MARKET TECHNICIAN
December 2007
Issue No. 60
The after shocks of this summer’s credit crunch continue to
reverberate around the city and, with some banks nursing very
large losses, there is bound to be some belt tightening and job
losses. But the market gloom did not dampen spirits at the
Society’s annual dinner, which was held at the National Liberal
Club on 20th September. After a lifetime working in the City,
Roger Nightingale had a rich seam of stories and anecdotes
with which to regale us during his after-dinner speech. Given
the current circumstances, perhaps his most important
message was that you cannot count on central banks always
to get things right. Clive Lambert masterminded a 'Bull and
Bear' game which was a cross between heads and tails and
musical chairs. Peter Ives was the eventual winner and elected
to give the Society’s £500 charitable donation to the Kiloran
Trust, an organisation which runs a house where people caring
for someone in their home can come and take a well-earned
break. Like last year, the evening was a very mild one and after
dinner everyone moved out to the terrace.
September's monthly meeting focused on system building
and back-testing trading performance. There have been
enormous changes in this area in recent years and Francesco
Cavasino, Shaun Downey and David Linton each looked at
different aspects of this important subject. The general
consensus seemed to be that the advantage of using a system
is the element of non-subjective discipline that it injects into
the process of trading the markets. Even if you don't use
systems actually to trade the markets, you can use them to
give a more structured approach to your existing trading
strategy or to analyse how well the indicators that you use
work. But (and it is a big but) it is absolutely essential to
understand the assumptions built into a system (for example
the correlation between different markets) and to understand
a system's limitations. We can perhaps all draw comfort from
David Linton's conclusion that subjective analysis is not dead -
yet! All three speakers have contributed articles to this issue of
the journal which are based on their presentations.
A number of companies offer STA members a discount on
their services or products and we are delighted to add CQG to
this list. They are prepared to offer members of the Society a
FOR YOUR DIARY
Wednesday 9th January A panel of technical
analysts will give their views
on the outlook for 2008
Wednesday 13th February Monthly meeting
Tuesday 11th March Monthly meeting
N.B. Unless otherwise stated, the monthly meetings will take
place at the Institute of Marine Engineering, Science and
Technology, 80 Coleman Street, London EC2 at 6.00 p.m.
The Journal of the STA
www.sta-uk.org
10 per cent reduction on their CQG Integrated Client product.
(This offer cannot be combined with any other discount but is
valid for both new and existing clients.) A list of companies
offering STA members a discount is on the website. We are at
the moment trying to increase the range and number of
suppliers on this list so if any members have any suggestions
or ideas of companies that we might approach, could they
please contact Karen Jones?
For the first time the IFTA conference was this year held in
Egypt and ESTA put together a packed program of speakers.
We hope to include some of the papers in the next issue of
the Journal. Away from the conference hall, delegates had the
opportunity to enjoy the seaside resort of Sharm El-Sheikh.
ESTA also arranged a technical analysts’ version of Formula
One. The race took place on the nearby 1.3km international
go-karting track and we are pleased to report that Axel
Rudolph, wearing the STA colours, came first narrowly beating
the ESTA president Ayman Waked!
Paris will host next year’s IFTA conference, which will take
place on 6-8th November. Rather fittingly, Thiery Biechu
arrived in London by Eurostar on the first day the St Pancras
station started operating to give a presentation at the
November monthly meeting. With Paris now just 2hrs 15mins
away from London we hope that a large number of STA
members will attend next year’s conference so put a note in
your diaries now.
STOP PRESS: STA Administration has a new telephone
number. It is 0845 003 9549
COPY DEADLINE FOR THE NEXT ISSUE
FEBRUARY 2008
PUBLICATION OF THE NEXT ISSUE
MARCH 2008
IN THIS ISSUE
Bytes and pieces . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
M. Feeny Book review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
F. Cavasino Systematic trading: it is more about
risk than you may imagine . . . . . . . . . . . . . . . . 6
S. Downey System building and back testing –
opportunities, methods and caveats . . . . . 8
D. Linton Technical trading systems . . . . . . . . . . . . . . . . 12
J. Smithson Rediscovering Gann’s Law of
Vibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
A. Rudolph Honing your trading skills . . . . . . . . . . . . . . . . 20
 Networking Bytes and pieces
WHO TO CONTACT ON YOUR COMMITTEE

Online Free Seminars

CHAIRMAN
Moneyshow.com has recently released a series of free online
Adam Sorab: adam.sorab@cqsm.com
seminars under the “University” section, of their website. A
series of seminars are available on trading, investing and
TREASURER
markets. These are the best free education resource, I have
Simon Warren: warrens@bupa.com
found on the web. Previously priced at $200, for free they are a
steal. I looked over Art Collins on system trading where he
PROGRAMME ORGANISATION
describes how to produce a trading system, one of many
Mark Tennyson-d'Eyncourt: mdeyncourt@csv.org.uk excellent seminars. Also available are the moneyshow webcasts
Axel Rudolph: axel.rudolph@dowjones.com from the previous shows.
www.moneyshow.com
LIBRARY AND LIAISON
Michael Feeny: michaelfeeny@yahoo.co.uk Web TV
The Barbican library contains our collection. Michael buys new books for it CNBC and Bloomberg TV are now available via the web. CNBC
where appropriate. Any suggestions for new books should be made to him.
requires a monthly subscription and while both have small
window boxes CNBC can be viewed full screen. CNBC also
EDUCATION allows you to follow the markets for 24 hours via its Asian, UK
and US services. So with more coverage and no adverts the
John Cameron: jrlcameronta@tiscali.co.uk
web services can keep you informed 24/7.
IFTA www.CNBC.com, www.Bloomberg.com
Robin Griffiths: robin.griffiths@rathbones.com
Quotes on the phone
MARKETING
Better than a “Blackberry”? Yahoo has just released for mobile
phones – “Yahoo Go”. This new service allows any standard
Clive Lambert: clive@futurestechs.co.uk
mobile with web access to obtain quotes, charts and market
David Sneddon: david.sneddon@csfb.com
news. Email, weather and a city guide are just a few of the
Simon Warren: warrens@bupa.com
pages available and used on the Apple “Iphone”. If travelling, it’s
Karen Jones: karen.jones@ commerzbank.com
an essential resource and no doubt will get even better. A 3G
enabled phone will make loading the quotes page much faster.
MEMBERSHIP
More details and the link are available via this web page.
Simon Warren: warrens@bupa.com http://mobile.yahoo.com
REGIONAL CHAPTERS
Mobile Web
Alasdair McKinnon: AMcKinnon@sit.co.uk Looking for a last minute Christmas present? PocketSurfer2, the
latest mobile gadget, allows you full web access for 20 hours
SECRETARY
per month, wherever you are. The first year subscription is
Mark Tennyson d’Eyncourt: mdeyncourt@csv.org.uk included and then it is £40 per year. It will load a web page in
seven seconds and lasts five hours before needing a recharge.
STA JOURNAL The price is £179, which is less than many mobile phones.
Editor, Deborah Owen: editorial@irc100.com http://www.pocketsurfer.co.uk/homepage.htm

WEBSITE
David Watts: DWattsUK@aol.com
Dates of the Society’s 2008
Simon Warren: warrens@bupa.com
monthly meetings
Deborah Owen: editorial@irc100.com
9th January
Please keep the articles coming in – the success of the Journal depends
13th February
on its authors, and we would like to thank all those who have supported
us with their high standard of work. The aim is to make the Journal a 11th March (N.B. Tuesday)
valuable showcase for members’ research – as well as to inform and 9th April
entertain readers. 14th May
The Society is not responsible for any material published in The Market 11th June
Technician and publication of any material or expression of opinions
9th July (Summer party)
does not necessarily imply that the Society agrees with them. The Society
10th September
is not authorised to conduct investment business and does not provide
investment advice or recommendations. 8th October
Articles are published without responsibility on the part of the Society, 12th November
the editor or authors for loss occasioned by any person acting or 10th December (Christmas party)
refraining from action as a result of any view expressed therein.

2 MARKET TECHNICIAN Issue 60 – December 2007


Book review
By Michael Feeny, MSTA
Ichimoku Charts: an introduction to Ichimoku
Kinko Clouds, by Elliott, N.
Harriman House Ltd, 2007.
If you have studied hard to learn to appreciate Japanese candle
charts and now think you know all about Japanese techniques of
technical analysis, I have to tell you that there is more to come,
there is another name with which to become familiar: Ichimoku
The area on the chart between j and m is the cloud.
Traditionally this area is shaded. One colour is used if j > m and a
different colour is used if j < m.This colourisation dominates the
chart, and is what makes an Ichimoku Kinko chart so immediately
distinctive. As Elliott notes:
The thickness of the cloud is important. The thicker the cloud, the
less likely it is that prices will manage a sustained break through
it. The thinner the cloud, the better chance of a break through. So
cloud is cloud regardless of whether Span A or Span B is on top;
the thickness is what matters.
.N225, Last Trade [Candle], Last Trade [Ichimoku 9, 26, 52, 26] Daily
15Aug07 - 15Jan08
Pr
.N225 , Last Trade, Candle JPY

Kinko. Essentially Ichimoku Kinko is a method of overlaying 10Dec07 16007.33 16017.14 15826.25 15924.39
.N225 , Last Trade, Tenkan Sen 9
10Dec07 15598.50
17800

.N225 , Last Trade, Kijun Sen 26

moving averages on a candle chart, but with a time shift. 10Dec07 15662.29
.N225 , Last Trade, Senkou Span(a) 52
17600

14Jan08 15630.39 17400

Fortunately Nicole Elliott has opened up this method of .N225 , Last Trade, Senkou Span(b) 52
14Jan08 16079.41
.N225 , Last Trade, Chikou Span 26 17200
05Nov07 15924.39
forecasting price over time to Western analysts by writing a clear 17000

guide on the methodology. 16800

16600

16400

Goichi Hosoda began overlaying moving averages onto candle 16200

16000
charts in the 1940s, and he published his method in 1968 (writing
15800

under the pseudonym Ichimoku Sanjin), but, being computationally 15600

intensive, the method did not take off until the mid-1990s with the 15400

15200

advent of affordable computers.The revival was triggered by Sasaki 15000

(1996), a classic work now in its 18th edition. 14800

14600
15Aug07 29Aug 05Sep 12Sep 19Sep 26Sep 03Oct 10Oct 17Oct 24Oct 31Oct 07Nov 14Nov 21Nov 28Nov 05Dec 12Dec 19Dec 26Dec 02Jan 09Jan

The terms used in Ichimoku Kinko may seem forbiddingly

unfamiliar, but that is only because they are in Japanese; the
concepts themselves are straightforward enough. The system
uses a daily candle chart, on which are overlaid two moving
averages and three other derived lines. The area on the chart
between two of these lines is called a cloud.
The cloud is plotted on the chart not concurrently, but with a lead
of 26 days ahead. So the latest plot of the cloud lies 26 working
days ahead of the daily candle from which it is constructed.
A worksheet would contain the following data points:
a. day’s date
b. day’s open
c. day’s high
d. day’s low
e. day’s close
f. day’s close plotted 26 days behind day’s date
g. mid-point of the day’s range = (c + d)/2
h. 9-day moving average of g, plotted at day’s date
i. 26-day moving average of g, plotted at day’s date
j. (h + i)/2 plotted 26 days ahead of day’s date
k. highest g of past 52 working days
l. lowest g of past 52 working days
m. (k + l)/2 plotted 26 days ahead of day’s date.
Elliott does not find the crossover point of the cloud lines (and
the consequent change of colour of the cloud) to be significant
“other than the fact that at that point the cloud is at its thinnest”.
So the principle is that Ichimoku Kinko is a method of overlaying
moving averages on a daily candle chart. Two moving averages
are plotted concurrently, but some other derived numbers are
plotted with a time shift in the belief that these may then act as
support or resistance.The cloud referred to is the area on the chart
lying between two of these numbers (Senkou Span A and B).
If today’s candle is above the cloud, the trend is for higher prices:
the top of the cloud is the first level of support, and the bottom of
the cloud is the second level of support.
Conversely, if today’s candle is below the cloud, the trend is for
lower prices: the bottom of the cloud is the first level of
resistance, and the top of the cloud is the second level of
resistance.
A trend reversal could be suggested if the price moves through
the cloud and closes beyond the cloud.
If the price moves into the cloud but fails to go through it, the
daily candles should be watched to see if they give a reversal
signal.

From this worksheet, b to e are plotted as the candles, and the But in principle Ichimoku Kinko is a system for markets that are
other plotted lines have the following names: trending. It is not for sideways markets. The thicker the cloud, the
f. Chikou Span less likely it is that prices will manage a sustained break through
it, regardless of whether Span A or Span B is on top. Software
h. Tenkan-sen
packages strongly distinguish these two cloud types by the use of
i. Kijun-sen bright colours, but this is over-emphasis – the colour of the chart
j. Senkou Span A leaps out, to become the most instantly recognisable feature of
m. Senkou Span B Ichimoku charts, whereas in reality it is the thickness of a cloud

Issue 60 – December 2007 MARKET TECHNICIAN 3

 that matters rather than its colour per se. If a cloud is becoming
thicker that indicates a lessening in the chance of a trend reversal
in the period ahead. Thin sections in the cloud suggest times
when the market is likely to change trend, and at what price. The
clouds indicate price levels that need to be broken for a
significant turn, with the move accelerating as prices break
through the crossover point.
Elliott notes the caveats: support and resistance levels have to be
given “a little leeway”,“very often” the market “seems to fail
somewhere in the middle of the cloud”, and target dates should
be taken to mean “three or four days around the central day”.
A wide distance between the cloud and the current price is not
significant according to Elliott. In a fast-accelerating uptrend, she
advises watching the candles for signs of a crash, rather than
watching the cloud.
Using the moving averages
The 9- and 26-day moving averages are used conventionally to
give a signal on crossover, i.e. the system goes long when the
9-day crosses above 26-day, and reverses to short when the 9-day
crosses below 26-day.
The moving average periods were optimised (by manual
calculation) in the 1940s by the system’s original proponent and
remain the standard to this day – even though the Japanese
working week has shortened from 6 to 5 days, taking the monthly
average of days from 25.8 down to 21.5. The parameters have not
been adjusted to take account of this change, and there seems to
be no inclination to do so.
The 9- and 26-day moving averages are also used less conventionally,
as support and resistance levels (plotted concurrently, with no lead
or lag).Thus a rising market should find minor support at the 9-day
moving average and more support at the 26-day moving average –
a fall through the 26-day moving average “is the first warning signal
of a potential turn in trend”. Vice-versa in a falling market – the 9-day
is minor resistance and the 26-day a more important resistance.The
degree of slope of the 26-day indicates the degree of strength of the
trend. As Elliott notes, if the trend is flat or sideways, do not solely
rely on Ichimoku because “Ichimoku is a trend-following system”.
Using the clouds
If today’s candle is above the cloud, the trend is for higher prices.
So, if the whole of today’s price action has taken place above the
cloud, the top of the cloud is the first line of support and the
bottom of the cloud is the secondary support level. A market
close below the cloud is needed “before even beginning to
consider whether the trend has reversed” – here, again, Elliott
issues a caveat.“From experience, I have seen that these really do
often work, but one has to give them a little leeway.”There is no
hard and fast rule about how much “leeway” to give the market,
practitioners have to learn to gauge this themselves. If the market
falls through the first support and “fails somewhere in the middle
of the cloud... watch the shape of the daily candlesticks to see if
they give a reversal signal”. The thicker the cloud, the less likely it is
that prices will manage a sustained break through it; the colour of
the cloud (whether Senkou Span A or B is uppermost) is
irrelevant; thin sections of the cloud give advance notice (to
within three or four days around the central day) of when the
market is likely to change trend; and the crossover point (where
4 MARKET TECHNICIAN
the cloud changes colour) indicates “price levels that need to be
broken for a significant turn, with the move accelerating as prices
slice through the crossover point”.
By contrast, if the current price is far above the cloud that does
not in itself cause a presumption that the price move is
overstretched to unsustainable levels; rather the opposite, it
indicates that a powerful trend is in place. In such a situation,
Elliott would watch the daily candles closely for warning signs of
instability or reversal.
Using Chikou Span
Chikou Span is today’s closing price plotted 26 days earlier. If it is
above the candle of 26 days ago, then the market today is in a
bullish long-term phase. If it is below the candle of 26 days ago,
then the market today is in a bearish long-term phase. Also if it is
above the cloud of 26 days ago the market today is bullish and, if
it is below the cloud of 26 days ago, the market is bearish. It can
find suggestions of support and resistance from the candles, the
moving averages and the cloud.
Using the system as a whole
In a bull market, Chikou Span and the cloud provide solid
support, and there is little overhead resistance. In a bear market,
Chikou Span and the cloud are tough resistance and there is little
support.
Using further analysis: interlinked principles of waves,
price targets and timespan
Consolidation patterns can be divided into small waves and, on
breakout, the size of the consolidation will determine the size of
the breakout wave. Elliott describes the wave theory of Hosoda
(‘Ichimoku Sanjin’) and Sasaki, and discusses their differences
from Western wave counts. Sasaki’s long-term counts can be of
unlimited number, but she concludes:
“Personally, I do not feel these are true wave counts, as Westerners
understand them. I think Sasaki is merely marking intermediate
highs and lows in some way so that these can be pinpointed
clearly, prior to further analysis and classification into the different
pattern types.
Elliott is dismissive of the Ichimoku price target technique, finding
it too fiddly and short-term.
Elliott also describes Ichimoku timespan principle, in which
approximate compounds of 9 days give the series 9, 17, 26, 33,
42, 65, 76, 129, 172, 257. Counted ahead from an important high
or low, these timespan numbers are used to project how many
days ahead an interim high or low is likely to occur.“The more
counts that end at, or close to, the same day in the future, the
more likely that that day will see a trend end and reverse.
Again, all these numbers were discovered through trial and
error...” Elliott notes the formidable caveats: the need to allow a
day or two either side of each number and the fact that there
can be gaps in the count. She feels, and I would agree, that
“there are simply too many potential turning dates to cope
with.” [I would extend this criticism to areas of Western
technical analysis.] She concludes that in looking for turning
points “it is the cloud itself rather than the wave counts or price
targets that are the basis of my view; if and when the two
coincide the likelihood increases”.
Issue 60 – December 2007
In very strongly trending markets Elliott does not use wave
counts nor most price targets, nor the Relative Strength Index
(RSI), but she would be cognisant of time targets. In sideways
markets she would not use moving averages nor the Ichimoku
cloud.
Chapter 5 usefully puts the whole technique together in a set of
case studies.
Chapter 6 introduces the application of options to Ichimoku time
and price analysis. Buy options on a daily or weekly close through
key levels such as the cloud and be ready to sell out an option
which has reached its price target sooner than expected in order
to recoup some time premium. Grant options whose strikes are
just beyond pattern objectives or big clouds. Elliott is strong on
options, and this chapter is recommended reading for its
examples of options strategies at least as much as for its
application of Ichimoku techniques.
Written in a straightforward and conversational style, Nicole Elliott
has done us a good service in promulgating Ichimoku Kinko. It is
essentially an empirical study and my only disappointment was
the scope of the book did not extend to some rationalisation of
the technique together with back-testing of results and
probabilities of success. It is, however, likely to trigger further
study, perhaps from a more academic perspective.
Being generally little known, at least among Western investors,
Ichimoku Kinko adds a new dimension to candle stick charts. As a
keen proponent of candle charts, I must confess that I have not, as
yet, developed the same rapport with clouds. But who knows?
Perhaps armed with Elliott’s very useful book, I will come to see
that, yes, every cloud does indeed have a silver lining.
Michael Feeny was for 15 years Chief Economist and Market Analyst
at Sumitomo Mitsui Banking Corporation.

Ichimoku Kinko – Some issues to resolve:

True range, language, curve-fitting
Ichimoku is an interesting concept but there seem to me to be some issues which remain to be resolved, even after Nicole Elliott’s
excellent exposition of the technique.

Candles are constructed using the opening price and subsequent high-low, and therefore in Ichimoku the true range is not used to
calculate the day’s mid-point. This issue would seem to need elucidation.

I would take issue with Elliott in the matter of language. She uses all the Japanese terms, whereas I would contend that for
international use several of these have English equivalents that are fully satisfactory and are already common parlance. In the
fullness of time we will see how the language issue resolves itself. In the meantime, I offer the following suggestions as to best
practice in the international sphere:

– there is no need to use the terms koten or gyakuten, as the English terms bull and bear are completely established.

– there is not much need for the 9-day and 26-day moving averages to be expressed in Japanese (Tenkan-sen and Kijun-sen) as the
English names are commonplace. But I would concede that they might have some utility because they refer specifically to the
moving average of the mid-points of each day’s range. I think the jury is out on this one; personally I would use the English
names.

– there is no need for a Japanese word for cloud: English fully suffices.

– but I would recommend international best practice to retain and adopt the other Japanese terms, namely:
Chikou Span
Senkou Span A
Senkou Span B
because there is no English name which fully includes their notion of time shift, so it is convenient to adopt the ready-made
Japanese terms for brevity and conciseness. In repeated use, maybe the word Span could be omitted in each case, just for
abbreviation, so the terms used would be Senkou A and Senkou B.

The name Ichimoku Kinko itself has caught on in the West, though not the full form Ichimoku Kinko Hyo. Hyo simply means chart and
so this Japanese term does not need to be used, as the English term suffices. In repeated use, the single word Ichimoku would seem a
fair enough abbreviation.

Academic rigour is an issue. The fact that the parameters have not been systematically tested adds further fuel to the long-standing
debate in academic and practitioner circles on the merits or otherwise of re-optimisation and to the wider issue of curve-fitting in
general. The argument is not settled. The debate continues. Results are not conclusive, and conflict. In the absence of definitive
quantification we may perhaps allow that model parametisation appropriate for econometrics may differ from that appropriate for
the practical exigencies of technical analysis. Econometric models seek parsimonious explanatory variables, whereas technical
analysis seeks an abundance of forecasting variables, even at the risk of curve-fitting (on the basis that reputations can be built on
even the short run of success that curve-fitting can on occasion provide).
M. Feeny

Issue 60 – December 2007 MARKET TECHNICIAN 5

 Systematic trading: it is more about risk than
you may imagine…
Systematic trading is one of the oldest hedge fund strategies, born
at the beginning of the 1970s, when the first computers became
available to satisfy the desire to study historical data using statistical
tools.The scarcity of data and computational power kept these
methodologies hidden for many years, until the 1990s, when the
Windows revolution made data, software and computational power
available to both professionals and private investors.
In essence,“systematic trading” is an asset management method,
based on time series analysis, aimed at identifying and exploiting
repetitive price behaviour which cannot be considered as random
from a statistical perspective. Systematic strategies can be
directional or relative-value: meaning that one can buy or sell an
asset outright or buy one asset versus another(s) to exploit the
difference in relative performance between the two instruments.
One simple example of a directional system might be the
application of a slow and fast moving average crossover method to
identify long or short directional trades in an individual stock. A
simple example of a relative-value system might be the application
of relative strength analysis to identify long and short positions
amongst stocks in the same sector of a stock market.
Analytical methods used to develop systematic strategies can derive
from fundamental, technical or quantitative approaches. Quite
often, the most sophisticated models try to blend different analytical
methods in order to obtain a more effective investment process.
Similarly, while systematic strategies may trade one asset class only,
for example equities, they can also be applied across a more
diversified universe of instruments ranging from interest rates,
foreign exchange, bonds and commodities. Furthermore, many
systematic approaches also seek to diversify across geographical
regions and even time frames.
Most importantly, systematic trading is as much about risk
management and instrument selection as it is about designing a
sensible and profitable strategy. For example, there is a huge
amount of literature published on moving average calculation and
optimisation methods, while risk management issues and
instrument selection are often overlooked.
Instrument selection
Harry M. Markowitz and his CAPM showed that positions which are
highly positively correlated will increase the overall portfolio risk;
this is why most professional systematic traders attempt to trade a
high number of uncorrelated markets, ranging from soft
commodities to equities and grains, from energy and foreign
exchange to short term interest rates.They are looking for lowly
correlated instruments to aid their portfolio diversification to which
they apply their trading models. As a result, a multi-asset class
portfolio is likely to be more efficient than one focused exclusively
on one area. However, even the exercise of diversification is not easy.
Correlations are not stable at all, they are much more volatile than
returns and volatility. In particular market conditions – such as a
flight to quality - correlations will jump, making the portfolio risk
measures increase dramatically and unpredictably. Most
importantly, the more a portfolio composition is based on the
6 MARKET TECHNICIAN
By Francesco Cavasino
correlation estimates, as in relative value trading, the more the risk
will be likely to jump when a sudden correlation breakdown
appears. So many times, from a long term correlation point of view, a
portfolio may seem to be well diversified. However, when an
unexpected piece of information reaches the market, all positions
may suddenly become correlated and portfolio risk increases.
Frequently this is created by the positioning of investors, which may
have one macro view expressed in many different ways. For
instance, in the recent past, short volatility, long equities and long
Latin American currencies, would all have reflected the same
positive view on the global economy.These positions have since
become even more correlated than that which a long term
correlation matrix would suggest. Should an unexpected
announcement, such as a weak payroll number, reach the market, it
is very possible that traders of different asset classes will react in a
similar way, pushing up the absolute value of correlations and
portfolio risk will jump. Suddenly we could see the realization of
significant profits or losses, which is sometimes referred to as “fat-
tails” or Kurtosis.
One way to anticipate and mitigate these issues is to analyse the
data series of the instruments you would like to trade under specific
market conditions.What many do is to evaluate how correlations
changed in a peculiar historical period, for instance in a financial
crisis. In this way, they are attempting to see how balanced their
portfolios would have been in those specific market conditions.This
is definitely a sensible way to evaluate the potential kurtosis of the
portfolio. On the other hand, any such analysis is still only based on
what happened in that particular period. As a result, such historical
simulation is fraught with danger as subsequent shocks could be
different, with unexpected correlation changes.
It is very difficult to predict the shape of future financial market
dislocations but at least one can do one’s homework on past events.
Usually the best instruments to combine in a portfolio are those that
have no direct economic relationship. For instance, the economic
relationship between AUD/JPY and NY Coffee futures could be
reasonably expected to be quite loose and should not be variable in
case of a financial turmoil. Unfortunately with the globalization of
finance it is becoming increasingly difficult to find non-correlated
instruments.That said, introducing correlation stability analysis into
an investment process, while selecting instruments to trade, will
help in obtaining a more theoretically efficient portfolio and
generate a better understanding of overall risk in times of both
normal and abnormal trading conditions.
Risk allocation
After having gone through the process of instrument selection,
strategy design and testing, several statistical tests such as stress-
testing, scenario and what-if analysis should be constructed in order
to estimate the potential future losses and to calibrate risk according
to the given mandate.
In this business, the correct determination of the targeted risk is a
step which is at least as important as strategy design. It is industry
practice to express the sizing as a function of capital and be aware
Issue 60 – December 2007
of the exposure limits.These limits can be expressed as gross and
net exposures, beta exposure, leverage and so on.This way of
looking at the portfolio is partially misleading from a risk
perspective: being invested in Tesco for the 5% of the capital under
management does not tell us much about the risk.The only thing
measured is the exposure towards the stock, not its riskiness. Any
sizing done as a function of the capital managed is calibrating risk
only as a by-product. Sizing should be done as a function of the
fluctuations of the asset traded i.e. its volatility.
Investing 5% of capital in Vodafone has a different risk compared to
5% invested in BHP Billiton: the yearly volatility of Vodafone may
well be around 25% while BHP’s could be as high as 40%.Without
considering the impact of correlations, having positions rescaled as
a function of volatility should generate a more diversified and
efficient portfolio.
The exercise of rescaling positions as a function of volatility can be
done with a variety of indicators: from the standard deviation of
historical returns to Average True Range (ATR) or by computing the
Value at Risk or VaR, which measures the maximum loss that could
be incurred in a set period of time at a certain level of probability. At
a single position level, for the sake of accuracy ATR is probably the
most effective measure because it also considers the intraday
swings while the others consider just close-to-close variations.
By calibrating the size as a function of the instrument variability, the
strategy will continuously be adjusting its size maintaining the
targeted risk. In this way one can manage markets’ volatility, without
being driven by it.
Targeting the correct amount of risk, given the risk limits associated
to the mandate is critical. Let’s say there are two traders: Lewis and
Fernando, running the same system called “Silver Arrow” on the
same instruments and asset classes, with the same amount of
capital and trading limits, over the same period. Can Lewis end up
hitting his portfolio stop-loss while Fernando generates a profit by
year end? Certainly he can. Lewis could target an average risk level
too high for the given mandate and end up being stopped out
before the realisation of the following run up. Meanwhile the other
trader by keeping a lower targeted risk, does not trigger the stop
loss and still has the chance to recover the losses generating a
positive return for the period.
So, even with an overall profitable strategy, a trader can trigger his
stop loss if he is targeting a risk which is too high, given the
mandate. In a way, risk budgeting is more important than the
strategy itself and the above mentioned example demonstrates the
implications of being too greedy.
At portfolio level, risk metrics are expressed in a variety of ways:
stop loss year-to-date, realised volatility and Value at Risk (VaR)
are among the most common. Applied to a directional system,
VaR and realised volatility can help determine the actual risk of
the portfolio in normal market conditions. Financial literature
describes many ways to compute these statistics – especially VaR -
each one based on some underlying statistical assumptions. One
of the most interesting VaR calculations is called “non-parametric”
or “historical”: it just computes the value associated to the n-th
percentile of the historical returns distribution of a portfolio with
no underlying assumption on the shape of the distribution. This
allows the analyst to capture the overall instrument’s volatility,
correlations and even the sudden changes in correlations which
generate the fat-tails across the analyzed period. Computed on at
least a couple of years of daily data, it should provide a fairly
Issue 60 – December 2007
reliable measure of risk and its implementation is also quite
straightforward.
Realised annualised volatility is the standard deviation of the
realised daily returns of a portfolio. It is a measure of the realised risk
of the book and it is an industry standard. For directional portfolios it
is a useful tool to determine the average risk taken by the manager.
Realised annualised volatility and parametric VaR are statistically
linked together. In a nutshell, under the assumptions of normality,
stationarity of volatilities and correlations and independency of
portfolio returns, an annualised volatility of 16.00% should
correspond to a daily standard deviation of 1.00% and an average
daily VaR @ 97.5% probability of 2.00% meaning that a book that
has 16% annualised volatility should not lose more than 2% in one
day at 97.5% probability.
By taking advantage of the statistics associated with the normal
distribution, we also know that events of +/- 2 standard deviations
will happen over time with a probability of 2.5%. Assuming an
Information Ratio1 of 1.002, a volatility of 16% and the normality and
independency of returns assumptions, a negative annual return
should roughly be realised one year out of seven and a -16% annual
return or more will be realised one year out of 40. Assuming we
have a stop loss year to date of -16% with an information ratio of
1.00 and targeting a volatility of 16%, statistical simulations
demonstrate the worse drawdowns could be in the region of 30%
i.e. -2 standard deviations.
Given the statistics that many strategies generate when back tested,
these numbers sound much more worrying… or are they just more
realistic than our over-optimistic expectations? Especially when
considering that the hypothesis of normality, stationarity and
independency are quite simplistic and not exactly the most
conservative ones!
Results can be exciting in backtesting but it is very difficult to move
away from these figures.Too often, system designers focus their
efforts on the historical results of their system without realising that
those performance analytics are just a reflection of a limited data
sample drawn from an unknown population.They should be
followed as an indication – rather like a map in a treasure hunt, not
as the output of a precise navigation system.
In order to obtain a more realistic picture of risk, some stress testing
should also be applied. Scenario and what-if analysis will help in
formulating estimates for market conditions which did not happen
in the historical dataset but that could still occur in the future.
However, even stress test design is full of perils and designing a
stress test is more of an art than a science. In essence it is about
designing a market scenario which might never happen or may
occur on a handful of occasions but which is also plausible from an
economic point of view. One can increase volatilities, change
correlations, create trends, manipulate the data in a million ways but
defining where lies the fine line between the “possible” and the
science fiction is not easy and it is completely arbitrary.
Alternatively, it is also possible to let the computer randomly design
a huge number of scenarios and then look at the aggregate results.
In this case some of the outliers will be truly extreme and should be
considered “cum grano salis”. However, even if some of those
scenarios are meaningless, they will give a deeper understanding of
the risks the portfolio will be running.
Continued on page 11
MARKET TECHNICIAN 7
 System building and back testing - opportunities,
methods and caveats
Learning the mechanics and logic behind trading systems is
invaluable in understanding how technical analysis based
indicators function. You may never use the systems that you have
built and they may not prove to be good enough, but you can still
use the knowledge to provide structure to your existing trading
and technical methods. Whilst optimization in the wrong hands
can be a time bomb, the correct use of it and its application via
three dimensional graphics is a vital tool in understanding how
technical indicators can help your trading.
The development of trading models and systems is an area rich in
exaggeration. Building robust, profitable trading models isn’t
impossible but it’s not trivial either. Therefore, having a clear plan
of approach and the correct structure is vital to success.
Firstly, it is extremely difficult to build a single trading model that
is all things to all markets and conditions even in a single market.
This need not matter in the modern age as execution speeds,
costs and logistics of deploying multiple models across multiple
markets in multiple timeframes are acceptable. Therefore, instead
of looking for a single silver bullet, be prepared to accept a fistful
of lead ones.
Diversification is the key and can be broken down into three
methods:
1. By timeframe: applying the same logic across multiple
timeframes
2. By parameter : combining different parameter sets for the
same model e.g. the 5 period moving average crosses beyond
the 10 period, the 15 period crosses beyond the 25 and the 30
crosses beyond the 45. They will enter at different moments in
a trend and a short lived trend will create counter balances.
3. By model: combining models based upon methods that have
non or lowly correlated returns. This translates to trend
following systems, sideways systems, and if possible a contra
trend system.
Figure 1 shows two systems, the top one being trend following
and the bottom one a sideways. The green shows the relative P*L
between the two systems and you can see that when the trend
one loses the sideways one wins. Highlighting how simplistic
Figure 1:
8 MARKET TECHNICIAN
By Shaun Downey
systems can be – when placed as part of a portfolio – is the
sideways system. The entry is just the 5 period Stochastic crossing
up or down provided that the Adx is falling, which indicates a lack
of trend. The sensitive nature of the Stochastic means that it acts
as a stop loss, the only other money management being a profit
target. This is set at a relatively high percentage so that each time
a new trend begins both the trend following and sideways
systems are active.
The next key area in building systems in the element of time and
timing. Several questions can be asked.
● What is the time of day that entry is occurring?
● Based on that should risk and expectation be adjusted?
● Where are you entering in the trend?
● What is your risk profile over the first 5 bars?
● How long should your trade last?
● Did losers turn into winners?
Taking the first two questions first. Figure 2 shows a study called
Volatility Time Bands. These compute the normalized range on
any time frame chart and then take a user defined average for
that time of day. When the bar opens it then plots 1 2 and 3
standard deviations around that opening price, which provides a
fixed view of risk and expectation within the early part of the
trade’s history. As can be seen on the chart, the bands concertina
up and down depending on the time of day. This is critical
information that allows not only a firm understanding of what to
expect but, depending on the time of day, allows for changes in
volume as absolute risk adjusts. The importance of this when
system building (or for that matter prop trading) should not be
underestimated.
Figure 2: Point A is Australia, Point B and C Japan’s and London’s
opening, whilst D and E are when American statistics are released.
The next four questions are answered by using the Cqg Entry Signal
Evaluator.This application allows the trader to input their entry code
and then assess its performance 60 bars into the future.There is no
money management so it provides both the best and worst case
scenario.Various analytical tools and graphics are included in the
results but one of the key ones is the summary of the profit curve
(Figure 3). Running a basic system test may say that the system is
poor when in fact it is simply that the timing of entry is poor. Entry
Issue 60 – December 2007
Signal Evaluator will tell you whether your timing of entry is correct.
Where you are entering in the trend is determined by where the low
point occurs and peak point before the first reaction. Exhaustive and
extensive years of testing reveals that normalized trends peak at 15
to 20 bars from inception before a correction occurs.Therefore,
understanding where your peak point is, tells you how far the trend
must have been going before your system recognized that fact.
What will be the opening position size of your next trade? Nearly
all systems will experience a period of at least 10 losses in a row
and these occurrences normally are associated with the longest
drawdown durations and greatest damage. Therefore, creating
code that lowers volume after each loss and then returns to the
original volume after a winning trade will often make a huge
difference to the systems overall robustness.

The next volume based consideration is pyramiding. Most

Figure 3:
When building trading models, a common error is to focus mainly
on entry signals. But exit methodology and sound money
management will have far more effect on individual model
profitability, while careful portfolio selection (market, trading model
or timeframe) can underpin a profitable long term strategy.
A generic exit code should ideally have the following:
It must be dynamic to volatility or range and timeframe especially
on commodities, bonds and indices.
FX can rely on tick based concepts.
Percentage money management over initial period or sensitive
technical exit based on the time of day of entry.
From there a wider money management stop.
High level low level disaster exit.
Profit target based on percentage (not FX) and linked to the time
of day as the trade develops.
pyramiding techniques increase profitability but at the expense
of stability. This is usually due to the fact that most pyramiding
techniques enter the trade based on the close. Not surprisingly, in
a downtrend closes tend to be near the lows and in up trends
near the highs. This means that risk increases. One way around
this is to use a more sophisticated technique that involves
identifying levels that are intraday corrections to the trend. Range
Deviation Pivots are based on the day’s opening and therefore
provide a fixed historical reference to both the length and
directional bias. They have an in built trend identifier which
means that in contrast to the Volatility Time Bands they are not
symmetrical. The Deviation Pivots are closer together and nearer
the opening above the market when the trend is identified as
down and vice versa when the trend is up. This means that the
pyramid can be placed as a limit order at the 1st and 2nd
deviation. In all the systems I have ever added this method to,
profits always increase and in the vast majority of cases it has a
limited impact on robustness - and can actually improve it.
Figures 4 and 5 show the difference between using the pyramids
and not on a Cqg customers trend following system.
Figure 4:

Time. The trade can only last so long before it must be exited.
(This concept and reason for its importance are discussed later).

A variable look back test so market timing is determined.

Figure 5:
All of the concepts above reflect money management. When
using technical analysis based code, the rules are different. A
common error is not building an exit code of sufficient
robustness. This is an easy trap to fall into as the code only creates
an exit if there has been an entry. This means there may have
been many times when an exit was true but is not shown,
because some other rule beats it to it, or there simply wasn’t a
trade that needed to be exited. Therefore the basis on any exit
must be tested as though it is an entry. If it stands up to the rigors
of the Entry Signal Evaluator then not only is the code valid, it can
also potentially form the basis of a contra trend system.

The time of day that a trade is entered can allow for moments of
increased volume but there are other volume based
considerations.

Issue 60 – December 2007 MARKET TECHNICIAN 9

 Common traps and pitfalls include curve fitting, optimization
abuse, sequences, poor data, and synchronization.The first two are
by far the most common as the latter three have become less of an
issue as technology and electronic data have ironed out these
problems. Curve fitting is a natural human tendency that involves
looking at charts and then creating code that captures the major
trends without any one off disasters.This is especially true if one is
trying to build systems that are all things to all market conditions. If
your entry code has more than six rules and you find yourself
adding code in order to stop one off large losses, or a sequence of
losses, you are probably falling into this trap.
Whilst curve fitting is delusional and means that it is highly
unlikely that future results will match the historical ones,
optimization abuse is a one way ticket to oblivion. Markets
continually evolve and change, sometimes drastically such as
crude oil, so building systems or money management that use
what was the best combination in the past, is a sure fire way of
guaranteeing that they will not be the best combination in the
future. This is especially true in individual stocks as the value can
change dramatically over time, in contrast to futures and FX
which tend to be more mean reverting. Highlighting the folly of
balancing your system on a pin is the statistical fact that if you
took the most recent 100 trades and then the next 100 trades
followed the same buy sell and profit sequence it will have a 1 in
approximately 11 billion chance of happening.
However, in the correct hands the use of optimization is an integral
part of understanding the driving force of any system, and just as
importantly provides a true guide to the robustness of the system
itself.This is done via the use of three dimensional graphics.
Nearly all systems whatever the number of rules and exits
normally have a few key components that are the key to the
system. Optimizing all the variables associated with the system
reveals what those keys are. This information is essential when the
system goes live as, if it does not live up to expectations, you must
know which areas of the system you must concentrate your
efforts. If you don’t know this information you must re-analyze
everything from scratch.
The building blocks of optimization are as follows.
The first test is on look back (entry timing point) and pyramid.
The second optimization takes just 2 variables and is a short test.
Third test has narrowed down ranges of first test and a 3rd
variable is added.
This continues until the final variable
Lastly a large test is done of all the variables at once, remembering
that this inevitably means it is creating a compromise solution.
This whole process is repeated on an out of sample basis and
compared. Out of sample tests are usually worse than the first test
(due to subconscious curve fitting), but if they are better this is a
good sign.
The process is repeated once again with buys and sells separately.
Uptrends and downtrends do not behave in a symmetrical
fashion so consideration should be given to differences between
buy and sell signals particularly from a time based point of view.
It is crucial that when analyzing any two variables in 3-d that a
change is made in one of the other variables to assess its impact.
Figure 6 shows an ideal graphic where by any combination of
variables provides a relatively flat profitable outcome. This means
10 MARKET TECHNICIAN
there is a far better chance that the system will work in the future.
Sudden peaks and troughs are a recipe for disaster as only a small
change in the underlying markets behaviour can cause a huge
difference in performance.
Figure 6:
Even if a model appears robust in out of sample testing, it may
still be overly dependent upon a particular sequence of trades.
Monte Carlo simulation can be used to test for this by reordering
the trades randomly, and also provides thresholds for best/worst
case scenarios. Minimum and maximum excursion analysis will
then tell you how much of any particular trend you are actually
capturing.
Whilst there are many statistics that can be placed on trading
systems the standard deviation of risk is one of the most
important. However for the statistics to make sense it is essential
that various building blocks are in place in regards to how a trade
is money managed.
These are stop loss, profit target, and time. The first two seem
obvious but the last one is an often overlooked component. By
creating a fixed loss and fixed profit we are putting boundaries to
what any one trade can produce. However, by placing a limit of
time as well, we are creating a box or cube of expectation which
means that the standard deviation of risk has the opportunity to
provide a sound assessment of a system’s ability to reflect its
historical results. Most systems’ statistics are distorted by what I
call elephant trades. Curve fitting usually means that there are no
elephant losses and also means that there are some elephant
winners. These are often very unusual or one off events and the
longer the timeframe chart the more dangerous these trades are.
If a large win (usually an extended trend) only occurs once every
10 years, you may have to wait another 10 years or more for the
next one. Therefore, it is essential that any trend following system
has a limit in time of how long the trade lasts. It then must have
sufficient sophistication to identify that the trend is continuing
and begin a new trend following trade with the same time based
exit. The Pyramid system shown earlier utilises this concept. By
doing this it means that if an extended trend does occur you are
capturing the majority of it by a series of trades rather than one
huge one. This means that the standard deviation of risk statistic
(and all the other stats) is not distorted by one off events.
This time based concept has two approaches. The first is a simple
limit in time to how long the trade can last. As mentioned earlier,
extensive years of testing using the Entry Signal Evaluator reveal
that the first part of a trend (excluding stocks) typically lasts 15 to
20 bars, whatever the timeframe. The key is whether once the
correction has ended the trend restarts. This means that in order
Issue 60 – December 2007
to capture a two tier trend the time based exit should either be
20 or 40 bars.
The second time based exit is more sophisticated and adjusts
automatically depending on how long the trade has lasted. Most
system builders and systems themselves have some sort of
trailing stop. Whilst there is nothing inherently wrong with this
concept, what it guarantees is that any exit is normally a
considerable distance from the absolute peak of the trend
whatever the level of sensitivity. The parabolic is a sound and
consistent trailing stop method if used with the correct variables
and has an in built acceleration based on how long the trend has
lasted. Whilst the market will eventually catch the parabolic up
and create an exit, it makes far more sense to take this concept
and reverse the logic. Taking an uptrend as an example, as the
trade develops a parabolic based theory starts above the market
and drifts downwards as the trend develops and accelerates
towards the current price. If built correctly this means those
profits are limit orders and are far more likely to be exits nearer to
the top of the trend rather that allowing the market to retrace
significantly. This theory can be evolved still further by looking at
concepts of average true range in relationship to length of trend,
enabling the creation of exits that are based on expansion of
range that are adjusted based on the number of bars since the
trade was initiated. These can also be built on a multitude of
levels so that a ratio can be created that links trade length with
that expansion. An example would be that the trend is now more
than 20 bars since inception and price has reached two times its
average true range of the long time average of range.
Systematic trading: it is more about risk than you
may imagine… Continued from page 7
Conclusions
This brief discussion is aimed at showing that portfolio composition
and risk analysis play a critical part in systematic trading
development.They are far more important than defining the optimal
length of the RSI or the most effective method of calculating the
moving average. Once the mandate and trading limits are defined
and the Information Ratio estimated through the strategy and the
time series, targeting the “right level of risk” becomes critical, just as in
the Fernando and Lewis example.
There are very few things we can control in trading - as in life
generally. It is not possible to control the profitability of the strategy;
Issue 60 – December 2007
If wanting to take this concept still further and add another level
of sophistication, we can return to the time of day that the trade
finds itself. Using the Volatility Time Bands we already have
computed the limit of range within any particular timeframe for
that time of day and, if this is linked to the overall length of trend
as price hits the 3rd deviation, powerful exit points emerge. So
powerful that they have the ability to be the basis of contra trend
trades in the same fashion as the Rsi divergence based patterns
mentioned earlier. The key difference is the fact that the Volatility
Time based concepts are infinitely more common (as they use
short timeframe charts) and therefore are consistently part of the
traders and system builder’s armoury.
The power of such concepts is apparent when looking at two
wildly different markets using the same system. One is the
semaphoric Euribor and the other is the Dollar Swiss. Figure 7
shows the statistics of both markets. Superficiality the Dollar
Swiss looks the better bet as profits are 196%. However, closer
scrutiny shows that drawdown is 15% and the standard deviation
of risk if above 2. You make lots of money but you will be in for
wild ride. The Euribor stats are far more reassuring. Drawdown is
only 2% and was actually below 1 for the vast majority of the test
period. More important is the fact that the standard deviation of
risk is very low at 0.2%, whilst still returning 20%.
Shaun Downey is Technical Analyst at Cqg and Writer of Technical
commentaries at www.Ransquawk.com. He has recently written a
book Trading Time (www.trading-time.com)
one can only design it according to a given set of parameters,
estimate the profitability on the historical data at disposal and run it.
Furthermore, it is not possible to control volatilities and correlations
either; one can only estimate them ex-post and react to their sudden
changes. However, what one can do is to size the bets using historical
data, quantitative tools and some common sense, adjust sizing
according to volatility changes and evaluate by how much one could
potentially go under water. …And believe me, that in itself is a fairly
daunting task.
1 Information Ratio = Average Annual Return/ Annualised Volatility
2 In real life, for a directional systematic diversified portfolio an
Information Ratio of 1.00 is an excellent result.
MARKET TECHNICIAN 11
 Technical trading systems
The idea of system testing a trading idea is not a new one, but
this subject has gown so rapidly in recent times that it has
inherited a host of different names. You may see it referred to as
algorithmic trading, automated trading, backtesting, black boxes,
program trading, quant models or portfolio testing. Here we will
refer to it as ‘system testing.’
We define system testing as entering and exiting trades purely
based on specific criteria. This is an objective system generating a
series of buy and sell trades without any subjective input. You
may not necessarily ‘trade’ a system but instead use the idea of
testing and optimising one as an aid to trading. There is a good
deal of evidence to suggest that this is one of the real values of
system testing.
Does it work?
One thing that recent history does tell us, is that when a system
fails it can fail quite spectacularly. Recent failures as a result of the
sub prime crisis were previously estimated to be 1 in a million
year events with moves of over 20 stand deviations occurring.
These moves in price were considered a virtual impossibility and
yet this summer they did suddenly occur. This poses the bigger
question – especially for technicians - “is subjective analysis dead?”
Where to start
Probably the most obvious place to start with system testing is to
run backtests on technical analysis indicators and see what the
results would be from taking the ‘buy’ and ‘sell’ signals as set out
in textbooks. This could be an idea as simple as trading on the
crossovers of 60 and 200 day moving average as we see below.
One of the key elements of system testing is the equity line,
shown here in the bottom window. This is a line which measures
Chart 1
12 MARKET TECHNICIAN
By David Linton CFTe, MSTA
how well your system is performing. The chart above is a long
only system that buys when there is a cross of the 60-day
exponential moving average rising up through the 200-day EMA
and sells when it falls back down through 200-day moving
average leaving the trader out of the market until the next buy
signal. The sideways move in the equity line is the point where we
are out of the market between a sell and a buy. The number one
thing you should always be looking for at a glance is ‘am I better
off than the underlying instrument on the equity line?’ here we
see that the equity line is much higher than the year 2000 high
while the Footsie has not made a new high, showing the benefit
of staying out of the market based on the signals.
System testing is made possible by a scripting language and the
code for this sort of test is very straight forward. For instance the
code for system testing how well an RSI works would look like this:
NAME RSI System
‘Allows you to System Test the RSI breaking levels
‘To Optimise the Periods and levels for the best results,
‘use Optimise System Test - See below for changing to a
Long/Short strategy
Parameter “RSI Period” #PERIOD=14
Parameter “Buy Level” #BL=30
Parameter “Sell Level” #SL=70
INDICATORTYPE CHART
DRAWLEVEL LINE,#BL,RGB(0,0,255)
DRAWLEVEL LINE,#SL,RGB(0,0,255)
SHOWEQUITYCURVE
FOR #CURDATE=#PERIOD to #LASTDATE
IF HASX(RSI(#PERIOD),#BL,UP)
Issue 60 – December 2007
‘Remove the ‘ in front of COVER (and ‘SHORT) for long/short trading
‘COVER
BUY
ELSEIF HASX(RSI(#PERIOD),#SL,DOWN)
SELL
‘Remove the ‘ in front of SHORT for long/short trading
‘SHORT
ENDIF
@PLOT=RSI(#PERIOD)
NEXT
The key elements of this short test program start with some
comments that allow description of what the system does. These
can also be used to comment out commands with a ‘. Then you
set some parameters so, for instance, in this example the RSI
period and the levels at which to buy and sell. Setting them as
parameters makes them easy to change on the fly and allows you
to optimise these values for the best profit. Then you set how you
want the lines to look on your chart when you have run the test.
For the script to be fully flexible, iterative calculations need to be
run through the price history and this is done by way of a loop
(here FOR NEXT) and within this loop we can ask the questions
we want. If the RSI crosses up through 30, buy, and if it falls
Chart 2
through 70, sell, and we plot the result. You could write the code
for an RSI yourself (by the way RSI is actually incorrectly calculated
on most systems) but in this case you can simply call a pre-
written RSI function using the RSI command.
Rather than writing all this code from scratch most traders prefer
to draw it from a custom indicator library which contains all the
standard technical analysis indicators as well as ones that have
been published in the public domain. Editing and reverse
engineering the code behind these can also be easier than
starting with a blank sheet.
System testing can be as complex as you like and once you see
the signals of your system in the context of your chart you may
then decide to add further conditions to filter out less good
Issue 60 – December 2007
signals. For instance you may be trading the cross of an
exponential average (signal line) on a momentum line but decide
you only want buy signals generated if the momentum is less
than zero. The sky is really the limit with the flexibility of being
able to code anything yourself.
Optimisation
One of the most valuable aspects of system testing is that you
can optimise the parameters you set to find the values that have
produced the best profits. This lets you question the conventional
wisdom surrounding the various technical analysis tools we use.
For instance are 30 and 70 the best levels to read an RSI? Which
periods produce the best results?
Another aspect that optimisation of system tests allows is to pitch
different buy and sell criteria against each other for the best
trading results. From this we learn that more often than not, the
best results are obtained where a criteria or technique that gets
you into a trade is different from the one that gets you out. And
running exhaustive tests we find that the optimised stop-loss is
frequently one of the best tools for exiting trades with the best
overall profit results. Here we see how trading an optimised RSI
for entry and an optimised stop-loss looks on the chart.
Recently for those trading the sterling/dollar rate (chart 2), the
19-day RSI rising through 40-day has been the best entry with a
1.9% stop-loss providing the best exit. It is also interesting to note
that the stop-loss is a guaranteed exit as it works on the price
while the RSI may not reach 70 to give us a sell signal as we see in
the last trade.
Apart from developing your very own system to test and trade,
you may do one of the following:
1. System test some basic technical analysis indicators
2. System test some of your own scans
3. System test things that you notice occurring on charts
4. System test indicators you see published.
MARKET TECHNICIAN 13
 These are all very straight forward to do and may ultimately
provide you with better value than attempting to develop the all
elusive ‘holy grail’ system.
Stop-loss as a system
We could look at a number of systems, but one simple system
that is quite simple is the ‘flip-flop’ stop-loss which swaps
between a long and short stop. By setting these values as
variables, we can optimise for the best stops to use for longs and
the best for short trades.
Chart 3 shows the equity line for the system on Euro/dollar with
the trades marked on.
Chart 3
So how does the flip-flop match up against more traditional
technical analysis indicators as a system to trade? This is one of
the real advantages of system testing. You can run tests to
compare techniques. Running some optimisations on various
technical analysis techniques as a Long:Short Strategy on 25
currency rates, we can see the results above.
This is by no means an exhaustive exercise and only a handful of
14 MARKET TECHNICIAN
indicators have been chosen. In the case of exponential moving
averages, the average periods were optimised between 5 and 34
thereby covering five Fibonacci numbers. The same range of
periods was used for RSI, directional movement and commodity
channel index using the textbook standard entry and exit levels
for flipping from long to short. In the case of Bollinger bands, the
standard deviation was kept constant and only the periods were
optimised for a cross back into the bands.
Conclusion
System testing has a value way beyond developing your own
trading system. It can be used to assess how well the indicators
you use work and what the best settings are for trading them.
One thing you realise when you run lots of different systems is
that many strategies do not work. Indeed, it is often tempting to
swap the buy and sell criteria around to turn a losing strategy into
a winning one. Perhaps the greatest value of system testing for
technical analysts is what it can tell us about the standard tools
that we use. Try it yourself!
David Linton is chief executive of Updata plc
Issue 60 – December 2007
Rediscovering Gann’s Law of Vibration
By James Smithson

Introduction “From my extensive investigations, studies and applied tests, I find

William D. Gann (1878 to 1955) was an outstanding technical that not only do the various stocks vibrate, but that the driving forces
analyst. He was also a prolific teacher of how to make speculation controlling the stocks are also in a state of vibration” (Ticker
a profitable profession, writing some seven books and producing interview).
two courses on trading the stock and commodity markets.
3. The overall energy/ vibration of a stock or commodity is
However, Gann's superlative skill was his ability to forecast
reflected in its price.
accurately the stock and commodity markets. His forecasting
method was based upon what he called the Law of Vibration. This “These vibratory forces can only be known by the movements they
paper seeks to rediscover Gann’s Law of Vibration. generate on the stocks and their values in the market” (Ticker
interview).
Gann’s great discovery of August 8th 1908
4. Financial markets essentially comprise a series of impulses
Almost a hundred years ago Gann made one of his most
that produce price movements with specific rates of vibration.
important discoveries, if not his most important discovery.
“Science teaches that an original impulse of any kind finally resolves
More specifically, as Gann recorded in his booklet entitled “Why
itself into periodic or rhythmical motion” (Ticker interview).
Money Is Lost On Commodities And Stocks And How To Make
Profits” (1954): 5. The price movement of a stock or commodity unfolds in a
coherent way. This is because stocks and commodities are
“1908 May 12th left Oklahoma City for New York City. August 8th
essentially centres of energies and these energies (or
made one of [the]greatest mathematical discoveries for predicting
vibrations) are controlled mathematically.
the trend of stocks and commodities. Started trading with a capital of
$300 and made $25,000. Started another account with $130 and “Stocks, like atoms, are really centres of energies. Therefore they are
made $12,000 in thirty days’ time”. controlled mathematically…. There is no chance in nature because
mathematical principles of the highest order lie at the foundation of
On August 8 1908 Gann was 30 years old. He was 76 years old in
all things” (Ticker interview).
1954 when he wrote the booklet “Why Money Is Lost On
Commodities and Stocks and How To Make Profits”. The discovery 6. When the overall vibration of a stock or commodity is in
must, therefore, have been of great significance for Gann to recall balance its price will maintain a constant rate of vibration (i.e.
the precise date 46 years later. prices will form a trend). Consequently this overall rate of
vibration (or trend line) can be precisely measured and future
In December 1909 (16 months after his important discovery)
prices forecast by means of the so-called Gann angles or Gann
Gann gave an interview to the “Ticker and Investment Digest”
fan lines (i.e. 1 x 1, 1 x 2, 1 x 4, 1 x 8 angles and their
magazine in which he revealed that he had developed a unique
subdivisions).
method of precisely forecasting the trend of stocks and
commodities, which was based upon what he called the Law Of “The power to determine the trend of the market is due to my
Vibration. Furthermore, the practical application of this technique knowledge of the characteristics of each individual stock and a
was producing very successful results. certain grouping of different stocks under their proper rates of
vibration. Stocks are like electrons, atoms and molecules, which hold
In the interview Gann made it clear that he would not provide a
persistently to their own individuality in response to the fundamental
detailed explanation of his Law Of Vibration (“Mr Gann has refused
Law Of Vibration…. After exhaustive researches and investigations of
to disclose his method at any price”, Ticker interview). However,
the known sciences, I discovered that the Law Of Vibration enabled
Gann was willing to provide a general description of his Law of
me to accurately determine the exact points to which stocks or
Vibration.
commodities should rise and fall within a given time. The working
out of this law determines the cause and predicts the effect long
The Principles of Gann’s Law of Vibration
before the Street is aware of either” (Ticker interview).
The principles of Gann’s Law Of Vibration, as discerned from his
interview of December 1909 to the “Ticker And Investment 7. These principles can be applied to forecast the trend of stocks
Digest”, are as follows: or commodities over multiple time frames. For example, a
minor impulse may produce a price movement with a specific
1. Stocks and commodities (and everything else on earth)
rate of vibration that lasts only a few hours. Alternatively, a
vibrate. Moreover, vibration provides a comprehensive
major impulse may produce a price movement with a specific
explanation of price movements in financial markets.
rate of vibration that lasts for a number of years (e.g. the rise
“Vibration is fundamental; nothing is exempt from this law; it is in the Dow Jones Industrial Average from 1921 to 1929).
universal, therefore applicable to every class of phenomena on the
“The law which I have applied will not only give these long cycles or
globe…. After years of patient study I have proven to my entire
swings, but the daily and even hourly movements of stocks” (Ticker
satisfaction, as well as demonstrated to others, that vibration explains
interview).
every possible phase and condition of the market” (Ticker interview).
8. It is thought that Gann believed the external energy/
2. Stocks and commodities vibrate in accordance with both their
vibration acting on a stock or commodity is subject to
own individual energy/ vibration (i.e. internal vibration) and
astrological influences (although he does not explicitly state
also in accordance with energy/ vibration transmitted
this in his Ticker interview).
through space (i.e. external vibration).

Issue 60 – December 2007 MARKET TECHNICIAN 15

 9. It could be these astrological influences to which Gann was
referring when he described market trends as acting in a way
that is analogous to radio waves; i.e. they have a specific
wavelength, they travel through space and they are received
by and influence those stocks and commodities that vibrate
with a resonant frequency.
“It is impossible here to give an adequate idea of the Law of Vibration
as I apply it to the markets. However, the layman may be able to
grasp some of the principles when I state that the Law of Vibration is
the fundamental law upon which wireless telegraphy, wireless
telephones and phonographs are based” (Ticker interview).
10. From time to time a stock or commodity will lose its
sensitivity (or receptivity) to certain influences (astrological or
otherwise). As a consequence it will become inert (i.e. its rate
of vibration will fall) and its price will typically enter a
downtrend.
“Stocks create their own field of action and power; power to attract
and repel, which principle explains why certain stocks at times lead
the market and ‘turn dead’ at other times” (Ticker interview).
Thus, if the assumption that astrology plays an important role in
Gann’s method of forecasting markets is correct, the key
technique in applying the Law of Vibration is to accurately
identify the major astrological influence driving a particular stock
or commodity. It is then necessary to identify the resultant rate of
vibration and to forecast how future astrological influences will
impact this rate of vibration.
“By my method I can determine the vibration of each stock and by
also taking certain time values into consideration I can in the
majority of cases tell exactly what the stock will do under given
conditions” (Ticker interview).
Taken together, these principles of the Law of Vibration constitute
a coherent theory of how financial markets work. Indeed, they
constitute a new paradigm. However, as with any new paradigm,
it challenges the conventional wisdom and therefore encounters
resistance from practitioners of the conventional wisdom.
“It appears to be a fact that Mr Gann has developed an entirely new
idea as to the principles governing stock market movements….We
have asked Mr Gann for an outline of his work and have secured some
remarkable evidence as to the results obtained therefrom.We submit
this in full recognition of the fact that in Wall Street a man with a new
idea, an idea which violates the traditions and encourages a scientific
view of the proposition, is not usually welcomed by the majority, for the
reason that he stimulates thought and research.These activities said
majority abhors” (Ticker interview).
The practical application of Gann’s Law of Vibration
We will now turn from an examination of the general principles of
the Law Of Vibration, as discerned from Gann’s interview to the
“Ticker And Investment Digest”, to an examination of the key
steps in its practical application. These key steps in the practical
application of Gann’s Law of Vibration are as follows.
● Identify the point in time that marks the start of an uptrend or
downtrend. This can be achieved by examining the daily,
weekly or monthly price chart of the stock or commodity.
● Identify the predominant astrological influence (or cycle)
driving the uptrend or downtrend. In order to achieve this it
will be necessary to examine previous cycles of the stock or
commodity in order to identify which particular astrological
influences have driven the stock or commodity in the past. In
this task it will be especially helpful to examine the all-time
16 MARKET TECHNICIAN
high and all-time low price of the stock or commodity
because at these price extremes the astrological influences
will typically be very strong or very weak, respectively. Thus,
under the Law of Vibration, a high price is caused by a high
rate of vibration, which in turn is caused by strongly positive
astrological influences (and vice versa).
● Identify the general rate of vibration of the uptrend or
downtrend. This can be achieved by placing the origin of the
Gann angles (i.e. 1 x 8, 1 x 4, 1 x 2, 1 x 1, 2 x 1, 4 x 1, 8 x 1… and
their subdivisions) or Gann fan lines at the starting point (in
time and price) of the uptrend or downtrend.
● Forecast the approximate date when the predominant
astrological influence (or cycle) that is driving the uptrend
(and was identified in point 2 above) will end. This can be
achieved by consulting an ephemeris and the astrological
chart of the start of the uptrend or downtrend.
● Forecast the future price when the uptrend or downtrend will
end. This can be achieved by identifying the intersection of
the general rate of vibration of the uptrend or downtrend
(point 3 above) and the forecast date that the uptrend or
downtrend will end (point 4 above).
● Monitor one’s forecast, which comprises all of the above
elements. In particular, note that short-term positive astrological
influences will increase the rate of vibration and temporarily
drive prices above the long-term rate of vibration (i.e. above
the long-term Gann angle identified in point 3 above).
Conversely, note that short-term negative astrological
influences will decrease the rate of vibration and temporarily
drive prices below the long-term rate of vibration (i.e. below the
long-term Gann angle). However, when these short-term
influences expire, stock or commodity prices will revert to their
long-term rate of vibration (i.e. the long-term Gann angle).
Examples of the practical application of Gann’s Law of
Vibration
Two examples of the practical application of Gann’s Law of
Vibration, which were provided in his interview to the “Ticker And
Investment Digest”, will now be examined.
A) September 1909 Wheat Futures Contract (see chart 1).
“One of the most astonishing calculations made by Mr Gann was
during last summer (1909) when he predicted that September wheat
would sell at $1.20. This meant that it must touch that figure before
the end of the month of September. At twelve o’clock, Chicago time,
on September 30th (the last day) the option was selling below $1.08
and it looked as though his prediction would not be fulfilled. Mr
Gann said,‘If it does not touch $1.20 by the close of the market it will
prove that there is something wrong with my whole method of
calculation. I do not care what the price is now, it must go there’. It is
common history that September wheat surprised the whole country
by selling at $1.20 and no higher in the very last hour of the trading,
closing at that figure” (Ticker interview).
i. Gann identified the start of the uptrend in the September
1909 wheat futures contract as a price of 94 cents on January
26 1909.
ii Gann identified the predominant astrological influences
driving this uptrend.
iii Gann identified the long-term rate of vibration of this uptrend,
which was 0.1053 cents per day (or 1 cent per 9.5 days).
iv Gann forecast that the predominant astrological influences
driving this uptrend would remain in force until at least the end
of this futures contract (i.e. until at least September 30 1909).
Issue 60 – December 2007
 Chart 1

v Gann forecast that at the end of the futures contract the price
Chart 2
would be $1.20. This was based on the starting point of the
uptrend (point i above), the long-term rate of vibration (point
iii above) and the contract’s expiry date of September 30
1909.
vi In monitoring his forecast, Gann observed that since the
beginning of the uptrend on January 26 1909 short-term
astrological influences had temporarily driven prices above
and below the long-term trend or rate of vibration. Gann also
observed that between July 21 and August 26 1909 stronger
short-term negative (or malefic) astrological influences had
driven prices down well below the long-term rate of vibration.
Moreover Gann observed that commencing August 26 1909
(i.e. the low point of 963/4 cents) these strongly negative
short-term influences started to expire and he forecast that
they would fully expire over the next month, when prices
would revert to their earlier long-term rate of vibration.
Importantly, Gann received corroboration of the low point in
August from the fact that a price of 963/4 cents on August 26 1909
equates to a rate of vibration of 0.0132 cents per day (based on
the starting point of 94 cents on January 26 1909). This rate of
vibration is one eighth of the long-term rate of vibration of 0.1053
cents per day. Another perspective is that on August 26 1909 the
long-term rate of vibration of this wheat futures contract had
halved three times. Thus from August 26 1909 Gann forecast and
observed the simultaneous expiration of the short-term negative
astrological influences and the doubling three times of the rate of
vibration, as the long-term rate of vibration was regained on
September 30 1909.

B) United States Steel Stock Price (see chart 2).

“He (i.e Mr Gann) came to me when United States Steel was selling
around 50 and said,‘This Steel will run up to 58 but it will not sell at
59. From there it should break 16 points’. We sold it short around
58 3/8 with a stop at 59. The highest it went was 583/4. From there it
declined to 411/4; -171/2 points” (Ticker article).
i. Gann identified the start of the uptrend in U.S. Steel as a price
of 21 7/8 cents on October 23 1907.
ii. Gann identified the predominant astrological influences
driving this uptrend.
iii. Gann identified the long-term rate of vibration of this
uptrend, which was 0.0950 cents per day (or 1 cent per 10.5
days).
iv. Gann forecast that the predominant astrological influences
driving this uptrend would remain in force until October 1909

Issue 60 – December 2007 MARKET TECHNICIAN 17

 and hence in November 1908 he was only forecasting a short-
term correction. More specifically, Gann made his forecast
“When United States Steel was selling around 50", which was
in early November 1908. Gann then forecast that due to short-
term negative astrological influences a correction would start
on November 14 1908 (i.e. within two weeks).
v. Based on the starting point of the uptrend (point i above) and
the long-term rate of vibration (point iii above) and the starting
date of the correction (point iv above), Gann was able to forecast
that “Steel will run up to 58 but it will not sell at 59”. In fact the
price of U.S. Steel peaked at 583/4 on November 14 1908.
vi. Gann then forecast that the short-term negative astrological
influences that he had identified would remain in force until
February 23 1909.
vii. Gann then had to forecast what the rate of vibration would
fall to on February 23 1909 (i.e which Gann angle would
provide support before the long-term uptrend was resumed).
Importantly, in making this forecast Gann sub-divided the rate
of vibration. More specifically and, as the price chart of U.S.
Steel shows, Gann forecast that the price of U.S. Steel would
fall to the bottom of its current vibratory band and then
finally fall three quarters of the band below. Thus Gann firstly
forecast that the short-term correction would last until
February 23 1909 and secondly that the rate of vibration of
U.S. Steel would fall on that day from its long-term rate of
0.0950 cents per day to (1/1.5) X (1.25/2) X 0.0950 = 0.0396
cents per day. This is in fact exactly what happened. More
specifically, on February 23 1909 U.S. Steel made a low price of
411/4 cents (which based on the starting point of 21 7/8 cents
on October 23 1907 equates to a rate of vibration of 0.0396
cents per day). From that point the long-term uptrend of U.S.
Steel was resumed.
An important point from this example is that Gann did not merely
use his so-called Gann angles as a crude measure of the rate of
vibration of stocks and commodities. More specifically, he did not
use them simply to measure the doubling and halving of the rate
of vibration. Rather, he also discovered and employed sub-shells
within a principal energy level. This is analogous to modern
quantum theory. Therefore we have discovered another
important principle of Gann’s Law Of Vibration; namely the rate of
vibration of stocks and commodities, as measured by so-called
Gann angles, conforms to a series of principal energy levels and
sub-shells. As we have seen, an important implication (and
practical application) of this is that rates of vibration, as measured
by these principal energy levels and sub-shells, constitute support
and resistance levels. This therefore clarifies the statement made
by Gann: “By knowing the exact vibration of each individual stock I
am able to determine at what point each will receive support and at
what point the greatest resistance is to be met” (Ticker interview).
Moreover, this principle in turn sheds light upon a somewhat
obscure concept that Gann briefly introduced in both his stock
market course and his commodities’ course, namely the concept
of lost motion:
“As there is lost motion in every kind of machinery, so there is lost
motion in the stock market due to momentum, which drives a stock
slightly above or below a resistance level. The average lost motion is
1 7/8 points.
When a stock is very active and advances or declines fast on heavy
volume, it will often go from 1 to 1 7/8 points above a halfway point
or other strong resistance level and not go 3 points. The same rule
applies on a decline. It will often pass an important resistance point
by 1 7/8 points but not go 3 full points beyond it. That is why I advise
using a stop-loss order 3 points above a top or 3 points below a
18 MARKET TECHNICIAN
bottom” (W. D. Gann Stock Market Course, chapter 10).
In summary therefore, from examining examples of the practical
application of Gann’s Law Of Vibration, we have identified three
further principles of the Law Of Vibration to those stated on
pages 15 and 16:
11) The rate of vibration of stocks and commodities conforms
to a series of principal energy levels and sub-shells. More
specifically, the principal energy levels equate to a doubling
and halving of the rate of vibration and the sub-shells equate
to a fourfold division of a principal energy level.
12) These principal energy levels and sub-shells constitute
important support and resistance points.
13) When a stock or commodity is very active, momentum will
often drive the price very slightly above or below the precise
support or resistance point, which is determined by the rate
of vibration (in conjunction with astrological influences).
Gann’s annual forecasts
As the above examples from the Ticker interview show, from
around 1909 Gann was employing his Law of Vibration to
precisely forecast stock and commodity prices up to several
months forward. However, in 1915 he started producing and
selling annual forecasts of the stock and commodity markets.
Although Gann produced these annual forecasts up to his death
in 1955, relatively few survive. But, from those that do survive, it
appears that Gann produced them in exactly the same way as he
had produced his earlier shorter-term forecasts; namely based on
the Law of Vibration.
One particularly accurate annual forecast was Gann’s 1929 stock
market forecast (which Gann reproduced in the appendix of his
book “Wall Street Stock Selector” that he wrote in 1930). In
summary, Gann’s 1929 annual stock market forecast was
completed and distributed on November 23 1928 and included
the following elements:
● A narrative which stated “General Outlook For 1929. This year
occurs in a cycle that shows the ending of the bull market and
the beginning of a prolonged bear campaign…. The fact that it
has run longer and prices have advanced to such abnormal
heights means that when the decline sets in it must be in
proportion to the advance. The year 1929 will witness some
sharp, severe panicky declines in many high-priced stocks”.
● A projected graph or chart of the Dow Jones Industrial
Average which forecast this index would peak on August 7
1929 and then start a major downtrend for the rest of the
year.
● A projected graph or chart of the Dow Jones Railroad Average
which forecast this index would peak on August 8 or 9 1929
and then start a major downtrend for the rest of the year.
Although it should be noted that the Dow Jones Industrial
Average and the Dow Jones Railroad Average both peaked on
September 3 1929 (rather than in early August), overall Gann’s
annual stock market forecast for 1929 was highly accurate.
Moreover, from a careful examination of Gann’s 1929 stock market
forecast it is possible to discern further principles of the Law of
Vibration. These principles are as follows.
14) Although the Law Of Vibration comprises a number of
elements, the time factor is the most important. More
specifically, throughout his career Gann used the term “time
factor” as a substitute or synonym for astrological influences.
Issue 60 – December 2007
 Therefore astrological influences are the most important
element in the Law of Vibration.
“The time given for tops and bottoms is the most important factor for
you to know and watch. It makes no difference about the price a
stock is selling at. So long as you know when it will reach low or high
levels you can buy or sell and make money…. Remember you must
buy and sell at the right time regardless of prices. No matter how
high stocks are, if they are going higher, you should buy. It makes no
difference how low they are; if the trend is down and they are going
lower, you must sell short and go with the trend” (1929 Annual Stock
Market Forecast).
15) In applying the Law of Vibration to the stock market, it is
important not only to assess the astrological influences (i.e.
external vibrations) but also the internal vibrations of a stock.
For example, assume that during a general stock market
uptrend there is a short-term correction (due to negative
astrological influences) and most stocks fall in price. If during
that period of time a particular stock merely moves sideways,
rather than falls, it indicates that the internal vibrations of that
stock are especially strong and therefore it will subsequently
perform strongly when the overall uptrend (i.e. positive
astrological influence) is resumed.
“The Dow Jones 30 Industrial stocks are representative of the active
industrials and most of them will follow the Industrial Curve (i.e.
Gann’s forecast) very closely. But some of the individual stocks that
are in strong or weak position will vary from this Curve and make
tops and bottoms at different times. These special stocks and their
position will be covered in the supplements each month” (1929
Annual Stock Market Forecast).
16) Stocks and commodities typically do not switch from an
uptrend to a downtrend until their rate of vibration has
slowed down. This reduction in the rate of vibration can of
course be observed as prices move sideways (or down) over
time to lower (and slower) Gann angles.
“The ones (i.e. the stocks) that make top in the early part of
the year and fail to reach higher levels in July or August will
be the ones to lead the decline, because they will have had
longer time for distribution. Guard against selling short the
late movers until they have had time to complete distribution”
(1929 Annual Stock Market Forecast).
It is important to note that although for many years Gann
produced and sold annual forecasts of the stock and commodity
markets he did not intend his subscribers to rely on these alone.
Consequently Gann issued supplements, or updates, three times
each week by means of his “Supply And Demand Letter”, which he
described as follows:
“People often write for my opinion on Baldwin, U.S. Steel, General
Asphalt or some special stock. I judge the stock by the position of
time and volume as it is today. If in a few days I see a large amount of
volume, up or down, I change my position, so it is not always what I
think of a stock today, but what I am going to think of it later that
counts. That is why I issue a tri-weekly letter because the market
changes and I can advise my subscribers to change their position
and protect themselves against losses. If the market never reversed its
trend, there would be no need of a tri-weekly letter” (“Wall Street
Stock Selector”, 1930, appendix).
Issue 60 – December 2007
Thus, in the practical application of the Law of Vibration the time
factor, or astrological influences, are the most important element.
Consequently, in preparing his annual forecasts, Gann was
required to assess numerous astrological influences over the
subsequent year. Assessing months in advance how strong
astrological influences (both positive and negative) will be and
how long they will remain in force is a complex task and prone to
error on occasion. Therefore Gann found it necessary to issue
regular letters to his subscribers in order to clarify and correct his
annual forecasts when necessary, as well as to identify particular
stocks and commodities that were especially strong or weak.
Therefore, at a fundamental level, Gann was constantly
forecasting and monitoring external vibrations (in the form of
astrological influences) and internal vibrations (in the form of
assessing the particular strength or weakness of individual stocks
and commodities).
Conclusion
This paper has identified, or rediscovered, many of the elements
of Gann’s Law of Vibration. However, the most important and
most difficult element is to identify and assess the past, present
and future astrological influences on a stock or commodity.
Consequently over the next year, as we approach the centenary
on August 8 2008 of Gann’s discovery of the Law of Vibration, this
should be the principal focus of Gann researchers world wide.
Indeed, correctly identifying the true principles of astrology and
the precise astrological influences impacting a particular financial
market should perhaps be the focus of technical analysts in
general who truly wish to extend the frontiers of technical
analysis in the early twenty-first century.
Finally, the centenary of Gann’s discovery of the Law of Vibration,
August 8 2008, is also the start of the next Olympic Games, which
will take place in Beijing, China. The ancient Greeks not only
provided the world with the Olympic Games but also an early
example of financial forecasting through correctly assessing
astrological influences. Aristotle’s account of the dealings of the
Greek philosopher and mathematician Thales of Miletus (who
lived from 625 to 547 B.C) provides one such example.
“There is an anecdote of Thales the Milesian and his financial device,
which involves a principle of universal application, but is attributed
to him on account of his reputation for wisdom. He was reproached
for his poverty, which was supposed to show that philosophy was of
no use. According to the story, he knew by his skill in the stars while it
was yet winter that there would be a great harvest of olives in the
coming year. So, having a little money, he gave deposits for the use of
all the olive presses in Chios and Miletus, which he hired at a low
price because no one bid against him. When the harvest time came,
and many wanted them all at once and of a sudden, he let them out
at any rate which he pleased, and made a quantity of money. Thus he
showed the world that philosophers can easily be rich if they like”
(Aristotle’s “Politics”, book one, chapter eleven).
The investment paradigm and methodology that Gann
discovered approximately 100 years ago might, in fact, have been
discovered and been in use some 2,500 years earlier.
James Smithson is an investor, trader and student of Gann based in
London, England. smithsonjames@hotmail.com
MARKET TECHNICIAN 19
 Honing your trading skills
Traders who consistently fail to make money often search out
courses that will help them improve their performance. But how
does one separate the wheat from the chaff when looking for a
trading education seminar?
Avoid seemingly free courses
First of all be wary of the much-hyped "free" trader training
courses. Most of these basically spend most of the free
introductory session trying to make you sign up for subsequent
very expensive “trading seminars” which provide little more in the
way of guidance than a reminder that ‘markets can go down as
well as up’ . The result is that attendees end up not only paying a
lot of money for the course itself but they are no wiser at the end
about how to trade and so go on to lose more money in the
markets.
Analyse why you are not making money
Many people trading the markets make the mistake of believing
that the reason that they are not making money when they are
trading is because they are not employing enough state of the art
technical indicators. But it is often not a shortage of technical
knowledge that prevents them from making money, it is their
inherent inability first to establish a coherent trading philosophy
and then to stick to it that is their undoing. Some trading courses
take what might be described as ‘holistic’ approach, in that they
focus on an individual’s core skills rather than the mechanics of
trading.
Trading Workshop
One such course is Dr Van Tharp’s three-day workshop called
"Blueprint for Trading Success". As a Dow Jones journalist, I was
invited to participate on a complimentary basis in July. The other
people attending the course had come not as a result of any ‘hard
sell’ advertising but because they had come to realise that to
become a successful trader entails a lot of hard work on one's
beliefs and weaknesses amongst other things.
Strengths and weaknesses
On the first day of this particular workshop around fifteen people
from as far afield as India, Dubai, the United States and all corners
of Europe had to work on their beliefs, strengths and challenges
in order to find out what resources and skills they possessed.
These factors are crucial in any trading business plan.
Setting clear objectives
The workshop then went on to look at the setting of clear trading
objectives and how specifically to attain them. It suggested
financial freedom as a worthwhile objective. This is to say, to earn
enough money via passive income to pay for all monthly
expenses, so that one would not need to work anymore, if one
was this way inclined.
According to Dr Van Tharp, the trader's overall purpose or mission
in life should be part of any successful business plan, not just the
usual suspects such as research, back office, cash flow, marketing
and dealing with clients etc.
Contingency planning
The first day's homework was on "worst-case contingency
planning" where everyone had to come up with as many things
20 MARKET TECHNICIAN
By Axel Rudolph CFTe, MSTA
that could go wrong concerning family, the environment, one's
broker, problems with equipment, regulatory changes, market and
system disasters and psychological problems.
The next morning all of these worst-case scenarios where
compiled and discussed, leading to much laughter and
amazement. Who would believe that squirrels could chew
through a broadband cable in the roof of one participant and
disrupt his live trading feed or that a cat could have triggered an
order by jumping on another trader's keyboard? It is uncanny to
realise all the things that could potentially go wrong and
astonishing how little most traders prepare for these
eventualities.
Developing a trading strategy
The second day was all about developing strategies and systems
based upon one's overall "big picture" market view – for example
are we in a bull or bear market? - and upon one's personal
assessment from the previous day.
Extensive research about trading strategies and study of markets
over at least a 5-10 year period as well as listing realistic goals for
a trader's performance are all part of this step. It is followed by
strategy development, covering entry signals, profit taking exits
and understanding risk versus reward principles but also
expectancy, standard deviation of returns and position sizing, all
of which are crucial to a trader's success.
Understanding the risk : reward ratio
Van Tharp has developed some marble trading games (explained
in the last edition of Market Technician) which not only help to
clarify the principle of risk versus reward and position sizing but
also, and just as importantly, reveal what emotions a trader goes
through and his thought processes when trading. Not all of these
are beneficial and often lead to self-sabotage.
Basically, in order to benefit from one of these courses, attendees
must be willing to work on themselves. This is what was covered
on the third day of the workshop and included areas such as
responsibility, commitment, mental state control, beliefs/values
and regular self-work, both mental and physical. The course then
gives a detailed top-down approach to discipline, what to strive
for and why, tasks to accomplish to get there and how to translate
it all into daily/weekly/monthly procedures.
"Blueprint for Trading Success Workshop" is not a technical
analysis course; it does not show traders specific trading
strategies or which chart patterns to look for and how to trade
them but it does give extensive guidelines of how to set up and
work through a complete trading business plan.
For traders wishing to become consistently successful, Van Tharp
courses are an excellent starting point.
Axel Rudolph is a jounalist with Dow Jones
Issue 60 – December 2007