commodities

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

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
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
trigger a premature entry.
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
article.
Step 6: Apply a sell signal. I tested moving averages from
10 to 250 days, trailing stops from 5% to 25% below a high-
water mark, and a target price exit based on the height of the
chart pattern.
Testing
I used 59 stocks for in-sample data and 425 for out-of-sample
data starting January 2000 (yes, in the middle of the bear
market whose trades I discarded but logged anyway) to June
2015. Not all stocks covered the entire range.
To find ugly double bottoms automatically, I looked for the
lowest low within a sliding window of five trading days wide.
That means finding the lowest low from five days before to
five days after the bottom (11 days total) and then looking for
the next adjacent bottom.
I used in-sample data to determine the best stop location,
Tom Bulkowski
If you were to trade the setup
perfectly, it wins 87% of the
time, making an average of 48%
from winning trades.
how far the bottoms should be from one another (price scale),
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
back as far as 1990. I didn’t see any performance difference
between in-sample and out-of-sample data that would change
the setup.
Perfect trades
The first question bottom fishers will want answered is how
often will trades be stopped out? If you were to trade the
setup perfectly (using ugly double bottoms with bottoms 5%
to 20% apart), it wins 87% of the time, making an average
of 48% from winning trades, but incurring an average loss
of 17% on losing trades. Overall, you could make an average
of 40% per trade.
To find those statistics, I used a stop-loss order placed a
penny below the bottom of the chart pattern, triggered on a
close at or below the stop price, and sold at the open the next
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
turn and move in another direction. But there are
tools you can apply to your charts to identify those
probable turning points. Here’s a simple technique
any intraday trader can use.
any product in the securities markets. I’m certainly not
the first to notice this phenomenon of prices bouncing
around between numbers whose basis is a thousand-
year-old mathematical formula, but I had not seen the
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
indicators
The Fibonacci tool is not magi-
cal. What is needed is one more
indicator that will act like a
compass at Fibonacci levels,
telling you which way to go,
whether it is appropriate to take
a position or not, whether to
buy or sell, and whether there
may be follow-through from
the point at which you take a
position. It’s another of those mathematical studies made visual:
the stochastic oscillator. There are others of this variety, but I
like this one.
Notice on the chart in Figure 3 the coincidence of price
meeting a Fibonacci level and the position, high or low, of the
stochastic. (The ovals are drawn at the same times on the upper
and lower panels of each part of the chart. This is the coordina-
tion you’re looking for.)
It’s clear on this chart that the meeting of price and the Fibo-
nacci levels combined with a high or low level on the stochastic
gives a good indication of what will happen next. The prob-
abilities are very high that this combination will be predictive
of the direction that price will go, and that there will be enough
follow-through to make the trade worthwhile. You don’t want
to make a trade only to have the thing do an about-face as soon
as you click the buy or sell button. Ideally, you see the price
rise along with the stochastic and then see the price meet a Fib
level while the stochastic is high in its range. That will signal
an opportunity to sell. It’ll be the opposite for buys.
By the time the market opens, Fibonacci calculations have
been made for the day: the levels are on the chart. (See sidebar
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
“Calculating Fibonacci Levels” for the method of deriving these
numbers.) At the open, or even earlier, we look for an indica-
tion of which way prices will go. Where is the Fib level? Is the
stochastic high or low, if either? These are the things that will
give indications of what the market wants to do.
The chart in Figure 4 shows the first two hours of activity of
the S&P emini futures contract on a recent day. (The vertical
lines are put in to show the connection between the stochastic
and price levels.) You can see that price opened (9:30 am Eastern
Time, the first of the vertical lines) up against a Fibonacci level
at about 2096 and the stochastic was quite high in its range. This
made for a reasonable sell of the contract, which went down to
2083 before reversing for the day. There were various points at
which you could get in or out, but the possibility is clear that a
skillful trader might have captured 13 points on this contract.
Small time frames like this have the advantage of letting the
trader know quickly when a trade is not working as expected.
A large trader might use a five, or 15-minute, or even larger
time frame because he doesn’t need to worry as much about
the drawdown that can happen while a single bar (or candle) is
being painted. If a small trader tries to use even a five-minute
time frame he may find himself in trouble before he knows
it. That, combined with the use of the Fibonacci system, is
specifically geared to keep the small trader out of trouble. The
trader has what I am calling a “decision area” within which
he is safe. The large trader might be able to afford to take 15
minutes to make his decision, but the little guy has sometimes
only a few moments. You want to quickly know when you are
wrong. You need to have guideposts that you respect because
otherwise you will be tempted to think that you know better
than that mathematician who is long dead, and try to pit yourself
against the market, which is always a mistake.
I believe that this system, simple as it is (one chart with two
 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
is a chance that there could be some distortions in the data.
Here’s what you can do to avoid those distortions.
by John F. Ehlers
I
imagine that most traders consider the price data they
use for analysis to be a continuous function. Nothing
could be further from the truth. And, depending on your
trading style, the impact of this assumption can range
from trivial to dramatic. The fact is that the data is sampled
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-
age the high, low, and close; you still only have one sample
per day on daily bars.
One impact of sampled data is that it can lead to aliasing. In
my youth, the old cowboy movies had a sample rate of only 16
frames per second, letting the eye integrate those individual
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
result in aliasing. The frequency at which there are exactly two
18 • January 2016 • Technical Analysis of Stocks & Commodities
samples per cycle is called the Nyquist frequency. The theory
is demonstrated in Figure 1, where the shorter cycle depicted
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
real data of the red sine wave, the data is interpreted as the
phantom aliased blue sine wave. Just imagine the impact on
your trading if your data is subject to aliasing!
Mathematically, the process of sampling is multiplying a
sine wave at the sampling frequency with the cycles in the
continuous data. From your high school trigonometry class
you may recall this equation:
Sine(A)*Sine(B) = 0.5*(Sine(A+B) + Sine(A-B))
If A represents the sampling frequency and B represents the
frequencies of the continuous data, the sampling frequency is
heterodyned with the continuous data with upper and lower
sidebands. This is exactly the same process as with your AM
Figure 1: theory of sampled data. Sampling less than twice per cycle
produces phantom aliased signals.
 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
risk-to-reward is favorable. Forecasting, on the other hand,
is outcome dependent. Find out how you can use both and
take advantage of those opportunities.
by Tyler Yell, CMT
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
chart. When you look at a chart, price movement that
occurred in the past may look like it had only one likely
outcome. But when you look at a chart in real time, you don’t
know what the outcome will be. There could have been multiple
scenarios, and credible people will argue for price to move in
completely different paths from a specific point.
Price charts and potential outcomes often play cruel tricks
on the brain. Trading, on the surface, is similar to a casino in
that it informs you of the prize of a low-probability outcome
while the quantitative edge that the casino holds is purposely
hidden from you. Just as the blackjack player thinks about the
22 • January 2016 • Technical Analysis of Stocks & Commodities
number of ways to hit 21, often blind to the hundreds of ways
to go bust or have the dealer beat you, traders often think of a
favorable outcome instead of thinking about what can go wrong.
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
on the data and validating their proposed outcome.
Where forecasters get it right
and wrong
Philip Tetlock, who has a new book out titled SuperFore-
casters, recently brought to light a great analogy of common
forecasting personalities. He explains it well in his prior book,
Expert Political Judgment:
The intellectually aggressive hedgehogs knew one big thing
and sought, under the banner of parsimony, to expand the
explanatory power of that big thing to “cover” new cases;
the more eclectic foxes knew many little things and were
content to improvise ad hoc solutions to keep pace with a
rapidly changing world.
 FOREX FOCUS
2008 Top
Labels are from the technical forecasting methodology known as Elliott wave
a c
The financial crisis
A
d iv?
b
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
served by adding incoming data to see if your outcome is more
or less likely to come to fruition as opposed to putting your
head in the sand, hoping you are proven right.
Another rock star in the world of nonmarket forecasting
is Nate Silver, who predicted the outcome of the 2008 US
presidential election with far more accuracy than highly paid
political forecasters. He attributes his methodology of fore-
casting to Bayes’ theorem, an algorithmic approach for which
its namesake is an 18th-century pastor. Bayes’ theorem opines
that recently available evidence should be used to bring down
or bring credibility to an outcome. Nate Silver’s model used
individual states’ high-credibility polls in the 2008 election to
predict the likelihood of the winner and updated his forecast
the night of the elections as individual state outcomes were
being announced.
The trading equivalent to this is to look for obvious failures
toward your desired outcome developing in real time. An
Elliott wave–based trader will consider invalidations of a
primary market view as casting doubt or outright invalidating
his forecasts. The point here is that you should not be married
The desire to avoid a loss
is understandable, but the
unwillingness to accept a
loss is futile.
e/B
ii
Some people believe we’ll have
i another strong bounce off the trendline,
FXCM’s Marketscope/Trading Station II
at least to midline.
iii
v/C
Many people believe we “must” hit parity (1.000) or below
to any one outcome but be flexible with your outlook, because
markets appear chaotic in real time.
In Michael Toma’s informative book The Risk Of Trading:
Mastering The Most Important Element In Financial Specu-
lation, he walks traders through the process of identification,
assessment, control, measuring, and monitoring of trading
risks. The purpose is to show traders that when trading, there
is more to risk management than placing a stop-loss. Similarly,
traders would likely be better served by focusing on how their
forecast could be nullified as opposed to validated.
Clash of trading
& forecasting
When looking at the present, a new
thought often creeps into your mind
as a trader. First, you think if I can
only figure out the future I will be
able to avoid a loss and book a profit.
Daniel Kahneman’s prospect theory
from his book Thinking Fast And
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.
To avoid such a fallacy, you are probably better off holding
your strong opinions or forecasts with consistent pessimism.
In other words, hold your strong opinions weakly so that you
do not find yourself overrelying on an assumed outcome that
doesn’t take place.
January 2016 • Technical Analysis of Stocks & Commodities • 23

You can be incorrect in
forecasting but place a good
trade, and you can be good at
forecasting but poor at trading.
Marrying the two worlds of
forecasting & trading
Businesses are fond of making a premortem prior to major
projects. A premortem is an explanation of potential causes
of failure for an important project. As you can imagine, the
goal of the premortem is to think outside of the “hedgehog
view” so that you may act accordingly before the start of the
real project.
In trading, a premortem will hopefully cause you to trade
smaller or use less leverage than you might have otherwise
done with a more confident but likely flawed forecast. Second,
a premortem may help you identify where, as a trader, you may
want to flip your bias and potentially your exposure. Either way,
optimism surprisingly has little room in a trader’s career.
Mark Spitznagel, the hedge fund manager and former head
trader for Naseem Taleb, notes in his book The Dao of Capital
that to survive, you must learn to “hate to win, love to lose.” As
a multibillion-dollar hedge fund manager, he obviously needs
profits to attract new investors. Spitznagel is driving home the
point that staying in a losing position is the quickest way out
of the business. In addition, poor forecasting or overreliance
on your market forecasting methods is one of the quickest
ways to convince yourself to stay in a bad position.
Little bets
Many traders come to the market with a per-
verted view of their likely success. In other
words, it is common for them to look at stories
on financial news networks regarding the one
big trade that made someone’s career like bet-
ting on subprime mortgages in 2003 or betting
against them in 2007. However, the one big bet
can often turn into one big loss, since few things
unfold in a straight line.
Instead of placing one big bet, a better approach would be
to place multiple small bets. Sure, if your one big bet is large
enough and you come out on the winning side, someone may
write a book about you, but the likelihood of that is under-
standably small. As a trader looking for double-digit returns
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
their well-researched views. That said, there are often com-
pelling views that the market will go higher or lower. Only
one of these forecasts will be proven correct, although in a
sideways market, both could be correct, revealing the need
for combining risk management with forecasting.
Summary
Learning how to forecast and finding an accurate trading
method should play a separate role from learning how to trade.
Forecasting is outcome dependent, and the road toward the
realized outcome is often full of unpredictable developments.
Trading is about recognizing present opportunities where
the risk–reward tradeoff is presently favorable, and taking
advantage of those opportunities. Ironically, yet importantly,
you can be incorrect in forecasting but place a good trade, and
likewise, you can be good at forecasting but poor at trading.
The latter is surprisingly common.
Regardless of your method of forecasting, recognizing a
good risk–reward trade setup as per your preferential trad-
ing methodology is crucial. It is best to avoid the mistake of
believing the market must end up at a certain juncture a week,
month, or quarter from now and overexposing your account on
that hope. Rather, it is best to use a forecast as a springboard
for entering the market and then analyzing how the market
is reacting to your forecast to see whether or not more weight
should be given to that outcome coming to fruition.
Trade (as opposed to forecast) well.
Tyler Yell, CMT, is a currency analyst and trading instructor
for DailyFX.com, a forex market news and analysis site.
Further reading
Spitznagel, Mark [2013]. The Dao Of Capital: Austrian In-
vesting In A Distorted World, Wiley.
Tetlock, Philip E., and Dan Gardner [2015]. Superforecasting:
The Art And Science Of Prediction, Crown Publishers.
Tetlock, Philip E. [2005]. Expert Political Judgment: How
Good Is It? How Can We Know? Princeton University
Press.
Toma, Michael [2012]. The Risk Of Trading: Mastering The
Most Important Element In Financial Speculation, John
Wiley & Sons.
Yell, Tyler [2015]. “Gold & The Yen,” Technical Analysis of
Stocks & Commodities, Volume 33: October.
_____ [2015]. “Bond Markets & FX Effects,” Technical Analy-
sis of Stocks & Commodities, Volume 33: August.
‡Marketscope/Trading Station II (FXCM)
‡See Editorial Resource Index
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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.
Here are two quick technical points to keep in mind when
entering long inverse H&S breakouts: first, it’s best if the
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
this example. This compression pattern—one with shallow
cups—in an H&S breakout often leads to solid upside moves.
In this example, it did a full three-point upside breakout.
From a timing standpoint, when you see these types of
upside high-volume breakouts, a nice feature is that they’re so
strong you don’t have to enter early or “right on time” above
the neckline. They will often move a dollar or more before
a pullback, making them ideal for both intraday as well as
swing trading.
High volume above 50-period moving average
For longer-term swing trading, you can use a 90-day daily
candlestick chart with the 50/100/200-period simple moving
average (SMA) lines that are favored by institutional traders.
One high-volume breakout pattern that capitalizes on 50-pe-
riod SMA breakouts is illustrated in the chart of Best Buy Co.
Inc. (BBY) in Figure 4. A long entry is initiated following a
day in which price action trades above the 50-period SMA
on strong volume.
The 50-period SMA on a 90-day daily chart is a key tech-
nical indicator that, when combined with volume, can help
you spot strong breakouts as they progress in an uptrend. You
can see that this pattern trended up for three weeks before
pulling back, going from $33/share to $39/share. Your initial
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
even after that exit target was hit.
The reason this high-volume 50-period SMA breakout
pattern works is simply because professional traders use this
technical moving average value to make their entry decisions.
The strong buying volume that comes in after a move above
the 50-period SMA attracts additional buying momentum,
which leads to the multiday breakout continuation.
Your breakout trading
plan
Think of the supply & demand involved
in trading; when volume is high and price
continues in an uptrend, it’s because
there’s not enough share supply at one
price point, so price increases. As long as
price and volume both continue increas-
ing in an uptrend, the breakout continues. If you see volume
drop and price move sideways in a consolidation, or start to
drop, it’s time for you to tighten your trailing stop or exit the
trade altogether.
Here are some trading tips to keep in mind:
zz Use high volume as a disciplined trading guideline; do
not take trades until strong volume (>30% higher than
usual) starts to show up on your charts.
zz High-volume breakouts will usually trend for much
longer than average-volume breakouts. Capitalize on
this phenomenon by planning to scale in and add to
winning trades as they continue in your favor (in swing
trading, you may wish to add additional shares every
two points or so).
zz Selectively trade only the strongest-trending charts in
sustained uptrends; for swing trades, the prior trend
should have at least three to five days of continuous new
highs on your chart prior to entering.
Keep the relationship between price action and volume
firmly in mind when you place your trades. See if you can spot
similar high-volume breakout charts when you scan through
your charts to help identify successful trading entries.
Ken Calhoun is a producer of trading courses, live seminars,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for day and swing traders.
Further reading
Calhoun, Ken [2015]. “Trading First-Hour Breakouts,” Tech-
nical Analysis of Stocks & Commodities, Volume 33:
December.
[2015]. “Managing Breakout Trades,” Technical Analy-
sis of Stocks & Commodities, Volume 33: November.
[2015]. “Breakout Or Fakeout?” Technical Analysis of
Stocks & Commodities, Volume 33: October.
[2015]. “Gap Continuation Breakouts,” Technical
Analysis of Stocks & Commodities, Volume 33: Sep-
tember.
Gopalakrishnan, Jayanthi, and Bruce R. Faber [2011]. “Trading
Momentum With Ken Calhoun,” interview, Technical Anal-
ysis of Stocks & Commodities, Volume 29: March
‡eSignal
‡See Editorial Resource Index
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
Why not just buy a straddle into an
earnings report, attempting to profit on
either side?
While this sounds like a great idea,
it is not always the case. This month, I
want to review straddles but in particular,
I want to show you when not to use one.
The straddle is a nondirectional strategy
in which you buy an at-the-money call
and put with the same strike price and
expiration date. The combined cost of
this option strategy is double what it
would cost to simply take a side, but it’s
also a nondirectional view. This sounds
simple and I think this covers the basics
of it. I’ll show you an example of buy-
ing a straddle just before earnings, with
none other than one of the most popular
companies in the world, Amazon.com,
Inc. (AMZN).
The chart of AMZN in Figure 1 is a
great read for straddle traders. It displays
price along with the result of the last
earnings report back in late July, and
it displays volatility. The red line you
few weeks ago seemed to make a lot of
sense in hindsight, as option volatility
has risen with price. Funny thing is that
most novice traders think that buying a
straddle and holding it through earnings
makes sense, because they have seen big
moves happen on the stock, and have
the idea that a trade, like a straddle,
will make money on the big move. It’s
not as easy as it sounds, so let’s take a
more experienced approach to see if
this indeed is a good idea ahead of this
week’s earnings on AMZN (as I write
this in early November 2015).
The first thing I do is evaluate what
the near-term straddle is trading for,
so it makes sense to look at the near
options expiring in the current week
(Figure 2). This gives me a gauge of
how far the stock could go just after the
report. AMZN 570 calls and 570 puts
620
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)
580 SMA (200)
560 7-30 day ATM IV
that are expiring in the current week are
trading at around 50 points when you
combine the costs of both. That’s what
I like to do to get a read on where this
stock might go after earnings. Based on
these numbers, option traders expect the
range of AMZN to be contained to 50
points after the report. That’s about an
8.5% move in the stock, which is a big
anticipation for a jump after earnings. If
option traders are already digesting 50
points post earnings, there would have to
be a move greater than that to the upside
or downside to profit on the straddle by
Friday’s expiration.
Would I buy this straddle that expires
only one day after the earnings an-
nouncement? Of course not, since the
opportunity simply isn’t there. Here’s
why: First, the straddle would cost $5,000
per contract to buy, which already vio-
85
80
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

option prices. If the line goes from 20
to 80, it means that the time value of
an option theoretically increases by a
factor of four.
A smart straddle trader would try and
buy when volatility is low, and sell when
volatility is high. Buying a straddle a
Figure 1: PRICE, EARNINGS, VOLATILITY. The red line, or implied volatility, moves within a range of 20 to
80. As the line moves down, there is less fear and as it goes up it means there is uncertainty about the future.
AMZN ATM calls and puts
expiring this week
Figure 2: calls and puts expiring in the near term. Here you see that the AMZN 570 calls and
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
there’s only one day after earnings for
this trade to become profitable, there’s a
big chance of risk at this price.
What I am talking about is called statis-
tical probability. With options, when you
bet on the long shot, you could win more,
but the percentage of winning becomes
far less. Don’t let this calculator fool you
into thinking that naked option selling
Straddles are best used in periods of
Straddles are best used low volatility when you expect price to
in periods of low volatility break but are not sure in which direction,
when you expect price to or if you expect a rise in volatility because
break or if you expect a of impending news such as an earnings
report. If you’re trading it for any other
rise in volatility. reason, then you’re not stacking anything
in your favor. Keep this in mind when the
is the only way to trade. It’s just a guide next earnings season approaches!
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
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1500

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

1450
1400
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Any commentary and feedback from seems like it has

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1150

the authors on this would be greatly something to do

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1050
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appreciated to better complete the whole with the “.DJI”

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850
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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!
ViNceNt
Author James Rich replies:
If you reread the paragraph under the
subheading “The Method,” you’ll see
that I like the 20 SMA above the 50
and the 50 above the 200. When the 50
flattens out, the 20 has normally crossed
below it. If the 20 is above the 50, the 50
has a noticeable slope to the upside that
has been in place since the 20 crossed
it, or shortly thereafter. If you wanted
to be a little more aggressive, you might
consider taking an initial position when
both the 20 and 50 SMAs have turned
up (or down) but have not yet crossed
the 200.
mONEY FLOW OSCiLLATOR CODE
Editor,
Vitali Apirine’s article in the October
2015 issue, “The Money Flow Oscilla-
tor,” was very interesting.
I’m long-term user of MetaStock, but
I’m not so good at coding formulas. I
wanted to try Apirine’s indicator on my
database, but unfortunately, the code
supplied in the article doesn’t seem to
all my different FiguRE 1: S&P 500 WiTh READER’S TREND-FOLLOWiNg iNDiCATOR AND ViTALi
indexes/securi- APiRiNE’S VOLumE iNDiCATORS. In this chart, green=uptrend, blue=strong up,
red=down, black=strong down, and orange=extreme.
ties?
UWe, Germany
fits the actual data very well, if it’s
Author Vitali Apirine replies: smoothed to 50 days (I was able to
Thank you for your inquiry. Following manage this...), one might get a better
is MetaStock code to implement the view of the medium-/longer-term trend.
MFO: Although not as clear in the uptrends
(indexes spend more time up, and need
MetaStock MFO code:
multiple divergences), downtrends seem
{avoid division by zero} to terminate only if downtrends on his
Dvs:=if((H-Ref(l,-1))+(Ref(H,-1)- volume indicators are clearly violated.
l)=0,.00001,(H-Ref(l,-1)+(Ref(H,-1)-l))); In Figure 1 is a chart of the S&P
mlTp:=if(H<Ref(l,-1),-1,if(l>Ref(H,-
500 with my trend-following indi-
1),1,((H-Ref(l,-1))-(Ref(H,-1)-l))/dvs)); cator (green=uptrend, blue=strong
up, red=down, black=strong down,
{avoid division by zero} orange=extreme!) and Apirine’s volume
Dvsv:=if(V=0,.00001,V); indicators. I definitely will add them to
my arsenal, and I’m eager to test this on
sum((mlTp*V),20)/sum(Dvsv,20); individual stocks.
Because of the author’s help I wanted
FOLLOW-ON to share this with him, as he might be
Thank you very much to Vitali Apirine able to research it a little deeper and find
for his fast response and the code—the something valuable for his trading!
code works. My first observation is that Thanks again.
it fits very well with my own simple UWe
trend-following indicator.
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
“for me” is because I have a math/sci-
ence/engineering-type background, so
doing things with objective steps, even
if the system’s good or not, or passes
certain criteria, made a lot more sense
to me. This is something I wasn’t doing
when I started trading. I was doing a
little bit of it in the beginning, but not
enough of it.
That was probably what I learned
the most from my mistakes. I realized
that I have to approach this problem a
little differently and treat it a little dif-
ferently. Once I did that, things started
working better and that helped me with
the psychological aspect of trading. It
was always the psychology of making
and losing money that was difficult to
overcome. The other aspect is that even
if you follow rules, you can still have
those feelings of elation when you make
money, and feelings of distress when
you lose money. Many people think that
automated or mechanical trading means
there are no emotions involved, but that’s
not true. There are emotions, but the
emotions are different than those of a
discretionary trader. That’s something
I had to learn as well.
Even if somebody has a trading system
that’s mechanical or automated, I
would imagine there are times when
the trader will allow their emotions to
dictate what to do, especially when it
comes to exiting the trade. Are emo-
tions always going to be there, and is
that something you have to accept, or
is it possible to get rid of them com-
pletely?
I think, to an extent, emotions are
always going to exist. I was able to
eliminate emotions by trading several
systems. For example, right now I trade
about 80 or so strategies that are all
rule-based. Most, not all, of them are
automated. What I found was when you
start trading—let’s say when you get
above five or 10 strategies—it becomes
more difficult to overrule strategies.
It’s impossible to make decisions on
each system when there’re so many to
look at. You can’t keep track of all the
times you’re cheating or lying to your
system. I have done that before when I
34 • January 2016 • Technical Analysis of Stocks & Commodities
was trading three to four systems, but
when you’re trading more systems, you
just can’t keep track of everything. When
you have so many systems, it becomes
easier to just follow the systems without
taking other things into consideration.
For me, that was when the emotions
went out the window. I realized that if
I decide to ignore a signal generated by
one system, I should do the same with all
signals. But it’s impossible to keep track
of those decisions for each system. It’s
better just to follow the systems and do
what they indicate. What is important is
to put mechanisms in place to stop trad-
ing if the system stops performing. Then
it becomes completely objective. For all
of my systems I have certain criteria that,
if met, will indicate to me that I should
stop trading that system.
Trading becomes a lot less emotional,
which is nice, but you have to have con-
fidence in your systems, and that goes
back to having a process for developing
systems. I have a process that I use,
and over time, I’ve proven to myself
that when I follow the process to create
systems, the systems tend to work well.
This gives me the confidence to build
new ones because I know most of them
will work. It’s similar to a feedback loop,
but once you have confidence, it’s much
easier to follow it. But that comes with
experience. It’s not unusual for traders
who are starting out to be tempted to do
something contrary to what their systems
are suggesting.
You mentioned that you follow a pro-
cess when it comes to creating a system.
What are some of the basic steps that
you follow in that process?
There’re a total of seven to eight steps.
It starts with the goals and objectives that
you set for a strategy. If you don’t have
goals and objectives, you get trapped
into continually trying to improve your
system. There’s more to a system than
just developing it. You need to have goals,
and this could include what your annual
return or maximum drawdown is. Many
traders who are just starting out develop-
ing trading systems have never thought
of these goals. They are interested in
developing something that makes a lot
of money with a small drawdown.
The truth is you can’t design a system
using such nonspecific goals. You have
to set some realistic goals. I come across
people who set some ridiculously unreal-
istic goals and I can guarantee you that
the steps they take to get there will in-
volve too many rules such as overfitting,
curve-fitting, overoptimizing, and the
system will not work going forward.
A successful system starts with setting
realistic goals. Then, part of it has to do
with the way I do it. I look for systems
that are good; they don’t have to be great
or the holy grail–type systems. Too
many people get hung up on that sort of
thinking. I take a different approach. I
can probably develop 10 good systems
and if I trade those 10 systems together,
assuming they look at different markets,
different styles of trading, or different
time frame, I can be diversified and
achieve much better performance than
someone who trades just one system. And
I’m not relying on just one strategy.
My next step, after setting goals, is to
always look for trading ideas. You’ve got
to have what I call a “strategy factory,”
where ideas come in the door. These ideas
are your raw material and as you build
strategies based on these ideas, you test
them. I run a lot of tests such as Monte
Carlo simulations and walk-forward test-
ing. Believe it or not, a lot of the strategies
I test don’t work well. They may work
for a short time, but my time horizon is
typically five to 10 years long, and the
system I test has to give decent results
during that time period. If it doesn’t, the
idea goes into the trash.
I’m always looking for ideas to apply
to my trading. If I run out of ideas, then
I have nothing to test, and I’m not go-
ing to get any strategies. I have to have
a constant flow of ideas. Once you have
your goals and objectives and your ideas,
 ninjatrader.com
then it’s a matter of running some tests. I
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on a limited timeframe just to get an idea
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I try to make the systems as simple as
possible and once I do that I run some
Monte Carlo simulations, which gives me
some probabilities. A lot of people make
decisions based merely on an equity
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If you look at just one equity curve, you
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risk. In Monte Carlo simulations, you
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back and testing and retesting a system
five or six times. You have to be willing
to throw away an idea if it doesn’t work.
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
size. Follow-up is extremely important.
One of the biggest mistakes I see people
make is that they never think their new
system will fail. They don’t plan for their
system failing. Instead, they plan for all
the money they’re going to spend when
they make their expected profits. What
they should focus on is what to do if their
system fails. You don’t want your system
to wipe out your account, so you have
to know when you should quit trading
a system. I continue to do research on
aspects of trading other than developing
trading systems. One of things I have
been looking at lately is what criteria to
use to stop trading a system.
Could you talk about that a little bit
more? When is it a good time to stop
trading the system, when do you change
the size of your positions, and what type
of an exit strategy do you apply?
For position sizing, I typically use a
simple fixed fractional–type approach,
which is based on my account size. I try
not to get too clever with it. There’s a lot
of different position-sizing techniques
you can apply, and you can always find
one technique that’s best for one of your
systems. You may have strategy A that
suggests you use fixed-fractional position
sizing, strategy B might suggest some
other technique, and strategy C might say
something else. But to me, that’s a form of
optimization, because you’re taking the
data and then applying different things
to it and selecting the best one. I tend to
keep it simple and use fixed fractional,
and if my account size goes down into
drawdown territory, I will cut back my
position sizes. When I start trading a new
system, I usually start with one contract.
I always have a fear that perhaps I did
something wrong or something isn’t quite
right. I let—at the beginning at least—
profits dictate if I’m going to increase
my position size and then I switch over
to a fixed-fractional method.
As far as when to stop trading a system,
it’s also system-dependent. In my trading,
I use a few different things. For example,
I might use two times the maximum
historical drawdown as a criterion. I
know somebody who uses half of the
historical drawdown as a criterion, and
36 • January 2016 • Technical Analysis of Stocks & Commodities
he’s content with it. You can look at the
number of consecutive losing trades and
if in your history you’ve only had five
consecutive losing trades, then perhaps
by the time you get to seven or eight, it
might be time to quit.
There’re a lot of different ways to
decide when to quit using a system and
I haven’t found one way that stands
head and shoulders above others. But
what I have concluded is that having
the exact criteria isn’t going to make a
huge difference, but what will make a
difference is having the criteria versus
not having them. I think the best way to
approach this is to write down whatever
your criterion is before you start trading.
That would be something along the lines
of if x happens then you’ll stop trading
the strategy. Ideally, you share this with
someone, whether it is a trading partner,
a spouse, or significant other and they’ll
help hold you accountable for it. Ask them
to check in with you every six months or
so and see if the strategy ever hit the point
where you said you’d quit trading it. That
will hold you accountable because it’s
difficult to tell someone that the system
did hit the quitting point but you’re still
trading it. It’s a good mechanism to help
ensure that when you say you’re going
to quit, you do quit. A lot of people will
say they’ll quit when they’re down 30%
but when 30% comes, and they continue
to use it for another month to see how
it goes because in their mind, it’ll turn
around. But what usually happens is
they’re down another 20% and then they
want to just keep going because they
think it has to turnaround sometime.
You know how that goes.
The best thing to do is to have your
criteria defined upfront. Everybody,
myself included, has at some point not
had the criteria defined and then ended
up making an emotional heat-of-the-
moment decision. Their system is go-
ing down, they get frustrated, and then
finally at some point they just quit. And
what’s even more frustrating is after you
quit, the system turns around. That of
course makes you angrier and you start
doubting yourself. These are the types of
psychological games that you can play,
so I found it best, before you start trad-
ing, to write down when you’re going to
quit trading a system. Keep it somewhere
where you can see it or remember it and
if your criteria are met, then quit trading.
This helps for those who trade part-time.
This is how the professionals do it. They
have their risk limits, and if they exceed
them, they’re cut off or fired from their
job. You’ve got to treat your own trading
the same way.
This process that you described is what
it takes to create an algorithmic trading
system. When you use the term “algo-
rithmic trading,” many people tend to
think it’s reserved for the institutional
or the high-frequency traders. But it
sounds to me like the retail trader can
also apply such a strategy. How should
the retail trader’s approach to develop-
ing an algorithmic system be different
from that of an institution’s?
What I mean when I say algorithmic
systems is that the computer makes all
the decisions, which will tell you when
to buy and sell. If you automate that, the
computer will do it for you. It’s similar
to mechanical rule-based trading. You’re
right in that a lot of people think algo-
rithmic means high-frequency, and that
they have to be a hedge fund to have
such a system. The key for retail traders
is to not play where the high-frequency
people are playing. I don’t try to scalp; any
retail platform is going to have trouble
doing that because you’ll need to have
a platform, either a professional-type
platform or create your own. Then, you
probably need colocation equipment, and
you may even take your code and burn
it onto a chip so it runs faster. For the
retail trader, this is not an option because
it’s expensive and you’re fighting against
people that have teams of statisticians
with PhDs and a lot of cash to support
an infrastructure suited to trading.
 The retail trader is better off staying
away from the institution’s domain. That
means more swing trading, that is, more
trades that last days to weeks or even
months. I do have some intraday trading
systems, but oftentimes, I’ll get into a
trade and stay in the entire day. I won’t
get in and out of trades several times
because in the long run, the trading costs
will gobble up a lot of your profits.
In all the research & development I’ve
done, the longer-term systems, that is,
systems based on daily bars, tend to be
easier to create than systems based on
one-minute bars. Yes, you have to endure
drawdowns if you’re holding a position
overnight or holding it longer. There’s
a higher probability of intratrade draw-
down, but this is where trading multiple
strategies helps because they smooth
things out, which is something you can
afford to do. A retail trader can consider
themselves an algorithmic trader but they
should realize who their competition is
and try to avoid playing in the same terri-
tory as the high-frequency firms, because
you can’t compete with them.
What are the benefits of using multiple
trading systems?
When you trade several strategies,
you’re diversifying. Instead of trading
one strategy, you trade five, 10, 20, or
however many you can. What I’ve found
in my trading experience, say in the
last five to six years, is that I went from
trading one or two strategies to the point
where now I’m trading about 80. I look
at the volatility of my monthly returns
using standard deviation and what I’ve
found is that as I increase the number of
systems, volatility goes down. As a result,
my returns have become a lot smoother
and so have my equity curves. The down-
side to diversification is that you give up
some of the upside potential.
If there was a trader who was knowl-
edgeable about price-action trading
or had one well-performing algorithm
and traded one market, it is possible
that, from a performance standpoint, he
could do better than somebody trading
10 strategies. He’d have higher upside,
but if his system breaks, then he’ll have
more downside. It’s a tradeoff. For
those who are starting out, it’s difficult
to diversify, which is
probably a good thing I trade about 80 or so strategies
because what that is that are all rule-based. Out of
telling them is to wait
until they have more those 80 strategies, I would say
money in their ac- that maybe 50 of them are in
count. Then their risk some type of trade.
of ruin goes down and
things get a lot better.
But diversification, if anything, is like the ing for situations where there might be
holy grail of trading, because it’s nice to spurts of upward movement. The strategy
trade a handful of systems knowing that might level out for a while after that if
if one stops working, you’re not going to market conditions change. Then, it may
lose everything. It’ll still hurt you, but go up again. I can handle those types of
there are other well-performing systems strategies because I can afford to break
you can use. even for a while in the hope that over the
It dawned on me a few years ago that long term, they’ll go up at times.
if I was trading four or five systems in Out of the 80 strategies that I trade at
any given year, one or two would prob- any point in time, I would say that maybe
ably do well, one or two would maybe 50 of them are in some type of trade, and
break even, and one would not do well. sometimes the trades cancel out. You’ll
But I did not know which ones would have a system that’s long, and another
do well in the next 12 months, which is one that’s short. There’ll be times when
why it was good to trade them all. You you’re just flat and that’s okay because I’ll
don’t want to put all your money behind still monitor the strategies individually.
one system just because it did well the Overall, it’s not going to have an effect
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.
tion is really the key.
Besides trading, do you offer courses
When you’re saying that you have about or act as a mentor?
80 strategies, do you use them in con- The main thing I do is trade full-time.
junction, or do you use them separately After my book was released, people
for different market conditions? started becoming interested in getting
All of the systems could trade at any a more in-depth study than what I gave
time. I don’t try to discern between mar- in the book. So I hold online workshops
ket conditions. I know a lot people like on strategy development about once a
to trade some strategies when the market month. I help people build strategies and
is bullish and the concept is good. But then support them afterwards. I also do
the problem with this kind of approach some mentoring and consulting for CTAs
is that it depends on you having a good or people who work for hedge funds.
strategy for that particular market and
having a good switching mechanism, or Thank you for speaking with us,
a meta-strategy that will overrule and tell Kevin.
you that on any given day you’ll trade
strategy A but not strategy B because Further reading
the market is bullish. You run the risk Davey, Kevin [2014]. Building Winning
of curve-fitting and usually what ends Algorithmic Trading Systems: A
up happening is your strategy will be Trader’s Journey From Data Mining
too late for the bull market and you’ll to Monte Carlo Simulation to Live
still be trading your bear strategy for a Trading + website, Wiley.
while. Although I like the idea, I don’t
think it works. My strategies will trade all
markets and I don’t necessarily need to
have performance that continually goes
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
world. When we were in school we were taught to look for the
correct answers to questions. Success was rewarded with a
passing grade. Failure was undesirable. If you failed, you felt
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
about the hoops society expected you to jump through and to
learn how to be a good hoop jumper. There were right answers
for every subject and wrong answers for every subject. Right
was good, wrong was bad. It was that simple. You came out
of school and your day job also rewarded right answers. You
play it safe because that is how the game is played and you
get the promotions and rise through the ranks.
But when the work fails to be satisfying and you look
around for a way to make your riches, you think about trading
and reason that the same skills that got you through school
exams with good grades and got you promotions on your job
should be enough to enable you to succeed in the financial
markets. Surely, the skills of life are transferable, you reason.
And so you open a brokerage account, subscribe to a couple
of newsletters, find a trading system that promises to return
good results, and begin to trade. Failure, you reason, is not
an option. You will succeed at trading in the same manner
that you have succeeded at everything else. But reality rarely
follows your mental script. If you are lucky, you will fail
early. It is through mastering a skill that was never taught in
school—failing successfully—that you can hope to evolve into
the kind of trader who can consistently beat the market.
Trading is often spoken of as a zero-sum game because what
one person wins, someone else must lose. There are always
two sides to a trade. Every trade must have a counterparty who
is willing to take the other side of the trade. For this reason,
you can look at any trade and figure you have a 50% chance
of being on the right side of the trade. If your trading system
gives you wins 50% of the time, you can still make a lot of
money trading, yet many don’t. Even the institutions with
their algorithms expect their trading systems to lose anywhere
from 30% to 70% of the time, and yet they are still profitable.
Therefore, in order to trade successfully, it is not the number
of times you are in a losing position that determines your
ultimate success, but the ability to master what to do when
you are in a losing position.
It’s okay to lose
Recognizing that the inability to deal with failure success-
fully is a handicap to our success as traders is perhaps the
most important lesson a trader will learn. If we expect 50%
or more of our trades to fail, then it is statistically possible
to have a series of five, maybe even 10 or more consecutive
failing trades. Preparing ourselves for failure is essential to
being able to manage the stress of trading successfully. With
any discretionary trading system, you should have a setup and
an entry price. But you should also have in mind a price level
To succeed you must fail, you
must fail often, and you must
fail strategically.
below/above which price should not go. This is the price at
which you exit the trade, no matter what. This is where you
set your stops, mental or otherwise.
Once it is hit, the trade has failed and you are out. But once
out, be prepared for anything to happen. Study the chart as
though you had not made the first trade and if a new setup and
entry forms, you should be prepared to go back into the trade
if your new stop will not expose you to too much risk. When
studying the charts, you want to force yourself to stay in the
present as much as possible. Every new bar that is formed on
the chart carries within it information that potentially creates
a new set up. Staying in the present and being prepared for all
contingencies is the only way to trade successfully.
Cognitive biases
The reason that trading can be so
difficult is because even though it
appears to be deceptively simple, it
isn’t. Many of the causes of failure
are the result not of the trading
system employed, but of cogni-
tive biases. Cognitive biases are
systematic errors in our thinking
that lead us to act in predictably irrational ways. These biases
are insidious because we are often not aware of them or their
influence on our thinking unless we have trained our minds
to be alert to our thought processes. But many trading systems
do not account for cognitive biases in their methods. Biases
such as the endowment effect can work against us in trading,
causing us to ascribe more value to a position because we
own it. This prevents us from getting out of a position when
we should. Fear of failure is another bias that can prevent us
from entering a position when we should because we fear being
wrong. Fear of regret can lead us to enter a position when it
has moved too far from our stop, thereby increasing our risk.
Loss aversion is another bias that can cause us to hold onto
a losing position too long because we are unwilling to take a
loss. Studies have shown that, on average, we feel the pain of
a loss 1.5 to 2.5 times more than the pleasure of a gain. These
and many other biases actively work against us to reduce our
chances of success in trading.
Often, when a trader has made a series of unsuccessful
trades, he will then go looking for a “better” trading system.
But trading is more of a psychological game. Many trading
systems work some of the time. But misapplied, trader psy-
chology will jeopardize all trading systems.
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
In the land of diminishing pair returns,
grab some catalysts for your spreads!
We live in an instant-fix environment.
If you’ve got a problem, you want an
instant solution. This is often carried
into the trading world. You want access
to information so that your computers
can crunch data and find those statistical
anomalies. The computer does all the
work and spits out the results you are
searching for. In this machine age, traders
often forgo the heavy lifting implied by
quality time spent researching, reflecting,
and contemplating the current and future
economic landscape. Instead, they want
a formula or a magic pill for profits they
think automation can provide.
I am certainly not against the com-
puter age, but I do have an abundance
of street smarts gained from years of
trading, working with other traders,
and observing numerous statistically
significant samples. I understand how
pairs behave in good times, bad times,
and most of the time. Traders will go
after pair opportunities, but this can
also end up increasing risks to their
capital. Attempting to pick up pennies in
front of a steam roller, they make a dime,
make another, and then lose a dollar.
I believe that traders can get much
better bang for their arbitrage buck and
reduce some inherent problems by add-
ing some additional ingredients to their
spread trading soup. For those of you
not familiar with the concept of pair
trading, here is a brief explanation. Pair
trading is the combining of two stocks,
one long and one short, in an effort to
lower market risk and macro risk, where
the focus shifts from trading a stock in
a directional manner to relying on the
spread price between the two. You would
profit from or lose money based on the
40 • January 2016 • Technical Analysis of Stocks & Commodities
relative change between the two stocks.
Both could go up, down, converge or
diverge; it all depends on which stock
you choose as your long stock, which
one you short, and what ratio of capital
is applied to each.
Pair trading can be done with equities,
ETFs, options, futures, or currencies. In
this column, I will discuss the first two.
Typically, the main concept applied to
pair-related strategies is that of mean
reversion, that is, looking for relation-
ships that are stretched out and revealing
anomalies. The trader would go long and
short as simultaneously as their trading
tools can facilitate when presented with
an opportunity that usually comes in
Traders can get much
better bang for their
arbitrage buck by adding
some additional ingredients
to their spread trading
soup.
the form of an anomaly or outlier in the
spread relationship. Once capital is ap-
plied, the trader looks for the spread to
mean-revert (return to the norm).
My experience, through trading, ob-
servation, research, and working with
many other statistical-arbitrage (stat-arb,
or pairs) traders is that market conditions
play heavily into the yield and risk when
a mean-reverting focus is applied. Dur-
ing times of significant trends caused by
technically driven algorithmic traders or
when the investment community is vot-
ing directionally due to macro influences,
mean reversion is frustrating and can
result in diminished returns or outright
losses. Similarly, during seasonal trends
in the market, strategies have times of
best and worst returns; rarely is there
uniform distribution of returns.
Trending conditions would favor
relative-strength pair trading rather than
fading (going against) a directional move.
It’s fading in this environment that is like
picking up those pennies at the risk of
losing dollars. I am often asked, “Why
not just trade an unhedged position if
you are being directional anyway?” If
you are new to the concept of pairs, I
can understand the skepticism, but if you
have experienced the benefits as well as
the problems of pairs you can appreciate
the information I am providing.
Spread traders appreciate watching
a spread number that is experienced as
statistically muted or smoothed com-
pared to watching an individual stock.
Relationship-based trading often pro-
vides more information than single-
stock trading. An example would be
thus: it is hard to compare an apple to
an orange, but much easier to compare
one apple to another apple.
Having a long and short position
at the same time can reduce event-
related risk. You want to be protected
from market moves but take advantage
of potentially better performance of
one stock over another. Even though the
VIX is hovering around 17 at the time
of this writing, the actionable volatility
feels much lower. Stocks trend during
the day or even multiday with nominal
retracements. Can you take advantage of
this behavior? Can pairs be optimized
for these market attributes?
Here are some building blocks or
ingredients of pair trades:
• Technical patterns on a variety of
time frames
• Technical and quantitative indica-
tors
 Q&A
• Persistence of short-term or long-
term performance
• Fundamental
• Macro catalysts
{{ Currency influences
{{ Interest rate impact
{{ Political platforms
• Opportunities created from events
{{ Trader enters post-event
{{ Streaks
{{ Seasonal tendencies
{{ Dividends
{{ Earnings and EPS changes.
Besides a peer group pairing of one long
stock against a stock short, here are some
other combinations that can be done. The
combination can be:
• Any stock long against any stock
short
• A few stocks long against a single
stock or ETF short
• One stock or ETF long against a few
stocks short
• A diversified basket of longs against
XXX / XXXXX
a diversifiedContinued
basket of from
shorts
page PB
• One industry or sector basket long
against a different industry or sector
basket short.
There are many ideas to draw from to
create a combo trade. Too often, the buzz
words of correlation and cointegration
are thrown around as the sauce that is
going to bring home the bacon. Tradi-
tionally, there has been some merit to
that analysis but there are so many more
ducks to line up to increase the odds of
a successful combo trade.
Again, money is made by the relative
performance between your longs and
shorts, so focus on what catalysts would
contribute to your long position(s) slight-
ly outperforming your short position(s),
whether all your positions go up, down,
or stay in a trading range.
I have heard it said that if you want to
write an award-winning screenplay, then
study past successful scripts. If you want
to compose a hit song, then study the
ingredients of songs that have risen in
the charts. If you want to make brilliant
combo trades, then study any red flags,
ducks that lined up, and micro and macro
catalysts that caused peer group stocks
to separate from each other.
Think about the following:
• Why Blockbuster went to zero while
Netflix soared
• Why Blackberry lost market share
to rivals Apple and Google
• Why Facebook is monetizing mobile
and performing better than Twitter
• What impacted retailers such as
Aeropostale versus American Eagle
Outfitters
• Why Bank of New York Mellon
was able to outperform Franklin
Resources
• What is it about Costco’s business
model that has its stock outpacing
that of Walmart.
Can you find and exploit these types
of divergent big-picture opportunities
again?
There are many more stocks that
have been than are, so the future will
be filled with winners and losers in each
peer industry. Traders can capture this
potential through pairs or diversified
combo trades. Focus on the ingredients
that make up your opportunities and
write some rules for entry, exit, and risk
management.
I hope I have planted some seeds for
inspiration and creativity.
For more information, contact Rob Fri-
esen at robfriesen@brighttrading.net.

OSOBA / FAILING SUCCESSFULLY
Continued from page 39
If trading is a probability game, then a failed trade cannot
be a reflection of your ability as a trader. Many, if not most,
trades will fail. Failure is essential to trading. The ability to
acknowledge the failure early, to not deflect or make excuses
for the failure, and to exit the trade all come with humility
and practice. In the words of Brendan Moynihan in his book
What I Learned Losing A Million Dollars, “Success can be
built upon repeated failures when the failures aren’t taken
personally; likewise, failure can be built upon repeated suc-
cesses when the successes are taken personally.”
Failure is uncomfortable, and repeated failure is many times
more uncomfortable. But you must learn to embrace failure
however it comes and move forward from it. Failure is not a
skill that society prepares most of us for. So many will come
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
trading, so give yourself permission to fail. Fail often, but fail
successfully. A failed trade is never a reflection of your skill
as a trader, but a refusal to accept failure is.
Stella Osoba is a financial writer who has written for the
Market Technician Association’s (MTA) e-newsletter Techni-
cally Speaking, their Journal Of Technical Analysis, and their
CMT e-newsletter, as well as for TraderPlanet.com. She may
be reached via email at stellaosoba@gmail.com.
FURTHER READING
Brooks, Al [2012]. Trading Price Action Trends, John Wiley
& Sons.
Osoba, Stella [2015]. “Loss Aversion,” Technical Analysis of
StockS & commoditieS, Volume 33: April.
Paul, Jim, and Brendan Moynihan [2013]. What I Learned
Losing A Million Dollars, Columbia University Press.
January 2016 • Technical Analysis of Stocks & Commodities • 41

TC2000 Version 16
WORDEN BROTHERS, INC.
PO Box 1139
Wilmington, NC 28402
Phone: 800 776-4940,
international: 1 919 408-0542
Email: support@TC2000.com
Internet: www.TC2000.com
Product: Stock market charting
software
Requirements: Windows-based PC,
or Mac with Parallels Desktop
Price: Basic software and data services
start at $9.99/month for the Silver edition;
$29.99/month for TC2000 Gold; $89.99/
month for Platinum. Real-time data and
LiveBriefs by MT Newswires available
for additional fees. Savings are available
via yearly payment options.
by James E. Rich
W
orden Brothers’ new TC2000
Version 16 software was origi-
nally developed as a white-label
trading platform for TC2000 Brokerage,
Inc., the company’s new affiliated online
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
product review
brokerage. When the finished product ex-
ceeded all of their expectations, brothers
Chris and Peter Worden and their staff
felt it only fair to release the software
to the entire TC2000 family of users,
whether they used TC2000 Brokerage
or just continued to use the software
for analysis.
Features
One of the many new features that first
caught my attention was the simulated
account component. Several platforms
and standalone software programs pro-
vide simulated accounts, but TC2000
Version 16 offers by far the most robust
of any that I have tried. The feature allows
you to establish a cash or margin account,
set the opening balance, set buy & sell
stops, track your daily and total profits
& losses—realized and unrealized—plus
all the other features normally available
only in live accounts. Of course, if you
go to TC2000 Brokerage and open an
account, then you’ll have the option of
trading in real time or executing simu-
lated trades. Multiple layouts, a feature
introduced in Version 12, enhances
the usefulness of the trading platform
whether you trade live or use the simu-
lated account. With the multiple layout
feature, you can set up a trading layout
with a window to track your portfolio,
a window for orders, and a window for
trades. The windows in your layout can
be pinned anywhere on the screen, hid-
den, or left free-floating.
In your trading layout there are multiple
ways to enter orders. The detailed order
ticket is available at the top of the chart
(Figure 1) and can be set up as a template,
or even as multiple templates. An abbrevi-
ated trade window is also available and
can be set up as one or more templates. A
buy or sell-stop order can also be estab-
lished using a trendline by first drawing
the trendline and right-clicking to bring
up a dropdown menu (Figure 2) and then
clicking on buy limit or sell stop, which
immediately turns the trendline into an
order and displays the order box on the
chart. When the trendline is turned into
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
dotted line and the abbreviated order
box appears with your completed order.
Once your trading layout is established,
you can create additional layouts with
watchlists, charts, news, and scans to use
for research and analysis.
Upcoming earnings dates is another
new feature and can be applied to any
watchlist. Bring up the S&P 500 watch-
list, add the upcoming earnings date
column, sort, and there you have all the Version 16 of TC2000
earning dates, starting with the most
current. In my trading, I personally don’t
gives you the option
like to hold positions over earnings dates, of trading in real
and with Version 16, I can simply take time or executing
my trading portfolio, add the earnings simulated trades.
date column, sort, and I can see which
positions have upcoming earnings dates
(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
factory toolbar and cannot be edited,
but now you can add a second, third,
and fourth row with any of the buttons,
data, and so on, that suit your trading or
analysis style.
Since Bruce Faber’s review in this
magazine of TC2000 Version 12.2 in
2012, Worden Brothers has added a
reports button that allows you to open
either a prebuilt fundamentals report or a
price & volume report. Or you can create
your own custom report, allowing you
to check the edit box to add, delete, and
move fields. Recently, Worden Brothers
added an optional service—the newsfeed
from MT Newswires, which offers a
wide variety of news announcements
on a real-time basis (Figure 4).
Support
Worried about the learning curve with a
new platform? Don’t be. When you click
on the help button and then on tutorial
videos, links to more than 60 videos ap-
pear. The videos average three to seven
minutes each, covering every aspect of
the program. Speaking of videos, if you
want help with your trading, you can go
to www.worden.com to view a myriad
44 • January 2016 • Technical Analysis of Stocks & Commodities
trading and then go down to the bottom
of the page to see the entire webinar
archive dating back to 2009.
Still need help? In the past, the
Worden Brothers training guru, Michael
Thompson, put on live seminars around
the country. He took a brief sabbatical
from traveling in 2015 but plans on
scheduling a series of live webinars in
2016, so keep an eye on your email if
you’re already a member of the TC2000
user family, or go to the website to see
upcoming seminars. In addition to the
tutorial videos, webinar archives, and
soon-to-come live seminars, TC2000
has a superb support team available six
days a week via phone or email.
James E. Rich has been trading for
more than 30 years and currently
trades multiple family accounts using
a combination of technical analysis,
fundamental analysis, and intermarket
analysis. He is the cofounder of Palm
Beach Traders, an investment round-
table group that meets monthly in Palm
Beach Gardens, FL to hear speakers
and discuss various aspects of trading
and investing. Rich can be contacted at
Richtrader3@gmail.com.
Worried about the
learning curve with a
new platform? Don’t be.
More than 60 tutorial
videos are available.
Further reading
Faber, Bruce R. [2012]. “TC2000 Version
12.2 Update,” Technical Analysis of
Stocks & Commodities, Volume
30: November.
[2012]. “TC2000 Version 12,”
Technical Analysis of Stocks &
Commodities, Volume 30: January.
Rich, James E., with John B. Rich [2015].
“Simplify It,” Technical Analysis of
Stocks & Commodities, Volume
33: November.
‡TC2000 (Worden Brothers, Inc.)
‡See Editorial Resource Index
 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
TO ZERO?
Could a commodity bull with deep enough
pockets weather any storm?
The simple answer to that question is an
unequivocal yes. If you had unlimited
trading capital, an unlimited time horizon,
and the sense to mitigate futures market
leverage, you could theoretically never
lose when trading commodities. This
theory is based on the fact that commodity
prices, although they can get very cheap,
cannot go to zero. In other words, com-
modities are “goods,” not “bads”; unless
something changes dramatically in the
way we live, we will always need corn,
soybeans, crude oil, natural gas, and so,
to some degree.
If society finds a substitute for the
commodities we currently use, then as
the demand for such alternative resources
increases, so will the price of the substi-
tute. Eventually, consumers will migrate
back to the original source. To reiterate,
there will always be some value in com-
modities. Further, the commodity markets
go through boom and bust cycles. Even
in the most trying time—think natural
gas in the fall of 2015 or crude oil in the
summer of 2015—there is light at the end
of the tunnel. Producers and end users
adjust their behavior according to the
state of the boom and bust cycle, only to
trigger a repeat. For instance, when crude
oil was above $100 per barrel, US shale
oil producers were rushing to frack as
much oil out of the ground as they could
with little concern for budgeting or cost
management. However, when crude oil
fell below $40, oil producers were aggres-
sively handing pink slips to employees
and shutting down rigs. Each of these
behaviors works toward repeating the
commodity cycle. When prices are high,
producers rush to bring product to market,
and demand tapers. Yet when prices are
low, producers reign in operations while
demand is on the rise. Simply put, there
are antagonistic forces that prevent prices
from going to zero.
Accordingly, for a trader with the pain
tolerance, financial capital, patience, and
discipline necessary to accept massive
drawdowns in exchange for nearly certain
trading success, it is realistic to say that you
might never lose money trading commodi-
ties. Of course, this assumption ignores
transaction costs, the contango (rolling
contract months at unfavorable prices),
the slim possibility of an MF Global or
PFG repeat, and the unpleasant likelihood
of the trader dying before price recovers
from the entry price. Although commodity
markets tend to trade in ranges, the peaks
and valleys are sometimes seen several
years, or even decades, apart.
Naturally, none of us have the luxury
of unlimited time or money. Even the
largest funds in the world don’t have un-
limited funds, nor do they generally have
the discipline to pace themselves, or the
wherewithal to hold positions indefinitely
without investors withdrawing funds.
With this in mind, let’s take a look at how
big the drawdowns might be in any given
commodity per single lot traded. Let’s as-
sume that a commodity price could lose as
much as 70% of its current value, which
is a stretch but not impossible. We’ll use
that as the risk of going long a long-term
position trade with unlimited financial
backing. With crude oil trading at $45,
the potential drawdown of going long here
with no other expectation other than prices
will eventually be higher than $45, a trader
would suffer a paper loss of $31,500 should
January 2016
the commodity lose 70% from entry. An
emini S&P trader could lose over $70,000
if prices drop 70%. These are substantial
sums of money that the coolest of heads
would struggle to endure.
Obviously, the goal of such long-term
position trading is to go long a market
after it has already made a substantial
decline. Buying into a commodity in a
massive upswing could take both your,
and your kids’, lifetimes to recover. Just
imagine going long crude oil at $150 per
barrel in 2008. Oil prices will probably
see this price again, but will it be in our
lifetime? Maybe not.
On a side note, individual stocks, unlike
commodities, have the ability to become
completely worthless. Thus, if you pur-
chase shares of a particular company with
the mindset that it will be impossible to
lose if held long enough, that would be an
even bigger fallacy. In my lifetime, I’ve
seen companies that were once staples
in our society disappear, all the while
putting their shareholders through the
ringer. Remember the telephone company
WorldCom or more recently Blockbuster
video? I think we can all agree that in the
history of the commodity markets, we’ve
never seen a market go to zero. Even if it
did, there would always be potential for a
recovery, which also differs from individ-
ual stocks. If a stock becomes worthless,
it is delisted, leaving shareholders with no
chance of recouping lost money.
So again, is it possible to construct a
scenario in which a trader could ride out
any storm? Yes, it’s possible. Is such a
strategy more feasible in commodities,
than it is for stocks? Yes, it is. Neverthe-
less, it isn’t realistic.
• 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


Figure 4: THINKORSWIM. Here is a chart of National Oilwell Varco (NOV), with the aver-
ages used to define strategies as well as the channels used to trigger stops and limit orders. A
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
based on moving averages.
The study contains formula parameters that may be
configured through the edit chart window (right-click on the
chart and select “edit chart”). A sample chart implementing
the study is shown in Figure 3.
To discuss this study or download a complete copy of the
formula code, please visit the EFS library discussion board
forum under the forums link from the support menu at www.
esignal.com or visit our EFS KnowledgeBase at http://www.
esignal.com/support/kb/efs/. The eSignal formula script (EFS)
is also available for copying & pasting from the Stocks &
Commodities website in the Traders’ Tips area.
—Eric Lippert
eSignal, an Interactive Data company
800 779-6555, www.eSignal.com
F THINKORSWIM: JANUARY 2016 TRADERS’ TIPS CODE
In “Simplify It,” which appeared in the November 2015 issue
of Technical Analysis of Stocks & Commodities, authors
James and John Rich recounted how they have been using
technical analysis since the 1960s. In that time, they have
experimented with many different strategies, with John Rich
even considered an authority on Elliott wave theory. They
discuss how they have come to the conclusion that simple is
better. Thus, using only moving averages, the brothers have
constructed a strategy that defines trends and also has the
granularity to include stops and limit prices.
We have recreated their SimpleTrendChannel study and
strategy using our proprietary scripting language, thinkscript. We
48 • January 2016 • Technical Analysis of Stocks & Commodities
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
A division of TD Ameritrade, Inc.
www.thinkorswim.com
F wEALTH-LAB: JANUARY 2016 TRADERS’ TIPS CODE
The WealthScript strategy we are presenting here combines
trend-detection ideas that James and John Rich had researched
and presented in their November 2015 article in Stocks &
Commodities, titled “Simplify It.” Users have the means to
experiment with which method of determining overall mar-
ket direction works better: the one that relies on the external
symbol’s (SPY) movement used by John Rich, or the one that
uses a combination of multiple moving averages as used by
James Rich. The system’s C# code for Wealth-Lab is shown
here and can also be found at the Stocks & Commodities
website in the Traders’ Tips area. A Wealth-Lab chart dem-
onstrating the system is shown in Figure 5.
The method of screening for entries is so simple that it
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;
using System.Collections.Generic;
using System.Text;
using System.Drawing;
using WealthLab;
using WealthLab.Indicators;
namespace WealthLab.Strategies
{
public class SimplifyIt : WealthScript
{
private StrategyParameter paramTrendRule;
public SimplifyIt()
{
paramTrendRule = CreateParameter("SPY for trend", 1,
0, 1, 1);
}
 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.
Perhaps one could change the trigger rules to fire if any
part of the high/low span of the bar crosses the upper or lower
band and then trade at a price from within that span on the
actual trigger day.
One other usage note: To keep the SPY index prices in
sync with the stock prices, I am forcing a refresh of the index
every time you request historical data for a stock symbol. So
there will be a bit of additional screen flickering and flashing,
but not much additional time consumed.
Figures 14 & 15 approximate the data range we see 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
the SMA(200) versus SMA(50) rule will eliminate the losing
short we see in Figure 2 beginning around 11/8/2014.
Figure 16 shows my transaction summary tab, which lists
the details of the transactions that appear on the chart. A bot-
tom line version of the transaction results is carried over to
the CalculationsAndCharts tab for quick reference.
Due to the way I am calculating trades, you may see a
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.
In that event, you will see a partial trade documented here as
an exit with no entry.
This left edge partial trade will not be reflected in the
transaction counts, nor in the totals. If you wish to include
it, you can increase the points to plot value (cell A11) on the
CalculationsAndCharts tab a little bit at a time until you can
see the transaction entry bar on the chart.
Figures 17, 18, & 19 are the results of various combina-
tions of the entry setup controls using my approximation of
Figure 2 from Richs’ article.
56 • January 2016 • Technical Analysis of Stocks & Commodities
This stock is clearly in a downtrend, but the market, as
reflected in the trend of the SPY index, is not.
With some trial combinations of the screening rules, we
find that the index trend screen was blocking all potential
short entries.
The spreadsheet file for this Traders’ Tip can be downloaded
from www.traders.com in the Traders’Tips area. To successfully
download it, follow these steps:
• Right-click on the Excel file link, then
• Select “save as” to place a copy of the spreadsheet
file on your hard drive.
James and John Rich have given us lots to play with here.
Enjoy!
—Ron McAllister
Excel and VBA programmer
rpmac_xltt@sprynet.com
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January 2016 • Technical Analysis of Stocks & Commodities • 57

 FUTURES LIQUIDITY

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

TOP 10 VIEWED TRADING SYSTEMS LINKS

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
a sampling of recent book releases in the investing field.
Books described here may be from some of the major book
publishers as well as some independent book publishers.
These are not critical reviews or editorial evaluations, but
rather a brief look at the book marketplace to help keep
readers up to date on new or recent book offerings.
Trading Psychology 2.0: From Best
Practices To Best Processes (448 pages,
$60 hardcover, $39.99 ebook, September
2015, ISBN 978-1-118-93681-8) by Brett N.
Steenbarger, published by Wiley.
Trading Psychology 2.0 is a guide to apply-
ing the science of psychology to the art of
trading. Veteran trading psychologist and
bestselling author Brett Steenbarger offers
advice and techniques to help interested
traders better understand the markets, with
practical takeaways that can be implemented
immediately. Steenbarger draws on his own experience in psychology and
statistical modeling as an active trader to offer insights into the practical
aspect of trading psychology. Academic research is made understandable
using examples, illustrations, and case studies to make it meaningful for
practical traders. Interactive features include a blog offering ever-expanding
content and a Twitter feed for quick tips. There are also contributions
from market bloggers, authors, and experts for fresh perspectives to the
topic. Studying the market from the perspective of human behavior gives
traders insight into how human behavior drives market behavior. Trading
psychology is equally relevant to daytraders and active investors, market
makers and portfolio managers, and traders in all different markets. This
book seeks to act as a personal trading coach in print, accessible 24/7 no
matter what the market is doing.
www.wiley.com
The Trade Lifecycle: Behind The Scenes
Of The Trading Process, second edition
+ website (416 pages, $70 hardcover, $45.99
ebook, October 2015, ISBN 978-1-118-99946-
2) by Robert P. Baker, published by Wiley.
The Trade Lifecycle catalogs and details the
various types of trades, including the inherent
cashflows and risk exposures of each. Now
in its second edition, this guide includes new
coverage of traded products, credit valua-
tion adjustment, regulation, and the role of
information technology. The author teaches how to dissect a trade into its
component parts, track it from preconception to maturity, and learn how it
affects each business function of a financial institution. You will become
familiar with the full extent of legal, operational, liquidity, credit, and market
risks to which it is exposed. Case studies of real projects cover topics
such as forex exotics, commodity counterparty risk, equity settlement,
bond management, and global derivatives initiatives, while the companion
website features additional video training on specific topics to help the
reader build a strong background in this fundamental aspect of finance.
Trade processing and settlement combined with control of risk was thrust
60 • January 2015 • Technical Analysis of Stocks & Commodities
into the limelight with the 2007 near collapse of the global financial market.
This book provides thorough, practical guidance toward processing the
trade, and the risks & rewards it entails.
www.wiley.com
Financial Risk Management: Applica-
tions In Market, Credit, Asset And Li-
ability Management And Firmwide Risk
(576 pages, $95 hardcover, $$61.99 ebook,
October 2015, ISBN 978-1-119-13551-7) by
Jimmy Skoglund & Wei Chen, published by
Wiley. This book presents an in-depth look
at banking risk on a global scale, including
comprehensive examination of the US Com-
prehensive Capital Analysis and Review and
the European Banking Authority stress tests.
Written by experts in global banking risk products and management, this
book provides up-to-date information and insight into risk management.
The discussion begins with an overview of methods for computing and
managing a variety of risks, then moves into a review of the economic
foundation of modern risk management and the growing importance of
model risk management. Market risk, portfolio credit risk, counterparty
credit risk, liquidity risk, profitability analysis, stress testing, and others
are dissected and examined, helping the reader to develop strategies
to construct a robust risk management system. The book takes readers
from basic market risk analysis to major recent advances in financial risk
disciplines seen in the banking industry. The quantitative methodologies are
developed with business case discussions and examples illustrating how
they are used in practice. Chapters devoted to firmwide risk and stress test-
ing cross-reference the different methodologies developed for the specific
risk areas and explain how they work together at firmwide level. Since risk
regulations have driven a lot of the recent practices, the book also relates
to the current global regulations in the financial risk areas.
www.wiley.com
Financial Planning Competency Hand-
book, second edition (944 pages, $175
hardcover, August 2015, ISBN 978-1-119-
09466-1) from the CFP Board, published
by Wiley. This is a reference for those at any
stage of certification and is also a resource
for practitioners looking to better serve their
clients. The book contains over 90 chapters
for practitioners, students, and faculty. There
is a US edition and an international edition.
The revised text includes an in-depth review of
the major content areas associated with financial planning including estate
planning, taxation, investments, principles of communication, and more. This
edition includes new content on connections diagrams, new case studies,
and instructional videos, and a new section devoted to the interdisciplinary
nature of financial planning. The reference seeks to provide insights from
fields like psychology, behavioral finance, communication, and marriage
& family therapy to help the reader better connect with their clients and
perform to the highest expectations as a financial planner.
www.wiley.com
 AT THE CLOSE
Sell With Confidence
The Green Line
Knowing when to exit a trade can work wonders for your
trading returns. Here’s one tool that can help you make that
critical decision.
by Ron Jaenisch
It
was a very hot day in September and I was at a pri-
vate lunch meeting with the CEO and CFO of a legal
consulting company. They were making the rounds to
encourage well-heeled investors to consider investing
in their company. Their stock had a high market cap but a low
daily turnover, which for most money managers, is a criterion
that brings up a caution flag.
I decided to use the opportunity to practice presenting a small
piece of what I was working on, one of the many automated
techniques used by the technical analysis software that was
being built for a family office consortium.
I decided to present them with credible evidence that I had
technology that is used by the money managers of the ultra-
wealthy in Vienna to know when to sell. This may sound like
a tall tale, but I taught technical analysis to Vienna money
managers several years back.
First I showed them the chart of the Dow Jones Industrial
Average (DJIA) you see in Figure 1 and mentioned that a
year ago I posted a video that suggested the DJIA was near
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
technician who first identified the pattern and coined the term
mega horn wrote that it was more reliable for finding highs
than lows. The green line is the far parallel of an Andrews
pitchfork. The pitchfork is drawn using the recent three large
pivots. Most charting software has the ability to draw this
line. The Andrews line was originally written about in this
magazine by Tom French.
Over the years I found that price often finds strong resis-
tance at the green line. This is something I taught to money
managers in Vienna years ago. Figure 2 shows the weekly
scale of the DJIA and you can see that price did reverse near
the green line.
muellek josef/Shutterstock
I showed them several other charts such as the daily chart
of Apple Inc. (AAPL) that you see in Figure 3. Once again
I pointed out that prices had made a top at the green line.
Interestingly, a similar scenario took place in AAPL in 2012
(Figure 4) in that prices reversed near the green line. However,
I didn’t include this chart in my presentation.
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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