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THE TRADERS’ MAGAZINE SINCE 1982

www.traders.com MARCH 2019

The 21st-Century
Covered Call
How to kill two birds
with one option 8

Does History
Repeat Itself?
Looking for time-based
patterns for a trading edge 12

Trading
The FakeouT
Keep an eye on these
winning patterns 18

Interview
Claudio Demb and
the psychology of trading 34

Breakaway Gaps
Testing them for reliability
and profitability 38

MARCH 2019
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03-IB19-1167CH1165
Contents MARCH 2019, Volume 37 Number 3

7 Daytrading Pivot Channels INTERVIEW


by Ken Calhoun 34 The Psychology Of Trading
The Traders’ MagazineTM Does “intraday swing trading” With Claudio Demb
sound like a contradiction in terms? by Jayanthi Gopalakrishnan
Well, it may actually not be because Claudio Demb, MD, is a
EDITORIAL
editor@traders.com it combines the best of both worlds. psychiatrist and has been an
Editor in Chief Jack K. Hutson
Find out how this approach can individual trader since the 1990s.
solve some of the trouble spots of He is a frequent contributor to
Editor Jayanthi Gopalakrishnan
both daytrading and swing trading this magazine. Along with his
Production Manager Karen E. Wasserman
Art Director Christine Morrison
and ultimately boost profit potential. professional practice, he has an
Graphic Designer Wayne Shaw academic appointment as an
Webmaster Han J. Kim
8 The 21st-Century Covered Call instructor in psychiatry at Harvard
Contributing Editors John Ehlers,
by Robert J. Seifert Medical School. We spoke with
Anthony W. Warren, Ph.D. Are you tired of writing covered him about how he juggles trading
Contributing Writers Thomas Bulkowski, Martin Pring, calls only to see your stock get and a full-time job, and how he uses
Barbara Star, Markos Katsanos called away as it heads into the his insights into trading psychology
stratosphere? Here is a strategy that to improve his own trading.
OFFICE OF THE Publisher professional traders use to kill two
Publisher Jack K. Hutson birds with one option. 38 Trading Breakaway Gaps
Industrial Engineer Jason K. Hutson by Pawel Kosinski
Project Engineer Sean M. Moore FEATURE ARTICLE Many traders like to trade
12 Does History Repeat Itself breakaway gaps. How effective are
Advertising Sales
4757 California Ave. S.W. In The Markets? they? Here, we look at backtesting
Seattle, WA 98116-4499 by Alessandro Aldrovandi, results of trading different
206 938-0570 Fax 206 938-1307
advert@traders.com Max Malandra, & Fabio Pacchioni breakaway gaps to determine if
National Sales Manager Edward W. Schramm Seasonality or repeating patterns they can be profitable.
ESchramm@traders.com in financial data can come in many
shapes and sizes and can put the 41 Futures For You
Circulation probabilities on your side. Or does by Carley Garner
Subscription & Order Service 1 800 832-4642 general market unpredictability Here’s how the futures market
1 206 938-0570 Fax 1 206 938-1307
circ@traders.com ultimately undermine that edge? really works.
Subscription Manager Sean M. Moore Here are some ideas on looking for
time-based patterns and an example 42 Sector-Rotation ETFs
Website
of how to backtest their reliability. Underperform
http://www.traders.com by Leslie N. Masonson
Staff members may be emailed through the Internet 18 Trading The Fakeout Rotating into leading sectors while
using first initial plus last name plus @traders.com by Fawad Razaqzada switching to a defensive position
Can you profit from fakeouts? in downturns is an ideal tactic if it
Author­i­za­tion to pho­to­copy items for inter­nal or per­sonal Here’s one trader’s take on how to can be implemented successfully,
use, or the inter­nal or per­sonal use of spe­cific cli­ents, is grant-
ed by Tech­ni­cal Anal­y­sis, Inc. for users reg­is­tered with the identify these patterns and trade but can it? Are there any ETFs that
Cop­y­right Clear­ance Cen­ter (CCC) Transactional Reporting them profitably. have succeeded with it? If there
Serv­ice, pro­vided that the base fee of $1.00 per copy, plus
50¢ per page is paid directly to CCC, 222 Rosewood Drive,
are, they could save you the work
Danvers, MA 01923. Online: http://www.copyright.com. For 25 Algo Q&A of implementing the approach
those organ­iz­ a­tions that have been granted a photocopy by Kevin J. Davey yourself, so we’ll investigate.
license by CCC, a sep­a­rate sys­tem of pay­ment has been
arranged. The fee code for users of the Transactional
Got a question about system or algo
Reporting Serv­ice is: 0738-3355/2019 $1.00 + 0.50. trading? 46 Explore Your Options
Sub­scrip­tions: USA: one year (13 issues) $89.99; by Jay Kaeppel
Magazines shipped outside the US require additional
postage as follows: Canada, US$15 per year; Europe,
26 All About OBV Got a question about options?
US$25.50 per year; all other countries US$39 per year. by John Devcic
Sin­gle copies of most past issues from the cur­rent year are On-balance volume is a classic 60 Trading Perspectives
avail­a­ble pre­paid at $8 per copy. Prior years are avail­a­ble
in book format (without ads) or digitally from www.traders. indicator that can be helpful by Rob Friesen
com. USA funds only. Washington state res­i­dents add for indicating trends and for Some perspectives on the equities
sales tax for their locale. VISA, MasterCard, AmEx, and confirming other indicators. You’ve world.
Discover accepted. Subscription orders: 1 800 832-4642
or 1 206 938-0570. undoubtedly looked at it on your
Technical Analysis of Stocks & Commodities™, charts, but if you’ve never really
The Traders’ Magazine™, is prepared from information known exactly how it works or how DEPARTMENTS
believed to be reliable but not guaranteed by us with­out
further verification, and does not purport to be complete. it’s most useful, here’s a close-up 6 Letters To S&C
Opinions expressed are subject to revision without noti- view. 48 Traders’ Tips
fication. We are not offer­ing to buy or sell securities or 57 Advertisers’ Index
commodities discussed. Technical Anal­ysis Inc., one or
more of its officers, and authors may have a position in
57 Editorial Resource Index
the securities discussed herein. 58 Futures Liquidity
The names of products and services presented in this 59 Classified Advertising
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benefit of the trademark owner, with no intention of infring-
59 Traders’ Resource
n Cover: Inga Poslitur
ing on trademark rights.
n Cover concept: Christine Morrison
Copyright © 2019 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 • March 2019 • Technical Analysis of Stocks & Commodities


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Futures, foreign currency and options trading contains substantial risk and is not for every investor. Only
risk capital should be used for trading and only those with sufficient risk capital should consider trading.
The editors of S&C invite readers to submit their opinions and information on subjects
relating to technical analysis and this magazine. This column is our means of communi- script LeavittProjection{
input y = close;
cation with our readers. Is there something you would like to know more (or less) about? input n = 20;
Tell us about it. Without a source of new ideas and subjects coming from our readers, this rec x = x[1] + 1;
magazine would not exist. def a = (n * sum(x * y, n) - sum(x, n) * sum(y,
Email your correspondence to Editor@Traders.com or address your correspondence n) ) / ( n *sum(Sqr(x), n) - Sqr(sum(x, n)));
def b = (sum(Sqr(x), n) * sum(y, n) - sum(x,
to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All n) * sum(x *y, n) ) / ( n * sum(Sqr(x), n) -
letters become the property of Technical Analysis, Inc. Letter-writers must include their full Sqr(sum(x, n)));
name and address for verification. Letters may be edited for length or clarity. The opinions plot LeavittProjection= a*x+ b;
expressed in this column do not necessarily represent those of the magazine.—Editor }

script LeavittConvolution
{ input price = close;
LEAVITT CONVOLUTION indicator; I would be very interested in an input n = 20;
Editor, indicator that outperforms the HMA. def intLength = Floor(Sqrt(n));
I read with interest Jay Could you either share or direct me to plot LeavittConvolution = LeavittProjection
Leavitt’s article in the a place where I might be able to obtain (LeavittProjection (price, n), intLength);
January 2019 issue of the thinkscript for Leavitt’s convolution }
Technical Analysis of indicator? def price = Close;
input length = 9;
Stocks & Commodities, Thank you very much for your time.—
“Leavitt Convolution.” I then logged David def intLength = Floor(Sqrt(length));
in to the S&C archives at Traders.com plot LeavittConvolution = LeavittProjec-
and read all of his previously published Author Jay Leavitt replies: tion (LeavittProjection (price, length),
intLength);
articles in S&C. I just went into the thinkorswim plat- LeavittConvolution.AssignValueColor(if
I am a user of thinkorswim and I see form and perused the list of studies LeavittConvolution > LeavittConvolution [1]
that this is one of the trading platforms there, and I was able to find the Leavitt then Color.GREEN else Color.RED);
that Leavitt uses. The thinkorswim plat- convolution in the list. In any case, here
form has a very nice Hull moving average is the code:

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6 • March 2019 • Technical Analysis of Stocks & Commodities


TRADING ON MOMENTUM
2018 WINNER
Gaps Got Your Stops? AI TRADING SOFTWARE

Intraday Swing Winner

Trading Basics
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Does “intraday swing trading” sound up all day long you can gain as much as Build powerful
like a contradiction in terms? Well, it $1 to $5 per share in a single trade.
may actually not be because it combines
trading systems in
the best of both worlds. Find out how Enter early, exit late MINUTES
this approach can solve some of the The best chart pattern to use this tech-
trouble spots of both daytrading and nique with is minor gap continuations,
without coding
swing trading and ultimately boost as seen in the chart of Canopy Growth
profit potential. Corp. (CGC) in Figure 1. Minor gaps
are those in which the opening price

O
by Ken Calhoun gaps up less than 10%, for example, $3 ®

or less for a $30 stock. I use buy stop-


ne of the biggest risks active limit orders to enter all of my positions.
traders struggle with is hold- In this example, that would be a buy-stop
ing positions overnight that $31.50 limit $32.
gap against them, causing I have found that my biggest error in
expensive stop-losses. Classic daytrading using this approach has been tightening
www.NeuroShell.com
can also be challenging, because of the up trailing stops on winners and exiting 301.662.7950
speed and accuracy needed to capital- my trades too soon. If you are a veteran
ize on early breakouts that move just daytrader, you may also experience this,
$0.30–$0.80 during the opening hour. because early profit-taking is a way of
There is a hybrid trading approach life. If I’m up $0.80 per share on a trade I stay active until right before the closing
that involves intraday swing trading, in just entered 10 minutes ago, for example, bell, at which time I close the trade.
which you enter your position during the I usually tighten up my stop to lock in
first hour of the market open, then close a profit. However, the solution that has Step-by-step action plan
the position at the end of the day. The worked best for me is to scale out, so I Here’s how you can start using this
main benefit to this technique is much may exit half my winning trade with a strategy.
higher profit potential compared to clas- tight stop at the first sign of a pullback,
sic daytrading, because when stocks run but let the remaining half of the position Scanning: Find a stock with a small
gap up of less than 10%, as seen in
Figure 1.

Step 1: Enter longs $0.50 above the


nearest whole number premarket
high. We wait this amount to help
minimize false breakouts, which
often occur during the first $0.20 or
so above the opening high day (this
would be at $31.50 in Figure 1).

Step 2: Set your initial stop-loss at


$0.50 below the whole number price
value ($30.50 in Figure 1). You can
also test using a loss of the premarket
low as your initial stop value ($30
in Figure 1).
esignal

FIGURE 1: Intraday Swing Trading (CGC). A large three-point intraday breakout moved up all day. Continued on page 32
March 2019 • Technical Analysis of Stocks & Commodities • 7
Weeklys To The Rescue

The 21st-Century Covered Call


Are you tired of writing covered calls only to see your stock had unlimited downside risk. If the stock closed lower than the
get called away as it heads into the stratosphere? Here is a naked leg strike price but above your cost for the underlying
strategy that professional traders use to kill two birds with stock, you would have kept the premium, which lowered your
one option. average cost for the stock.
The problem with this strategy was that when the stock
by Robert J. Seifert moved against you by more than the credit amount, you were

W
left with unlimited downside risk. Trying to get out of this
hen I began trading options in 1983, one of the situation usually resulted in selling lower strikes, which ended
hardest trades to execute was to buy a put to with the stock getting called away at a loss.
protect against the downside risk inherent in the As time moved on, the powers that be decided that if quar-
market. The problem with buying puts then and terly options were good then perhaps monthly options might
now is that the price you pay for the protection is even be better, so they added monthly options to the mix. You
HAND LOGO: ART4ALL/SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON

high and it’s very hard to overcome the premium could write the same call 12 times a year. The advantage of
CAR: ALEXANDER KONDRATENKO/WEEKLY PLANNER: ISOLATED/

loss. An alternative trade was to sell a covered call for each writing the call 12 times a year was that it gave you more
quarterly expiration. Unfortunately, although this offers some downside protection. However, it also gave you four times as
protection, it can create a problem in markets that are in a much risk in that the premium in the call you sold may not be
long-term congestion phase. enough to cover an advance in the stock price and you could
Back then, executing a covered call trade was done by selling then lose the underlying stock.
a call every quarter against an underlying stock you owned. Around 2010, the SEC decided that if monthly options were
When the option contract expired, you kept the premium good, options that expired each week would be great! They
you received when you sold the call, no matter what. If the started a pilot program using weekly options, which is now
stock closed above the naked call’s strike price, you would the biggest option product in the world. So if selling covered
keep the credit, but the stock would be called away from you calls four times a year was a good deal, it must be a much
(exercised). Your upside was limited to the credit while you better proposition to write them 52 times a year, right? The
8 • March 2019 • Technical Analysis of Stocks & Commodities
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answer is a resounding yes. Over the years, this strategy has return and you still own the stock.
evolved and allows traders and investors a much better chance What about the downside? If Tesla’s stock were to close
to make money. No approach offers more opportunity than lower for the week, you would keep the $5.90 spread credit,
what I call the “21st-century covered call.” Let’s look at how which would limit your stock loss for the week. The good
this strategy works. news is that no matter what happens, if you write the 21st-
century covered call for around a $5.90 credit 52 times a
Initiating the 21st-century year, it would give you $306.80 ($5.90 × 52= $306.80) of
covered-call strategy downside protection, which is 95.6% of the purchase price
First, we must address the number-one problem of writing of the stock ($320.87).
covered calls: losing the upside potential if the stock takes
off. To counter this situation, I sell a weekly call-credit spread How does all this work in real time?
instead of simply selling a call. To see how this strategy sets Ideally, you want to do this covered-call strategy with stocks
up, let’s look at the option chain in Figure 1 for Tesla Motor that have a good chance of trading higher over the near term and
Co. (TSLA) when the stock closed at $320.87. that also have liquid, weekly options. To select stocks that meet
With TSLA at $320.87, the at-the-money (ATM) call is the this criteria, you can use a scanner similar to the one we offer
320.0 and it is trading at approximately $11.60. We want to at MarketEdge (www.marketedge.com, a website developed
use the ATM strike as the short call leg of the spread since it by Computrade Systems, Inc., which has been in existence as
gives you the most premium. Under the old method of selling either a software application or website since 1992).
covered calls, you would buy the stock at $320.87 and sell
the 320.0 call for $11.60. If the stock settled above $320, you Profit/loss scenarios
would lose the stock at $320 but would keep the $11.60 credit for the strategy
for a net gain of $10.73 ($11.60 credit - $0.87 stock loss). Not There are six scenarios you can expect each
a bad deal, but if the stock went on to $360, you would miss week when employing this strategy: flat, small
out on any profit past $10.73. gain, rally, big rally, small loss, and big loss.
Meanwhile, under the 21st-century covered-call strategy, Using TSLA as an example, let’s check out
you would buy the stock at $320.87, sell the 320.0 call at the possible outcomes. Say you purchase 100
$11.60 and buy another call at a higher strike price with the shares of TSLA at $320 and initiate the 320–335 call credit
same expiration date. You can buy any strike price you like spread for $5.90. For illustrative purposes, the following as-
but I recommend you buy one that is no more than $15.00 sumes the option positions are closed on the weekly expiration
higher than the ATM, which in this case would be the 335.0 date and the stock position remains open. Each week there
call (ATM +6). will be a realized gain or loss in your option account and an
So you would buy the stock at $320.87 and initiate a 320.0– unrealized gain or loss in your stock account.
335.0 call-credit spread by selling the 320.0 call for $11.60
and buying the 335.0 call for $5.70, resulting in a net credit Initial position: 100 shares (TSLA) @ $320 = $32,000
of $5.90 ($11.60 - $5.70). If the stock settles above $325.90 Options: 320–335 call credit spread @$5.90 = $590 credit
($320.00 + $5.90), let’s
say $335.00, the call
spread would be a $9.10
loser since you would be
called away at $320.00
but you would exercise
your 335.0 call for a
spread loss of $15.00
less the $5.90 credit.
However, the stock por-
tion of the trade would
make $14.13 ($335.00 -
$320.87), so you would
net $5.03 ($14.13 stock
gain - $9.10 spread loss)
for the trade. So while
your gain is $5.70 less
than what you would
have made the old-
fashioned way ($10.73
- $5.03), you get a nice FIGURE 1: OPTION CHAIN OF WEEKLYS. See what the at-the-money calls are trading for and then set up your trading strategy.
10 • March 2019 • Technical Analysis of Stocks & Commodities
1) Flat: The stock settles unchanged at $320
This is a no-brainer. You pocket the $590 from the call credit
spread. You have no change in your stock value. You want to do this covered-
Continue the next week by initiating another 320.0–335.0
call credit spread for a credit of around $5.90.
call strategy with stocks
that have a good chance of
Total account value: $32,000 + $590 = $32,590 trading higher over the near
($590 gain) term and also have liquid,
2) Small gain: The stock rises by about 1.5% to $325
weekly options.
You pocket the $590 from the call credit spread on Monday,
buy back the expiring in-the-money (ITM) short call at $500 on
Friday afternoon (before expiration) for a realized gain of $90
on the options, an unrealized gain of $500 on the stock. Continue the next week by initiating another 335.0–350.0
Continue the next week by initiating a 325.0–340.0 call call credit spread for a credit of around $5.90.
credit spread for a credit of around $5.90.
Total account value: $33,500 + $590 - $1,500 = $32,590
Total account value: $32,500 + $590 - $500 = $32,590 ($590 gain)
($590 gain)
4) Big rally: The stock rallies by about 9% to $350
3) Rally: The stock rallies by about 5% ($15) to $335 You pocket the $590 from the call credit spread on Monday,
You pocket the $590 from the call credit spread on Monday, and buy back the expiring in-the-money spread at $1,500 on
and buy back the expiring in-the-money spread at $1,500 on Friday afternoon (before expiration) for a realized loss of $910
Friday afternoon (before expiration) for a realized loss of $910 on the options, an unrealized gain of $3,000 on the stock and
on the options, an unrealized gain of $1,500 on the stock and
you keep the stock. Continued on page 33

SINCE

Test-drive it to See All the Signals!

THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS
DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FAC-
TORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS
BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. THE TESTIMONIAL MAY NOT BE REPRESENTATIVE OF THE EXPERIENCE OF OTHER CLIENTS AND THE
TESTIMONIAL IS NO GUARANTEE OF FUTURE PERFORMANCE OR SUCCESS. TECHNICAL ANALYSIS OF STOCKS & COMMODITIES LOGO AND AWARD ARE TRADEMARKS OF TECHNICAL ANALYSIS, INC.

March 2019 • Technical Analysis of Stocks & Commodities • 11


12 • March 2019 • Technical Analysis of Stocks & Commodities
QUANTITATIVE ANALYSIS

Time As A Trading Signal

Does History Repeat Itself


In The Markets?
Seasonality or repeating patterns in financial data Translating it into financial terms, we can easily de-
can come in many shapes and sizes and can put the duce that Kairos represents market timing, relating to
probabilities on your side. Or does general market those ex ante, unpredictable times when an operating
unpredictability ultimately undermine that edge? Here alert pops up and signals you to open long or short
are some ideas on looking for time-based patterns positions due to technical reasons. That reason could
and an example of how to backtest their reliability. be a breakout of a resistance; reaching an overbought

Is
or oversold condition on a particular oscillator; the
it possible to forecast market moves by using completion of a particular pattern; or so on. Kronos,
a “time factor”? Here, we’ll attempt to answer on the other hand, represents the cyclical nature of
that question using monthly timeframes. For events that regularly happen in financial markets.
this study, we used the forex market and sta- Market timing (Kairos) is one of the pillars of
tistically analyzed historical monthly performances of technical analysis, while Kronos has not yet been
some of the major currency pairs. We hypothesized deeply detected. The question could be: Do we need
that the major currencies vs. the US dollar, which is to wait for a technical “event” (such as the break of
usually a mean-reverting relationship, could indicate resistance/support, the cross of a moving average, or
seasonality in the different months of the year. so on) to have a profitable trade, or do we, perhaps,
Then we looked at those monthly performances to need to wait for the “right” day (or month or hour) to
try to discover (ex post, or based objectively on past enter a trade? Let’s find out.
results) seasonal patterns that we later tested in an
in-sample/out-of-sample strategy. Would any seasonal Statistical research
effect discovered in exchange rates in past years or While classic technical analysis mostly focuses on de-
decades work as well in recent years despite market termining whether price is trending (ignoring whether
volatility and central bank quantitative easing policies? and when price trends could happen), technical analysis
Or is the market too unpredictable for the monthly based on time focuses on time-based alerts and trends
seasonal effect to prevail? observed in past data. In our study, we chose monthly
timeframes applied to three well-known and liquid
“Timed” technical analysis forex (FX) markets: EUR/USD, GBP/USD, and USD/
Ancient Greeks believed the concept of time was CAD. We followed these two steps:
so important that they had two gods dedicated to
it: Kronos and Kairos. The former referred to time 1. In-sample analysis. We looked for monthly
as “in being,” with the flow of hours, days, months, historical trends (bullish and bearish). From
and years, while the latter as “momentum.” Kronos 1998–2013 we calculated monthly returns for
connotes time quantitatively as “past,” “present,” and each major pair and the average return for each
INGA POSLITUR

“future,” while Kairos connotes time in qualitative month over a period of 15 years. When positive,
terms as “when something happens.” the trend of that month was defined as “bullish.”

by Alessandro Aldrovandi, Max Malandra, & Fabio Pacchioni


March 2019 • Technical Analysis of Stocks & Commodities • 13
If the returns were mainly negative for a Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

given month, it was defined as a “bear- 1998


1999
-1.86% 0.93% -1.12% 2.37% 0.07% -0.38% 1.05% 1.90% 4.36% 0.86% -2.15% 1.05%

ish” month. The entry point of the “trade”


-2.78% -3.25% -1.97% -1.85% -1.58% -0.59% 3.34% -1.29% 1.08% -1.43% -4.39% 0.05%
2000 -4.56% -0.68% -0.73% -4.70% 2.33% 2.25% -2.69% -4.12% -1.72% -3.96% 2.77% 7.94%
was the open price of the first trading day 2001 -1.08% -1.54% -5.02% 1.25% -5.06% 0.53% 3.16% 4.14% -0.11% -1.16% -0.51% -0.70%

of the month and the exit point was the 2002


2003
-3.39% 1.21% 0.29% 3.36% 3.69% 6.11% -1.46% 0.43% 0.43% 0.44% 0.32% 5.47%

closing price of the last trading day of


2.68% 0.25% 1.31% 2.43% 5.45% -1.64% -2.51% -2.18% 6.00% -0.51% 3.63% 4.70%
2004 -0.57% 0.14% -1.69% -2.63% 1.82% -0.05% -1.38% 1.15% 2.04% 2.88% 3.61% 2.06%
the same month. 2005 -3.81% 1.31% -1.91% -0.75% -4.32% -1.76% 0.26% 1.78% -2.25% -0.35% -1.60% 0.41%
2006 2.62% -1.77% 1.57% 4.25% 1.50% -0.17% -0.20% 0.27% -1.05% 0.66% 3.72% -0.32%
2. Out-of-sample analysis. We then used the 2007 -1.27% 1.49% 0.92% 2.19% -1.45% 0.67% 1.01% -0.41% 4.68% 1.57% 1.02% -0.42%
subsequent four-year period (2014–2017) 2008 1.88% 2.13% 3.81% -1.08% -0.40% 1.25% -0.97% -5.97% -4.12% -9.75% -0.55% 10.12%

to test the same signals. Using the same


2009 -8.28% -0.61% 5.00% -0.16% 7.05% -0.71% 1.60% 0.44% 2.11% 0.53% 1.83% -4.54%
2010 -3.21% -1.69% -0.84% -1.60% -7.69% -0.54% 6.65% -2.92% 7.53% 2.27% -7.03% 3.09%
definitions of bullish/bearish months as in 2011 2.62% 0.82% 2.55% 4.59% -2.90% 0.73% -0.72% 0.10% -6.85% 3.85% -2.97% -3.65%
the earlier in-sample analysis, we opened 2012 1.08% 1.84% 0.12% -0.90% -6.60% 2.44% -2.92% 2.24% 2.23% 0.86% 0.22% 1.51%

long trades in the months that were previ-


2013 2.94% -3.85% -1.82% 2.79% -1.28% 0.12% 2.21% -0.62% 2.24% 0.41% 0.05% 1.14%
Avg -1.06% -0.20% 0.03% 0.60% -0.59% 0.52% 0.40% -0.31% 1.04% -0.18% -0.13% 1.74%
ously defined as bullish and short trades in SHORT SHORT LONG SHORT LONG LONG SHORT LONG SHORT SHORT LONG
the months that were previously defined as Figure 1: Average monthly returns of EUR/USD exchange rates, 1998–2013
bearish. Near-zero-return months weren’t
included in this second step, as they were
considered trendless.
N. Date Trade En.Price Ex.Price % Chg Profit Cum. Profit
Note that whenever more than one month in a row presented 1 Jan 2014 Short 1.374 1.349 -1.88% 258 258

the same trend (bullish or bearish), the trade wasn’t closed and 2
3
Feb
Mar
Short
-
1.349
1.379
1.380
1.377
2.30%
-0.11%
-310
0
-52
-52
immediately reopened, but rather kept in place until a month 4 Apr Long 1.377 1.387 0.72% 99 47
of the opposite sign occurred. 5 May Short 1.387 1.363 -1.71% 237 284

Our aim with this two-step analysis was to verify the earlier 6
7
Jun
Jul
Long
Long
1.363
1.369
1.369
1.339
0.43%
-2.21%
58
-303
342
39
long-term (15-year) results in a shorter (four-year) time period and 8 Aug Short 1.339 1.313 -1.93% 258 297
test whether the pattern holds up—indicating that history does 9 Sep Long 1.314 1.263 -3.85% -506 -209

sometimes tend to repeat—or whether the markets are just too 10


11
Oct
Nov
Short
Short
1.263
1.252
1.252
1.245
-0.84%
-0.52%
106
65
-103
-38
unpredictable for seasonal patterns to be reliably predictive. 12 Dec Long 1.246 1.210 -2.87% -358 -396
13 Jan 2015 Short 1.210 1.129 -6.71% 812 416

EUR/USD 14
15
Feb
Mar
Short
-
1.128
1.119
1.119
1.073
-0.79%
-4.08%
89
0
505
505
The last row of the table in Figure 1 shows the 16 Apr Long 1.073 1.122 4.58% 491 996
average monthly returns of the EUR/USD from 17 May Short 1.122 1.099 -2.09% 234 1,230

1998 to 2013. Following the specified criteria 18


19
Jun
Jul
Long
Long
1.099
1.114
1.114
1.099
1.36%
-1.36%
149
-151
1,379
1,228
(positive or negative average monthly returns), 20 Aug Short 1.097 1.121 2.22% -243 985
we considered April, June, July, September, 21 Sep Long 1.121 1.118 -0.29% -33 952

and December to be bullish. January, Febru- 22


23
Oct
Nov
Short
Short
1.118
1.101
1.101
1.056
-1.52%
-4.09%
170
450
1,122
1,572
ary, May, August, October, and November were bearish. Based 24 Dec Long 1.057 1.086 2.78% 294 1,866
on the dispersion of the performances, March was considered 25 Jan 2016 Short 1.086 1.083 -0.26% 28 1,894

trendless. 26
27
Feb
Mar
Short
-
1.083
1.087
1.087
1.138
0.37%
4.67%
-40
0
1,854
1,854
Once we defined the bullish and bearish months, we applied 28 Apr Long 1.138 1.145 0.67% 76 1,930
the second step of the analysis. The strategy was tested in the 29 May Short 1.144 1.113 -2.75% 315 2,245

2014–2017 period, going long in the months defined as bullish 30


31
Jun
Jul
Long
Long
1.113
1.110
1.110
1.117
-0.23%
0.60%
-26
67
2,219
2,286
and short in the ones defined as bearish. The table in Figure 2 32 Aug Short 1.117 1.116 -0.15% 17 2,303
displays all trading data (32 total trades—16 long and 16 short, 33 Sep Long 1.116 1.124 0.74% 83 2,386

and flat for four months). The chart in Figure 3 shows the equity 34
35
Oct
Nov
Short
Short
1.123
1.098
1.098
1.059
-2.26%
-3.59%
254
394
2,640
3,034
line for the strategy (3,263 pips earned in total). 36 Dec Long 1.059 1.051 -0.71% -75 2,959
37 Jan 2017 Short 1.053 1.080 2.53% -266 2,693

GBP/USD 38
39
Feb
Mar
Short
-
1.080
1.057
1.058
1.065
-2.05%
0.72%
221
0
2,914
2,914
“The cable” is a slang term used by FX traders to refer to the 40 Apr Long 1.066 1.090 2.22% 237 3,151
exchange rate between the British pound and the US dollar; this 41 May Short 1.091 1.124 3.08% -336 2,815

name was coined in the 19th century, when the rate began to be 42
43
Jun
Jul
Long
Long
1.124
1.142
1.142
1.184
1.63%
3.70%
183
422
2,998
3,420
transmitted across the ocean by a submarine communication 44 Aug Short 1.184 1.191 0.57% -68 3,352
cable (and since 1866 has been transmitted continuously). 45 Sep Long 1.191 1.181 -0.81% -97 3,255

In the table in Figure 4 we report the monthly returns of “the 46


47
Oct
Nov
Short
Short
1.182
1.164
1.164
1.190
-1.46%
2.22%
172
-258
3,427
3,169
cable” for the 1998–2013 period, and in the last row of the table 48 Dec Long 1.190 1.200 0.79% 94 3,263
we state the average return for each month. Looking at the data, Figure 2: Long & short trades on EUR/USD in the period 2014–2017

14 • March 2019 • Technical Analysis of Stocks & Commodities


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April, June, July, September, and December can Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

be considered bullish, while January, February, 1998 -0.85% 0.91% 1.46% -0.06% -2.45% 2.05% -1.94% 2.91% 1.13% -1.47% -1.74% 0.39%

March, May, August, and November are bearish.


1999 -0.80% -2.77% 0.77% -0.09% -0.43% -1.56% 2.77% -1.04% 2.72% -0.26% -2.80% 1.37%
2000 -1.32% -2.11% 0.77% -2.51% -3.43% 1.11% -1.40% -3.16% 1.81% -1.79% -1.57% 4.63%
October has a near-zero average return, so it’s 2001 -1.90% -1.24% -2.12% 0.87% -0.99% -0.04% 0.64% 2.03% 1.50% -1.24% -2.09% 2.23%

considered trendless and wasn’t included in the 2002 -2.98% 0.35% 0.67% 2.20% -0.20% 5.32% 1.99% -0.86% 1.39% -0.40% -0.42% 3.43%

out-of-sample test.
2003 2.32% -4.29% 0.46% 1.11% 2.42% 1.65% -2.76% -2.14% 5.19% 2.11% 1.56% 3.54%
2004 2.60% 2.38% -1.49% -3.57% 3.23% -0.73% 0.03% -1.05% 0.51% 1.42% 3.81% 0.51%
With the benefit of historical data series 2005 -1.83% 1.92% -1.56% 1.05% -4.67% -1.49% -1.84% 2.73% -1.98% 0.35% -2.20% -0.36%

analysis, we adopted the same month-based long 2006 3.13% -1.38% -0.96% 5.12% 2.64% -1.19% 1.12% 1.93% -1.64% 1.77% 3.05% -0.36%

and short strategy for the subsequent 2014–2017


2007 0.31% -0.07% 0.22% 1.59% -0.99% 1.48% 1.07% -0.70% 1.48% 1.61% -1.12% -3.39%
2008 0.14% 0.07% -0.11% 0.12% -0.19% 0.77% -0.40% -8.20% -1.67% -9.77% -4.57% -5.01%
period, going long (or holding long) in bullish 2009 -0.78% -0.82% 0.37% 3.26% 9.45% 1.71% 1.54% -2.58% -1.90% 2.92% -0.09% -1.60%

months and short in bearish ones. The table in 2010 -1.24% -4.51% 0.17% 0.59% -4.65% 2.80% 4.97% -2.35% 2.41% 2.04% -3.20% 0.30%

Figure 5 shows all the trades (32 total trades—16


2011 2.98% 1.51% -1.41% 4.24% -1.24% -2.40% 2.29% -1.20% -4.18% 3.75% -2.39% -0.99%
2012 1.61% 0.98% 0.58% 1.51% -5.07% 1.93% 0.10% 1.21% 1.85% 0.01% -0.73% 1.39%
long and 16 short trades) and the chart in Figure 2013 -2.45% -4.38% 0.30% 2.26% -2.14% -0.01% -0.09% 1.98% 4.34% -0.89% 2.05% 1.20%

6 shows the equity line for the strategy (2,474 Avg -0.07% -0.84% -0.12% 1.11% -0.54% 0.71% 0.51% -0.66% 0.81% 0.01% -0.78% 0.46%

pips earned on the whole).


SHORT SHORT SHORT LONG SHORT LONG LONG SHORT LONG SHORT LONG

Figure 4 Average monthly returns of GBP/USD exchange rates, 1998–2013

USD/CAD
The third major we exam-
ined was the exchange rate between the US N. Date Trade En.Price Ex.Price % Chg Profit Cum. Profit

dollar and the loonie, that is, the Canadian 1 Jan 2014 Short 1.656 1.643 -0.74% 123 123

dollar (usually abbreviated as Can$ or C$ to


2 Feb Short 1.644 1.674 1.82% -299 -176
3 Mar Short 1.675 1.666 -0.50% 83 -93
distinguish it from the US dollar). The table 4 Apr Long 1.666 1.687 1.27% 211 118

in Figure 7 shows all monthly returns of the 5 May Short 1.687 1.675 -0.73% 123 241

exchange rate from 1998 to 2013. As usual, the last row of the
6 Jun Long 1.676 1.710 2.05% 344 585
7 Jul Long 1.711 1.688 -1.30% -222 363
table shows the average returns for each month. On a historical 8 Aug Short 1.689 1.660 -1.71% 288 651

basis, January, June, July, August, October, and November are 9 Sep Long 1.659 1.621 -2.30% -381 270

bullish months, while February, March, April, May, September,


10 Oct - 1.621 1.600 -1.34% 0 270
11 Nov Short 1.598 1.565 -2.06% 329 599
and December are bearish ones. 12 Dec Long 1.565 1.557 -0.48% -75 524

We applied the same out-of-sample strategy to this FX pair. 13 Jan 2015 Short 1.558 1.507 -3.28% 511 1,035

We opened (or continued to hold) long trades in the bullish


14 Feb Short 1.508 1.543 2.31% -348 687
15 Mar Short 1.544 1.482 -4.01% 619 1,306
months and short trades in the bearish ones. The table in Figure 16 Apr Long 1.482 1.535 3.58% 531 1,837

8 shows, in detail, all trades (24 total trades—12 long and 12 17 May Short 1.535 1.529 -0.40% 61 1,898

short), while the chart in Figure 9 shows the equity line for the
18 Jun Long 1.529 1.571 2.71% 414 2,312
19 Jul Long 1.571 1.562 -0.55% -86 2,226
strategy (2,124 pips earned in total). 20 Aug Short 1.562 1.534 -1.80% 281 2,507
21 Sep Long 1.534 1.513 -1.40% -215 2,292

And the results show…


22 Oct - 1.513 1.543 1.99% 0 2,292
23 Nov Short 1.545 1.505 -2.56% 395 2,687
Through time series analysis and concrete application of an 24 Dec Long 1.505 1.474 -2.10% -316 2,371

operational strategy to test our hypothesis, we attempted to show 25 Jan 2016 Short 1.474 1.425 -3.33% 491 2,862

that for each financial instrument tested, in this case major forex
26 Feb Short 1.424 1.392 -2.28% 324 3,186
27 Mar Short 1.392 1.436 3.18% -442 2,744
pairs, each month of the year can have a particular bullish or 28 Apr Long 1.436 1.461 1.75% 252 2,996

bearish “personality” that lasts over time. Our findings show 29 May Short 1.461 1.448 -0.90% 132 3,128

that in terms of profitability and linearity of the profit curve,


30 Jun Long 1.448 1.331 -8.09% -1171 1,957
31 Jul Long 1.331 1.323 -0.60% -80 1,877
32 Aug Short 1.323 1.314 -0.70% 92 1,969
33 Sep Long 1.314 1.298 -1.24% -163 1,806
34 Oct - 1.294 1.224 -5.38% 0 1,806
35 Nov Short 1.224 1.250 2.20% -269 1,537
36 Dec Long 1.250 1.234 -1.34% -168 1,369
37 Jan 2017 Short 1.234 1.258 1.89% -233 1,136
38 Feb Short 1.258 1.238 -1.59% 200 1,336
39 Mar Short 1.238 1.255 1.33% -165 1,171
40 Apr Long 1.254 1.295 3.25% 407 1,578
41 May Short 1.295 1.289 -0.48% 62 1,640
42 Jun Long 1.289 1.303 1.07% 138 1,778
43 Jul Long 1.301 1.321 1.55% 202 1,980
44 Aug Short 1.321 1.293 -2.14% 283 2,263
45 Sep Long 1.293 1.340 3.61% 467 2,730
46 Oct - 1.339 1.328 -0.78% 0 2,730
47 Nov Short 1.328 1.353 1.84% -245 2,485
48 Dec Long 1.352 1.351 -0.08% -11 2,474

Figure 3: equity line FOR THE strategy on EUR/USD, 2014–2017 Figure 5: Long & short trades on GBP/USD in the period 2014–2017

16 • March 2019 • Technical Analysis of Stocks & Commodities


Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
1998 1.66% -2.23% -0.15% 0.86% 1.84% 0.71% 3.11% 3.50% -2.28% 0.78% -0.65% -0.25%
1999 -1.37% -0.09% -0.18% -3.32% 1.24% -0.75% 2.99% -0.93% -1.70% 0.31% 0.22% -1.63%

For each financial


2000 -0.17% 0.20% -0.11% 2.19% 1.18% -0.90% 0.51% -0.99% 1.97% 1.30% 0.82% -2.38%
2001 0.21% 2.60% 2.51% -2.63% -0.52% -1.42% 1.25% 1.14% 1.86% 1.03% -1.53% 1.08%

instrument, each 2002


2003
-0.44%
-3.28%
1.18%
-2.41%
-0.56%
-1.05%
-1.66%
-2.50%
-2.56%
-4.59%
-1.30%
-1.65%
4.39%
4.42%
-1.60%
-1.49%
1.91%
-2.56%
-1.76%
-2.17%
0.82%
-1.53%
0.51%
-0.07%
month of the year 2004 2.26% -0.11% -1.76% 4.83% -0.87% -2.14% -0.14% -0.96% -3.89% -3.53% -2.50% 1.38%

has a particular
2005 3.31% -0.41% -2.02% 4.00% -0.40% -2.35% -0.17% -2.89% -1.73% 1.33% -1.26% -0.33%
2006 -2.28% -0.25% 2.77% -4.38% -1.44% 1.40% 1.31% -2.48% 1.30% 0.45% 1.62% 2.22%

bullish or bearish 2007


2008
0.96%
0.39%
-0.59%
-1.52%
-1.33%
3.94%
-3.76%
-1.70%
-3.70%
-1.46%
-0.32%
2.62%
0.12%
0.32%
-1.01%
3.84%
-6.04%
0.25%
-5.10%
13.88%
5.90%
2.28%
-0.08%
-1.25%
“personality” that 2009 0.56% 3.81% -1.18% -5.36% -8.57% 6.64% -7.30% 1.44% -2.20% 1.38% -2.59% -0.28%

lasts over time.


2010 1.65% -1.76% -3.54% 0.27% 2.68% 1.87% -3.22% 3.54% -3.42% -0.97% 0.65% -2.77%
2011 0.57% -2.95% -0.11% -2.63% 2.47% -0.54% -0.82% 2.42% 7.43% -4.67% 1.68% 0.36%
2012 -1.85% -1.27% 0.84% -1.13% 4.61% -1.58% -1.35% -1.67% -0.25% 1.65% -0.52% -0.15%
2013 0.47% 3.36% -1.29% -1.00% 2.99% 1.47% -2.31% 2.50% -2.14% 1.16% 1.76% 0.10%
Avg 0.17% -0.15% -0.20% -1.12% -0.44% 0.11% 0.19% 0.27% -0.72% 0.32% 0.32% -0.22%
LONG SHORT SHORT SHORT SHORT LONG LONG LONG SHORT LONG LONG SHORT

Figure 7: Average monthly returns of USD/CAD exchange rates, 1998–2013

harnessing time in monthly windows has proved


to not be meaningless.
Using this type of study, you can discover other types of N. Date Trade En.Price Ex.Price % Chg Profit Cum. Profit

potentially actionable strategies. You could perform similar 1 Jan 2014 Long 1.062 1.113 4.74% 503 503

research by considering different timeframes (weekly data,


2 Feb Short 1.113 1.106 -0.57% 63 566
3 Mar Short 1.105 1.105 -0.05% 5 571
yearly data, and so on). Once you filter out the background 4 Apr Short 1.105 1.096 -0.81% 89 660

noise that is always present in shorter temporal horizons by 5 May Short 1.096 1.084 -1.10% 121 781

always using average returns, you should be able to obtain


6 Jun Long 1.084 1.067 -1.62% -176 605
7 Jul Long 1.067 1.090 2.20% 235 840
solid findings on these as well. In addition, in order to test for 8 Aug Long 1.090 1.088 -0.27% -29 811

reliability and persistency, you could easily extend this analysis 9 Sep Short 1.087 1.120 2.96% -322 489
10 Oct Long 1.119 1.127 0.63% 71 560
11 Nov Long 1.126 1.141 1.33% 150 710
Continued on page 33 12 Dec Short 1.142 1.162 1.74% -199 511
13 Jan 2015 Long 1.162 1.273 9.55% 1110 1,621
14 Feb Short 1.273 1.251 -1.76% 224 1,845
15 Mar Short 1.248 1.269 1.67% -208 1,637
16 Apr Short 1.269 1.208 -4.82% 611 2,248
17 May Short 1.208 1.245 3.06% -369 1,879
18 Jun Long 1.244 1.249 0.42% 52 1,931
19 Jul Long 1.249 1.309 4.76% 594 2,525
20 Aug Long 1.309 1.314 0.31% 41 2,566
21 Sep Short 1.314 1.331 1.32% -174 2,392
22 Oct Long 1.331 1.308 -1.76% -234 2,158
23 Nov Long 1.307 1.336 2.20% 288 2,446
24 Dec Short 1.336 1.384 3.57% -477 1,969
25 Jan 2016 Long 1.384 1.397 0.95% 132 2,101
26 Feb Short 1.397 1.354 -3.10% 433 2,534
27 Mar Short 1.354 1.300 -3.96% 536 3,070
28 Apr Short 1.300 1.255 -3.47% 451 3,521
29 May Short 1.255 1.309 4.34% -544 2,977
30 Jun Long 1.309 1.292 -1.29% -169 2,808
31 Jul Long 1.292 1.303 0.81% 105 2,913
Figure 6: equity line FOR the strategy on GBP/USD, 2014–2017
32 Aug Long 1.303 1.310 0.60% 78 2,991
33 Sep Short 1.311 1.313 0.17% -22 2,969
34 Oct Long 1.313 1.341 2.10% 276 3,245
35 Nov Long 1.341 1.343 0.21% 28 3,273
36 Dec Short 1.344 1.343 -0.06% 8 3,281
37 Jan 2017 Long 1.344 1.303 -3.04% -408 2,873
38 Feb Short 1.303 1.330 2.06% -268 2,605
39 Mar Short 1.330 1.331 0.09% -12 2,593
40 Apr Short 1.330 1.365 2.62% -348 2,245
41 May Short 1.365 1.350 -1.13% 154 2,399
42 Jun Long 1.350 1.296 -3.98% -537 1,862
43 Jul Long 1.296 1.248 -3.76% -487 1,375
44 Aug Long 1.248 1.248 0.02% 3 1,378
45 Sep Short 1.248 1.247 -0.08% 10 1,388
46 Oct Long 1.247 1.288 3.30% 411 1,799
47 Nov Long 1.289 1.289 0.05% 7 1,806
48 Dec Short 1.290 1.258 -2.47% 318 2,124

Figure 9: strategy equity line on USD/CAD, 2014–2017 Figure 8: Long & short trades on USD/CAD, 2014–2017

March 2019 • Technical Analysis of Stocks & Commodities • 17


Anticipate, Spot, Trade

Trading The Fakeout


Can you profit from fakeouts? Here’s one trader’s take on how Remember, price is a function of liquidity: The market goes
to identify these patterns and trade them profitably. where orders are resting, that is, from one area of liquidity to
the next. So being able to identify such setups may not only
by Fawad Razaqzada lead to better trading opportunities but could potentially help

A
you cut your losing trades quicker if you happen to be one of
false breakout—or fakeout—is by far one of my those breakout traders who got trapped.
favorite technical patterns. It is when price mo- In this article, I will discuss and share examples of: 1) how
mentarily moves above a previous high or below a to anticipate the emergence of such patterns, so you know
previous low, but then goes back within the existing exactly what to do when they occur; 2) how to spot these
range. This happens when there isn’t enough demand patterns after they are formed; and perhaps most important,
above the old high, or enough supply beneath the 3) how to trade them. I will also discuss various other factors
KTASIMAR/SHUTTERSTOCK/COLLAGE:NIKKI MORR

prior low, to help push price significantly in the you’ll want to take into account when spotting these patterns,
direction of the break. When a breakout fails, it suggests including how price gets to old highs/lows.
the move is exhausted, and the rejection alone could provide
significant reward if traded correctly. What’s more, price Identifying price action
typically then goes back to areas where the breakout traders, As your experience grows, you will hopefully become more
some of whom are now trapped, would be placing their stop- patient and better at reading price action. You will be able
loss orders. Those areas now become the ideal profit target to spot the difference between very high-probability setups
zones for fakeout traders. and normal trades. Professional poker players typically bet
18 • March 2019 • Technical Analysis of Stocks & Commodities
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TRADING TECHNIQUES

6660.0 anticipate and spot them and take


Nasdaq 100 1-Min Chart 6656.0.0 appropriate action when they
6652.0 are formed. To illustrate, I have
6648.0
come up with a few examples
6644.0
on different markets and various
6640.0
timeframes so that you too can
potentially spot these patterns.
6636.0

6632.0

Selling into support


6628.0
6626.0
6624.0

6620.0 False breaks can happen on any


6616.0 timeframe. Generally speaking,
6612.0 the higher the timeframe, the bet-
6608.0
ter the quality of the setup. But
6604.0
even on the one-minute chart,
such as in this example of the
6600.0

Nasdaq 100 in Figure 1, the mar-


6596.0
TradingView

kets can form false break reversal


6592.0

6588.0

patterns. The 6590–6595 area


14:30 15:00 15:30 16:00 16:30 17:00 17:30 18:00 18:30

Figure 1: false break reversal pattern on a one-minute chart of the nasdaq 100. Notice how the had been a key short-term pivotal
index fell to below the 6592 level. This could have been because of a cluster of sell stop orders resting below the 6592 level.
Some may have been stop-loss orders from those who bought around 6592 earlier in the day (and then tightened their stops
zone on the higher timeframes,
to just beneath 6592 as price moved higher, in order to reduce their risk). The rest of these sell stops may have been from so the sharp 65-point jump off
breakout traders who, anticipating a breakdown of support, had placed their entry orders just below this low. the 6592 level just after the cash
market had opened made perfect
technical sense.
But when the market came
2120.0

S&P Futures Daily Chart 2100.0

back down again, notice the ac-


2097.6

2080.0

2060.0
celerated downward move just
2040.0
prior to the quick rejection. This
is where a lot of newer traders
2020.0

2000.0

get into trouble: selling right into


3. Buy rounded retest of old
resistance (now support)
1980.0

support as the fear of missing out


Confirmation: Higher high close
2. Buy the break here
1960.0
High
1940.0
1940.2
(FOMO) kicks in. The reason
the index fell sharply there was
1920.0

undoubtedly because of the clus-


1900.0
Another fakeout — more evidence
that sellers are getting into trouble
1880.0

1. Buy the break here 1860.0 ter of sell stop orders that were
1840.0
resting below the 6592 level.
Some of these may have been the
1820.0
1805.0

stop-loss orders from those who


Low Spikes below old low but closes well above 1800.0

had bought around 6592 earlier


60.0000

RSI in state of negative divergence (higher low relative to S&P,

in the day (and then tightened


40.0000
which was making a lower low). This indicates weakening selling pressure

their stops to just beneath 6592


Nov 16 Dec 14 23 2016 18 Feb 15 Mar 14 23 Apr 18

FIGURE 2: BUYING OPPORTUNITY? The follow-through that occurred on the day after the fakeout could have been a nice as price moved higher, in order
to reduce their risk), while the
breakout buying opportunity. And if you wanted to wait for extra confirmation, you could have waited for the break above
the old high at 1940. The index formed a false break reversal pattern and went on to make a higher low.
rest of these sell stops may have
been from breakout traders who,
large on premium hands. In trading, putting size on very anticipating a breakdown of the support, had placed their
high-probability setups could potentially make your month, entry orders just below this low (which is a typical rookie
quarter, or even your year. I am not implying that you should mistake, by the way).
be reckless and bet the farm on one trade. Rather, the risk In any case, the point I am making is that the liquidity
can remain the same, but the position size could be increased (cluster of sell stop orders) was used here to fill what must have
substantially as you become better with precision entry tech- been a large buy order, which explains why the market rallied
niques while simultaneously reducing the distance between sharply afterwards, as demand outweighed supply. Once the
entry and stop-loss placement, though not so tight that you index started to trade above the 6592 level, the idea here would
are shaken out of your position by market noise. have been to go long with a market order and place a tight
For me, these types of trades are typically made on the stop-loss beneath the most recent low. The potential reward
back of false break setups. Experience has taught me how to from this type of a trade would have been huge.
20 • March 2019 • Technical Analysis of Stocks & Commodities
What’s the ideal entry point?
False breaks can be traded many different ways and on dif-
ferent timeframes. In the daily chart of the S&P 500 futures The beauty of the false break
in Figure 2, I have highlighted at least three different areas setup is that sometimes price
to buy around, after the false break took place. Here, the
S&P spiked below the old low at 1805 but the sellers couldn’t goes significantly in the opposite
hold their ground for too long. To some degree, the fakeout direction, hence the saying
here could have been anticipated given the magnitude of the “from false moves come fast
prior drop and as the relative strength index (RSI), which moves in the opposite direction.”
is a popular momentum indicator, was in a state of positive
divergence already as the index retested that low. That is, the
RSI was making a higher low as the underlying S&P index
tried to break its old low, clearly indicating that the selling
momentum was waning. closes lower than the opening price. It clearly shows that the
As the false break could have been anticipated, intraday buying pressure has ended abruptly.
traders could have potentially bought near the low, based on These types of candlesticks are most effective when they
price action on a smaller timeframe chart such as the hourly occur at the top of trends, around old resistances or prior
or even the one-minute as per the Nasdaq example in Figure swing points, as is the case in this example. Based on this, a
1. But you don’t necessarily need to buy near the low. potential short trade would have been to simply enter once the
The important point is that once a false break takes place hourly candle closed. The stop-loss would have been a tight
and there is a good reaction away from that level confirm- one, placed just above this shooting star signal candle, and the
ing the mismatch between supply and demand, usually—not main target could have been, for example, the liquidity pool
always—the market goes in the other direction for several below the old low at $1,223 where sell stops would be rest-
days, providing plenty of subsequent tradable opportunities. ing, some of which are used to fill your closing buy order(s).
In this case, the follow-through that occurred on the day
after the fakeout could have been a nice breakout buying Downside directional bias
opportunity, as highlighted on the chart in Figure 2. But if To make it clear that false breaks can
you needed extra confirmation, well, the break above the old literally take place on any timeframe, the
high at 1940 was just that: Not only did the index form a false chart in Figure 4 shows a weekly chart of
break reversal pattern, it went on to make a higher low. As WTI crude oil. Although this fakeout has
the bullish trend is starting to emerge, traders can now utilize taken place on the weekly, you don’t nec-
various entry techniques to get onboard, such as the entry essarily need to trade on this timeframe.
examples I have highlighted on the chart. But it all started After a long-term reversal signal such as
with that false break!

Using candlestick Stop loss


1240.00
1238.00

signals
1237.00
1236.00
1235.95

When it comes to intraday trad- Short entry 1234.00


1232.70
1232.00

ing, the same logic applies: The 1230.00

false break will materialize as 1228.00

a temporary move above an old


1226.00
1224.00

high or below an old low and a


1223.18
1222.00

quick rejection. In the chart in


1220.00
Potential 1st target 1218.00
below old low
Figure 3, gold attempted to break 1216.00

above its old high at $1,236, but


1214.00
1212.00

the bulls’ advance was quickly 1210.00

rejected after a brief break. The


1208.00
1206.00

resulting price action was an 1204.00

inverted hammer (or shooting


1202.00
1200.00

star) candlestick pattern on the 1198.00

hourly chart. This particular 1196.00

pattern forms when a security’s RSI: Negative divergence 60.0000

price—in this example, the price


40.0000

of gold—advances well above


20.0000
12:00 6 12:00 7 12:00 8 12:00 9 12:00 12 12:00 13 12:00

the opening level of that time FIGURE 3: OLD HIGHS AND OLD LOWS CAN BE HELPFUL. Gold tried to break above its old high at $1236, but was met
period (in this case, hourly) but with rejection. The appearance of the inverted hammer suggests the abrupt end of the buying pressure.

March 2019 • Technical Analysis of Stocks & Commodities • 21


Notice of Class Action Settlement
If you transacted in Euribor Products1 between June 1, 2005 and March 31, 2011, inclusive
(“Class Period”), then your rights will be affected and you may be entitled to a benefit.
The purpose of this Notice is to inform you of your rights in Defendants make false Euribor submissions on their behalf to
connection with the proposed settlement with Settling Defendants benefit their Euribor Products positions.
Citigroup Inc. and Citibank, N.A. (collectively “Citi”) and Plaintiffs further allege that Defendants continuously conspired
JPMorgan Chase & Co. and JPMorgan Chase Bank, N.A. to fix the prices of Euribor Products in the over-the-counter
(collectively, “JPMorgan”) in the action titled Sullivan, et al. v. market to financially benefit their own Euribor Products
Barclays plc, et al., 13-cv-2811 (PKC) (S.D.N.Y.). The settlement positions. In addition to coordinating Euribor submissions and
with Citi and JPMorgan (the “Settlement”) is not a settlement with agreeing on where to price Euribor Products, Plaintiffs allege
any other Defendant and thus is not dispositive of any of that in order to effectuate their alleged manipulations of Euribor
Plaintiffs’ claims against other Defendants. and Euribor Products during the Class Period, Defendants
The Settlement has been proposed in a class action lawsuit engaged in “pushing cash,” transmitted false bids and offers,
concerning the alleged manipulation of the Euro Interbank Offered used derivative traders as submitters, and rigged bids and offers
Rate (“Euribor”) and the prices of Euribor Products during the for Euribor Products.
Class Period. The Settlement provides a total of $182.5 million Plaintiffs have asserted legal claims under various theories,
to pay claims from persons who transacted in Euribor Products including the Sherman Act, the Commodity Exchange Act, the
during the Class Period. If you qualify, you may send in a Proof Racketeering Influenced and Corrupt Organizations Act, and
of Claim and Release form to potentially get benefits, or you can common law.
exclude yourself from the Settlement, or object to it.
Settling Defendants have consistently and vigorously denied
The United States District Court for the Southern District of Plaintiffs’ allegations.
New York (500 Pearl St., New York, NY 10007-1312) authorized
What Does the Settlement Provide?
this Notice. Before any money is paid, the Court will hold a
Settlement Hearing to decide whether to approve the Settlement. Under the Settlement, Citi and JPMorgan agreed to pay a total
of $182.5 million into the Settlement Fund. If the Court
Who Is Included? approves the Settlement, potential Settlement Class Members
You are a “Settlement Class Member” if you purchased, sold, who qualify and send in valid Proof of Claim and Release forms
held, traded, or otherwise had any interest in Euribor Products may receive a share of the Settlement Fund after it is reduced by
during the Class Period, and during the Class Period were either the payment of certain expenses. The Settlement Agreement,
domiciled in the United States or its territories or, if domiciled available on the Settlement Website, describes all of the details
outside the United States or its territories, you transacted Euribor about the proposed Settlement. The exact amount each
Products in the United States or its territories during the Class qualifying Settlement Class Member will receive from the
Period. “Settlement Class Members” include, but are not limited Settlement Fund cannot be calculated until (1) the Court
to, all persons who during the Class Period traded CME Euro approves the Settlement; (2) certain amounts identified in the
currency futures contracts, all persons who during the Class full Settlement Agreement are deducted from the Settlement
Period transacted in NYSE LIFFE Euribor futures and options Fund; and (3) the number of participating Class Members and
from a location within the United States, and all persons who the amount of their claims are determined. In addition, each
during the Class Period traded any other Euribor Product from a Settlement Class Member’s share of the Settlement Fund will
location within the United States or its territories. vary depending on the information the Settlement Class Member
Contact your brokerage firm to see if you purchased, sold, provides on their Proof of Claim and Release form.
held, or traded or otherwise had any interest in Euribor Products. The number of claimants who send in claims varies widely from
If you are not sure you are included, you can get more case to case. If less than 100% of the Settlement Class sends in a
information, including the Settlement Agreement,2 Mailed Proof of Claim and Release form, you could get more money.
Notice, Plan of Allocation, Proof of Claim and Release, and How Do You Ask For a Payment?
other important documents, at www.EuriborSettlement.com
(“Settlement Website”) or by calling toll free 800-492-9154. If you are a Settlement Class Member, you may seek to
participate in the Settlement by submitting a Proof of Claim and
What Is This Litigation About? Release to the Claims Administrator at the address in the
Plaintiffs allege that Defendants, during the Class Period, Settlement Notice postmarked no later than July 31, 2019. You
conspired to manipulate and manipulated Euribor and the prices may obtain a Proof of Claim on the Settlement Website or by
of Euribor Products. Plaintiffs allege that Defendants did so by calling the toll-free number referenced above. If you are a
using several means of manipulation. For example, Plaintiffs Settlement Class Member but do not file a Proof of Claim and
allege that panel banks that made daily Euribor submissions to Release, you will still be bound by the releases set forth in the
Thomson Reuters, falsely reported banks’ costs of borrowing in Settlement Agreement if the Court enters an order approving the
order to financially benefit their Euribor Products positions. Settlement Agreement.
Plaintiffs also allege that Defendants requested that other (continued on next page)

1 “Euribor Products” means any and all interest rate swaps, forward rate agreements, futures, options, structured products, and any other instrument or
transaction related in any way to Euribor, including but not limited to, New York Stock Exchange (“NYSE”) London International Financial Futures
and Options Exchange (“LIFFE”) Euribor futures contracts and options, Chicago Mercantile Exchange (“CME”) Euro currency futures contracts and
options, Euro currency forward agreements, Euribor-based swaps, Euribor-based forward rate agreements, and/or any other financial instruments that
reference Euribor.
2 The “Settlement Agreement” means the agreement between Plaintiffs, Citi and JPMorgan, entered into on November 21, 2018, and filed with the
Court in this action.
(continued from previous page)
Notice of Class Action Settlement

If you transacted in Euribor Products1


between June 1, 2005 and March 31, 2011,
inclusive (“Class Period”), then your rights The fakeout, if traded correctly,
will be affected and you may be could be a very lucrative setup,
entitled to a benefit. requiring very few indicators but
a lot of common sense and a ton
If you timely submitted a Proof of Claim and Release
pursuant to the class notice dated November 29, 2017, of patience.
related to the $94 million settlement with Defendants
Barclays plc, Barclays Bank plc, and Barclays Capital Inc.
(collectively, “Barclays”); the $45 million settlement with
HSBC Holdings plc and HSBC Bank plc (collectively,
“HSBC”); and the $170 million settlement with Deutsche Bank this one is formed, speculators can move down to their own
AG and DB Group Services (UK) Ltd. (collectively, “Deutsche desired timeframes when it comes to looking for entries. The
Bank”) (the “2017 Notice”), you do not have to submit a new important thing is that price is now in a reversal profile and no
Proof of Claim and Release to participate in the Settlement longer in a rising trend or sideways profile. Thus, one way to
with Citi and JPMorgan. Any member of the Settlement Class look for potential short entries (in this case) would be to enter
who previously submitted a Proof of Claim and Release in as soon as price has formed a trap on the lower timeframes, as
connection with the 2017 Notice will be subject to and bound
we know from the weekly chart that the directional bias is to
by the releases set forth in the Settlement Agreement with Citi
and JPMorgan, unless such member submits a timely and valid
the downside now. Similarly, fading short-term strength at key
request for exclusion, explained below. old support levels should also provide ideal entry points.

What Are Your Other Options? Zoning in …


All requests to be excluded from the Settlement must be To illustrate the point of viewing price action on a lower time-
made in accordance with the instructions set forth in the frame, I would like to draw your attention to the daily chart
Settlement Notice and must be postmarked to the Claims of the WTI in Figure 5. We have already seen the fakeout on
Administrator no later than April 12, 2019. All requests for the higher weekly timeframe (in Figure 4). So any short-term
exclusion must comply with the requirements set forth in the rebounds should now be treated cautiously given that we are
Settlement Notice to be honored. The Settlement Notice, now in a potential reversal profile (I say potential here because
available at the Settlement Website, explains how to exclude we don’t know for certain which direction prices would go—
yourself or object. If you exclude yourself from the Settlement
obviously this is a hindsight example). Anyway, my point is
Class, you will not be bound by the Settlement Agreement and
can independently pursue claims at your own expense.
you don’t need to trade from the weekly chart after a fakeout
However, if you exclude yourself, you will not be eligible to reversal pattern unfolds on that timeframe.
share in the Net Settlement Fund or otherwise participate in the So, looking at the daily chart, I have highlighted five clear
Settlement. entry points using two different entry techniques on this
timeframe, all because of that reversal pattern on the weekly.
The Court will hold a Settlement Hearing in this case on
The first sign that the bulls were getting trapped was when
May 17, 2019, to consider whether to approve the Settlement
and a request by the lawyers representing all Settlement Class
price formed a bullish hammer-looking candle (highlighted)
Members (Lowey Dannenberg, P.C. and Lovell Stewart but there was no follow-through. So a potential entry on the
Halebian Jacobson LLP) for an award of attorneys’ fees of no back of a no-show from bulls here would have been to go short
more than nineteen percent (19%), or $34,675,000, of the once price broke the support level shown on the chart.
Settlement Fund for investigating the facts, litigating the case, Two further similar patterns are also highlighted on this
and negotiating the settlement, and for reimbursement of their chart. The other entry style would be to sell the rounded
costs and expenses in the amount of no more than retest of broken support levels at $62.60 and $61.26. Notice
approximately $1,300,000. The Plaintiffs may also request no that once the reversal occurred, the follow-through in selling
more than $400,000 from the Settlement Fund as pressure has been more significant each time prices broke
reimbursement of their own expenses and compensation for down than was the case when prices rebounded. This is why
their time devoted to this litigation. The lawyers for the
trading with the trend makes more sense, regardless of your
Settlement Class may also seek additional reimbursement of
costs and expenses in connection with services provided after
style of trading.
the Settlement Hearing. These payments will also be deducted
from the Settlement Fund before any distributions are made to Key takeaway points
the Settlement Class. In all the examples I have provided in this article, the com-
mon denominator behind these false breakout patterns was a
You may ask to appear at the Settlement Hearing, but you do
not have to. For more information, call toll free 800-492-9154
sharp move into an old significant high or low. If price drifts
or visit the website www.EuriborSettlement.com. toward the level, typically it will break through it. After all,
the more distance price must travel to an old swing point, the
March 2019 • Technical Analysis of Stocks & Commodities • 23
Swing high False break You would rather make
$100 from a 10-point
76.000
75.360

WTI Crude Oil Weekly Chart 74.000


72.000
move, risking $10 per
point, rather than from
70.000
68.000
66.000 a 100-point move, risk-
ing $1 per point. In both
64.000
62.000
60.000 cases, the nominal and
58.000
percentage r isks a re
the same, but the nomi-
56.000
54.000
52.000
nal position sizes are
significantly different.
50.000
48.000
46.000 Therefore, to achieve
the same nominal return,
44.000
42.000

Mar May Jul Sep Nov 2018 Mar May Jul Sep Nov 2019 price needs to travel a
FIGURE 4: LONG-TERM REVERSAL SIGNAL. After you see a long-term reversal signal on a weekly or higher timeframe, you much shorter distance,
can move down to a lower timeframe chart to look for entries. Keep in mind that price is now in a reversal profile and no longer in compared to setups with
a rising trend or sideways profile. lower reward-to-risk pro-
files. The shorter the
WTI Crude Oil Daily Chart 76.000
distance of your profit
Low from weekly fakeout candle 74.000
target, the more likely it
is it will be reached, since
73.128
Sell on break below this level. 72.000
Reason: No upside follow-through
despite bullish-looking candle
(highlighted) AND given weekly 70.000 the more time elapses,
the more likely it is for
bearish bias
68.000

something to go wrong,
Sell here
or here (similar setup to above)

for example, some unex-


66.000
Sell on rounded retest
of these broken support
pected news announce-
levels (new resistance) 64.000

62.601

ment causing a reversal


Resistance 62.000
61.267

against your position.


Resistance
60.000

58.000 So the fakeout, if traded


56.000 correctly, could be a very
16 24 Aug 13 21 Sep 17 Oct 15 23 Nov 12 20 Dec
lucrative setup, requiring
FIGURE 5: FOCUSING IN ON A SHORTER TIMEFRAME. Here you see five clear entry points using two different entry techniques
very few indicators but a
on this timeframe that came about because of that reversal pattern on the weekly. lot of common sense and
a ton of patience.

more likely it will be hit by profit-taking and thereby increas- Fawad Razaqzada is an economist and market analyst who
ing the likelihood of a rejection. has been involved in the financial markets for almost 10 years.
Indeed, there are market participants out there—among He has worked for several leading brokerages as a market
them “mean reversioners”—who anticipate breakouts to fail analyst in London. Specializing in forex, commodities, and
and sometimes, when the conditions meet their requirements, stock indexes, Razaqzada has expertise in reading price action
enter heavily as price breaks an old high or low. on the charts. He uses his knowledge of economics together
The beauty of the false break setup is that sometimes price with fundamental analysis to forecast short-term price fluc-
goes significantly in the opposite direction, hence the saying tuations. He has also been trading his personal account for
“from false moves come fast moves in the opposite direction.” many years. Follow him on Twitter at @Trader_F_R.
In addition to the multiple entry potentials after the fakeout
is formed, it is also possible for traders to establish long-term ‡TradingView
position trades from price action on lower timeframe charts ‡See Editorial Resource Index
such as the hourly, as long as the formation occurs around
a higher timeframe technical level. These trades normally
have lopsided risk-to-reward profiles, allowing the trader to
put on size behind the trade as the stop-loss is typically very
tight, especially if the fakeout setup is identified on the lower
timeframes relative to, for example, an entry off a daily or
weekly chart.
These premium types of trades can significantly increase the
potential reward, simply because of having a tight stop-loss.
24 • March 2019 • Technical Analysis of Stocks & Commodities
Algo Q&A
ALGORITHMIC TRADING
Have a question about system or algo trading? Kevin J. Davey has over 25 years of
system trading experience. Davey is a full-time trader, and he also teaches and con-
sults via his Strategy Factory online workshop (http://kjtradingsystems.com). He is the
author of several bestselling trading books, including Building Winning Algorithmic
Trading Systems and Introduction To Algo Trading. Send your questions or topic sug-
gestions to Kevin Davey at kdavey@kjtradingsystems.com. Selected questions will
appear in a future issue of S&C.
Kevin J. Davey

A DAY IN THE LIFE OF AN algo traders. There is a phrase, “auto- diversification to a trading portfolio, or
ALGO TRADER mated trading doesn’t mean unattended just be an improvement over existing
As a new algorithmic trader, how should trading,” and that is wise advice. In ad- strategies. This is where many algo
I be scheduling my day? I am an expe- dition, there are always “maintenance”- traders spend most of their time. De-
rienced trader in futures and forex, but type trading activities to be performed, veloping strategies is time-consuming,
only as a discretionary trader. such as checking equity runs, conducting but it is critical to keeping your trading
It’s good you have trading experience, contract rollovers, adjusting portfolio al- at a high level.
since many people try to jump into algo locations, and more. In total, most algo Think of this task as research and
trading without knowing the basics. To traders spend part, but not all, of their development. Every successful company
know the markets and be able to use your day monitoring and correcting their dedicates some of its budget and man-
trading platform are two essentials any live trading. power to R&D. Without it, the company
trader should have before starting with Second, good algo traders constantly stagnates and will eventually be over-
algorithmic trading. Not understanding develop new strategies. These new taken by competitors. The same holds
how to manually enter an emergency strategies can replace broken ones, add true with trading—having a steady supply
order, or realizing you must roll of new strategies in development is
over futures contracts prior to a way to keep your trading going
expiration are just two examples You can’t just automate for years and years. No strategy
of the kind of thing you don’t want an algo and let it run with lasts forever—just ask the formerly
to have to learn in the heat of the well-known Turtle Traders!
moment! no supervision. Checking Finally, algo traders spend a
With the basics under your belt, positions throughout the day portion of their time improving
what kinds of tasks are involved in and night is typical for most their trading. This could include
day-to-day algo trading? Certainly algo traders. investigating new platforms or
not what you are used to in discre- programming languages, learning
tionary trading, especially if you different styles of algo trading (for
found yourself glued to a screen instance, pair trading or spread
throughout the trading day. Algo Algo Trader — Sample Time Distribution trading to complement directional
trading is not like that at all. trading), educating themselves on
First, since algo traders typically new trends in trading (for example,
Monitoring
run many automated strategies, Live Strategies machine learning), and researching
keeping an eye on these strate- novel and unique approaches to
gies is your highest-priority task. Enhancing Trading
Skills/Education
13% portfolio trading, position sizing,
After all, this is where your money and more. Just as with develop-
is made (or lost!). Luckily, most 28% ing new strategies, the top algo
trading platforms are pretty user- traders devote part of their time
friendly, and the chances of a tested to enhancing their craft. Reading
algorithm going rogue and placing this magazine, for instance, is an
thousands of orders are small. But Developing New important endeavor in this area.
odd things can happen, so “set it Strategies As an example, for a week I kept
and forget it” is definitely not ap- 59% track of my trading-related activi-
propriate here. ties. During this week, which was
You can’t just automate an algo fairly typical, my time was divided
and let it run with no supervision. as shown in Figure 1.
Checking positions throughout the
day and night is typical for most Figure 1: Typical Time Breakdown for Algo Trading Continued on page 62
March 2019 • Technical Analysis of Stocks & Commodities • 25
The On-Balance Volume

All About OBV


On-balance volume is a classic indicator that can be helpful and to provide some trend perspective.
for indicating trends and for confirming other indicators. In order to fully understand OBV, you need to know how
You’ve undoubtedly looked at it on your charts, but if you’ve it’s formulated. Joseph Granville in 1963 published a book
never really known exactly how it works or how it’s most titled Granville’s New Key To Stock Market Profits and in it
useful, here’s a close-up view. introduced the on-balance volume calculations. OBV is a tool
used to measure current buying and selling pressure levels. This
by John Devcic is done by adding to a running total the volume on days with

W
higher closes to give you a measure of buying pressure, and
hile the number of tools available to the trader subtracting volume on days with lower closes to measure selling
grows all the time, sometimes the tools and pressure. The formula assumes that on up days, all volume is
indicators that have been around a long time still positive and on down days, all volume is negative.
serve the trader well. In this article, I’ll examine The calculations are simple. Let’s say that today, stock XYZ
one of them, the on-balance volume (OBV), and closed higher, meaning that buying dominated. It would be
XYZ LOGO: FULLRIZQISHUTTERSTOCK/

show you how I have used it to trade. calculated as:


COLLAGE: CHRISTINE MORRISON

Inexperienced traders tend to debate one indicator versus


another and which one is the best to use. Experienced traders Current OBV + Today’s volume = Today’s OBV
know there is no one perfect indicator, just as there is no one
perfect security or investment. OBV is an indicator that can Meanwhile, if XYZ closed lower today than the previous close,
be used in conjunction with other trading signals for context meaning that selling dominated, it would be calculated as:
26 • March 2019 • Technical Analysis of Stocks & Commodities
Technical Indicators

Current OBV – Today’s volume = Today’s OBV trend—as opposed to diverging from it.
Here are two other important things to keep in mind as well:
Finally, we have to account for sideways moves. This is when You want to be on the lookout for volume spikes that can cause
today’s close equals yesterday’s closing price: the OBV indicator to be thrown off; and remember, OBV is
using closing prices so you should make it a point to note all
Today’s OBV = Previous OBV support & resistance levels using closing prices.

I’ll provide a couple of examples to clear up any confusion. Divergences can be key
Using one week’s worth of trading, here is a simple example I mentioned that you are looking for whether the OBV trend
to illustrate how to calculate OBV: matches the price trend or diverges from it. There are two
main types of divergences to keep a lookout for. A bearish
• On Monday, XYZ closed at 100.
divergence will be seen when price is advancing while the
• On Tuesday, XYZ closed at 101.10 with a trading volume OBV line is declining. Bullish divergence is when price is
of 40,000. declining but the OBV is moving higher, signaling that future
• On Wednesday, XYZ closed down at 100.10 with vol- prices will move higher.
ume of 10,000. For example, when looking at a chart, you want to look
for a break in price trend while the OBV remains higher; the
• On Thursday, XYZ closed up at 102 with volume of
higher OBV level signals there is still strength in the price
15,000.
trend, and this minor divergence can allow you to move into
• On Friday, XYZ closed up again at 102.75 with volume a security before it changes direction.
of 10,000. Now that you know how to calculate the OBV and under-
stand how it works, let’s look next at using it to trade. I traded
Now let’s put those numbers into the formula. a few stocks using the OBV line alone so I could present how
it fared. I simply entered a position once an OBV slope was
• Tuesday’s close was up, so we have a positive day. The
moving upward, and exited when that same OBV line was
OBV will be 0 + 40,000 = 40,000.
rapidly moving downward. Here are the stocks I traded, along
• On Wednesday, XYZ fell, and that’s a negative day. The with the results:
OBV will be 40,000 – 10,000 = 30,000.
• Thursday was an up day, so the new OBV will be 30,000 GOOG
+ 15,000 = 45,000. Google (GOOG) is my first case study. But first, just to illus-
trate what OBV looks like on a chart, Figure 1 shows a basic
• Friday saw another positive close, bringing our new
chart of GOOG in 2018 through December 28, 2018. OBV is
OBV to 45,000 + 10,000 = 55,000.
in the bottom panel, right beneath volume.
It’s a simple enough calculation that can also be plotted on a In Figure 2, the shaded rectangle that I’ve added labeled
chart, and I’ll provide some chart examples shortly. “1” tells us a few things. On January 2, the stock is moving
Calculating OBV and having all these numbers based on and closes at 1065, just shy of the high of the day. Volume
volume is nice, but what exactly do we do with them when it was not as impressive as the actual point move. That was
comes to trading? A rising OBV signals that the current buying followed by another new close on January 3 at 1082. This
pressure is strong and building and can
signal more buying. If the OBV is fall-
ing, that can tell us that selling pressure
is building and growing stronger and can
lead to more down days ahead. Accord-
ing to Granville, you can expect prices
to move higher if the OBV is going up
and the current price is either sideways or
falling slightly. The reverse is also true: If
OBV is falling, you should expect prices
to move down if current prices are either
sideways or rising slightly.
Granville explains that the actual OBV
number is irrelevant; instead, you want to
spot the trend of OBV before you worry
thinkorswim

about anything else. Once you have


figured out the OBV trend, you need to FIGURE 1: ON-BALANCE VOLUME. OBV is shown in the bottom panel on this 2018 price chart of Google
see if that trend matches the current price (GOOG).
March 2019 • Technical Analysis of Stocks & Commodities • 27
upward movement continues until the
end of the rectangle on January 30 at a
close of 1163.69. A good move indeed,
but the OBV indicator was not moving 1
upward. This is clearly a divergence and
we stayed on the sidelines, although we
missed a good move.
In Figure 3, the second shaded rect-
angle tells us a different story. The move
down was real and it began on January
31 with a close of 1169.94. Take a look
at OBV. It spirals downward fast on that
same date. You had a couple of days to
get out if you were in. The second thing
FIGURE 2: OBV DIVERGENCE. GOOG moves strongly upward in the shaded rectangle area but the OBV
that OBV is good at is indicating if a indicator did not, keeping the trader on the sidelines.
trend is indeed real. In this case, there is
no doubt that the downward selling was
on. We hit a bottom on February 8 with
a close of 1001.
2
In the shaded rectangle labeled “3” in
Figure 4, we see a longer pattern where
OBV sent us some very interesting sig-
nals. We get one more push upward that
stalls on March 12 with a higher close of
1164.50. Volume again is relatively low
but OBV signaled some trouble—not
enough to sell or get out but enough for
me to keep a closer eye on it. The next
day was a rough one, with a low of 1133
and a close of 1138. I did not exit nor FIGURE 3: OBV CONFIRMATION. In this case, OBV spirals downward with price, confirming the downward
did I see a reason to at this point. This trend and indicating an exit.
sets us up for point A, which perfectly
corresponds with March 19 and you can
see that OBV is now sloping down hard. D
3 E
At this point, I exited the position. You’re
not getting back in until May 31 and you A
would have seen OBV finally moving
upward away from that low. I got back in B C
on June 1. OBV is now higher and with
that next downturn we see that the OBV
line does not really move downward as
far as the already low points. This works
out beautifully and brings us to point D,
where we get a high that is tested a couple
of times and fails. This is July 27 and now
we are getting lower highs. At this point, FIGURE 4: OBV SIGNALS. In the shaded area, OBV is indicating possible trouble ahead. At point A on March
volume is stalling but OBV stays strong. 19, 2018, OBV indicated an exit. It didn’t turn upward until May 31, a reentry point. On August 31, OBV signaled
We see a divergence between price and another exit. A reentry signal has not yet appeared.
the OBV level, which can signal potential
opportunity to add to our current position. All of this changes NFLX
on August 31 when OBV signals it is time to exit. There was Our next test subject is one of the popular stocks being traded
a holiday in between, and your first opportunity to get out is today, that being Netflix (NFLX), shown in Figure 5.
on September 4. We can see that for the rest of the year, OBV Much like Google, it was heading upward right from the
does not signal another opportunity to get in. This chart ends start of 2018. OBV was trending upward, confirming the
on December 28 and so far going into 2019 as I write this, move higher. Our first real signal comes around that point
we’ve seen a small rally in Google but no signal to enter. A at January 22. The slope is now clearly heading upward
28 • March 2019 • Technical Analysis of Stocks & Commodities
and an entry here is ideal. Volume backs
that up, as we have back-to-back higher- C
than-average volume bars. The move
continues unabated until we get to our F
D
first real point where we would even think B
about the possibility of a trend change
A
on March 27, represented by point B on
the chart. Looking at the OBV panel, you
can see a corresponding shaded box that
shows us that indeed, the current trend
is not broken, and while it does move
lower, the OBV slope is not rapidly going
down, indicating that we should sit tight
and do nothing. We are rewarded by this
decision, as NFLX continues higher all
the way to our first worry point on June FIGURE 5: IDEAL SIGNALS. OBV trended upward with higher-than-average volume, confirming the move higher
21 (represented by C) when we hit some in Netflix (NFLX) and signaling an entry near point A on January 22. It didn’t signal an exit until point D on July
16, with the OBV sloping down rapidly and confirmed by high volume and falling price.
resistance. If we look to the OBV line we
see that it starts moving down but again,
as in the previous example, we sit tight.
This proves to cost us some profits. Our
next worry point, and what eventually
turns into the sell point, is point D on
July 16.
At this point, we have three indications
lined up telling us to get out: We have A
a huge move down in price correspond-
ing to extraordinarily high volume, and
an OBV line that slopes down rapidly.
Thus, you get out and you stay out for the
rest of the year. This is simply because
OBV stays in the middle and does not
give us any signals that any price move
is an entry point or one to consider. Our FIGURE 6: WIDE VIEW. Citigroup (C) is in a channel for most of the year.
next level comes on October 17, which is
represented by point F on the chart. We
have an unexpected move higher with
an unusual volume spike, as well as an
OBV line that moves up but not high
enough to really look at. After this point, A
NFLX continues moving down and that
continues as we head into 2019.

Citigroup (C)
My next example takes us away from
the high-flying tech sector and to the
more mature banking sector. The chart
in Figure 6 is Citigroup (C).
I had an existing position in this stock
going into 2018. There are two price
levels drawn on the chart. The top one is FIGURE 7: ZOOMING IN. Here in higher resolution, you can see that the first sign of trouble is on October 23 and
then the real trouble starts around December 4 with a falling OBV, high volume, and falling price. By December
at 76.63 and the lower one was placed at 10 (point A), the OBV line is sloping downward fast and hard, an unmistakable exit signal.
64.26. Between these levels is clearly the
area where Citigroup stayed throughout the bulk of the year. the line signaled that the uptrend was intact. From that point
On January 29, it hit its high for the year at 80.70. Looking it’s a series of lower highs and just staying in the channel. But
at the OBV line, I was confident to stay in at that point, since this chart is far too wide for my taste so I’ll narrow it down
March 2019 • Technical Analysis of Stocks & Commodities • 29
instead, it remained fairly neutral. We had a minor rally toward
If the OBV is falling, that can the tail end of 2018 but no entry signal was generated.
tell us selling pressure is
TWTR
building and growing stronger Of course, it’s not all roses when it comes to trading. Here
and can lead to more down is one example where the OBV was in no way helpful. The
days ahead. stock is Twitter (TWTR), shown in Figure 9.
Where do we start? How about right at the beginning of
the chart at point A. There is a gap up. The move shows that
we should have gotten in since the slope was moving up
a bit to better see what’s going on (Figure 7). quickly even though the price was not moving up. This all
The first sign of trouble comes on October 23 when Citi- happened on February 1 when the OBV line moved upward.
group touches the lower price level and then closes below it. The gap occurred seven days later. We hit our first high on
After that, we have a mini rally but it closes below that level March 14. This was followed by a move in the other direc-
on November 14. At this point OBV is still high and not tion. We can see that OBV does not really head down to the
signaling any real worry. It trades below that level for a few lows and instead stays in the middle so I stayed in the trade.
sessions, does a brief rally, and on December 3, it hits a high I saw another buy signal to add to my current position with
of 66. December 4 is when OBV starts to slant downward, a strong upward slope at point B at May 31. This turned out
corresponding to a large drop in the price. Volume at this point to be an excellent decision, as the price nearly doubled from
is picking up steam and remaining high. The problem is the my original entrance price.
price is falling. Point A on the chart is on December 10 and OBV remains strong even though after the high is hit on
this is when there is no mistaking that the OBV line is sloping June 15 we are greeted with lower highs until we get to the
down fast and hard. This is an exit position straight away. In trouble zone on July 27, represented by point C. Is OBV head-
summary. we had a high of 80 and a low of 48. That’s nearly ing down? Yes, but its slope is not significant enough for me
half the value gone over the course of the year. Currently, there to exit the trade and that’s even followed by a higher OBV
is no buy signal from OBV even though the shares have seen line. Here is divergence in action. OBV remains high as the
a bit of a pop toward the end of 2018. price continues downward.
That brings us to point D on October 11 with a close of
ISRG 27. The OBV line is not even sloped downward but instead
Medical stocks are always worth trading and our next example remains strong. The price does bounce upward, eventually
is no different. Intuitive Surgical (ISRG) was a high flyer in 2017 hitting a high of 37.14 on December 12. The OBV remains
and made some pretty decent moves in 2018 (Figure 8). high on TWTR heading into 2019. Yes, with hindsight I can
I was not in this stock at the beginning of 2018 but I decided quickly point out my mistake of ignoring the lower highs
to enter a position on January 19. Price was moving higher and when I saw them occurring. However, you cannot successfully
OBV was sloping upward so I got in. The signal to get out came trade with a tool and second-guess it at the same time. Will
on February 2, which resulted in a loss. The stock continued Twitter move upward in 2019? I don’t know, but currently, I
to trade slightly upward but I waited until I got that gap up (B) am still in the trade.
and entered a position on April 18. Since
OBV stayed relatively benign I stayed in
the position and watched the stock move
up and it did so pretty consistently. The C D
first sign of trouble came on October 8
(point C) shortly after it hit its high. I
remained in the position for a little while A
longer and saw that indeed, the OBV line
B
was sloping downward, and I exited on
October 11. I continued to watch the stock
the remainder of the year and we got a
bump up on November 7 (point D), but
OBV remained right in the middle so
there was no signal to reenter.
Interestingly, even though the stock
traded up and down until December 14
and since then it has gone almost straight FIGURE 8: HIGH FLYER. The gray shaded rectangles highlight strong OBV slopes, which are the signals.
Here, the first trade from January 19 to February 2 ended in a loss while the second trade between April and
down, still, the slope of the OBV line was October was profitable. Throughout the ups and downs in ISRG late in the year, the OBV remained neutral,
not even close to confirming a downtrend; with no signals generated.
30 • March 2019 • Technical Analysis of Stocks & Commodities
TLRY
One of the hottest sectors of 2018 was
the marijuana stocks and there were
a couple that were worth playing. The
one I traded was the fast-moving Tilray A
(TLRY), shown in Figure 10.
B
As with most everyone else as well, I C
didn’t pick up on Tilray until September D
5, when OBV slopes upward. I did not
get in at that time; instead, I waited and
entered on September 13, represented by
point A at 119. It ended up being perfect
timing, since on September 19, TLRY
hit a high of 300 only six days later. The
price quickly came right back down and
remained in a trading range. On October FIGURE 9: OBV DOESN’T ALWAYS WORK. OBV was less helpful on TWTR in 2018. Two entries signaled by
upsloping OBV lines were promising but I didn’t exit my position in 2018 because OBV remained strong despite
2 at point B, an up day is followed by a a falling price. Will 2019 prove OBV correct for TWTR?
down day. OBV remained in the upper
range, and it stayed in the upper range
for the rest of the year. On November 7
at point C, the stock closed at 139.60.
That ended the good times, since from
that point, price meandered downward B
almost on a daily basis followed by a A C
declining, almost-dead volume level
and an OBV that remained flat but in
the upper range.

Real-world
OBV
These examples are
based on real trades
that were not fitted in
any way in order to FIGURE 10: FAST AND FURIOUS STOCKS. One of the hottest sectors of 2018 was marijuana stocks. The
fast-moving Tilray (TLRY) stock was one that was worth playing. OBV produced several signals.
make the OBV indica-
tor look good or bad. Understandably,
you will never want to trade using just
OBV, and the last couple of examples
demonstrate why. So what’s a better way
to use OBV? An easy way is to simply add B
another indicator to the same chart. C
A
Figure 11 is the same chart of TLRY as
in Figure 10 but with two simple moving
averages (SMAs) added. This is a better
real-world example of how OBV should
be used. The black line represents a 25-
day SMA and the red line is a 50-day
SMA. Looking at this chart, my exit
signal would have been at point C when
the 25-day moving average crosses below
the 50-day moving average. Why is this FIGURE 11: OBV WITH MOVING AVERAGES. Here’s the same chart as in Figure 10 but with two simple mov-
a more realistic example? Again, it’s not ing averages (SMA) added for signal confirmation. An exit is signaled at point C when the 25-day SMA crosses
below the 50-day SMA. It’s best to use OBV in conjunction with other trusted indicators.
because it’s hindsight, but rather it high-
lights why you shouldn’t rely on only one
indicator. No indicator, no matter what it measures, should be I’ve demonstrated a couple of examples where OBV worked
used in isolation. OBV is a good example of that. Granted, by itself pretty well and resulted in profits. The problem is,
March 2019 • Technical Analysis of Stocks & Commodities • 31
we never know which occasions those will be.
The other problem is when to get out. Sure, we can easily The second thing that OBV is
spot an entry point and say that an OBV sloping upward tells good at is indicating if a trend
you the trend is up and you can enter. But as we have seen, we is indeed real.
are not given a sell signal the same way, as OBV can diverge
from the current trend.
OBV signals, or tries to signal, money flowing into and out
of a security. An upward-sloping OBV line indicates money is For this article, I traded with only this one indicator simply
flowing in and it’s time to enter a position or add to a current to test its effectiveness. Clearly, OBV is a very useful tool
position. A downward-sloping OBV line tells us that money when used properly and in conjunction with another indicator
is flowing out and it’s time to get out. Pretty simple. that you can trust.
You could also use OBV to indicate when a prevailing trend
may be losing steam. If the OBV line is sloping downward John Devcic is a market historian and freelance writer. He
and price is moving higher, you should be looking for an exit may be reached at jdevcic@gmail.com.
as soon as you can.
In either case, when used in conjunction with other indica- Further reading
tors, OBV can signal spots where money is entering. Granville, Joseph [1963]. Granville’s New Key To Stock
In all the examples in this article, you can see when accu- Market Profits.
mulation happens. Use OBV along with other reliable indica- ‡thinkorswim (TD Ameritrade)
tors, as was shown in my final example where I simply added ‡See Editorial Resource Index
two simple moving averages that would have told me to exit.
Other indicators might have signaled an earlier exit.
TrAdinG On MOMenTUM

CALHOUN terns. I will often use this technique with it was my experience that many of my
Continued from page 7 three to fi ve trades per day. You should biggest winning trades used a “set it
always diversify, and trade several stocks and forget it” intraday swing trading
simultaneously, to minimize your over- approach. By this, I simply mean that
Step 3: Don’t watch the stock chart all risk. Successful trading is all about I initiated the trades between 9:30 and
all day long; instead, simply come minimizing upfront risk, and maximiz- 10:30 am, entered my stop-loss, then
back during the last 30 minutes or so ing overall profi t potential. This intraday came back during the last hour of the
and close the entire position around swing trading approach accomplishes market to close the trades. This helped
3:50 pm ET. both for you. My personal trading goal keep me from overtrading or getting
is to make the majority of my trades with out too soon during intraday minor
insights: Why this tech- this technique (it requires patience!). As reversals.
niQue WOrks a reminder, on down days in which there The two critical risk management
This strategy combines the best of both are few upside gaps, I use this technique variables are the initial share size and
worlds from intraday and longer-term with inverse ETFs and ETNs like TVIX, initial stop-loss price. You may want to
swing trading. You get the benefi t of a SQQQ, and LABD. On up/green days experiment with these to fi nd the best
multipoint move, without the risk of hold- I use this strategy with long ETFs like combination for your personal trading
ing overnight. I believe this is the single TQQQ, SPXL, and LABU. style. You can also consider adding to a
best approach for active traders, because winning trade sometime in the middle
you can use a smaller 100- to 300-share traDe ManageMent tips of the day to scale in; if you do this, then
size initial position and still have solid In doing over 2,280 real-money trades be sure to tighten up your trailing stop to
profi t potential. It also avoids the foolish during the last several months of 2018, breakeven on the entire position.
upfront risk that inexperienced, young,
small-cap daytraders advocate, trying Ken Calhoun is a producer of trading
to trade thousands of shares of cheap, This strategy combines courses, a live trading room, and video-
under-$10 stocks for quick scalps, which the best of both based training systems for active traders.
usually go against the trader and cause He is the founder of TradeMastery.com,
massive losses.
worlds—intraday and an educational resource site for active
By trading strong initial gap charts for longer-term swing traders and is a UCLA alumnus.
all-day-long trades, you can often get big trading.
moves out of these uptrending chart pat-
32 • March 2019 • Technical Analysis of Stocks & Commodities
Seifert/21st Century covered call a profit, and the stock can’t be called away. If the stock goes
Continued from page 11 slightly lower, you may win money. If the stock tanks week
after week, you lower your average price and hopefully when
it recovers you have lowered your average price so much that
you keep the stock instead of having it called away at $320. you are in a position to make money on the rebound. The trade
Continue the next week by initiating a 350.0–365.0 call requires just a few minutes a week to manage and removes
credit spread for a credit of around $5.90. almost all of the problems of the covered-call strategy!

Total account value: $35,000 + $590 - $1,500 = $34,090 Robert J. Seifert is president and CEO of The Optionomics
($2,090 gain) Group LLC, www.optionomicsgroup.com. He is a 35-year
veteran options trader and was an options market maker for
5) Small loss: Stock drops by about 1.5% to $315 almost 20 years at the CME, CBOT, and CBOE. In the early
You pocket the $590 from the call credit spread. You have an 1990s, he was appointed by the CME to the position of Vice-
unrealized loss of $500 in the stock. Chairman of International Monetary Markets (IMM), which
Continue the next week by initiating a 315.0–330.0 call was the highest-ranking options floor position at the CME.
credit spread for a credit of around $5.90. Until his retirement in 2018, he was an adjunct instructor at
UNLV where he taught Finance 485, an advanced options
Total account value: $31,500 + $590 = $32,090 strategy course. He is the author of Profiting From Weekly
($90 gain) Options and Trading Options My Way. He may be reached
at optionomics@marketedge.com.
6) Big loss: The stock drops by about 5% ($15) to $305
You pocket the $590 from the call credit spread. You have an Further reading
unrealized loss of $1,500 in the stock. Seifert, Robert J. [2015]. Profiting From Weekly Options:
Continue the next week by initiating a 305.0–320.0 call How To Earn Consistent Income Trading Weekly Option
credit spread for a credit of around $5.90. Serials, Wiley Trading.
[2018]. “One-Day Wonder Trades,” Technical Analysis
Total account value: $30,500 + $590 = $31,090 of Stocks & Commodities, Volume 36: October.
($910 loss) Trading Options My Way, digital booklet, www.op-
tionomicsgroup.com.
Manage the weeklys ‡Optionomics Group LLC
As you can see, the advantage of this strategy is that it can be ‡See Editorial Resource Index
used either long or short term. If the stock goes higher, you may †See Traders’ Glossary for definition
give up some of your potential gain, but you are guaranteed

aldrovandi, Malandra, & PaCCHioni/HiStory strategieditrading.it or www.strategieditrading.it.


Continued from page 17 Max Malandra is a financial analyst and journalist with
a degree in economics. He cofounded the financial website
www.finanzaoperativa.com, which was later sold. He recently
to different types of financial instruments. You could also add authored a book on the markets (published in Italian). He
a money management strategy, since we did not incorporate may be reached at malandra@finanzaoperativa.com or www.
that in this study. finanzaoperativa.com.
Fabio Pacchioni is a blockchain developer and trading
Alessandro Aldrovandi has worked as a futures trader and system designer with a master’s degree in electronic engineer-
portfolio manager. He has a degree in economics and is a ing. He is also a software engineer using various commercial
member of the Italian Society of Technical Analysis and the trading platforms to test and validate trading systems. He may
Italian Financial Analysts Association. He founded the pro- be reached at fabio.pacchioni@gmail.com.
prietary trading firm STRATEGIEDITRADING.IT, which uses
both discretionary and quantitative strategies. He has authored
five books on trading techniques. He may be reached at info@
March 2019 • Technical Analysis of Stocks & Commodities • 33
INTERVIEW

Getting Your Game On

The Psychology Of Trading


With Claudio Demb
Claudio Demb, MD, is a psychiatrist and has been an individual trader and
investor since the 1990s. He is a frequent contributor to this magazine on the
topic of trading psychology. Along with his professional practice, he has an
academic appointment as an instructor in psychiatry at Harvard Medical School.
He is the author of the recently published Trading Your A Game: How Feelings
& Emotions Influence Trading & Investing Decisions. His blog about trading
and the psychological aspects of trading can be found at claudiodemb.com.
Stocks & Commodities Editor Jayanthi Gopalakrishnan spoke with Clau-
dio Demb on January 15, 2019 about how he juggles trading and a full-time
job, and how he uses his insights into trading psychology to improve his own
trading.

Claudio, tell us a little bit nothing after a few years. I couldn’t


about your background. believe I could lose all that. As a kid,
What led to your interest that was a hard lesson.
in trading? I was always conscientious with
I grew up in Argentina. My grand- money; I was conservative and was
parents had escaped from Russia. The always saving. So I started to buy for-
reason it matters is because they came eign currency, mostly US dollars and
Short-term trading
to Argentina without any money and Swiss francs. When I was a teenager, doesn’t match up with
died poor. Thus, my parents wanted to I would take whatever savings I had my personality. I need
do well and wanted to do better than and I would sneak into a dealer bank to make sure I am
my grandparents did. So money matters and buy foreign currency. At that time,
were important in my house as a way to I had no idea about stocks or bonds.
comfortable with my
succeed, and we were mindful or aware I had no clue whatsoever because trading style.
of the power of trying to live well given that was not part of the culture. It
how poor my grandparents were. And as was not available to me. But buying
a boy, I was curious about finance and foreign currency was how the seeds When I was finishing up my medical
wanted to learn about it. got planted. residency in New York City, I started
In school, there was a government Pursuing a graduate-level education to think about saving money again,
program that encouraged kids to save was highly encouraged in my family. I since until then, I had no money. When
money, and that’s what I did. You could had an interest in people and biology, so I started to earn some money, it gave
buy government stamps that could be I chose medicine. It was a well-received me the opportunity for the first time as
redeemed for money. But something choice. And I dedicated many years to a young adult to save. I would go to a
happened in Argentina when I was attending medical school. Barnes & Noble bookstore and sit on the
young—I lived through hyperinflation. My stint living in Argentina was floor and read all the books there were
That was a lesson that left a mark on traumatic, not just in terms of finances, about finance. That’s how I learned about
me forever. People born and raised in but also politically. During my medical stocks, bonds, and mutual funds. I started
the US may be able to understand that school years, we lived through a govern- to buy mutual funds. I wasn’t thinking at
conceptually, but to live through it is ment led by military rule. Then came the that point about trading; it was more for
something else. Imagine what happens Falkland Wars. I was disenchanted by long-term investment. In 1997 I bought
when a country’s currency loses its value all that, so I wanted to emigrate. I came my first stock ever, which was Dell. At
extremely rapidly. If you saved, say, $100 to the US. I did my post-medical school the time, I had no clue that we were in
today, at the end of the month it could training in the US, and all my education the midst of a huge bull market. I bought
be worth only $1. So all that effort to in psychiatry was here as well. I’ve been 100 shares of Dell for $99. I remember
painstakingly save money could mean here ever since then. That was in 1990. how it quadrupled in price—a 400%
34 • March 2019 • Technical Analysis of Stocks & Commodities
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know about risk manage- partly because I work as a psychiatrist
ment. That large drawdown full-time and can’t also be a trader full-
I found that I manage my sent me into a panic, and time. So I had to adapt my trading not just
emotions much better if I suddenly I felt that I knew to my personality but also to the hours
divide my position in thirds. nothing. I had an emotional and amount of time I had available in my
meltdown and could hardly life. If you want to be a full-time trader,
I scale out by one third, recognize myself because up it’s a full-time job. You can’t be a full-
then take another third. until that point I was living time trader and also have another line of
on a cloud. But the market work. But you can be a part-time trader,
handed me a very sobering as long as you have realistic expectations
return in less than three years. dose of reality, which brought me down and as long as you can adapt your trading
Of course, I thought I knew everything to earth. That’s when my life as a serious to what you’re comfortable with.
about the stock market, and I was hooked. trader began. I’m drawn to the Wyckoff aspects of
I started to get serious about it and read the market: supply/demand and technical
more books on it. I thought I could in- What did you do? What changes did analysis, because to me, it’s a reflection
vest in stocks as a sort of part-time job you make? of the people in the market, and that’s
while being a psychiatrist. What hooked I started to look for a mentorship what my life’s work is all about. For me,
me was not just the thrill of it but also through a technical analysis group in it’s a parallel or linked universe.
the emotional aspects of it. Since I was the Boston area. I would go to every
a psychiatrist, I thought this was the meeting of the group, which took place What led you to begin writing about
ultimate study in human behavior. on the MIT campus. Through those trading?
A lot of emotions are involved in buy- meetings, I met David Weis. He mentored I’ve been trading and investing for
ing and selling, or in the reactions to the a lot of traders and wrote a newsletter more than two decades. I keep it very
market. I had an instinctual attraction to about technical analysis of the indexes. simple now, but that has been after years
studying the market and market behavior, He was my first coach/mentor. I stud- and years of doing it. You become good
to understand why things rise so fast and ied basic chart patterns, chart analysis, at it and that’s when you can simplify it
why they drop so fast. doing charts by hand, and recognizing and know what you’re doing. I would say
areas of interaction. He’s a Wyckoffian I’m a classic or typical type of investor or
What led you to technical analysis? and he teaches the Wyckoff method of trader. And because I’m passionate about
I was attracted to the behavioral technical analysis, so I learned all the it, I started to write about it from what
aspects of the market, which technical Wyckoff language of the market. That I know, that is, about the psychological
analysis is basically all about. It was love approach was close to my heart, and aspects: the feelings and emotions that
at first sight. I realized that fundamentals that’s how I started to get serious about are behind trading and financial deci-
didn’t make much sense, but reading market analysis. I worked with him for a sions. Most of the investing mistakes that
and studying charts, and the behavioral while, learning about stocks and futures, are made are due to human folly or due
patterns that showed up in charts over and I even dabbled a bit in options and to making decisions emotionally.
time, spoke to me like a playbook. And shorting. But eventually, I settled on in- It happens with institutions as well.
that’s how I began my parallel career in dividual stocks, which is what I do today. As we all know, there have been situ-
investing and trading. After David, I had another mentor for a ations where the Fed had to come to
The problem was that I started out in while who is also well-known to your the rescue.
a bull market and I did very well, which magazine, Dr. Alexander Elder.
made me think investing was easy. I Why do you think these types of
knew about long-term charts and I would How do you juggle trading with your situations happen?
focus on them, and I started to learn to full-time work? How do you make that I think there is a complete disregard
recognize patterns of euphoria or manic work for you? for the possibility of a black swan event
behavior. Somehow, even though I was a In my trading, I manage two accounts: that can wipe you out. I find these types
young investor, I sold most of my holdings a long-term account and a short-term of things very interesting. I’m naturally
before the 2000 technology collapse. So account, mostly on the long side. Over inclined towards working with human
for me at the time, I made a significant 90% of my trades are on the long side, struggles. A number of times, trad-
amount of money. ers have asked me questions or asked
So naturally, I believed I knew what I for advice, and from them I know the
was doing—that is, until the 2001–2002 struggle is not about intelligence or IQ,
bear market came along. I ended up with it has to do with individual psychologi-
a huge drawdown, in fact, a drawdown cal makeup. Someone may have a great
of 79% of my entire capital that I had system, but then something happens. The
allocated to trading and investing. I didn’t problem is not with the system; it’s with
36 • March 2019 • Technical Analysis of Stocks & Commodities
the trader. If a trader suddenly enters account, I use a strategy that
into an impulsive trade—a trade they I don’t use in the short-term
shouldn’t have put on—then it means they account as far as the type If you go for all the best
didn’t honor the process. A calculated of investment I am seeking, setups—or A setups—your
loss that was supposed to be 1% of the which is value stocks. And
equity account becomes 10%. They blow in the short-term account,
returns are much better.
up the account, which leads to negative I may use stock selections
consequences, and everything can get that I normally wouldn’t use
messy. But it may have had nothing to in my long-term account. In my trading works for me.
do with the method itself. account, I will pick a growth stock even I may trade some ETFs—my watch-
That’s why I started to write about if it’s expensive, provided there is a good list includes both ETFs and individual
trading and psychology. You can find setup, which is something I probably stocks. Someone may send me a stock
some of my writings on my blog, as wouldn’t do in the long-term account. trading idea and I may check it out to
well as in this magazine, and the book For my trading account, I tend to look see if it meets my criteria and I’ll put
I recently published is Trading Your A for small caps because there is more bang it on my watchlist. If I have the right
Game, and it’s my story. It’s very real, for the money, so better returns. And I setup, I may go with it. I would need the
and I’m very open with it. In it I discuss look for stocks with good volume. market to be in a bullish mode before I
the psychological aspects of trading and In my short-term account, I swing go long. If I’m not seeing that, I’ll be
share my actual trades in both my short- trade, and I will scale out. I could be a sitting on cash.
term swing trading account and in my pure trend follower who gets all in and all I look at the market in the context of
long-term account. out. But what happens is, in my mind, I whether it’s trending. I need a setup and
I also published in my book my track can do it, but then in the actual trade, I’m the right context. To go long, I need the
record of managing my long-term ac- not so good. That’s because if the trade market to be either in a trading range or
count for the last 20 years. I did that to starts to move in my favor, and it starts bullish. If the market is in a downtrend
tell my story but also to be receptive. In to get good and there’s a lot of money in or a bear market, I get a red light. I can’t
fact, part of the purpose of launching my it, I find it very difficult to manage when go long in my short-term account in that
blog was to build up a network of traders a big drawdown starts to occur or when case. But even if the US markets are
who are interested in the same aspects the trade turns against me. I found that in a downtrend, there may be another
of trading as I am, because otherwise, I manage my emotions much better if I market that’s in an uptrend that I can
trading can be lonely. I understand the divide my position in thirds. So I get in, still trade.
importance of connecting with others all in, but then I have predefined targets.
who are doing similar things or who I scale out by one third, then take another When you wait for the setup and the
have similar interests, especially if third, and then I can usually follow the right market context, do you use an
they struggle with something. It gives rest without any problem. automated trading system or are you
them somewhere or someone to touch With regard to that, it’s not that dif- a discretionary trader?
base with. ferent from what I do in the long-term I’m a discretionary trader, but the
account. system is well-defined. It’s not based on
You said that you have both long-term a whim. I use TradeStation and I have
and short-term accounts. Are the So in your short-term account, your a well-defined system I developed with
nature of your investments in these time horizon is all swing trades? my latest coach. I need to see a clear
accounts different in terms of how you My short-term account is mostly all formation. I don’t have an automated
select stocks? swing trading. I may do some shorting trading system; I initiate the trades, I put
In my long-term account, I buy dis- here and there, but then I need to be very on a trade, and then I exit a trade. It’s all
counted stocks and hold them when attentive and need to move fast. But very visual. I use the same strategy over and
they’re not popular in sectors that have short-term trading doesn’t match up well over and over but it’s not necessarily the
been out of favor and they’re selling at a with my personality. I need to make sure same setup each time. It’s the repetition
heavy discount. They’re very cheap. And that I am comfortable with my trading that makes it easier to identify the forma-
you may need to hold onto stocks like style. If I’m not comfortable with it, I tion and the opportunity.
these for as long as a couple of years. I can’t do the task well. Swing trading
may build a significant position there and You said that you generally don’t trade
wait it out, which I don’t do in the short- short, despite the fact that you have a
term account. There’s a chunk of my net well-defined system?
worth in my long-term account, but that’s That’s correct. I don’t often go short
a no-no in my trading account. not only because my personality is not
So yes, the nature of my investments in
each account is different. In the long-term Continued on page 56
March 2019 • Technical Analysis of Stocks & Commodities • 37
BULL LOGO: NIFFHAN/GOLD DUST: MILA_LS/SHUTTERSTOCK/
COLLAGE: JOAN BARRETT
Look For That Extra Thrust

Trading Breakaway Gaps


Many traders like to trade breakaway gaps. How effective are In my backtesting, I used stocks from the Russell 3000
they? Here, we look at backtesting results of trading different index. I ran the backtests from January 2000–June 2018.
breakaway gaps to determine if they can be profitable. During this period there were two bear markets, included so
that your real trading could lead to better performance than
by Pawel Kosinski what statistical results might otherwise suggest.

G
I analyzed the backtesting results by focusing on the fol-
aps occur on a price chart because of some impetus lowing parameters:
that made the price move higher or lower than the
previous day’s closing price. Several types of gaps
are possible and in this article I’ll focus on upward Entry
breakaway gaps, which occur when price suddenly
jumps from a congestion zone and moves up. It is
considered to be a bullish action and something traders are
familiar with.
As tempting as it may be to simply jump on a breakaway
gap when you see one appear on a chart, I prefer backtesting
a trading strategy before applying it. For this reason, I created Gap
a computer program that recognizes breakaway gaps.

It’s breaking away


TRADINGVIEW

You can see an example of a typical breakaway gap in Fig- A


ure 1. Initially, there was equilibrium between the bulls and
bears. Price oscillated around some average value. Suddenly, FIGURE 1: A BREAKAWAY GAP IN NIKE IN 2013. A breakaway gap originates
from a congestion zone, which is when price moves within a trading range. A sud-
a breakout in the upward direction, together with a gap, initi- den gap in the upward direction may initiate bullish action. Point A shows a local
ated bullish price action. minimum in price that occurred shortly before the breakout.

38 • March 2019 • Technical Analysis of Stocks & Commodities


charting

• Profit factor (the higher the better)


• Maximum drawdown (I want its absolute value to be
as low as possible) Generally, the larger the gap,
• Number of trades (the more successful trades there the better your trading results.
are, the more you will earn, and statistical results are
more reliable)
• Percentage of profitable trades tion of stop-loss placement. If you place a stop-loss under the
• Average trade gap, your potential loss could be high. But I’ll discuss this
further later in this article.
• Win/loss ratio
• Kelly ratio (discussed in my September 2018 S&C article Then there’s volume
“Double Bottoms Revisited”) I assumed trading volume on the breakout day was twice
the average volume of the past 14 days. In other words, the
In my initial backtesting, I set the gap size be at least 1% of “multiplication factor” was 2.0. Now I will consider other
the stock price. Most traders say that the breakout day should cases: a multiplication factor of less than 1.0, greater than
be accompanied by high volume, so I state that it has to be at 3.0, and greater than 4.0. You can see the backtesting results
least twice the average trading volume of the past 14 days. My in Figure 4.
final assumption was that the breakout price was the highest The results are quite clear: The larger the trading volume
of the past 60 days, but I didn’t try to optimize or change this on the breakout day, the better. This, I observed when look-
value in my backtesting. ing at all the studied parameters. Of course, the number of
trades decreases when you look for stocks with high trading
How long should you hold?
I enter a trade at the open on the next day after the breakout
(see Figure 1), that is, after I know for sure the breakout has 5 days 10 days 15 days 20 days
happened. I investigated four simple cases: exiting the trade Profit factor 1.43 1.24 1.31 1.39
Maximum drawdown -2.36% -3.16% -3.63% -3.97%
after 5, 10, 15, or 20 days. I don’t specify any stop-loss or
Number of trades 1208 1208 1208 1208
take-profit levels, so it isn’t a complete trading strategy. My Profitable trades [%] 53.81% 54.39% 55.71% 58.44%
objective was to investigate the market direction after the gap. Average trade [%] 0.33% 0.49% 0.76% 0.97%
The results can be seen in Figure 2. Win/loss 1.07 1.04 1.05 1.01
The shortest holding period (five days) is also the safest Kelly ratio 0.106 0.105 0.135 0.173
because maximum drawdown is the lowest, as expected. But FIGURE 2: HOW LONG SHOULD YOU HOLD THE SHARES? According
the average trade percent is also the lowest so it may be bet- to the backtesting results, the longer the holding time, the better for
your account. Nevertheless, the maximum drawdown (risk) increases
ter if you hold onto a stock longer. Keep in mind that if you gradually with time.
earn 0.33% per trade you’ll have to consider how much you
have to pay for commissions. Note that the Kelly criterion is 2% 3% 4% 5%
the highest for the longest holding period, indicating that the Profit factor 1.43 1.46 1.59 1.58
breakaway gap can identify the start of a longer rally and not Maximum drawdown -3.69% -3.53% -3.19% -3.07%
just a short-term event. Number of trades 912 669 513 368
Profitable trades [%] 58.00% 57.10% 57.31% 57.07%
In the subsequent testing, I use 20 days as the number of Average trade [%] 1.04% 1.13% 1.41% 1.49%
days in a trade. Win/loss 1.05 1.12 1.21 1.22
Kelly ratio 0.180 0.188 0.220 0.219
How large should the gap be? FIGURE 3: INFLUENCE OF GAP SIZE. The larger gap results in better
In the backtesting shown in the previous section, I used a gap performance but note the number of trades decreases.
size of 1.0%. What happens if I increase the gap size to 2%,
3%, 4%, and finally to 5%? The results are shown in Figure Less Greater Greater
than 2 than 3 than 4
3 and the results can be compared with the last column of Profit factor 1.26 1.46 1.69
Figure 2. Maximum drawdown -4.11% -3.38% -2.62%
Generally, the larger the gap, the better your trading results. Number of trades 912 623 250
Most parameters increase: profit factor, average trade, win/ Profitable trades [%] 54.80% 57.95% 60.80%
loss ratio, and especially the Kelly ratio. On the other hand, Average trade [%] 0.78% 1.18% 1.69%
for the gap size of 5% there is no significant improvement in Win/loss 1.05 1.08 1.10
performance. But the number of trades is lower so it may be Kelly ratio 0.180 0.188 0.219
FIGURE 4: VOLUME’S INFLUENCE. When trading volume
difficult to say whether such large gaps should be avoided was more than four times the average volume of the previ-
or whether the number of trades isn’t enough to confirm the ous 14 days, the strategy outperformed in spite of having the
statistical results. Such large gaps may also bring up the ques- lowest number of trades.

March 2019 • Technical Analysis of Stocks & Commodities • 39


volume, but you shouldn’t ignore the importance of volume
when trading breakaway gaps.
Note that if the multiplication factor is more than 4.0, the The larger the trading volume on
Kelly criterion increases to about 0.25. This is quite an out- the breakout day, the better.
standing result.

Candle type
Let’s look at the candle bars of the breakout day. The bars before the recent lowest price (shown as point A in Figure 1).
can be of different shapes and sizes, so I looked at two cases Then I calculate the distance: closing price of the breakout
that are considered bullish by most traders: day minus this lowest price. I add this distance to the closing
price of the breakout day. This means a potential reward/risk
1. The body of the candle was the longest of the past four
ratio of about 1.0. Nevertheless, I still limit the maximum
trading days (as it appears in Figure 1)
number of days in the trade to 20, that is, I exit the trade after
2. The upper shadow/wick of the candle is relatively short 20 days if neither the stop-loss nor the take-profit level has
(shorter than the candle body itself). been reached.
In the second case (case 2), the take-profit level will be
You can see the results I collected in the table in Figure 5. higher: the reward/risk ratio is equal to 1.5. The other condi-
The long body on the breakout day results in a significant tions are the same as for case 1.
improvement in results. Here again, all parameters in the The third case (case 3) is similar to case 1, but I don’t limit
table are better than for the standard case. The number of the number of days in trade to be less than 20. In other words,
trades is less, but the odds increase greatly if the breakout I wait until the stop-loss or take-profit levels are reached.
candle is bullish. The fourth case (case 4) is similar to case 2, but I remove
What about the second option, the short upper wick? The the requirement of the maximum 20 days in trade (like in
number of entries is reduced again and the strategy outper- case 3).
formed the standard one. Nevertheless, the performance isn’t All these four cases refer to the standard setup discussed
as remarkable as for the long bullish candle. Of course, these previously: Trading volume on the breakout day was at least
are two different scenarios and it’s like comparing apples twice the average of the past 14 days and the gap size was
and oranges. at least 1% of the closing price of the stock. I didn’t analyze
the candle type on the breakout day here. All the results are
A full trading strategy displayed in Figure 6.
Is it possible to develop a full trading strategy with the infor- The most important observation is that all the cases are
mation we have? For starters, I’ll need to specify a stop-loss profitable and the performance is acceptable. Most of the
and a take-profit level. Let us consider the four cases. parameters indicate that cases 3 and 4 outperform, that is, it is
In the first case (case 1), I place a stop-loss a few cents profitable to hold the stock longer and not exit too early. This
could increase your risk but the final result may be superior.
Short The most profitable is case 4, where the take-profit level
Long body upper wick is located higher but the percentage profitable is lower, as
Profit factor 1.51 1.41 expected, and the maximum drawdown is less attractive.
Maximum drawdown -3.24% -3.12%

Size, volume, and direction


Number of trades 654 756
Profitable trades [%] 59.79% 58.60%
Average trade [%] 1.22% 1.01% Even though I tried different modifications such as chang-
Win/loss 1.02 1.00 ing the gap size, trading volume, and so on, the results were
Kelly ratio 0.180 0.219 always positive. This confirms that trading breakaway gaps
FIGURE 5: LONG BODY OR SHORT WICK? Here can lead to profitable results. Of course, the odds can be fur-
you see that the long body of the breakout candle ther increased by some bullish action even though this could
outperforms. The short upper wick improves results
but not as much.
reduce the number of successful trades.
In real trading, if the trade continues to move upward, you
Case 1 Case 2 Case 3 Case 4 can adjust the stop-loss and take-profit levels by trailing the
Profit factor 1.32 1.36 1.38 1.43 stop. Sometimes it may be less risky to wait until the price
Maximum drawdown -3.47% -3.88% -6.21% -8.70% retraces (or pulls back), and then enter. This may reduce the
Number of trades 1208 1208 1202 1190 risk, but you could always lose some profitable trading op-
Profitable trades [%] 61.09% 57.95% 69.47% 63.03%
portunities. After all, the price can continue north without
Average trade [%] 0.71% 0.87% 1.44% 2.23%
Win/loss 0.86 1.01 0.61 0.85
waiting for you (and such trades may turn out to be even more
Kelly ratio 0.159 0.163 0.194 0.195 profitable). Nevertheless, I didn’t test these issues.
FIGURE 6: COMPARING FOUR TRADING STRATEGIES. Cases 3 and
4 show greater profitability but their maximum drawdown is high. Continued on page 56

40 • March 2019 • Technical Analysis of Stocks & Commodities


FUTURES FOR YOU
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner is the senior
strategist for DeCarley Trading, a division of Zaner, where she also works as a
broker. She has written four books on futures and options trading, with the latest
being a new edition of her book A Trader’s First Book On Commodities (third
edition, October 2017) as well as Higher Probability Commodity Trading (July
2016). Garner also authors widely distributed e-newsletters; for a free subscrip-
tion, visit www.DeCarleyTrading.com. To submit a question, email her at info@
carleygarnertrading.com or via www.DeCarleyTrading.com. Selected questions Carley Garner
will appear in a future issue of S&C.

OPTION SELLING: RISKS AND REMEDIES of protection. Accordingly, looking to illustrate, the trader would have needed
(Part 2 of 2) options with expiration dates prior to to purchase a March put with a strike
In late 2018, energy market option sell- that of the primary short option might price of $30 to keep the premium spent
ers paid a price for trading naked. How make sense. comparable, near $150. Of course, this
could this have been avoided? For example, a trader speculating on creates a spread with a much deeper risk
As I discussed in this column last an imminent rally in crude oil while the of roughly $8,000 before considering the
month, the practice of option selling market is valued at $44 per barrel might premium collected. This is obviously
is a relatively high-probability trading look to sell a March $38 put option with much more concerning than the $2,000
strategy in that it often comes with 60 days to expiration for $750, and then of exposure the previous version of the
unusually high win percentages. Yet we purchase a February $36 put with 30 days trade offers (prior to considering the
also know that it comes with unlimited to expiration for $150 to create a net credit credit collected).
risk, and the small percentage of losing of $600. Because the trader believes the While this column isn’t dedicated
trades can wreak havoc on trading ac- price reversal will occur within 30 days, to teaching the mechanics of option
counts. We witnessed several examples there is no need to purchase a March put spreads, I am compelled to clarify that,
of this in the energy complex in late 2018, as protection which is more expensive when trading options with differing ex-
where at least one large hedge fund (and (time is money when it comes to option pirations, it is impossible to quantify the
likely others we aren’t aware of) were maximum risk. This is because the profit
wiped out. and loss of such a position will depend
While I am a proponent of option- It is always in the best on time and volatility, whereas an option
selling strategies, years of trial & error interest of the trader spread utilizing securities with the same
and learning about the difficulties of op- to have some sort of expiration date can always be mathemati-
tion selling firsthand lead me to believe cally defined using an “at expiration”
it is always in the best interest of the
catastrophic insurance equation. In the case of a diagonal spread,
trader to have some sort of catastrophic in place to prevent such as selling the March $38 and buying
insurance in place to prevent the unthink- the unthinkable from the February $36, we have already noted
able from happening. This is in line with happening. the intrinsic risk between $38 and $36,
the thinking of a typical vertical credit which equates to $2,000 for a trader. But
spread in which a trader sells an option we must note the risk is reduced by the
and then purchases an option with the pricing). Further, the lack of time in the premium collected, in this case, $600.
same expiration date but with a more February options and cheaper pricing We can use $1,400 ($2,000 - $600) as a
distant strike price to limit risk exposure. structure because of the time difference starting point for a guess as to what the
In my view, traders shouldn’t confine enables traders to purchase protection worst-case scenario might be; to figure
themselves to buying protection in the with a more proximal strike price. In the upper end of the range we will use
same expiration month of the primary this case, the trader has “naked” risk the intrinsic risk of $2,000. Thus, when
short option. Instead, traders should look from $38 to $36, a gap worth $2,000 of deciding whether the risk and the reward
to various expiration dates in search for risk, but is covered beneath $36. Had the make sense, the trader should work on
the “option” (no pun intended) that offers trader constructed a similar spread using the premise that he is collecting $600,
the best protection, for the lowest cost, a March put option as protection, it would which represents the maximum profit
for the appropriate timeframe. In other have been necessary to either spend more potential, and risking $1,400 to $2,000
words, directional option sellers might money for the protection, which cuts into to do it (again, these are estimates not
be speculating on a move anticipated to profit potential, or purchase a deep out- hard numbers, depending on timing and
occur in the coming weeks, thus there of-the-money put option as protection,
isn’t necessarily a need to pay for months which weakens the risk management. To Continued on page 62
March 2019 • Technical Analysis of Stocks & Commodities • 41
Following The Money

Sector-Rotation ETFs
Underperform
Rotating into leading sectors while switching to a defensive the hype, especially in bull markets where moving between
position in downturns is an ideal tactic if it can be implemented sector funds too often resulted in missed opportunities and
successfully, but can it? Are there any ETFs that have suc- subpar performance.
ceeded with it? If there are, they could save you the work of Today, all of those newsletters have disappeared from the
implementing the approach yourself, so we’ll investigate. marketplace. There is probably a handful or so of active sector
fund ETF managers/timers who offer this type of investment

S
by Leslie N. Masonson service online. Some may be tracked by TimerTrac.com, a
market timing service tracking professional timers; however,
ector investing has been popular since Fidelity in some instances you have to pay for this service if you want
introduced its sector mutual funds in the mid- to check them out any further. A quarterly trial is $74.95 to
1980s, and even more so with the offering of view all the timing strategies compiled on 570 timing services.
nine popular SPDR sector ETFs in 1999. Since Alternatively, you can search the web for that type of manager
then many more have been made available from and request verified past results from those offering the service.
multiple ETF providers. Investors and traders And in some cases they will provide their TimerTrac results
looking to achieve a performance advantage are embracing for their performance, if they are tracked.
a sector-rotation approach to select the best-performing ETFs Because of the constant ebb and flow of the markets, and
based on fundamental and/or technical factors, and riding particularly the performance and volatility of individual market
them until their trend changes. In reality, that objective is sectors, successful investing with a sector rotation focus has
much more difficult to achieve than it appears, as shown by been fleeting compared to a simple buy & hold approach even
the disappearance of sector fund newsletters and the closure with its inherent bear market risk and losses along the way.
of two sector-rotation ETFs.
Sector rotation ETFs reviewed
Sector investing popular in past decades I have covered varying aspects of ETF sector investing in
For example, in the 1990s and early 2000s, I noticed a pro- three previous articles in this magazine, which are listed in
IMAGENTLE/SHUTTERSTOCK

liferation of ads from newsletters offering sector mutual the “Further reading” section at the end of this article. Those
fund investing/timing services for conservative to aggressive articles covered seven sector fund families, momentum sec-
investors. Their backtest results, when provided, were always tors, and a focus on three technology ETFs, respectively. This
excellent, and a few had outperformance with real-time article provides insights into investing in ETFs that offer actual
records, but overall, their expected results did not live up to sector-rotation strategies, where the sector mix is based on
42 • March 2019 • Technical Analysis of Stocks & Commodities
WHY TRADE ETFS?

predetermined criteria. The five existing ETFs, all open-end similar to FVC but below SCTO (1.6%) and SECT (1.02%)
investment companies, are shown in Figure 1. Their names The one-year performance through December 26, 2018 was
and ticker symbols are as follows: -7.77%, which was better than the others but lagging the SPY
(S&P 500) at -3.65%. However, over three years, FV advanced
• First Trust Dorsey Wright Focus 5 ETF (FV) only 13.30% compared to 34.53% for the SPY, not a favor-
able outcome for an actively managed rule-based portfolio.
• First Trust Dorsey Wright Dynamic Focus 5 ETF
This ETF had 48% of large-cap exposure, 37% of mid-cap
(FVC)
exposure, and 10% small- and micro-cap exposure with a 75%
• Global X JPMorgan US Sector Rotation Index ETF style exposure to growth.
(SCTO)
First Trust Dorsey Wright Dynamic Focus 5 ETF (FVC)
• Invesco DWA Tactical Sector Rotation ETF (DWTR)
FVC, the second five-sector rotation ETF from First Trust
• Main Sector Rotation ETF (SECT) Advisors, LP, follows the same investment logic and methodol-
ogy as FV with two differences. First, it was introduced two
First Trust Dorsey Wright Focus 5 ETF (FV) years later on March 17, 2016. Second, when market condi-
This ETF was the earliest entrant among the five reviewed, tions change, investment exposure to a one- to three-month
with an inception date of March 5, 2014. The fund was devel- US Treasury bill component can be put in place. This comes
oped to provide specific exposure to only five of First Trust’s into play when the relative strength of more than one-third
many sector and industry ETF offerings. Dorsey Wright & of the universe of First Trust ETFs declines relative to the
Associates (DWA), the fund’s manager, uses its proprietary cash index that is evaluated twice monthly. The cash index
relative strength approach to select the strongest-performing can vary from 0% to 95% of the Dorsey Wright benchmark
ETFs, which are ranked from highest to lowest. Also included index, but is limited to no more than 33% per evaluation. As
in the selection criteria are minimum daily trading volume of December 26, 2018, its current holdings were: FXL, FDN,
and sufficient liquidity. QTEC, FXH, and FBT—the same as that of FV! Since the
Initially, the ETFs with the five highest-ranking scores September 2018 highs and subsequent collapse into yearend,
were placed in the portfolio. Thereafter, twice a month, DWA it is surprising that this portfolio remained in the nondefen-
performs its review by replacing ETFs falling in ranking to a sive sectors—technology, Internet, biotech, and (somewhat
predetermined level. The remaining ETFs are then rebalanced, defensive) healthcare—rather than holding any cash position
so that there are five nearly equally weighted positions. The at all. If a 15% to 20% market drop doesn’t effect a portfolio
current portfolio holdings, as of the previous night, can easily change, then that is something investors should be concerned
be found on its website by keying in the ticker symbol in the about, as the portfolio is evaluated semimonthly.
site’s search box. In this way, you can look for any changes, Both FV and FVC have an annual expense ratio of 0.89%,
although they aren’t made often, sometimes for months. higher than that of the others reviewed here, which ranged
Its holdings as of December 26, 2018, each with about 20% between 0.75% and 0.83%. FVC’s one-year performance was
of the assets, we re: FXL, FDN, QTEC, FXH, and FBT. The -7.90% compared to -3.65% for SPY, and was slightly worse
market took a big hit during the last few months of 2018. More than FV’s by 23 basis points. There is no XTF rating for this
than 50% of S&P 500 stocks were down more than 20% for ETF, probably because of its short track record and perhaps
the year since the September 2018 highs and this portfolio its underwhelming performance.
remained in the nondefensive sectors of
technology, Internet, biotech, and health- ETF FV FVC SCTO DWTR SECT SPY
care (somewhat defensive). XTF Rating 4.3 1.7 9.7
XTF.com rates this ETF with an XTF Expense Ratio 0.89% 0.89% 0.83% 0.75% 0.88% 0.10%
rating of 4.3 out of 10. Its rating system Market Cap $2B $496M $3M $58M $375M $245B
methodology is provided on its website,
Avg. Daily Volume 286,493 98,964 933 17,405 63,632 87,752,464
and is based on a statistical analysis
Annual Yield 0.64% 0.65% 1.6% 1.02% 1.44%
of structural integrity and investment
metrics. Inception Date 03/05/2014 03/17/2016 10/22/2014 10/09/2015 09/05/2017 01/22/1993
As Figure 1 shows, FV is the heavy- Geography Global US US US US US
weight as far as asset accumulation with Index Composition Custom- Equal- Custom- Equal- Cap- Cap-
$2 billion—far outpacing FVC ($496 Weighted Weighted Weighted Weighted Weighted Weighted
million) and SECT ($375 million). It Avg. # of Components 5 5 5 4 11 505
DATA SOURCE: XTF.com

also has the highest daily trading volume Investment Metric rank 26% 33% 67%
of 286,493 shares, with FVC second at Perf. - 1 Year -7.77% -7.90% -9.59% -12.27% -8.01% -3.65%
98,964. It is the only one with options Perf. - 3 Years 13.30% 11.25% 1.32% 34.53%
available for the more venturesome trad- FIGURE 1: SECTOR ROTATION ETF COMPARISON. The SPY has outperformed these ETFs with a much
ers. It offers an annual yield of 0.64%, lower annual expense ratio.
March 2019 • Technical Analysis of Stocks & Commodities • 43
This ETF had 48% of large-cap exposure, 37% mid-cap
exposure, and 10% small- and micro-cap exposure with a
51% style exposure to growth, which is getting pummeled as These specialized, highly
this is written in late December 2018. concentrated ETFs have had
a rough time meeting their
Global X JPMorgan US Sector Rotation Index ETF
(SCTO) goals or keeping up with their
The current issuer of this ETF is Mirae Asset Global Invest- benchmarks or the S&P 500.
ments Co., Ltd. SCTO was introduced seven months after FV
in October 2014, but it has been unable to match FV’s massive
asset-gathering success, with only $3 million in assets—a
very low number by anyone’s measure—and a minuscule PRN (30.5%), PTF (28.0%), PEZ (23.2%), and PTH (18.3%).
daily trading volume of 933 shares. Its annual expense ratio These sector funds represent, in order: industrials, technol-
at 0.83% is lower than that of First Trust’s products, and its ogy, consumer cyclicals, and healthcare. Its September 30,
1.6% yield is 100 basis points better, as well as 16 basis points 2018 holdings were the same within less than a percentage
above the SPY. However, its one-year performance of -9.59% difference. So there was no portfolio change in that time span
is the second worst of the group. although the market took a 15% to 20% hit during that period.
This ETF’s goal is to invest in the best-performing three The healthcare ETF is somewhat defensive, but the fact that
to six sectors (out of the 10 available) while limiting expo- there was no cash at all is something that both potential and
sure during market setbacks or periods of high volatility. existing investors in this ETF should be concerned about,
The portfolio as of December 26, 2018 consisted of: RWR since the portfolio is evaluated semimonthly and a defensive
(28.3%), XLV (19.5%), XLI (17.6%), XLF (17.5%), and XLB posture could have been put into place to limit potential losses
(16.2%). This ETF had 75% large-cap exposure, 19% mid-cap as the market decayed.
exposure, and 6% small- and micro-cap exposure, with a 50% The ETF and benchmark index are analyzed monthly and
style exposure to growth. rebalanced and reconstituted as necessary. There is no XTF
Since the market’s large decline from the September 2018 rating. This ETF had 31% of large-cap exposure, 31% of mid-
highs to late December 2018, this portfolio had no cash com- cap exposure, and 24% small- and 14% micro-cap exposure
ponent but does have the SPDR Dow Jones REIT ETF (RWR), with a huge 83% style exposure to growth. Its sector exposure
which is somewhat defensive. On September 30, 2018, the is 30% technology, 21% industrials, 20% healthcare, and 18%
portfolio contained XLV (30.4%), XLY (18.4%), XLK (17.8%), consumer cyclicals.
XLY (17.0%), and RWR (16.4%). So you can see that since
the end of September through late December, the portfolio Main Sector Rotation ETF (SECT)
increased its exposure to XLV by just over 10 percentage points, This is an actively managed cap-weighted ETF introduced
eliminated XLY and XLI, reduced RWR by 12 percentage by Main Management LLC and is now known as Northern
points, and added new positions in XLF and XLB. Thus, the Lights Fund Trust IV Main Sector Rotation ETF. It seeks to
portfolio composition was shifted to include XLF and XLB, outperform the S&P 500 index in advancing markets, while
which don’t offer the expected defensive posture. limiting losses during market declines by using dynamic
sector rotation based on fundamental analysis (for example,
Invesco DWA Tactical Sector Rotation ETF (DWTR) economic forecasts, inflation data, macroeconomic and capital
This Invesco Capital Management LLC ETF came into ex- markets input). SECT was born on September 5, 2017 and has
istence on October 9, 2015. It is based on the Dorsey Wright amassed a respectable $375 million in assets in just over 14
Sector 4 Index. At least 90% of assets are invested in securities months. Daily trading volume is 63,632. Its one-year perfor-
in this index. A relative strength concept is used, as is the case mance is -8.01%, slightly worse than FV and FVC. Note the
with all the DWA-managed ETFs. The universe available for portfolio consists of 505 positions, a great variance from the
this ETF is the nine PowerShares ETFs. This ETF may hold other ETFs reviewed here.
up to 100% cash using one- and three- month T-bills when The portfolio holds 10 ETFs and a 3% component of cash.
stocks are out of favor, although as of late December 2018 The fund has a low XTF rating of 1.5. Its annual expense ratio
with the market in correction mode or worse, this ETF had is 0.88% and annual yield is 1.02%, the second-best in the
no cash holdings. group. Up to 20% of the portfolio can hold any market cap or
It has the second-lowest asset base at $58 million and the country-denominated security in any currency.
lowest annual expense ratio at 0.75%. Its one-year performance This ETF had 63% of large-cap exposure, 11% of mid-cap
is the worst at -12.27%. And its three-year performance of exposure, 10% small-cap, and 10% emerging market expo-
1.32% is poor compared to 34.53% for the SPY and 23.4% for sure with a 48% style exposure to growth. Its sector exposure
its Russell 3000 benchmark for that period. A daily trading when I checked it was 20% technology, 15% financials, 17%
volume of 17,405 is the second-lowest of the group. healthcare, and 9.7% banking, with another 34% spread among
The portfolio as of December 26, 2018 was as follows: six other sectors.
44 • March 2019 • Technical Analysis of Stocks & Commodities
Performance during year-end meltdown Indexes. The top three sectors with the best momentum (for
How did these five funds perform during the September 21 to example, relative strength) received 20% of the cash, with
December 26 market collapse? Here are the numbers: 10 stocks in each of those sectors each being allocated 2%
of the cash. The next four sectors with the highest relative
FV -20.78% strength received 10% of the cash, with five stocks in each
FVC -20.79% sector receiving 2% of the cash.
SCTO -15.71% This ETF used the Dorsey Wright proprietary Point & Fig-
DWTR -22.60% ure Relative Strength charts to select the 50-stock portfolio.
SECT -17.45% A quarterly ranking of sectors was used and ranking changes
SPY -15.20% were made as necessary. During its short lifespan, SWIN
returned a respectable 22%, which compared favorably to the
Clearly, none of the funds offered any benefit in performance SPY, which rose 22% as well.
compared to the S&P 500 index, even though they all profess A second ETF that folded was the Guggenheim Sector Rota-
to be able to assess the situation and move to more defensive tion ETF (XRO). It was launched on September 21, 2006 and
sectors or cash during a market downturn to minimize principal closed on March 23, 2012. During that nearly six-year period
losses. That goal was not met in any of these ETFs. it returned 10.7% compared to 18.3% for the SPY. The ETF
Let’s go to a longer time period to see if the results are used a proprietary quantitative methodology that focused on
any better. First, let’s review these ETFs with their earliest sectors with superior risk–return characteristics. The port-
common date of September 26, 2017. Figure 2 shows the bar folio held 100 stocks that were selected from a universe of
chart data. The S&P 500 outperformed these ETFs showing the 1,000 largest market-cap listed equities. It had an annual
a return (based on price, not total return) of 2.67% through expense ratio of 0.60%. Formerly, this ETF was known as the
December 26, 2018 compared to losses ranging from -1.2% Claymore/Zacks Sector Rotation ETF.
to -6.26%, again not a favorable outcome.
Finally, Figure 3 shows the return, excluding the more A rough road
recent SECT, to examine an earlier common date of March Clearly, these specialized, highly con-
18, 2016. Again, the S&P 500 beat all these funds over this centrated ETFs have had a rough time
30-month period by a minimum of 9.5 percentage points to meeting their goals or keeping up with
a maximum of 23.55 percentage points. their benchmarks or the S&P 500. Most
Thus, over the three time periods reviewed here, these
unique ETFs have consistently underperformed. Continued on page 55

Two rotation ETFs already


closed down
Based on the arduous task of
beating its benchmark and
garnering sufficient assets,
it wasn’t shocking that two
ETFs in this category have

Stockcharts.com
already closed their doors.
The most recent closure
was the ALPS/Dorsey
Wright Sector Momentum FIGURE 2: ETF PERFORMANCE SINCE SEPTEMBER 26, 2017. During this rapid decline, these ETFs failed to provide the
ETF (SWIN). It had a short defensive shift in the portfolio that was expected based on their objectives. The SPY did much better.
life, as it was introduced on
January 10, 2017 and was
liquidated on October 22,
2018 with about $11.6 mil-
lion in assets, and an annual
expense ratio of 0.40%.
SWIN used a rules-based
approach to select, from a
10-sector universe, a total of
50 stocks with the highest
relative strength (excluding
real estate) in the NASDAQ FIGURE 3: ETF PERFORMANCE SINCE MARCH 18, 2016. Once again, with a longer time horizon, these ETFs failed to deliver.
US Large Cap and Midcap The SPY outpaced them by at least 9.5 percentage points.

March 2019 • Technical Analysis of Stocks & Commodities • 45


Explore Your Options

Got a question about options? Jay Kaeppel has over three decades of experi-
ence in the options markets. He was a head trader for a CTA firm, an options
trading software developer, and is a portfolio manager for an investment
management firm. He also spent several years writing a weekly column titled
“Kaeppel’s Corner” and now publishes a blog, “Jay On The Markets” (http://
jayonthemarkets.com). He is the author of several books, including The Four
Biggest Mistakes In Option Trading; The Option Trader’s Guide To Probability,
Volatility, And Timing; and Seasonal Stock Market Trends. Send your ques-
tions or topic suggestions to Jay Kaeppel at jaykaeppel@gmail.com. Selected Jay Kaeppel
questions will appear in a future issue of S&C.

ADJUSTING POSITIONS wanted to play this bias in a limited risk our trader may have considered several
USING OPTIONS fashion. One possibility would be to buy choices. The simplest thing to do is let
I hear traders refer to “adjusting” an a deep in-the-money (ITM) January 2019 the position ride and hope the decline
option position. What does that mean, put option on United States Oil ETF continues and that profits continue to
and is it worth knowing about? (USO) which ostensibly tracks the price grow. The problem here is that the trade
Learning to adjust an option position of crude oil. Say USO is trading at $15.52 now has essentially $2,990 of risk if USO
is absolutely worth learning about and a share and a trader bought 10 January reverses and rallies (the original $1,280
is one of the key advantages to trading 2019 17 puts at $1.82 apiece for a total cost plus the $1,170 open profit). If the
options versus other vehicles such as cost of $1,820. As shown in Figure 1, this trader decides to adjust at this point there
stocks, exchange traded funds (ETFs), represents the total risk on the trade and are many choices. What follows is a dis-
and commodity futures. To “adjust” an the breakeven price at January option cussion of just a handful of possibilities,
option position means buying or sell- expiration is $15.18 a share. not a definitive “best choice.”
ing options to change the nature of an By October 23, 2018 USO had fallen
existing position. The good news is that -8% and the put option was showing a 1. Sell enough to lock in a profit: In
option adjustments can often be used to gain of +$1,170 (+64%). At this point this example, to lock in a profit by sell-
improve the reward-to-risk profile of the
trade in question. The tradeoff—in most
cases you give up something in order to
get something else. This idea will become
clearer in the examples that follow.
Trade “adjustments” are frequently
used to try to “lock in” a profit and
then let the remaining adjusted position
“ride.” One old adage in option trading
is to “sell half after a double.” In other
words, if you buy a call or put option and
it doubles in price, you can essentially
lock in at least a breakeven situation if
you sell half of the options you bought.
While this isn’t bad advice, the reality is
that this approach first requires you to buy
a call or put and have it double in price.
Anyone who has traded for any length
of time will know this is no simple feat
(and doesn’t happen nearly as frequently
www.OptionsAnalysis.com

as most of us would like). So let’s look


at some less-rigid examples.

Crude oil
Crude oil has displayed a negative sea- Figure 1: Playing seasonal weakness in crude oil with USO put options. If you bought 10
sonal bias during the months of October January 2019 17 puts at $1.82 apiece for a total cost of $1,820 that would be the total risk on the trade. The
and November. Let’s assume a trader breakeven price at January option expiration is $15.18 a share.

46 • March 2019 • Technical Analysis of Stocks & Commodities


Explore Your Options

To “adjust” an option
position means buying
or selling options to
change the nature of
an existing position.

ing part of his position, the trader would


have to sell seven of his 10 puts. The
risk curves for this adjustment appear
in Figure 2. The good news is that the
trade has a locked-in profit of +$273. The
bad news is that a lot of profit potential
is removed. Before the adjustment, the
open trade had a delta of roughly -900.
This implied that for each $1 USO shares
declined in price, this position would add
an additional $900 in profit. After the
adjustment, the delta is down to -270. So
if USO continues to decline, the trader
will make significantly less additional
profit than if they “let it ride.”
Figure 2: Selling enough to lock in a profit. To lock in a profit by selling part of the position, the
2. Roll down the strike price: In this ex- trader would have to sell seven of the 10 puts. The trade has a locked-in profit of +$273 but a lot of profit
ample, our trader simply sells the original potential is removed.
position and simultaneously enters a new
one, this time at a lower strike price. For
this example, the trader sells 10 January
2019 17 puts at $2.99 a piece and buys
10 January 2019 14 puts at $72 apiece.
As you can see in Figure 3, by doing this
the trader has locked in a profit of $450
and has more profit potential than the
trader in example #1 because this new
position has a delta of -448.

3. Playing both sides: Now let’s go off


the beaten path a bit. In this example,
let’s say that our trader has decided that
an explosive move in crude oil will oc-
cur within the next six months, but they
aren’t quite willing to fully buck the
bearish trend just yet. The trader in this
example might choose to use his or her
open profit to finance a trade to play their
new projected scenario. In his example,
the trader sells 10 January 2019 16 puts
at $2.99 apiece and buys four April 2019
14 calls and four April 2019 14 puts at
$1.12 and $1.01 apiece, respectively. The
risk curves for this new adjusted position
appear in Figure 4. Figure 3: Rolling down by selling the 17 strike price puts and buying the 14 strike
price puts. You could sell the original position and simultaneously enter a new one, this time at a lower
Continued on page 62 strike price.

March 2019 • Technical Analysis of Stocks & Commodities • 47


For this month’s Traders’ Tips, the focus is At Traders.com you can also right-click on
Sylvain Vervoort’s article in the September any chart to open it in a new tab or window
2018 issue, “The V-Trade, Part 7: Technical and view the chart at a much larger size.
Analysis—V-Wave Count.” Here, we pres- The Traders’ Tips section is provided to
ent the March 2019 Traders’ Tips code help readers implement a selected tech-
with possible implementations in various nique from an article in this issue or an-
software. other recent issue. The entries here are
The code for the following Traders’ Tips contributed by software developers or pro-
selections is posted here: grammers for software that is capable of
customization.
• Traders.com  S&C Magazine 
Traders’ Tips

Point( NULL ),
double NewSwingPrice( 0 ),
F TRADESTATION: MARCH 2019 TRADERS’ TIPS CODE double SwingPrice( Close ),
In “The V-Trade, Part 7: Technical Analysis-V-Wave Count,” int TLDir( 0 ),
bool SaveSwing( false ),
which appeared in the September 2018 issue of Technical
bool AddTL( false ),
Analysis of Stocks & Commodities, author Sylvain Vervoort bool UpdateTL( false );
introduces a tool to assist in counting waves based on Elliott
wave theory. His SVE zigzag ticks indicator automatically method TrendLine CreateNewTrendline()
draws trendlines highlighting the waves using a specified variables: TrendLine tempTL;
begin
number of points to detect the pullbacks. A sample chart is
if UseBNPoint then
shown in Figure 1. tempTL = TrendLine.Create(
Here is the TradeStation EasyLanguage code for a zigzag LastSwingBNPoint, SwingBNPoint )
indicator based on the author’s description. else { use DTPoint }
tempTL = TrendLine.Create(
Indicator: SVE ZigZag Ticks LastSwingDTPoint, SwingDTPoint );
// SVE ZigZag Ticks
// TASC Mar 2019
// Sylvain Vervoort

using elsystem;
using elsystem.drawing;
using elsystem.drawingob-
jects;

inputs:
double HighPivotPrice(
High ),
double LowPivotPrice(
Low ),
double RetracePnts( 5 ),
int LineColor( Yellow ),
int LineWidth( 1 ) ;

variables:
intrabarpersist bool
UseBNPoint( false ),
int DrawingObjectBar-
Number( 0 ),
TrendLine ZigZagTrend-
line( NULL ),
DTPoint SwingDTPoint(
NULL ),
DTPoint LastSwingDT-
Point( NULL ),
BNPoint SwingBNPoint(
NULL ), Figure 1: TRADESTATION. This sample TradeStation mean renko chart of the FDAX index shows the SVE zigzag ticks
BNPoint LastSwingBN- indicator.

48 • March 2019 • Technical Analysis of Stocks & Commodities


AddTL = true;
tempTL.Persist = false; TLDir = -1;
tempTL.Lock = true; end
tempTL.Color = GetColorFromInteger( else if TLDir = -1 and NewSwingPrice <=
255, LineColor ); SwingPrice then
tempTL.ExtLeft = false; begin
tempTL.ExtRight = false; SaveSwing = true;
tempTL.Weight = LineWidth; UpdateTL = true;
if DrawingObjects <> NULL then end;
DrawingObjects.Add( tempTL ); end;
return tempTL; end;
end;
if SaveSwing then
method Color GetColorFromInteger( begin
int Alpha, int ColorInteger ) if UseBNPoint then
begin begin
return Color.FromARGB( LastSwingBNPoint = SwingBNPoint;
Alpha, GetRValue( ColorInteger ), SwingBNPoint = BNPoint.Create(
GetGValue( ColorInteger ), GetBValue( DrawingObjectBarNumber[1],
ColorInteger ) ); NewSwingPrice );
end; end
once else
begin begin
UseBNPoint = BarType = 0 or ( LastSwingDTPoint = SwingDTPoint;
BarType > 4 and BarType <> 14 ); SwingDTPoint = DTPoint.Create(
BarDateTime[1], NewSwingPrice );
if UseBNPoint then end;
SwingBNPoint = BNPoint.Create( SwingPrice = NewSwingPrice;
CurrentBar + MaxBarsBack - 1, Close ) SaveSwing = false;
else end;
SwingDTPoint = DTPoint.Create(
BarDateTime, Close ); if AddTL then
end; begin
ZigZagTrendline = CreateNewTrendline();
if UseBNPoint then AddTL = false;
DrawingObjectBarNumber = end
CurrentBar + MaxBarsBack - 1; else if UpdateTL then
begin
NewSwingPrice = SwingHigh( if ZigZagTrendline <> NULL then
1, HighPivotPrice, 1, 2 ); begin
if UseBNPoint then
if NewSwingPrice <> -1 then ZigZagTrendline.SetEndPoint(
begin SwingBNPoint )
if TLDir <= 0 and NewSwingPrice >= else
SwingPrice + RetracePnts then ZigZagTrendline.SetEndPoint(
begin SwingDTPoint );
SaveSwing = true; end;
AddTL = true; UpdateTL = false;
TLDir = 1; end;
end
else if TLDir = 1 and NewSwingPrice >= To download the EasyLanguage code, please visit our
SwingPrice then TradeStation and EasyLanguage support forum. The files
begin
SaveSwing = true; for this article can be found here: https://community.trades-
UpdateTL = true; tation.com/Discussions/Topic.aspx?Topic_ID=156727. The
end; filename is “TASC_MAR2019.ZIP.” For more information
end about EasyLanguage in general, please visit TradeStation.
else com.
begin
NewSwingPrice = SwingLow( 1, This article is for informational purposes. No type of
LowPivotPrice, 1, 2 ); trading or investment recommendation, advice, or strategy
if NewSwingPrice <> -1 then is being made, given, or in any manner provided by Trade­
begin Station Securities or its affiliates.
if TLDir >= 0 and NewSwingPrice <= —Doug McCrary
SwingPrice - RetracePnts then TradeStation Securities, Inc.
begin www.TradeStation.com
SaveSwing = true;

March 2019 • Technical Analysis of Stocks & Commodities • 49


release.

Description:
The V-Trade. Part 7:
Technical Analysis—V-
Wave Count
by Sylvain Vervoort

Version: 1.00
01/15/2019

Formula Parameters:
Default:
NumberOfTicks
200

Notes:
The related article is copy-
righted material. If you are
not a subscriber
of Stocks & Commodities,
please visit www.traders.
com.

Figure 2: eSIGNAL. Here is an example of the study plotted on a 60-minute chart of SPY. *****************************
*****/

var fpArray = new Array();

function preMain(){
F eSIGNAL: MARCH 2019 TRADERS’ TIPS CODE setPriceStudy(true);
For this month’s Traders’ Tip, we’ve provided the study Sve- setStudyTitle("SveHLZigZagTicks");
HLZigZagTicks.efs based on the article by Sylvain Vervoort,
“The V-Trade, Part 7: Technical Analysis-V-Wave Count,” from var x = 0;
fpArray[x] = new FunctionParameter("NumberOfTicks",
the September 2018 issue of Technical Analysis of Stocks & FunctionParameter.NUMBER);
Commodities. with(fpArray[x++]){
The study displays the waves (swings) on the price chart. setName("Reversal Number of Ticks");
A sample chart is shown in Figure 2. setLowerLimit(2);
The study contains formula parameters that may be con- setDefault(200);
}
figured through the edit chart window (right-click on the
chart and select “edit chart”). fpArray[x] = new FunctionParameter("LineColor", Func-
To discuss this study or download a complete copy of the tionParameter.COLOR);
formula code, please visit the EFS library discussion board with(fpArray[x++]){
forum under the forums link from the support menu at www. setName("Line Color");
setDefault(Color.RGB(0,148,255));
esignal.com or visit our EFS KnowledgeBase at http://www. }
esignal.com/support/kb/efs/. The eSignal formula script }
(EFS) is shown below and is also available for copying &
pasting from the Stocks & Commodities website at Trad- var bInit = false;
ers.com from the Traders’ Tips menu. var bVersion = null;
var vFlat = null;
/********************************* var vCurrentTrend = null;
Provided By:
eSignal (Copyright c eSignal), a division of Interactive var xOpen = null;
Data var xHigh = null;
Corporation. 2016. All rights reserved. This sample eSig- var xLow = null;
nal var xClose = null;
Formula Script (EFS) is for educational purposes only and
may be var vLastHigh = null;
modified and saved under a new file name. eSignal is not var vLastHigh_1 = null;
responsible var vLastLow = null;
for the functionality once modified. eSignal reserves the var vLastLow_1 = null;
right var vZZTemp = [];
to modify and overwrite this EFS file with each new var vZZfinal;

50 • March 2019 • Technical Analysis of Stocks & Commodities


var point = null; else {
var fNewBar = null; vLastHigh = vLastHigh_1;
var vLastSwingH = null; if (!fNewBar) vZZTemp.shift();
var Count = null; vZZTemp.unshift(vLastHigh);
}
var x1a = null; }
var x1b = null; else {
var y1a = null; if (xLow.getValue(0) <= vLastLow_1){
var y1b = null; vLastLow = xLow.getValue(0);
var cntr = null; if (!fNewBar) vZZTemp.shift();
var sType; vZZTemp.unshift(xLow.getValue(0));
}
function main(NumberOfTicks, LineColor){ else if (xHigh.getValue(0) >= (vLastLow_1 + (point *
if (bVersion == null) bVersion = verify(); NumberOfTicks))) {
if (bVersion == false) return; vLastHigh = xHigh.getValue(0);
vLastLow = xHigh.getValue(0);
if (getBarState() == BARSTATE_ALLBARS){ if (!fNewBar) vZZTemp.shift();
bInit = false; vZZTemp.unshift(xHigh.getValue(0));
} vCurrentTrend = 1;
}
if (!bInit){ else {
vLastLow = vLastLow_1;
xClose = close(); if (!fNewBar) vZZTemp.shift();
xHigh = high(); vZZTemp.unshift(vLastLow);
xLow = low(); }
xOpen = open(); }
point = getMinTick();
vCurrentTrend = 1; if (vZZTemp[vFlat] < vZZTemp[vFlat+1] && vZZTemp[0]
Count = null; >= vZZTemp[1]) {

x1b = null; if (vLastSwingH == false ){


y1b = null; removeLine(sType+cntr)
x1a = null; cntr -= 1;
y1a = null; }
cntr = null; else {
x1a = x1b;
bInit = true; y1a = y1b;
} }

fNewBar = false; x1b = -vFlat;


y1b = xLow.getValue(-vFlat)
if (getBarState() == BARSTATE_NEWBAR){
vLastHigh_1 = vLastHigh; doLine("con",LineColor);
vLastLow_1 = vLastLow; vLastSwingH = false;
fNewBar = true; }
Count = Count+1; else if (vZZTemp[vFlat] > vZZTemp[vFlat+1] && vZZ-
Temp[0] <= vZZTemp[1]) {
if (x1a != null) x1a -= 1;
if (x1b != null) x1b -= 1; if (vLastSwingH == true ){
} removeLine(sType+cntr)
cntr -= 1;
vFlat = 1; }
else {
if (vCurrentTrend > 0) { x1a = x1b;
if (xHigh.getValue(0) >= vLastHigh_1) { y1a = y1b;
vLastHigh = xHigh.getValue(0); }
if (!fNewBar) vZZTemp.shift(); x1b = -vFlat;
vZZTemp.unshift(xHigh.getValue(0)); y1b = xHigh.getValue(-vFlat)
}
else if (xLow.getValue(0) <= (vLastHigh_1 - (point * doLine("con",LineColor);
NumberOfTicks))){ vLastSwingH = true;
vLastLow = xLow.getValue(0); }
vLastHigh = xLow.getValue(0);
if (!fNewBar) vZZTemp.shift(); if (vZZTemp[0] == vZZTemp[1]) vFlat = vFlat + 1;
vZZTemp.unshift(xLow.getValue(0)); else vFlat = 1;
vCurrentTrend = -1;
} return;

March 2019 • Technical Analysis of Stocks & Commodities • 51


Figure 3: WEALTH-LAB. This sample chart demonstrates application of the indicator to a one-minute chart of TSLA (data provided by AlphaVantage).

function doLine(sType, LineColor) {


cntr += 1;
if (x1a != null && x1b != null){ F WEALTH-LAB: MARCH 2019 TRADERS’ TIPS CODE
drawLineRelative(x1a, y1a, x1b, y1b, PS_SOLID,
3, LineColor, sType+cntr); The SVEHLZigZagTicks indicator, introduced by Sylvain
} Vervoort in his September 2018 S&C article, “The V-Trade,
return; Part 7: Technical Analysis-V-Wave Count,” is now part of our
} TASCIndicators library.
We coded it as a trailing reverse indicator, which marks
function verify(){
var b = false; the reverse of a trend-following move of a certain number of
if (getBuildNumber() < 779){ ticks off the last price extreme. It can be applied to any bar
scale, not just tick-based charts. Crossovers and crossunders
drawTextAbsolute(5, 35, "This study requires version of the indicator line can be used to trigger trend trades.
10.6 or later.", A sample chart is shown in Figure 3.
Color.white, Color.blue, Text.
RELATIVETOBOTTOM|Text.RELATIVETOLEFT|Text. In addition, we’ve extended the already-published SVE-
BOLD|Text.LEFT, HLZZperc indicator to accept “points” (that is, ticks) as in-
null, 13, "error"); put in addition to the other types of price movement (per-
drawTextAbsolute(5, 20, "Click HERE to upgrade.@ cent, ATR, and combined).
URL=http://www.esignal.com/download/default.asp", After updating the TASCIndicators library to its latest
Color.white, Color.blue, Text.
RELATIVETOBOTTOM|Text.RELATIVETOLEFT|Text. version, the SVEHLZigZagTicks indicator can be found
BOLD|Text.LEFT, under the TASC Magazine Indicators group. Please install
null, 13, "upgrade"); (or update if you haven’t done so already) the library from
return b; the wealth-lab.com site to its latest version. Then you can
} plot it on a chart or use it as an entry or exit condition in
else
b = true; a rule-based strategy without having to program any code
return b; yourself.
} —Gene (Eugene) Geren, Wealth-Lab team
MS123, LLC
—Eric Lippert www.wealth-lab.com
eSignal, an Interactive Data company
800 779-6555, www.eSignal.com

52 • March 2019 • Technical Analysis of Stocks & Commodities


Figure 4: NEUROSHELL TRADER. This NeuroShell Trader chart displays the EUR/USD 200-tick SveHLZigZagTicks indicator.

F NEUROSHELL TRADER: MARCH 2019 the current price is a new peak or valley.
TRADERS’ TIPS CODE Users of NeuroShell Trader can go to the Stocks & Com-
The SveHLZigZagTicks indicator that was in- modities section of the NeuroShell Trader free technical
troduced in Sylvain Vervoort’s September 2018 support website to download a copy of this or any previous
article in Stocks & Commodities, “The V-Trade, Part 7: Traders’ Tips.
Technical Analysis-V-Wave Count,” can be implemented in A sample chart is shown in Figure 4.
—Marge Sherald, Ward Systems Group, Inc.
NeuroShell Trader using NeuroShell Trader’s ability to call
301 662-7950, sales@wardsystems.com
external dynamic linked libraries. Dynamic linked libraries www.neuroshell.com
can be written in C, C++, Power Basic, or Delphi.
After coding the indicator in your preferred compiler
and creating a DLL, you can insert the resulting SveHLZig-
ZagTicks indicator as follows:

1. Select “new indicator” from the insert menu


F Quantacula Studio: MARCH 2019 TRADERS’
2. Choose the “external program & library calls” category
TIPS CODE
3. Select the appropriate external DLL call indicator
In “The V-Trade, Part 7: Technical Analysis-V-Wave Count” in
4. Set up the parameters to match your DLL
the September 2018 issue of Technical Analysis of Stocks &
5. Select the finished button.
Commodities, author Sylvain Vervoort uses several custom-
ized zigzags as part of his trading methodology. The Quantacula
An alternative method to analyzing wave counts in Neu-
platform contains two built-in indicators to let you easily add
roShell Trader is to use the Turning Points add-on, which
zigzags to your charts or to your trading models.
not only plots lines between peaks and valleys, but also plots
peak/valley support & resistance lines, the support/resis-
• Our ZigZag indicator takes as input a single data series,
tance price oscillator, Fibonacci retracement lines, price,
generating zigzags based on a specified reversal amount,
time and slope statistical measures, and the probability that

March 2019 • Technical Analysis of Stocks & Commodities • 53


troughs of the price
moves. This is your
typical zigzag and is
plotted in red in Fig-
ure 5. Notice how
the black zigzag is
always delayed by
one or more bars.
The red zigzag can
be useful when
scanning for histori-
cal chart patterns,
but it is not safe to
use when backtest-
ing, since it relies on
future information
when establishing
its values.
Quantacula de-
Figure 5: quantacula. The standard zigzag is plotted in red, while the zigzag that is “safe” for backtesting is plotted in black. faults to the “safe”
zigzag option, which
expressed either as a percentage or a flat value. can be used in a
• Our ZigZagHL indicator uses the historical highs and backtest. But it also provides the classic zigzag for charting
lows to create a zigzag, letting you specify the reversal and pattern-detection purposes. More importantly, it clearly
amount to use, either as a percentage or a flat value. shows you the delay in the standard zigzag, so you can make
more informed decisions when using zigzag in a trading
Both indicators have an important additional parameter strategy.
—Dion Kurczek, Quantacula LLC
called assign when confirmed. When this is set to true (de- info@quantacula.com
fault), the zigzag points are anchored to the bars at which www.quantacula.com
they were detected, that is, the point in time that the source
data moved by at least the specified reversal amount. In the
chart shown in Figure 5, this zigzag is colored in black. This
indicator is safe to use in a backtest. F AIQ: MARCH 2019 TRADERS’ TIPS CODE
When assign when confirmed is false, the zigzag is an- The AIQ program has a built-in zigzag indicator that
chored to the points on the chart that contain the peaks and is similar to the one discussed in Sylvain Vervoort
September 2018
S&C article, “The
V-Trade, Part 7:
Technical Analysis-
V-Wave Count.”
This indicator is
demonstrated on
an AIQ chart in
Figure 6.
—Richard Denning
info@TradersEdge­
Systems.com
for AIQ Systems

Figure 6: AIQ. This demonstrates the built-in zigzag indicator on an AIQ chart of SPY.

54 • March 2019 • Technical Analysis of Stocks & Commodities


Once the file is download-
ed, you can import the indi-
cator into NinjaTader 8 from
within the Control Center by
selecting Tools → Import
→ NinjaScript Add-On and
then selecting the down-
loaded file for NinjaTrader 8.
To import into NinjaTrader
7, from within the Control
Center window, select the
menu File → Utilities →
Import NinjaScript and se-
lect the downloaded file.
You can review the indi-
cator’s source code in Nin-
jaTrader 8 by selecting the
Figure 7: NINJATRADER. The SveHLZigZagTicks indicator is displayed on a one-minute EURUSD chart during January
2019. menu New → NinjaScript
Editor → Indicators from
within the Control Center window and selecting the Sve-
HLZigZagTicks file. You can review the indicator’s source
code in NinjaTrader 7 by selecting the menu Tools → Edit
F NINJATRADER: MARCH 2019 TRADERS’ TIPS CODE
NinjaScript → Indicator from within the Control Center
The SveHLZigZagTicks indicator, as discussed in the Septem-
window and selecting the SveHLZigZagTicks file.
ber 2018 S&C article titled “The V-Trade, Part 7: Technical
NinjaScript uses compiled DLLs that run native, not in-
Analysis-V-Wave Count” by Sylvain Vervoort, is available
terpreted, which provides you with the highest performance
for download at the following links for NinjaTrader 8 and
possible.
for NinjaTrader 7:
A sample chart implementing the indicator is shown in
Figure 7.
NinjaTrader 8: www.ninjatrader.com/SC/ —Raymond Deux & Jim Dooms
March2019SCNT8.zip NinjaTrader, LLC
NinjaTrader 7: www.ninjatrader.com/SC/ www.ninjatrader.com
March2019SCNT7.zip

MASONSON/ETFS strategies. He is the author of Buy—Don’t Hold: Investing With


Continued from page 45 ETFs Using Relative Strength To Increase Returns With Less
Risk; and All About Market Timing, as well as Day Trading
On The Edge. His website is www.buydonthold.com, where
of the period during which these ETFs existed, except for he writes a weekly blog. To submit topics for future columns,
XRO, was bullish, so it is surprising the returns weren’t a reach him at lesmasonson@yahoo.com.
good deal better. Based on the analysis provided in this article,
you could conclude that these ETFs don’t offer advantages FURTHER READING
over buying and holding SPY with its low annual expense Masonson, Leslie N. [2017]. “ETF Sector Funds,” Techni­
ratio of 0.10%. However, the lifespan of these ETFs is rather cal Analysis of StockS & commoditieS, Volume 35:
short; perhaps a performance review after at least 10 years September.
will show improved relative performance. In the meantime, [2017]. “ETF Sector Investing,” Technical Analysis of
I recommend investors look elsewhere for more practical, StockS & commoditieS, Volume 35: January.
viable, and less-expensive ETFs. [2016]. “ETF Sector Investing,” Technical Analysis of
StockS & commoditieS, Volume 34: November.
Are you interested in learning more about using exchange • www.ftportfolios.com • www.invesco.com
traded funds (ETFs) in your trading? Leslie N. Masonson, • www.globalxfunds.com • www.mainmgt.com
an active ETF trader, is president of Cash Management
Resources, a financial consulting firm that focuses on ETF
March 2019 • Technical Analysis of Stocks & Commodities • 55
Interview/Claudio Demb they realize they’re wiped out. A lot of But over time, I’ve learned what the A
Continued from page 37 accounts get blown up this way. It takes game looks like. I know what my A trades
years to develop something that you feel or best-quality setups look like. Once one
well-suited for shorting, but in addition, you know and you’re on a solid founda- appears, you need to trade it, even though
I’m no longer in front of the screen when tion with and can make money from it. you may feel it’s not good. You have to
the market is open because of my profes- But yes, it’s extremely difficult and many go for it because if you don’t trade those,
sional life outside of trading. The market people downplay the difficulty. They then what are you going to trade? That’s
moves too fast when it is going down. think it’s a lot easier than it is. what an “A game” means.
I need clarity. So I put all my trades
on when the market is closed and with Your book is called Trading Your A Thank you for sharing your thoughts
conditional orders. I didn’t used to do Game. How did you come up with with us, Claudio.
that. I used to carve out one day a week the title?
when I would be in front of the screen. My most recent coach, Kerry Lov- Further reading
I can no longer do that. And that forces vorn, always spoke about finding your A Demb, Claudio [2018]. Trading Your A
me to be more patient. It’s not necessar- trade. He would ask, “What’s your best Game: Are Feelings Expensive?
ily a drawback. setup that leads to your best trade?” So [2019]. “How Does Impulsivity
I learned to categorize or rate my trades Affect Your Trading Results?” Tech-
No, it’s not at all. Earlier you said into A, B, C, or F as in failure. I did a nical Analysis of Stocks & Com-
something interesting in that if you’re small study—I don’t know how statisti- modities, Volume 37: January.
not comfortable with something, you cally significant it was—on the returns [2018]. “Decision-Making: Why
won’t do it well. That’s something I made by doing only my A trades. The Is It So Difficult?” Technical Analysis
people don’t give much importance to. difference was almost 100% more earned of Stocks & Commodities, Volume
They think that if something is moving during the period I studied. That’s what 36: November.
fast, they will need to get in there and the book is about: your “A trade” or “A [2017]. “Unrealistic Expecta-
make money quickly. I think a lot of game.” The book is about trading your tions,” Technical Analysis of Stocks
people fall into that trap. Do you often best-quality setups. & Commodities, Volume 35: Au-
see that with traders? I replicated the study with the trades gust.
Absolutely! People underestimate, made by a friend of mine who is a day- [2017]. “The Pernicious Effect Of
by a wide percentage, what it takes to trader, and we saw that if you go for all The Loss Of Opportunity,” Technical
be successful in trading. Trading is an the best setups, or A setups, your returns Analysis of Stocks & Commodities,
extremely difficult activity and is highly are much better. The problem is, you don’t Volume 35: May.
seductive. You get attracted to it, and you always have the best-quality setups. If [2017]. “Successful Trader
think that you can do it; you see move- you do trade only your A trades, then Must-Haves,” Technical Analysis of
ment up and down and you think “this you’ll have to be prepared to sit on your Stocks & Commodities, Volume
will be easy.” It calls a part of our brain hands for a while because these setups 35: March.
that responds to this, but it’s an optical don’t come often. And then that poses [2017]. “How Feelings Influence
illusion. It’s very difficult to be a suc- another problem: You can’t sit on your Your Trading,” Technical Analysis of
cessful trader and it takes a tremendous hands for a long period of time and then Stocks & Commodities, Volume
amount of work. Many people will start pretend that you’re going to play your 35, January.
trading but they’ll lack the knowledge A game when you haven’t been playing • claudiodemb.com
and know-how and before they know it, for a while.

KoSInSKI/breaKawaY GaPS
Continued from page 40 trading breakaway gaps can
lead to profitable results.
Pawel Kosinski, PhD, MEng, is a professor in process tech-
nology at University of Bergen in Norway. His research Further reading
interests involve mathematical modeling of various physical Kosinski, Pawel [2018]. “Double Bottoms Revisited,” Tech-
phenomena, and he uses this experience for researching the nical Analysis of StockS & commoditieS, Volume 36:
financial markets. He was the principal founder of the site September.
lookintotrade.com, which offers backtesting of various strate- ‡TradingView
gies. He may be reached at pawel.kosinski@uib.no. ‡See Editorial Resource Index

56 • March 2019 • Technical Analysis of Stocks & Commodities


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accuracy, last-minute changes may result in omissions or errors.

March 2019 • Technical Analysis of Stocks & Commodities • 57


FUTURES LIQUIDITY

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

Trading Liquidity: Futures


Contracts to
Effective
Commodity Futures Exchange % Margin Trade for Equal Relative Contract Liquidity
% Margin
Dollar Profit
S&P 500 E-Mini (Mar ’19) CME 5 15.4 2 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>>>>
10-Year T-Note (Mar ’19) CBOT 1 9.8 7 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>>
5-Year T-Note (Mar ’19) CBOT 0.7 9.4 10 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
T-Bond (Mar ’19) CBOT 1.9 8.6 3 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
Ultra T-Bond (Mar ’19) CBOT 2.5 11.4 2 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
Crude Oil WTI (Mar ’19) NYMEX 8.7 16.9 3 ••••••••••••••••••••••••••••••••••••••••••••••••••••••
2-Year T-Note (Mar ’19) CBOT 0.3 7.3 11 •••••••••••••••••••••••••••••••••••••••••••••
Russell 2000 E-Mini (Mar ’19) CME 1.7 4.5 2 •••••••••••••••••••••••••••••••••••••••••••
Nasdaq 100 E-Mini (Mar ’19) CME 6.2 14.5 1 ••••••••••••••••••••••••••••••••••••
Euro FX (Mar ’19) CME 1.8 13.4 5 •••••••••••••••••••••••••
Ultra 10-Year T-Note (Mar ’19) CBOT 1.3 9.1 5 •••••••••••••••••••••••
Eurodollar (Dec ’19) CME 0.1 3.6 16 ••••••••••••••••••••
Soybeans (Mar ’19) CBOT 4.2 13.2 6 ••••••••••••••
Gold (Feb ’19) COMEX 2.9 20.6 5 ••••••••••••
Sugar #11 (Mar ’19) ICE/US 7.2 8.6 7 •••••••••••
Corn (Mar ’19) CBOT 4 19.1 21 ••••••••••
Dow Indu 30 E-Mini (Mar ’19) CBOT 5.3 14.2 2 •••••••••
Natural Gas (Mar ’19) NYMEX 20.2 34.3 5 •••••••••
Silver (Mar ’19) COMEX 5.2 13.6 3 •••••••••
Gasoline RBOB (Mar ’19) NYMEX 8.3 14.5 2 ••••••••
British Pound (Mar ’19) CME 3.3 20.3 7 •••••••
Coffee (Mar ’19) ICE/US 7.5 11.1 3 •••••••
Japanese Yen (Mar ’19) CME 1.7 16.3 7 ••••••
S&P Midcap E-Mini (Mar ’19) CME 5 15.4 1 ••••••
Soybean Meal (Mar ’19) CBOT 4.2 11.2 7 ••••••
ULSD NY Harbor (Mar ’19) NYMEX 6.2 11.7 2 ••••••
High Grade Copper (Mar ’19) COMEX 5.1 19.6 5 •••••
30-Day Fed Funds (Apr ’19) CBOT 0 2 10 ••••
Live Cattle (Apr ’19) CME 3.2 12.5 6 ••••
Wheat (Mar ’19) CBOT 5.3 17.4 11 ••••
Australian Dollar (Mar ’19) CME 1.9 14.1 9 •••
Hard Red Wheat (Mar ’19) KCBT 5.7 20.6 12 •••
Palladium (Mar ’19) NYMEX 5.4 8.6 1 •••
Platinum (Apr ’19) NYMEX 4.7 9.3 4 ••• CBOT Chicago Board of Trade, Division of CME
Soybean Oil (Mar ’19) CBOT 2.8 9.1 16 ••• CFE CBOE Futures Exchange
Canadian Dollar (Mar ’19) CME 1.7 16.5 11 •• CME Chicago Mercantile Exchange
Cotton #2 (Mar ’19) ICE/US 7.9 25.8 8 •• COMEX Commodity Exchange, Inc. CME Group
Crude Oil Brent (F) (Mar ’19) NYMEX 8.1 15.3 3 •• ICE-EU Intercontinental Exchange-Futures - Europe
Lean Hogs (Apr ’19) CME 5.6 14 8 •• ICE-US Intercontinental Exchange-Futures - US
Cocoa (Mar ’19) ICE/US 9.1 22.5 9 • KCBT Kansas City Board of Trade
Feeder Cattle (Mar ’19) CME 4.3 25.7 7 • MGEX Minneapolis Grain Exchange
Mexican Peso (Mar ’19) CME 4.3 32.3 25 • NYMEX New York Mercantile Exchange
S&P GSCI (Feb ’19) CME 5.3 15.7 2 •
Spring Wheat (Mar ’19) MGEX 5.4 12.9 7 • 1903
Swiss Franc (Mar ’19) CME 2.3 19.9 6 •
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 • March 2019 • Technical Analysis of Stocks & Commodities


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March 2019 • Technical Analysis of Stocks & Commodities • 59


Trading Perspectives

SOME PERSPECTIVES ON THE EQUITIES WORLD


Rob Friesen is a professional trader and president & COO of Bright Trading (www.
stocktrading.com), a proprietary trading firm hosting independent trader/members,
an online trading school, and utilizing the StockOdds database (www.stockodds.
net). This column shares his thoughts and outlooks on trading, locating opportunity,
probabilistic outcome, and maintaining perspective throughout industry changes. He
can be reached at robfriesen@brighttrading.net or via www.stocktrading.com.
Rob Friesen

PAIR TRADES: TO BUILD OR In total, Trader A (TA) adds three lay- therefore didn’t reestablish.
NOT TO BUILD ers at spread prices -1, -2, -4, so the Regardless of TA’s decision to add or
Continuing with the theme of pair trading average is -2.33. Say the pair retraces not, production in the pair would have
that I set out to focus on in this column from -4 back to the average at -2.33. At occurred and closed profits would have
for 2019, I will discuss some of the areas this point, TA feels happy because the been made, offsetting the open losses
that offer opportunities to handle things pair is back to the breakeven price. TA from the first two layers. Note: Traders
in one of more ways, or not at all. takes no action, watching closely. What may differ from investors in tax consid-
is most likely going through TA’s mind erations, so be sure to know what is best
Tips on position building in pair is the thought that the pair will continue for your specific tax situation.
trading to move higher from this point. (Like Don’t mix styles on the fly or outside
In my opinion, it is more important to most people, TA would be inclined to your plan. In the heat of the battle or
be a student of your own trading than value the recent move from -4 to -2.33 the fog of war, traders can abandon dis-
a student of the markets. Through this heavily, when what should be consid- ciplines regarding rules, trading plans
sort of self-analysis, you may discover for the day, or plans for the specific pair.
that you are accurate on your initial Trying to hit homeruns, get your money
trades, resulting in “one-off” trades and
When pair trading, back, or get even will all work to hurt
without the need to build larger posi- it is better to trade you. I recommend readers to take a mo-
tions through averaging in additional each layer or unit ment to reflect on the value of managing
pair layers. Others may find themselves independently so that positions, trading around a core position,
usually wrong on the first pair trade, but and closing profits through the “produc-
able to perform better with the second
the trader focuses on tion” of multiple slices of capital into a
and third layer using that first layer for the production of some pair. Can this work with trading a stock
information-gathering. or all the units. naked? Certainly, but naked traders may
There is a difference between estab- have market exposure.
lishing a position through averaging When layering, logarithmic distribu-
layers (that is, having an average spread ered is overall context—what catalyst tion may provide an advantage over
price) and trading the position according caused the move up, the pair’s average fixed-distance scaling. Varying bets at
to that average price. For stocks, it may be daily range (ADR) or average true range key levels or inflection points may also
suitable to trade the average, but for pairs (ATR) and percentage move of that, and increase the benefits.
I never recommend trading the average readouts from other suitable indicators). Be mindful of my previous recom-
of a position. My personal experience, Later, the pair retraced back to -4 and mendations in this column to classify all
along with my numerous observations unfortunately, nothing was accomplished pairs into two distinct categories: those
in working with other traders during my as Trader A sat through the volatility. that are trendy by nature (signal) versus
career, is that the mathematics of success- Most likely, risk has increased with the those that are range-bound by nature
ful pair trading doesn’t support trading spread action, and TA is fully loaded (noise). Classifying pairs accordingly can
the average spread price. It is better to and exposed. assist you in allocating capital correctly.
trade each layer or unit independently so Here might be a better approach for Noise trading suggests scaling, while
that the trader focuses on the production Trader A: If TA in the same situation signal trading suggests “one-off” trades
of some or all the units. acted at the -2.33 by taking the -4 layer may be better for harvesting opportunity
Here are some examples: off, TA would have made 1.67 times the while managing risk.
position size of that last layer. This would
Trader A: have reduced the total capital needed. To stop-loss or not to: Tips on the
• Has a long bias for a pair In addition, when the spread sold back mechanics and psychology of stop-
• Wants to establish the first unit of down to -4, TA could have redeployed losses
capital or layer at a spread price that unit of capital. Or TA may have How should stop-loss considerations be
of -1. decided the risks were increasing and incorporated into our trading plans?
60 • March 2019 • Technical Analysis of Stocks & Commodities
Trading Perspectives
We all know that many traders bleed loss procedures could be introduced that abandoned self-management and any
accounts out through the repetitive are parameters based on any of the 10 attempt to produce any alpha. Some
actions of stopping out trades that are symbols or they could remain symbol- buy ETFs to somewhat self-manage, but
losing money. specific. The overall theme, though, is don’t want to be stock pickers. Others
So perhaps the answer is in the initial that going wide and reducing the size hand their money over to mutual funds,
construction of the trade. A benefit of into any one idea, you reduce risk and personal advisors, robo-advisors, or
trading pairs is the ability to reduce direct therefore reduce the stopping out of hedge funds.
market exposure and macro exposure in large losses. I understand the sentiment and reasons
some cases. Pair traders tend to be indif- for these decisions, but I will communi-
ferent to or insulated from the types of cate my views here. I believe that arming
problems naked traders can have. Let’s I view stop-losses not yourself with information and the educa-
say a strong setup or signal occurs and as stopping losses but tion on how to apply that information in
through point & click or through auto- as responding to the a focused manner can be a game changer.
mation, the signal is acted on opening a validity of a trade. There are still two distinct communities
long position. Through no fault of their in equities markets: the herd and the
own, the market has a significant selloff informed. The herd is rather large, and
and renders the trade as a loser. The pair I view stop-losses not as stopping the informed community is smaller,
trader may have seen no real change to losses but as responding to the validity of considering the information age.
his P/L during this market event, as both a trade. We need a valid reason to enter It is a challenge and it takes effort to
stocks went down together. a position, build a position, remain in create alpha, but through using analytical
Next, it’s about the position size. If the position, and finally, a valid reason data and tools, trading with a positive
you trade smaller per idea, there may to exit. If the pair you have chosen is expectation, and staying focused on
be less need to stop out with the minor no longer “business as usual,” then it relative performance, it is my view that
fluctuations that are hard to sit through may be best to exit the position, whether it can be achieved.
with size. This applies to both the naked profitable, breakeven, or a loss. Just as
trader and the pair trader. there is usually a fundamental reason
In my July 2018 column I wrote re- behind a chart pattern, there could be a
garding stop-losses: “One of the ways fundamental reason to enter, remain in, SUBMIT AN ARTICLE!
to position size is by how much you or exit a single pair trade or an averaged-
are willing to lose on any given bet.” I in position.
discussed that this is a noble ambition Stop-loss parameters are often in-
with no guarantees, especially if you troduced by drawing on the common
take positions overnight. Regardless, and familiar considerations. This is
position sizing is crucial and should be problematic for a naked trader more
specific to several factors. Position size so than for the pair trader. When a pair
should be based on risks such as news trader constructs a unique opportunity
catalysts, fundamentals, price, liquid- not widely known, or adopted, then that
ity, volatility, and your specific holding trader is insulated from the traps and
timeframes. predatory, informed order flow. If the Are you knowledgeable about technical
Perhaps it’s better to go wide rather pair is widely traded, the trader is more indicators, charting, trading systems, and
than deep into one idea or one strategy. vulnerable to many who are watching money management? Or do you have a solid
If you could touch 10 symbols with the same support, resistance, and key background with intraday trading, trading
qualified probabilities instead of just price points or ranges. psychology, options and cycles? If so, we’d
one, you would reduce your need to be like to hear from you!
perfectly right on the single selection, To trade or not to trade: timing the To write for any of our publications or
and your advantage could come from market obtain more information, please click on
being right as an average from all your From speaking to industry colleagues, Contact Us at www.Traders.com.
bets. Remember, there is only a one in 10 it appears the message that needs to be
chance of selecting the right (profitable) communicated to market participants
symbol out of 10 symbols, but if you have is “you can time the market.” This has
a positive expectation for each symbol, been a debated subject and of course,
then the outcome might be that four of the trading industry wants activity in the
the 10 give you significant profits, one form of volume and purchases of tools
a slight profit, three breakeven, and two and services related to the industry.
have a loss. As long as the magnitude of Many, through failure, disillusionment,
losses doesn’t outweigh the gains, stop- increased fees, and lifestyle choices, have
March 2019 • Technical Analysis of Stocks & Commodities • 61
Explore
Algo Q&AYour Options
Davey acceptable one is found. So this task is tion will be different, hopefully you now
Continued from page 25 frequently frustrating, which may be one have an idea of what to expect in the life
reason people do not spend enough time of an algo trader. I’m sure you’d agree
As you can see, I spend the bulk of my on it. Meanwhile, I still spend significant it is much different than for discretion-
time developing strategies. This is also time on the other tasks, which helps keep ary trading.
the hardest task, since many potential every trading day interesting.

FUTURES FOR YOU


strategies get thrown away before an While every algo trader’s time alloca-

GaRNeR outnumber the losers. ic insurance outlined here should not


Continued from page 41 I should point out that because the be confused with a strategy that offers
protection expires prior to the short absolutely limited risk, nor should it be
volatility the risk might prove to be much option, it will eventually be necessary assumed that normal ebb and flow of
less or moderately more). for the trader to either purchase fresh market pricing won’t impact this trade.
Those accustomed to buying options insurance for the remainder of the trade, What I’ve outlined here is simply a
or trading futures might look at this exit the short option upon expiration of way for option sellers to continue with
risk and reward profile as unattractive, the protective put, or face theoretically premium-collection efforts without
but that assumption is overlooking the unlimited risk beyond expiration of the exposing themselves to the tail risk and
primary benefit of option selling; options February option. In other words, unlike account blowups that can occur on rare
are eroding assets that generally expire vertical credit spreads, diagonal spreads occasions.
worthless. Thus, risking more than the require moderately more attention and
expected payout makes sense if it is ex- ongoing management.
pected that the winners will considerably The strategy of purchasing catastroph-

KaePPeL
Continued from page 47

As you can see in Figure 4, the trader


can make money if crude oil rallies
sharply or falls sharply but will suffer
time decay if USO remains relatively
unchanged. Still, the worst-case sce-
nario for this position is an open profit
of +$318.

The benefi ts of adjusting


Everything in trading is a tradeoff. This
is especially true when adjusting an op-
tion position. In most cases, you give up
something (in these examples, primarily
a certain amount of profit potential) in or-
der to get something (in these examples,
the elimination of this risk of loss). Often
adjusting an option position can result
in significant psychological benefits by
virtue locking in a profit and “playing
with the house money”, as well as freeing
up a significant amount of trading capital
that can be deployed elsewhere. FIGURe 4: aDJUSTING INTO a LONG STRaDDLe. By adjusting the position, you can make money if crude oil
rallies sharply or falls sharply. However, your position will suffer time decay if USO remains relatively unchanged.
Still, the worst-case scenario for this position is an open profit of +$318.

62 • March 2019 • Technical Analysis of Stocks


tockS & C
commodities
ommoditieS
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