Technical Analysis of Stocks Commodities 2015 No 05 May PDF

THE TRADERS’ MAGAZINE SINCE 1982
www.traders.com MAY 2015
Schrödinger’s Cat
Finding information in
market data 8
Filtering Price
Movement
Introducing a new zigzag
indicator 12
Predicting The VIX

By reordering the data 26
10 Selling Tips
Knowing when is “when” 30
INTERVIEW
Technical analyst
Boon Chin Low 34
REVIEWS
n Haguro Method
n MetaStock XIV
MAY 2015
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CONTENTS MAY 2015, Volume 33 Number 6
8 Schrödinger’s Cat 30 10 Selling Tips

by John F. Ehlers by Thomas Bulkowski
What information is contained in Do you spend as much time decid-
market data? Can you develop an ing to sell as deciding to buy? Here
indicator or trading system that are 10 tips to make deciding when REVIEWS
can extract this information to to sell easier.
provide an edge in trading? Here’s 42 • Haguro Method
a look. Product review: MetaStock add-on
INTERVIEW based on the Haguro method
FEATURE ARTICLE TIPS
34 TA For The Longer Term 46 • MetaStock XIV
With Boon Chin Low Product review: Trading and chart-
12 Filtering Price Movement by Jayanthi Gopalakrishnan ing platform
by Giorgos E. Siligardos
BC Low has been a teacher and
Here is an alternative to the classic
practitioner of technical analy-
zigzag indicator, which may prove
sis since the 1980s. He is one of DEPARTMENTS
useful to visual technical analysts
Singapore’s earliest practitioners to
and chart pattern researchers. 6 Opening Position
attain the Chartered Market Techni-
cian credential. At Singapore 7 Letters To S&C
22 Mean Reversion And Polytechnic, he created and taught 44 †Traders’ Glossary
The S&P 500 two modules of “Technical Analy- 49 Trade News & Products
by Stephen Beatson sis and Trading,” the only formal
course on technical analysis in Sin- 50 Traders’ Tips
It is generally believed that mar-
kets tend to mean-revert. But this gapore. He was a technical analyst 56 Futures Liquidity
is true for some markets more than for Merrill Lynch Bank, where he 57 Advertisers’ Index
others. Here’s an in-depth look provided currency views to dealers, 57 Editorial Resource Index
at how the S&P 500 responds to private bankers, and institutional
clients. Currently, he continues to 58 Books For Traders
mean reversion.
trade his own equity. We asked him 59 Classified Advertising
about how longer-term investors 62 Traders’ Resource
25 Futures For You can apply technical analysis.
by Carley Garner
Here’s how the futures market 41 Explore Your Options
really works.
by Tom Gentile
Got a question about options?
26 Predicting The VIX
By Reordering Data AT THE CLOSE
by Stephen Butts
In recent years, the CBOE Volatil-
60 Gambling, Speculating,
ity Index (VIX) has increased in & Investing
importance and use as an indicator by Stella Osoba
of market direction. This article What do these terms mean as
demonstrates how the direction applied to the participant in the fi-
of tomorrow’s change in the VIX nancial markets? Let’s have a look
might be determined by restructur- to try to come up with some clear
ing readily available market data. definitions.
29 Q&A This article is the basis for

by Don Bright TIPS Traders’ Tips this month.
This professional trader answers
a few of your questions. n Cover: Jose Cruz
n Cover concept: Christine Morrison
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May 2015 • Volume 33, Number 6
Opening Position
The Traders’ MagazineTM
W
EDITORIAL
editor@traders.com
Editor in Chief Jack K. Hutson

Editor Jayanthi Gopalakrishnan
ill they, or won’t they, and if so, when?
Production Manager Karen E. Wasserman All eyes were on the policy statement
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Graphic Designer Wayne Shaw from it was that the word “patient” was not
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Contributing Editors John Ehlers,
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Contributing Writers Don Bright, Thomas Bulkowski,
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Martin Pring, Barbara Star, Markos Katsanos is what we are led to believe. Immediately after
the Fed released their statement suggesting
OFFICE OF THE Publisher they may start raising interest rates sometime
Publisher Jack K. Hutson in 2015, it was almost as if there was a huge
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sigh of relief. Stocks moved higher, commodities moved higher, treasuries moved
Project Engineer Sean M. Moore
Controller Mary K. Hutson lower, and the US dollar moved lower.

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My conclusion: Single weekly candle-
sticks were of no value in predicting the
CANDLESTICKS, CONDENSED 1. You really need two, three, or four following week’s market action for the
Editor, sequential patterns to make the re- S&P 500 index.
I just read Dave Cline’s sults discrete enough John Rathbun
February 2015 article in 2. Then you need tons of data to build Asheville, NC
Stocks & Commodi- the dataset to get enough patterns to
ties , “Candlesticks, make their numbers significant. Author Dave Cline replies:
Condensed,” and found Interesting translation into a StdDev-
it quite interesting. I had And those two items fight each other. based variation. The compression
never thought of using the approach he Fortunately, on Quantopian.com, you technique already is fairly lossy; are you
describes. It’s a nice way to create pat- can use 200 instruments going back to sure you’re not losing any additional
tern signatures. I took a course through about 2003 to build the source database information by this technique?
Coursera on quantitative analysis by of patterns. Also, you’ve got 2,751 samples, which
Tucker Balch and used Python during Thanks for your inquiry. I would suggest is a somewhat limited
the course. One of the exercises was set to work with.
to analyze historical events based on MORE ON CONDENSED CANDLES As you can probably surmise, and
price movements. Adding a candlestick Editor, I think I alluded to this in my article,
signature could be used as an extension I was interested in the article single candles have nearly zero pre-
to this. by Dave Cline in the Febru- dictive information within them. But
I have also done some basic simula- ary 2015 issue (“Candle- in sequences, they may provide small
tions of crossing EMAs in Excel. When sticks, Condensed”), so I probability benefits. Unfortunately, you
I went to download the Python code decided to see if I could replicate his need tens or hundreds of thousands of
associated with Cline’s article from work. A summary of results follows and sequence samples to build up statisti-
Traders.com, I read that Cline had also the relevant spreadsheet is attached [not cally significant sets. So I would suggest
done some work in Excel and wondered shown]. I would be interested in Cline’s building pairs of candles as patterns. For
if he is willing to share a version of the comments. I have also written code in instance, what is the average return on
Excel file referred to there. PowerBASIC. the CDC-CBA sequence (if it exists)?
Morley I analyzed 53 years (1962–2014) of When I built and tested this mecha-
S&P 500 index weekly candlesticks with nism, I ran 10 years of daily data on
Author Dave Cline replies: reference to the past 10 weeks, and each all the S&P securities through it. I used
I can provide the Excel spreadsheet, candle was assigned a three-letter code three-candle sequences. I've also tried
although it’s not much, really. I can also for the body, upper shadow, and lower two years of hourly data of the same.
provide the Access.MDB file into which shadow, as follows: Within those tests, I could find significant
I dumped the Excel data for grouping/ sequences that tested out-of-sample to
consolidation. You can get these files “A” means +2 SD about one half of their in-sample return.
from the following link: (standard deviations) So I think there's value, if tiny and hard
“B” means +1 SD to see, in the technique. To me, its just
https://dl.dropboxusercontent. “C” means normal one more layer of probability to add to
com/u/29771494/Finance/ “D” means -1 SD a list of filters when scanning thousands
CandlesticksCondensed.xlsx “E” means -2 SD of instruments for possible trades.
My analysis showed minimal predic- Thanks for reading and going through
You’ll find that some of the problems with tive significance, as SD was usually wider the trouble of testing the theory. It means
the compressed candles approach are: than the gap between zero and the percent- a lot to me.
age gain for the following week.
May 2015 • Technical Analysis of Stocks & Commodities • 7
boundary value solutions
and there is no definable
boundary.
In another physical area,
Peter Swerling noted that
the radar echoes returned
from flying aircraft were
noise-like. The echoes would
vary from pulse to pulse and
from one antenna sweep to
another. The explanation is
that there was a total average
power returned, but the total
power was the summation
of components that were
bounced off the fuselage,
wings, rudder, and so on,
and the changing aspect of
the aircraft caused the sum-
mation of these components
to look like noise. When
building deception jammers
for radars, I simulated the
Swerling noise by using the
received radar pulse plus an
exponential moving average
(EMA) of past pulses. This
jamming signal was a remark-
PATRICK KELLEY
ably good replica of the real
radar echo. This kind signal is
called random with memory,
and it’s consistent with other
Random With Memory phenomena described by the
Schrödinger’s Cat
Hurst coefficient. Synthesiz-
ing market data using a ran-
dom number generator and
an EMA is simple to do and
could be an interesting way to
What information is contained in market data? Can you develop an indicator or trading examine the nature of market
system that can extract this information to provide an edge in trading? Here’s a look. data. Knowing the nature of
the data can therefore lead to
by John F. Ehlers the generation of an indicator
T
that possibly can give us a
he purpose of technical analysis is to discern what information is contained in market trading edge.
data and, if you are clever enough, to develop an indicator or trading system that extracts
this information to provide an edge in trading. On the other hand, there are those who Measuring synthe-
believe in the efficient market hypothesis: that all the information about the markets is known sized market data
and the effects are purely random due to the law of large numbers of traders. The discussion Synthesizing market data is
goes downhill from there. one thing, and measuring its
One of my favorite theoretical descriptions of market activity is the drunkard’s walk. When characteristics is quite anoth-
the random variable is position, the partial differential equation solution is called the diffusion er. The problem is similar to
equation, and it describes random motion like a particle of smoke in a smoke plume. When that of the “Schrödinger’s cat”
the random variable is momentum, then the partial differential equation solution is called the thought experiment: Merely
wave equation. Taken together, the drunkard’s walk describes physical phenomena like the measuring the outcome deter-
meandering of a river, which can be random (trending) or cyclical. Unfortunately, there is no mines the outcome itself.
closed solution for the differential equations that can lead to an indicator, because they require Here’s the problem: When
the market is modeled as
a random variable with
memory, the memory is
provided by a filter such
as an EMA. However,
when measuring the fre-
quency content of market
data with any technique
such as a Fourier trans-
form or a contiguous
TRADESTATION
bank of bandpass filters,
they all have filters with
memory as part of the
analysis technique. Thus, FIGURE 1: MEASURED SPECTRUM OF THE SPDR S&P 500 OVER THE LAST YEAR. The dominant cycle period was between 20 and 25
measuring a truly ran- bars in the fall of 2012, was on the order of 15 bars during most of the uptrend, and was an ill-defined longer cycle period most recently.
dom set of data would
involve the memory being provided by the measurement daily data). The spectrum shows that there is not much cyclic
technique, and the entire process would become self-fulfilling. activity, and the dominant cycle is mostly near a 10-bar cycle
Measuring the frequency content of synthesized data must due to aliasing noise.
avoid the use of filters. The next experiment is to see the effects of adding memory
Interfering with the synthesis of market data is minimized to the random data. For example, Figure 3 shows the data
through the use of an autocorrelation periodogram. This and spectrum when the memory low-pass filter has a criti-
process first creates the autocorrelation of the data, a process cal period of 20 bars. Not unexpectedly, the data is much
that is basically without filters. Then, a Fourier transform of smoother than in Figure 2. Also, the dominant cycle period
the autocorrelation function is taken to extract the frequency in the measured spectrum is near a 20-bar period most of
content of the data. On a related note, the autocorrelation the time.
periodogram is now my preferred method of frequency mea- Continuing with the experiment, the memory of the low-pass
surement of market data because it mitigates the effects of filter is changed to have a critical period of 40 bars (Figure 4).
spectral dilation. In this case, the data is smoother across the graph. Further,
Figure 1 shows what the measured spectrum of real market the measured dominant cycle period has increased.
data looks like. The data is approximately one year’s worth
of daily bars of the SPDR S&P 500 (SPY). The measured So what does it all mean?
spectrum is shown below the price bars as a heatmap. The Dealing with random data is tricky because you can never
strength of the cycle amplitude is shown in colors ranging reproduce your results. The best you can do is infer charac-
from white hot through red hot to ice cold. The period of the teristics from your measurements. The first observation is that
measured cycles is indicated on the vertical scale from zero market cycles are ephemeral—they come and go, and the cycle
through 48-bar periods. Figure 1 shows that the dominant periods of the dominant cycle can often change rapidly.
cycle period was between
20 and 25 bars in the fall
of 2012; was on the order
of 15 bars during most of
the uptrend; and was an
ill-defined longer cycle
period most recently.
Now that you are fa-
miliar with displays of
market spectra, let’s
turn your attention to the
measurement of purely
random data with no
memory, as shown in
Figure 2. The random
data is shown as the green
ragged line over ap-
proximately 250 samples FIGURE 2: MEASURED SPECTRUM OF PURELY RANDOM DATA WITH NO MEMORY. The spectrum shows that there is not much
(essentially one year of cyclic activity, and the dominant cycle is mostly near a 10-bar cycle due to aliasing noise.
FIGURE 3: MEASURED SPECTRUM OF RANDOM DATA WITH MEMORY HAVING A 20-BAR CRITICAL PERIOD. The dominant cycle period in the measured spectrum is near
a 20-bar period most of the time.
time variable across the chart.

But most of all, you can gain the edge in your trading that
Market cycles are ephemeral — you sought in the first place. Knowing that market cycles are
ephemeral, you can quickly jump on them with predictive
they come and go, and the cycle filters when they appear. You can get an idea of how this works
periods of the dominant cycle by looking at the trade setup analyzer on www.StockSpotter.
can often change rapidly. com. A trade setup occurs when the MESA cycle indicator is
at or near a cycle trough and the MESA momentum indicator
is declining or is at a minimum.
Synthesizing market data as random with memory does
gain some credibility because the resulting measured spectra S&C Contributing Editor John Ehlers is a pioneer in the use of
look similar to real market data. Further, the characteristics cycles and DSP techniques in technical analysis. He is presi-
of the synthesized data can be controlled simply by varying dent of MESA Software. MESASoftware.com offers the MESA
the critical period of the memory component of the synthe- Phasor and MESA intraday futures strategies. He is also the
sized data. Credible replicas of market data can therefore be chief scientist for StockSpotter.com, which offers stock trading
created simply by making the critical period of the memory signals based on indicators and statistical techniques.
Further
reading
Ehlers, John [2013].
Cycle Analytics For
Traders, Wiley &
Sons.
[2014]. “The
Quotient Tra ns-
form,” Technical
Analysis of Stocks
& C ommodities,
Volume 32: Au-
gust.
‡TradeStation,
‡StockSpotter.com
‡See Editorial Resource Index

FIGURE 4: MEASURED SPECTRUM OF RANDOM DATA WITH MEMORY HAVING A 40-BAR PERIOD. The data is smoother across the
graph and the measured dominant cycle period has increased.

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INDICATORS
For Your Digital Eyes Only
Filtering
Price Movement
Here is an alternative to the classic zigzag indi-
Applied Micro Devices 15.5
cator, which may prove useful to visual technical (daily)

15.0
14.5
analysts and chart pattern researchers. 14.0
13.5
W
13.0
hen there is need for algorithmic iden- 12.5
tification of price swings in a chart, 12.0

11.5
there is a word that always comes to 11.0
mind for technical analysts: zigzag. The zigzag 10.5

10.0
indicator is based on the concept from Arthur 9.5
Merill’s 1977 book Filtered Waves, Basic 9.0

8.5
Theory: A Tool For Stock Market Analysis. It 8.0
filters price movements below a cutoff level,

7.5
7.0
that is, a threshold. The threshold is either in 6.5
point terms or in percentage terms. If you were,

6.0
Zigzag (20%) 5.5
for example, using a threshold of x points, the Zigzag (20%)

5.0
zigzag would disregard all price movements

4.5
T1 T2 4.0
less than x points. If, on the other hand, you 3.5
used a threshold of x percent, the zigzag would

May Jun Jul Aug Sep Oct Nov 2014 Feb Mar Apr May
disregard all price movements of magnitude of Applied Micro Devices, Inc. (AMD) is based on a percentage threshold of 20% and it uses data up to
Figure 1: the dynamic nature of the zigzag’s last legs. The red zigzag in this daily chart
less than x percent. When plotted, the zigzag date T1. The blue zigzag is based again on the 20% percentage threshold but it uses data up to date
T2. In other words, the red zigzag is a snapshot from the history of the blue one. Notice how the last
is shown as a crooked line connecting peaks two legs of the red zigzag changed when price information from T1 and later were taken into account to
and troughs. The line segments of the zigzag create the blue zigzag. This chart was created in MetaStock, which plots the zigzag in a way such that
its last two legs are dynamic. In other versions of zigzag, only the last legs are dynamic.
are commonly referred to as its legs.
Notwithstanding that the zigzag identifies promi- are dynamic and usually change significantly as new
nent peaks and troughs, it doesn’t filter the price data comes in. Consequently, the historical values
swings the same way a technician’s eye would. In this of the zigzag are based on hindsight. So if you’re
article, I will introduce you to a more natural way of using the zigzag in the same way that you use other
filtering the price, which is accomplished via what are classic technical indicators such as moving averages,
called perceptually important points. This alternative relative strength index (RSI), stochastics, and so
to the classic zigzag indicator is closer to the way a on, then zigzag won’t be of much use. However, it
human perceives the movement of price. can be useful if it’s used to identify prominent price
swings on a chart. Simply put, there is no way to
Limitations of the zigzag know when the current price movement will pass the
The zigzag is accused of a serious drawback: Its last cutoff threshold before that happens (see Figure 1 for
JOSE CRUZ
two legs (or, depending on the software, its last leg) an example). In effect, the zigzag is a static tool that
by Giorgos E. Siligardos
analyst, the dynamic nature of the zigzag’s last legs is not a
drawback but a merit. For example, in his November 2003
Stocks & Commodities article “The Zigzag Trend Indicator,”
Spyros Raftopoulos introduced an interesting binary indicator
that he called zigzag trend. The zigzag trend is essentially the
zigzag without its dynamic feature, so its strong point is that it
can be used and treated the same way as other common trend
indicators such as the MACD, with the additional benefit of a
2 low number of whipsaws. From a pattern analyst’s standpoint,
1 however, the absence of dynamic parts makes it completely
incapable of identifying visually prominent peaks and troughs
in a snapshot of a chart.
A more substantial drawback of the zigzag as a tool to rep-
resent a chartist’s perception could be its dependence on the
Figure 2: not all points identified by the zigzag are visually prominent.
The zigzag always tries to find and accent prominent price swings based on how high or
threshold parameter. In other words, you can’t use the same
low these swings go, but this makes it quite stiff. In this iconic example, the zigzag would cutoff threshold for all charts. A 20% threshold for long-term
disregard point 2 just because point 1 is a bit lower. From a visual perspective, however, daily charts of stocks does a pretty good job most of the time,
point 2 was more important than point 1 since it was the pivot that sparked a swift and but it might be inefficient for short-term daily charts. So the
analyst must first see the chart and then define the threshold
strong uptrend.
that will give the zigzag the opportunity to identify the major
tries to mimic—often in a clumsy way—the eye of the analyst swings. That initially negates the usefulness of the zigzag as a
when it looks at a snapshot of a chart. It does so from a more representative of the human eye when there is need for iden-
mathematically rigid point of view, concentrating on the major tification of major swings in thousands of charts. This is not a
swings of price (as defined by the cutoff threshold). serious drawback, however, since there is a simple (albeit not
It must come as no surprise then that for the chart pattern perfect) workaround: You can take the range of values in a chart
(highest value minus lowest value) and then define the
threshold as a percentage of that range.
35 1 So what are the essential limitations of the zigzag
34 from a chartist’s point of view? One limitation is that
33 CBS Corp. CL B
it focuses exclusively on prominent price swings (peak
32
(daily)
31
30
to trough and trough to peak). More precisely, although
29 it indeed identifies meaningful pivots in price, it often
28
27
misses other pivots that are even more important regarding
26 their role in the visual comprehension of the movement
25
24
2 of the price (Figure 2). Also, its bias toward only price
23 swings makes it incapable of perceiving special cases
where connection of peaks to peaks or troughs to troughs
22
21
20 describes the price behavior in a better way (see Figure
19
18 3). Another important limitation of the zigzag has to do
17
with the way it summarizes and ranks information on a
16
15 3 chart. More precisely, you can’t force the zigzag to sum-
14
13
marize the price action into a specific number of swings.
12 For example, you can’t tell the zigzag to filter the price
action and condense it into, say, four swings (legs). You
11
10
9 will know the total number of the zigzag’s legs only after
8
7 Zigzag (20%) 4 it has filtered the price.
6
Meet the PIPs method

5
4 5
J A S O N D 2007 A M J J A S O N D 2008 A M J J A S O N D 2009 A M J An alternative method of filtering price fluctuations is
Figure 3: the zigzag always connects peaks with troughs. The zigzag has a unilateral
one that is based on the idea of perceptually important
way to filter price movements. It always connects peaks with troughs. This means that it is blind points, or PIPs. While roots of this method trace back to
regarding changes in the strength of directional movements and so misses important information 1973, it was mainly introduced in 2001 by F.L. Chung et
with respect to the visual perspective of a price trend. In this daily chart of CBS Corp., the 20% al. in their academic research paper “Flexible Time Se-
threshold zigzag (in blue color) is unable to see the visual importance of points 2 and 3 although
they clearly mark changes in the severity of the downtrend. It considered point 4 as significant, but
ries Pattern Matching Based On Perceptually Important
that is not visually prominent. The pink crooked line gives a much better sight of the price movement Points.” The PIPs method makes it feasible to construct a
from point 1 to point 5. modified version of the classic zigzag indicator that will
Euclidian Vertical Perpendicular
distance distance distance
X d2 X X
{
overcome the limitations I mentioned
{
Z Z Z
earlier because its filtering process is d1 dx(Y,Z)
much closer to the way a technician’s dx(Y,Z)
eye scans a chart. This doesn’t mean
that this new method should wholly dx(Y,Z) = d1+d2
replace the classic zigzag. It is just a Y Y Y
different method serving a different
purpose. The PIPs method is more
appropriate for representing price Figure 4: the tHree flavors of distance of one point from A PAIr of two points. Three ways to define
movement from a visual standpoint. perpendicular.
the distance of a point X from a pair of points Y, Z have been proposed in the literature: The Euclidian, the vertical, and the
In brief, while the zigzag starts from

the left of a chart and creates legs as
it moves to the right, the PIPs method identifies important points based B
on a holistic approach: All price data is indirectly taken into account
Identifying the third PIP
for the identification of each and every leg.
The concept of distance

Before diving into the details of PIPs, it is necessary to define the concept
of the distance of one point with respect to two other points. Let X, Y,
and Z be three points in a time–price chart in this order: Y, then X, then
Z. In their 2008 paper “Representing Financial Time Series Based On
Data Point Importance,” Tak-chung Fu et al. proposed three ways to
define the concept of distance dX(Y,Z) of X from points Y and Z:
Euclidian distance: dX(Y,Z) is defined as the distance of X

C
n A
from Y plus the distance of X from Z.
B
n Vertical distance: If ε is the straight line connecting the points Identifying the fourth PIP
Y and Z, then dX(Y,Z) is defined as the vertical distance of X
from ε.
D
n Perpendicular distance: If ε is again the straight line that
connects the points Y and Z, then dX(Y,Z) is defined as the
perpendicular distance of X from ε.
In Figure 4 you can see pictorial examples for these three flavors
of distance. C
A
Identifying the PIPs B
Consider a set of points in a time–price chart that are derived by the Identifying the fifth PIP
values of an indicator such as the MACD or the closing price of a stock. E
A point from this set will be considered perceptually important when
it dominates all other points in terms of importance in the perception
of the visual shape that these points create. D
That’s a loose definition, I know, so let me define the PIPs via a
formal inductive procedure using the vertical kind of distance (refer
to Figure 5 for a visual aid).
Step 1: The first two PIPs are the first and last points in the chart.
Name them A and B, respectively. I call these PIPs marginal for C
obvious reasons. All the other PIPs will be called internal. A
Figure 5: identifying PERCEPTUALLY IMPORTANT POINTS (PIPs) US-
Step 2: To find the third PIP, calculate the vertical distances of ING THE VERTICAL DISTANCE. The first two PIPs are the first and last points
all points of the set from the couple A, B (that is, calculate (A and B). From there on, to designate a point as perceptually important, you
go through a procedure that takes into account all price data in the chart. More
all dX(A,B) where X runs all points of the set). The point X, precisely, you go through calculations of vertical distances involving all data in
which produces the maximum distance, is the third PIP. Let the chart and lines connecting previously identified PIPs.

this point be C. There are now three PIPs that appear and, voilà—you have a new zigzag-like indicator. (Note that
in this time order in the chart: ACB. the number of legs equals the number of PIPs minus one.) I call
this indicator zzTOP. The “zz” part of the name comes from it
Step 3: Using the same previous idea, run through all set being a generalized kind of zigzag and—what can I say—the
points between A and C and calculate their vertical “TOP” part comes because I am listening to ZZ Top’s hit song
distances from the couple A, C. Also run through all “Legs” as I write this article.
set points between C and B and calculate their vertical The zzTOP indicator requires three arguments (parameters).
distances from the couple C, B. The maximum distance These are: indicator, LegsNo, and scale. Let’s look at them
found from these two runs marks point D, which is in detail.
the fourth PIP.
Indicator
Step 4: Say that D is between A and C. For the fifth PIP
Unlike the classic zigzag, the zzTOP doesn’t rely on cutoff
you make three runs of vertical distance calculations:
thresholds, so it can be directly applied successfully to any
one from A to D, one from D to C, and one from C to
kind of indicator. The indicator parameter is therefore the
B. The maximum distance found marks the fifth PIP
indicator upon which you want the zzTOP to be applied.
(E in Figure 5).
It can be the closing price line, the MACD, the RSI, or
Next steps: You can repeat this procedure to find as many any indicator you can think of.
PIPs as you like (a new PIP for every step). The pro- LegsNo
cedure stops when you have identified your desired This is a numeric parameter (a positive integer greater than
number of PIPs or when the maximum distance in or equal to 1) that defines the total number of legs you want
a step is zero (as this would mean that no additional the zzTOP indicator to have. The number of PIPs equals this
information is gained by identifying new PIPs). Of number plus 1. For example, a value of 20 for this parameter
course, there is always a natural limit to the number indicates that you want the zzTOP to have exactly 20 legs
of PIPs you can identify—and that limit is the total (or equivalently, you are interested in 21 PIPs).
number of points in the chart.
As you probably noticed, the inductive procedure used to

identify the PIPs has an additional benefit: The PIPs are automati- Ball Corp. 50
cally ranked in descending order of perceptual importance. The (daily)
mathematically inclined, however, might have already found a
possible problem with this procedure: What if there is not one
and only one maximum distance among the vertical distances
you calculate for a step? This is rare but it can happen. In this
occasion, there will be more than one finalist for the next PIP
designation, so you either designate all of them as PIPs or, when
you need to select only one of them because you want only one
PIP, you need a selection convention regarding which one to zzTop (Close,5,L)
designate as the next PIP.
As a simple solution for the second case, I opt for the finalist,
which lies in the right-most side of the chart. In other words, I
focus on the most recent data. You could use other methods of 50
selection, but I believe this is the simplest and most efficient
for our purpose.
A similar procedure could be used to identify PIPs using
Euclidian or perpendicular distance. But what is the most ap-
propriate distance to use? A study of various examples shows
that from a visual point of view, the Euclidian distance identifies
terrible PIPs. Further, the vertical and perpendicular distances
produce exactly the same PIPs in most of the real cases. In ef-
fect, you can use only the vertical distance and disregard the zzTop (Close,20,L)
other two. The indicator I will present uses the vertical distance
and the selection convention discussed earlier.
1980 1990 2000 2010
The zzTOP indicator Figure 6: zztop performance in the daily chart of ball corp. (BLL). The
Now that you know how to calculate PIPs in an indicator’s plot, zzTOP indicator is a nice way to approximate the price action via a predefined number of
you can connect them using straight line segments to create legs linear legs. The more legs that are used, the closer the approximation.

Scale
This parameter refers to the scaling
of the y-axis of the chart, and it has a
significant effect on the performance
of the zzTOP. The scale parameter
can take two values: “A” (arithmetic)
and “L” (logarithmic). If you want
the zzTOP to filter the movements
of the indicator parameter as seen
in an arithmetic scale, then you set
this parameter to “A.” This instructs
the zzTOP indicator to apply its PIPs
identification algorithm to the indica-
tor itself. If, however, the indicator is
positive and you want the zzTOP to
filter its movements as seen in a semi-
logarithmic scale (in such a scale,
the y-axis is logarithmically scaled,
whereas the x axis is arithmetically
scaled), then you set this parameter
to “L.” This latter case is equivalent
to first taking the natural logarithm
of the indicator, then applying the
zzTOP with a scale parameter of
“A,” and then applying the exp()
function in the result.
As an example, zzTOP(close, 30, L)

refers to the zzTOP indicator applied on
the semilogarithmic chart of the closing
price of a security demanding that the
zzTOP must have exactly 30 legs. Simi-
larly, zzTOP(MACD, 20,A) refers to the
zzTOP applied on an arithmetic chart of
MACD and demanding that the zzTOP
must have exactly 20 legs.
It is important to note again that while
the zigzag scans the price series from left
to right using a number (the threshold) to
classify a price swing as important, the
zzTOP uses information from all loaded
data in a chart every time it identifies
a new internal PIP. This is invaluable
from the point of visual comprehension
of a chart, but it comes at a price: The
zzTOP is much more prone to changing
many of its legs when new price data
is added to the chart.
Chart examples
It is now time to go through some chart
examples. In Figure 6 you can see how the
zzTOP(close,5,L) and zzTOP(close,20,L)
perform in the same chart. The former
scans all prices shown in the chart, finds
six PIPS, and summarizes the price action
ASML (daily) 100
50
dicator with a percentage threshold

zzTop (Close,20,L) of 20%. Note especially the period
from the end of 1999 until the end of
100
2001. The zzTOP clearly depicts the
50
price movement in a better way than
the zigzag does in terms of visual
clarity, using just a few legs.
Figure 8 shows how the zzTOP
Zigzag (20%)
may change when you put new
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 data in a chart. Period 2 starts at
Figure 7: zztop and zigzag vis À vis. The upper and lower daily charts of ASML Holding (ASML) are the same. The the beginning of 1983 and ends
zzTOP(close,20,L) indicator is overlaid in the upper chart, whereas in the lower chart, the zigzag identifies peaks & troughs based at the beginning of 2000, whereas
on a percentage threshold of 20%. From a visual standpoint, the zzTOP indicator can effectively render the essentials of the price period 1 starts at the beginning of
movement using much fewer legs than the zigzag (see its performance between late 1999 and late 2001). This is mainly because 1983 and ends near the summer of
of two reasons: First, it is allowed to connect peaks to peaks and troughs to troughs, and second, it takes into account all price data
for the calculation of each leg. The zigzag on the other hand doesn’t look at all price data every time it creates a leg. It processes 2009. The zzTOP indicator in blue
the data strictly from left to right and it can only change its last two legs during the identification procedure. is applied in period 2 only (that is,
it doesn’t look outside period 2) and
identifies 20 legs for that period.
into only five legs. The latter finds 15 more PIPs and summarizes the price action into 20 The zzTOP indicator in red is ap-
legs. Note that the zzTOP doesn’t have to connect only peaks with troughs. It can also plied in period 1 and summarizes
connect peaks to peaks or troughs to troughs and thus it is more flexible in summarizing the price action into 20 legs for the
and expressing the price movement quirks. In this regard, the choice of “zz” in the name entire period. Both zzTOPs have
zzTOP is perfectly suited because the zzTOP is not limited to only zigzags—it can do the same parameters except for
zigzigs and zagzags too. the time period upon which they
In Figure 7 you can see how the zzTOP(close,20,L) differs from the classic zigzag in- are applied. It is obvious that new
data can have a significant effect
on the performance of zzTOP not
only because of the restriction in the
For the chart pattern analyst, the dynamic nature of number of legs it is allowed to pres-
the zigzag’s last legs is not a drawback but a merit. ent but also because its algorithm
identifies all internal PIPs, starting
from the marginal ones (the first and
last prices in the chart). In effect, all
internal PIPs—and consequently all
Baxter Intl. Inc. legs—are affected by the first and
(daily)
80
70
60
last prices in the chart.
50
40
In Figure 9 you can see why the
scale parameter is important. In the
zzTop (Close,20,L)
30
20 top chart you see the weekly price

zzTop (Close,20,L) of Caterpillar Inc. (CAT) with the
10
20-leg zzTOP based on the closing
price using arithmetic as its scale
parameter. In the lower chart you see
the same weekly chart of CAT with
the same 20-leg zzTOP indicator,
Period 1 but this time, the scale parameter
is logarithmic. The upper chart is
1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
arithmetic, whereas the lower one is
Period 2 semilogarithmic. It is clear that the
scale parameter is there to ensure
Figure 8: zztop usually changes dramatically when new data IS added. That zzTOP identifies an internal PIP that the zzTOP “sees” the chart the
taking into account all previously identified PIPs, and that the first and last prices in the chart are always the first two PIPs means same way a chartist would do with
that all internal PIPs (and consequently all legs) are indirectly affected by the first and last prices of the chart. So as new data is his eyes. In the upper chart (the
added to a chart, all the legs of the zzTOP face the danger of change. As more and more data is added, all of its legs will finally
change, since the number of legs is constant. This feature of the zzTOP is clearly seen in the daily chart of Baxter International
arithmetic one), the price movement
Inc. (BAX), where the zzTOP(close,20,L) is applied to price data for two periods. The red zzTOP is applied to price data for period before the year 2000 is seen as al-
1 and the blue zzTOP is applied to price data for period 2. most horizontal by the human eye.
Caterpillar Inc.
(weekly) 90
80
70
60
That’s because after 2000, the prices

50
Arithmetic scale 40
advanced significantly. In effect,

30
20
the swings of the price after 2000 zzTop (Close,20,A) 10
0
overshadow those before 2000 from 100
an arithmetic perspective and the Semilogarithmic scale

50
arithmetic-scale zzTOP correctly

focuses on the price swings after
2000 because that’s what a human zzTop (Close,20,L)
eye would naturally do.
In the lower chart, though, the 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
semilogarithmic scale makes it pos- Figure 9: arithmetic vS. logarithmic scale. The scale parameter of the zzTOP determines the way the zzTOP “sees”
sible to see things from a percentage the price. The “A” (arithmetic) scale parameter instructs the zzTOP to see the price from an arithmetically scaled y-axis whereas
perspective, so the price swings be- the “L” (logarithmic) scale parameter instructs it to see the price from a logarithmically scaled y-axis. The results can be strikingly
different for these two cases as it is seen in this weekly chart of Caterpillar Inc. (CAT).
fore 2000 are visually more promi-
nent now. The logarithmic-scale
zzTOP in the lower chart correctly
identifies the 20 most noticeable The zzTOP doesn’t rely on cutoff thresholds so it can be
price swings the same way a human directly applied successfully to any kind of indicator.
eye would.
Most chartists use semilogarith-
mic charts to plot the prices of trading
instruments, so an arithmetic-scale Archer Daniels Midland Co.
zzTOP is practically useless when (weekly)
applied to the price charts (especially 50
the long-term ones). The charts of zzTop (Close,20,L) 40
common technical indicators (such

30
as stochastics, MACD, and RSI) are

20
nonetheless always arithmetic, so the 10

ability of zzTOP to adapt to scale
differences can be useful. In Figure 4.0
10 you can see how the arithmetic-

3.0
2.0
scale zzTOP performs in a weekly

1.0
0.0
chart of Archer Daniels Midland

-1.0
MACD
-2.0
Co. (ADM).
-3.0
-4.0
zzTop (MACD,20,A) -5.0
Automation
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
The zzTOP requires you to state how Figure 10: identifying the swings of macd in a weekly chart of archer daniels Midland co. (ADM). The
zzTOP indicator performs pretty well when applied in indicators without the need to define filtering thresholds.
many legs you are interested in. The
opportunity to a priori define the
number of legs gives you tremendous freedom, but sometimes closer the zzTOPauto line must be to the indicator plot and
you may want the indicator to choose how many legs to identify thus the more legs will be needed.
based on a goodness of fit level that you desire. In other words, Consider, for example:
you might be interested in a hybrid between the zzTOP and the
zigzag. This can be accomplished by requiring the zzTOP indi- zzTOPauto(indicator,20,A)
cator to keep finding PIPs and to create legs up to a predefined
proximity level (an equivalent to the threshold of the zigzag). and say that the highest value of the indicator is 200 and its
I named this automated version of zzTOP the zzTOPauto. lowest value is 40. The range of the indicator is therefore
The zzTOPauto indicator has the same indicator and scale R=200-40=160. Since the proximity parameter is 20, you are
parameters as the zzTOP does, but instead of LegsNo, it has interested in the required number of legs such that the verti-
a proximity parameter. So zzTOPauto(close,10,L), for ex- cal distances between the values of the indicator and the legs
ample, refers to the zzTOPauto applied to the closing price are less than 20% of 160 (which equals 32). In other words, a
of a security on a semilogarithmic chart with a proximity of proximity of 20 means that you want the zzTOPauto to keep
10. Proximity is a positive number up to 100 and represents a finding PIPs and to keep creating legs up to the point where the
percentage of the range of values of the indicator parameter. indicator’s values will not divert more than 20% of R from the
Its purpose is to give the zzTOPauto a level of goodness of fit zzTOPauto’s plot. Of course, for logarithmic-scale zzTOPauto,
you are interested in. Note that the lower the proximity, the the range of the indicator must be measured in a way that will
55
Boston Scientific 50
45
(daily) 40
35
30
25
perform the backtesting, the typical
technical analysis software loads
20
15
all historical data, then calculates
10
the values of indicators, and then
uses these calculated values to
zzTOPauto (Close,10,L) simulate the backtesting. This is
5
fine for common indicators such as
MACD and RSI, but for dynamic
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 indicators like zigzag, zzTOP, and
Figure 11: performance of zztopauto with a proximity parameter of 10 in a daily chart of boston zzTOPauto (which change their
scientific inc. (BSX). The zzTOPauto indicator in this chart did a great job in outlining the price movements of BSX. Using historical values when new data
a higher proximity parameter would result in fewer legs for the zzTOPauto, whereas a lower proximity parameter would result comes in), this approach produces
erroneously prettifying results.
in more legs.
As a consequence, the zzTOP and

take into account the visual idiosyncrasy of the semilogarithmic zzTOPauto indicators must not be used for backtesting in the
charts. More precisely, for the logarithmic-scale zzTOPauto, the typical software program using the software’s built-in backtest-
range of the indicator is measured using the logarithms of the ing feature. You can, however, use these indicators in a static
indicator values instead of the values themselves. In Figure 11 fashion as a digital substitution for your eyes when you want
you can see how the zzTOPauto (close,10,L) did a great job in your software to scan thousands of charts.
outlining the price movements of Boston Scientific Inc. (BSX). Coding the zzTOP and zzTOPauto indicators requires some
Using a higher proximity parameter would result in fewer legs time and effort. For software whose formula language lacks
for the zzTOPauto, whereas a lower proximity parameter would looping capabilities (like MetaStock, for example), the zzTOP
result in more legs. and zzTOPauto must be coded using a versatile programming
language, embedded inside a dynamic link library (DLL) file,
Coding and usage and then be called by the software as external functions from
The correct way to perform backtesting is the DLL. To plot the zzTOP and zzTOPauto indicators in
to recalculate the values of all indicators MetaStock, I created a DLL (named “zzTOPindicators.dll”)
involved whenever a new bar is taken into that’s available for download from the Article Code area of
account. But that would require too many www.traders.com, or from http://traders.com/files/zzTOPindi-
calculations. To decrease the time needed to cators.zip directly. In the sidebar “ZZTOP And ZZTOPauto
Indicators In Metastock,” you can find information on how
ZZTOP AND ZZTOPAUTO INDICATORS IN METASTOCK to download and use it.
Readers can download my “zzTOPindicators.dll” file as a .zip archive Rock & roll
from http://traders.com/files/zzTOPindicators.zip or from the Article The zigzag’s way of filtering fluctuations, although simple, is
Code of the Technical Analysis of Stocks & Commodities website, not always appropriate for capturing the visual representation of
www.traders.com. After downloading, you will need to expand price behavior. The zzTOP and zzTOPauto indicators presented
the .zip file and place a copy of it in MetaStock’s external function in this article offer an alternative way to transfer your visual
DLLs folder (usually located at C:\Program Files\Equis\MetaStock\ perception to your software. Perhaps, if you go through thou-
External Function DLLs). sands of charts, chances are you will encounter cases where the
The zzTOP and zzTOPauto indicators can be called by the fol- zzTOPs will miss a few points that your eye would consider as
lowing code: visually important; however, that would generally be rare. So if
you are not pleased with the way the zigzag indicator perceives
ExtFml( "zzTOPindicators.zzTOP",Indicator ,LegsNo ,Scale) the price movements in a chart, then get ready to rock and let
the zzTOPs do their magic.
and
Giorgos Siligardos holds a PhD in mathematics and a market
ExtFml("zzTOPindicators.zzTOPauto",Indicator,Proximity,Scale) maker certificate in derivatives from the Athens Exchange. He
is a financial software developer, coauthor of academic books
respectively. For example, the code: in finance, and a frequent contributor to Technical Analysis of
Stocks & Commodities magazine. He has also been a research
ExtFml( "zzTOPindicators.zzTOPauto",CLOSE ,15 ,L )
and teaching fellow to the University of Crete as well as a
teaching fellow to the Department of Finance and Insurance
calls the zzTOPauto indicator for the close price in a semilogarithmic
at the Technological Educational Institute of Crete for many
scale with a proximity of 15.
—G. Siligardos years teaching math and financial courses and supervising
masters dissertations. His academic website is http://www.tem.
NOTICE OF CLASS ACTION SETTLEMENT
If you purchased, sold, or otherwise traded July and/or September 2008 CBOT Rough Rice futures
contracts from July 8, 2008 through July 15, 2008 as an opening or closing transaction or
uoc.gr/~siligard and his current views on otherwise, inclusive, then your rights will be affected and you may be entitled to a benefit.
the markets can be found in http://market- A settlement has been proposed in a class action Settlement Agreement, available at the
calchas.blogspot.gr/. He may be reached lawsuit concerning the allegedly improper trading settlement website, describes all of the details
at siligard@tem.uoc.gr. of July 2008 and September 2008 CBOT Rough about the proposed settlement.
Rice futures contracts on the Chicago Board of
The exact amount each qualifying
Trade from July 8, 2008 through July 15, 2008,
The DLL file mentioned in this article is inclusive. The settlement will provide $625,000 to
Settlement Class member will receive from
available from http://traders.com/files/ the Settlement Fund cannot be calculated
pay claims from Persons who bought, sold, or
until (1) the Court approves the settlement;
zzTOPindicators.zip as a downloadable zip otherwise traded the referenced futures contracts at
(2) certain amounts identified in the full
archive as well as from the Subscriber Area any time from July 8, 2008 through July 15, 2008.
Settlement Agreement are deducted from the
at our website, www.Traders.com, in the If you qualify, you may send in a Proof of Claim
Settlement Fund; and (3) the number of
Article Code area. form to potentially get benefits, or you can exclude
participating Class members and the amount of
yourself from the settlement, or object to it.
their Allowed Claims are determined.
See our Traders’ Tips section beginning on The United States District Court for the Northern
The number of claimants who send in claims
page 50 for commentary on implementation District of Illinois (219 South Dearborn Street,
varies widely from case to case. If less than
Chicago, IL 60604) authorized this notice. Before
of Siligardos’ technique in various technical 100% of the Settlement Class sends in a Proof of
any money is paid, the Court will hold a Fairness
analysis programs. Accompanying program Hearing to decide whether to approve the settlement.
Claim form, you could get more money.
code can be found in the Traders’ Tips area How Do You Ask For a Payment?
Who’s Included?
at Traders.com. If you are a Settlement Class member, you
You are a Settlement Class member if you
may seek to participate in the Settlement by
purchased, sold, or otherwise traded July and/or
Further reading September 2008 CBOT Rough Rice futures contracts
submitting a Proof of Claim to the Settlement
Administrator at the address below, postmarked
Chung, F.L., and TC Fu, R. Luk, and V. from July 8, 2008 through July 15, 2008, inclusive.
no later than November 9, 2015. You may
Ng [2001]. “Flexible time series pat- Excluded from the Settlement Class are (i) the Released
obtain a Proof of Claim on the settlement
Parties (as defined in Section 1(k) of the Settlement
tern matching based on perceptually Agreement), and (ii) any Opt-Outs (as defined in
website or by calling the toll-free number
referenced above. If you are a Settlement Class
important points,” International Joint Paragraph 7 of the Settlement Agreement).
member but do not file a Proof of Claim, you
Conference On Artificial Intelligence Contact your futures broker or futures will still be bound by the releases set forth in the
Workshop On Learning From Tempo- commission merchant to see if you purchased, Settlement Agreement if the Court enters an
ral And Spatial Data (pp. 1–7). sold or otherwise traded the referenced contracts. order approving the Settlement Agreement.
If you’re not sure you are included, you can get
Douglas, D., and T. Peucker [1973]. more information, including the Settlement
What Are Your Other Options?
“Algorithms For The Reduction Of Agreement, Mailed Notice, Plan of Allocation,
If you don’t want to be legally bound by
the settlement, you must exclude yourself
The Number Of Points Required To Proof of Claim and other important documents,
by July 21, 2015, or you won’t be able to sue, or
Represent A Digitized Line Or Its Cari- at www.ricefuturessettlement.com (“settlement
continue to sue, Defendants about the legal claims
website”) or by calling toll free 800-918-8964.
cature,” The Canadian Cartographer, in this case. If you exclude yourself, you can’t get
Vol. 10, No. 2, pp. 112–122. What’s This About? money from this settlement. If you stay in the
The lawsuit claims, among other things, that on settlement, you may object to it by August 3, 2015.
Fu, Tak-chung, and Fu-lai Chung, Rob- July 11, 2008, Defendants held 100% of the reported All objections to or requests to be excluded from
ert Luk, and Chak-man Ng [2008]. open interest in the CBOT Rough Rice futures the settlement must be made in accordance with
”Representing Financial Time Series contract expiring in July 2008 and that Defendants, the instructions set forth in the formal Mailed
Based On Data Point Importance,” by July 11, 2008, had made large purchases in the Notice. The Mailed Notice available at
rice cash market with the purpose and intent of www.ricefuturessettlement.com explains how to
Engineering Applications Of Artifi- limiting the amount of rice that would be available exclude yourself or object.
cial Intelligence, Vol. 21, Issue 2, pp. for delivery against the July 2008 CBOT Rough The Court will hold a Fairness Hearing in this
277–300, March. Rice futures contracts. Plaintiffs also alleged that case (In re: Rough Rice Commodity Litigation,
Merrill, Arthur A. [1977]. Filtered Waves, Defendants uneconomically stood for delivery on Case No. 11-cv-00618) on August 25, 2015, to
their July 2008 position during the Settlement Class consider whether to approve the settlement and a
Basic Theory: A Tool For Stock Market Period. Defendants deny any wrongdoing that request by the lawyers representing all
Theory, Technical Trends. Plaintiffs allege in the lawsuit and maintain that
Settlement Class members (Lovell Stewart
Phetchanchai, Chawalsak, and Ali Selamat, they have complied with their legal obligations.
Halebian Jacobson LLP and Lowey Dannenberg
Amjad Rehman, and Tanzila Saba The Court did not decide which side is right. Cohen & Hart, P.C.,) for an award of attorneys’
[2010]. “Index Financial Time Series But both sides agreed to the settlement to resolve fees of no more than one-third (i.e., 33 1/3%) of
Based On Zigzag: Perceptually Im- the case and get benefits to potentially affected the Settlement Fund for investigating the facts,
market participants. The two sides disagree on litigating the case, and negotiating the
portant Points,” Journal Of Computer how much money could have been won if the settlement, and for reimbursement of their costs
Science, Vol. 6, No. 12, pp 1,389–95. Plaintiffs had won at trial. and expenses in the amount of no more than
Raftopoulos, Spyros [2003]. “The Zigzag What Does the Settlement Provide? approximately $50,000.00.
Trend Indicator,” Technical Analysis Under the settlement, Defendants agreed to You may ask to appear at the Fairness Hearing,
of Stocks & Commodities, Volume create a $625,000 Settlement Fund. If the Court but you don’t have to. For more information, call
approves the settlement, potential Settlement toll free 800-918-8964, visit the website
21: November. Class members who qualify and send in valid www.ricefuturessettlement.com, or write to In
‡MetaStock Proof of Claim forms will receive a share of the re: Rough Rice Commodity Litigation
†See Traders’ Glossary for definition Settlement Fund, after it is reduced by the Settlement, c/o A.B. Data, Ltd., PO Box 170500,
‡See Editorial Resource Index payment of certain fees and expenses. The Milwaukee, WI 53217-8091.

Different strokes
The simple truth is that
some markets respond well
to mean-reversion strategies,
and others don’t. There are
several possible explanations
for this, including what fac-
tors drive the instrument’s
price (macro economics,
earnings, news, and so on);
the number of market par-
ticipants; the ability to take
short positions; the volumes
involved; and the average
volatility of the instrument
Rhythm Of The Markets in question.
Mean Reversion
It is generally believed that
commodity time series re-
And The S&P 500

spond better to continuation-
type systems (trend-following,
breakout, and so on) than to
mean-reversion systems. The
same applies to currency
It is generally believed that markets tend to mean-revert. But this is true for some markets more pairs, which are understood
than others. Here’s an in-depth look at how the S&P 500 responds to mean reversion. to exhibit long- and short-term
trending tendencies. The US
by Stephen Beatson stock market daily time series,
on the other hand, has consist-
M
ean reversion is not a universal phenomenon; some markets have a tendency toward ently demonstrated a strong
mean reversion, while others don’t. This has led a number of analysts and traders to propensity toward mean re-
look upon mean reversion with some degree of suspicion. If mean reversion has a solid version. In this article, I will
statistical foundation, should it not be applicable to all markets all the time? try to determine whether this
has always been the case. The
focus here will be on long-side
400,000 mean reversion, that is, on a
security’s price’s tendency to
move upward after a short-
term decline.
300,000
I looked at the S&P 500
index from 1970–2013 and ap-
plied the following strategy:
Equity ($)
200,000
n Buy on the close if the
index closes at a 10-day
ShredDEd bills: mary981/Arrow: tomwa/collage: JOAN BARreTT
low
100,000
n Sell on the close 10
Equity curve
days later
0 n $100,000 per trade, no

allowance for commis-
sions or slippage
-100,000
1/2/1970 8/18/1978 4/6/1987 11/16/1995 7/20/2004 3/18/2013
Figure 1 shows the resulting
equity curve. During the
Figure 1: EQUITY CURVE. Here you see the results of buying the S&P 500 index at a 10-day low and selling 10 days later 1970–2013 period, the strat-
(1970–2013). The green line shows the strategy’s strong and persistent edge. egy’s win rate was 60.52%
During both bull and bear
markets, a short-term fall in
the S&P 500 is more likely to
be followed by a bounce than
by a continued drop.
and the profit factor (total profits/total losses) was 1.71. This
indicates that when the index hit a 10-day low, a trader with
a long position was generally better off holding his position
PivotHunter.com®
and exiting 10 days later. Where Order Flow
The equity curve’s regular upward slope is quite remarkable.
Of course, some of this tendency must be assigned to directional
Meets Price Velocity
bias — after all, the S&P 500 went up in value almost 20 fold
over the period, so you would expect the equity curve of this
Watch the Cops and Kings chase down
long-only strategy to display a positive edge. However, the up-
ward slope is also stubbornly present throughout the past two the elusive Convict
decades (1994–2013) that saw some extreme rises and falls in Live Charting Room
stock market prices. Free to First 100
Thus, the data suggests that during both bull and bear markets, every week.
a short-term fall in the S&P 500 is more likely to be followed
by a bounce than by a continued drop, at least in the first few
days that follow. In other words, buying price dips and selling
at mean reversion would have been a simple and profitable followed by further selling, at least in the short term (two
strategy over the past 50 years. days). From 1987 to date, however, and quite consistently for
To further understand the nature of this short-term mean- the past three decades, the exact opposite appears to have
reversion cycle, I used the same strategy but applied a much happened: A 10-day low was generally followed by a quick
shorter two-day holding pe-
riod, as follows:
n Buy on the close if the 50,000

index closes at a 10-day 40,000
low 30,000
n Sell on the close two 20,000

Reversion
days later 10,000
0
n $100,000 per trade, no
Equity ($)
allowance for commis- -10,000

sions or slippage -20,000
-30,000
Figure 2 shows the resulting -40,000
Continuation
equity curve for the two-day -50,000
Equity curve
holding period. What you -60,000
see here is a very different -70,000
chart. The downward sloping
-80,000
red line indicates that from
1970–1987, the S&P 500 -90,000
Black Monday
exhibited a strong tendency -100,000
1/2/1970 8/18/1978 4/6/1987 11/16/1995 7/20/2004 3/18/2013
toward short-term continua-
tion, or follow-through — that Figure 2: EQUITY CURVE OF A SHORTER HOLDING PERIOD. Here you see the results of buying the S&P 500 index at a 10-day
is, a 10-day low in the index low and selling two days later (1970–2013). The strategy had a negative edge until late 1987, then a fairly consistent positive edge
had a strong tendency to be thereafter.

1.4E+10 MARKET OUTLOOK
1.2E+10
occurring intraday instead of
interday. That meant that price
1E+10
stability could be reached before
the end of the trading session,
allowing opportunistic buyers
to step in the following morning,
8E+09
pushing prices back up toward
the mean.
The third likely explanation for
6E+09
the US stock market’s short-term
Volume mean-reverting tendency is the
pervasiveness of short selling.
4E+09
Short selling, in its many forms,
has been around for a long time
and was certainly very much
2E+09
alive in the 1960s and 1970s.
But it was only in the 1980s that
shorting on electronic platforms
0
became widely available. This
rise in the collective power of
1/4 965
1/4 67
1/4 969
1/4 971
1/4 73
1/4 975
1/4 77
1/4 979
1/4 81
1/4 983
1/4 85
1/4 987
1/4 89
1/4 991
1/4 93
1/4 995
1/4 97
1/4 999
1/4 001
1/4 03
1/4 005
1/4 07
1/4 009
1/4 11
13
/19
/19
/19
/19
/19
/19
/19
/19
/20
/20
/20
/20
/1
/1
/1
/1
/1
/1
/1
/1
/1
/1
/2
/2
/2
the shorts has exacerbated the
1/4
FIGURE 3: RISING VOLUMES. Stock market volumes have grown exponentially since the early 1960s, reaching their peaks
short-rally effect, which is one
in the fourth quarter of 2008. of the main ingredients of mean
reversion. Essentially, when an
instrument’s price is falling,
bounce, or reversion. And the inflection point of the equity short sellers must buy to cover and take their profits. This
curve occurred on a specific date, which was October 19, 1987, buying interest drives prices back up toward the mean. So
also known as Black Monday. the greater the short interest, the stronger is the pressure for
falling prices to revert back upward.
Why the change? Finally, we must also consider the advent of strategy-driven
There are arguably four main reasons for this fundamental automated trading systems and high-frequency traders (HFTs).
change in the US stock market’s short-term profile from trend- These have, ironically, brought considerable short-term
ing to mean reverting. The first lies in the extraordinary rise rationality to the marketplace. Trading systems designed to
in the volume of stock market transactions over the past 50 recognize panic selling step in to oversold situations and buy
years, as reflected in Figure 3. Buy & hold investing that was into market overreactions. This serves to discourage follow-
the hallmark of most of the 1900s has made way for active through and favors mean reversion.
investing, short-term trading, and hedging. Financial products
that were intended as vehicles for investment have become Stay the course
tools for speculation. This is the case for just about every We have seen that the S&P 500 index has
financial instrument available in the electronic marketplace. exhibited short-term long-side mean rever-
This increased volume has brought about an unprecedented sion for at least the past half century. What’s
level of liquidity to the marketplace, allowing buyers and more, this tendency has been prevalent in
sellers to find each other more efficiently, thereby slowing the bullish and bearish periods. We have also
runaway trains associated with illiquid markets. seen what appears to be a quickening in the
A second possible explanation is that until the mid-1980s, way the market responds to falling prices.
stop-loss orders were often executed on the day following Reversion cycles that in the 1970s and 1980s
the stop being hit. That is, if a stop-loss level was touched took several days now occur within a much
on Monday, the broker would execute the sale at the open on shorter time frame. Traders recognizing
Tuesday morning. These sell orders would serve to compound this phenomenon should be able to profit by
the downward effect, resulting in more stops being hit, and using mean-reversion strategies that exploit
more sell orders being generated on Wednesday morning. The this edge.
downward spiral would continue until value investors stepped
in and confidence was restored. The big change occurred in the Stephen Beatson is an investment consultant based in Paris,
mid-1980s with the advent of automated systems that allowed France and is founder of the educational site TheMechani-
stop-losses to be executed instantly when hit. The multiday calTrader.com.
price erosion process I described was suddenly compressed,
FUTURES FOR YOU
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner is the senior
strategist for DeCarley Trading, a division of Zaner Group, where she also works
as a broker. She authors widely distributed e-newsletters; for your free subscrip-
tion, visit www.DeCarleyTrading.com. Her books—Currency Trading In The Forex
And Futures Markets; A Trader’s First Book On Commodities; and Commodity
Options—were published by FT Press. To submit a question, post your question at
http://Message-Boards.Traders.com. Answers will be posted there, and selected
Carley Garner
questions will appear in a future issue of S&C.
PIT CLOSURE IMPACT candid story of the ups and downs ex- out of a job. Even though the numbers
What impact will the CME’s pit closure perienced by those on the CME trading of these individuals has dwindled over
have on the average trader? floors in Chicago. the years, there are still hundreds that
In early 2015, the Chicago Mercantile As I mentioned, along with the full- will be affected. In addition, those who
Exchange (CME) announced that it size S&P 500 futures, the option pits made a living disseminating order flow
would be closing pit trading for all futures will continue operation. This is because information (such as which banks and
contracts in its Chicago and New York the complexity of option trading hasn’t hedge funds were buying or selling in
operations, with the exception of the translated to the screens as well as the pits), are finding they no longer have
full-sized S&P 500 contract and most futures contracts have. Simple long & a place on the trading floor.
of its option pits. short calls & puts can easily be executed Moreover, despite the clear advan-
The S&P 500 futures contract was via an electronic platform, but in some tages of electronic trade matching such
the only product that had never been circumstances, those trading multileg as transparency, speed of execution
moved to “the screen.” While all other option spreads in high volume still find and fill reporting, and fill quality (less
CME futures products traded in both an benefits in using an open-outcry execu- slippage), the disadvantages are often
electronic version and open-outcry ver- tion broker. This is expected to be the case overlooked. For instance, up until now,
sion side-by-side, execution in the “big” for the foreseeable future. Nonetheless, when the exchange, or even brokerage
S&P has always been strictly open outcry. firms, experienced technology issues, it
Because of this, many traders moved Although the closure of was possible to route orders to the pit for
their speculation from the original S&P execution. These types of events don’t
contract into the electronically executed the futures trading pits occur frequently, but they do happen. In
emini S&P 500 futures (ES) to avoid the officially marks the end the absence of an alternative means of
delays and slippage that sometimes came of an era, there will be execution, it only takes a single instance
with pit-traded execution. of halted trades to dramatically affect
If you are young or new to the trading little to no impact on the the integrity of the markets and work
community, you might not be aware of average retail trader. against orderly trading.
what trading pits are or about the prac- In the aftermath of side-by-side trading
tice of open-outcry execution. In short, the writing is on the wall: Eventually, (simultaneous futures markets trading)
the pits are designated circular areas in the option pits will likely go the way of we are left with some residual chaos
which exchange members buy and sell the futures pits. when it comes to identifying products in
futures contracts through hand gestures Although the closure of the futures a trading platform or on a quote board.
known as arb. Although the transactions trading pits officially marks the end of This is because when electronic trad-
are dictated by hand movements, they are an era, there will be little to no impact ing was first introduced, the exchange,
accompanied by aggressive voices, and in on the average retail trader. At the platform vendors, and brokerage firms
some cases, a degree of physicality. The time the CME Group announced the opted to identify the electronically ex-
process of open-outcry trade execution pit closure, roughly 1% of all executed ecuted contract with a different symbol
is often referred to as “organized chaos.” futures contracts on the exchange were than the open-outcry version. This was
If you haven’t seen the movie Trading traded in the pits. In other words, nearly because at the time, electronic trading
Places starring Eddie Murphy and Dan all of CME Group trades are executed hadn’t fully developed. Consequently, it
Aykroyd (one of the greatest movies of electronically; thus, most of us won’t was important that traders had the ability
all time, in my opinion!), you should; it even notice the change. to choose which venue to route trades to.
manages to capture the essence of pit However, there will certainly be For example, the open outcry version of
trading in all of its glory. As another one casualties. For starters, all of those crude oil has always been denoted by
to mention, the documentary Floored working on the trading floor (executing
directed by James Allen Smith tells a brokers, order clerks, and so on) will be Continued on page 62
are likely to come from today and
previous days.
Recognizing
relationships
But ordering data in just one way
limits us. If there are patterns in
the data that are not related to the
one-directional march of time,
we may miss them. This article
seeks to explore one of many
possible orderings of data from
a well-studied, readily-available
financial derivative—the volatil-
ity index (VIX). My objective
is to see if I can discover useful
relationships that are hidden in a
time series view.
I’ll begin with a small sample of
VIX index data from the 30 days
of trading between December 16,
1996 and January 28, 1997 (Figure
1). I arrange this data with the date
in column 1, the closing value for
each of the 30 days in column 2,
and the next day’s change in the
closing value in column 3.
For example, the VIX closed at
19.27 on January 14, 1997 and I put
the difference between this close
and that for the following day, 0.13,
into column 3 for January 14, not
for January 15. I then sort all three
columns together by descending
value of the VIX close and add
The Road Ahead another column containing each
Predicting The VIX

day’s cumulative sum of the next
day’s change (see Figure 2). Note
that after the sorting, the dates are
By Reordering Data
no longer in ascending order, and
that the cumulative change in the
VIX is calculated based on the new
order of the 30 days. For the sake
of brevity, hereafter we will refer
In recent years, the CBOE Volatility Index (VIX) has increased in importance and use
to the change in the closing value
as an indicator of market direction. This article demonstrates how the direction of
PHOTO: STUART JENNER/SHUTTERSTOCK/COLLAGE: NIKKI MORR
of the VIX between a given trading

tomorrow’s change in the VIX might be determined by restructuring readily available
day and the trading day immedi-
market data.
ately after as the delta, and to the
cumulative value of the delta when it
by Stephen Butts
is ordered according to the scheme
As
usually presented, financial data is ordered in a time series: The data runs from above as the cumulative delta.
left to right or top to bottom by increasing values of days, months, years, and so The chart in Figure 3 presents a
on. The data may be altered (with a moving average, lagged values, the log, or graph of the descending VIX and
square taken, and so forth), but in most cases, data is envisioned and laid out according the cumulative delta from Figure
to the arrow of time. Patterns are then observed or discovered in this time-based frame- 2, and it shows a pattern: While
work, and this makes great sense: The factor that may produce tomorrow’s market moves the closing VIX values have been
sorted to descend steadily from their
highest value to their lowest (the 30
days are no longer in calendar order),
the cumulative delta values (that is,
the next day’s changes in the VIX)
generally, but with several detours,
drift down to a low point (-6.84)
somewhere around the middle of
the chart, and then change direction
and move upward (with detours) to
the last point in the chart. The low
point for the cumulative delta oc-
curs on day 15 of this re-sorted data
(December 18, 1996) with a closing
VIX value for that day of 19.42.
To the left of and including this
low point, more cumulative deltas
fall (10) than rise (five), and the
sum of the deltas for these (-9.93)
is larger in a negative direction than
the sum of the rises (3.09) is in a
MICROSOFT Excel
positive direction.
So for every day in this 30-day
period where the closing value of the
VIX is greater than or equal to the
VIX value on the day of the lowest Figure 1: closing vix sorted by date Figure 2: closing vix sorted by descending vix. Here,
(december 16, 1996–january 1997). The
point in column 5 of Figure 2, you data is arranged by date, closing value, and next
the VIX close is sorted in descending order and a column containing
each day’s cumulative sum of the next day’s change is added.
would be correct 10 times out of 15 if day’s change.
you were to predict that tomorrow’s
VIX will be lower than today’s. And for every day when the 1990, for every day with a closing VIX greater or equal to
closing value of the VIX is less than the VIX value on the day the VIX on the day with the lowest value for the cumulative
of the lowest point in column 3, you would be correct 11 times next day’s change in the VIX (delta), there is a higher-than-
out of 15 if you were to predict that tomorrow’s VIX will be average probability that the next day’s VIX will drop. And
higher than today’s. In other words, if you knew the closing the reverse is true for all the days when the closing VIX is
VIX for every day in the table and the value of the VIX on the less than the VIX on the day with the lowest value for the
day having the low point of the cumulative deltas, you would cumulative delta.
predict correctly for 21 of the 30
days for a total of 16.64 points,
and incorrectly for nine days for
-4.72 points, leaving you 11.92 22.00 0.00
points ahead. Needless to say, 21.50 -1.00

this is a far better performance
VIX cumulative change
Value of closing VIX
21.00
-2.00
than the simple 30-day change 20.50
in the VIX itself, which results 20.00
-3.00
in a drop of just 1.76 points over
19.50 -4.00
the period.
This general pattern for the 19.00 -5.00
reordered data is true for most 18.50 19.42
-6.00
of the 30-day periods since the 18.00
VIX has existed. The low point 17.50 -7.00
for the cumulative delta is rarely -6.84
17.00 -8.00
in the exact center of the chart 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
as in the example in Figure 3, Days in order of descending VIX
and often is skewed well to the FIGURE 3: DESCENDING VIX WITH CUMULATIVE CHANGE IN TOMORROW’S VIX. While the closing VIX values have been
left or the right. However, in all sorted to descend steadily from their highest value to their lowest, the cumulative delta values generally drift down to a low point
30-day periods since January around the middle of the chart.
700.00
OPTIONS
600.00
500.00 for each 30 days would give a fair

estimate of the VIX at the low point.
In fact, both of them do: If you sub-
Cumulative VIX
400.00
Maximum drawdown stitute the mean VIX value (which

300.00 = 59.57 points you know for all days, including
today) for the observed VIX at each
200.00 low point in the historical data, the
predictions for the next day’s VIX
change are correct for 3,078 (54%)
100.00
of the days and produce 652 points

0.00
on the VIX. The chart in Figure 4
-100.00 shows the cumulative points gained
Year over the 23 years in this case; note
that the maximum drawdown for
FIGURE 4: cumulative vix outcome by year using mean prediction. The maximum drawdown for the entire the entire run is less than 60 points.
run is less than 60 points.
Using the median is almost as good,
producing 617 points.
How well does this method work? Predicting the direction of tomorrow’s VIX with an advan-
The historical database I used for the VIX comprises every tage of 652 points in 23 years may not sound like much until
trading day from January 29, 1990 to December 31, 2012 and you consider the alternatives. If you were simply to predict
there are 5,749 overlapping 30-day periods in this span. If for each day over the 23 years that tomorrow’s VIX would
you predict whether the next day’s VIX change is up or down always rise or always fall, you would be right about 47.6% of
for the 30th day in each period as per the method discussed, the time for rising and 52.4% for falling, for a grand total of
3,686 of the total 5,713 predictions (that is, 65%; for 36 days, only ±1.91 points. A 1,000-trial Monte Carlo simulation of
the VIX change is zero) are correct for a net gain of 2,571 random predictions for each day in the 23 years shows that
VIX index points for the 23 years studied. you would have achieved a gain of more than 300 points just
But you want to predict not just the following day’s VIX for eight times in 1,000 tries (that’s 23,000 years), and that you
some dates in the past, but tomorrow’s VIX today, in real time. would gain a maximum of 361 points just once.
Since you want tomorrow’s change in the VIX, you should
begin with the 30 trading day period ending today, and then What will tomorrow bring?
reorder the data as mentioned. Then find which day has the In fact, you may get a more accurate estimate of the VIX value
lowest cumulative delta, and note the VIX value on that day. needed from the historical data by using more sophisticated
However, remember that for each day in the period, you need statistical methods than simply calculating the mean. With a
to have the next day’s change in the VIX, and of course, you least-squares approach using multiple variables, I have been
don’t know tomorrow’s number today. Thus, you can reorder able to achieve close to a 900-point gain over the period (I
the data by sorting them into descending order by each day’s leave an exploration of this to readers as an exercise, and if
VIX, but you cannot calculate the cumulative change values you can do better, I invite you to share your method with other
because the latest one is missing. readers of this magazine).
The only way to overcome this problem is to bypass it. You I hope that the information I have presented here will give
need the value of the VIX on the day when the cumulative delta traders a small but useful advantage in predicting short-term
is the lowest for the last 30 days. Without knowing the data moves in the VIX, and encourage all analysts to take another
from the last day you can use various means to estimate that look at how time-series market data might be rearranged to
VIX value. For example, you know from historical analysis produce interesting insights.
that the low points for the cumulative VIX changes tend to
cluster somewhere near the middle of the sorted VIX values Stephen Butts has a PhD in political science. He has worked
for each period. Perhaps the mean or the median VIX value as a statistical and methodological consultant and teacher at
Columbia University, the Bureau of Applied Social Research
in New York, and the University of Wisconsin-Madison. He
may be reached via email at sjbutts@yahoo.com.
The factor that may produce
tomorrow’s market moves are Further reading
Gardner, Trent [2012]. “Using VIX To Forecast The S&P
likely to come from today and 500,” Technical Analysis of Stocks & Commodities,
previous days. Volume 30: July.

Q&A
SINCE YOU ASKED

Confused about some aspect of trading? Professional trader Don Bright of Bright
Trading (www.stocktrading.com), an equity trading corporation, answers a few of
your questions. To submit a question, post your question to our website at http://
Message-Boards.Traders.com. Answers will be posted there, and selected questions
will appear in a future issue of S&C.
Don Bright of Bright Trading
MARKET LIQUIDITY AND THE The Securities And Exchange Com- participant raises their bid to $25.03, the
TICK SIZE PILOT PROGRAM mission (SEC) has been taking public algorithmic program will raise its bid to
Mr. Bright, thanks for all the informa- comments regarding this pilot program. $25.04. If the original participant cancels
tion over the years. Your columns have We at Bright Trading submitted a com- their bid, the algorithmic penny-jumping
been very helpful. I have been hearing/ ment letter to the SEC on it, prepared program cancels its bid as well, and the
reading about the possibility of chang- by Dennis Dick, CFA (a trader at best bid returns to $25.00. The penny-
ing from the penny tick size in trading. Bright Trading and a trader lobbyist). jumping technique is designed to battle
I have to admit that I’m not sure what I’ll summarize and reiterate some of for the top of the order queue, so as to be
this even means. Are exchanges going our submitted comments here. (Note: the first to interact with incoming market-
to make changes? Will traders benefit This information and the link to our able order flow, giving it the best chance
from these changes? Does this mean comment letter represent the opinion of to capture the spread. The dominance
the end to subpennies? (I’ve read some Bright Trading, and may not be shared of this penny-jumping activity discour-
of your past columns on the topic of by all traders.) ages other participants from providing
subpennies.) Are these changes coming One of our concerns is the lack of inter- liquidity, which keeps the spread on these
soon?—Ted A. est in the small- and mid-capitalization securities artificially wide.
Thanks, Ted, for the nice words. companies. We believe this is primarily We believe the tick size pilot will help
Always glad to help. Please keep the due to a lack of liquidity caused by the address this issue. Firms will not want to
questions coming. discouragement of limit-order traders. risk 500% more slippage than they face
To address your question, what you’re As we see it, many small-capitalization with penny ticks.
referring to is the Tick Size Pilot Program companies trade with very wide spreads, Another major concern of ours is
(SEC File No. 4-657). “Tick size” here broker–dealer internalization (that is,
refers to expanding the minimum tick to when the broker takes the other side
five cents (or similar) for certain smaller-
The dominance of of trade versus open market trading).
cap securities. Remember, we “old guys” the penny-jumping We write in our comments that “The
traded with 1/8th tick sizes and what was biggest issue that our traders cite is
called “teenies” (12.4 cents and 6.25
program discourages their inability to get filled on their limit
cents as the minimum tick size). This other participants orders, even when they are at the top
was before subpenny denominations and of the order queue. This is primarily
high-frequency trading and other such
from providing due to over-the-counter (OTC) market
activities came to be, and before “penny liquidity. makers intercepting marketable order
jumping” practices came to be, although flow that would otherwise interact with
some firms did engage in “leaning” on which should be attractive for market the trader’s displayed limit order.” In an
another order, placing their order a “tee- makers to trade because of the potential earlier public comment letter that we
nie” higher, thus limiting their losses to profit opportunity from the wide spread. submitted to the SEC in June 2010, we
the 6.25 cents. However, algorithmic penny-jumping cited this issue and recommended that
These minimum price increments programs appear to dominate these se- the SEC require an OTC market maker
have an impact on displayed liquidity curities, discouraging other participants internalizing a retail order to provide
and transaction costs. Since the markets from providing liquidity. meaningful price improvement over the
adopted decimalization, there have Here’s an example: Assume stock displayed quote.
been changes in market structure, the XYZ is trading with a spread of $25.00 We commend the SEC in attempting
way people trade, and the roles market x $25.20. If a market participant places a to address this issue in the tick size pilot
participants played. How will expanding bid at $25.01 to tighten the spread, the al- program but believe an exception in one
the minimum tick size for certain stocks gorithmic penny-jumping program will
help market participants? automatically bid $25.02. If the original Continued on page 45
price movement. A volatility stop works well
when no other stop locations are nearby.
To use a volatility stop, compute the high-low
difference of price each day for the last month
(about 21 price bars). Average the result and
multiply by 2 to get the volatility. Subtract the
volatility from the current low price to get the
stop price. Trail the stop upward as price rises.
This type of stop is similar to a chandelier stop,
but Kaufman’s stop performs better.
I found that a multiplier of 2 works best for
my trades, but you may prefer 1.5 or another
number. If the stop price, in percentage terms,
is too far away from the current price, then skip
the trade and find a less volatile stock.
The computation need not be a painful expe-
rience. One way to do it is to go to http://finance.
yahoo.com (Figure 1), type in the stock symbol,
and on the left, you’ll see a link to historical
prices. I show that circled in red in Figure 1.
Click on that link and download the prices
into a spreadsheet. On the same Yahoo page,
the link for a spreadsheet download is located
below the price grid. Subtract the high price
from the low and use the average() worksheet
function to get the volatility. I am providing a
sample spreadsheet at http://traders.com/files/
VolStop.xls.zip that does this math for you. All
you have to do is paste in a month’s worth of
price quotes from Yahoo.
Psst, Here’s A Secret
10 Selling Tips
Tip #2: Sell at a target price. When the stock
reaches a price target, sell. You should have the
target (and a stop-loss) price picked out before
trading the stock.
Consider placing the target just below overhead
Do you spend as much time deciding to sell as deciding to buy? resistance, such as at a prior peak or valley, or at a
Here are 10 tips to make deciding when to sell easier. round number (double
or triple zeros such as
by Thomas Bulkowski $9.00 or $10.00 are
T
good for daytraders),
he stock of Ferro Corporation (FOE) has flatlined like a dead animal or at some other price
since November 2013. It is now 2015, and I have more than doubled target. If using a round
my money. Should I sell? number, consider sell-
Every trader or investor must answer that type of question for their own ing a few cents below
investments. In this article, I’ll discuss 10 selling tips to help you find your the target, like 8.93
answer. and 9.95. You want
to beat the crowd to
Tip #1: Use stops. This has to top the list of selling techniques because it the exit.
Landscape: blue67 sign/sign pole: vipman
makes the process simple. If you use a stop-loss order, you can quit wor- If you are using
rying about when to sell. The order will take care of that. All you have to chart patterns as the
do is locate the stop in the right place. Stop placement is an art beyond this entry signal, take the FIGURE 1: HISTORICAL PRICES.
article, but if you are having difficulty, use a volatility stop. height of the chart Downloading historical prices can be
I learned about volatility stops from Perry Kaufman’s book A Short Course pattern and add it to eral resources available from which
done easily given that there are sev-
In Technical Trading. The idea behind a volatility stop is to place a stop far the breakout price to do so. Here you see an example
enough away from the current price to avoid being stopped out on normal to get a target. That using Yahoo! Finance.
Noisy indicators
delay your analysis
method works about 70% to 80% of the time, depending on
the chart pattern. You can cut the height in half for a closer
target that will work close to 90% of the time. In Figure 2
you see such an example.
A double-bottom chart pattern appears at AB and it con-
firms as a valid pattern when price closes above C, which
is the highest peak between the two bottoms. C is also the
Jurik algorithms
breakout price. deliver low lag,
The height from C ($24.50) to the lower of the two bottoms, low noise analysis
A ($21.67), is 2.83. Add the height to the breakout price (C)
to get a target of $27.33. Line D shows the target. For double
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader,
bottoms, this method works 68% of the time. Using half the eSignal, NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader,
height boosts the success rate to 86%. Line D is also where Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
overhead resistance begins (between the two red lines). Thus,

the target and overhead resistance merge to form a good sell Jurik Tools on live charts, on the web !
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Target selling is most useful for swing and daytraders be-
cause time is money (that is, they want to keep their money
in stocks climbing the fastest). Position traders looking for a Jurik Research
trend change (a drop of at least 20%) should avoid using this
approach. That’s because, as the chart shows, selling at the price
of line D limits profit since the stock can continue higher. 2010 -- 2011 -- 2012 -- 2013
Add-In software
Tip #3: Sell after an adverse breakout. If you see a chart

pattern and buy into it before the breakout, sometimes the jurikres.com • 800-810-3646 • 719-686-0074
breakout is opposite of what you had planned. In that case, sell

immediately. This applies to any approach you use to buy a
stock. If the stock moves in a surprising direction (down when section at the end of this article.
you expected it to rise), then you need to sell your position. Avoid buying or owning countertrend stocks by checking
This tip is especially useful during earnings season. A stock whether they drop when the market makes a big move higher.
suffering a hit in earnings will get slammed by the market. For If so, and if they do that for several days in a month, consider
any trading style other than buy & hold, sell immediately. Oth- selling those holdings. The days need not be consecutive, but if
erwise, the stock is likely to be whacked
again in three or six months’ time.
Overhead
Tip #4: Watch for countertrend moves. resistance
Last year I was planning to add a stock to
my portfolio, but when I checked its price,
I saw that the stock price was dropping
when the Dow Jones Industrial Average
D
was soaring. That drop in the stock was
a countertrend move.
You may have heard the phrase a ris-
ing tide lifts all boats, but this boat had
C
a hole in it. I avoided the stock and saved
myself from drowning.
I did a study on stocks that made
countertrend moves. I compared stocks
that dropped when the index made a B
significant move upward (at least 1%). A
Stocks that dropped underperformed
Tom Bulkowski
the index for at least three months and

underperformed the trend followers
(those stocks that followed the index
higher) for a year. You can find a link FIGURE 2: APPLYING CHART PATTERNS TO MAKE SELL DECISIONS. In this case, take the height of the chart
to this research in the “further reading” pattern and add it to the breakout price to get a target.

TRADING TECHNIQUES
ness happens repeatedly. Do what it takes to eliminate that

If you wake up in the early hours stress by making adjustments such as reducing your trading
of the night and your first thought and investing more or moving into cash for a while. Or perhaps
it’s time for a vacation.
is of trading, that’s a clue you
have unresolved issues. Tip #7: Sell when the market says you’re wrong. Keep that
phrase in mind when looking at your losing positions. If the
stock did not act as you expected it to, then sell.
the countertrend moves occur too frequently, you will be able I like to have a diversified portfolio by owning several
to do better by selecting a stock that follows the uptrend. securities and diversifying by trading style. I may have some
stocks that I am swing trading, some that I am position trad-
Tip #5: Obey indicator sell signals. If you are a system trader, ing, and some that I am buying & holding.
when your system issues a sell order, obey it. If you try to finesse The buy & hold stocks do not require much attention. That
the exit by waiting, that could cause you more grief because inattention can lead to problems when a cyclical stock goes
you’re creating a bad habit. out of favor. Perhaps the reasons for ownership have changed.
Imagine that you delay selling and the stock climbs further. If the company sells a division that removes a source of big
By holding on longer, you are rewarded. The next time this profits, the stock could suffer, and it’s time to sell.
scenario unfolds, you do the same thing and make more money. What sometimes happens is that I’ll buy a stock and it’ll act
By delaying selling and winning, you create a bad habit that is like I expected it to for a few weeks by moving higher. As soon
like a bomb waiting to explode. Eventually, the same scenario as my focus turns elsewhere, the stock drops. The decline is
will unfold, you’ll hold on, and boom! The stock will plummet, not an in-your-face plunge of 50% in one session. Rather, the
giving you a huge loss. stock eases lower day by day, eating away the meager profit it
If your system is flawed such that it gives sell signals too early, once enjoyed. Soon, the position is losing money. The market
then that’s fine. Indicator testing can identify this problem. I’m is telling me I made a mistake. The transition from profit to
not talking about living with a flawed system. I’m talking about loss is a wake-up call—a sell signal. Obey it.
ignoring trading signals.
If you are going to use a system, then trust it and obey it. Tip #8: Price drops 10% from a high. A financial consultant
If you don’t trust the system, then research its operation to I know told me that she uses a 10% rule to sell her blue-chip
identify its weaknesses and become confident that the system stocks.
works. Then avoid trading when those weaknesses are appar- A blue-chip stock is a low-volatility, high-quality, high-
ent (say, during bear markets or during the afternoon session volume security priced above $5. If it drops by 5% from a
when volume tapers off). peak, it piques her interest. She will look at the fundamentals
Tip #6: Worried about a trade? I remem-

ber planning to daytrade Intel (INTC) by
shorting 2,000 shares of the stock at the
open. I went to bed and worried about B
the trade. Why? Because the position C D
size was double what I normally used.
So I got up and reduced the size of the
trade. That turned out to be a good idea
because the trade lost money (I was right
in the direction, but was flushed out when
the stock spiked upward within minutes
of the open).
A friend of mine had a similar problem.
She was having difficulty sleeping through
the night because of worries about her po-
sition in a mining stock. My advice to her
was to cut the position size until her worries
disappeared. If the stock still bothered her,
then she should sell it completely. A
If you wake up in the early hours of the
night and your first thought is of trading,
then that is a good clue you have unresolved FIGURE 3. PRICE BREAKS SUPPORT. When a stock breaks support, as in the case of Ferro Corp. (FOE) in this
issues. This is especially true if sleepless- weekly chart, consider selling it.

and try to understand the reason for the
decline. If the market is dropping as part
of a bullish move higher (a retrace in an
uptrend), for example, she will ignore
the temporary slump.
If the drop turns into a 10% decline
from the peak, she will sell at least half, but
most often, the entire position will go.
Tip #9: Market relative strength. If

you manage money for a living, either
privately with your own portfolio or
professionally by steering a hedge fund,
your goal is to beat the competition. The
competition is the market indexes.
One way to do that is to find stocks that
are outperforming the market. Here’s
what you do. Divide the closing stock
price each day by the corresponding
close in the S&P index (or the index
of your choice, like the utility index
for a utility stock, as an example). You
should see one line on the chart. If the
line slopes upward, your stock is out-
performing the index. If it trends lower,
the stock is performing less well.
This technique is what I call market
relative strength since you are comparing the stock’s perfor- closed slightly above the open. I decided to sell the following
mance to the overall market. Sell stocks that are underperform- day. After buying the stock at $4.93, I sold it at $11.53 for a
ing the market. I apply a moving average to the line (22 days gain of 134%.
is what I use) to smooth out the bumps so I can see the overall The point of this anecdote is a simple one. When a stock breaks
trend. The direction of the trend is what’s most important. Ide- support, consider selling it. In Ferro’s case, it was time to let it
ally, you want to have a portfolio of stocks that are climbing go, so I sold. Timely selling is what this game is all about.
faster than the market.
S&C Contributing Writer Thomas Bulkowski (who may be
Tip #10: Price breaks support. I mentioned this stock (Figure reached via email at tbul@hotmail.com) is a private investor
3, weekly scale) at the beginning of this article. The stock hit and trader with more than 30 years of market experience and
bottom at A in November 2012 and then it went on a tear. considered by some to be a leading expert on chart patterns.
The stock climbed in a stairstep fashion until it bumped up He is the author of several books including Getting Started
against a ceiling. It slid horizontally for months, resting on In Chart Patterns, Second Edition and The Evolution Of A
a new floor at $12. Trader trilogy. His website and blog, www.thepatternsite.com,
After such a big gain from the low at $2.38, I expected it have more than 600 articles of free information dedicated to
to take an extended break. My hope was that the stock would price pattern research.
continue higher, resuming the stairstep move up.
When the stock poked its tail through support at C, it was The spreadsheet file mentioned in this article is downloadable
not an automatic sale. I know that these types of false signals from http://traders.com/files/VolStop.xls.zip as well as from the
happen from time to time when the smart money tries to Subscriber Area at our website, www.Traders.com, in the Article
shake out the uninformed. I monitored the stock closely and Code area.
decided to hold on. Fortunately, the stock recovered but still
continued moving sideways. Further reading
Then the stock pushed through support at D and congested Kaufman, Perry [2003]. “Short Course In Technical Trading,”
just below $12. It sat there for about two weeks. Again, I sat Wiley & Sons.
and waited just in case the move was trying to shake me out of • http://thepatternsite.com/CounterTrends.html (note this URL
a winning position. However, with the stock resting below sup- is case-sensitive)
port, it pushed me closer to the exit. I just needed a shove.
The push came when the stock dropped 5% in one day but
INTERVIEW
Knowledge, Patience, Discipline
TA For The Longer

Term With
Boon Chin Low
BC Low has been a teacher and practitioner of technical analysis
since the 1980s. He is one of Singapore’s earliest practitioners to
attain the Chartered Market Technician credential from the Market
Technicians Association, which is based in New York.
From 1991 to 2011, Low was a senior lecturer at Singapore
Polytechnic, where he introduced education in technical analysis to
the curriculum. He created and taught two modules of “Technical
Analysis and Trading,” the only formal course on technical analysis
in Singapore.
Low has been active in the Singapore Technical Analysts & Trad-
ers Society (STATS) since the 1990s. He launched the Certificate
in Technical Analysis (CTA) through STATS in 2004; he launched
the society’s Diploma in Technical Analysis (DTA) in 2010. Prior to
his work at Singapore Polytechnic, Low was a technical analyst for
Merrill Lynch Bank, where he provided currency views to dealers,
private bankers, and institutional clients. Currently, he continues to Understanding the relationship
trade his own equity. His recent book release is Integrating Technical between the different time frames
Analysis For The Investor.
S tocks & Commodities Editor Jayanthi Gopalakrishnan
helps the investor to know how the
communicated with him via email in early March 2015 to find out more bigger time frame trends change.
about how longer-term investors can apply technical analysis.
What led to your being inter- That’s interesting. You know, the pre- Applying technical analysis for invest-
ested in technical analysis? miere issue of this magazine was dis- ing or on longer time frames is con-
It was 1986 when I began tributed at a CompuTrac seminar. From tradictory to what most people do. Do
trading in Japanese commodi- your experience, do you think technical you combine technical analysis with
ties that I started in technical analysis taught you things about the fundamental analysis and if so, how?
analysis. There was little by market that you may not have known if I think the reason technical analysis
way of fundamentals, so charts were the you hadn’t applied technical analysis? has not been used for the longer time
only thing that made sense. Technical Certainly. Technical analysis taught me frame is because there has not been
analysis was on the cusp of a new era in that all markets can be reduced to the com- sufficient focus on using it that way.
Singapore, spurred by the publication mon denominator of price. And as Charles Technicians tend to be traders and not
of John Murphy’s first book, Technical Dow said more than 100 years ago, charts investors. So the use of technical analysis
Analysis Of The Futures Markets, in show that markets move in trends. With tended to be skewed towards the shorter
1986. Still, it was tough trading com- technical analysis, it is possible to forecast time frame. And in recent times, time
modities with huge paper charts, hand- market direction, something much needed frames have gotten even shorter.
drawn candlestick bars, and trendlines, by all investors and traders. But there is no reason for technical
plus moving averages calculated manu- What I hope to add to this premise analysis not to work in the longer time
ally. I began to feverishly learn technical through my book Integrating Technical frame—it is, after all, still about price, al-
Singapore skyline: joyful/Shutterstock
analysis from as many sources as I could. Analysis For The Investor is that it is also beit on a longer time frame. And investors
When I joined Merrill Lynch Singapore possible to forecast farther into the future should discover that technical analysis
in 1989 as a technical analyst, I had my with the consistent application of techni- works just as well in those time frames.
first encounter with technical analysis cal analysis into the larger time frame Some mental adjustment is needed to get
software, CompuTrac. From then on, I charts such as weekly, monthly, quarterly, used to the larger dimensions in time and
was hooked on TA! and even longer time frames. space, but it can be done.
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If the fundamental view is divergent with Historically, I observed that while
®
my technical views, naturally I will not reversal patterns—such as double tops
act on the fundamental view. or bottoms, or head & shoulders—do not
occur frequently, trends do change all
You integrate trend, price, and timing. the time. So there is a need for reliable
How do you determine if a trend is just indicators of trend change other than
beginning or is close to maturing? price patterns.
NeuroShell Trader The end of one trend may signal the My use of price patterns is to have them
Now Works with FXCM start of a new trend; that is, the end of play a confirmation role. Once you can
a downtrend may imply the start of an establish that a trend is possibly reversing
Data and Brokerage uptrend. There are indicators that help with another indicator, you can look out
investors ascertain the timing of the start for price patterns to confirm the impend-
and end of a trend. One of my favorites is ing change. I find that breakaway gaps
the combination of a 10- and 40-period have done very well in this respect, as
exponential moving average (EMA). have certain candlestick patterns.
In the simplest terms, the crossing I have used this approach of using
of the 10 EMA above or below the 40 price patterns as a confirmation tool
EMA can be interpreted as the start of for many years in various markets, and
an uptrend or downtrend, respectively. it has worked well. It places the horse
I have used this combination for all before the cart, so to speak, rather than
Winner 13 years in a row! markets and all time frames, and it has the other way around.
proved to be invaluable.
www.NeuroShell.com What time frame charts do you look at
That sounds simple enough. You also when you do your analysis?
301.662.7950 look at price patterns. What patterns do I look at time frames from daily all the
you look at and how are they helpful? way to the quarterly. Sometimes, I even
As far as possible, I try to avoid fun- My view is that trends change as a look at the yearly chart just for a very
damental analysis. But once I am given result of changing fundamentals. But big picture view, but that is rare and I do
a fundamental view, I will look at my as we know, economic fundaments do that only for exceptional circumstances.
charts to evaluate the outlook based on not normally change overnight. As such, Typically, the daily and weekly charts
the fundamental analysis and see if the larger reversal patterns will reflect such are the staples; I prefer to use the weekly
fundamental view is supported by the changes in fundaments better than the chart, as it filters the noise of the daily
technical view on the longer time frames. minor patterns will. chart and provides earlier signals than
the monthly. As the monthly chart is
only evaluated at the end of the calendar
month, its impact will be slower, but it is
still a necessary tool for investors.
My interest in the longer time frames
led me to the important discovery
that technical signals are consistent in
whichever time frame they are used. If,
for example, the crossing of two moving
averages signals an uptrend in the daily
chart, the same is true in the weekly,
monthly, and other charts. The differ-
ence is that the time and price scales will
be increasingly larger. Because of this
consistency in technical signals across
all time frames, it is possible to achieve
longer-term views of markets. This consis-
tency has in fact been proved with charts
dating back several decades such as in the
Dow Jones Industrial Average.
One important issue in using more
“Calls may be monitored because these are uncertain times.” than one time frame is to understand the
relationship between the different time
frames at any one point in time. If the
monthly, weekly, and daily trends are at
odds with each other, how is the inves- ninjatrader.com
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is the 10 & 40 EMA combinations, as I including exclusive
mentioned earlier. It has a proven track advanced platform
record and is unique in being able to per-
features and single
form more than one important function
well, and that is to forecast future trends, source support.
to monitor the process of a change in
trend, and to provide important support
or resistance levels in a trending market.
Few other indicators can achieve that
much that well.
Go Direct to the Source.
The other indicator I like a lot is
George Lane’s classic stochastic oscilla- NinjaTrader Brokerage.
tor, because of its ability to signal quick
turns in the market under certain market
conditions. However, I recommend that
investors understand the specific role that Trading is about probability. How does of making the right decision.
stochastics is equipped to play, and not applying TA for the longer time frame
expect it to perform more than it can. A improve your odds of success? Most people will think that trading for
sprinter is not a marathon runner, and I’ll start with Charles Dow’s axiom the longer term is more forgiving. Is it,
vice versa. that markets move in trends. If you look or do you still have to have as much
at the longer time frame charts, the trends discipline to gain the higher returns?
are more clearly discernible because the The use of the longer time frames
short-term gyrations are filtered out. How- gives the investor expanded space to
ever, as you get into the shorter time frame, place the stops in return for catching the
say, daily or intraday, the shorter-term bigger returns from longer-term moves.
gyrations complicate the view of the trend. If the investor focuses on the long term,
This greater shorter-term uncertainty the day-to-day market gyrations may
increases the probability of making the not impact the bigger trend. Because of
wrong decision or lowers the probability that, you can be misled into thinking
that discipline can be more relaxed, term, I wish to emphasize that investors them better and make more effective
but that should not happen. Key market should not neglect their positions just use of them?
levels of longer-term charts should still because they are long term. Investors, The three basic needs of an investor or
be identified and earmarked for action like everyone else, lead busy lives—work, trader are to correctly define the trend,
even though they may be further away. family, and social. So when a position and based on the trend, the optimum
In other words, the same discipline is is profitable, they tend to just let it run timing and price to enter and exit the
needed for the longer time frame as it and take no action. But as markets move market. This means assembling a tool
is for the shorter. in trends, they eventually turn bearish box of effective trend, timing, and price
and wipe out what was previously a indicators, and then integrating them for
How much of an influence does funda- profitable position. This is one of the the best outcomes. However, the investor
mental analysis have on your invest- more common and serious errors in should also be aware that his technical
ment decisions? investing—investors do not plan the exit tool box is a dynamic one and he should
While trends are underpinned by of their positions enough. constantly look out for better indicators
market fundaments, technicals, in my In my experience, investors are more over time.
opinion, pinpoint the timing of trends focused about entering the market, but Having said that, I innovated on J.
more clearly and visibly. I find that not so much in exiting. Investors must Welles Wilder’s famous indicator, the
technical signals tend to front-run the monitor their investments regularly; and directional movement index (DMI), a
fundamentals, such that when the news while identifying a good time and price to few years ago by creating three clusters
finally appears, good technical signals exit a position may not be easy, neglecting each of the ADX, +DI and –DI lines.
would have already been triggered and the positions is not an option. [Editor’s note: For an explainer on the
the move is well underway. ADX indicator, see sidebar “The ADX.”]
In fact, when I am given a fundamental From your book, it appears as if you I named my indicator DMI clusters and
view of a market, I immediately refer to use indicators and patterns that are in its function is to identify the timing of
my charts to evaluate the fundamental the public domain. Do you rely on these the highest or lowest bar in a trend. For
view. tools or do you come up with your own example, on the weekly chart of the
indicators or tools? NASDAQ Composite in Figure 1, you
What are the important factors to In my practice of technical analysis the see how the market top is signaled by
be mindful of when managing your past 30 years, I have focused on achiev- the ADX cluster peak at 90 and the 3X
positions? ing better interpretation and integration -DI cluster bottom at 5.
There are many factors to bear in of indicators rather than creating new I have since used it for five years
mind, but since I am advocating the use indicators. There are enough good indi- with very good outcomes. In fact, you
of technical analysis for investing long cators out there, so why not understand published my article “Identify The Start
Directional Movement -DI (15.0000), Directional Movement -DI (12.0000) Directional Movement -DI (8.00000)
50
40
30
20
10
- DI < 5 - DI < 5 - DI < 5
Directional Movement ADX (71.0000) Directional Movement ADX (43.0000) Directional Movement ADX (56.0000) 0
3X ADX cluster turning 3X ADX cluster turning 95
down around 90 down around 90 85
75
65
55
45
35
25
15
USA - Nasdaq 100 index (2,821.03, 2,823.34, 2,780.24, 2,784.89, -40.2202
Market top
Market top 2500
Market top
2000
1500
1000
Mar Jun Sep Dec 2010 Mar Jun Sep Dec 2011 Mar Jun Sep Dec 2012 Mar Jun Sep Nov
FIGURE 1: MARKET TOP. On this weekly chart of the NASDAQ Composite, the market top is signaled by the ADX cluster peak at 90 and the 3x ‑DI cluster bottom at 5.

Of A Trend With DMI” on this topic in
the November 2012 issue of Technical Key market levels of longer-term charts
Analysis of Stocks & Commodities.
should still be identified and earmarked for
Yes, we did. [Readers can find that action even though they may be further away.
article in our article archives at our
website, www.traders.com.] Would you
say that technical analysis has gained
more respect than when you started using suited to individuals who are comfortable Stocks & Commodities, Volume
it in the 1980s? with numbers. Investors not inclined that 29: April.
Yes, TA is better understood today way still feel more comfortable with the Low, BC [2014]. Integrating Technical
than when I started 30 years ago. There intuitive logic of fundamental analysis. Analysis For The Investor, Technical
must be hundreds of books on the subject This is why I have written my book Analysis Consultancy.
of technical analysis alone. Its use has in a concise manner so that it can be [2012]. “Identify The Start Of A
expanded from end-of-day to intraday understood by investors. My hope is that Trend With DMI,” Technical Analysis
markets, from off-line to online and to with this book, the lay investor can make of Stocks & Commodities, Volume
more markets globally than ever before. better and more profitable decisions in 30: November.
There are also many more technical in- their investments. [2010]. “Trading, Time Frames,
dicators and approaches today compared And Trends,” Technical Analysis of
to the past. Thank you for sharing your thoughts, Stocks & Commodities, Volume
Despite the proliferation in the ap- BC. 28: September.
plication of TA among trading profes-
sionals, I still feel that TA is still not well Further reading
understood by the investor community. Gopalakrishnan, Jayanthi, and Bruce
By nature, technical analysis tends to be Faber [2011]. “Then And Now With
numeric or quantitative, and as such, it is Tim Slater,” Technical Analysis of
THE ADX
The calculation of the average directional movement (ADX) indicator
Directional Movement Examples
is built on the intuitive notion that a trend is a series of price ranges
extending in a consistent direction.
In sidebar Figure 1, example A, the second day’s trading range is
higher than the first day’s trading range, indicating positive directional A B C D
movement. In example B, the second day’s trading range is below the
first day’s trading range, an indication of negative directional movement. +DM +DM 2
Example C is more complicated because the second day’s range is both 1 1
lower and higher than the first day’s range. 2
Directional movement is only considered to be up, down, or not
present. Therefore, the larger part of the day’s range extending beyond 2
the previous day’s range is used to identify directional movement. In
example C, the largest part of the second day is higher; consequently, 1 1 -DM
-DM 2
the directional movement is positive. In example D, the largest part of
the second day’s range is lower so that the directional movement is
negative. In example E, the second day’s range is within the first day’s
range so the directional movement is zero. 12
Directional movement for the ADX is expressed as a function of true
range (TR). True range is the largest of the following:
1 The difference between today’s high and today’s low
2 The difference between today’s high and yesterday’s close E
3 The difference between today’s low and yesterday’s close. SIDEBAR FIGURE 1: DM EXAMPLES
In the Excel 4.0 spreadsheet (sidebar Figure 2), the first calculation
for ADX is the true range value. This is performed in column E. The Next, column F determines the positive directional movement or
formula for cell E3 is: returns zero if there is no positive directional movement. The formula
=MAX(B3-C3,ABS(B3-D2),ABS(C3-D2)) for cell F3 is:

SIDEBAR FIGURE 2: MICROSOFT EXCEL
=IF(B3-B2>C2-C3,MAX(B3-B2,0),0) to calculate the ratios of +DM and ‑DM to TR. The ratios are called the
+directional indicator (+DI) and ‑directional indicator (‑DI). The formula
Column G calculates the negative directional movement or returns for the +DI column begins at cell K16:
zero if there is no negative directional movement. The formula for
cell G3 is: =Round((100*(I16/H16)),0)
=IF(C2-C3>B3-B2,MAX(C2-C3,0),0) The formula for the +DI column begins at cell L16:
The daily calculations are volatile and so the data needs to be =Round((100*(J16/H16)),0)
smoothed. First, sum the last 14 periods for TR, +DM and ‑DM. The
formula for summing the TR is in cell H16: The INT (integer function) is used because the original developer
dropped the values after the decimal in the original work on the ADX
=SUM(E3:E16) indicator. The next step is to calculate the absolute value of the differ‑
The formula for summing the +DM is in cell I16: ence between the +DI and the ‑DI. This is done in column M and the
formula for cell M16:
=SUM(F3:F16) =ABS(K16-L16)
The formula for summing the -DM is in cell J16: The next column calculates the sum of the +DI and ‑DI. The formula
=SUM(G3:G16) for cell N16:
=K16+L16
The smoothing formula for the TR14 column begins at cell H17:
The next step is to calculate the DX, which is the ratio of the ab‑
=Round((TRUNC((H16-(H16/14)+E17),3),2) solute value of the difference between the +DI and the ‑DI divided by
The smoothing formula subtracts 1/14th of yesterday’s TR14 from yes‑ the sum of the +DI and the ‑DI. This is done in column O. The formula
terday’s TR14 and then adds today’s TR value.The rounding((truncating for cell O16:
function is used to calculate the indicator as close as possible to the =Round(100*(M16/N16)),0)
developer of the ADX’s original form of calculation (which was done The final step is smoothing the DX to arrive at the value of the
by hand). ADX. First, average the last 14 days of DX values. The formula for
The smoothing formula for the +DM14 column begins at cell I17: cell P28:
=Round((TRUNC((I16-I16/14)+F17),3),2) =AVERAGE(O15:O28)
The smoothing formula subtracts 1/14th of yesterday’s +DM14 from The smoothing process uses yesterday’s ADX value multiplied by
yesterday’s +DM14 and then adds today’s +DM value. The smoothing 13, and then add today’s DX value. Finally, divide this sum by 14. The
formula for the -DM14 column begins at cell J17: formula for cell P29:
=Round((TRUNC((J16-(J16/14)+G17),3),2) =Round((((P28*13)+O29)/14),0)
—S&C
The smoothing formula subtracts 1/14th of yesterday’s ‑DM14 value
from yesterday’s ‑DM14 and then adds today’s ‑DM value. Now we Readers can find a copy of this ADX spreadsheet file at our website, www.
have a 14-day smoothed sum of TR, +DM and ‑DM. The next step is traders.com, in the Article Code area in the May 2015 issue listing.

Explore Your Options
Got a question about options? Tom Gentile started his trading career on the floor
of the American Stock Exchange in 1994. He has appeared on many financial TV
and radio shows, as well as hosting a weekly talk show himself, and has co-authored
many books on the markets. He can be found at www.tomgentile.com. To submit a
question for Tom Gentile, post it to our website at http://Message-Boards.Traders.
com. Answers will be posted there, and selected questions will appear in a future
issue of S&C.
Tom Gentile
BUYING INSURANCE options. So what’s a trader to do, when starts calling in claims? Easy. They cut
Which way will oil and energy prices go opportunities present themselves in a their losses by reinsuring with a bigger
as we head into the spring and summer market such as oil and energy? company. So for instance, let’s say that
months, and how can you trade these ABC insurance sells $50 million in home
markets? Become the insurance salesman insurance and they want to hedge their
As spring creeps up on us, so does The best way to capitalize on this op- risk. What they do is perhaps reinsure so
the winter thaw out of the Northeast. portunity is to become an option seller. that if claims go over $100 million, they
For much of the winter season, record Selling options increases your probability are covered from that point on. Their risk
amounts of snowfall blanketed the north- of being right over time, but the risks if you is between $50 and $100 million, but no
eastern part of the United States, with are wrong increase as well, and in some more. You want to do the same thing
some storms so fierce, they were given cases can be unlimited risk. So how do with options. In Figure 2 is an example
names such as Pandora and Thor. insurance companies stay in business after
Those poor Nor’easters, as I like to a hurricane blows through and everyone Continued on page 45
call them, are happy that the winter
season of 2014–2015 is finally behind
them. So much so that “cabin fever” is
in full effect from North Carolina up to
Maine. People are eager to get out and
travel, and this should bode well for oil
and gas demand.
This year presents us with different
problems that were not around last sea-
son. For instance, there is a much greater
supply of oil worldwide, so perhaps prices
will shift up and down more on the
economy and off of international growth
than before. The move in oil over the last
year presents risks that were unseen in
years, no matter how much the demand
for oil might occur this summer. How
can a trader capitalize on this potential Figure 1: exploding option premiums. Premiums on USO options look to be three times higher than
opportunity with minimal risk? this time last year.
If there’s one thing that oil markets are
yielding these days, it’s uncertainty. All
of this uncertainty about the future price
of oil has option premiums exploding this
year versus last year. Looking at the chart
in Figure 1, this tells an option trader that
premiums on USO options look to be
three times higher than at this time last
year. That’s like seeing your car insur-
ance go up triple for the same coverage.
Good for the insurance salesman, bad Figure 2: hedging your risks. Here you’re selling the 16 puts and hedging the 14 puts for a combined credit
for you. The one thing we don’t want of 0.50 or $50 per spread. A credit spread has limited reward and risk. The risk is that USO drops in value, causing
to do as option traders is buy expensive the price of puts to rise. The most you can lose is the difference between strikes minus the credit received.

product review
Haguro Method
METASTOCK Overview
90 South 400 West, Suite 620 High High
Given that the Haguro method is
Salt Lake City, UT 84101 Japanese in origin, it shouldn’t
Phone: Sales 800 508 9180, Here, we see the open
& close below the
Open come as a surprise that it employs
support 801 265 9998 midpoint of the line. candlesticks. The current encod-
Email: sales@metastock.com, ing of the method is designed
support@metastock.com Close
to work with weekly charts.
Close
Product: MetaStock add-on There may be a daily strategy
based on the Haguro method This example shows worked out somewhere, but it’s
the open & close above
System requirements: Win- the midpoint of the line. not simply a matter of chang-
Open
dows 7 and above, 2.4GHz ing periodicity. For example,
or higher, 4GB RAM, 1.6GB Low Low when using weekly charts, gaps
disk space and other events are just about
Price: Free High
Figure 1: Candlestick Versus Midpoint. Candlestick patterns are
given a specific number to identify them. There are two groups with eight
eliminated.
price
patterns in each. One group will be based on bodies where the close is There are two parts to this
by S&C Staff greater than the open (the green candle on the left). The other group uses strategy. The first part looks at
where the candle is relative to
T
candlesticks where the body is red (that is, close<open). Within each group,
Middle
he Haguro method ofprice
chart specific patterns are based on the relationship of the body to the midpoint.
the midpoint of range, and the
analysis was written about second looks at where the close
by Seiki Shimizu in his of the week is relative to the last
book The Japanese Chart
Low
High
price
peak or valley of a 7% zigzag.
Of Charts, and we published price There’s no user manual that tells
16 15 13an article
12 10on the 14 method
11 by you how to trade this strategy,
Gary Burton in the April 2015 Middle but there is a video available on
issue of Technical Analysis of price YouTube titled “Trading The
Stocks & Commodities. The Haguro Method—Jeff Gibby”
method has now been adapted Low
that you can take a look at.
as a MetaStock add-on, which price
is available to MetaStock users 1 2 3 4 5 6 7 8 Range midpoint
at no additional cost. You can and candlestick
download the add-on from www. Figure 2: Identifying Numbers for Up Candle Bodies. Again, the body position
metastock.com/haguro. Burton, reference to “line” means “range.” The middle point is the midpoint calculated We’ll tackle the first part using
director of the Australian School charts from the video for some
as explained in the text of this article.
of Technical Analysis, had trans- of the explanation. The relation-

lated Shimizu’s work, and Jeff ship of the body to a midpoint
High
Gibby, Business Development price and whether the body is green
Manager for MetaStock, saw a (close>open) or red (close<open)
presentation by Burton on the (Figure 1) will determine the
method while attending a confer- Middle identifying pattern number
ence in Australia. Since Gibby price (Figure 2 for green bodies and
manages the development of Figure 3 for red bodies). Cal-
new software for MetaStock and culating the midpoint is simple:
also trades the market himself, Low It’s just (high+low)/2. But which
price
Gibby is well-qualified to evalu- midpoint do you use? Do you
ate new methods and strategies. 9 16 15 13 12 10 14 11 use this week’s midpoint, the
What he saw in the Haguro one from the previous week, or
Figure 3: Identifying Numbers For Down Candle Bodies.
method was unique, he thought, These down candle bodies versus midpoint have been put in the same
one from another week? You
and could be a potentially profit- order as those in Figure 2. Note that the Haguro numbering is no longer in use the midpoint for the week
able method to use. ascending order. with the largest range, which
you determine by comparing the cur-
rent week to the previous week and the
weeks before that.
To give you an idea of how these
patterns are employed with a price chart,
we’ll consider two patterns: number 3 The pattern you are looking for is no. 16 (see Figure 3)
AND the candle body and range are visibly larger than
(see Figure 2) and number 16 (Figure those of the preceding weeks, and thus the midpoint goes
3). The number 3 pattern is frequently through the middle of the body
found in reversals. Pattern 16 is one that
covers the middle of the range. According
to Burton, the strong trading period is
one where the range and body are vis-
ibly larger than in preceding weeks. It No. 3 pattern
is considered to be the soldier guarding (see Figure 2)
the area going forward, and the weakest
part of the soldier is the midriff, which, if
pierced, will result in certain death.
There are eight occurrences of pattern
16 in Figure 4, with the first three being
pointed out. As you can see in Figure FIGURE 4: WEEKLY CHART OF GM (General Motors). Here you see the two indicators of the Haguro method. In the
4, the midpoint acts as resistance on price chart, a black line with horizontal segments goes through the candles and is the midpoint calculation. The candles with
the left-hand portion of the price chart. the greatest range dictate the value of the midpoint. Above the price chart in an inner chart window is an indicator designed
to show normal versus extreme behavior. Note that the number 16 pattern appears eight times on this price chart.
Later on, the midpoint acts as support.
Also shown in Figure 4 is an example
of pattern 3 in action; note that pattern
3 is part of a trend and that it precedes a
trend reversal typically by two or three
The strategy looks at where the candle is
weeks. Finally, Figure 4 shows the two relative to the midpoint of range and where
indicators that are part of the Haguro the close of the week is relative to the last
method, namely Haguro - % in range peak or valley of a 7% zigzag.
zigzag and Haguro range. In this case,
the nearest zigzag peak or value (based
on a 7% zigzag) was used as a reference
point to calculate the percentage between
the valley or peak and this week’s closing
price. The number 3 pattern has the most
significance if it occurs when the market
is overextended because of the indicator
above the price chart exceeding 7%.
As you’ve probably figured out by
now, the pattern numbers do matter. To
help with this, there is a template as part
of the add-on. In Figure 5 you see the
same weekly chart of GM but with the
Haguro template applied. The template
labels every candle with its identifying
number. The dark line with horizontal
segments represents the midpoint.
The number 2 pattern is considered
a strong buy pattern and is seen as the
second candle in April in Figures 4 and 5
(also seen as the point where the midpoint
changes from resistance to support). But Figure 5: Weekly GM (General Motors). Applying the Haguro template to the price chart makes it easy to see the
you don’t have to memorize each of the patterns. Every candle is labeled with its identifying number. The dark line with horizontal segments is the midpoint. In the
first week of March (center of chart) the candle is labeled as 12 because there is no upper candle wick. But given its wide
patterns and what they mean. All you range, it’s a player in dictating price movement. The midpoint serves as resistance & support. In the earlier weeks on the
have to do is to add expert commentary left, the midpoint line acts as resistance, but in the middle of chart (April 2014), the midpoint acts as support.

to your chart (Figure 6). When you do,
you’ll get an explanation of whatever
candle is identified by the commentary
(seen as text to the right of the price
chart in Figure 6). Not surprisingly, the This caret is controlled
commentary will tell you that the pat- by arrows at the top of
the commentary
tern is more significant if it is occurring
when the 7% Haguro range indicator is
showing a value above or below 7%. The
indicator is displayed above the price
chart in Figure 6.
In this particular example, the com-
mentary included this text: “The range of
this stock has extended more than 7%.”
This is again a reference to the indicator
at the top of the chart and it identifies the
percentage change in price as measured
from the last 7% zigzag peak or valley
that is greater than (+) 7%.
Figure 6: Weekly GM (General Motors). Starting with the price chart shown in Figure 5, two changes have been
Other features made. Most apparent is the addition of expert advisory commentary on the right. A black caret on the price chart points
Two additional explorations are part of to the candle being described. You can control placement of the caret by using the arrows at the top of the commentary.
Each pattern is explained for you.
the add-on. The user manual for this add-
on is the video available on YouTube that
was mentioned toward the beginning of forward and robust. Gibby did the cod- Further reading
this review. One thing to keep in mind, ing, and the formula language he used Burton, Gary [2015]. “Candlesticks And
to avoid confusion, is that Burton often is clever and short. To use this add-on, The Haguro Method,” Technical
uses the terms longer line or shorter line you need MetaStock. If you don’t already Analysis of Stocks & Commodities,
to refer to range. use MetaStock and are looking for a Volume 33: April.
charting platform, consider that it has Shimizu, Seiki [1990]. The Japanese
Summary been the recipient of numerous Readers’ Chart Of Charts [English translation],
What a deal. This add-on makes use of Choice Awards in this magazine and is Shroff Publishers.
many great features of MetaStock such a top-notch program. Technical support ‡MetaStock
as expert advisories and explorations. is extremely capable and free.
MetaStock’s user interface is straight-
A Priori—Known ahead of time. open, the body is black. being a fraction of a common fundamental
Average Directional Movement Index (ADX)— Chandelier exit—A stop order calculated cycle length.
Indicator developed by J. Welles Wilder to based on either the highest high or the Market maker—A broker or bank continually
measure market trend intensity. close and some multiple of average true prepared to make a two-way price to pur-
Average true range—A moving average of range. chase or sell for a security or currency.
the true range. Drawdown—The reduction in account equity Moving average convergence/divergence
Back-resting—A strategy is tested or op- as a result of a trade or series of trades. (MACD)—The crossing of two exponen-
timized on historical data and then the Dynamic link library —Refers to a group of tially smoothed moving averages that are
strategy is applied to new data to see if small programs that can be used (“called”) plotted above and below a zero line. The
the results are consistent. by your main program while running crossover, movement through the zero
Candlestick charts—A charting method, under Windows. line, and divergences generate buy and
originally from Japan, in which the high Efficient market theory—All known informa- sell signals.
and low are plotted as a single line and are tion is already discounted by the market Volatility index—A widely used measure of
referred to as shadows. The price range and reflected in the price due to market par- market risk. Sometimes referred to as the
between the open and the close is plotted ticipants acting upon the information. “investor fear gauge.”
as a narrow rectangle and is referred to as Fast Fourier transform—A method by which
the body. If the close is above the open, to decompose data into a sum of sinusoids
the body is white. If the close is below the of varying cycle length, with each cycle

Explore Your Options
GENTILE
Continued from page 41
using USO.
USO as of this writing sits just above
$18. You believe the price will be above
$16 by summer, but want to be covered in
case you are wrong. You create a credit
spread using puts, selling the 16 puts
and buying the 14 puts for a combined
credit of 0.50 or $50 per spread. This is
the most that you can receive, if USO is
above $16 by mid-July. What are your
costs and risks of this type of spread?
A credit spread, as this is, has limited
reward and risk. The reward is limited
by the amount of money received, as you FIGURE 3: PLAYING THE NUMBERS. Oil has a 68% chance of being above the sell price of $16, and a 95%
chance of being above $14 by mid-July. You have a 68% chance of keeping the full amount collected ($50 per
make money when the spread drops in spread) and a 5% chance you will lose $150 per spread.
value to zero. So what’s the risk? The
risk is that USO drops in value, causing
the prices of puts to rise, so much so of USO is on the left, as well as where spread their risk around different areas,
that the 16 and 14 puts are deep in-the- you don’t want it to go. Statistically, oil and most important, they reinsure in
money. The good news is that because has a 68% chance of being above the risky demographics, where premiums are
of the purchase of the 14 puts, the most sell price of $16, and a 95% chance of highest. Do yourself a favor: If you are
that can be lost is the difference between being above $14 by mid-July. This means going to sell option premiums, do what
strikes, minus the credit received. there’s a 68% chance of keeping the full the insurance companies do. They have
Let’s dive into this a bit deeper. Look- amount collected ($50 per spread) and been in business a long time, and they
ing at Figure 3, this chart shows what you have a 5% chance that you will lose will be here long after we are gone!
could happen if the price of USO were $150 per spread.
to rise, fall, or stay the same over time. This is exactly how insurance com-
Figure 3 clearly shows where the price panies work—they play the numbers,
Q&A
BRIGHT orders. This discourages participants uled to begin in May 2015 and is expected
Continued from page 29 from placing passive limit orders on the to run for 12 months. Thus, it will be a
exchanges, which, at certain levels, may while before changes are implemented.
of the program’s terms hurt the case for impair public price discovery. Readers can view our complete comment
price improvement, and we address this Further, we are concerned about the letter at http://www.sec.gov/comments
in our submitted comments. so-called “dark markets” (that is, non- /4-657/4657-82.pdf or can read more
We strongly believe that the lack of dis- displayed bids & offers) in the market- about the pilot program itself at the
played liquidity in the small-cap space is place. Because of this, we recommend SEC’s website.
primarily due to the rise in off-exchange that one of the tests be modiﬁed to I will be interested to see the data
trading and broker–dealer internaliza- restrict broker–dealer internalization that the SEC starts to gather on the pilot
tion. Displayed market makers are set- to see if market quality improves in the program later this year. I’ll return to this
ting the price but not getting the reward underlying securities. topic then.
of getting the execution on their limit The pilot program is currently sched-

product review
MetaStock XIV
MetaStock Product: Trading platform by S&C Staff
M
90 South 400 West, Suite 620 System requirements: Windows 7
Salt Lake City, UT 84101 and above, 4GB RAM, 1.6GB disk etaStock has had a devoted
Phone: sales 800 508 9180 space; see website for specifics following since its early
Email: sales@MetaStock.com, Price: Daily charts, $499; real-time, days and continues to have
support@MetaStock.com $1,395 one. It’s a terrific product that has only
gotten better. In this version, navigation
is more robust, the Forecaster tool has
been enhanced, and there’s a new trading
system that’s part of version 14, just to
name a few of the changes. We’ll start
by looking at the power console.
Power console
In Figure 1 you see the new look of the
power console. If you are familiar with
MetaStock, the first thing you’ll notice
is the split screen. On one side is a tree
structure that lets you find the instrument
you want to use in your analysis. The
advantage of the tree structure is you can
start with a broad class of securities and
FIGURE 1: POWER CONSOLE SCREEN. On the far left are tabs you can use to select one of four major catego- then use subclasses to narrow your search
ries. For this screen capture, the major category chart was selected, but explore, system test, and forecaster are
to view only your pertinent subclass of
alternative choices. To the right of the tabs is a split screen, with the left-hand portion being an instrument (that is,
equities) tree structure and the right being chart options, such as the number of records to load and whether or equities. Since the charts tab on the left
not to use a template. At the top of the instrument tree for this screen capture, it reads “Instruments 1 of 359972.” was chosen, the right side of the screen
This means one instrument out of a possible 359,972 has been selected. Using the tree structure and looking for a lets you choose chart periodicity, use of
“1 of …” type of statement, the next class of items is public online data lists, followed by equities – North America,
a template, how many records you want
and then US ETF. From the list of ETFs, we selected the symbol QQQ.O.
to load, and more. It’s not obvious from
the screenshot for Figure 1, but you can
resize the power console screen. In earlier
versions, it was a fixed size.
At the very top of the tree list shown
in Figure 1 is the word instrument. If you
right-click on it, you will be prompted
with a screen that asks if you want to
manage your public online data list
or build a custom list. If your focus is
going to be North American instruments,
it might make sense to pare down the
tree a bit. Let’s say you select “manage
public lists…” You get a screen similar
to what you see in Figure 2. It’s simple
to use. All you have to do is scroll down
the list on the left, and use the buttons in
middle, that is, add, remove, and remove
FIGURE 2: PUBLIC LIST EDITOR. Choose an item from the left and then an action using the buttons in the all, and create a list of items you want to
middle to add, remove, or remove all from the list on the right. If you don’t like the order of the items in this newly
created list, select one and move it up or down using the move up and move down buttons on the right. You can
see. Give this newly formed list a name
create a header to name your list. Use a button on the right or pick a header from the left-hand list of equities and by using the header button. Then, the
add it to items on the right. next time you use the charts tab in the
power console, you’ll see just the list
you have created.
Other bells and whistles have been
added to this revised power console
interface, but one worth noting is that
you can now open a chart using a
template with several different periods.
For example, if you have a template
that has three charts with monthly,
weekly, and daily periodicities, you
can open that three-chart layout from
the power console. Prior to version 14,
if you opened that kind of template,
the software would have selected one
of the periodicities and used it for all FIGURE 3: Forecaster Price and Volume Chart. The title above the price series chart displays the symbol and
of the charts. Speaking of periodicity, the last event used from the library. The gray highlighted square overlaying the price series is the result of clicking & drag-
you can now create bars using ticks. ging a special mouse icon created when you choose user-defined pattern select in the upper right-hand corner. As soon
The interface defaults to a selection of as you click a second time, the area where you want to base your pattern is created and the dialog screen overlaying the
price appears asking you if you are done with the selection portion of the price chart with the pattern you want.
Fibonacci numbers. All of this is well
and good, but what will really tickle the
trader is the Forecaster. which way you want to go. You can it fits a price series.
draw the pattern free-hand, or you can In the Forecaster window there are
Forecaster start with the price series you’ve chosen two tabs: forecast analysis and event
This ingenious, clever feature unique to and locate the pattern you want. Let’s try recognizer library. Choose the former
MetaStock has been made better. Here’s the latter because it illustrates some of and then choose the price, volume, and
the idea: Suppose you wanted to know the steps you would go through if you event markers tab to arrive at a chart with
what a price would do after a technical choose the path of starting with a free- your selected price series. Clicking on a
event such as a Bollinger Band upward hand drawing and then seeing how well button in the upper right allows you to
breakout. Ideally, you would like to
see some sort of depiction of the prob-
ability of price change after this event
has occurred. When you say “after,” it
could range anywhere from a few days
up to 90 days. What Forecaster does is
find out, on a purely statistical basis, if
price moved in the direction you thought
it would, based on the technical event
that occurred.
MetaStock has over 70 events you can
choose from. If you are not exactly sure
what a specific event is, you can click on
the event and get a short and complete
textual description. In version 14, in
addition to adding six new events and
more ways to sort the results, MetaStock
has added the ability to draw your own
pattern and have the software match it
against a price series.
There are a couple of ways to go about
doing this. You start from the power
console, select the Forecaster tab, and
follow an instrument from the tree. Figure 4: Price Pattern Editor. The top portion reflects the pattern you identified in the price series defined in
You are now in the Forecaster, which Figure 3 by clicking & dragging the mouse cursor over the area of interest in the price series. Circles connect straight-line
has its own window separate from the
segments. The circles correspond to closing prices from your price series, and only the closing prices that require a change
in direction. You can use your mouse to alter the shape of the pattern, you can decide how many price bars you want in the
MetaStock XIV window. Here’s where pattern, the sensitivity, and your cloud focus. There’s a button on the lower-left corner of the circle and line diagram that
you are going to make a decision about allows you to get the pattern quick test, which is displayed in the bottom portion with green and red segments.

Figure 5: Forecast Cloud. This forecast cloud shows the probability (shown as different colors, for example, blue is about a 50% probability) on a grid that uses
price percentage for the y-axis and bars after the event for the x-axis. The thermometer on the right is a scale showing which color corresponds to which probability.
use your mouse in a click & drag fashion pattern, you can easily save it in the event Other
to identify the portion of the price series recognizer library, which is one of the Another feature of MetaStock XIV is
you want for your pattern (Figure 3). first tabs you could have chosen from the the LCI trading system. It is so robust
In Figure 3 you see a dialog screen Forecaster window. Once saved, you can that it will take a second review to cover
overlaying the price series. In that dialog select the pattern and request the software it sufficiently. Suffice it to say, it is a
screen is this question: “Do you want to find out how well it did in actual use system based on support & resistance
to capture the selected price formation by selecting the tab that lets you see the using support & resistance calculations
as a user-defined pattern?” If you select forecast cloud (Figure 5). and Fibonacci levels.
the “yes” button on the right, it’ll result You get to make a couple of important You can find a number of webinars on
in the upper portion of the screen you inputs from the screen shown in Figure 4. YouTube that will help you understand
see in Figure 4. The series of straight One of these is pattern match sensitivity. how to use the Forecaster feature and
lines drawn between the circles is a You have three choices: high, medium, or the LCI system. There is also friendly
representation of the pattern you located low. The idea behind these three choices and knowledgeable support available at
in Figure 3. You can take your cursor is to give the user the ability to say how no extra cost.
and move the circles to draw a slightly closely they want to have the pattern
different pattern or you can create a new match a part of the price series. If you Summary
one. You can now name your pattern to select low sensitivity, you’ll have more With navigation made easier and more
save it in the event library. Next, you events but the match may not be too close features added to the Forecaster, this
can click on the button pattern quick to what you’re looking for. You could go new iteration has made an outstanding
test, which will display what you see in to the opposite extreme and select high product even better.
the bottom portion of Figure 4. sensitivity, in which case you’ll probably
The quick test allows you to scroll get fewer events but with a much better Further reading
your price series underneath your pattern match. A key element in this process is Gopalakrishnan, Jayanthi [2013].
to see how well it fits other parts of the that a cloud will not be drawn if there are “Charting The Future With Scott
price series. This makes perfect sense fewer than three events. In other words, Brown” (interview with CEO of
since you have the ability to alter the your pattern must match some part of the MetaStock), Technical Analysis of
shape of your pattern using the circle and price series at least three times. Thus, a Stocks & Commodities, Volume
line diagram that is displayed above the key result is in the heading of Figure 5, 31: October.
pattern quick test. When you get to the which states that the cloud is based on S&C Staff [2013]. “MetaStock 12,”
point where you are satisfied with the the most recent 14 events. product review, Technical Analysis
of Stocks & Commodities, Volume
31: January.
S&C Staff [2014]. “MetaStock XIII,”
Navigation is more robust, the Forecaster Technical Analysis of Stocks &
tool has been enhanced, and there is a Commodities, Volume 32: March.
new trading system in this version. ‡MetaStock

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technology solutions to advisory firms. key energy benchmarks including oil,
For this month’s Traders’ Tips,
the focus is Giorgos Siligardos'
article in this issue, “Filtering
Price Movement.” Here, we pres-
ent the May 2015 Traders’ Tips
code with possible implementa-
tions in various software.
Code for MetaStock is already provided by Siligardos
in his article, which S&C subscribers will find in the Sub-
scriber Area of our website:
• Traders.com  Home–S&C Magazine 
S&C Article Code
The code for the Traders’ Tips section is posted here:
• Traders.com  Home–S&C Magazine 
Traders’ Tips
(Or from Traders.com, scroll down to the current articles

section and click on the Traders’ Tips tab.)
The Traders’ Tips section is provided to help the reader
implement a selected technique from an article in this is-
sue or another recent issue. The entries here are contrib-
uted by software developers or programmers for software
Figure 1: TRADESTATION. Here, the zzTop indicator is applied to an intraday
that is capable of customization. chart of IBM.
method void LoadBarDataVector ()

begin
if BarData <> NULL then
BarData.Push_Back(
F TRADESTATION: MAY 2015 TRADERS’ TIPS CODE DTPoint.Create( BarDateTime, Close ) astype DTPoint ) ;
In “Filtering Price Movement” in this issue, author Giorgos end ;
Siligardos describes a process to analyze historical market
method DTPoint BisectPairs ( Vector DTPPair )
data. He begins by describing a concept that he refers to as variables: DTPoint BegDTP, DTPoint EndDTP,
perceptually important points (PIPs), which he uses to identify DTPoint MidDTP,
price extremes. From these, he creates an indicator he calls int BarDataStartIndex, int BarDataEndIndex,
int BarDataCnt,
zzTOP that identifies these points and then connects them int HighDiffIndex, double HighDiff,
using trendlines. int Count, double TL_Val ;
begin
For convenience, we’re providing the code for a TradeSta- HighDiffIndex = 0 ;
tion indicator based on the author’s description. HighDiff = -999999 ;

Indicator: _zzTop BegDTP = DTPPair.Items[0] astype DTPoint ;
EndDTP = DTPPair.Items[1] astype DTPoint ;
using elsystem;
using elsystem.collections ; for Count = 0 to BarData.Count - 1
using elsystem.drawingobjects ; begin
using elsystem.drawing ; if (BarData.Items[Count] astype DTPoint).DateTimeOfBar =
BegDTP.DateTimeOfBar then
inputs: BarDataStartIndex = Count ;
int Iterations( 3 ); if (BarData.Items[Count] astype DTPoint).DateTimeOfBar =
EndDTP.DateTimeOfBar then
variables: BarDataEndIndex = Count ;
Vector BarData ( NULL ), // Bar DTP end ;
Vector Segments ( NULL ); // of Rounds of Pairs
BarDataCnt = BarDataEndIndex - BarDataStartIndex ;
method void CreateTL ( DTPoint Begin_DTP, if BarDataCnt = 0
DTPoint End_DTP ) then BarDataCnt +=1 ;
variables: TrendLine New_TL ; for Count = BarDataStartIndex to BarDataEndIndex
begin begin
New_TL = TrendLine.Create( Begin_DTP, End_DTP ) ; // Find TL Value
New_TL.ExtLeft = false ; TL_Val = (BarData.Items[BarDataStartIndex]
New_TL.ExtRight = false ; astype DTPoint).Price astype double +
New_TL.Persist = true ; (( BarData.Items[BarDataEndIndex] astype DTPoint).
New_TL.Color = Color.Aquamarine ; Price astype double -
DrawingObjects.Add( New_TL ) ; (BarData.Items[BarDataStartIndex] astype DTPoint).
end ; Price astype double )

* ( ( Count ) / BarDataCnt ) ; ClearPrintLog ;
if AbsValue( TL_Val - (BarData.Items[Count] astype DT- BarData = new Vector ;
Point). Segments = new Vector ;
Price astype double ) > HighDiff then end ;
begin
HighDiff = AbsValue( TL_Val - if BarStatus( DataNum + 1 ) = 2 then
(BarData.Items[Count] astype DTPoint).Price astype LoadBarDataVector () ;
double ) ;
HighDiffIndex = Count ; once ( LastBarOnChartEx )
end ; begin
end ; SeedSegmentsVector( ) ;
MidDTP = BarData.Items[HighDiffIndex] astype DTPoint ; For Value1 = 1 to Iterations
return MidDTP ; begin
end; findDiffBisect( ) ;
end ;
method void findDiffBisect( ) DrawAllTLs( ) ;
variables: Vector RecursRound, Vector NewRound, end ;
Vector NewPairR, Vector NewPairL,
int Count, bool OKToUse, To download the EasyLanguage code, please visit our
DTPoint BegDTP, DTPoint EndDTP, DTPoint Mid-
DTP ;
TradeStation and EasyLanguage support forum. The code
begin can be found here: http://www.tradestation.com/TASC-
NewRound = new Vector ; 2015. The ELD filename is “_TASC_ModifiedTrueRange.
RecursRound = new Vector ;
OKToUse = false ; ELD.” For more information about EasyLanguage in gen-
RecursRound = segments.Items[Segments.Count -1] astype eral, please see http://www.tradestation.com/EL-FAQ.
Vector ; A sample chart is shown in Figure 1.
for Count = 0 to RecursRound.Count -1
begin This article is for informational purposes. No type of trading
begin or investment recommendation, advice, or strategy is being made,
MidDTP = BisectPairs( RecursRound.Items[Count] given, or in any manner provided by TradeStation Securities or its
astype Vector ) ; affiliates.
NewPairL = new Vector ;
NewPairL.Push_Back( (RecursRound.Items[Count] —Doug McCrary
astype Vector).Items[0] astype DTPoint ) ; TradeStation Securities, Inc.
NewPairL.Push_Back( MidDTP astype DTPoint ) ; www.TradeStation.com
NewRound.Push_Back( NewPairL astype Vector ) ;
NewPairR = new Vector ;
NewPairR.Push_Back( MidDTP astype DTPoint ) ;
NewPairR.Push_Back( (RecursRound.Items[Count]
astype Vector).Items[1] astype DTPoint ) ;
NewRound.Push_Back( NewPairR astype Vector ) ; F eSIGNAL: MAY 2015 TRADERS’ TIPS CODE
end ; For this month’s Traders’ Tip, we’ve provided the formulas
end ;
Segments.push_back( NewRound ) ; zzTOP.efs and zzTOPauto.efs based on the formulas described
end ; in Giorgos Siligardos’ article in this issue, “Filtering Price
method void SeedSegmentsVector()
Movement.”
variables: Vector RecursRound, Vector Pair ; The studies contain formula parameters to set the desired
begin period and price, which may be configured through the edit
Pair = new Vector ;
RecursRound = new Vector ; chart window (right-click on the chart and select “edit chart”)
Pair.Push_Back( BarData.Items[0] astype DTPoint ) ;
Pair.Push_Back( BarData.Items[BarData.Count -1] astype
DTPoint ) ;
RecursRound.Push_Back( Pair astype Vector ) ;
Segments.Push_Back( RecursRound astype Vector ) ;
end ;
method void DrawAllTLs( )

variables: Vector RecursRound, Vector Pair, int Count ;
begin
Pair = new Vector ;
RecursRound = new Vector ;
RecursRound = Segments.Items[Segments.Count -1] astype
vector ;
Print( "TLStart" ) ;
for Count = 0 to RecursRound.Count -1
begin
Pair = RecursRound.Items[Count] astype Vector ;
CreateTL( Pair.Items[0] astype DTPoint, Pair.Items[1]
astype DTPoint );
end ;
end ;
once Figure 2: eSIGNAL. Here is an example of the study implemented on a chart of

begin Boston Scientific Corp. (BSX).

to set the desired period and price. A sample chart is shown
in Figure 2.
To discuss these studies or download a complete copy
of the formulas’ code, please visit the EFS Library Discus-
sion Board forum under the forums link from the support
menu at www.esignal.com or visit our EFS KnowledgeBase
at http://www.esignal.com/support/kb/efs/. The eSignal for-
mula scripts (EFS) are also available for copying & pasting
from the Stocks & Commodities website at Traders.com
in the Traders’ Tips area.
—Eric Lippert
eSignal, an Interactive Data company
800 779-6555, www.eSignal.com
Figure 4: WEALTH-LAB. Wealth-Lab’s zzTOPauto routine automatically adjusts

for the chart pane’s log or arithmetic scale.
F THINKORSWIM: MAY 2015 TRADERS’ TIPS CODE
In “Filtering Price Movement” in this issue, author Giorgos
Siligardos takes a fresh look at the old technical analysis tool
zigzag. He discusses the limitations of a traditional zigzag
indicator and introduces concepts to strengthen it.
We have recreated his zzTOP study using our proprietary F WEALTH-LAB: MAY 2015 TRADERS’ TIPS CODE
scripting language thinkscript. We have made the loading We’ve implemented the perceptually important points (PIPs)
process extremely easy: Simply click on the link http://tos. method introduced by Giorgos Siligardos in his article in this
mx/npjeNL and choose “save script to thinkorswim,” then issue, “Filtering Price Movement,” in a script study. The script
choose to rename your study to “zzTOP.” You can adjust the uses a recursive call to find the PIP having the maximum ab-
parameters of these within the edit studies window to fine- solute value of the vertical distance from the line connecting
tune your variables. two PIPs previously found. The price movement plot is based
In the example in Figure 3, we have added a 10-leg strat- on a user-specified percentage.
egy version of the zzTOP on a thinkorswim chart of Ball As suggested by the article’s author, for a DataSeries plotted
Corp. (BLL). Refer to Siligardos’ article for a detailed de- in the arithmetic scale, the minimum vertical distance required
scription of the strategy. to find a PIP is the percentage of the DataSeries’ entire range,
—thinkorswim whereas a fixed vertical distance in a logarithmic plot is
A division of TD Ameritrade, Inc. inherently represented equally by the same percentage. For
www.thinkorswim.com example, on a log chart, the distance between 1 and 10 is the
same as that between 10 and 100 (or for any other 1,000%
price change).
Finally, note that due to the manner in which the indicator
is constructed, the zzTOP indicator must not be used for
backtesting, but rather could be useful for digitally scanning
numerous charts for patterns.
The Wealth-Lab code listing is shown at Traders.com in
the Traders’ Tips area.
See Figure 4 for an example chart.
—Robert Sucher
Wealth-Lab, www.wealth-lab.com
F AMIBROKER: MAY 2015 TRADERS’ TIPS CODE

In “Filtering Price Movement” in this issue, author Giorgos
Siligardos presents a new zigzag-style indicator for visual
identification of price patterns, which he calls zzTOP. Using
Figure 3: THINKORSWIM. This example chart shows a 10-leg version of the AmiBroker’s formula language (AFL), it’s possible to write
zzTOP study on a daily chart of Ball Corp. (BLL).

{
if ( pips[ i ] )
{
x1 = i;
if ( x1 > x0 )
{
curdist = 0;
newpip = FindMiddlePIP( data, x0, x1, "curdist" );
if ( newpip != -1 AND curdist > maxdist )

{
maxdist = curdist;
if ( oldpip != -1 )
pips[ oldpip ] = 0; // remove smaller one
pips[ newpip ] = 1;
oldpip = newpip;
}
Figure 5: AMIBROKER. Here is a sample chart showing the zzTop indicator applied
on ASML daily data, replicating the chart from Siligardos’ article in this issue. x0 = x1; // next leg
x1 = -1; //
}
code directly in AmiBroker in a short and concise way without }
}
having to use an external DLL and/or external languages. The }
code listing follows.
An example of the zzTOP indicator as implemented on an // draw lines connecting pip points
x0 = 0;
AmiBroker chart of ASML Holdings is shown in Figure 5. x1 = -1;
zzline = Null;
AmiBroker code listing for ( i = 0; i < BarCount; i++ )
{
SetBarsRequired( sbrAll, 0 ); if ( pips[ i ] )
{
function FindMiddlePIP( data, x0, x1, curdist ) x1 = i;
{ line = LineArray( x0, data[ x0 ], x1, data[ x1 ] );
bi = BarIndex(); zzline = IIf( NOT IsNull( line ), line, zzline );
x0 = x1;
y0 = data[ x0 ]; }
y1 = data[ x1 ]; }
line = y0 + ( y1 - y0 ) * ( bi - x0 ) / ( x1 - x0 ); if ( LogMode )
zzline = exp( zzline );
distance = abs( data - line );
maxbars = HHVBars( distance, x1 - x0 ); Plot( zzline, "zzTop", colorRed, styleThick );
pipbar = Nz( x1 - maxbars[ x1 ], -1 ); Plot( C, "Price", colorDefault );
if ( pipbar != -1 )
VarSet( curdist, distance[ pipbar ] ); —Tomasz Janeczko, AmiBroker.com
www.amibroker.com
return pipbar;
}
LogMode = ParamToggle( "Mode", "Linear|Logarithmic", 0 ); F NEUROSHELL TRADER:

MaxLegs = Param( "MaxLegs", 20, 4, 35 );
MAY 2015 TRADERS’ TIPS CODE
data = Close; The PIPs (perceptually important points) method
// one leg first - from start to end
legs = 1;
described by Giorgos Siligardos in his article in this issue,
pips = 0; “Filtering Price Movement,” can be easily implemented in
pips[ 0 ] = 1; NeuroShell Trader using NeuroShell Trader’s ability to call
pips[ BarCount - 1 ] = 1;
external dynamic linked libraries (DLLs). Dynamic linked
if ( LogMode ) data = log( Data ); libraries can be written in C, C++, Power Basic, or Delphi.
After writing the indicator code in your preferred compiler
for ( ; legs < maxlegs; legs++ )
{ and creating a DLL, you can insert the resulting indicators
x0 = 0; as follows:
x1 = -1;
oldpip = -1;
maxdist = 0; 1. Select new indicator from the insert menu
2. Choose the External Program & Library Calls category
for ( i = 0; i < BarCount; i++ )
3. Select the appropriate External DLL Call indicator

Figure 6: NEUROSHELL TRADER. This NeuroShell Trader chart shows the zzTOP FIGURE 7: EXCEL, User Controls. Here you see the controls implemented in
indicator applied to the closing price and the zzTOPauto indicator applied to an the spreadsheet for the zigzag, zzTOP, and zzTOPauto indicators.
MACD indicator.
4. Set up the parameters to match your DLL Traders’ Tips.

5. Select the finished button. A sample chart is shown in Figure 6.
—Marge Sherald, Ward Systems Group, Inc.
As noted by Siligardos in his article, these indicators 301 662-7950, sales@wardsystems.com
“change their historical values when new data comes in” and www.neuroshell.com
thus should not be used for backtesting or automated trad-
ing, and instead should only be used “as a digital substitution
for your eyes” when scanning charts. F MICROSOFT EXCEL: MAY 2015 TRADERS’ TIPS CODE
Users of NeuroShell Trader can go to the Stocks & Com- In “Filtering Price Movement” in this issue, author Giorgos
modities section of the NeuroShell Trader free technical Siligardos shows us a tool that lets us determine the level of
support website to download a copy of this or any previous price swing detail that we wish to pay attention to.
FIGURE 8: EXCEL, zzTOP Interval Controls. Slider controls allow you to immediately see the effects of changing the starting and ending points for the
zzTOP indicator.

FIGURE 9: EXCEL, ZigZag and All. Here, the interval is the full chart and we can see how the zzTOP indicators stack up against a standard zigzag over the same
interval.
Much like zooming in on a map from satellite level down Use the checkboxes to select the indicator or indicators
to neighborhood level, the closer we get, the more fine de- you wish to display as a way to control chart clutter.
tail we can see. What he calls perceptually important points In Figure 9, the interval is the full chart and we can see
(PIPs) can do that for us. When we ask for only a few PIPs, how the zzTOP indicators stack up against a standard zigzag
we are highlighting the large (high-level) moves and ignor- over the same interval.
ing the small ones. As we ask for more points, we are, in
effect, zooming in to highlight the ever-finer details. Additional uses for PIPs
The zigzag indicator I will use here was excerpted from (perceptually important points)
the spreadsheet I built for my June 2013 Traders’ Tips sub- In 2010, while Google and I were looking for discussions of
mission (which readers can find in the Traders’ Tips archive pattern matching in time series data, I came across an inter-
at Traders.com). I am using that indicator as a starting point esting master’s thesis written in 2008 titled “Novel Pattern
since Siligardos’ article in this issue compares the behaviors Matching Methods For Stock Data Analysis” by Zhang Zhe,
of his zzTOP indicators to the traditional zigzag. City University of Hong Kong. It’s a fairly accessible read
My implemention of the zzTOP indicator in Excel has and proposes a three-step process for locating and identify-
three user controls (see Figure 7): ing patterns such as head & shoulders in a time series stream.
Interested readers can access a free PDF of the paper at:
• Type in the number of legs you want to see
• Click on the checkbox to toggle between arithmetic or http://lbms03.cityu.edu.hk/theses/abt/mphil-is-
logarithmic calculation modes b23405983a.pdf.
• Click one or more times on the gray button to select the The spreadsheet file for this Traders’ Tip can be down-
pricing column to use in calculation of the indicator. loaded from www.traders.com in the Traders’ Tips area. To
This “tumbler” button includes a hybrid choice of Hi:Lo successfully download it, follow these steps:
Combo.
• Right-click on the Excel file link (“PIP_Filters.xlsm”),
In the Hi:Lo Combo mode, both the high and low of a bar then
are tested when selecting candidate points. This behavior is • Select “save as” to place a copy of the spreadsheet file
similar in concept to the standard zigzag and can produce a on your hard drive.
very choppy zzTOP indicator.
The zzTOPauto version of the indicator swaps the specific —Ron McAllister
number of legs for a proximity test, but otherwise, the con- Excel and VBA programmer
rpmac_xltt@sprynet.com
trols behave the same way.
To be able to see the effects of changing the starting and
ending points for the zzTOP indicators, I have provided the
ability to specify the interval of interest via slider controls
(Figure 8). These can be used to step the left and right edges
of the computation interval in or out and immediately see
what happens to the indicator.
FUTURES LIQUIDITY
T
rading liquidity is often over- very high volumes. The greatest number three-year period. Thus, all numbers in
looked as a key technical of dots indicates the greatest activity; this column have an equal dollar value.
measurement in the analysis futures with one or no dots show little Columns indicating percent margin
and selection of commodity activity and are therefore less desirable and effective percent margin provide
futures. The following explains how to for speculators. a helpful comparison for traders who
read the futures liquidity chart pub- Courtesy of CBOT wish to place their margin money ef-
lished by Technical Analysis of Stocks ficiently. The effective percent margin
& Commodities every month. is determined by dividing the margin
value ($) by the three-year price range of
Commodity futures contract dollar value, and then multiply-
The futures liquidity chart shown being by one hundred.
low is intended to rank publicly traded
futures contracts in order of liquidity. Stocks
Relative contract liquidity is indicated Trading liquidity has a significant ef-
by the number of dots on the right-hand fect on the change in price of a secu-
side of the chart. rity. Theoretically, trading activity can
This liquidity ranking is produced by serve as a proxy for trading liquidity
multiplying contract point value times All futures listed are weighted equally and equals the total volume for a given
the maximum conceivable price motion under “contracts to trade for equal dol- period expressed as a percentage of the
(based on the past three years’ historical lar profit.” This is done by multiplying total number of shares outstanding. This
data) times the contract’s open interest contract value times the maximum pos- value can be thought of as the turnover
times a factor (usually 1 to 4) for low or sible change in price observed in the last rate of a firm’s shares outstanding.
Trading Liquidity: Futures

Commodity Futures Exchange % Margin Effective Contracts to Relative Contract Liquidity
% Margin Trade for Equal
Dollar Profit
E-Mini S&P 500 GBLX 3.7 9.2 5 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>>
S&P 500 Index CME 3.7 9.2 1 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
Crude Oil WTI NYMEX 10.8 7.4 3 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••
Gold COMEX 7.7 14.9 3 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••
Russell 2000 Mini ICEUS 3.5 8.2 4 ••••••••••••••••••••••••••••••••••••••••••••••••••
Euro FX CME 1.8 6.2 5 ••••••••••••••••••••••••••••••••••••••••••••••••
E-Mini Nasdaq 100 GBLX 2.5 5.4 5 •••••••••••••••••••••••••••••••••••••••••
Japanese Yen CME 2.6 4.7 4 ••••••••••••••••••••••••••••
Natural Gas NYMEX 8.9 6.7 6 •••••••••••••••••••••••
Sugar #11 ICEUS 11.2 11 14 •••••••••••••••••••
Gasoline RBOB NYMEX 8 8.7 3 ••••••••••••••
Australian Dollar CME 2.1 5.7 7 ••••••••••••
Corn CBOT 14 11.8 9 •••••••••••
E-Mini S&P Midcap GBLX 2.9 6.8 3 ••••••••••
Soybeans CBOT 9.4 11.2 5 ••••••••••
DJIA mini-sized CBOTM 3 9.1 7 ••••••••
Nasdaq 100 CME 2.5 5.5 1 •••••••
British Pound CME 1.4 9.4 15 ••••••
Canadian Dollar CME 1.4 4.5 9 ••••••
U.S. Dollar Index ICEUS 1.3 6.7 11 •••••
CBOE S&P 500 VIX CFE 7.7 10.2 17 ••••
Cotton #2 ICEUS 7.9 14.3 12 ••••
Lean Hogs CME 6.1 4.7 7 ••••
Live Cattle CME 2.1 7.3 11 ••••
Platinum NYMEX 6.7 12.8 7 ••••
Soybean Meal CBOT 8.3 11.7 9 •••
Wheat CBOT 12.2 15.5 10 •••
Crude Oil Brent (F) NYMEX 8.9 7 3 ••
Eurodollar CME 0.1 81.9 507 ••
Soybean Oil CBOT 9.2 10.4 13 ••
Swiss Franc CME 1.7 8.8 8 •• CBOT Chicago Board of Trade, Division of CME
10-Year T-Note CBOT 1.1 22.2 31 • CFE CBOE Futures Exchange
DJIA CBOT 3 9.2 3 • CME Chicago Mercantile Exchange
Hard Red Wheat KCBT 8.8 13.1 11 •
COMEX Commodity Exchange, Inc. CME Group
Mexican Peso CME 6.7 25.2 24 •
GBLX Chicago Mercantile Exchange - Globex
S&P GSCI CME 7.7 10 3 •
ICE-EU Intercontinental Exchange-Futures - Europe
T-Bond CBOT 2.3 16.2 10 •
Ultra T-Bond CBOT 2.5 11.9 6 • ICE-US Intercontinental Exchange-Futures - US
2-Year T-Note CBOT 0.1 26.7 183 KCBT Kansas City Board of Trade
30-Day Fed Funds CBOT 0 85.6 873 MGEX Minneapolis Grain Exchange
5-Year T-Note CBOT 0.6 16.8 47 NYMEX New York Mercantile Exchange
Canola WCE 5.9 11.7 45
Class III Milk CME 5.6 9.7 12
Cocoa ICEUS 6.7 24.5 27
Coffee ICEUS 9.2 16.1 7 1505
Trading Liquidity: Futures is a reference chart for speculators. It compares markets “Relative Contract Liquidity” places commodities in descending order according to
according to their per-contract potential for profit and how easily contracts can be bought how easily all of their contracts can be traded. Commodities at the top of the list are easi-
or sold (i.e., trading liquidity). Each is a proportional measure and is meaningful only est to buy and sell; commodities at the bottom of the list are the most difficult. “Relative
when compared to others in the same column. Contract Liquidity” is the number of contracts to trade times total open interest times a
The number in the “Contracts to Trade for Equal Dollar Profit” column shows how volume factor, which is the greater of:
many contracts of one commodity must be traded to obtain the same potential return In volume
as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price 1 or exp –2
In 5000
Excursion).

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

The following selection of book descriptions represents a sampling of recent book connection between
releases in the investing field. Books described here may be from some of the ma- the movements of
jor book publishers as well as some independent book publishers. These are not planets and the vol-
critical reviews or editorial evaluations, but rather a brief look at the book market-
atility of the market.
place to help keep readers up to date on new or recent book offerings.
The book presents
Pasavento’s informa-
21st Century Point And explains how headlines affect the mar- tion in the context of
Figure (200 pages, £45 ket, and which noise (including talking one hundred years of
hardcover, 2015, ISBN heads in the media) and fads inves- historical data, and he instructs the reader
9780857194428) by Jere- tors should tune out. He teaches sim- to spot correlations from the past, then re-
my du Plessis, published ple tricks to think differently, which may fers to planetary and lunar data for the next
by Harriman House Press. help the investor to get it right more of- five years to help readers shape their own
From the author of The De- ten than not. He addresses how far strategy. The book covers the principles of
finitive Guide To Point And ahead an investor should look. A suc- astrological forecasting as applied to the fi-
Figure, this book seeks to cessful investment strategy requires in- nancial markets, explaining what to watch
bring point & figure chart- formation, preparation, brainpower, and for and how to interpret planetary and lu-
ing into the modern age. Point & figure has some luck, according to the author, and in nar activity, and offers guidance on every-
been around for more than 130 years; while this book he presents a tactical approach day practical application. For traders who
the basic principles of the technique have based on going against the grain. have always wanted to know what to do
remained unchanged, those working with www.wiley.com when Mercury is in retrograde or the moon
point & figure can try to push the boundar- is new, this market educator offers his in-
ies of how it is used in order to make it more Trading As A Business: The Methods struction.
effective and useful. Some analysts believe And Rules I've Used To Beat The Mar- www.wiley.com
that the lack of a time element on point & kets For 40 Years (168 pages, $60 soft-
figure charts means that time-based tools cover, $39.99 ebook, Fundamentals Of
and indicators can’t be used with them, January 2015, ISBN Actua rial M athe -
or that the lack of a volume component 978-1-118-47298-9) matics, 3rd ed. (552
means that the importance of individual by Dick Diamond, pages, $85 hardcov-
columns can’t be determined. However, in published by Wiley. er, $ 68.99 ebook,
his new book, du Plessis shows that nei- This book seeks to January 2015, ISBN
ther is the case, and that with some lateral provide a behind- 978-1-118-78246-0)
thinking, a host of other techniques can be the-scenes look at by S. David Prom-
added to point & figure charts and analysis. how the author says islow, published by
Finally, the author introduces a point & fig- he became a successful independent trad- Wiley. This book covers both the determin-
ure–based oscillator that can also be used er. The book discusses Diamond’s meth- istic and stochastic models of life contin-
on time-based charts. All topics are illus- ods for analyzing the market and timing gencies, risk theory, credibility theory, mul-
trated with color charts. trades, including his 80%/20% strategy tistate models, and an introduction to mod-
www.harriman-house.com and his six statistics that he believes are ern mathematical finance. This third edition
critical for determining where the stock restructures the material to fit into modern
Beat The Crowd: How market is headed. The book outlines what computational methods and provides sev-
You Can Out-Invest Diamond believes it takes to become an eral spreadsheet examples throughout. It
The Herd By Thinking independent trader who can make money includes new chapters covering stochas-
Differently (308 pag- over the long haul. tic investments returns and universal life
es, $29.95 hardcov- www.wiley.com insurance. Elements of option pricing and
er, March 2015, ISBN the Black-Scholes formula are introduced.
978-1-118-97305-9) A Trader’s Guide To Financial Astrology: It also covers the syllabus for the Institute
by Kenneth L. Fish- Forecasting Market Cycles Using Plan- of Actuaries subject CT5.
er & Elisabeth Del- etary And Lunar Movements (240 pag- www.wiley.com
linger, published by es, $90 softcover, $58.99 ebook, January
Wiley. This book is presented as a contrar- 2015, ISBN 978-1-118-36939-5) by Larry
ian’s guide to investing, with explanations Pasavento and Shane Smoleny, pub-
of how a true contrarian investor thinks and lished by Wiley. This book is a guide to
acts, and why it can work. The author ex- trading market cycles based on astrologi-
plains why the crowd often goes astray, cal data. Cowritten by well-known technical
and how the investor can stay on track. He analyst Larry Pasavento, the book states a

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For Technical analYsis

AT THE CLOSE
Place Your Bets
Gambling, Speculating, & Investing

What do these terms mean as applied to the participant in tense emotions. For example, we can agree that betting in the
the financial markets? Let’s have a look to try to come up Powerball lottery with a 1-in-175 million chance of winning
with some clear definitions. is gambling. Betting on a favorite team to win the Super Bowl
or on a favorite horse or jockey is similarly a high-risk play.
B
We have no control over the outcome and the odds are not in
ernard Baruch, the famed American financier and inves- our favor. But the stakes are usually low, and the thrill of the
tor, often repeated the following quotation, which he experience compensates for the ridiculously low odds of win-
attributed to Sir Ernest Cassel, good friend and banker ning. Now, when you bring that same mindset to the financial
to King Edward V11: markets in general or to the stock market in particular, you
are condemned to bet blindly, make high-risk bets character-
medieval backgammon scene: carmina boranus/wooden board: Lonely Walker/ collage: nikki Morr
When as a young and unknown man I started to be successful I
ized by recklessness and intense emotions, and our results are
was referred to as a gambler. My operations increased in scope
and volume. Then I was known as a speculator. The sphere of my
unlikely to be any different from those of the novice gambler
activities continued to expand and presently I was known as a hoping for luck in the Powerball lottery or on the races. But in
banker. Actually I had been doing the same thing all the time. gambling, as in speculating and investing, there is a minority
of participants who consider themselves professionals and
Much the same could be said today for gambling, speculating, who win consistently. What is it that this minority does that
and investing. When you start off, your operations are small sets them apart from the majority? I will attempt to answer
and people call you a gambler. As your operations grow, they this question later on in this article.
call you a speculator, and then when your operations are of
a decent size, you achieve a level of respectability and you Can you improve the odds by speculating?
become known as an investor. What do these terms really If gambling is characterized by high risk, recklessness, and
mean when applied to market participants? Can we arrive at intense emotions, what then is the commonly held view of
some clear definitions and remove some of the ambiguities speculating? To most people, it is no more respectable than
embedded in the common usage of these terms? gambling. In some corners of the investing world, speculat-
ing is viewed as dishonorable, seedy, and unwholesome. It
Is stock trading gambling? is the province of oily traders trying to wrest out a fast buck
For the novice player, gambling is a high-risk play on the from the markets, staring in darkened dens at screens lit up
outcome of an event characterized by recklessness and in- by red and green flashing lights. It is no more reputable than
by Stella Osoba
AT THE CLOSE
analysis as proxies for the investor. But holding a security
indefinitely will not protect an investment from catastrophic
Your most important consideration losses, nor will it guarantee gains. Fundamental data will not
when taking a position is how much tell you when to enter a position. That a company has good
fundamentals is no guarantee that the price of the security
you can afford to lose, not how will rise and not go sideways or even fall. A speculator has
much you hope to win. no less interest in preserving capital than the investor does.
In fact, the speculator and gambler might have more reason
to try to preserve the original capital because that’s how they
stay in the game. Moreover, being risk-averse does not guar-
gambling, and no one with an ounce of honor would dare antee the investor a steady income. The stock market is risky
admit in polite society to being a speculator. And yet in 1938, and everyone who participates in it has to learn to embrace
John Maynard Keynes said the following: “A speculator is a level of risk.
one who runs risks of which he is aware, and an investor is Less than 100 years ago, all stock trading was seen as
one who runs risks of which he is unaware.” It is also true speculating. In fact, in England, the Universities and College
that Keynes often referred to himself as a speculator. So what Estates Act of 1925 (The Trustees Act) made it onerous and
exactly is speculating? Speculators buy or sell with the idea of nearly impossible to invest any of the endowment money of
disposing of the asset for a profit in the future. But isn’t that the colleges of Oxford and Cambridge in the stock market
what investors do? How then are they different? It could be because stocks were seen as too risky and the colleges’ funds
that a speculator, knowing that he is involved in a high-risk were supposed to be managed conservatively. Speculators
trade, studies the market, and devises specific rules based on took positions in the stock market, not investors. It was John
particular strategies to enter and exit the market. As Jesse Maynard Keynes who in the early 1920s succeeded in per-
Livermore, the well-known speculator, once said: suading the Fellows at King’s College, Cambridge, to be the
first university college in England to put part of its funds in
Speculators in stock markets have lost money. But I believe it the stock market. Keynes also showed that it was possible to
is a safe statement that the money lost by speculation alone is speculate and invest in the stock market successfully.
small compared with the gigantic sums lost by so-called inves-
tors who have let their investments ride. From my viewpoint, Think like a statistician
the investors are big gamblers. They make a bet, stay with
Gambling, speculating, and investing
it, and if it goes wrong, they lose it all. The speculator might
buy at the same time. But if he is an intelligent speculator, he
are, at their core, disciplines that rely on
will recognize—if he keeps records—the danger signal warn- somewhat basically interchangeable skill
ing him all is not well. He will, by acting promptly, hold his sets. This is what the professional knows
losses to a minimum and await a more favorable opportunity but the public does not. And this is why
to reenter the market. it is so difficult to come up with defini-
tions that sufficiently differentiate each
In other words, what Jesse Livermore seems to be saying is term. To succeed at gambling, speculating, or investing, you
that a speculator is one who enters the market with clear rules need to be in control of your emotions and have a firm grasp
delineating the trade, which tell him under what conditions to of probabilities. Whether you are a professional gambler in
hold the trade and when to exit for a profit or loss. Las Vegas or a billion-dollar hedge fund manager on Wall
Street, you know that you do not have to be right all the time
What does “investing” mean? to be successful. Given this, you know you must have clear
Of the three terms, investing seems to be considered the most entry & exit rules, and you must also become an excellent
respectable among lay people. No one is abashed to refer to risk manager.
themselves as an investor. It appears that investing is what Unlike with the general public, your most important consid-
you must aspire to in order to achieve respectability. So how eration when taking a position is how much you can afford to
then can we define investing? For far too many people, in- lose, not how much you hope to win. In games of uncertainty,
vesting is a byword for buy & hold. The Business Dictionary you are guided by your knowledge of human nature (yours
describes the investor as one “whose primary objectives are and others) and chance. In order to win, you have to have a
the preservation of the original investment, a steady income, firm understanding of what your opponent is likely to do, what
and capital appreciation.” In this sense, the investor is seen you will do, and what your odds of winning are. You have
as more prudent than either the gambler, who is described as to know about risk, understand what it is, and master the art
one whose risk of loss is out of proportion to the rewards, or of managing it. It is not a coincidence that many gambling
to the speculator, who is defined as one who takes high risks terms such as risk of ruin, the Kelly criterion, Monte Carlo
for high rewards. Because of this aura of respectability, which simulation, and theory of runs are also used by speculators
common usage has attached to the idea of investing, lay people and investors. Investment firms that manage billions of dollars
aspire to investing and substitute buy & hold and fundamental recruit “quants” to build models based on statistical inference
AT THE CLOSE
to make best guesses on the outcome of market events. Statis- the rules of the game and has evolved the temperament and
tical inference can be thought of as gambling theory applied skill to stick with it and succeed.
to the world around us.
Stella Osoba is a financial writer who has written for the
What’s your priority? Market Technician Association’s (MTA) e-newsletter Techni-
To stay in the game, you must make it your business to preserve cally Speaking, their Journal Of Technical Analysis, and their
capital. This is your number-one priority, no matter what label CMT e-newsletter, as well as for TraderPlanet.com. She may
you apply to your dealings. And you must also make it your be reached via email at stellaosoba@gmail.com.
business to master the language of probabilities. You must
have clear rules that will dictate what you will do when you Further reading
are wrong. The thrill is not to be found in the playing of the Osoba, Stella [2015]. “Does Technical Analysis Work?”
game as the novice expects; rather, it’s in the staying in the Technical Analysis of Stocks & Commodities, Volume
game. That is what allows the rewards to come. So gamble, 33: February.
speculate, invest—call it what you may; the professional knows
FUTURES FOR YOU

GARNER suggests that all platforms and brokers tion of pure capitalism.” When the pits
Continued from page 25 should come together to determine a die, a little piece of the hearts and minds
single symbol to identify each product, of industry veterans will die with them.
“CL” but the electronic contract was but I doubt that will be the case. As it And yet, we’ve known all along this was
often “ECL” or “GCL,” where the “E” stands, some platforms already use the an inevitable and necessary step in the
refers to “electronic” and the “G” refers open-outcry symbol for electronic execu- progression toward market efficiency.
to Globex, which is CME Group’s elec- tion, so there is little uniformity. Today I mourn the death of tradition, but
tronic exchange. The letters “E” and “G” I embrace the future of the industry I’ve
represent the same method of execution; EMBRACE CHANGE dedicated my career to. Change is hard,
there is no difference between the two Louis Winthorpe III, the character played but it doesn’t have to be bad.
other than the preference of the trading by Aykroyd in Trading Places, described
platform vendor or quote service. Logic the futures trading pits as “the last bas-
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CommoditieS
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THE TRADERS’ MAGAZINE SINCE 1982

www.traders.com MAY 2015

Predicting The VIX

ALSO RECEIVE A FREE✝ BOOK

Interactive Brokers Interactive Brokers

Interactive Brokers Executions1 are:

Interactive Brokers ibkr.com/iwantmore

8 Schrödinger’s Cat 30 10 Selling Tips

29 Q&A This article is the basis for

4 • May 2015 • Technical Analysis of Stocks & Commodities

The math is simple. The benefits are clear.

Stocks & Commodities Magazine ✔ ✔

Join us on Facebook at www.facebook.com/STOCKSandCOMMODITIES Follow us on Twitter @STOCKSandCOMM

Editor in Chief Jack K. Hutson

6 • May 2015 • Technical Analysis of Stocks & Commodities

time variable across the chart.

‡See Editorial Resource Index

10 • May 2015 • Technical Analysis of Stocks & Commodities

Get into futures.

Open an account with TD Ameritrade at

For Your Digital Eyes Only

cator, which may prove useful to visual technical (daily)

tification of price swings in a chart, 12.0

mind for technical analysts: zigzag. The zigzag 10.5

Merill’s 1977 book Filtered Waves, Basic 9.0

filters price movements below a cutoff level,

point terms or in percentage terms. If you were,

for example, using a threshold of x points, the Zigzag (20%)

zigzag would disregard all price movements

used a threshold of x percent, the zigzag would

Meet the PIPs method

In brief, while the zigzag starts from

The concept of distance

Euclidian distance: dX(Y,Z) is defined as the distance of X

May 2015 • Technical Analysis of Stocks & Commodities • 15

As you probably noticed, the inductive procedure used to

16 • May 2015 • Technical Analysis of Stocks & Commodities

As an example, zzTOP(close, 30, L)

dicator with a percentage threshold

20 top chart you see the weekly price

That’s because after 2000, the prices

advanced significantly. In effect,

an arithmetic perspective and the Semilogarithmic scale

arithmetic-scale zzTOP correctly

common technical indicators (such

as stochastics, MACD, and RSI) are

nonetheless always arithmetic, so the 10

10 you can see how the arithmetic-

scale zzTOP performs in a weekly

chart of Archer Daniels Midland

As a consequence, the zzTOP and

May 2015 • Technical Analysis of Stocks & Commodities • 21

And The S&P 500

0 n $100,000 per trade, no

n Buy on the close if the 50,000

n Sell on the close two 20,000

allowance for commis- -10,000

May 2015 • Technical Analysis of Stocks & Commodities • 23

Predicting The VIX

of the VIX between a given trading

points ahead. Needless to say, 21.50 -1.00

500.00 for each 30 days would give a fair

Maximum drawdown stitute the mean VIX value (which

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