Stocks & Commodities V. 26:12 (72-75): Product Review: Red Rock Pattern Strategy by Dennis D.

Peterson
PRODUCT REVIEW

Red Rock Pattern Strategy

EQUIS INTERNATIONAL
90 South 400 West
Suite 620
Salt Lake City, UT 84101
Internet: www.equis.com
Email: sales@equis.com,
support@equis.com
Product: Plugin for MetaStock 10.1
Requirements: MetaStock Professional 10 for Quote Center, 800
megahertz (MHz) or faster processor;
512 MB RAM; 200 MB available hard
disk space; CD-ROM drive; video card
and monitor supporting at least 256
colors at 1024 x 768; mouse or other
pointing device; Microsoft Windows
XP (Service Pack 1 or higher) or
Windows 2000 (SP 4 or higher);
Internet Explorer version 6.0 or later
with latest service packs; MAPI
compliant email program.
Price: $299
by Dennis D. Peterson
ed Rock Pattern Strategies
(RRS) is a MetaStock plugin
developed by Jeff Crystal,
whose resume includes being a former hedge fund
manager. Although he is busy as a consultant, he still takes the time to educate
traders to his way of trading. Talking to
Crystal and listening in on the free class
will get you thinking about the market
and trading in the ways of the skilled
trader. If you are just starting out, this
will feel like drinking from a firehose.
Actually, it will feel like drinking from
a big firehose.
So what is this all about? As the name
implies, its about patterns. What
kind? you might ask. Crystal will tell
you that many are based on Elliott waves
and/or Fibonacci retracements. But he
will readily agree that if you pick five
Elliotticians you might get five answers.
But before we start to worry about
whether a price pattern is an Elliott
wave you would recognize, first weve
got to find a way to identify pivot peaks
and valleys.

FIGURE 1: DAILY S&P500 (SPY) WITH LIFE CYCLE ADVISOR OVERLAY. The Life Cycle Advisor creates the
R (resistance), S (support), I (intermediate pivot for position traders), and M (major pivot for investors). It colors
the price bars either blue (upswing) or red (downswing). Overlaid on the price chart are two zigzag indicators
to get a sense of how the pivots, R and S created by RRSs proprietary algorithm, match up. Red zigzag lines
are for support while green zigzag lines are for resistance.

RRS RESISTANCE
AND SUPPORT CALCULATION
With rare exception, all patterns are
based on resistance and support, which
translates to pivot peaks and valleys.
Head and shoulders, double tops and
bottoms, ascending/descending right
triangles and so forth are all defined
with price pivot peaks and valleys. This
is especially true when trying to find
Elliott waves, since the pivots will define each of the waves. Lets take a look
at the results of using the RRS Life
Cycle expert on a price chart (Figure 1).
RRSs actual calculation for resistance and support is proprietary, but we
can get a sense of how much we might
trust RRSs calculation by applying the
zigzag indicator to the price series. Zigzag is a way of eliminating noise by
ignoring any change smaller than the
parameter you input. I initially tried a
2% zigzag on closing prices, thereby
saying that I wanted to ignore any price
change less than 2%. I missed some of
RRSs pivots with the 2% zigzag on
closing prices, but noted that I could
catch more of them if I used a zigzag on
lows for support and a separate zigzag
Copyright (c) Technical Analysis Inc.

on highs for resistance. I then played

with the percentages to finally arrive at
the values shown in Figure 1. My conclusion, looking at the few mismatches,
was that zigzag was a reasonable approximation of RRSs resistance and
support algorithm and was something I
could trust.

PATTERNS
Using the Standard & Poors 500 (SPY),
we started by looking at the performance of RRS to find pivots. This choice
was intentional, as the first step you
want to take to use RRS is to attach the
Life Cycle Expert to an index because
you want to find a developing pattern.
You find out which pattern by examining the expert commentary. You will
then screen the individual stocks that
make up this index for this developing
pattern using MetaStocks Explorer software. There are 16 patterns encoded in
the Life Cycle Advisor, and becoming
familiar with the language used to describe each might take some thought.
The bull pullback pattern is the first
you will encounter in the PDF that comes
with the RRS CD. The first page gives an

Stocks & Commodities V. 26:12 (72-75): Product Review: Red Rock Pattern Strategy by Dennis D. Peterson

XX

FIGURE 2: BULL PULLBACK PATTERN. All 18 patterns

are shown in the PDF that is part of the installation disk.
The bull pullback pattern needs increasing momentum,
(R-R1)>(R1-R2), and then a retracement, delineated by
the arrowhead. Looking at the pivots created by RRS, we
note that a retracement that appears to be an Elliott wave
4. At issue with this kind of pullback is that it fits within
Fibonacci retracement percentages. In this case, the
desired retracement percentages for the price move
from R to S are 38.2% to 61.8%.

FIGURE 3: DAILY SPY WITH LIFE CYCLE ADVISOR AND COMMENTARY. Price bars show the resistance and
support points calculated by the Life Cycle Advisor and the arrowhead is at May 30, 2007, a point in time that
has several possible outcomes. The advisor commentary window shows these outcomes under the heading of
bullish pattern: Are we in a breakout? with a yes. If you scroll down under the bearish pattern heading, youll
see Are we in a slowing momentum? with a yes.

versus bear rallies. At the heart of RRS

is the identification of momentum. So
lets see what RRS might find.

LIFE CYCLE COMMENTARY

example of what the pattern looks like.
What you see (Figure 2) looking at this
pattern is that price is moving up (bullish) and that there has been a retracement
or pullback. You might also see that the
pivots labeled S1, R1, S, and R roughly
define Elliott waves 1, 2, and 3 and that
our pullback is wave 4.
On the next page are the parameters
used to define this pattern. Note the
notation (R - R1) > (R1 - R2). What this
shows is that resistance is lessening.
Another way of saying this is that momentum is gaining that is, the price
change from the most recent pair of
resistance points is greater than the price
change of the next resistance point pair.
This is a common thread that is woven
throughout all of RRS: increasing up
momentum, as defined by price change
increasing between resistance pairs, or
increasing down momentum as defined
by price change increasing between support pairs. Similarly, momentum can
slow to the upside or downside and you
will find slowing momentum in the title
of 10 patterns of the PDF.
These are the patterns that RRS is
trying to identify: a pattern of slowing
versus gaining momentum leading to a
reversal or a retracement; bull rallies

Anyone who has tried to program algorithms to find patterns knows it is a

tricky task. Lets see what happens when
we use the primary RRS tool for finding
patterns (Figure 3).
We do this by attaching the Life Cycle
Advisor to an index series, and then ask
for the commentary to see what patterns
have been identified. There are a number of descriptors in the commentary,

FIGURE 4: SLOWING MOMENTUM INTO RESISTANCE WITH A DOWNWARD BREAK. One of the keys
to identifying this pattern is that the difference in resistance pairs is lessening. It means that (R-R1)<(R1-R2).
Red Rock calls this slowing momentum.

Copyright (c) Technical Analysis Inc.

but the two I want to focus on are

bullish pattern and bearish pattern,
because it is in these two that you discover what patterns the software has
seen.
An important aspect of RRS is that the
Life Cycle Advisor is looking for developing patterns, and since the patterns
are not yet completed, there is some
ambiguity. Consequently, more than one
pattern might be developing. To see
what the advisor would do when faced
with some uncertainty, I chose to attach
the Advisor at May 30, 2007, of the SPY,
because there are a couple of possible
outcomes for that date; it found bullish
and bearish patterns.
If you agree that a reasonable description of price action has the difference between successive resistance pairs
as slowing momentum (Figure 4), then
prices might break out to the downside.
A different interpretation of the unfolding events is this: Since the close of the
May 30th bar is within one average true
range of the closest resistance, this could
be the start of an upward breakout, and
hence the possibility of multiple outcomes at this stage of development.
Even if the pattern had been completed, there is at least one more issue.
There is a fundamental problem in the
course of coding this type of algorithm
(pattern recognition). While we might
see how the algorithm will identify the
particular pattern, the algorithm can be

Stocks & Commodities V. 26:12 (72-75): Product Review: Red Rock Pattern Strategy by Dennis D. Peterson

At first glance, RRS seemed

to be only a tool, but it is
really a trading system.
There is absolutely so much
to like about it.
momentum and then fill out your arsenal of patterns with derivatives. But
there is more, and this is where RRS
again does something special.

RRS INDICATORS

FIGURE 5: MONEY FLOW INDICATOR COMPARISON. The top subchart is the standard money flow index, the
second from the top is an RRS modified money flow, while the bottom two are daily Arch Coal Inc. (ACI) with
volume. Overlaying all the charts are vertical lines drawn when the modified money flow first crosses above the
20 threshold. The horizontal lines in the top two subcharts are drawn at 20 and 80 for both charts. If you are trading
to hold positions for just two days at a time the RRS modified money flow gives you 12 opportunities, while the
standard money flow index gives six.

vulnerable to identifying variations of

the pattern. Thus, some equities tend to
fit some patterns better than others. With
RRS you can attach any of the 18 patterns. And the 18 individual advisors
show you completed patterns because
you want to see how the developing
pattern from the Life Cycle Advisor
compares to the completed pattern.
Besides, there is no way to backtest
these patterns with the indicators pro-

vided. By looking at completed patterns, you will also get a sense of the
reliability of the pattern.
What you need to be aware of is that
the PDF contains a section about basic
patterns and then follows with sections
about derivative bearish patterns and
bullish derivative patterns. What is going on is that starting with five pivot
series, much akin to Elliott waves, analyze the pivots for slowing or increasing

FIGURE 6: DAILY SPY WITH RRS TIME AND PRICE CYCLES. The top chart shows the average number of days
between R and S, while the one just below is the average price change between R and S. These computations
are used to see if price or time is overextended. If the next pivot has not appeared by the average number of days
between pivots, then RRS will say you are overextended. The same is for price.

Copyright (c) Technical Analysis Inc.

RRS developer Jeff Crystal had a conversation with George Lane, the creator
of the stochastic oscillator, that stimulated Crystals approach to some of the
RRS indicators. When Lane commented
on how the parameters were chosen for
the stochastic oscillator, he explained
that they corresponded to paydays; they
had no correlation to the market.
Think about that for a minute. How
many indicators where you have to
choose the number of periods work independently of the underlying pattern
of resistance and support? Or if you
have a reasonable approach identifying
resistance and support using pivot peaks
and valleys, how many work well independently of the pivot peaks and valleys? Not many, if at all. They kind of
work but seem to miss some events.
What RRS does is modify the number of
periods by the average number of days
between resistance and support. Lets
take a look at Figure 5.
In comparing the standard money
flow index and RRS modified money
flow, what you see is that you have
many more opportunities, six versus 12,
to trade if your trading style is to hold
positions for only a few days or close
out after each trading session. If you
look back at Figure 1 and see how often
resistance and support are found, you
should conclude that RRS is designed
for short-term trading when you consider the patterns being found.
Swing trader is a popular characterization of this type of trading. For longerterm trades, there is I for position
trader and M for investor (Figure 1).
If you want to use I and M pivots, youll
need to rely on what you have seen on
the screen only as there is no pattern
analysis done for I and M, just the Rs
and Ss.
Now that we can use average time to

Stocks & Commodities V. 26:12 (72-75): Product Review: Red Rock Pattern Strategy by Dennis D. Peterson

guess it is problematic. Unfortunately,

there is no way to backtest with these
patterns.
FIGURE 7: SCREENING REPORT USING RRS SEASONAL. Since Explorations are only partially documented, the
meaning of the columns are as follows: Over Ext (1 = over extended in price and/or time and 0 = not extended);
L/S (4 = Long for slowing momentum dropping to support and -4 = Short for slowing momentum rising to
resistance); u/d(u = 1 for slowing momentum breaking upward and d = -1 for slowing momentum breaking down);
1/ret (first retracement after slowing momentum +9 for long position and -9 for short position); M/W (+1 for head
and shoulder W and -1 for head and shoulder M); M Ret(+9 for first retracements following W and -9 for first
retracements following M);Bull Bear (+9 for bull pullback and -9 for bear rally). The other columns are average
days (date) and range (range) between resistance and support, and used is the percentage of range above or
below resistance or support.

modify some indicators, two indicators

for RRS were created as a logical follow-on: time cycle and price cycle (Figure 6). What they tell you is the average
number of bars between pairs of R and
S pivots and average price change. RRS
also has a modified relative strength
index (RSI), and the date/range/ATR indicator, which gives (from top to bottom) average days between pivots, average price between pivots, ATR, and
what RRS calls the dropback rate. It is
calculated as ATR-net movement, where
net movement is (price range between
pivots)/(average days between pivots).

SCREENING
MetaStock screening is accomplished
with a feature called the Explorer. Clicking on the binoculars, a menu icon for
Explorer, you will find that 21 explorations are available starting with RRS.
They will all look familiar except Seasonal and Pre Filter. Pre Filter is password-protected and not available, but
Seasonal is akin to Life Cycle Commentary. It identifies those patterns that
are the strongest (Figure 7).
What you see in the reports are scores
for the different patterns, and every pattern in the PDF that can be ranked is
identified as such and as a consequence

has ranking criteria. The implementation was to give a score of 1 if a criterion

was met and zero if not. Looking at the
ranking criteria, youll see the scores
run from zero to +9 or -9.
Youll also note that a few criteria
refer to money flow index. The actual
one used is the modified money flow
index, and you will also note that Fibonacci retracements are used as well.
If you know Advanced GET, this will
ring a few bells.

TRADING
Obviously, you could buy or short stock
using these patterns. But Crystals background includes options, and he uses
them in what he calls a synthetic stop.
If you are long and market moves below
your support, what about selling a call
deep in the money? The delta should be
close to 1, and you might make up some
loss with time value. So are these patterns good at higher versus lower levels? Once Crystal has a pattern he likes
at the daily level, he is trading at the
five-minute level to get in as soon as the
underlying moves in the direction he
expects, and as a result reports that the
patterns work going lower. Going
higher, such as weekly or monthly, you
are going to lose some detail, so I would

Copyright (c) Technical Analysis Inc.

SUPPORT
Your best shot at understanding RRS is
to study the PDF. For years, Jeff Crystal
has been giving a course on RRS through
the MetaStock online courses. The
MetaStock technical support, while one
of the absolute best in the industry,
doesnt always speak fluent RRS. But if
it is a question more about MetaStock,
they are superb.

SUMMARY
When I read a brief description of RRS,
it immediately got my interest. Trading
with patterns while integrating pivots is
a smart way to go. As I examined the
product more, the modification of money
flow index periods with an average number of days between support and resistance sounded right to me. I wonder if
two standard deviations work even better, and should the algorithm count every day between the resistance support
pivots?
Perhaps a version of RRS will be developed where you can input how many
days between Rs and Ss you want thrown
into the average. I always liked the idea
of modifying your choice of Bollinger
band periods and standard deviations
based on the moving average. Robust
systems like RRS always get me thinking
about other possibilities.
At first glance, RRS seemed to be
only a tool, but it is really a trading
system. There is absolutely so much to
like about it, not the least of which is
Jeff Crystals generosity.
Dennis Peterson is a Staff Writer for
STOCKS & COMMODITIES.
S&C