THE TRADERS’ MAGAZINE SINCE 1982
UGLY DOUBLE UGLY DOUBL E BOTTOM SETUP Prot from bottom bottom shing
8
DECISION AREAS DECISION AREA S IN DAYTRADING Identifying probable turning points
12
ALIASING Avoid A void data distorti d istortions ons
18
HIGH-VOLUME BREAKOUTS A trading strategy stra tegy
26
INTERVIEW Kevin Davey, Kevin Davey, systems developer
REVIEW n
TC2000 Version 16 JANUARY 2016
32
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Daily technical commentary Daily commentar y by expert analysts to help you make smarter investment decisions From daily blogs to live webinars, StockCharts.com hosts free current market analysis and educational commentary from some of the industry’s industry ’s most distinguished technical analysts.
Free daily blogs featuring over a dozen renowned technical commentators John Mu M urphy
Ma r tin Pr P rin g
Ar thu r Hi Hill
Tom Bo Bowley
Greg Sch Schnell nell
Chip Chi p Ande Anderson rson
Carl Ca rl Swe Swenli nlin n
Erin Er in He Heim im
Gati atiss Ro Roze ze
Julius Jul ius de Kem Kempena penaer er
StockCharts.com hosts free daily blog content from over a dozen professional technical analysts, including prominent names such as John John Murphy, Murphy, Martin Pring and Arthur Hill. Thousands of online investors trust StockCha StockChart rts.com s.com to provide the unbiased expert exper t analysis and enriching educational commentary they need to cut through the noise and make smarter investment decisions.
Live, interactive webinars hosted by seasoned market technicians Our free daily webinars are hosted by some of the nancial industry’s most distinguished chartists. chartist s. Join these technical titans LIVE as they put their years of experience on display and share invaluable insights into the tools and strategies they use in their own trading. Tune in to any of our seven different webinar shows for free, airing six days a week, Monday through Saturday, and learn from the best to boost your technical skills and nancial prowess.
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CONTENTS 8
Bottom Fishing & The Ugly Double Bottom Setup by Thomas Bulkowski Proting from bottom shing is notoriously difcult, but this setup may help.
JANUARY 2016, VOLUME 34 NUMBER 1
30
INTERVIEW
32
FEATURE ARTICLE
12
Aliasing by John F. Ehlers Since you are likely using sampled data when trading, there is a chance that there could be some distortions in the data. Here’s what you can do to avoid those distortions.
22
26
38
40
AT THE CLOSE
61
The Green Line by Ron Jaenisch Knowing when to exit a trade can work wonders for your trading returns. Here’s one tool that can help you make that critical decision.
REVIEW 42 • TC2000 Version 16
Product review: Stock market charting software
DEPARTMENTS 6 7 46 57 57 58 59 59 60
Opening Position Letters To S&C Traders’ Tips Advertisers’ Index Editorial Resource Index Futures Liquidity Classified Advertising Traders’ Resource Books For Traders
Q&A by Rob Friesen This professional trader answers a few of your questions.
High-Volume Breakouts by Ken Calhoun In this nal article in a series we’ve been presenting on breakout trading strategies from this professional daytrader and educator, we look at the role that volume and price-action breakout patterns play in conrming entry signals.
Failing Successfully by Stella Osoba, CMT We’re groomed to think of losses as a sign of failure, which is why trading is difcult. But experiencing losses is part of a trader’s life and is something you have to accept. Here’s how to approach the idea in a healthy way.
Trading Vs. Forecasting: What’s The Difference? by Tyler Yell, CMT Trading is about recognizing present opportunities where the risk-to-reward is favorable. Forecasting, on the other hand, is outcome dependent. Find out how you can use both and take advantage of those opportunities.
Developing Strategies With Kevin Davey by Jayanthi Gopalakrishnan Kevin J. Davey is a professional trader and systems developer. He is the author of Building Winning Algorithmic Trading Systems: A Trader’s Journey From Data Mining To Monte Carlo Simulation To Live Trading. An aerospace engineer and MBA by background, Davey has been an independent trader for over 25 years. He placed rst once and second twice in the World Cup Championship of Futures Trading during the years 2005–2007. We spoke with him about how a retail trader can trade algorithmically.
Decision Areas In Daytrading by Peter Hill It’s impossible to know when the market will suddenly turn and move in another direction. But there are tools you can apply to your charts to identify those probable turning points. Here’s a simple technique any intraday trader can use.
18
Explore Your Options by Tom Gentile Got a question about options?
45
Futures For You by Carley Garner Here’s how the futures market really works.
n n
Cover: William L. Brown Cover concept: Christine Morrison
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January 2016 • Volume 34, Number 1
OPENING POSITION
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As
we approach another year, it may be a good time to reect on what you expect to accomplish in 2016. A good starting point may be to look at what goals you set for 2015 at the same time last year. Did you meet your goals? Did you follow your strategies as you intended to? For the most part, 2015 was a strong year in the nancial markets. There were times when there was some volatility—especially in August and September—but the markets recovered. Also, we are in the midst of a season that has historically been strong for the US markets. It’s easy to get comfortable or complacent with how you have done when markets are strong. But it’s not something you can afford to do. Look at how your trading systems performed during August 2015. Did you apply good risk-management strategies or did you hold your positions hoping that the markets would rebound? If you did the latter, you can c ount your blessings since you would have recovered your losses. But we know too well that this doesn’t always happen, and living on hope isn’t going to give you the edge you are looking for.
B
ut how do you gain that edge? You’re playing in the same domain as large institutions who invest billions of dollars into building sophisticated algorithms and communications infrastructure to place trades in nanoseconds. As a retail trader, you don’t have access to any of this sophisticated technology. You’ve got to come up with your own game plan. Coming up with a system i s only one piece of the puzzle. You have to put your systems through rigorous tests so you know your systems are rock-solid before you start trading with them. And after all that testing, there’s a chance they could still not work the way you expect them to. Even a simple system that enters and exits trades based on moving average crossovers will have to be tested. And when your system is no longer working, it’s time to abandon it and come up wit h a new one. It’s a never-ending process. Even though the markets will always be about buying and selling and making and losing money, the dynamics change. You’ve got to be prepared to adapt and change your trading systems. Be prepared to face the markets with systems that give you an edge. There’s nothing more empowering than having control over your own systems. Here’s wishing you a protable 2016. Happy trading!
6 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
Jayanthi Gopalakrishnan, Editor
k c o t s r e t t u h S / i r e l l a v a C d r a h c i R n w o t n w o D i m a i M
Build powerful trading systems in MINUTES, not hours or days. 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 communication with our readers. Is there something you would like to know more (or less) about? Tell us about it. Without a source of new ideas and subjects coming f rom our readers, this magazine would not exist. Email your correspondence to
[email protected] or add ress your correspondence to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All letters become the property of Technical Ana lysis, Inc. Letter-writers must include their f ull name and address for vericat ion. Letters may be edited for length or clarity. The opinions expressed in this column d o not necessarily represent those of th e magazine.—Editor
IN MEMORY OF DON BRIGHT
Editor, I enjoyed reading Don Bright’s column each month. He died too young. THOMAS BULKOWSKI THANKS FOR YOUR MAGAZINE
Editor, Your magazine is informative and touches different areas of the industry. I especially enjoy Dirk Vandycke’s and Melvin Dickover’s ar ticles and t heir approach to the markets and trading. Other things that I would like to read about in your magazine are the so-called “quant” traders and the quantitative trading techniques and systems and their use. Any resources regarding this would be helpful. Another thing I think could be helpful is a column from the point of view of a novice trader for those just starting out in this business. It could be a how-to column with the required steps for starting out, including advice, choosing the right hardware, platforms, and systems, and incorporating as a business, up to the particulars of different markets and the best way to trade them. Thank you for your magazine and for the hard work you put into making the magazine a reality. I’m looking forward to reading more interesting articles. MIHAI ARNAUTA SIMPLIFY IT: SCREENING AND AVERAGE DAILY VOLUME
Editor, I read with great interest James and John Rich’s article in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, “Simplify It,” on their trading channel strategy.
My question relates to scanning for stocks that are trading more than one million shares a day. Over what period of time do the authors use to measure the average daily volume of one mil lion? (That is, two days? ve days? 20 days? 40 days? 60 days?) I did a scan for one million stocks over a 20-day period and many of my results had a current daily volume, on the day of the scan, of far below one mil lion. My scan for volume of over one million shares, using StockCharts.com, was as follows: [Daily SMA(20,Daily Volume) > 1000000] This scanned for an average daily volume of the last 20 days that was over one million shares. Feedback from the authors would be most welcome. And thank you for presenting a workable, simple trading strategy. WILLIAM
Lansing, MI
Author James Rich replies: As long as you use 20 days or more, I don’t think it’s going to make any difference, since the point is to avoid thinly traded stocks. Using 20 days is equal to four trading weeks, and there’s always the possibility of picking up a low-volume day or even a low-volume week, but you’ll still have stocks with enough volume to be traded by institutions.
®
Maybe it’s time to try something NEW! Winner 13 years in a row! www.NeuroShell.com 301.662.7950 SIMPLIFY IT: MOVING AVERAGE CRITERIA
Editor, Thank you for the November 2015 article, “Simplify It,” by James and John Rich. As an individual trader, I appreciate the way they simplied the process and I liked the ideas expressed in their article. A quick question for the authors: When they are using their 50-day SMA of the SPY to initially determine market direction, what specic criteria do they use to base this determination on? For instance, does the last 50d need to be higher than the readi ng 10 periods prior (and if so, is there a % requirement)? I’ve attached two sample charts [not shown] (I quickly grabbed wheat charts for this example but I would use SPY for stock scanning, of course). These are showing the 50d trending in a di rection, but obviously in very different degrees of trending. The downtrend of the rst is clear, but while the uptrend of the 50d in the second is going higher, it is happening in a rather range-bound sideways market. Continued on page 31
January 2016 • Technical Analysis of STOCKS & COMMODITIES • 7
how to improve the setup. I’ll begin with a chart pattern I call an ugly double bottom. In Figure 1 you see an example of this at points AB. In a traditional double bottom, price makes a valley, bounces, and forms a second valley at or near the price of the rst one. In the ca se of an ugly double bottom, you are looki ng for a second, higher h igher valley. valley. In this example, price makes a new yearly low at A, bounces to the horizontal blue line, and forms a higher bottom at B. When I rst tested teste d this pattern patt ern several years ago, I set a minimum price difference between bottoms of 5%. This example shows shows bottom B 7% above A. The ugly double bottom conrms as a valid chart pattern when price closes above the top of the pattern. That occurs at C in Figure 1, although it may be hard to see on the chart. Notice how price drops to D and then recovers. Testing shows that a stop placed below B is not ideal, but it will cut losses almost in half. The tradeoff is a drop of 20 percentage points in the win/loss ratio. I prefer a stop below A. I’ll discuss testing results later in this article.
A Turn For The Better
Bottom Fishing & The Ugly Double Bottom Setup
TRADING SETUP The setup described here is easy enough to follow. Look for an ugly double bottom when the stock makes a new yearly low. Here are the steps.
1. Only look for stocks during a bull market. 2. Find a stock maki making ng a new new yearly low. 3. Locate an ugly double double botbottom where the rst bottom sets the yearly low.
Proting from bottom shing is notoriously difcult, but this setup may help.
by Thomas Bulkowski
B
uy low, low, sell high. How many times have you tried to do that and lost money? Here’s a trading setup for buying stocks making new yearly lows. A shorter phrase for that is bottom shing. The technique I’ll describe here is not perfect. You can still lose money, perhaps a lot of it, but the setup gives you an indication of how often bottom shi ng works. works. Perhaps you will have ideas on
8 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
4. Place an order to buy the stock on or after the pattern conrms. 5. Place a stop-loss order a penny below the rst bottom. 6. Use your your favorite favorite sell signal to exit the trade.
k c o t s r e t t u h S / r e p e e w s k c o R
TRADING STRATEGIES
Step 1: Only bottom sh in a bul l market. In a bear market, price market. tends to keep going down and it busts ugly double bottoms. Testing results reinforce that belief. The median trade in a bull market gained 32%, 32%, but in a bear bea r market it lost 20%. Step 2: Using the yearly chart, look for price to set a new low for the year year at the rst bottom of the ugly double bottom. I bottom. I did not test variations with the rst bottom higher in the price range, so that is something you can explo explore. re. Step 3: The second bottom bott om should be between 5% and 20% above the rst one. The larger the difference di fference between bottoms, the larger the potential loss, but the number of winning trades increases. I tested a 5% to 25% range and found that the sweet spot is 10% and above. FIGURE 1: THE UGLY DOUBLE BOTTOM. An BOTTOM. An ugly double bottom appears at AB and confirms as a valid pattern at C when price closes above the top of the pattern.
Step 4: The pattern conrms when price closes above the top of the pattern. That pattern. That means buying at the open the next day. However, I often use a buy stop placed a penny above the top of the chart pattern pat tern to get me into i nto a trade. Using a close above above the top helps avoid avoid one-day price spikes that would otherwise trigger a premature entry. Step 5: Placing stops. I stops. I tested two stop locations—a penny below the rst bottom and a nd a penny below the second—triggered on a close at or below that price. Neither stop locations work well in my opinion. I will discuss stop placement later in t his article. Step 6: Apply a sell signal. I signal. I tested moving averages from 10 to 250 days, trailing traili ng stops from 5% to 25% below a highwater mark, and a target ta rget price exit based on the height of the chart pattern. TESTING I used 59 stocks for in-sample data and 425 for out-of-sample out-of-sample data starting January 2000 (yes, in the middle of the bear market whose trades I discarded but logged anyway) anyway) to June 2015. 201 5. Not all stocks covered the entire range. To nd ugly double bottoms automatically automatically,, I looked for the lowest low est low within a sliding window of ve trading days wide. That means nding the lowest low from ve days before to ve days days after aft er the bottom bot tom (11 (11 days total) and then looking for the next adjacent bottom. I used in-sample data to determine the best stop location,
If you were to trade the setup perfectly , it wins 87% of the time, making an average of 48% from winning trades.
how far the bottoms should be from one a nother (price scale), best exit technique, and so on. Then I applied the setup to the larger group of stocks and also ran some of the tests going back as far as a s 1990. I didn’t didn’t see any performance performa nce difference between in-sample and out-of-sample data that would change the setup. PERFECT TRADES The rst question bottom shers will want answered is how often will trades be stopped out? If you were to trade the setup perfectly (using ugly double double bottoms with bottoms 5% to 20% apart), it wins 87% of the time, making an average of 48% from winning trades, but incurring an average loss of 17% 17% on losing trades. tr ades. Overall, you could make an average of 40% per trade. To nd those statistics, I used a stop-loss order placed a penny below the bottom of the chart pattern, triggered on a close at or below the stop price, and sold at the open the next day. Otherwise, the stock sold when it reached the ultimate January 2016 • Technical Analysis of STOCKS & COMMODITIES • 9
I K S W O K L U B M O T
RESULTS The table shown in Figure 2 illustrates how performance Bottom Stop 1 2 1 2 1 1 varied depending on the height Bottom Diff 5% –20 % 5% –20 % 5% –20 % 5% –20 % 10 % –20% 5% –20 % of the target and stop placement. These are out-of-sample results Win/Loss 75% 75 56 % 66 % 47% 68 % 60% using ugly double bottoms with Avg Win 15% 15 15% 31% 32% 39 % 46 % bottoms between 5% and 20% Avg Loss -1 -19% -11% -20 % -11% -22% -20% apart (narrower than the 5% to Avg Profit 7% 4% 14% 9% 19 % 20 % 25% test range). Consider the 1x height for bottom 1. I placed Median Profit 12% 12 8% 22 % - 4% 32 % 26% a stop one penny below the rst No. of Trades 862 855 818 865 420 771 bottom of the chart pattern to FIGURE 2: TRADING RESULTS. Here, RESULTS. Here, you see the performance statistics for the ugly double bottom setup. limit lim it losses (again, (again, triggered only at close and sold at the open the next day). For the target exit, I high. The ultimate high is the highest peak before price closes computed the height of the chart pattern, added the height to at least 20% below below that peak. This is not the same as a tra iling the top of it, and then placed a sell stop at that price. stop set 20% below a high-water mark. The exit sells at the Trades won 75% of the time. Winning trades made 15% highest peak before the stock tumbles, so it is unrealistic. but losers lost 19%. The combined average of winning and The 20% price swing is what many use to disti nguish a bull losing trades was a gain of 7% (average) or a median of 12%. market from a bear market. I simply applied that mechanism There were 862 trades. to stocks. I used 867 perfect trades, so don’t expect your Since you are buying at the top of the pattern and getting results to duplicate it in actual trading. For a more realistic stopped out at the bottom of it, the loss is large, about 20% exit signal, I selected selling when price reached a target. The for stops placed below bottom 1. If you use bottom 2 as the target was a multiple of the height of the ugly double double bottom stop location (a penny below it), the loss drops from 19% to added to the top of it. 11%. 11 %. However, However, the win/loss win/ loss ratio rat io drops to 56%, so fewer trades trade s work. The overall prot drops from 7% to 4% 4%,, too. I narrowed the price difference di fference between the two bottoms in the ugly double bottom from 5% to 10% (second column from the right). The results are shown in the table in Figure 2. The win/ loss ratio climbs marginally from 66% to 68%. Losses increase from 20% to 22% but the average and median prots rise dradramatically, 14% to 19% and 22% to 32%, respectively. If I were to trade this t his setup, the 10% to 20% range with a 2x height would be my choice. The table shows that as the price target gets further away, prots increase but losses stay about the same. That makes sense because the loss size is determined by how tall the pattern is (with a stop below the rst bottom).. If you raise the stop-loss bottom) location, then you will have more losing trades and you will be stopped out of potentially winFIGURE 3: TRADING EXAMPLE. Here, EXAMPLE. Here, the two bottoms are at least 10% apart but no more than 20%. The entry is ning trades, decreasing prot. triggered a penny above the top of the pattern. This ugly double bott om trade leads to a 29% gain.
1x Height
1x Height
2x Height
10 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
2 x H e ight
2x Height
3x Height
Tall patterns help assure, but not guarantee, that the stock has changed trend.
HERE’S AN EXAMPLE The chart in Figure 3 shows an example of how the ugly double bottom setup works, using what I call the preferred setup. The preferred setup has bottoms at least 10% apart but no more than 20%, and entry triggers using a buy stop placed a penny above the top of the chart pattern. Price makes a new yearly low at A, at 57.55, in a bull market. At B, 64.91, the stock makes a higher bottom. The difference between those two bottoms is 13%, falling within the 10% to 20% range. A buy stop placed a penny above the top of the pattern considered by some to be a leading expert on chart patterns. (67.21) starts the t rade at C. The exit price ta rget is twice the He is the author of several books including Getting Started height of t he ugly double bottom, or 2 x (67.21 - 57.55) = 19.32. In Chart Patterns, Second Edition and the Evolution Of A Add the height to the top of the pattern (or the buy price) to Trader trilogy. His website and blog, www.thepatternsite.com, have more than 600 articles of free information dedicate d to get a target of 86.53. As the char t shows, the stock ma kes a strong recovery and price pattern research. soars to D, where it sold for a 29% gai n (not including commissions and fees). If the trade fai led, it would have meant a FURTHER READING potential loss of a lmost 15%. Notice t hat a stop placed below B, Bulkowski, Thomas [2013]. Fundamental Analysis And Position Trading: Evolution Of A Trader, John Wiley & the second bottom, would have triggered on the drop to E. Sons. [2014]. Getting Started In Chart Patterns, 2d. ed., THAT’S A WRAP John Wiley & Sons. The ugly double bottom setup is awed because the stop is placed below the bottom of the chart pattern. Thi s is necessary [2013]. Swing And Day Trading: Evolution Of A Trader, because stocks making new lows tend to make lower lows. John Wiley & Sons. Tall patterns help assure, but not guarantee, that the stock [2013]. Trading Basics: Evolution Of A Trader, John has changed trend. When the trend changes from down to up, Wiley & Sons. bottom shers can prot from the rise. [2015]. “10 Selling Tips,” Technical Analysis of STOCKS Since the potential loss is large, this setup is best for inves- & COMMODITIES, Volume 33: May. tors, those willing to buy and hold a stock for the long ter m. [2015]. “Four Lessons From Three Decades Of TradThey are willing to risk money in the short term to boost ing,” Technical Analysis of STOCKS & COMMODITIES, prots over the long term. Swing and position traders may Volume 33: August. • http://thepatternsite.com also benet from this setup, too. Although I used the height of the chart pattern as the exit tool, you may wish to use your own stop-loss and exit mechanisms to perfect this setup for the markets you trade.
S&C Contributing Writer Thomas Bulkowski (who may be reached via email at
[email protected]) is a private investor and trader with more than 30 years of market experience and January 2016 • Technical Analysis of STOCKS & COMMODITIES • 11
12 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
TRADING SYSTEMS
Looking Beyond Price
Decision Areas In Daytrading It’s impossible to know when the market will suddenly turn and move in another direction. But there are tools you can apply to your charts to identify those probable turning points. Here’s a simple technique any intraday trader can use.
trader with a small account is in a precarious situation judging when to take a position or to stay out of the action. He is normally a person who wants to be trading in the ma rkets, who is anxious to be involved and often thinks more of the reward than the risk. This is the reason that so many people who try to scalp—that is, take intraday positions for short periods trying to capture a few points during the day—so often come to grief. Trying to guess which way the market will go from one minute to another is a perilous adventure. Often, you can be right in one time frame and wrong in another, and if you’re wrong in the smaller time frame, it may be too late for you by the time you’re justied in the longer term. With its high degree of leverage, the futures market is unforgiving of mistakes. That makes it necessary for the small trader to take his position at the optimal moment, the one during which he will know within narrow limits whether he has made a good decision or not. Between these boundaries is the area I call the “decision area” within which the trader needs to take his position or keep it or abandon it before being hurt. Since so many traders are not able to withstand a large drawdown, my task was to nd a way to trade a small amount of money in such a way that prots could be made while taking the least possible risk.
A
N W O R B . L M A I L L I W
ENTER FIBONACCI
The genesis of this project was my observation of the effect of Fibonacci analysis on the prices of virtually
any product in the securities markets. I’m certainly not the rst to notice this phenomenon of prices bouncing around between numbers whose basis is a thousandyear-old mathematical formula, but I had not seen the particular analysis of intraday price activity that I found when I started my experimentation. After watching Fibonacci calculations seeming to exert great pressure on prices in the larger time frames, I had become a fan of this method. But it was when I looked at the smaller time frames that I saw I could make the power of the study a safety factor in daytrading. Of the hundreds of mathematical studies available on computer platforms that are used to access the stock, option, and futures markets, I had found Fibonacci study to be easily the most accurate predictive study of all. It has many devotees, which I believe is, in itself, the reason it is so powerful. Some have an almost mystical belief in this system, thinking that there is a metaphysical force expressing itself in the way that the Fibonacci number series applies to things like the formation of galaxies and the shells of turtles, the golden ratio in art, and other kinds of analysis. But I think it’s enough that many traders see the effects of the study and thus they use it for guidance when they put in their orders to buy and sell. That is what makes it seem as though the Fibonacci levels are ordained by heaven itself. The determination of “value,” meaning the right price for a securities product, is the job of all market participants, including banks, pension funds, hedge funds, and the daytrader. Their opinions about the worth of things vary with changing conditions; they are always approximate, and, to a large extent, participants differ according to the time frame in which they are observed. The time frame is the most important factor for the daytrader, who is, by denition, out of
by Peter Hill January 2016 • Technical Analysis of STOCKS & COMMODITIES • 13
are more enthusiastic about buying than selling, or the opposite. The charts are pictures of the “drama” of the market. These images tell a story that can be grasped immediately, which reams of written data cannot. In Japan, in the 17th century, charts were hand-drawn by rice traders, and even some contemporary traders have drawn their charts by hand. Those were E D A naturally daily charts, but with R T I R the conquest of the computer in E M A D the mid-’90s, everything changed, T can see that it’s difficult to figure out what’s going on here. Sometimes the FIGURE 1: A BASIC INTRADAY CHART. You and intraday charting came into its buyers are winning and sometimes the seller s are winning. There’s no way to predict what’l l happen next. own. The computer does it easily, manipulating data and putting it in the market when it is closed and therefore unconcerned about a form that can be appreciated at a glance. The trader can use whether it is going up or down in the longer term. He is inter- these charts to nd those areas where price may be too high ested only in the prices of things from 9:30 am until 4:15 pm or too low, that is, whether the instrument has value or not, US Eastern Time. During these six and three-quarters hours, even on the most eeting basis. I think charts have become prices change in ways that may well look unpredictable to those ascendant because most people are visually oriented and like without experience and the proper tools. the perspective that charts can provide. The chart that I believe is best for the small trader—since VIEWING THE CHARTS we’re interested here in safety—is one that is of a very small The security with which I am concerned, and which I will use time frame. I prefer two minutes; others like “tick” charts, in this article, is the futures contract that tracks the S&P 500 which paint bars (or candles) according to a specied number index. It is an instrument of interest to traders over the entire of trades. These are best for the “scalpers”—so-called because world and it trades nearly 24 hours a day, ve days a week, and of their hit-and-run style, taking a little out of the market here on a good day, over two million contracts will be exchanged, and there—because it is the sa fest way to be in what could be a making it highly liquid. Liquidity is not just an advantage for dangerous environment. There a re longer-term investors here, the daytrader; it is a necessity. The daytrader must be able to too; the two classes of market participants are there together, jump in and out of the market without delays. Another impor- but it’s the scalpers that determine the minute-by-minute ups tant advantage of trading in the futures market as opposed to and downs of the price action. It is the scalpers who are making the stock market is that you do not have to own the product in their living on this price action, minute by minute, in between order to sell it. A seller can take his position in the hope of a and sometimes using the activities of the long-term investors decline in price, aft er which he can take a prot. This can also as grist for their mills. Of course, they are equally grist for the be done in the stock ma rket, of course, but you need the ction mills of the long-term investors. Fair is fair. of ownership by “borrowing” the stock in order to sell it. The Though this is an arena for long-term investors in the end, effect is the same as long as the stock is not difcult to bor row, it’s one that could not exist without the sca lpers. It is supported but all in all, it’s easier with futures, especially in daytrading. by the scalpers in the same way that our farmers are supported There are two basic ways of describing the nancial mar- by the speculators who are willing to buy their crops before kets. One is appropriate for longer-term i nvestors: it concerns they have even sprouted from the ground. The farmers could itself with the fundamentals of nancial products, the ana lysis not remain in business without the speculators, and in t he same of the economy, monetary system, and so on. This is usually way, the investors need the sca lpers to function. applied to the equity market by people who want to nd the Let’s look at a basic intraday chart in Figure 1. There’s not best stock to own for the next 20 years. The daytrader is not much to go on here. The chart (one day in two-minute increinterested in the next 20 years, and he is not interested—at least ments) makes market action look like a brawl. Sometimes the immediately—in the balance sheet and quarterly report. But he buyers are winning and sometimes the sellers. It looks like is interested in the rst effect that those things have on other there’s no way to predict what will happen next. Clearly, the people, mainly other traders. And where others may use the chart, in a nd of itself, is not enough. This is where the Fibonacci daily newspaper, or even listen to t he CEO’s conference call to tool makes itself felt in the intraday environment. The tool—as decide what’s valuable, the daytrader, along with others traders, opposed to the Fibonacci mathematica l system that gave birth uses intraday charts. The charts tell him what effect the CEO’s to it—is another invention of the last few decades: mathematical call had on other market participants. They tell him if people studies applied in visual form to price action. The wild-looking 14 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
down; instead, you have something to go by. WHAT ARE
THE CHARTS
TELLING YOU?
Now that you have the Fibonacci levels on the chart, the next step is to gure out what they are telling you. In my observations I have found that they are, sometimes for just moments, the boundaries of what we call support & resistance. This idea may be the most important one in the world of trading. The trader’s idea of FIGURE 2: ADDING FIBONACCI LINES. Here, you can see how the price often pauses at the blue lines, sometimes right support & resistance will be his on the tick, or sometimes clustering, and then often turning to go in the other direction. reason for buying or selling or doing nothing. When the trader believes the price of something is at support, he will be willing to buy, and when it’s at resistance, he won’t buy, and may sell instead. Support can be dened as a level at which buyers are willing to pay up for the product in question, expecting that they will be able to get more for it in the future, even in the next couple of minutes. Resistance, on the other hand, comes about when buyers are no longer willing to pay up, and also where the sellers, a little anxious, are willing to take whatever is bid for their holdings, generally a little less than they would otherwise have FIGURE 3: ADDING AN INDICATOR. Here, the stochastic oscillator is used as a confirmation to the Fibonacci levels. Meeting of price and Fibonacci levels combined with a high or low level on the stochastic gives a good indication of what held out for. will happen next. Naturally, there are many valid ways to determine support & rechart that you saw in Figure 1 can be tamed to a large degree sistance. Every trader has at least one, and I am not trying with this tool. It clearly puts some order into the chaos of the to gainsay any other theory. But the evidence I have found chart in Figure 1. shows that the delineations that result from the proper use of The chart in Figure 2 has horizontal lines (blue on my charts) the Fibonacci tool become excellent estimations of support & laid across the price activity that were calculated by the Fibonacci resistance, at which times a majority of orders moves the price system. You can see in this chart how the price often pauses either up from support or down from resistance. Traders will at the blue lines, sometimes right on the tick, or sometimes respond to these numbers as denitions of the high and low of clustering, and then often turni ng to go in the other direction. It an area of value. is almost as though the price was poured into an oddly shaped But is every Fibonacci line a level of support or resistance? mold, the Fibonacci lines being its edges. There is occasional From the chart in Figure 2 you can see that price often changes spilling over, but it is unusual for price to ignore these lines direction at the blue lines. But these numbers are not always even at times when excitement and volatility are high. exact, and sometimes the turn is too small to be of use. You Those Fibonacci levels are landmarks in the alien territory need something else to give you the condence to ta ke a posithat we saw in the rst chart, a wasteland that gave no clues as tion, and to assure you that the change in direct ion you expect to where we were or what to do. You need to have something to will have some follow-through. The thesis here is that there judge whether the product you are trading was well or poorly is an important relationship between the price and Fibonacci priced. With the Fibonacci levels, you don’t need to buy or levels, but this fact turns out to be insufcient by itself for ef sell blindly with no good idea of whether prices will go up or fective trading. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 15
ADDING
CONFIRMING
INDICATORS
The Fibonacci tool is not magical. What is needed is one more indicator that will act like a compass at Fibonacci levels, telling you which way to go, whether it is appropriate to take a position or not, whether to buy or sell, and whether there may be follow-through from the point at which you take a position. It’s another of those mathematical studies made visual: the stochastic oscillator. There are others of this variety, but I like this one. Notice on the chart in Figure 3 the coincidence of price meeting a Fibonacci level and the position, high or low, of the stochastic. (The ovals are drawn at the same t imes on the upper and lower panels of each part of the chart. This is t he coordination you’re looking for.) It’s clear on this char t that the meeting of price and the Fibonacci levels combined with a high or low level on the stochastic gives a good indication of what will happen next. The probabilities are very high that this combination will be predictive of the direction that price wil l go, and that there will be enough follow-through to ma ke the trade worthwhile. You don’t want to make a trade only to have the thing do an about-face as soon as you click the buy or sell button. Ideally, you see the price rise along with the stochastic and then see the pric e meet a Fib level while the stochastic is high in its range. That will signal an opportunity to sell. It’ll be the opposite for buys. By the time the market opens, Fibonacci calculations have been made for the day: the levels are on t he chart. (See sidebar
“Calculating Fibonacci Levels” for the method of deriving these numbers.) At the open, or even earlier, we look for a n indication of which way prices will go. Where is the Fib level? Is the stochastic high or low, if either? These are the things that will give indications of what the market wants to do. The chart i n Figure 4 shows the rst two hours of activity of the S&P emini futures contract on a recent day. (The vertical lines are put in to show the connection between the stochastic and price levels.) You can see that price opened (9:30 am Eastern Time, the rst of the vertical lines) up against a Fibonacci level at about 2096 and the stochastic was quite h igh in its range. This made for a reasonable sell of the c ontract, which went down to 2083 before reversing for the day. There were various points at which you could get in or out, but the possibility is clear that a skillful trader might have captured 13 points on this contract. Small time frames like this have the advantage of letting the trader know quickly when a trade is not working as expected. A large trader might use a ve, or 15-minute, or even larger time frame because he doesn’t need to worry as much about the drawdown that can happen while a single bar (or candle) is being painted . If a small trader tries to use even a ve-minute time frame he may nd himself in trouble before he knows it. That, combined with the use of the Fibonacci system, is specically geared to keep the small t rader out of trouble. The trader has what I am calling a “decision area” within which he is safe. The large trader might be able to afford to take 15 minutes to make his decision, but the little guy has sometimes only a few moments. You want to quickly know when you are wrong. You need to have guideposts that you respect b ecause otherwise you will be tempted to think that you know better than that mathematician who is long dead, and try to pit yourself against the market, which is always a mistake. I believe that this system, simple as it is (one chart with two
CALCULATING FIBONACCI LEVELS Here’s how the Fibonacci tool is used to create intraday levels of support & resistance, creating some order in the chaos. On the two-minute chart in Sidebar Figure 1, the trader simply, before the market opens, drags the drawing icon labeled “Fibonacci retracements” from the low of the overnight session to its high (the areas designated by the red squares). The numbers upon which the lines are based correspond to percentages of the range of that overnight session (38.2%, 50%, 62.8%, etc., up to 423%). You then do the same thing from the high to t he low so you have numbers that would be appropriate to the ma rket going lower. This way, you’ll be ready for a nything.—P. Hill
SIDEBAR FIGURE 1: CALCULATING FIBONACCI LEVELS. You can prepare for any market scenario by creating intraday levels of support & resistance.
16 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
appropriate to the size of my account, never risking more than I can afford to lose. With these things in mind, the trader can see what the uses of the Fibonacci levels are. They dene a place on the chart with the number that may well be the exact point at which the price turns. My view is that it is good to put orders to buy or sell the Fibonacci numbers as early as possible. Discretion has to be use d in this situation: be wary of a fast-moving market. Each trader is competing for a place in the queue of the exchange, which will execute orders on the basis of the time they were entered. If all the traders who are looking see that 2089.75 looks like a good number to sell, they will be putting in their orders to do so as soon as they can. If I am late in deciding that it would be a good deal, my order may not be lled. My order will be left i n the queue while those ahead of me will get into the market. Then, next time, I will have to get ahead of FIGURE 4: TRADING THE S&P 500 EMINI FUTURES CONTRACT. At around the open, price was up the others by using a lower number for sales against a Fibonacci l evel at about 2096 and the stochastic was qui te high in its r ange. This would have been and higher for buys by a tick or two, which an indication to sell. From the chart, you can see there were several opportunities to buy and sell. may work but which will make my stop-loss more vulnerable. This may not be a terrible problem, but it is something to consider. It is always possible to cancel orders that look like they might be overrun because This system, simple as it is (one there is too much volatility or the stochastic is not in the right chart with two indicators), would position for that particular trade. provide a way for the small trader Finally, though this is not an attempt to cover all the aspect s of trading, I would be remiss if I didn’t remind anyone who to function in the market without wants to use this system that it is always necessary to keep an taking a lot of risk. eye on the general conditions of the day, especially the breadth indicators that will warn the trader of volatility and direction in the wider market. For example, if there is a st rong trend in the indicators), would provide a way for the smal l trader to function downward direction, it doesn’t mean that he can’t take counin the market without taking a lot of risk. I thi nk it’s just what is tertrend trades, buying signicant levels, but it does mean that needed by so many who inhabit the chat rooms on the Internet he is in more danger doing so, and should not expect as much waiting for gurus to tell them what to do. This can be learned from that buy trade as he would get if he were selling a good by anyone and can give all the guidance that a guru could give, number that he could go with for a longer, and better, trade. at least insofar as daytrading index futures is concerned. Going with the trend of the day is normally best, as usual, but days without trend are as promising for this system as trending days, and possibly safer. THE TRADING PLAN You can see in the chart in Figure 4 that the system does fail at certain points, mostly when the ma rket is volatile. However, Peter Hill was an equities trader until he made a bad speculathese instances are so rare that a trade will be safe from any tive investment in English real estate. The loss of capital in that serious drawdown as long as the trader always uses stop-loss deal led him to feel the need to use the higher leverage offered orders, especially for those volatile times, and as long as the by the futures market. After investing a great deal of time and trader respects those orders. The stop-loss order has to be un- money in learning how to trade in the futures markets, he questionable once it has been decided general ly how much the came up with a methodology to trade that offers discipline and trader can afford to risk on a trade. In my backtesti ng, I’ve found reasonable expectations of what might happen in the markets. that the price will only rarely overrun the Fibonacci level by He may be reached via email at
[email protected]. more than two points before going in the desired direct ion, so I use a 10-tick, or 2½ point, stop-loss, and it is rarely hit. Taking ‡TD Ameritrade ‡See Editorial Resource Index these losses is not terrifying as long as I know that the ratio of wins to losses is positive, and as long as I keep my trade size January 2016 • Technical Analysis of STOCKS & COMMODITIES • 17
Uncovering Hidden Truths
Aliasing Since you are likely using sampled data when trading, there is a chance that there could be some distortions in the data. Here’s what you can do to avoid those distortions.
by John F. Ehlers imagine that most traders consider the price data they use for analysis to be a continuous function. Nothing could be further from the truth. And, depending on your trading style, the impact of this assumption can range from trivial to dramatic. The fact is that the data is sampled data. The sample rate is once per day on daily bars, once per hour on hourly bars, and so on. It doesn’t matter if you average the high, low, and close; you still only have one sample per day on daily bars. One impact of sampled data is that it can lead to aliasing. In my youth, the old cowboy movies had a sample rate of only 16 frames per second, letting the eye integrate those individual still photographs to produce motion, albeit with a little icker. Aliasing at this slow sample rate made the wagon wheels look like they were turning backwards, and the effect was really weird. Aliasing can also produce some weird effects on your market data. The theory of sampled data states that you must have at least two samples per cycle. Otherwise, the sa mpled data will result in aliasing. The frequency at which there are exactly two
I
18 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
samples per cycle is called the Nyquist frequency. The theory is demonstrated in Figure 1, where the shorter cycle depicted by the red line is sampled at a rate less than two samples per cycle. Since there are less than two samples per cycle of the real data of the red sine wave, the data is interpreted as the phantom aliased blue sine wave. Just imagine the impact on your trading if your data is subject to aliasing! Mathematically, the process of sampling is multiplying a sine wave at the sampling frequency with the cycles in the continuous data. From your high school trigonometry class you may recall this equation: Sine(A)*Sine(B) = 0.5*(Sine(A+B) + Sine(A-B)) If A represents the sampling frequency and B represents the frequencies of the continuous data, the sa mpling frequency is heterodyned with the continuous data with upper and lower sidebands. This is exactly the same process as with your AM
FIGURE 1: THEORY OF SAMPLED DATA. Sampling less than twice per cycle produces phantom aliased signals.
R R O M I K K I N : E G A L L O C L A T I G I D / K C O T S R E T T U H S / N A M L E K K O F D E R F
TRADING TECHNIQUES
radio, where you tune your receiver to the carrier frequency and the information is contained in the upper and lower sidebands. Since the sampling process is nonlinear, aliasing can include harmonics of the sampling frequency mixing with different harmonics of the data to produce a really gnarly soup of noise superimposed on the information contained in the data. Here’s the important part for market data: there is nothing inherent in the data to preclude content whose period is shorter FIGURE 2: HOW DOES THE ALIASED COMPOSITE WAVEFORM AFFECT YOUR TRADING? Here you see that aliasing than that of the Nyquist frequency. produces short-term volatility in the composite data. That means you should expect the upper sideband to be folded back into the lower sideband, producing a false composite signal due to aliasing. The real question is how badly the aliased composite waveform affects your tradi ng. Figure 2 shows the closes of dai ly prices of SPY as the green line, while the red line shows the majority of the aliased signals removed by ltering in t he composite waveform at the cost of a half bar of lag.
JUST HOW BAD IS IT? To get a more quantitative estimate of aliasing effects, start by making a model of market data. It is well established that market data is fractal. That is, a chart using weekly data looks exactly like a chart using daily data if you remove the scales. In other words, the amplitude of the swings in market data is proportional to the wavelength of the cycle components in the data. Simply put, longer cycles have bigger swings. Using this model, you can extend the theoretical shape of the market spectrum on both sides of the Nyquist frequency. Figure 3 shows the spectrum amplitude of the data at frequencies below the Nyquist frequency as the blue line and, with the upper sideband
FIGURE 3: ALIASING IMPACT. The lower sideband blue line shows the ampl itude doubling every time t he cycle period doubles. In this simplified model, the red line represents the aliased upper sideband amplitude simply added to the amplitude of the blue line signal.
FIGURE 4: ALIAS AMPLITUDE. The aliasing impact becomes insignificant two octaves below the Nyquist frequency.
January 2016 • Technical Analysis of STOCKS & COMMODITIES • 19
basically insignicant at longer cycle periods. Other theoretical models of the market can be creat ed, and these generally show that the aliasing impacts depicted in Figures 3 & 4 are a conservative estimate. So what does all this mean to a trader? If you are a trend follower and are using tools like a 50-day moving average or a 200-day moving average, the cycle periods of the data you are using is so far removed from the Nyquist frequency that you can just ignore the impact of aliasing. On the other hand, if your technique involves recognizing short-term patterns in the range of two to ve bars, you should seriously rethink your approach because aliasing produces illusory patterns. Short-term traders using cycles or mean reversion should take active measures to mitigate the impacts of aliasing.
WHAT CAN BE DONE TO MITIGATE ALIASING
FIGURE 5: FREQUENCY RESPONSE OF A TWO-BAR SIMPLE MOVING AVERAGE. here you see that a simple two-bar moving average can remove much of the aliasing impact.
EFFECTS?
The rst line of defense to avoid problems associated with aliasing is to just accept that you should not work with cycle periods within two octaves of the period of the Nyquist frequency. For daily data, that means you should not expect to use cycle periods shorter than eight bars. Even with this constraint you should reduce the swing of the composite waveform by ltering. For example, if you wanted to use a cycle having a FIGURE 6: OVERSAMPLING RESULTS IN SMOOTHER EQUIVALENT FILTERED DATA. The top chart shows a four bar SuperSmoother four-bar period, you as the red line. The bottom chart shows the equivalent 52 bar SuperSmoother using 30 minute data. The green dots show the sampled need to recognize data in both cases. The filter output using the oversampled data is much smoother. that the composite signal at the Nyquist folded back about the Nyquist frequency, the amplitude of the frequency has the same amplitude as your desired signal. composite sidebands show as the red li ne. The lower sideband Therefore, it is imperative that a low-pass lter of some kind blue line shows the amplitude doubling every time t he cycle be used to reduce the amplitude of the frequency components period doubles. In this simplied model, the red line reprenear the Nyquist frequency. A simple two-bar moving aversents the aliased upper sideband amplitude simply added to age is often adequate, because this average has a theoretical the amplitude of the blue line signal. zero of transmission at the Nyquist frequency. The aliasing impact is better demonstrated in Figure 4, The frequency response of a two-bar simple moving where the ratio of the composite signal plus alias is shown as average is shown in Figure 5. This is a n effective way to be a ratio to the signal in terms of decibels. The maximum imsure that aliasing effects are removed. But when it comes pact is at the two-bar cycle period—the period of the Nyquist to ltering, more is often better, if there is not a price to be frequency. Two octaves below the Nyquist frequency, at the paid in terms of lag. Therefore, I also recommend using my eight-bar cycle, the impact is less than 0.5 dB, and therefore is SuperSmoother lter set to a four-bar cutoff period. 20 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
Noisy indicators delay your analysis
If you are using short-term patterns in the range of two to five bars, the effect of aliasing is dramatic. A trader can also elect to oversample the data by using a different sample rate. For example, there are 13 half-hour samples in the trading day. So if you use 30-minute data instead of daily data, the data of interest is nearly three octaves below the sample rate. The top chart in Figure 6 shows a four-bar SuperSmoother as the red line while the bottom chart shows the equivalent 52-bar SuperSmoother using 30-minute data. The green dots show the sampled data i n both cases. The lter output using the oversampled data is much smoother. More important, oversampling enables the trader to create a higher-delity waveform closer to the original Nyquist frequency. For example, the cutoff period of the oversampled SuperSmoother lter was reduced to 26 bars, resulting in a smoothed waveform with less lag as shown in the lower graph of Figure 7.
IT
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jurikres.com 800-810-3646 719-686-0074 Market data aliasing is real, but its impact on your trading depends on your style. If you are a trend trader using relatively long moving averages or slowly moving indicators, you can just ignore it. On the other hand, if you are using short-term patterns in the range of two to ve bars, the effect is dramatic and you might want to rethink your approach. Nonetheless, it’s a good idea to be aware that aliasing is real and it’s a good idea to mitigate its effects just by applying a simple two-bar moving average or FIGURE 7: SMOOTHER INDICATORS WITH REDUCED LAG. Reducing the cutoff period of the oversampled SuperSmoother filter to 26 the SuperSmoother bars resulted in the smoothed waveform with less lag. lter to the data before using any other indicator. More adventurous technicians FURTHER READING might want to explore oversampling using intraday dat a. Ehlers, John F. [2013]. Cycle Analytics For Traders, John Wiley & Sons. S&C Contributing Editor John Ehlers is a pioneer in the use [2015]. “Decyclers,” Technical Analysis of STOCKS & of cycles and DSP technical analysis. He is president of MESA COMMODITIES, Volume 33: September. Software. MESASoftware.com offers the MESA Phasor and MESA intraday fut ures strategies. He is also the chief scien- ‡MESASoftware.com, ‡Stockspotter.com, ‡TradeStation tist for StockSpotter.com, which offers stock trading signals based on indicators and statistical techniques. •
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January 2016 • Technical Analysis of STOCKS & COMMODITIES • 21
Wanna Bet?
Trading Vs. Forecasting: What’s The Difference? Trading is about recognizing present opportunities where the risk-to-reward is favorable. Forecasting, on the other hand, is outcome dependent. Find out how you can use both and take advantage of those opportunities.
by Tyler Yell, CMT
number of ways to hit 21, often blind to the hundreds of ways to go bust or have the dealer beat you, traders often think of a favorable outcome instead of thinking about what can go wrong. Traders who are condent in their ma rket forecast often focus narrowly on their outcome materia lizing, instead of focusing on the data and validating their proposed outcome.
ost of us are conditioned to make all our trading deci- WHERE FORECASTERS GET IT RIGHT sions based on what we see on the hard right side of a AND WRONG chart. When you look at a chart, price movement that Philip Tetlock, who has a new book out titled SuperForeoccurred in the past may look like it had only one likely casters, recently brought to light a great analogy of common outcome. But when you look at a chart in real time, you don’t forecasting personalities. He explains it well in his prior book, know what the outcome will be. There could have been multiple Expert Political Judgment : scenarios, and credible people will a rgue for price to move in The intellect ually aggressive hedgehogs knew one big thing completely different paths from a specic point. and sought, under the banner of parsimony, to expand the Price charts and potential outcomes often play cruel tricks explanatory power of that big thing to “cover” new cases; on the brain. Trading, on the surface, is similar to a casino i n the more eclectic foxes knew many little things and were that it informs you of the prize of a low-probability outcome content to improvise ad hoc solutions to keep pace with a while the quantitative edge that the ca sino holds is purposely rapidly changing world. hidden from you. Just as the blackjack player thinks about the
M
22 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
t t e r r a B . J : e g a l l o c / k c o t s r e t t u h S / y u g g : o a D / o t o h p a t a h W : l l i b o r u E / Y a k i b a m a Y : l l i b S U
FOREX FOCUS
2008 Top a
Labels are from the technical forecasting methodology known as Elliott wave c
e/B
ii i The financial crisis A b
d
Some people believe we’ll have another strong bounce off the trendline, at least to midline. iv?
iii
v/C Many people believe we “must” hit parity (1.000) or below
I I N O I T A T S G N I D A R T / E P O C S T E K R A M S ’ M C X F
FIGURE 1: WHICH WAY IS THE EUR/USD HEADING? There are often compelling views that the market will go higher or lower but only one of these forecasts will be proven correct. Here, some traders may have reason to believe that price will have another strong bounce off the lower channel line whereas others may feel that prices will break below that lower channel line.
Bringing this analogy to trading, you would likely be better to any one outcome but be exible with your outlook, because served by adding incoming data to see if your outcome is more markets appear chaotic in real time. or less likely to come to fruition as opposed to putting your In Michael Toma’s informative book The Risk Of Trading: Mastering The Most Important Element In Financial Specuhead in the sand, hoping you are proven right. Another rock star in the world of nonmarket forecasting lation, he walks traders through the process of identication, is Nate Silver, who predicted the outcome of the 2008 US assessment, control, measuring, and monitoring of trading presidential election with far more accuracy than highly paid risks. The purpose is to show traders that when trading, there political forecasters. He attributes his methodology of fore- is more to risk management than placing a stop-loss. Similarly, casting to Bayes’ theorem, an algorithmic approach for which traders would likely be better served by focusing on how their its namesake is an 18th-century pastor. Bayes’ theorem opines forecast could be nullied as opposed to validated. that recently available evidence should be used to bri ng down or bring credibility to an outcome. Nate Silver’s model used CLASH OF TRADING individual states’ high-credibility polls in the 20 08 election to & FORECASTING predict the likelihood of the winner and updated his forecast When looking at the present, a new the night of the elections as individual state outcomes were thought often creeps into your mind being announced. as a trader. First, you think if I can The tradi ng equivalent to this is to look for obvious failures only gure out the future I will be toward your desired outcome developing in real time. An able to avoid a loss and book a prot. Elliott wave–based trader will consider invalidations of a Daniel Kahneman’s prospect theor y primary market view as casting doubt or outright invalidating from his book Thinking Fast And his forecasts. The point here is that you should not be married Slow states t hat people (traders included) emotionally prefer to avoid losses than achieve gains. Unpacking this nding further, traders will often hold onto forecasts and hope that it will prove true so they do not have to take a loss. While the desire to avoid a loss is understandable, the unwilli ngness to accept a loss is futi le. The desire to avoid a loss To avoid such a fallacy, you are probably better off holding is understandable, but the your strong opinions or forecasts with consistent pessimism. In other words, hold your strong opinions weakly so tha t you unwillingness to accept a do not nd yourself overrelying on an assumed outcome that loss is futile. doesn’t take place. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 23
You can be incorrect in forecasting but place a good trade, and you can be good at forecasting but poor at trading.
MARRYING
THE TWO WORLDS OF
FORECASTING & TRADING
their well-researched views. That said, there are often compelling views that the market will go higher or lower. Only one of these forecasts will be proven correct, although in a sideways market, both could be correct, revealing the need for combining risk management with forecasting. SUMMARY Learning how to forecast and nding an accurate trading method should play a separate role from learning how to trade. Forecasting is outcome dependent, and the road toward the realized outcome is often full of unpredictable developments. Trading is about recognizing present opportunities where the risk–reward tradeoff is presently favorable, and taking advantage of those opportunities. Ironically, yet impor tantly, you can be incorrect in forecasting but place a good trade, and likewise, you can be good at forecasti ng but poor at trading. The latter is surprisingly common. Regardless of your method of forecasting, recognizing a good risk–reward trade setup as per your preferential trading methodology is crucial. It is best to avoid the mistake of believing the market must end up at a certain junct ure a week, month, or quarter from now and overexposing your account on that hope. Rather, it is best to use a forecast a s a springboard for entering the market and then analyzing how the market is reacting to your forecast to see whether or not more weight should be given to that outcome coming to f ruition. Trade (as opposed to forecast) well.
Businesses are fond of making a premortem prior to major projects. A premortem is an explanation of potential causes of failure for an important project. As you can imagine, the goal of the premortem is to think outside of the “hedgehog view” so that you may act accordingly before the star t of the real project. In trading, a premortem will hopefully cause you to trade smaller or use less leverage than you might have otherwise done with a more condent but li kely awed forecast. Second, a premortem may help you identify where, as a t rader, you may want to ip your bias and potentially your exposure. Either way, optimism surprisingly has little room in a trader’s career. Mark Spitznagel, the hedge fund manager and former head trader for Naseem Taleb, notes in his book The Dao of Capital that to sur vive, you must learn to “hate to win, love to lose.” As a multibillion-dollar hedge fund manager, he obviously needs prots to attract new investors. Spitznagel is driving home the point that staying in a losing position is the quickest way out Tyler Yell, CMT, is a currency analyst and trading instructor of the business. In addition, poor forecasting or overreliance for DailyFX. com, a forex market news and analysis site. on your market forecasting methods is one of the quickest ways to convince yourself to stay in a bad position. FURTHER READING Spitznagel, Mark [2013]. The Dao Of Capital: Austrian Investing In A Distorted World, Wiley. LITTLE BETS Many traders come to the market with a per- Tetlock, Philip E., and Dan Gardner [2015]. Superforecasting: The Art And Science Of Prediction, Crown Publishers. verted view of their likely success. In other words, it is common for them to look at stories Tetlock, Philip E. [2005]. Expert Political Judgment: How Good Is It? How Can We Know? Princeton University on nancial news networks regarding the one big trade that made someone’s career like betPress. ting on subprime mortgages in 2003 or bett ing Toma, Michael [2012]. The Risk Of Trading: Mastering The against them in 2007. However, the one big bet Most Important Element In Financial Speculation, John can often turn into one big loss, since few things Wiley & Sons. unfold in a straight line. Yell, Tyler [2015]. “Gold & The Yen,” Technical Analysis of Instead of placing one big bet, a better approach would be STOCKS & COMMODITIES, Volume 33: October. to place multiple small bets. Sure, if your one big bet is la rge _____ [2015]. “Bond Markets & FX Effects,” Technical Analysis of STOCKS & COMMODITIES, Volume 33: August. enough and you come out on the winning side, someone may write a book about you, but the likelihood of that is under- ‡Marketscope/Trading Station II (FXCM) standably small. As a trader looking for double-digit returns ‡See Editorial Resource Index year over year, the better approach is often to manage your downside aggressively, while strategically looking for a multipercentage move in the direction of a shorter-term forecast, which of course, can still be wrong. The chart in Figure 1 shows the EURUSD, the most heavily traded currency pair in the spot forex market. My role at DailyFX gives me exposure to a myriad of t he top-tier investment bank (sell-side) research that makes very compelling cases for 24 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
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high-volume breakout patterns when you’re entering your trades. A popular Wall Street professional traders’ saying is that “traders vote with volume, and prot with price action.” It’s wise to wait for volume conrmation prior to entering any breakout trade, because you want to have high volume serve as t he “wind beneath your wings” to support an up side technical price move whenever you trade. It’s not enough to simply buy new highs for breakout entries. You want price to continue upward after you enter your trade, and seeing strong volume is one of the best ways in which you can achieve this. Here, then, are some high-volume breakout patterns you can look for to help with nding good entries.
Heighten Your Confdence
High-Volume Breakouts In this nal article in a series we’ve been presenting on breakout t rading strategies from this professional dayt rader and educator, we look at the role that volume and price-action breakout patterns play in conrming entr y signals.
by Ken Calhoun
many traders know, the two most important technical trading signals are price and volume. By combining price-action breakout patterns with spe cic volume conrmation signals, you can identify strong trading entries as they’re moving to new highs. You can spot high-volume breakouts whenever volume increases signicantly—that is, at least 30% higher than their average trading volume—along with a move up in price. These are important because strong volume indicates institutional buying is at work, which can help you nd good entries. In this article, I’ll show you how to nd
As
26 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
High-volume breakouts & cups The rst volume breakout pattern to look for is one in which volume increases steadily near the right side of a bullish cup, as it tests prior resistance. You will often notice an uptrend in the height of volume bars, in addition to an upward sharp move in price. The volume bar uptrend should make a triangle-type pattern, with the highest volume bars on the right side. You can see this pattern illustrated in the chart of Oceaneering Interna tional, Inc. (OII) in Figure 1, in which the cup breakout is conrmed by a high-volume breakout on October 2, 2015. The volume trended up heavily during this triangle breakout pattern. When you’re scanning for these pat terns, a good entry strategy is to enter a new swing trade anywhere from 50 cents to a dollar above the high of the breakout pattern day on a subsequent day (in this case, an entry near $44 on October 5, 2015). You may often come across these high-volume breakout patterns a fter they’ve made their initial move. The good news is that enter ing above new highs on a day following this pattern is ne, as long as it has remained in an uptrend following the i nitial volume breakout day, as seen on the chart in Figure 1. A simple criterion for con-
k c o t s r e t t u h S / a p l a k t e l o i v
CHART PATTERNS
rming a new breakout entry is to determine if volume and price are both at 15-day highs. If price alone is at a 15-day high, you may still wish to take the trade, but to be cautious, you should trade a smaller share size. If price and volume are at 15-day highs, then you can trade a larger size. This is an effective guideline for helping to decide how many shares to trade; you can also use volume bar height to help you visually see if your trade size should be small versus large, based on overall trading volume. If current volume for the chart you’re considering is un changed during an uptrend, FIGURE 1: CUP BREAKOUT CONFIRMED BY HIGH-VOLUME BREAKOUT. Volume trended up heavily during the triangle then you trade a small size. breakout pattern. A good entry strategy, in this case, would be to enter a new swing trade $0.50–$1.00 above the high of the If, however, current (most breakout pattern on a subsequent day. recent) volume is at least 30% higher than average, in an uptrend or other breakout Strong volume indicates pattern, then you can consider trading a larger size.
institutional buying is at work, which can help you find good entries.
Volume gap continuations The most common high-volume day is one in which price has gapped up (or down), as seen on the cha rt of EMC Corp. (EMC) in Figure 2. These minor gaps of less than one to two points will often continue in the direction of the gap, often for several days. When you see a high-volume gap continuation pattern like this, it’s a smart trading idea to gure out how to enter your trade during the two to three days following the gap day. You will likely nd that these patterns make for a primary trading strategy, since high-volume gap continuations tend to work out well. Your initial, as well as second or third, scaled-in trades can also use volume conrmation signals to help you decide when to add to a winning position. In Figure FIGURE 2: GAP VOLUME CONTINUATION PATTERN. These minor gaps, of less than one to two points, will often continue in 2, you can see that October the direction of the g ap, often for several days. When you trade high-volume gap continuations, it ’s important to note that the best 12, 2015, on the rightmost ones are in a clearly defined, strong, sustained uptrend. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 27
L A N G I S E
side of the chart, was also a high-volume day. Entering on a later day, above the high of this volume breakout day, would also make sense. When you trade highvolume gap continuations, it’s important to note that the best ones are in a clearly dened, strong, sustained uptrend. Similar to visiting your eye doctor and reporting which letters are the clearest, i n trading, it’s importa nt to avoid up-anddown choppy charts, even if they have high-volume breakouts. Give preference instead to charts that exhibit price action in a FIGURE 3: INVERSE HEAD & SHOULDERS. High volume confirms a bullish upside breakout move. Note how much higher the tight, nar row, strongly upoverall volume bars are on October 20, 2015 compared to the prior day, during the inverse H&S breakout during the opening trending channel like those hour of the trading day. discussed here. Inverse head & shoulders breakout Another strong pattern for day or swing trading is to enter a long trade following an inverse head & shoulder (H&S) pattern (series of three bullish cups) on high volume. You can see how strongly this pattern works on the chart of Weight Watchers International, Inc. (WTW) in Figure 3. The multiple retest of resistance near $15/ share nally broke out to new highs, once volume increased right after 9:30 am. Note how much higher the overall volume bars are on October 20, 2015 compared to the prior day, during the inverse H&S breakout during the opening hour of the trading day. One interesting point to note on this chart is how the prior day’s range ($15 - $11 = $4) was met early in the day, as WTW moved four points during the early part of the day due to high-volume buying on the open. When you are looking for what’s worth trading, charts with FIGURE 4: HIGH VOLUME CONFIRMING 50-PERIOD SIMPLE MOVING AVERAGE (SMA). High volume confirms an entry in this 50-period SMA breakout chart. This pattern trended up for three weeks before pulling back, going from $33/share to $39 / volume and volatility (the “two Vs”) like this one are share.
When you’re looking for what is worth trading, charts with volume and volatility (the “two Vs”) are usually the best candidates.
28 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
usually the best candidates. Here are two quick technical points to keep in mind when entering long inverse H&S breakouts: rst, it’s best if the neckline is in a slight uptrend (as it is in Figure 3); second, it’s best if t he depth of the rightmost cup is less than $1, as in this example. This compression pattern—one with shallow cups—in an H&S brea kout often leads to solid upside moves. In this example, it did a full three-point upside breakout. From a timing standpoint, when you see these types of upside high-volume breakouts, a nice feature is that they’re so strong you don’t have to enter early or “right on time” above the neckline. They will often move a dollar or more before a pullback, making them ideal for both intraday as well as swing trading. High volume above 50-period m oving average For longer-term swing trading, you can use a 90-day daily candlestick chart with the 50/100/200-period simple moving average (SMA) lines that a re favored by institutional trader s. One high-volume breakout pattern that capital izes on 50-pe riod SMA breakouts is illustrated in the char t of Best Buy Co. Inc. (BBY) in Figure 4. A long entry is initiated following a day in which price action trades above the 50-period SMA on strong volume. The 50-period SMA on a 90-day daily chart is a key tech nical indicator that, when combined with volume, can help you spot strong breakouts as t hey progress in an uptrend. You can see that this pattern trended up for three weeks before pulling back, going from $33/share to $39/share. Your initial exit target can be set at the 200-period SMA (in this chart, that’s the black line at $36); this one kept going up strongly even after that exit target was hit. The reason this high-volume 50-period SMA breakout pattern works is simply because professional traders use this technical moving average value to make their entry decisions. The strong buying volume that comes in after a move above the 50-period SMA attracts additional buying momentum, which leads to the multiday breakout continuation. YOUR BREAKOUT TRADING PLAN
Think of the supply & demand involved in tradi ng; when volume is high and price continues in an uptrend, it’s because there’s not enough share supply at one price point, so price i ncreases. As long as price and volume both continue increasing in an uptrend, the breakout continues. If you see volume drop and price move sideways in a consolidation, or start to
drop, it’s time for you to tighten your trai ling stop or exit the trade altogether. Here are some trading tips to keep in mind: z
Use high volume as a disciplined trading guideline; do not take trades until strong volume (>30% higher than usual) start s to show up on your charts.
z
High-volume breakouts will usually trend for much longer than average-volume breakouts. Capitalize on this phenomenon by planning to scale in and add to winning trades as they continue in your favor (in swing trading, you may wish to add additional shares every two points or so).
z
Selectively trade only the strongest-trending charts in sustained uptrends; for swing trades, the prior trend should have at least three to ve days of continuous new highs on your chart prior to entering.
Keep the relationship between price action and volume rmly in mind when you place your trades. See if you can spot similar high-volume breakout charts when you scan th rough your charts to help identify successful trading entries. Ken Calhoun is a producer of trading courses, live seminars, and video-based training systems for active traders. He is a UCLA alumnus and is the founder of TradeMastery.com, an educational resource site for day and swing traders. FURTHER READING
Calhoun, Ken [2015]. “Trading First-Hour Breakouts,” Technical Analysis of STOCKS & C OMMODITIES, Volume 33: December. [2015]. “Managing Breakout Trades,” Technical Analysis of STOCKS & COMMODITIES, Volume 33: November. [2015]. “Breakout Or Fakeout?” Technical Analysis of STOCKS & COMMODITIES, Volume 33: October. [2015]. “Gap Continuation Breakouts,” Technical Analysis of STOCKS & COMMODITIES, Volume 33: Sep tember. Gopalakrishnan, Jayanthi, and Bruce R. Faber [2011]. “Trading Momentum With Ken Calhoun,” interview, Technical Anal ysis of STOCKS & COMMODITIES, Volume 29: March ‡eSignal ‡See Editorial Resource Index
January 2016 • Technical Analysis of STOCKS & COMMODITIES • 29
Explore Your Options Got a question about opti ons? Tom Gentile started his trading career on the oor of the American Stock Exchange in 1994. He has appeared on many nancial TV and radio shows, as well as hosting a weekly talk show himself, and has coauthored many books on the markets. He can be found at www. tomgentile.com. To submit a question for Tom Gentile, post it to our website at http://Message Boards.Traders.com . Answers will be posted there, and selected questions will appear in a future issue of S&C. Tom Gentile
TO STRADDLE OR NOT TO STRADDLE Why not just buy a straddle into an earnings report, attempting to prot on either side?
While this sounds like a great idea, it is not always the case. This month, I want to review straddles but in par ticular, I want to show you when not to use one. The straddle is a nondirectional strategy in which you buy an at-the-money call and put with the same strike price and expiration date. The combined cost of this option strategy is double what it would cost to simply ta ke a side, but it’s also a nondirectional view. This sounds simple and I think this covers the basics of it. I’ll show you an example of buying a straddle just before earnings, with none other than one of the most popula r companies in the world, Amazon.com, Inc. (AMZN). The chart of AMZN in Figure 1 is a great read for straddle traders. It displays price along with the result of the last earnings report back in late July, and it displays volatility. The red line you see moving up and down is not a moving average or any popular technical indicator. It’s the implied volatility li ne for the near-money options that trade on Amazon. Take a closer look at the chart, and you can see that this red line, or options IV , moves within a range of 20–80. This is what I refer to as a “fear factor” line. As the line goes down, there is less fear of the day-to-day movement of the stock. As the line goes up, so does the uncertainty about the future, and of course, option prices. If the line goes from 20 to 80, it means that the time value of an option theoretically increases by a factor of four. A smart straddle trader would try and buy when volatility is low, and sell when volatility is high. Buying a straddle a
few weeks ago seemed to make a lot of sense in hindsight, as option volatility has risen with price. Funny thing is that most novice traders think that buying a straddle and holding it through earni ngs makes sense, because they have seen big moves happen on the stock, and have the idea that a trade, like a straddle, will make money on the big move. It’s not as easy as it sounds, so let’s take a more experienced approach to see if this indeed is a good idea ahead of this week’s earnings on AMZN (as I write this in early November 2015). The rst thing I do is evaluate what the near-term straddle is trading for, so it makes sense to look at the near options expiring in the current week (Figure 2). This gives me a gauge of how far the stock could go just after the report. AMZN 570 calls and 570 puts 620 600 580 560 540 520 500 480 k c o460 t S 440 420 400 380 360 340 320 300
8 2 5 0 5 1 0 2
that are expiring in the current week are trading at around 50 points when you combine the costs of both. That’s what I like to do to get a read on where this stock might go after earnings. Based on these numbers, option traders expect the range of AMZN to be contained to 50 points after the report. That’s about an 8.5% move in the stock, which is a big anticipation for a jump after earn ings. If option traders are already digesting 50 points post ear nings, there would have to be a move greater than that to the upside or downside to prot on the straddle by Friday’s expiration. Would I buy this straddle that expires only one day after the earnings announcement? Of course not, since the opportunity simply isn’t there. Here’s why: First, the straddle would cost $5,000 per contract to buy, which already vio-
Stock: AMZN (AMAZON.COM) O=565.27 H=570.94 L=560.31 C=570.73 Next earnings in 6 days (2015-10-22 est)
SMA (200) 7-30 day ATM IV E
Volatility on the rise ahead of earnings 6 1 6 0 5 1 0 2
6 0 7 0 5 1 0 2
3 2 7 0 5 1 0 2
1 1 8 0 5 1 0 2
8 2 8 0 5 1 0 2
7 1 9 0 5 1 0 2
6 0 0 1 5 1 0 2
85 80 75 70 65 60 55 50 45 40 35 30 25 20 15 10
V I M T A y a d 0 3 7
FIGURE 1: PRICE, EARNINGS, VOL ATILITY. The red line, or implied volatility, moves within a range of 20 to 80. As the line moves down, there is less fear and as it goes up it means there is uncertainty about the future.
AMZN ATM calls and puts expiring this week FIGURE 2: CALLS AND PUTS EXPIRING IN THE NEAR TERM. Here you see that the AMZN 570 calls and 570 puts are trading at around 50 points when you combine the costs of both.
30 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
M O C . S L O O T N O I T P O S M O T . W W W
Explore Your Options lates a major rule for me. Also, because there’s only one day after earnings for this trade to become protable, there’s a big chance of risk at this price. What I am talking about is called statistical probabilit y. With options, when you bet on the long shot, you could win more, but the percentage of winning becomes far less. Don’t let this calculator fool you into thinking that naked option selling
Straddles are best used in periods of low volatility when you expect price to break or if you expect a rise in volatility. is the only way to t rade. It’s just a guide and should be treated as such.
Straddles are best used in periods of low volatility when you expect price to break but are not sure in which direction, or if you expect a rise in volatility because of impending news such as an earnings report. If you’re trading it for any other reason, then you’re not stacking anything in your favor. Keep this in mind when the next earnings season approaches!
MFO original Vitali (0.03153), MFO 50 (-0.07436)
Continued from page 7
Which is why I’m asking if there’s a criteria they apply to the 50d to determine if market direction is with conviction and more valid in establishing the base from which they then scan for the stocks? Any commentary and feedback from the authors on this would be greatly appreciated to better complete the whole picture from their article. Thanks again, and I’m looking forward to more insightful articles from these authors in the future! VINCENT
work when I put it into MetaStock. (I receive the error message “symbol not found in database,” so it seems like it has something to do with the “.DJI” in the code.) How can I use the indicator on all my different indexes/securities?
0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 SPX D (2,013.73, 2,020.13, 2,007.61, 2,014.89, +1.45996)
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Createdin MetaStockfrom Equis International
FIGURE 1: S&P 500 WITH READER’S TREND-FOLLOWING INDICATOR AND VITALI APIRINE’S VOLUME INDICATORS. In this chart, green=uptrend, blue=strong up, red=down, black=strong down, and orange=extreme.
UWE, Germany Author James Rich replies: If you reread the paragraph under the subheading “The Method,” you’ll see Author Vitali Apirine replies: that I like the 20 SMA above the 50 Thank you for your inquiry. Following and the 50 above the 200. When the 50 is MetaStock code to implement the attens out, the 20 has normally crossed MFO: below it. If the 20 is above the 50, the 50 MetaStock MFO code: has a noticeable slope to the upside that has been in place since the 20 crossed {avoid division by zero} it, or shortly thereafter. If you wanted Dvs:=If((H-Ref(L,-1))+(Ref(H,-1)to be a lit tle more aggressive, you might L)=0,.00001,(H-Ref(L,-1)+(Ref(H,-1)-L))); consider taking an initial position when MLTP:=If(H
Ref(H,both the 20 and 50 SMAs have turned 1),1,((H-Ref(L,-1))-(Ref(H,-1)-L))/dvs)); up (or down) but have not yet crossed {avoid division by zero} the 200.
MONEY FLOW OSCILLATOR CODE Editor, Vitali Apirine’s article in the October 2015 issue, “The Money Flow Oscillator,” was very interesting. I’m long-term user of MetaStock, but I’m not so good at coding formulas. I wanted to tr y Apirine’s indicator on my database, but unfortunately, the code supplied in the article doesn’t seem to
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Dvsv:=If(V=0,.00001,V); Sum((MLTP*V),20)/Sum(Dvsv,20);
FOLLOW-ON Thank you very much to Vitali Apirine for his fast response and the code—the code works. My rst observation is that it ts very well with my own simple trend-following indicator. Apirine’s original 20-day time frame
ts the actual data very well, if it’s smoothed to 50 days (I was able to manage this...), one might get a better view of the medium-/longer-term trend. Although not as clear in the uptrends (indexes spend more time up, and need multiple divergences), downtrends seem to terminate only if downtrends on his volume indicators are clearly violated. In Figure 1 is a chart of the S&P 500 with my trend-following indicator (green=uptrend, blue=strong up, red=down, black=strong down, orange=extreme!) and Apirine’s volume indicators. I denitely will add them to my arsenal, and I’m eager to test this on individual stocks. Because of the author’s help I wanted to share this with him, as he might be able to research it a little deeper and nd something valuable for his trading! Thanks again. UWE
January 2016 • Technical Analysis of STOCKS & COMMODITIES • 31
INTERVIEW
Algorithmic Systems For The Rest Of Us
Developing Strategies With Kevin Davey Kevin J. Davey is a professional trader and systems developer. He is the author of Building Winning Algorithmic Trading Systems: A Trader’s Journey From Data Mining To Monte Carlo Simulation To Live Trading. An aerospace engineer and MBA by background, Davey has been an independent t rader for over 25 years. Although he has had a great deal of recent success, many of his early years of trading were met with failure. Bloodied but not defeated, Davey spent the next few years researching, reading, and otherwise devouring all he could about trading. That legwork paid off in a worldwide futures trading contest, in which Davey came in frst place once and second place twice during the years 2005–2007. Currently, Davey trades full-time, writes for trading publications, and divulges many of his trading practices in his Strategy Factory workshop. He also consults with private individuals, hedge fund traders, and CTAs when he is not developing new strategies for his own personal account. S TOCKS & C OMMODITIES Editor Jayanthi Gopalakrishnan spoke with Kevin Davey via phone on October 30, 2015 about how a retail trader can trade algorithmically.
The biggest challenge in the entire procedure was to come up with a test process that yielded good results and prevented me from having too many rules, too many parameters, and too much optimization.
Kevin, tell us a little bit about It probably took me 10 years yourself and how you got or so of trading part-time, sort interested in the fnancial of taking it seriously but not markets. From what I’ve doing well and just ounderread about you, you have had quite a n ing around, to make some sense out of the markets. After interesting journey. I started out the way most people start reading a few of Van Tharp’s out—I got a piece of direct mail. This books, I become interested in system- traders make, and when those mistakes was about 25 years ago or so, and that type algorithmic mechanical trading. keep recurring, that’s what leads people piece of mail stated how much money I From there I went on to developing a to get frustrated with t rading and quit. could make trading commodities. That couple of systems. I was able to trade What did you learn from those mist akes got me hooked and even though that one of those systems and win the World and how did those lessons help you in particular method was garbage, I was Cup Championship of Futures Trading. your trading? able to go on from there. I was hooked One year I nished second, the followThe mistakes I made led me to realize because I saw the potential in trading ing year I nished in rst place, and the that trading is a lot more difcult than beyond passive investing, and so I thought year after that, I nished again i n second what those who sell you information I’d give it a try. Then I just grew from place. That gave me a lot of condence claim it to be. Trading is hard work and there and made a ton of mistakes. I prob- because I felt like I knew what I was you have to dedicate yourself to it, even ably did everything I possibly could do doing, at least a little bit. About a year if you’re just doing it part-time. That’s incorrectly, such as quickly changing after that last contest I made the leap because you’re up against the professionsystems, trading without any kind of from being a part-time trader to being als and people who trade full-time. It’s system, averaging down, and running to a full-time one. I’ve been trading full- a zero-sum game; somebody is taking the bank at lunchtime—this was when time ever since. money from somebody else. I learned t o I was working—to wire money just to take it a lot more seriously, and for me All the mistakes you made are ones all I found it was best to have a met hodical avoid the margin call. 32 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
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step-by-step approach. The reason I say was trading three to four systems, but goals and objectives, you get trapped “for me” is because I have a math/sci- when you’re trading more systems, you into continually trying to improve your ence/engineering-type background, so just can’t keep track of everything. When system. There’s more to a system than doing things with objective steps, even you have so many systems, it becomes just developing it. You need to have goals, if the system’s good or not, or passes easier to just follow the systems without and this could include what your annual certain criteria, made a lot more sense taking other things into consideration. return or ma ximum drawdown is. Many to me. This is something I wasn’t doing For me, that was when the emotions traders who are just star ting out developwhen I started trading. I was doing a went out the window. I realized that if ing trading systems have never thought little bit of it in the beginning, but not I decide to ignore a signal generated by of these goals. They are interested in enough of it. one system, I should do the same with all developing something that makes a lot That was probably what I learned signals. But it’s impossible to keep track of money with a small drawdown. the most from my mistakes. I realized of those decisions for each system. It’s The tr uth is you can’t design a system that I have to approach this problem a better just to follow the systems and do using such nonspecic goals. You have little differently and treat it a little dif- what they indicate. What is importa nt is to set some realistic goals. I come across ferently. Once I did that, things started to put mechanisms in place to stop trad- people who set some ridiculously unrealworking better and that helped me with ing if the system stops performi ng. Then istic goals and I can guarantee you that the psychological aspect of trading. It it becomes completely objective. For all the steps they take to get there will inwas always the psychology of making of my systems I have certain criteria that, volve too many rules such as overtting, and losing money that was difcult to if met, will indicate to me that I should curve-tting, overoptimizing, and the overcome. The other aspect is that even stop trading that system. system will not work going forward. if you follow rules, you can still have Trading becomes a lot less emotional, A successful system starts with setting those feelings of elation when you make which is nice, but you have to have con- realistic goals. Then, part of it has to do money, and feelings of distress when dence in your systems, and that goes with the way I do it. I look for systems you lose money. Many people think that back to having a process for developing that are good; they don’t have to be great automated or mechanical trading means systems. I have a process that I use, or the holy grail–type systems. Too there are no emotions involved, but that’s and over time, I’ve proven to myself many people get hung up on that sort of not true. There are emotions, but the that when I follow the process to create thinking. I take a different approach. I emotions are different than those of a systems, the systems tend to work well. can probably develop 10 good systems discretionary trader. That’s something This gives me the condence to build and if I t rade those 10 systems together, I had to learn as well. new ones because I know most of them assuming they look at different markets, will work. It’s similar to a feedback loop, different styles of trading, or different Even if somebody has a trading system but once you have condence, it’s much time frame, I can be diversied and that’s mechanical or automated, I easier to follow it. But that comes with achieve much better performance than would imagine there are times when experience. It’s not unusual for traders someone who trades just one system. And the trader will allow their emotions to who are starting out to be tempted to do I’m not relying on just one strategy. dictate what to do, especially when it something contrary to what their systems My next step, after setting goals, is to always look for trading ideas. You’ve got comes to exiting the trade. Are emo- are suggesting. tions always going to be there, and is to have what I call a “strategy factory,” that something you have to accept, or You mentioned that you follow a pro- where ideas come in the door. These ideas is it possible to get rid of them com- cess when it comes to creating a system . are your raw material and as you build pletely? What are some of the basic steps that strategies based on these ideas, you test I think, to an extent, emotions are you follow in that process? them. I run a lot of tests such as Monte always going to exist. I was able to There’re a total of seven to eight steps. Carlo simulations and walk-forward testeliminate emotions by trading several It starts with the goals and objectives that ing. Believe it or not, a lot of the strategies systems. For example, right now I trade you set for a strategy. If you don’t have I test don’t work well. They may work about 80 or so strategies that are all for a short time, but my time horizon is rule-based. Most, not all, of them are typically ve to 10 years long, and the automated. What I found was when you system I test has to give decent results start trading—let’s say when you get during that t ime period. If it doesn’t, the above ve or 10 strategies—it becomes idea goes into the trash. more difcult to overrule strategies. I’m always looking for ideas to apply It’s impossible to make decisions on to my trading. If I run out of ideas, then each system when there’re so many to I have nothing to test, and I’m not golook at. You can’t keep track of all the ing to get any strategies. I have to have times you’re cheating or lying to your a constant ow of ideas. Once you have system. I have done that before when I your goals and objectives and your ideas, 34 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
ninjatrader.com then it’s a matter of running some tests. I do a few different things. I run some tests on a limited timefra me just to get an idea of whether the idea has any merit. Most people take all the rules and put them in a strategy, apply that strategy to a chart for all the data they have, optimize it with all the pa rameters they can possibly optimize, hit “optimize,” get the best results, and trade that strategy. I would say that 90% of the time, this method doesn’t work. You want to avoid falling into this trap. This methodology might work for those who know what they’re doing and are really careful, but for most people, it’s not going to work. The biggest challenge in the entire procedure was to come up with a test process that yielded good results and prevented me from having too many rules, too many parameters, and too much optimizat ion. I try to make the systems as simple as possible and once I do that I run some Monte Carlo simulations, which gives me some probabilities. A lot of people make decisions based merely on an equity curve even if it’s not a sample dataset. If you look at just one equity curve, you could underestimate your true drawdown risk. In Monte Carlo simulations, you rearrange the trades a little bit and you could get drastically different results, especially in the drawdowns. At each one of those test points in the simulation, I have some criteria that have helped me in nding out whether the system is viable or not. When I run Monte Carlo simulations I don’t have to keep going back and testing and retesting a system ve or six times. You have to be willing to throw away an idea if it doesn’t work. I don’t become emotionally attached to an idea. I know a lot of people who spend years working on one system because they become attached to it and refuse to admit that it’s not working. Once I nd that the strategy is something I think is viable, I do what I call incubation, which is to say I take the strategy and set it aside for a period of time. I just look at it once a month and if necessary, I’ll do some reoptimization because of walk-forward testing. Then, after a set period of time, I reevaluate the strategy to see if it’s still holding up six months after I developed it. I have
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Go Direct to the Source. NinjaTrader Brokerage. found this to be helpful. I’ve found that if you start trading a system soon after you’ve nished developing it, it tends to fall apar t right away. This is mostly due to things like overtting, but sometimes it just happens. It’s good to avoid tradi ng systems that never work in real time. This is an important step, and I wish I had done it with some of the systems I developed 15 years ago. I would get so excited about the systems I developed that I would start trading t hem the next day. My approach is different now. Obviously there’ll be some randomness. Nothing ever performs in a straight line, but
you can have some criteria to see if the strategy is still performing in the same way. That gives you more condence to trade that system. The nal step is to combine the viable strategy with other strategies to make sure you’re not doubling your risk and avoid correlation among what you’re trading. Once everything is lined up, you go ahead and start trading your strategy. But once you to start trading it—and a lot of people don’t talk about this—you have to follow up by monitoring the strategies you already have, decide when to stop trading them, or
January 2016 • Technical Analysis of STOCKS & COMMODITIES • 35
maybe decide to increase your position size. Follow-up is extremely i mportant. One of the biggest mistakes I see people make is that they never think their new system will fail. They don’t plan for their system failing. Instead, they plan for all the money they’re going to spend when they make their expected prots. What they should focus on is what to do if t heir system fails. You don’t want your system to wipe out your account, so you have to know when you should quit trading a system. I continue to do research on aspects of trading other than developing trading systems. One of things I have been looking at lately is what criteria to use to stop trading a system. Could you talk about that a little bit more? When is it a good time to stop trading the system, when do you change the size of your positions, and what type of an exit strategy do you apply? For position sizing, I typically use a simple xed fractional–type approach, which is based on my account size. I t ry not to get too clever with it. T here’s a lot of different position-sizing techniques you can apply, and you can always nd one technique that’s best for one of your systems. You may have strategy A that suggests you use xed-fractional position sizing, strategy B might suggest some other technique, and strategy C might say something else. But to me, that’s a form of optimization, because you’re tak ing the data and then applying different things to it and selecting the best one. I tend to keep it simple and use xed fractional, and if my account size goes down into drawdown territory, I will cut back my position sizes. When I start trading a new system, I usually start with one contract. I always have a fear that perhaps I did something wrong or something isn’t quite right. I let—at the beginning at least— prots dictate if I’m going to increase my position size and then I switch over to a xed-fractional method. As far as when to stop trading a system, it’s also system-dependent. In my trading, I use a few different things. For example, I might use two times the maximum historical drawdown as a criterion. I know somebody who uses half of the historical drawdown as a criterion, and
he’s content with it. You can look at the up making an emotional heat-of-thenumber of consecutive losing trades and moment decision. Their system is goif in your history you’ve only had ve ing down, they get frustrated, and then consecutive losing trades, then perhaps nally at some point they just quit. And by the time you get to seven or eight, it what’s even more frustrating is after you might be time to quit. quit, the system turns around. That of There’re a lot of different ways to course makes you angrier and you start decide when to quit using a system and doubting yourself. These are the t ypes of I haven’t found one way that stands psychological games that you can play, head and shoulders above others. But so I found it best, before you start tradwhat I have concluded is that having ing, to write down when you’re going to the exact criteria isn’t going to make a quit trading a system. Keep it somewhere huge difference, but what will make a where you can see it or remember it and difference is having the criteria versus if your criteria are met, then quit trading. not having them. I think the best way to This helps for those who trade part-time. approach this is to write down whatever This is how the professionals do it. They your criterion is before you start tra ding. have their risk limits, and if they exceed That would be something along the lines them, they’re cut off or red from their of if x happens then you’ll stop trading job. You’ve got to treat your own trading the strategy. Ideally, you share this with the same way. someone, whether it is a trading par tner, a spouse, or signicant other and they’ll This process that you described is what help hold you accountable for it. Ask them it takes to create an algorithmic trading to check in with you every six months or system. When you use the term “algoso and see if the strategy ever hit the point rithmic trading,” many people tend to where you said you’d quit trading it. That think it’s reserved for the insti tutional will hold you accountable because it’s or the high-frequency traders. But it difcult to tell someone that the system sounds to me like the retail trader can did hit the quitting point but you’re still also apply such a strategy. How should trading it. It’s a good mechanism to help the retail trader’s approach to developensure that when you say you’re going ing an algorithmic system be different to quit, you do quit. A lot of people will from that of an institut ion’s? say they’ll quit when they’re down 30% What I mean when I say algorithmic but when 30% comes, and they continue systems is that the computer makes all to use it for another month to see how the decisions, which will tell you when it goes because in their mind, it’ll turn to buy and sell. If you automate that, t he around. But what usually happens is computer will do it for you. It’s similar they’re down another 20% and then they to mechanical rule-based trading. You’re want to just keep going because they right in that a lot of people think algothink it has to turnaround sometime. rithmic means high-frequency, and that You know how that goes. they have to be a hedge fund to have The best thing to do is to have your such a system. The key for retail tr aders criteria dened upfront. Everybody, is to not play where the high-frequency myself included, has at some point not people are playing. I don’t try to scalp; any had the criteria dened and then ended retail platform is going to have trouble doing that because you’ll need to have a platform, either a professional-type platform or create your own. Then, you probably need colocation equipment, and you may even take your code and burn it onto a chip so it runs faster. For the retail trader, this is not an option because it’s expensive and you’re ghting agai nst people that have teams of statisticians with PhDs and a lot of cash to support an infrastructure suited to trading.
36 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
The retail trader is better off staying away from the institution’s domain. T hat means more swing trading, that is, more trades that last days to weeks or even months. I do have some intraday tradi ng systems, but oftentimes, I’ll get into a trade and stay in the entire day. I won’t get in and out of trades several times because in the long run, the trad ing costs will gobble up a lot of your prots. In all the research & development I’ve done, the longer-term systems, that is, systems based on daily bars, tend to be easier to create than systems based on one-minute bars. Yes, you have to endure drawdowns if you’re holding a position overnight or holding it longer. There’s a higher probability of intratrade drawdown, but this is where trading multiple strategies helps because they smooth things out, which is something you can afford to do. A retail trader can consider themselves an algorithmic trader but they should realize who their competition is and try to avoid playing in the same territory as the high-frequency rms, because you can’t compete with them.
to diversify, which is probably a good thing I trade about 80 or so strategies because what that is that are all rule-based. Out of telling them is to wait those 80 strategies, I would say until they have more that maybe 50 of them are in money in their account. Then their risk some type of trade. of ruin goes down and things get a lot better. But diversication, if anything, is like the ing for situations where there might be holy grail of trading, because it’s nice to spurts of upward movement. The strategy trade a handful of systems knowing that might level out for a while after that if if one stops working, you’re not going to market conditions change. Then, it may lose everything. It’ll still hurt you, but go up again. I can handle those types of there are other well-performing systems strategies because I can afford to break you can use. even for a while in the hope that over the It dawned on me a few years ago t hat long term, they’ll go up at times. if I was trading four or ve systems in Out of the 80 strategies that I trade at any given year, one or two would prob- any point in time, I would say that maybe ably do well, one or two would maybe 50 of them are in some type of trade, and break even, and one would not do well. sometimes the trades ca ncel out. You’ll But I did not know which ones would have a system that’s long, and another do well in the next 12 months, which is one that’s short. There’ll be t imes when why it was good to trade them all. You you’re just at and that’s okay because I’ll don’t want to put all your money behind still monitor the strategies individually. one system just because it did well the Overall, it’s not going to have an effect previous year, because it might not do as on my account, but that’s just part of well next year. In my mind, diversica- diversication. What are the benets of using multiple tion is really the key. trading systems? Besides trading, do you offer courses When you trade several strategies, When you’re saying that you have about or act as a mentor? you’re diversifying. Instead of trading 80 strategies, do you use them in conThe main thi ng I do is trade full-ti me. one strategy, you trade ve, 10, 20, or junction, or do you use them separately After my book was released, people however many you can. What I’ve found for different market conditions? started becoming interested in getting in my trading experience, say in the All of the systems could trade at any a more in-depth study than what I gave last ve to six years, is that I went from time. I don’t try to discern between ma r- in the book. So I hold online workshops trading one or two strategies to the point ket conditions. I know a lot people like on strategy development about once a where now I’m trading about 80. I look to trade some strategies when the market month. I help people build strategies and at the volatility of my monthly returns is bullish and the concept is good. But then support them afterwards. I also do using standard deviation and what I’ve the problem with this kind of approach some mentoring and consulting for CTAs found is that as I increase t he number of is that it depends on you having a good or people who work for hedge funds. systems, volatility goes down. As a result, strategy for that particular market and my returns have become a lot smoother having a good switching mechanism, or Thank you for speaking with us, and so have my equity curves. The down- a meta-strategy that will overrule and tell Kevin. side to diversication is that you give up you that on any given day you’ll trade some of the upside potential. strategy A but not strategy B because FURTHER READING If there was a t rader who was knowl- the market is bullish. You run the risk Davey, Kevin [2014]. Building Winning Algo rithmic Trading Sys tems: A edgeable about price-action trading of curve-tting and usually what ends Trader’s Journey From Data Mining or had one well-performing algorithm up happening is your strategy will be to Monte Carlo Simulation to Live and traded one market, it is possible too late for the bull market and you’ll Trading + website, Wiley. that, from a performance sta ndpoint, he still be trading your bear strategy for a could do better than somebody trading while. Although I like the idea, I don’t 10 strategies. He’d have higher upside, think it works. My strategies will trade all but if his system breaks, then he’ll have markets and I don’t necessarily need to more downside. It’s a tradeoff. For have performance that continually goes those who are starting out, it’s difcult up in all types of situations. I am lookJanuary 2016 • Technical Analysis of STOCKS & COMMODITIES • 37
Osoba: 5.5” W, bleed L, x 6.5” H, bleed top
And that means embracing failure, for failure is an essential stop on the road to mastery, and in the nancial markets, mastery is the only road to success. To succeed you must fail, you must fail often, and you must fail strategically. This article will show the retail trader how to approach the idea of failing successfully.
BEING WRONG, MAKING MISTAKES, FAILING
Have Faith In Yourself
Failing Successfully We’re groomed to think of losses as a sign of failure, which is why trading is difcult. But experiencing losses is part of a trader’s life and is something you have to accept. Here’s how to approach the idea in a healthy way.
by Stella Osoba, CMT To others, being wrong is a source of shame; to me, recognizing my mist akes is a source of pride. Once we realize that imperfect underst anding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes .—George Soros
live in a society where the cult of success is worshipped. But what is often hidden are the failures that go into creating that success. Failure is often not understood and cultivated as a process that is integral to the creation of exceptional results. Many of those who come to tradi ng have succeeded in their day jobs, and they expect success to come to them in tradi ng in much the same way it came in their other endeavors. But often this is not the case, for nowhere is it more essential to develop a strategy for building mental strength than it is in trading.
We
38 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
We all want to be right. We want to enter a trade on a reversal, stay with that trade and multiply our account countless times with little effort. We want to be able to brag about our successes in the market, to tell others how our unique brand of smartness led us to make that million-dollar gain on one trade. Maybe we dream of walking out of our day jobs to pursue the dream of living in a tropical paradise, lying on a beach with a laptop by our side to monitor our trades. We dream of watching our accounts grow as we make trade after successful trade. This has to be possible, we think, for we are smart. After all, we have succeeded at many other things in life; maybe we are doctors, or lawyers, or nuclear physicists. When we look at the charts, we can clearly see the trends. We may think that we have only to start and learn a few rules to succeed. But success in trading is often far more elusive than we think it should be. Statistics show that most traders fail. Why is this? Why is it so difcult to make trading riches and why do so many people fail trying?
OUR UNENDING QUEST FOR RIGHTNESS
We go through life assuming that we are mostly right. We equate being
K C O T S R E T T U H S / S A S A C R J
TRADING PSYCHOLOGY
right with good, being wrong with bad. Rightness is pleasurable, it pumps up our egos, it enables us to feel good about ourselves, enables us to feel condent about our place in the world. When we were in school we were taught to look for t he correct answers to questions. Success was rewarded with a passing grade. Failure was undesira ble. If you failed, you felt stupid,inadequate, and you had to repe at the class. So youwent through school learning that to be respected, acknowledged, and to succeed, you needed to be right. You needed to learn about the hoops society expected you to jump t hrough and to learn how to be a good hoop jumper. There were right answers for every subject and wrong answers for every subject. Right was good, wrong was bad. It was that simple. You came out of school and your day job also rewarded right answers. You play it safe because that is how the game is played and you get the promotions and rise through the ranks. But when the work fails to be satisfying and you look around for a way to make your riches, you think about trading and reason that the same skills that got you through school exams with good grades and got you promotions on your job should be enough to enable you to succeed in the nancial markets. Surely, the skills of life are transferable, you reason. And so you open a brokerage account, subscribe to a couple of newsletters, nd a trading system that promises to return good results, and begin to trade. Failure, you reason, is not an option. You will succeed at trading in the same manner that you have succeeded at everything else. But reality rarely follows your mental script. If you are lucky, you will fail early. It is through mastering a skill that was never taught in school—failing successfully—that you can hope to evolve into the kind of trader who can consistently beat the market. Trading is often spoken of as a zero-sum game be cause what one person wins, someone else must lose. There are always two sides to a trade. Every trade must have a counterparty who is willing to take the other side of the trade. For this reason, you can look at any trade and gure you have a 50% chance of being on the right side of the trade. If your trading system gives you wins 50% of the time, you can still make a lot of money trading, yet many don’t. Even the institutions with their algorithms expect their trading systems to lose anywhere from 30% to 70% of the time, and yet they are still protable. Therefore, in order to trade successful ly, it is not the number of times you are in a losing position that determines your ultimate success, but the ability to master what to do when you are in a losing position. IT’S OKAY TO LOSE Recognizing that the inability to deal with failure successfully is a handicap to our success as traders is perhaps the most important lesson a trader will learn. If we expect 50% or more of our trades to fail, then it is statistically possible to have a series of ve, maybe even 10 or more consecutive failing trades. Preparing ourselves for failure is essential to being able to manage the stress of tr ading successfully. With any discretionary trading system, you should have a setup and an entry price. But you should also have in mind a price level
To succeed you must fail, you must fail often, and you must fail strategically. below/above which price should not go. This is the price at which you exit the trade, no matter what. This is where you set your stops, mental or otherwise. Once it is hit, the trade has failed and you are out. But once out, be prepared for anything to happen. Study the chart as though you had not made the rst trade and if a new setup and entry forms, you should be prepared to go back into the t rade if your new stop will not expose you to too much risk. When studying the charts, you want to force yourself to stay in the present as much as possible. Every new bar that is formed on the chart carr ies within it information that potentially creates a new set up. Staying in the present and being prepared for all contingencies is the only way to trade successfully. COGNITIVE BIASES The reason that trading can be so difcult is because even though it appears to be deceptively simple, it isn’t. Many of the causes of failure are the result not of the trading system employed, but of cognitive biases. Cognitive biases are systematic errors in our thinking that lead us to act in predictably irrational ways. These biases are insidious because we are often not aware of them or their inuence on our thinking unless we have trained our minds to be alert to our thought processes. But many trading systems do not account for cognitive biases in their methods. Biases such as the endowment effect can work against us in t rading, causing us to ascribe more value to a position because we own it. This prevents us from getting out of a position when we should. Fear of failure is another bias t hat can prevent us from entering a position when we should because we fear being wrong. Fear of regret can lead us to enter a position when it has moved too far from our stop, thereby increasing our risk. Loss aversion is another bias that can cause us to hold onto a losing position too long because we are unwilling to take a loss. Studies have shown that, on average, we feel the pain of a loss 1.5 to 2.5 ti mes more than the pleasure of a gain. These and many other biases actively work against us to reduce our chances of success in trading. Often, when a trader has made a series of unsuccessful trades, he will then go looking for a “better” trading system. But trading is more of a psychological game. Many trading systems work some of the time. But misapplied, trader psychology will jeopardize all trading systems. Continued on page 41 January 2016 • Technical Analysis of STOCKS & COMMODITIES • 39
Q&A SINCE YOU ASKED Confused about some aspect of trading? Professional trader Rob Friesen, president & COO of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question or suggest a topic, ema il him at [email protected], or post your question to our website at http:// Message-Boards.Traders.com . Answers will be posted there, and selected questions will appear in a future issue of S&C. Rob Friesen
PAIR TRADING: LOOK FOR CATALYSTS In the land of diminishing pair returns, grab some catalysts for your spreads! We live in an instant-x environment. If you’ve got a problem, you want an instant solution. This is often carried into the trading world. You want access to information so that your computers can crunch data and nd those statistical anomalies. The computer does all the work and spits out the results you are searching for. In this machine age, traders often forgo the heavy lifting i mplied by quality time spent researching, reecting, and contemplating the current and future economic landscape. Instead, they want a formula or a magic pill for prots they think automation can provide. I am certainly not against the computer age, but I do have an abundance of street smarts gained from years of trading, working with other traders, and observing numerous statistically signicant samples. I understand how pairs behave in good times, bad times, and most of the time. Traders wil l go after pair opportunities, but this can also end up increasing risks to their capital. Attempting to pick up pennies in front of a steam roller, they make a dime, make another, and then lose a dollar. I believe that traders can get much better bang for their a rbitrage buck and reduce some inherent problems by adding some additional ingredients to their spread trading soup. For those of you not familiar with the concept of pair trading, here is a brief explanation. Pair trading is the combining of two stocks, one long and one short, in an effort to lower market risk and macro risk, where the focus shifts from trading a stock in a directional manner to relying on the spread price between the two. You would prot from or lose money based on the
relative change between the two stocks. Both could go up, down, converge or diverge; it all depends on which stock you choose as your long stock, which one you short, and what ratio of capital is applied to each. Pair trading can be done with equities, ETFs, options, futures, or currencies. In this column, I will discuss the rst two. Typically, the main concept applied to pair-related strategies is that of mean reversion, that is, looking for relationships that are stretched out and revealing anomalies. The trader would go long and short as simultaneously as their trading tools can facilitate when presented with an opportunity that usually comes in
Traders can get much better bang for their arbitrage buck by adding some additional ingredients to their spread trading soup. the form of an anomaly or outlier in t he spread relationship. Once capital is applied, the trader looks for the spread to mean-revert (return to the norm). My experience, through trading, observation, research, and working with many other statistical-arbitrage (stat-arb, or pairs) traders is that ma rket conditions play heavily into the yield and risk when a mean-reverting focus is applied. During times of signicant trends caused by technically driven algorithmic traders or when the investment community is voting directionally due to macro inuences, mean reversion is frustrating and can result in diminished returns or outright losses. Similarly, during seasonal trends in the market, strategies have times of
40 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
best and worst returns; rarely is there uniform distribution of returns. Trending conditions would favor relative-strength pair trading rather than fading (going against) a directional move. It’s fading in this environment that is like picking up those pennies at the risk of losing dollars. I am often asked, “Why not just trade an unhedged position if you are being directional anyway?” If you are new to the concept of pairs, I can understand t he skepticism, but if you have experienced the benets as well as the problems of pairs you can appreciate the information I am providing. Spread traders appreciate watching a spread number that is experienced as statistically muted or smoothed compared to watching an individual stock. Relationship-based trading often provides more information than singlestock trading. An example would be thus: it is hard to compare a n apple to an orange, but much easier to compare one apple to another apple. Having a long and short position at the same time can reduce eventrelated risk. You want to be protected from market moves but take advantage of potentially better performance of one stock over another. Even though the VIX is hovering around 17 at the time of this writing, the actionable volatility feels much lower. Stocks trend during the day or even multiday with nominal retracements. Can you take advantage of this behavior? Can pairs be optimized for these market attributes? Here are some building blocks or ingredients of pair trades: • Technical patterns on a variety of time frames • Technical and quantitative indicators
Q&A • Persistence of short-term or longterm performance • Fundamental • Macro catalysts { Currency inuences { Interest rate impact { Political platforms • Opportunities created from events { Trader enters post-event { Streaks { Seasonal tendencies { Dividends { Earnings and EPS changes. Besides a peer group pairing of one long stock against a stock short, here are some other combinations that can be done. The combination can be: • Any stock long against any stock short • A few stocks long against a single stock or ETF short • One stock or ETF long against a few stocks short • A diversied basket of longs against a diversied basket of shorts • One industry or sector basket long against a different industry or sector basket short. There are many ideas to draw from to
OSOBA / FAILING SUCCESSFULLY Continued from page 39
create a combo trade. Too often, the buzz words of correlation and cointegration are thrown around as the sauce that is going to bring home the bacon. Traditionally, there has been some merit to that analysis but there are so many more ducks to line up to increase the odds of a successful combo trade. Again, money is made by the relative performance between your longs and shorts, so focus on what cat alysts would contribute to your long position(s) slightly outperforming your short position(s), whether all your positions go up, down, or stay in a trading range. I have heard it said that if you want to write an award-winning screenplay, then study past successful scripts. If you want to compose a hit song, then study the ingredients of songs that have risen in the charts. If you want to make brillia nt combo trades, then study any red ags, ducks that lined up, and micro and macro catalysts that caused peer group stocks to separate from each other. Think about the following: • Why Blockbuster went to zero while Netix soared • Why Blackberry lost market share to rivals Apple and Google • Why Facebook is monetizing mobile
and performing better than Twitter • What impacted retailers such as Aeropostale versus American Eagle Outtters • Why Bank of New York Mellon was able to outperform Franklin Resources • What is it about Costco’s business model that has its stock outpacing that of Walmart. Can you nd and exploit these types of divergent big-picture opportunities again? There are many more stocks that have been than are, so the future will be lled with winners a nd losers in each peer industry. Traders can capture this potential through pairs or diversied combo trades. Focus on the ingredients that make up your opportunities and write some rules for entry, exit, and risk management. I hope I have planted some seeds for inspiration and creativity. For more information, contact Rob Friesen at [email protected].
trading, so give yourself permission to fail. Fail often, but fail successfully. A failed trade is never a reection of your skill as a trader, but a refusal to accept failure is.
If trading is a probability game, then a failed trade cannot be a reection of your ability as a trader. Many, if not most, Stella Osoba is a financial writer who has written for the trades will fail. Failure is essential to trading. The ability to Market Technician Association’s (MTA) e-newsletter Techniacknowledge the failure ea rly, to not deect or make excuses cally Speaking, their Journal Of Technical Analysis, and their for the failure, and to exit the trade all come with humility CMT e-newsletter, as well as for TraderPlanet.com. She may and practice. In the words of Brendan Moynihan in his book be reached via email at [email protected]. What I Learned Losing A Million Dollars , “Success can be built upon repeated failures when the failures aren’t taken FURTHER READING personally; likewise, failure can be built upon repeated suc- Brooks, Al [2012]. Trading Price Action Trends, John Wiley cesses when the successes a re taken personal ly.” & Sons. Failure is uncomfortable, and repeated failure is ma ny times Osoba, Stella [2015]. “Loss Aversion,” Technical Analysis of more uncomfortable. But you must learn to embrace failure STOCKS & COMMODITIES, Volume 33: April. however it comes and move forward from it. Failure is not a Paul, Jim, and Brendan Moynihan [2013]. What I Learned Losing A Million Dollars, Columbia University Press. skill that society prepares most of us for. So many will come to trading ill-equipped to handle failure. But to become a successful trader, a mastery of the art of failing successfully is important. Recognize that failure is an essential part of January 2016 • Technical Analysis of STOCKS & COMMODITIES • 41
PRODUCT REVIEW
TC2000 Version 16 WORDEN BROTHERS, INC. PO Box 1139 Wilmington, NC 28402 Phone: 800 776-4940, international: 1 919 408-0542 Email: [email protected] Internet: www.TC2000.com Product: Stock market charting software Requirements: Windows-based PC, or Mac with Parallels Desktop Price: Basic software and data services start at $9.99/month for the Silver edition; $29.99/month for TC2000 Gold; $89.99/ month for Platinum. Real-time data and LiveBriefs by MT Newswires available for additional fees. Savings are available via yearly payment options. by James E. Rich
orden Brothers’ new TC2000 Version 16 software was originally developed as a white-label trading platform for TC2000 Brokerage, Inc., the company’s new afliated online
W
brokerage. When the nished product exceeded all of their expectations, brothers Chris and Peter Worden and their staff felt it only fair to release the software to the entire TC2000 family of users, whether they used TC2000 Brokerage or just continued to use the software for analysis. FEATURES One of the many new features that rst caught my attention was the simulated account component. Several platforms
and standalone software programs provide simulated accounts, but TC2000 Version 16 offers by far the most robust of any that I have tried. The feature allows you to establish a cash or margin account, set the opening balance, set buy & sell stops, track your daily and total prots & losses—realized and unrealized—plus all the other features normally available only in live accounts. Of course, if you go to TC2000 Brokerage and open an account, then you’ll have the option of trading in real time or executing simu-
lated trades. Multiple layouts, a feature introduced in Version 12, enhances the usefulness of the trading platform whether you trade live or use the simulated account. With the multiple layout feature, you can set up a trading layout with a window to track your portfolio, a window for orders, and a window for trades. The windows in your layout can be pinned anywhere on the screen, hidden, or left free-oating. In your trading layout there are multiple ways to enter orders. The detailed order ticket is available at the top of the chart (Figure 1) and can be set up as a template, or even as multiple templates. An abbreviated trade window is also available and can be set up as one or more templates. A buy or sell-stop order can also be established using a trendline by rst drawing the trendline a nd right-clicking to bring up a dropdown menu (Figure 2) and then clicking on buy limit or sell stop, which immediately turns the trendline into an order and displays the order box on the chart. When the trendline is turned into
FIGURE 1: ORDER TICKET. In the toolbar directly above the chart are buy and sell buttons that bring up a detailed order ticket that can then be saved as a template. 42 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 2: T RENDLINE ORDER TICKET. By drawing a trendline and then right-clicking on the line, a dropdown box appears, allowing you to turn the trendline into a buy limit or sell-stop order.
a sell-stop order, the line changes to a dotted line and the abbreviated order box appears with your completed order. Once your trading layout is established, you can create additional layouts with watchlists, charts, news, and scans to use for research and analysis. Upcoming earnings dates is another new feature and can be applied to any watchlist. Bring up the S&P 500 watch-
list, add the upcoming earnings date column, sort, and there you have all t he earning dates, starting with the most current. In my trading, I personally don’t like to hold positions over earnings dates, and with Version 16, I can simply take my trading portfolio, add the earnings date column, sort, and I can see which positions have upcoming earnings dates (Figure 3).
Version 16 of TC2000 gives you the option of trading in real time or executing simulated trades.
FIGURE 3: EARNINGS DATES. The upcoming earnings date column c an be added to any watchlist. Here, the column is added onto the positions watchlist and sorted by date for a heads-up on pending earnings announcements. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 43
FIGURE 4: MT NEWSWIRE. The recently added newsfeed from MT Newswires offers a wide variety of news announcements on a real-time basis.
Version 16 now allows customization of videos on various subjects related to of the chart toolbars. The top row is the trading and then go down to the bottom factory toolbar and cannot be edited, of the page to see the entire webinar but now you can add a second, third, archive dating back to 2009. and fourth row with a ny of the buttons, Still need help? In the past, the data, and so on, that suit your trad ing or Worden Brothers training guru, Michael analysis style. Thompson, put on live seminars around Since Bruce Faber’s review in this the country. He took a brief sabbatical magazine of TC2000 Version 12.2 in from traveling in 2015 but plans on 2012, Worden Brothers has added a scheduling a series of live webinars in reports button that allows you to open 2016, so keep an eye on your email if either a prebuilt fundamentals report or a you’re already a member of the TC2000 price & volume report. Or you can create user family, or go to the website to see your own custom report, allowing you upcoming seminars. In addition to the to check the edit box to add, delete, and tutorial videos, webinar archives, and move elds. Recently, Worden Brothers soon-to-come live seminars, TC2000 added an optional service—the newsfeed has a superb support team available six from MT Newswires, which offers a days a week via phone or email. wide variety of news announcements on a real-time basis (Figure 4). James E. Rich has been trading for more than 30 years and currently trades multiple family accounts using SUPPORT Worried about the learning curve with a a combination of technical analysis, new platform? Don’t be. When you click fundamental analysis, and intermarket on the help button and then on tutorial analysis. He is the cofounder of Palm videos, links to more than 60 videos ap- Beach Traders, an investment roundpear. The videos average three to seven table group that meets monthly in Palm minutes each, covering every aspect of Beach Gardens, FL to hear speakers the program. Speaking of videos, if you and discuss various aspects of trading want help with your trading, you can go and investing. Rich can be contacted at to www.worden.com to view a myriad [email protected]. 44 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
Worried about the learning curve with a new platform? Don’t be. More than 60 tutorial videos are available. FURTHER
READING
Faber, Bruce R. [2012]. “TC2000 Version 12.2 Update,” Technical Analysis of STOCKS & COMMODITIES, Volume 30: November. [2012]. “TC2000 Version 12,” Technical Analysis of
STOCKS &
COMMODITIES, Volume 30: January. Rich, James E., with John B. Rich [2015]. “Simplify It,” Technical Analysis of STOCKS & COMMODITIES, Volume 33: November.
‡TC2000 ( Worden Brothers, Inc.) ‡See Editorial Resource Index
FUTURES FOR YOU INSIDE THE FUTURES WORLD
Want to nd out how the futures markets really work? Carley Garner is the senior strategist for DeCarley Trading, a division of Zaner Group, where she also works as a broker. She authors widely distribut ed e-newsletters; for your free subscription, visit www.DeCarleyTrading.com. Her books—Currency Trading In The Forex And Futures Markets; A Trader’s First Book On Commodities ; and Commodity Options—were published by FT Press. To submit a question, email her at [email protected] or via www.DeCarleyTrading.com. Selected questions will appear in a future issue of S&C.
COMMODITIES: CAN PRICES GO TO ZERO?
Could a commodity bull with deep enough pockets weather any storm?
The simple answer to that question is an unequivocal yes. If you had unlimited trading capital, an unlimited time horizon, and the sense to mitigate futures market leverage, you could theoretically never lose when trading commodities. This theory is based on the fact that commodity prices, although they can get very cheap, cannot go to zero. In other words, commodities are “goods,” not “bads”; unless something changes dramatically in the way we live, we will always need corn, soybeans, crude oil, natural gas, and so, to some degree. If society nds a substitute for the commodities we currently use, then as the demand for such alternative resources increases, so will the pr ice of the substitute. Eventually, consumers will migrate back to the original source. To reiterate, there will always be some value in commodities. Further, the commodity markets go through boom and bust cycles. Even in the most trying time—think natural gas in the fall of 2015 or crude oil in the summer of 2015—there is light at the end of the tunnel. Producers and end users adjust their behavior according to the state of the boom and bust cycle, only to trigger a repeat. For instance, when crude oil was above $100 per barrel, US shale oil producers were rushing to frack as much oil out of the ground as they could with little concern for budgeting or cost management. However, when crude oil fell below $40, oil producers were aggressively handing pink slips to employees and shutting down rigs. Each of these behaviors works toward repeating the
commodity cycle. When prices are high, producers rush to bring product to market, and demand tapers. Yet when prices are low, producers reign in operations while demand is on the rise. Simply put, there are antagonistic forces that prevent prices from going to zero. Accordingly, for a trader with the pain tolerance, nancial capital, patience, and discipline necessary to accept massive drawdowns in exchange for nearly certain trading success, it is realistic to say that you might never lose money trading commodities. Of course, this assumption ignores transaction costs, the contango (rolling contract months at unfavorable prices), the slim possibility of an MF Global or PFG repeat, and the unpleasant likelihood of the trader dying before price recovers from the entry price. Although commodity markets tend to trade in ranges, the peaks and valleys are sometimes seen several years, or even decades, apart. Naturally, none of us have the luxury of unlimited time or money. Even the largest funds in the world don’t have unlimited funds, nor do they generally have the discipline to pace themselves, or the wherewithal to hold positions indenitely without investors withdrawing funds. With this in mind, let’s take a look at how big the drawdowns might be in any given commodity per single lot traded. Let’s assume that a commodity price could lose as much as 70% of its current value, which is a stretch but not impossible. We’ll use that as the risk of going long a long-term position trade with unlimited nancial backing. With crude oil trading at $45, the potential drawdown of going long here with no other expectation other than prices will eventually be higher than $45, a trader would suffer a paper loss of $31,500 should
Carley Garner
the commodity lose 70% from entry. An emini S&P trader could lose over $70,000 if prices drop 70%. These are substantial sums of money that the coolest of heads would struggle to endure. Obviously, the goal of such long-term position trading is to go long a market after it has already made a substantial decline. Buying into a commodity in a massive upswing could take both your, and your kids’, lifetimes to recover. Just imagine going long crude oil at $150 per barrel in 2008. Oil prices will probably see this price again, but will it be in our lifetime? Maybe not. On a side note, individual stocks, unlike commodities, have the ability to become completely worthless. Thus, if you purchase shares of a particular company with the mindset that it will be impossible to lose if held long enough, that would be an even bigger fallacy. In my lifetime, I’ve seen companies that were once staples in our society disappear, all the while putting their shareholders through the ringer. Remember the telephone company WorldCom or more recently Blockbuster video? I think we can all agree that in the history of the commodity markets, we’ve never seen a market go to zero. Even if it did, there would always be potential for a recovery, which also differs from individual stocks. If a stock becomes worthless, it is delisted, leaving shareholders with no chance of recouping lost money. So again, is it possible to construct a scenario in which a trader could ride out any storm? Yes, it’s possible. Is such a strategy more feasible in commodities, than it is for stocks? Yes, it is. Nevertheless, it isn’t realistic.
January 2016 • Technical Analysis of STOCKS & COMMODITIES • 45
For this month’s Traders’ Tips, the focus is James and John Rich’s article in the November 2015 issue, “Simplify It.” Here, we present the January 2016 Traders’ Tips code with possible implementations in various software. The code for the following Traders’ Tips selections is posted here: • Traders.com
Home–S&C Magazine
Traders’ Tips
(Or from Traders.com, scroll down to the current articles section and click on the Traders’ Tips tab.) The Traders’ Tips section is provided to help the reader implement a selected technique from an article in this issue or another recent issue. The entries here are contributed by software developers or programmers for software that is capable of customization.
JANUARY 2016 TRADERS’ TIPS CODE James and John Rich’s approach to trading with the trend, as described in their article “Simplify It” that appeared in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, can easily be applied in TC2000 Version 16. In Figure 1, you see a daily SPY chart with a 50-day moving average (yellow line). The 50-day average is moving up, signifying an overall uptrend. Below the SPY chart are two TC2000 EasyScans: SPY in uptrend and SPY in downtrend . Since the SPY chart is indicating an uptrend based on the 50-day moving average, we have SPY in uptrend selected. This scan shows ve stocks for which the following conditions are true: • Price is above its 50-day average (SMA) • 20-day SMA of price is above the 50-day SMA of price • 50-day SMA of price is above the 200-day SMA of price • 50-day average volume is greater than one million shares • Price has just crossed up through the eight-day moving average of the high.
FIGURE 1: TC2000. Here is a TC2000 Version 16 layout showing: 1) a chart of SPY; 2) scans for uptrending and downtrending markets; and 3) a chart showing the entry points for uptrends (green dots) and entry points for downtrends (red dots).
F TC2000:
F TRADESTATION:
JANUARY 2016 TRADERS’ TIPS CODE In “Simplify It,” which appeared in the November 2015 issue of Technical Analysis of STOCKS & C OMMODITIES, authors James and John Rich presented a trend-following approach to trading that they have developed over their many years of market experience. They noted that they begin by determining an opinion of the direction of the overall market. With this information, they described the criteria for selecting candidate stocks for trading. Finally, the authors listed their rules for
You can spacebar through the scan results to view the charts for each symbol. Green dots mark entry points during uptrends and red dots mark entry points during downtrends. Using t he new simulated trading feature in version 16, you can place trades on the symbols you nd interesting and see how they perform using this approach. If you would like a copy of this layout to use in your TC2000 software, simply send an email t o [email protected] and we’ll send it to you. —Patrick Argo Worden Brothers, Inc. www.TC2000.com 46 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 2: TRADESTATION. Here are example TradeStation Scanner results and the _RichMethod indicator and strategy applied to a daily chart of Amazon (AMZN).
entry and exit. Here, we are providing TradeStation EasyLanguage code for both an indicator and strategy based on the authors’ work. The indicator can be used in the TradeStation Scanner to search for candidate stocks as well as in a chart t o visualize the results; the strategy can be used to backtest on the symbols of your choice. To download the EasyLanguage code, please visit our TradeStation and EasyLanguage support forum. The code from this article can be found here: http://www.tradestation. com/TASC-2016. The ELD lename is “TASC_JAN2016. ELD.” For more information about EasyLanguage in general, please see http://www.tradestation.com/EL-FAQ. The code is also shown at the STOCKS & COMMODITIES website at Traders.com in the Traders’ Tips area. A sample chart is shown in Figure 2. This article is for informational purposes. No type of trading or investment recommendation, advice, or strategy is being made, given, or in any manner provided by TradeStation Securities or its afliates. —Doug McCrary TradeStation Securities, Inc. www.TradeStation.com
F METASTOCK: JANUARY 2016 TRADERS’ TIPS CODE
In “Simplify It,” which appeared in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, author James Rich along with brother John Rich presented a simple trading system. The article suggested using the direction of a 50-period SMA on the SPY to nd the market trend. Then look for stocks in a trend going the same direction. From there, channel lines are used to nd the entry & exit points. The MetaStock formulas provided here combine all those conditions into entry & exit signals that you can put into a system test or expert adviser in MetaStock. Enter long: s1:= Security("SPY", C); ma1:= Mov(C, 20, S); ma2:= Mov(C, 50, S); ma3:= Mov(C, 200, S); dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1); tradelong:= dir = 1 AND ma1 > ma2 AND ma2 > ma3; tline:= Mov(H,8,S); bline:= Mov(L,8,S); el:= C > tline AND tradelong; xl:= L < bline; trade:= If(el, 1, If(xl, 0, PREV)); trade = 1 AND Ref(trade = 0, -1)
xl:= L < bline; trade:= If(el, 1, If(xl, 0, PREV)); trade = 0 AND Ref(trade = 1, -1)
Enter short: s1:= Security("SPY", C); ma1:= Mov(C, 20, S); ma2:= Mov(C, 50, S); ma3:= Mov(C, 200, S); dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1); tradeshort:= dir = -1 AND ma1 < ma2 AND ma2 < ma3; tline:= Mov(H,8,S); bline:= Mov(L,8,S); es:= C < bline AND tradeshort; xs:= H > tline; trade:= If(es, 1, If(xs, 0, PREV)); trade = 1 AND Ref(trade = 0, -1)
Exit short: s1:= Security("SPY", C); ma1:= Mov(C, 20, S); ma2:= Mov(C, 50, S); ma3:= Mov(C, 200, S); dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1); tradeshort:= dir = -1 AND ma1 < ma2 AND ma2 < ma3; tline:= Mov(H,8,S); bline:= Mov(L,8,S); es:= C < bline AND tradeshort; xs:= H > tline; trade:= If(es, 1, If(xs, 0, PREV)); trade = 0 AND Ref(trade = 1, -1)
—William Golson MetaStock Technical Support www.metastock.com
F eSIGNAL:
JANUARY 2016 TRADERS’ TIPS CODE For this month’s Traders’ Tip, we’ve provided a study named “Simplify.efs” based on the formula described in James and John Rich’s article that appeared in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, “Simplify
Exit long: s1:= Security("SPY", C); ma1:= Mov(C, 20, S); ma2:= Mov(C, 50, S); ma3:= Mov(C, 200, S); dir:= If( ROC( Mov(s1, 50,S), 1,$)>0, 1, -1); tradelong:= dir = 1 AND ma1 > ma2 AND ma2 > ma3; tline:= Mov(H,8,S); bline:= Mov(L,8,S); el:= C > tline AND tradelong;
FIGURE 3: eSIGNAL. Here is an example of the study plotted on a daily chart of HUM. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 47
have made the loading process extremely easy: simply click on the links http://tos.mx/vTuhvW and http://tos. mx/YQ7z0L and choose save script to thinkorswim, and backtest in thinkScript . Choose to rename your study and strategy “SimpleTrendChannel.” You can adjust the parameters of this study within the edit studies window to fne-tune your variables. In the example in Figure 4, you see a chart of National Oilwell Varco (NOV), with the averages used to dene strategies as well as the channels used to trigger stops and limit orders. Beneath volume you can see a histogram chart of prot & loss for the charted time frame. In this example, there is a large prot, as the green indicates. For more on this technique, please see the Richs’ article in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES magazine. FIGURE 4: THINKORSWIM. Here is a chart of National Oilwell Varco (NOV), with the aver-
ages used to define strategies as well as the channels used to trigger stops and limit orders. A histogram of profit & loss for the charted time frame is beneath volume. In this example, there is a large profit, as the green indicates.
It.” In the article, the authors presented a simple trading method based on moving averages. The study contains formula parameters that may be congured through the edit chart window (right-click on the chart and select “edit chart”). A sample chart implementing the study is shown in Figure 3. To discuss this study or download a complete copy of the formula code, please visit the EFS library discussion board forum under the forums link from the support menu at www. esignal.com or visit our EFS KnowledgeBase at http://www. esignal.com/support/kb/efs/. The eSignal formula script (EFS) is also available for copying & pasting from the STOCKS & COMMODITIES website in the Traders’ Tips area. —Eric Lippert eSignal, an Interactive Data company 800 779-6555, www.eSignal.com
—thinkorswim A division of TD Ameritrade, Inc. www.thinkorswim.com
F WEALTH-LAB: JANUARY 2016 TRADERS’ TIPS CODE
The WealthScript strategy we are presenting here combines trend-detection ideas that James and John Rich had researched and presented in their November 2015 article in STOCKS & COMMODITIES, titled “Simplify It.” Users have the means to experiment with which method of determining overall market direction works better: the one that relies on the external symbol’s (SPY) movement used by John Rich, or the one that uses a combination of multiple moving averages as used by James Rich. The system’s C# code for Wealth-Lab is shown here and can also be found at the STOCKS & COMMODITIES website in the Traders’ Tips area. A Wealth-Lab chart demonstrating the system is shown in Figure 5. The method of screening for entries is so simple that it doesn’t require programming. For any Wealth-Lab user, it should be pretty trivial to drag and drop the conditions in a rule-based system (Figure 6). Wealth-Lab 6 strategy code (C#):
F THINKORSWIM: JANUARY 2016 TRADERS’ TIPS CODE
In “Simplify It,” which appeared in the November 2015 issue of Technical Analysis of STOCKS & C OMMODITIES, authors James and John Rich recounted how they have been using technical analysis since the 1960s. In that time, they have experimented with many different strategies, with John Rich even considered an authority on Elliott wave theory. They discuss how they have come to the conclusion that simple is better. Thus, using only moving averages, the brothers have constructed a strategy that denes trends and also has the granularity to include stops and limit prices. We have recreated their SimpleTrendChannel study and strategy using our proprietary scripting language, thinkscript. We 48 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
using System; using System.Collections.Generic; using System.Text; using System.Drawing; using WealthLab; using WealthLab.Indicators; namespace WealthLab.Strategies { public class SimplifyIt : WealthScript { private StrategyParameter paramTrendRule; public SimplifyIt() { paramTrendRule = CreateParameter("SPY for trend", 1, 0, 1, 1); }
LineStyle.Solid,1); } for(int bar = GetTradingLoopStartBar(200); bar < Bars. Count; bar++) { if (IsLastPositionActive) { Position p = LastPosition; if( p.PositionType == PositionType. Long ) { if( Close[bar] < smaLo[bar] - Bars.SymbolInfo. Tick ) FIGURE 5: WEALTH-LAB, EXAMPLE ENTRIES. This chart illustrates the application of the system’s rules on a daily chart of HUM.
SellAtMarket(bar+1, p ); } else { if( Close[bar] > smaHi[bar] + Bars.SymbolInfo. Tick )
CoverAtMarket(bar+1, p ); } } else { bool uptrend = // John’s / James’ method ( useSpyForTrend && (spy.Close[bar] > spySma[bar] && spySma[bar] > spySma[bar-1] && Close[bar] > sma50[bar])) || ( sma20[bar] > sma50[bar]&& sma50[bar] > sma200[bar]); bool downtrend = // John’s / James’ method ( useSpyForTrend && (spy.Close[bar] < spySma[bar] && spySma[bar] < FIGURE 6: WEALTH-LAB, DRAG & DROP. Users can build the system using drag & drop rules and conditions, with no spySma[bar-1] && Close[bar] < programming necessary. sma50[bar])) || ( sma20[bar] < sma50[bar] && sma50[bar] < sma200[bar]); protected override void Execute() { // market trend is up if( uptrend ) bool useSpyForTrend = paramTrendRule.ValueInt == 1; { Bars spy = GetExternalSymbol("SPY",true); // if( SMA.Series(Volume,50)[bar] > 1000000 ) SMA spySma = SMA.Series(spy.Close,50); the volume criterion SMA sma20 = SMA.Series(Close,20); if( Close[bar] > smaHi[bar] ) // the second step SMA sma50 = SMA.Series(Close,50); BuyAtMarket(bar + 1); SMA sma200 = SMA.Series(Close,200); } SMA smaHi = SMA.Series(High,8); // market trend is down else if( downtrend ) SMA smaLo = SMA.Series(Low,8); { //PlotSeries(PricePane,sma20,Color.Orange,WealthLab. LineStyle.Solid,1); PlotSeries(PricePane,sma50,Color.Red,WealthLab. LineStyle.Solid,1); //PlotSeries(PricePane,sma200,Color.Blue,WealthLab. LineStyle.Solid,1); PlotSeriesFillBand(PricePane, smaHi, smaLo, Color. Green, Color.Transparent, LineStyle.Solid, 1); if( useSpyForTrend )
{ ChartPane spyPane = CreatePane(30,true,true); PlotSymbol(spyPane,spy,Color.Blue,Color.Red); PlotSeries(spyPane,spySma,Color.Blue,WealthLab.
// if( SMA.Series(Volume,50)[bar] > 1000000 ) the volume criterion if( Close[bar] < smaLo[bar] ) // the second step ShortAtMarket(bar + 1); } } } } } }
—Eugene, Wealth-Lab team MS123, LLC www.wealth-lab.com January 2016 • Technical Analysis of STOCKS & COMMODITIES • 49
FIGURE 7: AMIBROKER. Here is a daily chart of Humana (HUM) with buy/sell arrows generated by eight-bar simple moving average channel crossovers.
FIGURE 8: NEUROSHELL TRADER.This sample NeuroShell Trader chart displays the method described by James and John Rich in their November 2015 article in S&C.
// MA channel breakout rules UpperChannel = MA( High, 8 ); LowerChannel = MA( Low, 8 ); F AMIBROKER:
JANUARY 2016 TRADERS’ TIPS CODE In “Simplify It,” which appeared in the November 2015 issue of Technical Analysis of STOCKS & C OMMODITIES, authors James and John Rich presented a very si mple trading method that involves simple moving average channel breakouts. A ready-to-use formula for AmiBroker is provided here. This code includes trend lters mentioned in the article for your use, however, the charts presented in Richs’ article show all channel breakouts without ltering, so the formula presented here does the same. To use the formula, enter the code in the formula editor and press apply indicator. To backtest the system, click send to analysis button in the formula editor and then the backtest button in the analysis window. You may need to change the symbol of SP500 to match your data provider’s symbology (the code given here uses Yahoo symbology). A sample chart is shown in Figure 7. AmiBroker code: // NOTE: the article mentions those lters
// yet charts presented in article don’t use them SP500 = Foreign("^GSPC", "C" ); UpMarket = MA( SP500, 50 ) > MA( SP500, 20 ); UpTrendStock = UpMarket AND MA( C, 20 ) > MA( C, 50 ) AND MA( C, 50 ) > MA( C, 200 ); DnTrendStock = NOT UpMarket AND MA( C, 20 ) < MA( C, 50 ) AND MA( C, 50 ) < MA( C, 200 ); Filter = Volume > 1000000 AND ( UpTrendStock OR DnTrendStock );
50 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
Buy = Cross( C, UpperChannel ); Sell = Cross( LowerChannel, C ); Buy = ExRem( Buy, Sell ); Sell = ExRem( Sell, Buy ); Plot( C, "Price", colorDefault, styleCandle ); Plot( UpperChannel, "UpperChannel", colorBlue ); Plot( LowerChannel, "UpperChannel", colorBlue ); PlotShapes( Buy * shapeUpArrow, colorGreen, 0, H, -80 ); PlotShapes( Sell * shapeDownArrow, colorRed, 0, L, -80 );
—Tomasz Janeczko, AmiBroker.com www.amibroker.com
F NEUROSHELL TRADER: JANUARY 2016
TRADERS’ TIPS CODE The trading method described by James and John Rich in their November 2015 in Technical Analysis of STOCKS & C OMMODITIES, “Simplify It,” can be easily implemented with a few of NeuroShell Trader’s 800+ indicators. Simply select new indicator from the insert menu and use the indicator wizard to create the following indicators: And3Long: Close > SMA Close,50 SMA Close,20 > SMA Close,50 SMA Close,50 > SMA Close,200 And3Short: Close <= SMA Close,50 SMA Close,20 <= SMA Close,50 SMA Close,50 <= SMA Close,200
To implement the method, simply select new trading strategy from the insert menu and enter the following in t he appropriate
locations of the trading strategy wizard: BUY LONG CONDITIONS: [All of which must be true] AND3Long CrossAbove(Close, Avg(High,8) SELL LONG CONDITIONS: [All of which must be true] CrossBelow(Close, Avg(Low,8)) SELL SHORT CONDITIONS: [All of which must be true] AND3SHORT CrossBelow(Close, Avg(Low,8)) COVER SHORT CONDITIONS: [All of which must be true] CrossAbove(Close, Avg(High,8)
Users of NeuroShell Trader can go to the STOCKS & COMMODITIES section of the NeuroShell Trader free technical support website to download a copy of this or any previous Traders’ Tips. A sample chart is shown in Figure 8.
FIGURE 9: AIQ. Here is a sample equity curve of the trend-following system versus the NASDAQ 100 index for the period 1/2/2000 to 11/06/2015.
—Marge Sherald, Ward Systems Group, Inc. 301 662-7950, [email protected] www.neuroshell.com
F AIQ: JANUARY 2016 TRADERS’ TIPS CODE The AIQ code based on James and John Rich’s article in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, “Simplify It,” is provided at www. TradersEdgeSystems.com/traderstips.htm. The code I am providing matches the description of the authors’ trend-following system with additional exit rules. The long exit has an additional prot-protect exit that is not coded, but when I ran tests, I used the built-in prot-protect exit set to 80% protection once the prot level reaches 5% or greater. Figure 9 shows the equity curve for the system versus the NASDAQ 100 index for the period 1/2/2000 to 11/06/2015. Figure 10 shows the metrics for this same test period. The system clearly outperformed the index. !SIMPLIFY IT !Author: James E. Rich with John B. Rich, TASC Nov 2015 (for Jan 2016) !Coded by: Richard Denning 11/1/2015 !www.TradersEdgeSystems.com !INPUTS mktTrendLen is 50. IDX is "SPY". stkLen1 is 20. stkLen2 is 50. stkLen3 is 200. trdBandLen is 8. pctStp is 0.07. minBarsSinceBandCross is 10. maxBarsHold is 10. !MARKET DIRECTION: mktClose is TickerUDF(IDX,[close]). mktSMA is simpleavg(mktClose,mktTrendLen). mktTrendUp if mktClose > mktSMA and mktSMA > valresult(mktSMA,10). mtkTrendDn if mktClose < mktSMA and mktSMA <
FIGURE 10: AIQ. Here are t he metrics for the trend-following system and the test settings.
valresult(mktSMA,10). !mktTrendUp if tickerRule(IDX,stkTrendUp). !mtkTrendDn if tickerRule(IDX,stkTrendDn). !STOCK SCREEN FOR UP TRENDING STOCKS: stkSMA1 is simpleavg([close],stkLen1). stkSMA2 is simpleavg([close],stkLen2). stkSMA3 is simpleavg([close],stkLen3). stkTrendUp if [close] > stkSMA2 and stkSMA1 > stkSMA2 and stkSMA2 > stkSMA3 and [close] > 5 and simpleavg([volume],50) > 10000. !volume in hundreds !STOCK SCREEN FOR DOWN TRENDING STOCKS: January 2016 • Technical Analysis of STOCKS & COMMODITIES • 51
stkTrendDn if [close] < stkSMA2 and stkSMA1 < stkSMA2 and stkSMA2 < stkSMA3 and simpleavg([volume],50) > 10000. !volume in hundreds !TRADING BANDS: stkSMAhi is simpleavg([high],trdBandLen). stkSMAlo is simpleavg([low],trdBandLen). Buy if mktTrendUp and stkTrendUp and [close] > stkSMAhi and countof([close] > stkSMAhi,minBarsSinceBandCross)=1. Short if mtkTrendDn and stkTrendDn and [close] < stkSMAlo and countof([close] < stkSMAlo,minBarsSinceBandCross)=1. PD is {position days}. PEP is {position entry price}. ExitBuy if [close] < stkSMAlo * (1-pctStp). ExitShort if [close] > stkSMAhi * (1+pctStp) or (PD > maxBarsHold and [close] > PEP).
The code and EDS le can be downloaded from www. TradersEdgeSystems.com/traderstips.htm. —Richard Denning [email protected] for AIQ Systems
F TRADERSSTUDIO: JANUARY 2016
TRADERS’ TIPS CODE The TradersStudio code based on the article “Simplify It” by James and John Rich, which appeared in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, can be found at www.TradersEdgeSystems. com/traderstips.htm. The following code le is contained in the download: • System: SIMPLIFY—Trend-following system based on author’s description in November 2015 article, “Simplify It”
Figure 11 shows the equity curve for the system from 2001 through 2013 trading one share per signal of the NASDAQ 100 stocks.
Here is the code: 'SIMPLIFY IT 'Author: James E Rich with John B Rich, TASC Nov 2015 (for Jan 2016) 'Coded by: Richard Denning 11/1/2015 'www TradersEdgeSystems com sub SIMPLIFY(mktTrendLen,stkLen1,stkLen2,stkLen3,trdBandLe n,pctStp,minBarsSinceBandCross,maxBarsHold,allowShorts) 'mktTrendLen = 50 'IDX = "SPY" 'stkLen1 = 20 'stkLen2 = 50 'stkLen3 = 200 'trdBandLen = 8 'pctStp = 0.07 'minBarsSinceBandCross = 10 'maxBarsHold = 10 'allowShorts = 0 'MARKET DIRECTION: Dim mktClose As BarArray Dim mktSMA As BarArray Dim mktTrendUp As Boolean Dim mtkTrendDn As Boolean mktClose = C Of independent1 mktSMA = Average(mktClose,mktTrendLen) mktTrendUp = mktClose > mktSMA And mktSMA > mktSMA[10] mtkTrendDn = mktClose < mktSMA And mktSMA < mktSMA[10] 'STOCK SCREEN FOR UP TRENDING STOCKS: Dim stkSMA1 As BarArray Dim stkSMA2 As BarArray Dim stkSMA3 As BarArray Dim stkTrendUp As Boolean stkSMA1 = Average(C,stkLen1) stkSMA2 = Average(C,stkLen2) stkSMA3 = Average(C,stkLen3) stkTrendUp = C>stkSMA2 And stkSMA1>stkSMA2 And stkSMA2>stkSMA3 And C>5 And Average(V,50)>1000000 'STOCK SCREEN FOR DOWN TRENDING STOCKS: Dim stkTrendDn As Boolean stkTrendDn = C1000000 'TRADING BANDS: Dim stkSMAhi As BarArray Dim stkSMAlo As BarArray stkSMAhi = Average(H,trdBandLen) stkSMAlo = Average(L,trdBandLen) 'ENTRY RULES: Dim isAboveSMAhi As BarArray isAboveSMAhi = C>stkSMAhi If mktTrendUp And stkTrendUp And C>stkSMAhi And countof(isA boveSMAhi,minBarsSinceBandCross,0)=1 Then Buy("LE",1,0,Market,Day) End If If allowShorts=1 Then Dim isBelowSMAlo As BarArray isBelowSMAlo = C
FIGURE 11: TRADERSSTUDIO. Here is a sample equity curve for the trend-following trading system from 2001 through 2013 trading one share per signal of the NASDAQ 100 stocks. 52 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
'EXIT RULES: If C
FIGURE 12: NINJATRADER. This sample chart of Humana (HUM) shows entries based on the strategy described in James & John Rich’s article “Simplify It.”
If allowShorts=1 Then If C>stkSMAhi*(1+pctStp) Or (BarsSinceEntry>maxBarsHold And C>EntryPrice) Then ExitShort("SXstop","",1,0,Market,Day) End If Dim maxProtSS As BarArray Dim pctOfMaxProtSS As BarArray Dim loC As BarArray If C0 And EntryPrice>0 And BarsSinceEntry>0 Then 'maxProtSS=(Lowest(C,BarsSinceEntry-1)/EntryPrice)-1 If BarsSinceEntry=1 Then loC=C Else loC = Min(loC,loC[1]) maxProtSS=EntryPrice/loC-1 End If If maxProtSS>0 And C>0 And EntryPrice>0 Then pctOfMaxProf itSS=(EntryPrice/C-1)/maxProtSS If maxProtSS>=0.05 And pctOfMaxProtSS<0.8 Then ExitShort("SXprotProtectSS","",1,0,Market,Day) End If End If End Sub
—Richard Denning [email protected] for TradersStudio
F NINJATRADER: JANUARY 2016 TRADERS’ TIPS CODE
The indicator and strategy presented in James and John Rich’s article “Simplify It,” which appeared in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, are available for download at www.ninjatrader.com/SC/January2016SC.zip. Once you have downloaded it, from within the NinjaTrader Control Center window, select the menu File Utilities →
→
Import NinjaScript and select the downloaded le. This le is for NinjaTrader Version 7. You can review the indicator and strategy’s source code by selecting the menu Tools Edit NinjaScript Indicator or Strategy from within the NinjaTrader Control Center window and selecting either the SimplifyIt indicator or SimplifyIT strategy. A sample chart implementing the strategy is shown in Figure 12. →
→
—Raymond Deux & Cody Brewer NinjaTrader, LLC www.ninjatrader.com
F UPDATA: JANUARY 2016 TRADERS’ TIPS CODE Our Traders’ Tip for this month is based on James and John Rich’s article from the November 2015 issue of Technical Analysis of STOCKS & C OMMODITIES, “Simplify It.” In the article, the authors sought to develop a system for rst de termining the long, medium, and short trends of a market, and then following the trend, with conrmation based on the direction of the S&P 500 index ETF (SPY). Exits are a trailing stop based on an average of the high or low. Figure 13 demonstrates an implementation of the system, with the triple moving average lter system applied to a chart of Humana Inc. (HUM). The Updata code based on this article is in the Updata library and may be downloaded by clicking the custom menu and system library. Those who cannot access the library due to a rewall may paste the code shown here into the Updata custom editor and save it. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 53
FIGURE 13: UPDATA. Here, the triple moving average filter system is applied to Humana Inc. (HUM) in daily resolution.
DISPLAYSTYLE 5LINES INDICATORTYPE TOOL PLOTSTYLE LINE RGB(200,0,0) PLOTSTYLE2 LINE RGB(0,200,0) PLOTSTYLE3 LINE RGB(0,0,200) PLOTSTYLE4 LINE RGB(100,100,100) PLOTSTYLE5 LINE RGB(100,100,100) PARAMETER "Period 1" #PERIOD1=20 PARAMETER "Period 2" #PERIOD2=50 PARAMETER "Period 3" #PERIOD3=200 PARAMETER "Hi/Lo Avg." #PERIOD4=8 PARAMETER "SPY" ~SPY=SELECT NAME "AVG[" #PERIOD1 "|" #PERIOD2 "|" #PERIOD3 "]" "" @AVG1=0 @AVG2=0 @AVG3=0 @UPPER=0 @LOWER=0 @SPYAVG=0 @LONGSTOP=0 @SHORTSTOP=0 FOR #CURDATE=#PERIOD1+#PERIOD2+#PERIOD3 TO #LASTDATE @AVG1=MAVE(#PERIOD1) @AVG2=MAVE(#PERIOD2) @AVG3=MAVE(#PERIOD3) @SPYAVG=SGNL(~SPY,#PERIOD2,M) @UPPER=SGNL(HIGH,#PERIOD4,M)
@LOWER=SGNL(LOW,#PERIOD4,M) 'ENTRIES IF @AVG1>@AVG2 AND @AVG2>@AVG3 AND HASX(CLOSE,@ UPPER,UP) AND ORDERISOPEN=0 AND VOL>1000000 BUY CLOSE @LONGSTOP=PLOW(@LOWER,#PERIOD4) ELSEIF @AVG1<@AVG2 AND @AVG2<@AVG3 AND HASX(CLOSE,@LOWER,DOWN) AND ORDERISOPEN=0 AND @ SPYAVG0 IF CLOSE<@LONGSTOP SELL @LONGSTOP ENDIF @LONGSTOP=MAX(PLOW(@LOWER,#PERIOD4),@LONGSTOP) ELSEIF ORDERISOPEN<0 IF CLOSE>@SHORTSTOP COVER @SHORTSTOP ENDIF @SHORTSTOP=MIN(PHIGH(@UPPER,#PERIOD4),@SHORTSTOP) ENDIF @PLOT=@AVG1 @PLOT2=@AVG2 @PLOT3=@AVG3 @PLOT4=@UPPER @PLOT5=@LOWER NEXT
—Updata support team [email protected], www.updata.co.uk
F MICROSOFT EXCEL:
JANUARY 2016 TRADERS’ TIPS CODE In “Simplify It,” which appeared in the November 2015 issue of Technical Analysis of STOCKS & COMMODITIES, the team of James and John Rich show us pieces that can be combined to build a simple trading system. The proposed system is a combination of several screening rules to establish trade setups along with trigger rules to actually enter and exit both long and short trades after a setup has been established. Since this system is based on bar close to generate signals, the actual trade cannot logically take place on the signal bar. So the long and short position shading used here begins and
FIGURE 14: EXCEL, TRADE SETUP SCREENS. This shows Humana with all trade setup screens in place. 54 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 15: EXCEL, SCREENING RULES. What a difference removing a couple of screening rules can make!
FIGURE 16: EXCEL, TRANSACTION SUMMARY
ends on the bar after an entry or exit signal. Perhaps one could change the trigger rules to re if any part of the high/low span of the bar crosses the upper or lower band and then trade at a price from within that span on the actual trigger day. One other usage note: To keep the SPY index prices in
sync with the stock prices, I am forcing a refresh of the index every time you request historical data for a stock symbol. So there will be a bit of additional screen ickering and ashing, but not much additional time consumed. Figures 14 & 15 approximate the data range we see in Figure 1 of Richs’ article. They demonstrate some of the
FIGURE 17: EXCEL, SCREEN EXAMPLE. Here is National Oilwell with all setup screens in force. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 55
FIGURE 18: EXCEL, TREND SCREENING. Here is the result of dropping the “index trend” screening rule.
FIGURE 19: EXCEL, SCREENING CONTROLS. Dropping another setup screening control lets in an additional trade, but it did not improve our results.
range of results based on varying the setup rules. Turning the SMA(200) versus SMA(50) rule will eliminate t he losing short we see in Figure 2 beginning around 11/8/2014. Figure 16 shows my transaction summary tab, which lists the details of the transactions that appear on the chart. A bottom line version of the transaction results is carried over to the CalculationsAndCharts tab for quick reference. Due to the way I am calculating trades, you may see a trade at the left of the price chart that actually started on a bar that occurred prior to the bars displayed in the chart window. In that event, you will see a partial trade documented here as an exit with no entry. This left edge partial trade will not be reected in the transaction counts, nor in the totals. If you wish to include it, you can increase the points to plot value (cell A11) on the CalculationsAndCharts tab a little bit at a time until you can see the transaction entry bar on the chart. Figures 17, 18, & 19 are the results of various combinations of the entry setup controls using my approximation of Figure 2 from Richs’ article. 56 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
This stock is clearly in a downtrend, but the market, as reected in the trend of the SPY index, is not. With some trial combinations of the screening rules, we nd that the index trend screen was blocking all potential short entries. The spreadsheet le for this Traders’ Tip can be downloaded from www.traders.com in the Traders’Tips area. To successfully download it, follow these steps: • Right-click on the Excel le link, then • Select “save as” to place a copy of the spreadsheet le on your hard drive. James and John Rich have given us lots to play with here. Enjoy! —Ron McAllister Excel and VBA programmer [email protected]
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January 2016
• Technical Analysis of STOCKS & COMMODITIES • 57
FUTURES LIQUIDITY rading liquidity is often overlooked as a key technical measurement in the analysis and selection of commodity futures. The following explains how to read the futures liquidity chart pub lished by Technical Analysis of STOCKS & COMMODITIES every month.
T
COMMODITY
very high volumes. The greatest number of dots indicates the greatest activity; futures with one or no dots show little activity and are therefore less desirable for speculators. Courtesy of CBOT
FUTURES
The futures liquidity chart shown be low is intended to rank publicly traded futures contracts in order of liquidity. Relative contract liquidity is indicated by the number of dots on the right-hand side of the chart. This liquidity ranking is produced by multiplying contract point value times the maximum conceivable price motion (based on the past three years’ historical data) times the contract’s open interest times a factor (usually 1 to 4) for low or
three-year period. Thus, all numbers in this column have an equal dollar value. Columns indicating percent margin and effective percent margin provide a helpful comparison for traders who wish to place their margin money ef ciently. The effective percent margin is determined by dividing the margin value ($) by the three-year price range of contract dollar value, and then multiply ing by one hundred.
STOCKS
All futures listed are weighted equally under “contracts to trade for equal dollar prot.” This is done by multiplying contract value times the maximum possible change in price observed in the last
Trading liquidity has a signicant ef fect on the change in price of a security. Theoretically, trading activity can serve as a proxy for trading liquidity and equals the total volume for a given period expressed as a percentage of the total number of shares outstanding. This value can be thought of as the turnover rate of a rm’s shares outstanding.
Trading Liquidity: Futures Commodity Futures
Exchange
E-Mini S&P 500 10-Year T-Note Crude Oil WTI 5-Year T-Note Euro FX E-Mini Nasdaq 100 Gold T-Bond Russell 2000 Mini Ultra T-Bond Japanese Yen Corn Natural Gas Silver Australian Dollar Gasoline RBOB 2-Year T-Note Canadian Dollar DJIA mini-sized High Grade Copper E-Mini S&P Midcap Sugar #11 Soybean Meal Soybeans Wheat British Pound Platinum Soybean Oil CBOE S&P 500 VIX Coffee Hard Red Wheat Lean Hogs Swiss Franc U.S. Dollar Index Crude Oil Brent (F) Eurodollar Live Cattle Mexican Peso Cotton #2 New Zealand Dollar Palladium Spring Wheat 30-Day Fed Funds Canola Class III Milk
GBLX CBOT NYMEX CBOT CME GBLX COMEX CBOT ICEUS CBOT CME CBOT NYMEX COMEX CME NYMEX CBOT CME CBOTM COMEX GBLX ICEUS CBOT CBOT CBOT CME NYMEX CBOT CFE ICEUS KCBT CME CME ICEUS NYMEX CME CME CME ICEUS CME NYMEX MGEX CBOT WCE CME
% Margin
Effective % Margin
Contracts to Trade for Equal
Relative Contract Liquidity
Dollar Proft
3.7 1.2 12.1 0.6 1.9 2.4 8.5 2.2 3.8 2.8 2.7 14.9 10.5 14.8 2.3 11.4 0.1 1.5 3.1 10.2 3.1 9.8 9.5 10.7 13.4 1.4 9.1 10.3 7 11.7 10.9 6.5 1.8 1.3 11.2 0.1 2.6 7.4 8 2.7 9.8 13 0 5.8 5.7
11 17.9 6.9 12.6 5.9 5.3 13.3 12.9 11.8 18.7 5.2 13.4 6 10.3 4.7 7.2 12.3 4.1 11.1 12.3 9.4 25 10.6 11.9 16.3 10.8 8.6 10.8 9.6 11.7 10.8 4.5 7.1 6.3 6.6 60.1 8.3 18.4 13.8 7.5 13.8 14.6 85.6 14.5 9.5
3 12 1 17 2 2 1 4 3 4 2 5 2 1 3 1 41 4 4 2 2 16 4 3 5 8 2 6 8 2 4 3 3 5 1 181 6 8 6 4 3 5 424 27 6
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“Relative Contract Liquidity” places commodities in descending order according to according to their per-contract potential for prot and how easily contracts can be bought how easily all of their contracts can be traded. Commodities at the top of the list are easior sold (i.e., trading liquidity). Each is a proportional measure and is meaningful only est to buy and sell; commodities at the bottom of the list are the most difcult. “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 Prot” column shows how volume factor, which is the greater of: many contracts of one commodity must be traded to obtain the same potential return In volume 1 or exp – 2 as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price In 5000 Trading Liquidity: Futures is a reference chart for speculators. It compares markets
Excursion).
58 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
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The information in Traders’Resource is the most accurate at the time of posting and is subject to change. Because the vendors posting to Traders’ Resource are responsible for their own listing, Technical Analysis, Inc. declines any and all liability for any representations made by the businesses and individuals listed. Nor can Technical Analysis, Inc. endorse any business or individual listed on Traders’ Resource. Technical Analysis, Inc. makes no warranties, express or implied, as to the accuracy and reliability of claims herein. You agree to release Technical Analysis, Inc., together with its respective employees, agents, officers, directors and shareholders, from any and all liability and obligations whatsoever in connection with or arising from your use of Traders’ Resource. If at any time you are not happy with the information posted to Traders’ Resource or object to any material within Traders’ Resource, your sole remedy is to cease using it. This list is updated frequently. If you are aware of a business that should be listed, please email us at [email protected].
January 2016
• Technical Analysis of STOCKS & COMMODITIES • 59
The following selection of book descriptions represents a sampling of recent book releases in the investing eld. Books described here may be from some of the major book publishers as well as some independent book publishers. These are not critical reviews or editorial evaluations, but rather a brief look at the book marketplace to help keep readers up to date on new or recent book offerings.
into the limelight with the 2007 near collapse of the global financial market. This book provides thorough, practical guidance toward processing the trade, and the risks & rewards it entails.
Trading Psychology 2.0: From Best Practices To Best Processes (448 pages, $60 hardcover, $39.99 ebook, September 2015, ISBN 978-1-118-93681-8) by Brett N. Steenbarger, published by Wiley. Trading Psychology 2.0 is a guide to applying the science of psychology to the art of trading. Veteran trading psychologist and bestselling author Brett Steenbarger offers advice and techniques to help interested traders better understand the markets, with practical takeaways that can be implemented immediately. Steenbarger draws on his own experience in psychology and statistical modeling as an active trader to offer insights into the practical aspect of trading psychology. Academic research is made understandable using examples, illustrations, and case studies to make it meaningful for practical traders. Interactive features include a blog offering ever-expanding content and a Twitter feed for quick tips. There are also contributions from market bloggers, authors, and experts for fresh perspectives to the topic. Studying the market from the perspective of human behavior gives traders insight into how human behavior drives market behavior. Trading psychology is equally relevant to daytraders and active investors, market makers and portfolio managers, and traders in all different markets. This book seeks to act as a personal trading coach in print, accessible 24/7 no matter what the market is doing.
(576 pages, $95 hardcover, $$61.99 ebook, October 2015, ISBN 978-1-119-13551-7) by Jimmy Skoglund & Wei Chen, published by Wiley. This book presents an in-depth look at banking risk on a global scale, including comprehensive examination of the US Comprehensive Capital Analysis and Review and the European Banking Authority stress tests. Written by experts in global banking risk products and management, this book provides up-to-date information and insight into risk management. The discussion begins with an overview of methods for computing and managing a variety of risks, then moves into a review of the economic foundation of modern risk management and the growing importance of model risk management. Market risk, portfolio credit risk, counterparty credit risk, liquidity risk, profitability analysis, stress testing, and others are dissected and examined, helping the reader to develop strategies to construct a robust risk management system. The book takes readers from basic market risk analysis to major recent advances in financial risk disciplines seen in the banking industr y. The quantitative methodologies are developed with business case discussions and examples illustrating how they are used in practice. Chapters devoted to firmwide risk and stress testing cross-reference the different methodologies developed for the specific risk areas and explain how they work together at firmwide level. Since risk regulations have driven a lot of the recent practices, the book also relates to the current global regulations in the financial risk areas.
www.wiley.com
www.wiley.com
The Trade Lifecycle: Behind The Scenes Of The Trading Process, second edition + website (416 pages, $70 hardcover, $45.99
Financial Planning Competency Hand- book, second edition (944 pages, $175
ebook, October 2015, ISBN 978-1-118-999462) by Robert P. Baker, published by Wiley. The Trade Lifecycle catalogs and details the various types of trades, including the inherent cashflows and risk exposures of each. Now in its second edition, this guide includes new coverage of traded products, credit valuation adjustment, regulation, and the role of information technology. The author teaches how to dissect a trade into its component parts, track it from preconception to maturity, and learn how it affects each business function of a financial institution. You will become familiar with the full extent of legal, operational, liquidity, credit, and market risks to which it is exposed. Case studies of real projects cover topics such as forex exotics, commodity counterparty risk, equity settlement, bond management, and global derivatives initiatives, while the companion website features additional video training on specific topics to help the reader build a strong background in this fundamental aspect of finance. Trade processing and settlement combined with control of risk was thrust 60 • January 2015 • Technical Analysis of STOCKS & COMMODITIES
www.wiley.com
Financial Risk Management: Applica- tions In Market, Credit, Asset And Li- ability Management And Firmwide Risk
hardcover, August 2015, ISBN 978-1-11909466-1) from the CFP Board, published by Wiley. This is a reference for those at any stage of certification and is also a resource for practitioners looking to better serve their clients. The book contains over 90 chapters for practitioners, students, and faculty. There is a US edition and an international edition. The revised text includes an in-depth review of the major content areas associated with financial planning including estate planning, taxation, investments, principles of communication, and more. This edition includes new content on connections diagrams, new case studies, and instructional videos, and a new section devoted to the interdisciplinary nature of financial planning. The reference seeks to provide insights from fields like psychology, behavioral finance, communication, and marriage & family therapy to help the reader better connect with their clients and perform to the highest expectations as a financial planner. www.wiley.com
AT THE CLOSE
Sell With Confdence
The Green Line Knowing when to exit a trade can work wonders for your trading returns. Here’s one tool that can help you make that critical decision.
by Ron Jaenisch was a very hot day in September and I was at a private lunch meeting with the CEO and CFO of a legal consulting company. They were making the rounds to encourage well-heeled investors to consider investing in their company. Their stock had a high ma rket cap but a low daily turnover, which for most money managers, is a criterion that brings up a caution ag. I decided to use the opportunity to practice presenting a small piece of what I was working on, one of the many automated techniques used by the technical analysis software that was being built for a family ofce consortium. I decided to present them with credible evidence that I had technology that is used by the money managers of the ultrawealthy in Vienna to know when to sell. This may sound like a tall tale, but I taught technical analysis to Vienna money managers several years back. First I showed them the chart of the Dow Jones Industrial
It
Average (DJIA) you see in Figure 1 and mentioned that a year ago I posted a video that suggested the DJIA was near a topping area. In the chart of the DJIA in Figure 1 a megahorn pattern is in play and price is near the green line. The technician who rst identied the pattern and coined the term mega horn wrote that it was more reliable for nding highs than lows. The green line is the far parallel of an Andrews pitchfork. The pitchfork is drawn using the recent three la rge pivots. Most charting software has the ability to draw this line. The Andrews line was originally written about in this magazine by Tom French. Over the years I found that price often nds strong resis tance at the green line. This is something I taught to money managers in Vienna years ago. Figure 2 shows the weekly scale of the DJIA and you can see t hat price did reverse near the green line. I showed them several other charts such as the daily chart of Apple Inc. (AAPL) that you see in Figure 3. Once again I pointed out that prices had made a top at the green line. Interestingly, a simila r scenario took place in AAPL in 2012 (Figure 4) in t hat prices reversed near the green line. However, I didn’t include this chart in my presentation. January 2016 • Technical Analysis of STOCKS & COMMODITIES • 61
K C O T S R E T T U H S / F E S O J K E L L E U M
AT THE CLOSE
FIGURE 2: STRONG RESIS TANCE. On this weekly char t of the DJIA you can see that price reversed at the green line.
M O C . S T R A H C Q
FIGURE 1: MEGAHORN PATTERN. On this daily chart of t he Dow Jones Industrial Average (DJIA), price is approaching the green line.
CONCLUSION I have come across several charts that show prices reversing at the green li ne. I’ve seen it enough times that I am convinced the green line is a reliable tool that lets me know when to sell.
Price often finds strong resistance at the green line, which is the far parallel of an Andrews pitchfork. and fut ures, using the techniques. He can be reached through Andrewscourse.com.
Ron Jaenisch spent time with Dr. Alan Andrews learning his techniques. Jaenisch has been authorized by Andrews to teach the Andrews techniques via a course that now includes videos. In 2015 Jaenisch was part of an international team that built software that automatically trades forex, stocks,
FURTHER READING French, Thomas E. [1985]. “Median Line Market Analysis,” Technical Analysis of STOCKS & COMMODITIES, Volume 3: April.
FIGURE 3: A TOP IN APPLE INC. (AAPL). Here in the daily chart of AAPL is another instance of prices reversing at the green line.
FIGURE 4: AND IT HAS HAPPENED BEFORE. Interestingly, a similar scenario occurred in the chart of AAPL in 2012.
62 • January 2016 • Technical Analysis of STOCKS & COMMODITIES
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