This Candle Comes In Threes
Finally! A Buy & Hold Sell Signal
When should you sell a long-term holding? Here’s a trading
setup that answers that question.
by Thomas Bulkowski
If
you own a diversified portfolio of stocks like
I do, then some of the stocks you will trade
frequently and some of them you may hold
for years. When should you sell a stock that
you have been holding for the long term (buy
& hold)? Here is a sell signal to help you
decide.
The signal appears in two variations, which I show in Figure
1. The first variation (left image) begins with a white candle
making a new high in a rising price trend or channel. Fol-
lowing the white candle, three consecutively black candles
appear. The candles are on the monthly scale, and they can
be any shape, including doji. (A doji is a candle with equal
opening and closing prices. Count them as black.) A black
candle appears when the closing price is below the opening
price, not when the candle closes below the prior close.
The second variation (right image) occurs when the candle
making a new high is black (again, all candles can be doji).
8 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
In this setup, look for two consecutive black candles, such as
those shown in C.
Candle color is important to this setup, but not their shape.
I tested only the two variations shown (color) and ignored the
shape (where price opens or closes in the monthly high–low
range).
Here are the setup’s rules:
1. Find a stock on the monthly scale that trends upward.
I used channels (two nearly parallel lines highlighting
price action), but trendlines work as well. Do not be
concerned if the trend bends; the idea is you want to
find a stock that continues to rise over the long term.
This setup does not apply to choppy-looking stocks that
move horizontally or down.
MATTZ90/SHUTTERSTOCK/COLLAGE NIKKI MORR
2. The trend must be at least two years long. This is an
arbitrary amount, but one I used to gather statistics and
eliminate false signals. Often, you may not even recognize
a trend shorter than two years on the monthly scale.
3. Valid signals only appear at the highest price in the channel
(or trend). Ignore all signals not beginning with the highest
price in the trend. This helps avoid false signals.
 CHARTING A C
B

4. Find a white candle followed by three black ones, or three
consecutively black candles starting from the highest peak
in the trend. Not all channels will have this exit signal,
but you want to obey the signal if it occurs.
5. Sell at the open in the month following the signal.
ONE EXAMPLE
Figure 2 shows the chart of a stock you have probably heard
of: American International Group, commonly known by its
symbol, AIG.
Notice that the time scale is in months. I chose the monthly
scale because I was studying the behavior of channels last-
ing years. Here, price trends along the red line, which bends
slightly upward in this case. I did not draw the top channel
line for clarity, but I include it in my charts.
Such a long uptrend is unusual, but the potential profit from
a buy & hold stock showing such a trend can pay for a new
house (or a month’s worth of health insurance premium).
The sell signal appears at A, and it is a timely one. Selling
at the opening price of the month after the signal would have
filled at approximately $1,620, preventing you from riding the
stock all the way down to $6.60.
The inset shows the four-candle sell signal for American International Group (Insurance (Prop/Casualty), AIG)
this stock. This signal begins with a white candle
at the top of the trend. I show that candle as A on
the blue rectangle, and held on. As
seasoned traders may tell you, it
is not important at what price you
buy a stock. Rather, it is important
at what price you sell. However, if
you intend to buy a stock and you
see a three black candle sell signal,
then look elsewhere for a different
buying opportunity. FIGURE 1: THE SELL SIGNAL
Periodically, you switch to the IN TWO VARIETIES. The three
black candle exit signal comes
monthly scale (I use the log scale, in two variations.
by the way) and wait for a sell
signal. The stock trends, following
the slightly bent red line.
At candle A, the highest price in the trend, a black candle
appears. Is this the start of a sell signal? Maybe. You will have
to wait two additional months to find out. However, a closer
examination of the chart shows that candle A is not black. The
inset shows this at A1 (the horizontal body is white, although
it may be hard to see). A white candle means you have to wait
at least three more months before a sell signal.
Continued on page 46
1966
1721
A
1511
1336
1161

the stock chart and as A1 in the inset. They are the 1021
881

same candle. Following the white candle, three 776

671
566
black candles appear. That four-candle combina- 496
426
D
tion comprises the sell signal. Sell at the open the 358

286
next month. 251
B C A1
216

Those of you astute enough to look for similar sell 181

146
signals in the chart might start squealing like stuck 111

pigs by now, so let’s look at the points highlighted

76
by B, C, and D.
Point B is a sell signal except it is too soon near the

TOM BULKOWSKI
beginning of the trend. Remember, the trend must be
at least two years long. The four-candle sell signal
at C also fails the duration test. It appears too near 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

the start of the trend. If you were considering buying FIGURE 2: A TIMELY SELL SIGNAL ON AIG. Only one exit signal appears on this chart and it
the stock, would you even notice that a multiyear precedes a massive decline.
trend had started at either B or C? AmerisourceBergen Corp (Biotechnology, ABC) A
Candle D looks like a valid signal but it is not. 119
113
108
103

Why? Because candle D is white, not black, even 98

93
88

though it appears black on this chart (you’d have to

84
80
76
72

zoom in to see that the fill of the body is actually 68

65
62
59
white). Because you have a white candle followed by 56
53
50

two black candles, and not three black candles, the 47

44
42

pattern is invalid. A is the only correct exit signal 40

38
36
A1
34
in the trend. 32
30
28
26
B
TRADING EXAMPLE
24
22
21
20

Figure 3 shows a more recent example. Imagine that 19

18
17

you bought AmerisourceBergen (ABC) sometime 16

15
14

in the trend highlighted by the red line. Perhaps 13

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

you bought it when it was not trending, such as in FIGURE 3: ANOTHER TIMELY EXIT. Point A is an example of a more recent exit signal.

December 2017 • Technical Analysis of STOCKS & COMMODITIES • 9

 BULKOWSKI/FINALLY! A BUY & HOLD SELL SIGNAL
Continued from page 9
As the inset shows, the three black candle sell signal does
appear, so it is time to sell. Sell at the opening of the next
month, which is candle B. A trader selling would receive a fill
near the opening price of 105.75, avoiding the 35% drop that
has taken the stock to a low of 68.38 so far. No other valid
sell signals appear in the trend.
STATISTICS
I manually catalogued 897 channels in 509 stocks on the
monthly scale using data from January 1990 through August
2017. Not all stocks covered the entire period. Please note
that I logged the channels first and then discovered the three
black candle exit signals. That means I did not cherry-pick
channels/trends that showed the exit signal.
Here is a summary of what I found:
1 How often does the exit signal appear? 42% of the time
2 On average, how far does price drop after the signal? 43%
3 How often do fake signals occur? 21% of the time
4 How far does price drop after any three black candle 27%
pattern?
5 After a signal, how long does it take before price 3.7 years
makes a new high?
6 Average channel length 5.1 years
1. How often does the exit signal appear? Forty-two percent
of the channels I looked at showed a valid exit signal. That
means most of the monthly trends will not have a sell signal,
so you will have to use other means to determine when to sell
a long-term holding. However, when you do see a signal, sell.
The next item tells why.
2. On average, how far does price drop after the signal?
The average drop after a sell signal is 43%, and it includes
stocks that have yet to recover.
To explain how I found this, think of the letter V. The left
top of the V represents the highest high price in the channel
or trend. To find the right top, I waited for price to close above
the left side of the V. The drop between those two points
represents the depth of the decline.
I measured the decline from the closing price of the last
month in the signal (for three black candles, I used the close
of month 3) to the lowest low price in the bottom of the V. If
the stock ran out of data before recovering, then I used the
lowest low found in the V. Thus, it is likely that the 43% aver-
age decline is understating the actual drop.
3. How often do fake signals occur? I checked the chan-
nels for false signals and found they occur 21% of the time. I
tried to minimize false signals by imposing the rules already
discussed, meaning the channel had to be at least two years
long and the signal needed to start at the highest price in the
46 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
evolving channel. The exit signal is correct 79% of the time,
and since the drop after the signal averages 43%, the signal
is worth obeying.
4. How far does price drop after any three black candle
pattern? I looked through my stocks for all consecutive
three black candles on the monthly scale and measured the
drop from the close of the last black candle to the time the
stock closed above the highest candle of the three. The dip
between those two points averaged 27% using 7,881 samples.
This compares to an average drop of 43% for the channel exit
signal. In other words, the drop after a trend pierce (that is,
after the exit signal) is more severe than normal.
5. After a signal, how long does it take before price makes
a new high? It took an average of 3.7 years for the stock to
close above the left top of the V (that is, makes a new high).
6. Average channel length. The minimum channel length is
two years, by design, but the average length was 5.1 years, much
shorter than the trends shown in the figures in this article.
ONE LAST TEST
Instead of using three black candles, I tried substituting three
consecutive lower closes. The results were within one percent-
age point of the three black candles signal. Three lower closes
happened 41% of the time (versus 42% for three black candles)
and 20% of them were fake (versus 21%).
The three black candle exit signal described in this article
will not appear in most of the channels or trends you see on
the monthly scale. However, when it does occur, it is best to
sell a long-term holding. Measured from the channel high,
the drop averages 50% and it takes an average of almost four
years before the stock again makes a new high. That is a long
time to wait to get your money back. Besides, the government
can use the taxes on your capital gains.
STOCKS & COMMODITIES Contributing Writer Thomas
Bulkowski (who may be reached via email at tbul@hotmail.
com) is a private investor and trader with more than 35
years of market experience and considered by many to be a
leading expert on chart patterns. He is the author of several
books including Chart Patterns: After The Buy and Getting
Started In Chart Patterns, Second Edition. His website and
blog, www.ThePatternSite.com, have more than 700 articles
of free information dedicated to price pattern research.
FURTHER READING
Bulkowski, Thomas [2016]. Chart Patterns: After The Buy,
John Wiley & Sons.
[2005]. Encyclopedia Of Chart Patterns, 2d ed., John
Wiley & Sons.
[2014]. Getting Started In Chart Patterns, 2d ed., John
Wiley & Sons.
‡THOMAS BULKOWSKI
‡See Editorial Resource Index
 TRADING ON MOMENTUM
Daytrading ADX
Breakouts
Would you like to know about a techni-
cal indicator that provides a consistent
way to spot volatile breakouts in a timely
manner? This tool may be sitting right
in front of you. If you aren’t already
using the ADX, here’s how to use it to
determine whether a breakout is strong
enough for a daytrade entry.
by Ken Calhoun
D
aytrading is all about finding
volatile breakouts in time to
make a successful entry. You
can use J. Welles Wilder’s
average directional index
(ADX) to help locate intraday
trading setups as they are breaking out
to new highs. I examined how to use this
useful indicator for swing trades in an
earlier article (STOCKS & COMMODITIES,
March 2016). In this month’s column,
you will see how to identify daytrades
using the ADX.
The ADX is especially useful for
daytrading breakouts because it is the
eSIGNAL
FIGURE 1: DAYTRADING WITH ADX (CREE). Here is an example of using the ADX to locate volatile daytrading
entries ahead of time.
best technical indicator available for
detecting an increase in volatility over
time. If you have ever struggled with
false breakouts and choppy entries when
daytrading stocks, you may find the
ADX is especially valuable to help focus
on volatile breakouts with exceptional
trade potential.
DAYTRADING STOCKS
WITH ADX
In my own trading, I have found ADX
to be the only technical indicator that,
in addition to a preexisting uptrend, is
a fairly consistent, reliable leading indi-
cator for finding volatile breakouts. My
students value it because the red ADX
signal line is easy to follow. When it
breaks out to new highs during the first
20 minutes of the stock market open, it
often indicates a strong likelihood the
stock price will continue upward.
From a price action daytrading
standpoint, my two favorite patterns
are gap continuations and two-day-high
breakouts. Similarly, when the red ADX
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signal line breaks out above the prior
day’s ADX high, it reveals an increase in
volatility in the underlying stock price,
which you can then capitalize on.
Because the ADX and the DMI+/-
lines may oscillate or cross over, it is
best to simply focus on a strong-
trending ADX signal, as illustrated
in the chart of Cree, Inc. (CREE)
in Figure 1.
Do you see how the red ADX
line came from below on October
17 and then broke out to new highs
on the morning of October 18? This
upward move in the red ADX signal
line, especially once it breaks out
over 40 on the market open, gives
your daytrading entry signal.
STEP-BY-STEP
ACTION PLAN
Here’s how you can use this
ADX breakout strategy with your
daytrades:
Step 1: Using a two-day five-
minute candlestick chart, visually
Continued on page 49
• Technical Analysis of STOCKS & COMMODITIES • 7
 TRADING ON MOMENTUM

CALHOUN / DAYTRADING ADX to trend back downward, as it did at

BREAKOUTS
Continued from page 7
scan for stocks in the $20 to $70/share
price range with the ADX indicator at
the bottom (using the standard 14-step
parameter). Look for charts in which
the ADX has stayed under 40 and is
trending upward into the day’s close.
You can see this pattern illustrated in
Figure 1 on October 17.
Step 2: During the first 20 minutes
of the trading session, check to see if
1) the red ADX line breaks over 40,
and 2) the stock price is breaking out
above the prior day’s high. If it does,
set a buy stop order at $0.20 above the
current price as your entry signal.
Step 3: A secondary technical con-
firmation signal you can use is to see
if the green DMI+ line crosses to the
upside above the red ADX signal line,
as it does in Figure 1. This bullish
DMI+ crossover (combined with a
red ADX signal line at a two-day high
over 40) is the best possible technical
breakout setup signal you will find
with this indicator.
Step 4: You can exit your trade as
soon as the red ADX signal line starts
1:30 pm in Figure 1.
INSIGHTS: WHY THIS
TECHNIQUE WORKS
Daytrading successfully depends on
your ability to make winning trades
when volatility is high and the trend is
in your favor, then exiting at the first sign
of trouble at a trend reversal. Wilder’s
ADX does a remarkably good job of
identifying increasing volatility for both
intraday and swing trades. My use of 40
as a signal took many years of testing
and experimentation; it works well as a
decision support tool to tell you whether
or not the ADX is strong enough to gen-
erate a technical entry signal.
TRADE MANAGEMENT TIPS
The biggest technical advantage ADX
provides is it serves as a leading indi-
cator for increasing volatility, which
can help you stay away from choppy
charts. Daytrading stops for stocks in
the $20 to $70 range should be no more
than $0.20 to $0.40 (often tighter). Note
this technique should not be used with
speculative, low-float, under-$10 stocks,
because those are foolhardy for daytrad-
ing due to their choppy “pop and drop”
dangerously inconsistent price action,
low volume, and inherently higher risk.
Instead, professional daytraders prefer
charts that will run at least $0.30 to
When daytrading stocks,
you may find the ADX is
especially valuable to help
focus on volatile breakouts
with exceptional trade
potential.
$0.50 or more during a single opening
range breakout, such as the example I
have described in this article.
The price that proves a two-day-high
breakout daytrade wrong is a reversal
back down into the previous day’s trading
range. As long as the ADX continues to
trend upward, you can consider adding
to a winning trade by scaling in every
$0.40 or so. Using the ADX breakout
daytrading technique can provide you
with a strong, high-volatility entry signal
that I encourage you to test out.
Ken Calhoun is a producer of trading
courses, live trading room, and video-
based training systems for active traders.
He is the founder of TradeMastery.com,
an educational resource site for active
traders and is a UCLA alumnus.
FURTHER READING
Calhoun, Ken [2016]. “ADX Breakouts,”
Technical Analysis of STOCKS &
COMMODITIES, Volume 34: March.

KAUFMAN/PROFIT-TAKING AND RESETS of technical analysis), and A Guide To Creating A Successful

Continued from page 18
profit. A strong market can continue to go up until you are
completely frustrated waiting for a pullback.
The same is true of simple entry techniques. When you get
a trend change signal, do you enter right away or wait for a
pullback to get a better price? It’s always a tradeoff. My ex-
perience is that three of four times, you can get a better price,
but the fourth time price runs away and you lose more than
the total of the three improvements. That’s why the percent-
age of profitable trades improves but the net profits fall. As
for myself, I follow the trend. I like taking profits, but I limit
profit-taking to short-term systems.
Algorithmic Trading System (2016). For questions or com-
ments, please go to www.kaufmansignals.com.
FURTHER READING
Kaufman, Perry J. [2017] “Optimization—Getting It Right,”
Technical Analysis of STOCKS & COMMODITIES, Volume
35: September.
[2013]. Trading Systems And Methods, 5th ed., Wi-
ley.
[2015 ]. A Guide To Creating A Successful Algorithmic
Trading System, Wiley.
[2003]. A Short Course In Technical Trading, Wiley.
[1995]. Smarter Trading, Wiley.

Perry Kaufman is a trader and financial engineer. He is

the author of many books on trading and market analysis,
including Trading Systems And Methods, 5th ed. (with the
first edition published in 1978 as a seminal book in the field
January 2018 • Technical Analysis of STOCKS & COMMODITIES • 49
 The Shares Are Out There
All About The Float
The float in a stock is a number that is easily available along
with other data, but do we pay enough attention to it in our
analysis? Here’s an in-depth look at float.
by John Devcic
W
all Street is filled with terms that on the face
of it seem easy to understand but often have a
deeper meaning that many investors and trad-
ers can overlook. One such term that has been
around for as long as stocks have been traded
is float. Let’s take a look at what float is and how it can help
an investor or trader.
The float for a given stock is easy to find on any stock
research website or platform. Simply put, float is the number
44 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
of shares that are available to trade on a daily basis. Yet that
deceptively simple number can have a powerful impact on
your analysis of a stock.
A difference in float can affect trading in that instrument,
as the following two examples will show.
REAL-WORLD EXAMPLES
For the first example, I’ll use one of the most popular stocks
in the world, Apple Inc. (AAPL). I used stats from a website
that gives the float along with other stats. From Figure 1, you
can see that the float for Apple was 5.19 billion shares avail-
FAITHIE/SHUTTERSTOCK
able to trade. That seems like a ton of shares available, and it
is, especially when you compare that to the number in what
will be my second example.
Let’s look next at a smaller company less widely traded.
 NOVICE TRADER

Duluth Holdings (DLTH), at the time I was stocks. Penny stocks are generally companies
Share Statistics
doing this research, was up 15% for the day. whose stock prices will move wildly in one day
From Figure 2, you can see that Duluth Avg Vol (3-month) 27.14M because of a massive purchase or sale. This is
Holdings has a float of 9.42 million shares to also why large traders or investors steer clear
Avg Vol (10-day) 26.03M
trade on the open market. So the difference in of stocks with lower floats. Once large traders
float between Apple and Duluth Holdings is Shares Outstanding 5.25B or investors step in with a big order on a stock
night and day. While their float number is easy with low float, the stock’s price will quickly
Float 5.19B
to read, you may still be confused about how move up. Since the stock already has a low
to really use this number. I’ll start by clearing FIGURE 1: APPLE INC. A difference in float, there are not a lot of shares available, so
float can affect trading in that instrument
up a few misconceptions. and whether a large order will affect the large block orders will usually be completed
In both examples, you also see a statistic share price. Here, the float for AAPL is in stages. This naturally drives the price of the
given called shares outstanding. This number a massive 5.19 billion shares available stock up which in turn causes the large traders
is often confused with the float. But they are to trade. to pay more.
not the same thing. Shares outstanding is the Float is simply the supply of stock in a par-
total number of shares that exist. In the case Share Statistics ticular company. The more supply, the more
of the Apple example, the number of shares Avg Vol (3-month) 227.56K demand it can meet without massive changes
outstanding was 5.25 billion, while the number in the price.
of shares outstanding for Duluth Holdings Avg Vol (10-day) 279.01K
As you research float, you may stumble upon
was 29 million. So to clear up any confusion, Shares Outstanding 29.01M another kind of float. Short float is another
shares outstanding is an all-encompassing number that can be a valuable reference for
number and refers to all the shares that the Float 9.42M
traders to have.
company has issued. Float is a subset of this FIGURE 2: DULUTH HOLDINGS. To be clear, short float is actually the per-
and is the number of shares available to trade at Meanwhile, DLTH had a relatively small centage of shares short in the float. It is also
float of 9.42 million shares.
any given time, which is a narrower and more referred to as the short interest ratio. This
useful number for traders to know. number will tell you how many shares of stock
Now that you understand the difference between shares are being shorted but have not been covered or closed out. On
outstanding and float, I’ll discuss how you can use float to the surface this may seem like just another percentage figure
your advantage. that doesn’t tell you much. But you would be wrong. You can
use the short interest percentage to gauge the overall sentiment
THE MILLION-DOLLAR TRADE of the stock. The higher the percentage of short float, the less
Staying with these two examples of Apple and Duluth Holdings, confident traders are in the future upward movement of the
I’ll hone in on why knowing the float is so critical. Imagine stock. When traders leave shorts open, that’s telling you that
that you manage a mutual fund or are a large investor. Say they see no reason to cover their position and that they expect
you have $1 million available to trade with, just to keep this the price to go down.
simple. You look at Apple and decide you want to buy it. The
number of shares available to trade—that is, the float—is 5.19 USING SHORT FLOAT
billion. With such a large number of shares available, you The best way to use short float is as a rolling indicator. Short
would have no problem buying a million dollars’ worth of interest reports are done biweekly, as FINRA requires broker-
Apple stock. age firms to report this information, so you can check in and
However, if you took that same million dollars and put it see if short interest has fallen or if it has increased. You can
into Duluth Holdings, you would find a different scenario. If find this on Yahoo Finance or the Nasdaq website.
the price of Duluth Holdings was $22.45 and there were 9.42 A decreasing short interest number means a turn from a
million shares available on the open market, that’s a total of bearish sentiment to a more positive one. Likewise, a grow-
roughly $20 billion. If you bought $1 million dollars’ worth ing short interest number can tell you that more traders are
of Duluth, you would be purchasing around 5% of the avail- feeling less bullish on the stock. Of course, you can’t assume
able shares. Compare that to Apple, with five billion shares
available at a price of roughly $141 per share, totaling $705
billion. Buying $1 million worth of Apple shares wouldn’t even
be 1% of the total number of shares available to trade. When traders leave shorts
If you went ahead and bought Duluth shares with your mil- open, that’s telling you that
lion dollars, there’s a good chance the purchase would affect
the stock’s price, forcing it higher before the order was filled.
they see no reason to cover
But in the case of Apple, that’s not even a remote possibility. their position and that they
This illustrates why it’s valuable to know the float. expect the price to go down.
A stock with a low float can see its price easily influenced
by a large order. You see this occur all the time in penny
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 45
 that short sellers know everything and indeed, there have been
many cases of heavy short sellers watching as a stock runs
upward, forcing them to cover.
One final way to look at short interest is as a contrarian
sign, and many contrarian investors and traders view it as
getting a stock at a discount. If you believe the price will
move upward, a high short-interest number is not the end of
the world; remember, the more shorts, the bigger the move
to the upside that the stock will have to achieve in order to
overcome the shorts and push the stock price higher.
DON’T OVERLOOK IT
Float may seem like a simple term, but we often have a
tendency to pay little or no attention to the simple terms,
especially when it comes to trading. Float is one figure that
the astute investor or trader, regardless of size, should keep an
eye on. Float gives you an idea of how many stock shares are
MONTEVIRGEN/SEASONALITY PIVOT POINTS
Continued from page 22
DOES MARKET HISTORY PROVIDE
A BASIS FOR ACTION?
History never repeats itself in exactly the
same manner. The slightest similarities will
always reveal heterogeneous differences
and discontinuities in anything resembling
a simple cause or effect. With regard to
seasonality research, terms like “cyclical-
ity” and “recurrence” are used loosely and frequently, as
they are hard to avoid. Unfortunately, these terms tend to do
more harm than good, as both can be taken a step too far as
to imply “prediction.”
Once again, seasonality research is not about prediction—it’s
about scenario planning. It’s about mapping potential outcomes
— “outcomes” with emphasis on plurality, and “potential” stand-
ing as its critical modifier. At times, certain market outcomes
will resemble the past, at other times they won’t.
Either way, if you value what historical consistencies may
reveal, despite the fact that patterns may not always repeat,
having a map that clearly illustrates historical patterns will
only keep you more informed and prepared. After all, it helps
to know what has consistently happened, in which market, in
what week or month, and by how much. It gives you a “road
map” of potential things to anticipate, things that you may
choose to avoid or act upon.
This is what seasonality research is all about—anticipating
46 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
The more supply there is, the
more demand it can meet
without massive changes in
the price.
available to trade. The bigger the order, the more important
the float is. Keep an eye on both float and short interest in the
stocks you own or plan on trading. It’s another analytical tool
to help keep your boat afloat.
John Devcic is a market historian and freelance writer. He
may be reached at drmorgus@gmail.com.
Seasonality research is not
about prediction—it’s about
scenario planning.
potential events based on historical patterns. And making these
histories clearer, more interpretable, and actionable are what
seasonality profiles and pivot points can help you achieve.
Karl Montevirgen is a content designer/strategist at Halifax
America LLC, a stocks/option, futures, and forex brokerage
in Sherman Oaks, CA. In addition to creating and designing
content, he has extensive knowledge of and experience with
commodity futures and foreign exchange. He can be contacted
through the Halifax America website at www.halifaxamerica.
com or by email at kmontevirgen@halifaxamerica.com.
Halifax America’s seasonality website can be found at www.
actionablemarkets.com.
FURTHER READING
Montevirgen, Karl [2017]. “Use Seasonality To Optimize
Algorithmic Strategies,” Technical Analysis of STOCKS
& COMMODITIES, Volume 35: January.
 May Day, May Day!
An Early Warning System
Part 1
Irrational human behavior influences stock prices, and this
behavior can lead to predictable outcomes. Here’s a trading
system that takes advantage of overreactions in the market,
which could give you a trading edge.
by Mike Slattery
discovered what I call my early warning system after
I
combining two indicators of different origins. The first
stemmed from the type of hyperbolic promotion that all
individual online retail traders have received at some
point: “We’re going to make you wealthy beyond your
wildest dreams.” This pitch capitalized on an old and
well-established trading convention of entering a stock in a
long-term uptrend after a short-term drop below a medium- or
short-term moving average. This sets up the stock to have a
24 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
high probability of success with a strong reversion-to-mean
event after a market overreaction.
This approach incorporated Hooke’s law of elasticity in
HOOKES LAW GRAPHIC: SVJO/JET:: MY IMAGES-MICHA:DIGITAL ART: KENTOH/
physics into calculating the likelihood and the extent a stock
would overshoot a short-term moving average on the upside
after deviating below that same moving average. Hooke’s law
of elasticity was discovered by the English scientist Robert
SHUTTERSTOCK/COLLAGE: CHRISITNE MORRISON
Hooke in 1660, and it states that for relatively small deforma-
tions of an object, the displacement or size of the deformation
is directly proportional to the deforming force or load.
John Ehlers, who is a frequent contributor to this magazine,
provided the second. His work producing highly reactive,
adaptive moving filters, in this case the Laguerre filter, enables
this indicator to respond in a more responsive and accurate
manner. I thought combining these two dissimilar concepts
might provide for an improved entry/exit signal.
 NEW TRADING TECHNIQUES

The results were both unexpected and excit-

ing. They could alert me to impending trend
direction changes, often several days in advance
of the emergence of actual turning points. This
provided the foundation to develop a swing/day
trading system named Swing•Genie, which we
have found surpasses any other combination of
indicators we have utilized to date.

CONCEPTS AND COMPONENTS

Can any technical analysis indicator predict the
future? No, but they can detect patterns that often
occur and sometimes recur, preceding inflection
points. This becomes a practical reality after
merging these two indicators, enabling some
insightful filtering, pattern recognition, and fi-
nally, reconfiguration of the visual output of the

STOCKDOTGENIE.COM
historical datastream.
Moving averages are one of the primary tools in
the armamentarium of technical analysis. There
are now many unique filters, including Arnaud
Legoux moving averages (ALMA), center of grav- FIGURE 1: EARLY WARNING SYSTEM APPLIED TO BANK OF AMERICA (BAC). Here you see
ity (COG), finite impulse response filters (FIR), turning points indicated in advance of them occurring during a period of moderate volatility. For pur-
and Laguerre filters, to cite just a few of the many poses of clarity, the dots of the EWS indicator in the lower portion of the graph have been extended
to their same relative bars on the candlestick chart in the upper portion.
currently being utilized as more advanced and
more profitable calculations of moving averages.
The EWS indicator, displayed in Figure 1, utilizes a short- The Laguerre transform filter overcomes these long-term
alpha-length Laguerre filter in place of a short-term moving moving average conflicts or contradictions by tracking the
average. Laguerre transform filters are derived from a field of price of your equity in a tighter manner, as it produces a
engineering referred to as digital signal processing (DSP). smoother track than a short-term moving average while
Mel Dickover wrote in 2012 that “The principles and math- maintaining approximately the same level of reactivity. While
ematics of digital signal processing (DSP) were developed to this system excels at removing and reducing whipsaws from
analyze real-world sensor signals, converted to digital form. volatile trading periods, it also has dramatically less lag,
A series of market ticks is a signal in digital form, so DSP enabling traders to enter and exit trades with more reactive
can profitably be utilized to analyze price data.” and profitable timing.
As one example, it can allow an audio engineer to manipulate
a signal by modulating, shifting, decreasing, or increasing the NORMALIZED MOVING AVERAGE
frequencies being utilized to produce a sound. Applying a DSP The early warning system is constructed by converting a short-
filter to the datastream produced by a stock’s historical data alpha-length Laguerre filter into a normalized, horizontal line
has been a concept advocated by Ehlers and he has authored (see steps in Figure 2). This line is then placed into a chart
several articles describing Laguerre filters. An explanation of on the zero axis. The calculation underpinning this gold line
the improvements provided over traditional moving averages is identical to that produced by a moving filter or traditional
can be found in his book Rocket Science For Traders and in moving average. Each current bar’s succeeding data is incor-
an article he authored by the title of “Time Warp—Without porated into the indicator’s updated calculation, but the visual
Space Travel.” output is plotted on a horizontal centerline that remains static.
Laguerre filters provide several advantages. Ehlers refers The current close is then subtracted from the normalized
to it as a highly reactive, adaptive smoothing filter. In a com- Laguerre filter, allowing the trader to visualize exactly what
mon moving average lag, the delay in the generation of the the difference is between the most current Laguerre filter’s
signal indicating the direction that your equity is most likely value and the close of the most recent candle or bar. To put
to take or trend in is exacerbated by the need to include more this in another way, the columns indicate how far away the
historical data into the calculation in order to smooth the sig- close of the day is from the most current value the Laguerre
nal. These longer periods reduce a problem that short-period moving filter calculation is producing. This enables the trader
moving averages can cause, that being whipsaw changes in to immediately visualize and gauge the beginning, middle,
the equity’s price, which can result in multiple entry and exit and end of each parabolic swing, clearly exposing diversion/
trade signals in rapid succession because of short-term changes reversion overreactions in both directions, creating insightful
in the trading price. entry/exit opportunities.
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 25

FIGURE 2: EARLY SIGNALS. Here you see a breakdown of the calculation steps
that enable you to see reversions and diversions of price from the mean.
In the July 2016 issue of STOCKS & COMMODITIES, Ehlers
described what he referred to as the super passband filter. The
concept behind this filter is to pass or subtract one short-length
filter through a second, longer-length filter or moving average.
This has the advantage of removing the longer and shorter
frequencies from the resulting output, providing the trader
with a core signal that is smoother, contains fewer whipsaw
movements, and tracks price more tightly.
The process of passing a short-length indicator through
a longer-length one of the same type further increases the
benefits that the Laguerre filters originally instilled, providing
you with a more refined and accurate trading tool.
REAL-TIME ZERO-LAG FILTER
All moving averages and smoothing filters have some lag
as a component of their output. Because we are measuring
26 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
the difference from the Laguerre filter that today’s price has
produced, passing the close of the most current bar through
the moving filter removes the lag or delay in the signal from
the output. The indicator becomes a real-time, immediate,
or zero-lag signal of the divergence of the current price from
the Laguerre filter. The difference between the normalized
Laguerre moving filter (the gold zero centerline) and the close
of each candle is then plotted, clearly displaying the green
(positive) or red (negative) divergence columns that you see
in Figure 2.
EARLY WARNING SYSTEM DOTS
Pattern recognition is utilized to identify when signals have
been triggered within the array of columns produced by the
EWS. Visually, these patterns can be all but indistinguish-
able because of the small and subtle changes that can trigger
them. For this reason, to visually communicate when these
patterns have developed, we use unique flags in the form of
distinctive dots.
Early warning indicator dots flag unique patterns within the
array of columns produced by the EWS modified passband
filter. These patterns are invisible until the relationship of the
close of each candle to the moving average/filter is reconfigured
as described in Figure 2.
The early warning indicator dots are generated by compar-
ing the relative sizes of each column within each positive or
negative array of columns. The first few candles producing
the columns seen at the beginning of divergence are often
of greater magnitude than subsequent columns in the array.
This magnitude includes the change in price produced by
gaps. Once these columns start to diminish in magnitude, the
early warning dot (•) is generated, indicating that a potential
reversal is predicted in the future. A dot (•) is placed above
or below the column with the greatest magnitude, after the
columns start diminishing in size. This introduces a delay of
at least one day or bar, as the indication dot can’t be drawn
until the columns begin to diminish in size and the dot is then
painted on the previous column.
The validation of this dot (•) is confirmed by a continuation
of diminishing column sizes. If a subsequent column exceeds
the size of any prior column, when the columns again start
to diminish after this latest, larger column, then the set point
for your reversal will be reset and a new or additional EWS
dot (•) will be drawn.
The number of columns between the first and second dots
can be instructive. If that period of time is four days, there is
a high probability that the warning time being provided prior
to the next price direction change will also be approximately
four days. The closer the proximity to the horizontal zero line
the divergent columns become, the greater the likelihood that
no additional dots will appear, increasing the likelihood that
an impending reversal event is about to occur.
EWS dots are not trading indication dots. They are a warning
of a change in trend direction. If you are in a stock for which
EWS dots appear, or if the stock is on your trading watchlist,
then it’s time to start watching it closely.
FIGURE 3: TRADING OPPORTUNITIES. The crossover dots produced within the early warning
system have been projected to their relative candlestick bars on the price chart. The crossover
dots indicate a move above or below the moving filter or the moving average.
CROSSOVER DOTS
CONFIRM TURNING POINTS
Crossover dots (•) (Figure 3) appear when the
price of the equity has crossed above or below
the normalized Laguerre moving filter. Each
of the dots seen in Figure 3 has a gold dot
within it and a gold circle around it. These
dots are utilized in addition to the changing
colors of columns because it is not unusual
for the columns to be small, as they intersect
the centerline of the normalized Laguerre
moving filter, making it difficult to be sure that a crossover has
actually occurred. Consolidation at these crossovers can also
make this transition difficult to pinpoint. Because the hori-
zontal zero centerline includes some lag (all moving averages
and filters do), that your stock’s price is now producing bars
of a different color is not just indicating a single additional
divergent candle, but conformation of a new trend direction.
Once a crossover dot appears, you are seeing your last good
opportunity to profitably enter or exit this stock.
The divergence between the peak occurring in the EWS
and the peak in the actual price gives the trader a decisive
advantage in anticipating pivot points. Smaller column sizes,
either diverting above or below the zero centerline, do not
accurately reflect proportional or relative changes in price
by their magnitude. The bars can diminish in size while the
stock’s price continues to rise. (See chart of CITI in Figure
4.) There is, however, a correlation between the current price
and the distance the price is currently away from the actual
and normalized moving average, producing the horizontal
gold centerline. This can be confusing because, although the
moving average is constantly being updated, the output of that
calculation is always static, that is, a horizontal line drawn at
zero. This anomaly is most noticeable as stocks move through
the top of a parabolic arc.
The obvious reason for this is the first few bars after a turn-
ing point are often large bars. These larger price changes get
incorporated into the moving average calculation, bringing
FIGURE 4: DIVERGENCE BETWEEN EWS AND PRICE. Here, the
increase in the equity’s price does not correlate with the bar height in
the EWS indicator.
the subsequent smaller price changes closer to the moving
average’s new value. The closer the close is to the normalized
moving average, the smaller the columns will be. At the top
of a parabolic arc, it is also not unusual to encounter a brief
period of consolidation that will add to this effect. Both these
parabolic price change conventions contribute to this indica-
tor’s ability to provide an advanced warning of impending
price changes. It accomplishes this task with a relatively high
degree of success by observing decreasing column sizes after
a peak column.
STRONG TRENDING STOCK, NOT SWINGING
Stocks that are in a strong uptrend, like Symantec Corp.
(SYMC) in Figure 5 starting on August 1, 2016 (A to B), utilize
the normalized moving average as a support level. Because
this stock is experiencing strong positive momentum, instead
of swinging above and below the horizontal gold centerline at
zero, it bounces off of what has now become a support level.
Any EWS reversal indications that appear in the absence of
significant penetration of the normalized moving average
line by columns of the opposite color become irrelevant as
crossover warnings.
You can also easily see that as the rate of change decreases
(B to C), the height of each column diminishes as this stock
enters the final phase of a typical, large-scale parabolic arc.
The long-term trend of these EWS indicator dots are not
irrelevant, providing you with an increasingly strengthening
indication of the next crossover point. Drawing a line through
The early warning system
alerts you to potential
opportunities to detect
turning points in real time.
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 27
 the EWS indicator dots of a long-term trending
stock provides you with a unique indication of
when this stock will approach its next potential
turning point (C). This trend combined with the
last dot’s close proximity to the demarcation line
is signaling an end to this long-term uptrend. The
exact opposite situation exists when stocks are in
a strong downward trend.
The point indicated by (D) in Figure 5 brings us
back full circle to the original inspiration for this
indicator—reversion-to-mean opportunities that
occur when a stock in a long-term uptrend tem-
porarily detrends, moving below the normalized
moving average, producing an ideal entry point.

ALTERNATIVE FORECASTING FIGURE 5: STRONG TRENDS. The dots produced by the EWS system during strong and prolonged
RESOURCES trends can point to the next turning point when a linear regression trendline is drawn through those
The EWS should not be confused with indicators dots and extended to the normalized moving average line.
that are often referred to as leading indicators,
such as the relative strength index or (RSI) or stochastic dots define a window of opportunity within which optimal
oscillators. Both of these produce reliable signals when the entry and exit opportunities reside.
stock or equity is trading in a period of consolidation or is My next article in this three-part series will describe a
in a nontrending trading range. Other attempts at predicting companion indicator that fills this sweet spot, providing you
or forecasting the future price of an equity utilize multiple with a potentially accurate, reactive, and profitable swing
technical indicators and support vector machines (SVM). If trading system.
you are interested in finding out more about SVM you can
perform a general Internet search. Michael Slattery is CEO of StockDotGenie.com, a technical
EWS does not attempt to forecast the next price in the trend. analysis (TA) charting platform and educational website that
It attempts to provide advanced warning that an equity’s price aims to shorten the learning curve for new and novice trad-
trend will reverse within the next few bars. Almost all other ers. He invests in equities based on technical, fundamental,
forecasting attempts are aimed at determining the probability human, social, and Internet sciences. He can be reached at
that an equity’s price will be within a specific price range StockDotGenie@dc.rr.com.
within a specific number of days or bars into the future.
FURTHER READING
FIND THOSE TRADES Di, Xinjie [2014]. “Stock Trend Prediction With Technical
A multitude of technical analysis techniques are utilized by Indicators Using SVM,” http://cs229.stanford.edu/proj2014/
hundreds of thousands of traders in an attempt to determine Xinjie%20Di,%20Stock%20Trend%20Prediction%20
when a stock will change directions. These turning points with%20Technical%20Indicators%20using%20SVM.pdf
are the hallmark of the most universal trading advice, “buy Dickover, Mel [2012]. “Rocket Science Made Easy: Digital
low and sell high.” Signal Processing Applied To Trading,” presentation to
Another oft-cited stock trading adage is don’t attempt to Society of Market Technicians, Washington DC.
predict what the stock price will do, but be prepared to react Ehlers, John F. [2001]. Rocket Science For Traders: Digital
and immediately capitalize on those changes once they have Signal Processing Applications, Wiley.
materialized. “Time Warp—Without Space Travel,” http://www.
The early warning system allows the trader to combine these stockspotter.com/Files/timewarp.pdf
two pieces of sage trading advice, alerting them to approaching [2016]. “The Super Passband Filter,” Technical Analysis
potential opportunities, allowing them to focus on a specific of STOCKS & COMMODITIES, Volume 34: July.
equity for the next few trading days or bars, applying their “Hooke’s Law,” https://www.britannica.com/science/Hookes-
own preferred suite of technical indicators to detect turning law
points in real time, and enabling them to immediately and Slattery, Michael [2016]. “The Closing Score: Extracting
profitably react to them. Sentiment From Price,” Technical Analysis of STOCKS &
COMMODITIES, Volume 34: June.
STAY TUNED ‡StockDotGenie.com
The early warning system produces two dots, one too early ‡See Editorial Resource Index
to trade (EWS dot) and one after the most profitable entry or
exit prospect has already occurred (crossover dot). These two
28 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
 Swing Signals For the Day & Swing Trader

An Early Warning System

Part 2

Some trading signals are better than others. In this second
part of a three-part series, we’ll describe a filter that’ll help
identify optimal swing trading buy/sell points.
by Mike Slattery
TARGETING THE WINDOW OF OPPORTUNITY
The EWS produces two primary signals that flank this trading
window. The first signal serves as a warning or alert, indicat-
ing that your stock is approaching a potential turning point
(see Figure 1). The second signal serves as confirmation that
TRAFFIC LIGHT: SIRIDHATA/SHUTTERSTOCK

this turning point has occurred and that the stock or equity has

L
ast month in part 1, I introduced my early warning
system (EWS), which combines two indicators of
different origins and defines a window of opportu-
nity for a trade. Here in part 2, I’ll introduce a swing
trading system with the EWS as its foundation that
produces relative reference points for a definitive
and optimal entry/exit signal within that window.
22 • September 2017 • Technical Analysis of STOCKS & COMMODITIES
crossed over or under the short-term moving filter that produces
the horizontal, center demarcation line for this indicator. These
two flags define a window of opportunity. The distance between
these two indications define the size of this window, which can
be as small as one day and as large as several weeks.
Pattern recognition is utilized to identify when these two
signals have been triggered within the array of columns pro-
 TRADING STRATEGIES

duced by the EWS. Visually, these patterns can be all

but indistinguishable because of the small and subtle
changes that can trigger them. For this reason, I use
unique flags in the form of distinctive dots to visually
communicate to the trader when these patterns have
developed. A legend of these dots is provided at the
bottom of Figure 1.

THE GOLDILOCKS PARADIGM

The problem with the two EWS indication dots is by
design. The first dot often occurs significantly before
a trading opportunity and the second dot often occurs
considerably after the most profitable entry or exit
opportunity has passed. The Swing•Genie indicator
described in this article aims to fill this window of

opportunity, generating a “Goldilocks” dot that is just
right. Swing•Genie displays all three indicator dots,
providing the trader with a minimum of three signals
or flags that indicate to the trader:
1. A trading opportunity is on the horizon
2. An optimal entry/exit opportunity has
occurred, and
3. A buy/sell decision is confirmed as the trend
continues, and your last chance for a profit-
able entry/exit opportunity is upon you.
Each one of these three indicators is designed to incrementally
and progressively increase the trader’s confidence that the
decisions he has made are correct by way of the appearance
of the next indication dot. The appearance of each additional
incremental signal validates the prior dot.
In the final article in this series I will provide you with a
structurally similar indicator utilizing volume as a final ad-
ditional validation/confirmation of your trading decisions.
This volume price projection indicator is shown at the
bottom of Figure 1.
STOCKDOTGENIE.COM
FIGURE 1: EARLY WARNING SYSTEM.4HEDOTSWEREGENERATEDBYTHE3WINGs'ENIEEARLY
WARNINGSYSTEMANDHAVEBEENDUPLICATEDONTHECANDLESTICKCHARTATTHETOPTOSHOWTHE
RELATIONSHIPBETWEENTHEINDICATORANDTHERESULTINGENTRYEXITSIGNALPOSITIONS
rocket on its intended trajectory. If you have ever watched a
rocket take off, the control generated by the combination of
the COG calculation and vector-directed thrust produced by
the rocket’s engines generates a path that often produces a
perfect parabolic swing. (See the left side of Figure 3.) The
analogy here is that the buying and selling over time provides
the equity’s fuel, driving its vector-directed path, and the COG
provides you with an excellent indication of exactly where
in this parabolic path your equity currently resides. Where
COG really excels, though, is determining and indicating
where within this parabolic path tipping or turning points
have occurred (Figure 2).

COMBINING CENTER OF GRAVITY AND

ARNAUD LEGOUX MOVING AVERAGES
Just as with the EWS indicator dots, the Swing•Genie
dot is also produced by combining several indicators.
And again, just as one indicator used in the EWS was
from the work of John Ehlers, for the Swing•Genie dot,
the first three indicators in the combination are from
Ehlers’ work.
The first is the center of gravity (COG) (Figure 2, gold
line) and it produces a moving filter indicator that heavily
weights the most extreme and most current values in
the stream of data within the window of the indicator.
The COG is an actual rocket science calculation that
is utilized to determine how the center of gravity of a
rocket is changing as its fuel burns off. This is a critical FIGURE 2: CENTER OF GRAVITY (COG).4HE#/'INDICATORISSHOWNFORANEIGHT DAY
PERIODONADAILYCHARTOF!MERICAN%XPRESS!80 4HE#/'CALCULATIONHEAVILYWEIGHTS
point of information because the vectoring of the thrust THEMOSTEXTREMEANDMOSTCURRENTVALUESINTHEDATAWITHINTHEWINDOWOFTHEINDICATOR
must constantly change, incorporating and adjusting 4HE#/'ISUSEFULFORINDICATINGWHEREWITHINAPARABOLICPATHATIPPINGORTURNINGPOINT
to this vital point of information in order to keep the HASOCCURRED

September 2017 • Technical Analysis of STOCKS & COMMODITIES • 23


The goal of the filter is to isolate
optimal swing/daytrading buy/sell
targets, which reside between
the early warning signals and the
crossover (last opportunity) signal.
Ehlers’ passband is again utilized here by taking a longer
COG period of 10 days, utilizing the candle’s body size as
its input and then subtracting a short period of six days us-
ing only the close of the day. The result is a tight tracing of
the stock’s price with an emphasis on the extreme values,
that is, the maximum apex and the minimum vertex of each
parabolic swing.
Finally, the Arnaud Legoux moving average (ALMA) is
utilized as a smoothing filter to slightly shift the weighting
from the COG passband filter in a selective and adjustable
manner to more current bars. This is desirable because COG
dramatically emphasizes the most current candle or bar as
well as large candles and strong deviations from within the
moving average.
Arnaud Legoux and Dimitrios Kouzis Loukas developed
ALMA. It’s a Gaussian distribution–shifted filter with an offset
that is not centered on the data’s window, but instead slightly
shifted to the more (not the most) current data. The ALMA
performs better in this situation because it takes into account
that the closer you get to the most current data, the higher the
uncertainty becomes. In this case, it’s true because the most
recent candle or bar is the one most heavily weighted by the
COG calculation and produces the most uncertainty about future
direction. Of course, we are also at a demarcation point between
what is known and what is unknown. This offset is adjustable so
the trader can balance between smoothness and responsiveness.
The data window size is also adjustable, allowing the amount
of data included within the filter to be dialed in.
The third parameter is sigma, which determines the filter’s
shape and is also adjustable, enabling the trader to widen or
shorten the filter’s focus. Another unique attribute of the ALMA
filter is the removal of small price fluctuations, enhancing the
trend by applying a moving filter twice—once from left to right,
and once from right to left. This process (called zero-phase
digital filtering) reduces noise in the signal, further reducing
the phase shift (price lag) commonly associated with moving
averages.
For anyone attempting to recreate this hybrid moving
filter, the settings that were used to generate the chart in
Figure 1 are:

• center of gravity (10) utilizing open + close / 2 as
The output of the results from the COG passband filter were
then utilized as the input into the ALMA filter. ALMA set-
tings were as follows:
• window size (4)
• offset float (0.67)
• sigma float (1.1).
The result of driving two lengths of COG filters with two
different inputs through a passband filter and finally smooth-
ing that reactive output by using an ALMA filter provides the
trader with excellent responsiveness within a smooth output
signal with few artifacts or whipsaws, which, in my experi-
ence, produce highly reliable trading signals that accurately
indicate optimal entry and exit points.
The ultimate advantage of the ALMA component of this
filter is it gives the trader the ability to adjust the data window,
allowing the primary entry/exit signals to dial down more
exactly to the optimal spot between the early warning indica-
tor dot and the crossunder/crossover dot. Because this system
was initially designed for swing traders, whose timeframe is
normally a few days to a few weeks, the lookback periods are
short. ALMA improves the system’s ability to dial in these
short timeframe filters with as few whipsaw trade indications
as possible. These same attributes also enable daytraders to
alter trading timeframes to effectively utilize this indicator.
AND STILL MORE TO COME
The goal of the Swing•Genie filter is to isolate optimal swing/
daytrading buy/sell targets, which reside between the early
warning signals and the crossover (last opportunity) signal. As
you can see in the chart of American Express (AXP) in Figure
1, intuitive and profitable trading signals are generated.
The third and final article in this series on the volume price
projection (VPP) will offer another confirmational indicator
that helps to validate the signals provided by the Swing•Genie
FIGURE 3: ROCKET TRAJECTORY.4HISISANIMAGEFROMTHE&ALCONAND3%3
LAUNCHFROM3PACE8SLAUNCHPADAT#APE#ANAVERAL)FYOUHAVEEVERWATCHEDA
the input ROCKETTAKEOFFTHECONTROLGENERATEDBYTHECOMBINATIONOFTHE#/'CALCULATION
ANDVECTOR
DIRECTEDTHRUSTPRODUCEDBYTHEROCKETSENGINESGENERATESAPATHTHAT
• center of gravity (6) utilizing only the close. OFTENPRODUCESAPERFECTPARABOLICSWING

24 • September 2017 • Technical Analysis of STOCKS & COMMODITIES

 Author — Connie Brown, CMT, MFTA
early warning system. The combination

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FURTHER READING

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Ehlers, John F. [2001]. Rocket Science
Real-Time Markets,

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For Traders: Digital Signal Process-

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ing Applications, Wiley.

tm
[2013]. Cycle Analytics For
Traders: Advanced Technical Trad- Starting @ $315 (2 hrs)
ing Concepts, Wiley.
[2016]. “Super Passband Filter,”
Technical Analysis of STOCKS &
LIVE ONLINE CLASSROOM
COMMODITIES, Volume 34: July.
[2014]. “Predictive And Suc- Technical Analysis of STOCKS & COMMODITIES, Volume
cessful Indicators,” Technical Analysis of STOCKS & 35: August.
COMMODITIES, Volume 32: January. ‡StockDotGenie.com
Slattery, Michael [2017]. “An Early Warning System, Part 1” ‡See Editorial Resource Index

FUTURES FOR YOU

GARNER
Continued from page 13
are free to create custom options spreads
in some trading platforms, but getting a
market maker to pay attention to it and
be willing to take the other side of it is
challenging. Further, it can take several
minutes to create the spread in the plat-
form. It is an extremely time-consuming
and often confusing process.
We generally recommend that clients
simply leg into options spreads in liquid
markets. We’ve found this to be simpler
and comes with more efficient fill quality.
For example, if a trader wanted to buy
a vertical call spread he might simply
enter an order to buy an emini S&P
2400 call and then another order to sell
a 2450 call. The exchange nets each leg
of the trade and margins it as a spread
… and the trader saved himself several
minutes in order entry.
Order flow, chatter, and sentiment
The greatest aspect of the open outcry
trading pits roaring on the floors of the
CME, CBOT, and NYMEX was the
constant chatter and visible order flow.
Although I was never stationed on the
trading floor, I had access to those who
were via telephone and instant message.
This type of admittance was helpful in
that those with eyes on the floor had
the ability to convey the feeling of the
market. Were local pit traders sweating
or getting excited? What were the big
banks’ desks doing (for example, was the
Goldman Sachs desk going long or short
and how aggressively)? And where were
September 2017
the stop-loss orders accumulating? This
type of inside information was extremely
helpful in judging market sentiment and
speculating on future price changes.
When the pits died, so did this source of
information. Big players now route their
orders through online trading platforms
via what are known as iceberg orders.
This means not only is their buying
and selling activity anonymous, but the
ultimate quantity of the orders of the
market-moving traders is disguised. In
short, now that trading activity has moved
to the screens, speculators, floor traders,
and brokers have been forced to find an
edge somewhere other than the pit order
flow and floor chatter.
• Technical Analysis of STOCKS & COMMODITIES • 25
 Volume Price Projections
An Early Warning System
Part 3
In this final part of a three-part series, we’ll describe a swing
trading system that provides traders with a simple, straight-
forward set of rules to help anticipate price trends based on
significant volume increases.
by Mike Slattery
If
you sell me one share of stock and that transaction
represents the entire number of trades for that equity
for that trading day, then the total volume for that day
would be one (1). This would represent little interest
and lack of enthusiasm for this stock and its price.
This price is unlikely to fluctuate (beyond this one
trade’s price change)—it would be impossible to fluctuate,
as price cannot change without volume sufficient to create
an atmosphere where market dynamics can come into play,
allowing for fluctuation of price. In the second article in this
30 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
series, “An Early Warning System,” which appeared in the
September 2017 issue of Technical Analysis of STOCKS &
COMMODITIES magazine, I compared the similarities between
the trajectory of a rocket’s path and parabolic movement of
a stock’s price. Volume is the fuel of this analogy and of the
equity markets.
HOW DO YOU MEASURE IT?
The irony represented by this one-share example is, if the normal
daily volume is one million shares, and today’s volume is one
million shares, you see a situation where there is no substantive
BY COLOR 4260/SHUTTERSTOCK
increase in the interest for this equity over normal daily market
activity. Again, the price is unlikely to change dramatically
given the interest level has remained unchanged.
Obviously, interest levels can have rapid and often unex-
plained changes that could be positive or negative. These
changes are driven by a multitude of events that the trader is
 TRADING SYSTEMS

often unaware of and/or has no control

over. These include earnings releases,
news, competitors’ news releases,
economic news, natural disasters and

STOCKDOTGENIE.COM
weather occurrences, market industry/
segment news, segment rotations, and
even fake news.
What is important about interest FIGURE 1: ISOLATING SIGNIFICANT VOLUME EVENTS. Here you see Volume Price Projection indicating only
levels, regardless of sentiment—whether volume events above or below the normalized moving average of volume.
positive or negative—produced by any
of these events, is if the event or news
is to have an impact on share price, the
volume will increase. This volume in-
crease provides the liquidity required to
allow market dynamics to fuel changes
in price. This makes significant volume
increases the hallmark of any mean-
ingful changes, first in interest, which
results in higher volume, and second,
in influencing sentiment with the end
result being a change in price.
If you see a significant increase in
volume, but you are not aware of what
news caused this dramatic change in the
level of interest in this equity, it creates
a red flag that implores you to find out
what is going on. This is imperative
if you already own this stock. Most
financial sites will include news feeds
FIGURE 2: COMBINING VOLUME PRICE PROJECTION WITH VOLUME/PRICE PROJECTION MATRIX. This
for all symbols and my first choice, of provides traders with the ability to project future price trends after significant volume increases.
course, is my charting and trading site,
Tradingview. Google, Seeking Alpha,
and the company’s own website are the next three places I go center demarcation line, plotted on a zero axis. Positive volume
to try and figure out what is going on. produces green columns and a reduction in volume from the
It now becomes obvious that volume is an important trading moving average produces red negative columns.
signal only when volume spikes are significant, that is, above Why zero this line out? Because any volume that does not
the normal daily average. Volume price projection (VPP), exceed your own chosen moving average indicator and time-
described here and depicted in Figure 1, displays only the frame are not providing tradable information. They become
differences the current volume represents above or below the noise in your system that can confuse or complicate quick
current moving average of volume. This isolates only significant trading execution decisions. We keep the red, reduction in vol-
volume events for the trader. When used in combination with ume columns because there are several situations, which I will
a simple rule set, such as the volume/price matrix, as seen in describe a little later, where this information is also insightful
the chart in Figure 2, traders get a powerful tool set, which to the trader as confirmation of developing opportunities.
alerts them to potential opportunities while providing strong
confirmations of your trading decisions. DECREASES IN VOLUME CONFIRMS
VPP can be easily calculated. In the swing-trading environ- When there’re decreases in volume, it could indicate lack of
ment we are targeting, a very short-term moving filter is used. interest. If that lack of interest continues, price can trickle
The daily volume is then subtracted from this moving filter and down as traders migrate to more volatile and profitable
any changes from the moving filter values are displayed as col- targets of opportunity. Decreased volume can also provide
umns. This effectively causes the volume that is not significant important information during common patterns such the
to disappear as the columns now being drawn only represent cup with handle pattern. Reduced volume during the trough
the volume amounts above or below the values represented by period of the cup pattern suggests that most traders in this
the moving filter. As in the other articles in this series, a La- equity are holding their shares despite the reduction in price.
guerre moving filter is being used. As you can see in the chart If and when price again starts to rise, it will be accompanied
in Figure 1, the moving average value, although continuously by an increase in volume as well. Reduced levels of volume
updated, is normalized to zero and displayed as a horizontal, below the normalized moving average can also provide traders
October 2017 • Technical Analysis of STOCKS & COMMODITIES • 31

FIGURE 3: VOLUME PRICE PROJECTION MATRIX. You will obviously encounter
exceptions to these rules, but most times this chart will provide you with accurate
price trend direction, based on prior historical prices and volume that are above
the threshold of the moving average of volume.
with an important confirmation of an impending, profitable
trading opportunity.
One of the most common short-term trading opportuni-
ties occurs when a stock is in a strong long-term uptrend and
experiences a short-term retracement. This divergence is a
great opportunity to enter this stock with a slightly better entry
position than if the upward trend had continued unabated.
This opportunity can be confirmed if there’s a reduction in
volume—below the normal moving average of volume—
during the retracement period. This reduction is the opposite
of interest and reflects indifference, as most traders basically
ignore this temporary change in price in a strong equity that
most wish to continue to hold. You are seeing an excellent
reversion entry point, as the likelihood that this stock will
revert to the mean is high.
It is not uncommon to see these new inflection points become
a base for a new strong upward leg to a new high. Confirma-
tion of an emerging reversal is, as you should now expect, an
increase in volume above the volume moving average.
PROJECTING PRICE TRENDS USING VOLUME
Before news events, your stock will either be trending or con-
solidating. During the time period that this new news event
becomes public, your stock will start to move in the direction
that was representative of the sentiment reflected by this news
32 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
on increased volume. As blatantly obvious as that may sound,
the relative importance of the impact this news has on your
stock’s future financial prospects can produce divergent results.
As the volume/price projection matrix in Figure 3 indicates,
there is a glaring contradiction to what would have otherwise
been a straightforward and clear relationship. Irrational exuber-
ance can cause a stock to accelerate, driving its price one or
even two standard deviations above or below the short-term
moving average. This produces a situation where the stock
becomes either overbought or oversold and that stock enters
a window of high probability to reverse its trend.
OR MAYBE NOT?
Another seemingly contradictory situa-
tion could also exist here and that is that
the exuberance may not be irrational.
If earnings are driving what appears
to be irrational exuberance and those
earnings are accompanied by revenue
beat and optimistic earning projections
sufficient to reset the current and future
earnings per share (EPS) expectations,
then the accelerating upward price
(large candle or gap up) may represent a new set-point or
base for this equity and it could climb higher from this point.
Anytime that earnings and projected earnings, also referred
to as forward guidance, are this positive (or negative), it will
draw attention to the equity, attracting new traders. These new
traders will arrive with a new sentiment baseline regarding
the future prospects for this equity. This influx of new trad-
ers can cause enough liquidity to allow for a continuation of
the price trends that would have previously appeared to be
overly exuberant.
As you can see, this situation of irrational exuberance—
creating a stock accelerating into overbought/oversold
territory—is complicated, and creates two potentially con-
tradictory outcomes. This makes accelerating price the pri-
mary exception to what would have been a straightforward,
common-sense, and all-encompassing approach to analyzing
volume. Keeping this double-edged sword of accelerating
price exceptions in mind, it is possible to still propose a set
of highly reliable volume rules.
With the exception of rare situations, volume spikes pro-
duced from news events will occur in concurrent trading days,
producing tightly grouped clusters of green columns. Volume
levels will almost always follow some semblance of a para-
bolic pattern, even if the actual column heights do not seem to
readily adhere to this visual description. You will see a spike
in volume followed by a steady reduction in volume as the
enthusiasm and interest in this equity wanes. Small increases
in volume prior to the spike do not always occur. But if the
news that is causing a change in sentiment and thus interest
levels has been selectively released and leaked to institutions
or hedge funds, an initial increase in volume can be common
in these situations. This is almost a certainty in the situation
where a secondary offering is about to be announced.
USING THE VOLUME/PRICE MATRIX
The blue dots with gold outer rings displayed in Figure 2
indicate the highest volume within each of these groupings.
These flagged columns represent the pinnacle of the volume
cycles and become the tipping points within the “during” col-
umn in the volume/price projection matrix, shown in Figure
3. This enables the trader to determine future price direction
trends based on volume.
You’ll notice the header of the volume/price projection ma-
trix contains a bell-shaped curve, which represents volume—
before, during, and after pinnacle volume spikes.
All the arrows below this header are graphic representations
of price before and during this volume increase, and indicate
where your equity’s price will trend after the volume event.
The only arrows requiring additional explanation are the
accelerating arrows, which have a segmented shaft. Acceler-
ating arrows represent large bars or gaps and often produce
contradictory results.
The before, during, and after arrows that appear in the
daily price chart of Nvidia (NVDA) in Figure 2 provide a
clear example of how to apply the information provided in the
volume/price projection matrix. The example is taken from
the second line of this chart.
DISTILLED VOLUME RULE SET
1. If the stock is rising during the volume spike (cluster
of green columns), then the stock will continue to
rise after the volume spike has receded.
2. If the stock’s price is declining during the volume
spike (cluster of green columns), then the stock
will continue to decline after the volume spike
has receded.
3. Exception: If the stock price is accelerating into
overbought or oversold territory accompanied, by
what in this situation is typically referred to as a
volume climax (cluster of green columns), then it is
likely to experience a reversal in price contradict-
ing rule 1 and 2. Rule 3 gets contradicted when the
news is very positive or very negative, causing a
continuation, not a reversal of the price trend. The
relative strength of this new news must guide your
interpretation of the future price trend.
NEW NEWS BECOMES DISCOUNTED
The efficient market hypothesis (EMH) states that asset prices
fully reflect all available information. It would then seem rea-
sonable in an era of instantaneous and constant news streams
that the impact resulting from any new news event would be
immediate and short lived. This would result in relatively rapid
changes in price as the new information is incorporated into
the price and that new price level would be maintained after
the spike in volume diminished. However, many traders are
sufficiently distracted by other activities of daily living, such
as jobs and family responsibilities. This results in the first
Significant volume increases
are the hallmark of any
meaningful changes, first
in interest, which results in
higher volume, and second,
in influencing sentiment
with the end result being a
change in price.
of many delays, staggering the dissemination of this news,
preventing an immediate reaction by all individual or retail
traders. Institutions can also take several days to analyze this
new information and revise their buy, sell, or hold recom-
mendations. This further extends the window this news cycle
could impact both volume and price of the equity.
Finally, many traders can remain oblivious of news in an
equity they do not closely follow, but will notice them when
they appear within newsletters or stock screeners detailing
dramatic volume and price changes. The sentiment of these
traders can now be projected technically into the market and
many other individuals will buy or sell based on this new
technical dynamic. Because of the time lag inherent in these
lagging information-disseminating resources, the window of
this news cycle is again extended, influencing the length of
time that price and volume could continue to be influenced.
Again, we see a basic tenet of the markets—human behavior
overriding the EMH as traders absorb new news and then over-
react, producing trading opportunities in both directions.
VOLUME RESOURCES AND RULES
There are a great many theories and articles
on how to utilize changes in volume to im-
prove your technical trades. Dow theory, a
market timing model that dates back around
100 years and that was derived from a col-
lection of editorials written by Charles Dow
of The Wall Street Journal, predominately
relied upon volume as a confirmation of
any new trend.
Tim Ord has published multiple articles and books on how
to utilize volume as a predictive indicator. You can read
“Price + Volume = Price Movement” in the May 2004 issue
of Technical Analysis of STOCKS & COMMODITIES. Jayanthi
Gopalakrishnan, editor of Technical Analysis of STOCKS &
COMMODITIES, published an examination of a proprietary
indicator and registered trademark of the Chicago Board
of Trade referred to as Market Profile. It enables traders to
determine the value area, utilizing either volume or time
price opportunity (TPO) as a defining axis. The value area
defines where prices are most likely to make significant moves
and it should come as no surprise that it coincides with an
increase in volume.
October 2017 • Technical Analysis of STOCKS & COMMODITIES • 33
 Statistically significant volume spikes
that have dramatic visual effects but that
only last one day are somewhat confus-
ing in that they produce a dramatic flag
attracting new traders to this equity.
This volume increase also transiently
increases the liquidity, allowing for
greater fluctuations in the equity’s
price. Two recent articles by Giorgos
Siligardos have detailed the implica-
tions of these types of volume spikes.
The conclusion by the author in both the
articles was, there is no predictive value
of this type of volume anomaly.

FINDING OPPORTUNITES
Many unique resources can be found
online to obtain lists of equities that
are experiencing above-normal vol-
ume. Any site that describes itself
as a screening site will have this
information. Some of these include
finviz.com, barchart.com, nasdaq.
com/markets/unusual-volume, and
thestreet.com/markets/actives.

THE SYNERGISTIC POWER OF

FIGURE 4: COMBINING ALL THREE INDICATORS. On this chart of Nvidia (NVDA) you see the synergism by THREE
COMBININGTHE3WINGs'ENIEWITH%ARLY7ARNING3YSTEM6OLUME0RICE0ROJECTIONAND6OLUME0RICE0ROJECTION All subchart references that follow refer
Matrix Chart.
In stocks trending up, a confirmation that an upward bull
trend exists is an increase in volume. Reversals that turn out
to be short countertrends will confirm their short-lived nature
by producing a reduction in volume. Bear trends will be con-
firmed by an increase in volume during the descent to lower
prices. Short, countertrend up movements will again be met
with a reduction in volume. Edwards and Magee identified this
fundamental principle of market trends being confirmed by
an increase in volume in their 1948 book Technical Analysis
Of Stock Trends.
VOLUME CONTRADICTIONS
If you see significant price changes on below-
average volume, then the change is unlikely
to hold, as it is not being confirmed by an
increase in volume. The opposite situation is
equally telling. High volume on very small
price changes are often an indication that
institutions are executing bracketed trades,
enabling them to ease into large positions,
usually over several days, without disrupting
the current price trend significantly. Multiple
candles with both wicks and shadows over several days that
also experienced an increase in volume are confirming signs
that this supposition is occurring.
34 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
to Figure 4. The combination of the three
indicators described in this series of
articles provides traders with a powerful and profitable swing/
day trading system. The cumulative and synergistic nature of
the signals provided enables implementation of trades with a
level of confidence that is reinforced by multiple sequential,
progressive, and confirming signals.
B (1) In subchart B, the Early Warning System (EWS)
indicator provides the trader with its first early in-
dication of a trend reversal, eight days prior to the
turning point (1). The second EWS signal (1) was
generated five days prior to the turning point.
B (2) In subchart B, you can see that the Swing•Genie
indicator painted (issued) a sell signal one day prior
to the turning point event. Note that the generation of
this signal relies on the relative change in magnitude
of the next candle/bar and the signal is then painted
on the prior peak histogram column.
A (3) In chart A—the top pane of Figure 4—you see that
on the next day there was a strong red candle closing
significantly below the closing price of the trading
action of the prior day.
C (4) The volume price projection in subchart C indicated
a peak in the volume of a multiday spike above the
moving filter/average, providing the peak in volume
 required to incorporate the Volume Price Projec- FURTHER READING
tion rule set. Using the volume/price matrix chart Goetzmann’s Dow page (http://viking.som.yale.edu/will/dow/
in Figure 3, the indicator projected that the price dowpage.html). Includes a link to Dow’s editorials and links
trend would be negative after the “during” period to numerous articles describing support of Dow theory.
this spike in volume defines. This peak in volume Gopalakrishnan, Jayanthi [1999]. “Market Profile Basics,”
spike occurred one day after the turning point in Technical Analysis of STOCKS & COMMODITIES, Volume
price and the sell signal generated by Swing•Genie 17: December.
in subchart B (2). Gopikrishnan, P., V. Plerou, X. Gabaix, and H.E. Stanley
B (5) The EWS in subchart B indicates that price from [2000]. “Statistical Properties of Share Volume Traded In
within the EWS has crossed the short-term moving Financial Markets,” Physical Review, October.
filter utilized in the indicator. This Swing•Genie Ord, Tim [2008]. The Secret Science Of Price And Volume:
crossover indicator provides traders with an indi- Techniques For Spotting Market Trends, Hot Sectors, And
cation that all the sequential indicators have been The Best Stocks, Wiley.
confirmed. It also provides the trader with a final Siligardos, Giorgos [2005]. “Spike Up The Volume,” Technical
“your time is up” signal to exit or short this trade. Analysis of STOCKS & COMMODITIES, Volume 23: June.
[2016]. “Volume Spikes During Swift Stock Trends,”
Journal of Technical Analysis.
THE IMPORTANCE OF VOLUME Slattery, Michael [2017]. “An Early Warning System, Part 1,”
The articles on volume I’ve mentioned here and a great many Technical Analysis of STOCKS & COMMODITIES, Volume
other technical analysis articles with a focus on volume 35: August.
give rule sets that are often difficult or confusing to follow. [2017]. “An Early Warning System, Part 2,” Techni-
This makes incorporating those rules into your own techni- cal Analysis of STOCKS & COMMODITIES, Volume 35:
cal trading regimen difficult because they do not provide a September.
straightforward and intuitive guide to the trader. This results
‡StockDotGenie.com
in most traders ignoring volume as a leading or confirming
‡See Editorial Resource Index
indicator. But when you have an indicator that clearly identi-
fies when these volume spikes are significant and you have
a price and volume matrix, then you will have a simple and
straightforward set of rules that provides an effective trad-
ing advantage that can easily be incorporated into your daily
trading regimen.
Today’s stock market and the news that could affect your
stocks’ performance can be a chaotic environment. Complete
situational awareness is almost impossible since multiple con- SUBMIT AN ARTICLE!
tradictory and divergent agendas attempt to propel price in a
predetermined trajectory. Multiple contradictory news events
can be simultaneously or sequentially released from anywhere
in the world, some fake and some real, causing your equity to
whipsaw as a result. The Swing•Genie indicators, including
the Volume/Price Projection Matrix provided here, constitute
an excellent guide and confirmation for entering and exiting
trades. My cautionary note is, anything can happen and often
does when you are invested in a financial equity instrument.
Risk and money management are your best guarantees of an
increased level of safety, which in the long run will result in
greater profits. Are you knowledgeable about technical indicators, charting, trading
systems, and money management? Or do you have a solid background
with intraday trading, trading psychology, options and cycles? If so, we’d
Michael Slattery has been developing stock screening tools, like to hear from you!
technical trading techniques and indicators for more than 17
To write for any of our publications or obtain more information, please
years. Slattery has been a Seeking Alpha author for the last click on Contact Us at www.Traders.com.
five years and contributed his first article to Technical Analysis
of STOCKS & COMMODITIES in the July 2016 issue. He is the
founder and CEO of StockDotGenie.com and is a programmer/
developer for TradingView.com, a socially interactive, program-
mable charting platform with live data and news feeds. He can Fax resume to 206-938-1307 or call 206-938-0570
email Editor@Traders.com, or see www.Traders.com for more information.
be contacted through the StockDotGenie.com website.
October 2017 • Technical Analysis of STOCKS & COMMODITIES • 35
 Riding The Ebbs & Flows

Another Look At Wave Theory

What do the swings on a chart really mean? Maybe organiz-
ing them into groups based on their size can help answer
that question.
by Michael Dylan
tock prices move in rhythms, but you never know
(swings) are part of a natural rhythm that markets produce.
There are many tradable rhythms, each having a distinct
pattern of movement yet going on at the same time, which is
why it’s hard for the untrained eye to decipher them. Here,
I will demonstrate how Dylan Wave Theory organizes price
charts, which can bring clarity to the price swings and help

S when a price drop is a correction or a reversal. A AAPL [CV] [M] Daily 135.00
stock such as Apple Inc. (AAPL) has been up for 130.00
several years, but the price dropped sharply in
125.00
August 2015, as you see in Figure 1. When you see
something like that happen, you have to wonder 120.00
whether the big price drop is a trend reversal or a big 115.00
correction. If it’s a correction, you would want to buy, but 110.00
108.98
when should you buy? I came up with a wave theory I call 105.00
Dylan Wave Theory that can help determine whether a
100.00
price drop is a correction or a reversal. It can also help
SIERRA CHARTS

you understand what the price swings really mean. 95.00

13 May 15 Jun 12 Jul 14 Aug 17 Sep 15 Oct 14 Nov 16 Dec 14 2

WHAT IS IT? FIGURE 1: CORRECTION OR A TREND REVERSAL? When you see a big price drop in a
Dylan Wave Theory organizes price swings into groups stock that has been moving up consistently for several years, you have to wonder whether
based on correction sizes. These groups of price waves it’s a correction or a trend reversal.

18 • July 2016 • Technical Analysis of STOCKS & COMMODITIES

 CHARTING

40
40 40
40 40
100

100

FIGURE 2: TWO RHYTHMS. In this illustra- 100 100

tion, there is a new uptrend and a correction
of 100 points. The market makes a new high
followed by a 40-point correction, and then
a new high. There are two rhythms on the FIGURE 3: CORRECTIONS DURING TRENDS. Each FIGURE 4: SMALLER RHYTHMS COMPLETE FIRST. The 40- and
chart—a 100-point rhythm and a 40-point rhythm has its own first correction and subsequent 100-point rhythms are completed with matching, similar-size correc-
rhythm. matching second correction. tion waves.

you find the natural support levels.
To take advantage of these market rhythms, you need to
follow three simple rules:
1. Identify new rhythms based on correction wave sizes.
To be a new rhythm, the size of the correction wave
must be 20% bigger or smaller than the other correction
waves in a trend. The first new correction by size will
be marked as correction number one.
2. As the trend continues to develop, the first correc-
tion wave in a rhythm will be matched by at least one
other correction wave of similar size. In other words,
rhythms develop between one or more pairs of similar
size correction waves. To be considered similar in size,
these correction waves must be within a 20% band. For
example, a correction that is 100 points can be matched
with a correction of 80–120 points. But a 100-point cor-
STYLIZED WAVE: JAVI RUIZ / ABSTRACT METAL: EKY STUDIO/SHUTTERSTOCK / COLLAGE: CHRISTINE MORRISON
rection, and then another new high. Now there are two rhythms
on the chart—one of 100 points and one of 40 points.
Rule 1 tells you that for a new rhythm, a correction must be
at least 20% bigger or smaller in size than previous corrections.
The 40-point correction is much smaller than the 100-point
correction and that’s why it’s considered a new rhythm.
Rule 2 tells you that as the trend continues to develop there
will be a similar-size correction(s) to the first correction in a
rhythm. It is important to remember that each rhythm has its
own first correction and subsequent, matching second cor-
rection. As the market makes new highs, subtract 40 points
from the new highs to calculate the first Dylan support price
(Figure 3).
Rule 3 says the smaller rhythms will complete first. In other
words, the 40-point correction will match first, followed by the
100-point correction. As the market makes a new high, you
subtract 100 points to calculate the second Dylan support price

rection cannot be matched with a 75-point correction or (Figure 4). There can be numerous patterns to these rhythms.
a 125-point correction. For example, the next correction may not be 100 points as in
3. Since there are several
different rhythm sizes
on a chart, the smaller
rhythms will complete
first. In other words, there
is a sequence to how
market rhythms work out. 70
The smaller corrections 40 70 100
40 40 70
are matched first and then 40
the bigger ones.

Here is a simple explanation

of these three rules. Let’s say
there is a new uptrend and a cor-
rection of 100 points (Figure 2).
Then the market makes a new
high followed by a 40-point cor-
100
FIGURE 5 : MANY PATTERNS TO THE
RHYTHMS. The smallest 40-point rhythm is
completed. The 70- and 100-point rhythms have
not been completed yet.
100
FIGURE 6: THREE RHYTHMS. All rhythms are completed with matching,
similar-size waves. Now we wait for a new rhythm to develop.

July 2016 • Technical Analysis of STOCKS & COMMODITIES • 19

 AAPL [CV] [M] Weekly #6 first, followed by a rally, even if it is a small rally.
Subsequently, the 100-point correction should be
120.00 matched (Figure 6). At this point, the uptrend has
100.72 105.67 developed in three rhythms, namely, the 40-, 70-,
100.00
and 100-point rhythms.
80.00
CHART ANALYSIS
60.00 When AAPL went through its large correction in
55.01
2013 it was bigger than any of the previous cor-
40.00
rections, as you can see on the weekly chart of
20.00 AAPL in Figure 7. According to rule 1, this is a
potential new rhythm. To measure the size of the
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 0 new correction wave, draw a box from the trend
FIGURE 7: MEASURING CORRECTION LOWS. On this weekly chart of AAPL, you see a new high at 100.72 to the correction low at 55.01, or
rhythm developing in correction 1. you could subtract 55.01 from 100.72 to get the
size of the correction.
AAPL [CV] [M] Weekly #6 When the stock price makes a new high, as il-
lustrated in Figure 8, the new rhythm is confirmed,
120.00 and in the future we should expect a similar-size
New high
100.72 105.67 correction one more time. As AAPL makes new
100.00
highs, keep moving the box up (Figure 9). The
80.00 bottom of the box is the Dylan support price.
Sometimes the second correction in a rhythm
60.00 will not quite reach that support price, which is
55.01 why I recommend that the entry price be placed
40.00
slightly above the support price. The first blue
20.00 box on the chart is the first correction, and the
second blue box represents the matching second
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 0 correction of the rhythm.
FIGURE 8: NEW HIGH, NEW RHYTHM. When the price goes above where the first correction Since the theory states that more often than not
began, 100.72, the new rhythm is confirmed. a trend will develop in sets of two similar-size
corrections, and since the correction of 2013 in
AAPL [CV] [M] Weekly #4 134.54
AAPL had not yet been matched with at least
130.00
2-to-1 certainty, then the current rhythm contain-
ing the 31% price drop can be considered a big
120.00
correction and not a trend reversal. Therefore, the
110.00 Dylan support price at 88.97 is an opportunity
100.72 105.67
100.00 to buy (Figure 9).
90.00 Dylan Wave Theory has answered the ques-
88.97 tion of whether the big downward price action
80.00
you saw in Figure 1 is the beginning of a bear
70.00
trend or whether it’s a big correction. It was a big
60.00 correction matching the one in 2013. The other
55.01 50.00 question Dylan Wave Theory answered is where
May Sep 2012 May Sep 2013 Jun 2014 Jun 2015 Jun 2016 1 to enter the market. The answer is to enter near
the 88.97 Dylan support price.
FIGURE 9: FINDING SUPPORT LEVELS. The size of the first correction, 45.71, is subtracted from
the new highs to find the support price.
It is not necessary to use the rectangular boxes
to find the support prices; however, they do pro-
vide a quick way to find the support prices and
the previous example, but rather 70 points followed by a new organize waves into color schemes. For example, instead of
market high (Figure 5). drawing a box, you could have subtracted the low of the first
Now there are two rhythms in the market, of 70 and 100 correction 55.01 from the beginning of the correction 100.72
points, and very likely the 70-point correction will match and come up with 45.71 for the correction size. As AAPL made
first. The 40-point rhythm is finished, because the 70-point new highs, you would subtract 45.71 to find the support price.
rhythm is 20% bigger. According to rule 3 of the Dylan Wave
Theory, the 70-point Dylan support price should be matched Continued on page 44
20 • July 2016 • Technical Analysis of STOCKS & COMMODITIES
 A chart of the averages or a single
stock reflects the ideas, hopes,
ambitions, and purposes of the
OSOBA/WYCKOFF mass mind operating in the market.
Continued from page 31

you may discover automatic buying and selling signals from
similar patterns.” Do not substitute anything for the necessity
of “employing judgment and sound, practical reasoning.”
The fifth and final part of this series will be a discussion of
Richard Wyckoff’s latter years, during which time he invested
in the phonographic industry, lost control of his Magazine Of
Wall Street, and also published his memoirs.
Stella Osoba is a freelance writer and trader. She has earned
the Charted Market Technician designation and has writ-
ten for several financial websites and publications. She is
a frequent contributor to Technical Analysis of STOCKS &
COMMODITIES magazine and Traders.com Advantage online
publication. She may be reached via email at stellaosoba@
gmail.com.
FURTHER READING
Osoba, Stella [2016]. “Richard Demille Wyckoff (part 1),”
Technical Analysis of STOCKS & COMMODITIES, Volume
34: April.
[2016]. “Richard Demille Wyckoff (part 2),” Technical
Analysis of STOCKS & COMMODITIES, Volume 34: May.
[2016]. “Richard Demille Wyckoff (part 3),” Technical
Analysis of STOCKS & COMMODITIES, Volume 34: June.
Wyckoff, Richard D. [1985]. Wall Street Ventures & Adven-
tures Through Forty Years. Originally published in 1931
by Harper & Bros.
[1910]. Studies In Tape Reading, Ticker Publishing
Company.
[1933]. Stock Market Technique, Number 1, Fraser
Publishing Co.
[1934]. Stock Market Technique, Number 2, Fraser
Publishing Co.
[1937]. Wyckoff Method Of Trading And Investing In
Stocks: A Course Of Instruction In Stock Market Science
And Technique, Wyckoff and Associates Inc.
‡StockCharts.com
‡See Editorial Resource Index

DYLAN/WAVE THEORY AAPL [CV] [M] Weekly #4

Continued from page 20 130.00
120.00

AAPL peaked at 134.54, so subtracting 45.71 will 110.00

give a support price of 88.97. 100.72
100.00
96.96
Naturally, the best trades are the ones when
90.00
the stock price does not reach the Dylan sup- 88.97
port level. To catch these best trades, your entry 80.00
should be placed a little above the support price. 70.00
Note that AAPL came close to the Dylan support
60.00
price of 88.97 twice and then rallied. The second
time it came near the support price, the weekly Sep 2013 Apr Jul Oct 2014 Apr Jul Oct 2015 Apr Jul Oct 2016 2
chart gave a double-bottom formation, and the FIGURE 10: THE RHYTHM OF THE CHARTS. Bigger trend waves will have several smaller
breakout of the previous week’s high was a nice rhythms in it. The yellow boxes illustrate smaller rhythms within the price range of bigger rhythms
confirmation signal. (blue boxes).

FOLLOW THE NATURAL RHYTHM
At any given time, there are bigger and smaller
rhythms, as illustrated in Figure 10. You’ll notice
that after the first big correction (shown in the
blue box), the uptrend wave developed in smaller
rhythms, and each of those rhythms is identified
by the yellow boxes. According to rule 3 of the theory, the
smaller rhythms complete their cycle first. Different-colored
boxes help you keep track of each rhythm and help to measure
the support prices. A daily chart will reveal additional rhythms,
and an hourly chart even more. The Dylan Wave Theory can
be used for day, swing, and position trading.
44 • July 2016 • Technical Analysis of STOCKS & COMMODITIES
Michael Dylan has more than 35 years of experience analyz-
ing the markets and has created trading systems, published
newsletters and videos, and given seminars. He provides an
analysis and timing service at www.dylanwave.com. The sec-
ond edition of his book Smart Trader has just been released as
an ebook. He can be reached at michael@dylanwave.com.
‡Sierra Charts
‡See Editorial Resource Index
 TRADING ON MOMENTUM

Ascending Triangle Breakouts

This month in our Trading On Momentum column, this profes- STEP-BY-STEP ACTION PLAN
sional trader introduces you to the ascending triangle pattern Here’s how you can start using this strategy with your swing
that you can use to help spot buying pressure as it builds. trades:

by Ken Calhoun Step 1: Look for a 15-day 15-minute candlestick chart in

which price is in an uptrend, as seen in Figure 1, Shopify,
inding potential breakouts before they happen is a Inc. (SHOP) from January 3, 2017 to January 5, 2017.

F helpful visual scanning skill to develop. You can use

ascending triangles to help you identify these new
trading opportunities, because they reveal increasing
buying pressure just in time to help you enter your position.
You will see how to trade this useful bullish breakout trading
pattern in this month’s column.
SWING TRADING ASCENDING TRIANGLES
An ascending triangle is formed when there is a horizontal
resistance level of three days or longer forming the top of a
consolidation pattern, accompanied by an uptrending, lower
trading line. You can think of this as a visual battle between
buyers and sellers, with buyers slowly winning during a
multiday timeframe. The uptrending lower line indicates that
buyers are gradually winning.
Once you see price action break out above the upper re-
sistance line, it indicates a long trade entry. It is important
to note that you should also wait until price moves at least
$0.50 above resistance (or you see a large green candle form
at the upper right area of the ascending triangle) to help avoid
false breakouts.
Step 2: An ascending triangle occurs from January 5–9, 2017
in this chart. You may enter your trade once price action has
broken out above the upper resistance line.
Step 3: To potentially avoid false breakouts, waiting until
$0.50 above resistance before entering (in this case that is
$47.50/share + 0.50 = $48 entry) as seen on January 10.
Step 4: Place an initial and trailing stop value of $2.00 per
share to manage the trade.
INSIGHTS: WHY THIS TECHNIQUE WORKS
The ascending triangle is a useful bullish entry pattern because
it visually shows the forces of demand overpowering supply,
which leads to an increase in price. It is important for you
to carefully observe what price does as soon as it breaks out
to new highs.
Much like you would anticipate a handle at the right side of
a bullish cup pattern breakout, you can also anticipate occa-
sional false breakout choppy price action following ascending
triangle patterns. That’s why
I have found it useful to wait
until price has moved up at
least $0.50 above resistance,
preferably with additional
bullish confirmations like a
tall green candle and high
volume, prior to entering
the trade.

TRADE MANAGE-
MENT TIPS
You can visually see the
forces of buyers and sell-
ers at work with the help
of the ascending triangles.
Managing your trade entries
is often simply a matter of
buying strength and using
careful risk management in
eSIGNAL

context of strong chart en-

FIGURE 1: ASCENDING TRIANGLE (SHOP). You enter a swing trade $0.50 above the upper resistance line after an ascending
triangle breakout entry signal. Continued on page 31
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 17
 What isn’t readily visible in media
soundbites is that it took Zanger years
to develop his technique to search and
find stocks like ACIA that have the
key components, both technically and
fundametally, to make them explosive
stockmarket outperformers.
But his is no get-rich-quick scheme.
Once you have found potential winners,
you need to have developed the patience
to wait for the move; the laser-like focus
to recognize that the move has begun; the
timing to know when to strike; and the
emotional control to manage the trade.
And finally, you need to have nurtured
the well-honed discipline not only to wait
for the move to unfold, but also to know
when to take profits. The only question
that remains for would-be successful
momentum traders is, do they have what
it takes to meet the challenge?

Matt Blackman, is a technical trader,

author, reviewer, keynote speaker and
regular contributor to a number of trad-
ing publications and investment/trading
websites in North America and Europe. He also writes client
newsletters and assists clients in building their professional
profiles through various financial and mainstream media
outlets as well as client resource management. He earned the
Chartered Market Technician (CMT) designation from the
Market Technicians Association (MTA). Follow Blackman
on Twitter @RatioTrade or email him at indextradermb@
gmail.com.
FURTHER READING
Blackman, Matt [2003]. “Chart Patterns, Trading, And Dan
Zanger,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 21: August.
[2014]. “Seeing The Patterns With Dan Zanger,” in-
terview, Technical Analysis of STOCKS & COMMODITIES,
Volume 32: Bonus Issue.
Bulkowski, Thomas N. [2005]. Encyclopedia Of Chart Pat-
terns, 2d. ed., Wiley Trading.
Zanger, Dan, and Matt Blackman [2010]. “Is Trading That
Simple?” Technical Analysis of STOCKS & COMMODITIES,
Volume 28: August.
‡ChartPattern.com

CALHOUN / ASCENDING TRIANGLE BREAKOUTS

Continued from page 17
tries. Remember, the reason for your entry is because buyers
are winning control of price action once it breaks above new
highs. If price drops $2.00 or more beneath your initial entry,
then it is smart to take a small stop, since the reason for your
initial entry is no longer valid. If price continues to move up,
it is often helpful to add shares to a winning position to scale
in every two points or so, with a two point trailing stop.
As with all of our professional swing and intraday charts,
it is best to use this strategy with stocks and ETFs priced in
the $20-$70/share range, because these charts tend to have
stronger, more sustainable breakout trends than cheap, choppy
stocks priced under $10/share. As with other bullish patterns
such as cups, gap continuations, and 45-degree angle uptrends,
The ascending triangle visually
shows the forces of demand
overpowering supply, which leads to
an increase in price.
you will find that ascending triangles can help you spot strong
breakout trading opportunities as they occur.
Ken Calhoun is a producer of trading courses, live trading
room and video-based training systems for active traders.
He is a UCLA alumnus and is the founder of TradeMastery.
com, an educational resource site for active traders.
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 31
 TRADING ON MOMENTUM

Bollinger Band
MA Crossover Breakouts (or simply, Bollinger Band Breakouts)

This monthly column written by a professional daytrader and
educator covers the general topic of breakout trading tech-
niques. This month, he explains how you can use a particular
combination of signals to help avoid false breakouts while
gaining earlier, stronger indications for entering.
by Ken Calhoun
the squeeze contraction, a long breakout entry is generated.
A common problem seen in classic BBand squeeze break-
outs is an unwanted “head fake” (that is, a false breakout). By
combining an earlier SMA crossover signal, you can minimize
this and get stronger entries instead. This SMA signal gives
you an early technical alert to help you prepare for a breakout
confirmation in an upcoming trading session.

ne of the most essential skills for successful breakout STEP-BY-STEP ACTION PLAN

O trading is to find charts that demonstrate a pattern of

increasing volatility. How do you do that? One way
is to use indicators. In addition to Wilder’s average
Here’s how you can put this strategy to work in your swing
trades:

directional index (ADX), you can use Bollinger Bands to help
you see when volatility is on the rise. This month, I will show
you how to use a simple two-step technical trading strategy
to combine an early moving average crossover pattern with a
classic Bollinger Band “squeeze” breakout trading signal.
Step 1: Scan through 90-day daily stock charts to find those in
which the Bollinger Band’s moving average line comes from
below and crosses over the 50 SMA line, as seen on June 9,
2016 in Figure 1 (the red BBand MA line crosses up over the
black 50 SMA line). This is your early signal.

TRADING STRATEGY: MA CROSSOVER WITH BOLLINGER Step 2: Wait until after a significant contraction or squeeze
BAND “SQUEEZE” occurs of at least several days’ duration, as seen from June
If you’re like many active traders, you may struggle with 21, 2016 to June 23, 2016.
your entry timing because you saw a technical trading signal
after the fact. It was too late to take action. The technique I’ll Step 3: Get ready to enter your trade following a new high
discuss here can help you
avoid this common trading
challenge.
42.00
On a 90-day daily candle- 41.50
stick chart, plot a 50-day 41.00
40.50
simple moving average
(SMA) and a standard Breakout above 40.00
39.50
nine-step, two-standard- 50 SMA upper band 39.00
38.50
deviation Bollinger Band
crossover 38.00
(BBand). The function of the 37.50
50 SMA is to help you see 37.00
36.50
an early alert for a potential ‘Squeeze’ 36.00
subsequent Bollinger Band (bands narrow) 35.50
squeeze breakout entry. The 35.00
34.50
squeeze occurs following 34.00
a pattern of contraction in 33.50
the BBands, as seen in the 1.40M
1.20M
chart in Figure 1 of Tanger 1.00M
Factory Outlet Stores (SKT) 800K
600K
from June 21, 2016 to June 400K
23, 2016. Once price breaks 200K
eSIGNAL

25 27 29 3 5 9 11 13 17 19 23 25 27 31 2 6 8 10 14 16 20 22 24 28 30 4 6 8 12 14 18 20 22
above the upper Bollinger Apr 2016 May 2016 Jun 2016 Jul 2016
Band, or above prior resis- FIGURE 1: BOLLINGER BAND SMA PLUS SQUEEZE BREAKOUT. The initial 50-period SMA crossover provides an early
tance levels observed during technical signal for the subsequent breakout entry in Tanger Factory Outlet Stores (SKT).
46 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
 TRADING ON MOMENTUM

breakout above the upper resistance level seen during the days
constrained by the contraction/squeeze days. The technical
entry signal is not generated, however, until a day after price
action breaks above the upper Bollinger Band. In Figure 1,
this occurred on June 24, 2016 so the long entry trigger price
is $38.50.
Step 4: You can use a maximum $2 initial and trailing stop
value, or a loss of the prior day’s low (whichever is smaller),
on all stock swing trades.
INSIGHTS: WHY THIS TECHNIQUE WORKS
This technique works because it combines a classic MA
crossover signal with a volatility-expansion signal generated
by a BBand squeeze breakout.
TRADE MANAGEMENT TIP: BOLLINGER BAND
BREAKOUTS
You should also keep an eye on volume once price starts to
By combining an earlier SMA
crossover signal, you can minimize
false breakouts and enter stronger
entries instead.
break out to new highs, and consider using a larger initial
share size if volume is increasing (as it did from June 22, 2016
to June 25, 2016), since an uptrend in volume also confirms
your technical entry signal.
Ken Calhoun is a producer of trading courses, a live room,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for active traders.

TRADINGVIEW
Continued from page 44
I would be remiss. So in Figure 2 you’ll
get an idea of what the charting feature in
TradingView looks like. You can change
the time interval of the chart, change the
style, compare the chart to another, apply
indicators, set alerts, publish your charts,
and view multiple charts on one screen.
Along the right-hand side is the online
chat window, where you can keep your-
self actively engaged with the various
group discussions that are taking
place. For example, if you’re looking
at a chart of the SPDR Gold Shares
(GLD) you can simultaneously view
the gold discussion group chat. So even
though you may be physically sitting
by yourself, you’re virtually connected
with other traders, where you can share
ideas, tell a joke or two, and not feel like
you are by yourself.
Along the left-hand side of the chart
are various drawing tools that are worth
exploring. There were a few there that I
wasn’t familiar with, and this is where the
community is an asset, since you have the
option to learn from other users. If you’re
unfamiliar with, say, using the XABCD
pattern tool, it doesn’t take much to find
others who have used the tool, and you
can learn from them.
If you’re a technical analysis junkie
and enjoy placing indicators on charts
and drawing on your charts, with just one
click you can post your chart to Twitter
or StockTwits. Thus, you have the option
to publish your charts with your opinions
online so that others can see and com-
ment on them.
Below the chart are various tabs that
give you access to the screener (still in
The social aspect of
TradingView is what
attracts traders to be
part of this community.
beta), a window in which to write notes,
the scripting tool called Pine Editor, a
strategy tester, a link to brokers who have
partnered with TradingView, and a link
to the paper-trading feature.
Besides being mobile, social, and
modern, you have access to most features
for free although you can subscribe to the
Pro, Pro Plus, or Premium options, which
range in price from $9.99 to $39.95 per
month. I highly recommend you at least
October 2016
try out the free version. If your trading
is at a level that will allow you to benefit
from the additional features that Trad-
ingView offers, or if you don’t want the
ads on your screen that are part of the
free version, then you can subscribe to
whichever level is most beneficial to you.
The additional features and pricing are
clearly described at the website.
THERE’S A LOT TO TALK ABOUT
You can spend hours on this site given the
number of features it has. If you choose
to become part of the TradingView
community of traders and investors,
you can stay connected with them
wherever you are. The community is
active and they seem to love what they
do. It takes the loneliness out of trad-
ing and at the same time you learn by
interacting with others.
FURTHER READING
Gopalakrishnan, Jayanthi [2012]. “Trad-
ingView.com,” Websites For Traders,
Technical Analysis of STOCKS &
COMMODITIES, Volume 30: June.
‡TradingView
‡See Editorial Resource Index
• Technical Analysis of STOCKS & COMMODITIES • 47
 Uncovering The Unseen
Bollinger Bands & RSI:
A Magical Combo
When combined in uncommon ways, Bollinger Bands and the
RSI generate subtle but dependable signals. Here are four
ways to combine them to uncover trading opportunities.
by Azeez Mustapha
eliable trading opportunities emerge as the maudlin
R bulls and bears engage in power tussles. Serious trad-
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response to them. LVDJDLQVWWKHGLUHFWLRQRIDVORSLQJ(0$
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• %X\ ZKHQ SULFH WRXFKHV ORZHU

%%DQG56,!DVORQJDVVLJQDO
DJUHHV ZLWK WKH GLUHFWLRQ RI WKH FIGURE 1: DIRECTIONLESS MARKET. Here you see a good example of when not to trade a market. The GBPUSD
(0$ was moving in an equilibrium mode. This is shown by the relatively flat 50-period exponential moving average
• 6HOOZKHQSULFHWRXFKHVXSSHU%% (EMA 50) and by price action. You’re better off ignoring this kind of market
June 2016 • Technical Analysis of STOCKS & COMMODITIES • 19
 The trick is to look
for weaknesses in
the bulls before going
short, or pinpoint
areas of weakness
in the bears before
going long.

FIGURE 2: PRICE TOUCHES BB LOWER BAND AND RSI GOES ABOVE 30. The GBPCHF price rammed into 'HFHPEHU   , RSHQHG D VKRUW
the lower Bollinger Band, and RSI(14) went above the 30 level immediately after that. The trade hit its target in
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less than a few days.
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FIGURE 3: PRICE TOUCHES BB UPPER BAND AND RSI IS JUST BELOW 70. When the EMA 50 is sloping WKH(0$LVLQDQXSWUHQG2QWKH
downward, you want to only take bearish signals. Here you see the EMA 50 is sloping downward, showing a (85$8'FURVVLQ)LJXUH,QRWLFHG
strong downtrend. On December 17, 2014, a short position was opened and the target was reached in less than
WKDW WKH SULFH VODPPHG DJDLQVW WKH
24 hours. Another short trade was taken on January 5, 2015. Each of the trades was taken as the price of the
EURNZD hit the upper Bollinger Band, and the RSI was below 70, but never below the 50—it’s all in the context ORZHU %% DV WKH 56, ZHQW EULHÁ\
of a downtrend. EHORZWKHOHYHO7KLVORRNVWREHWKH
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FIGURE 4: PRICE TOUCHES BB LOWER BAND AND RSI IS BELOW 30. On the EURAUD cross, price slammed
against the lower Bollinger Band as the RSI(14) briefly went below 30. A long position was opened when the next
,WRRNDVKRUWWUDGHZKHQWKH%ROOLQJHU
candlestick was formed, and the profit target was realized in less than 30 hours. Although the price action went %DQGVDQGWKH56,PHWP\HQWU\FRQ-
upward by at least 500 pips, the trend was up, as shown by the EMA 50. GLWLRQ $IWHU RQH ZHHN WKH WUDGH PHW
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WDUJHWDIHZGD\VODWHUZKHQSULFHZHQWDERYHWKHXSSHU%% $V \RX FDQ VHH IURP WKHVH H[DPSOHV VRPH
DQGWKH56,ZDVEHORZWKHOHYHO WUDGHV ODVWHG D IHZ KRXUV ZKHUHDV RWKHUV
:KHQWKH(0$LVVORSLQJGRZQZDUG\RXZDQWWRWDNH ODVWHGDIHZGD\V3UDFWLFDOZLVGRPGLFWDWHV
RQO\EHDULVKVLJQDOV,Q)LJXUH\RXFDQVHHWKDWWKH(0$
 LV VORSLQJ GRZQZDUG VKRZLQJ D VWURQJ GRZQWUHQG 2Q Continued on page 39
20 • June 2016 • Technical Analysis of STOCKS & COMMODITIES
those gap winners, and if my analysis is
correct and the data is setting up to break
away today, I’ll trade in the direction
away from the gap with my 15-minute
range analysis support levels.
What’s the biggest challenge facing
new traders?
I think the trading industry suffers
from too much unnecessary informa-
tion. Of course, I am biased given that
I’ve been trading for 12-plus years.
You have to know how to read charts,
but don’t spend two years learning how
to interpret charts. Instead, spend two
weeks learning how to interpret charts,
and then get into understanding what
drives the markets. Create trading rules
and then trade them. I am a disciplined
person but I still have emotions as much
as anyone. I’ve learned the hard way
that you’ve got to get them out of the
way. And the best way to
achieve that is to become A human emotion such as the
a purely rules-based trader
and not use charts to make
desire to make money tends
trade adjustments. to overwhelm the senses. It
I don’t think there has lends itself to making bad
ever been a better time judgments and losing the
to be an active investor
or trader. Big data, cloud
true sense of reality.
computing, and predictive
analysis are rapidly level-
ing the playing ground between Main I believe that focusing on trading with
Street and Wall Street. In fact, I believe history on their side is the edge that they
WKDW IRU WKH ÀUVW WLPH WKH LQGLYLGXDO need for consistent success. If you can
trader has access to institutional-quality do that, then just about anyone can make
tools and research at an affordable price. money in the market.
And that means that the serious, well-
disciplined trader should be able to Thank you for sharing your thoughts
generate returns that are comparable to with us, Scott.
or even better than the best funds year
in and year out. Of course, the key is
to have a real edge. For most traders,

CHARTING

MUSTAPHA / BOLLINGER
BANDS & RSI
Continued from page 20

that I let the forces of supply & demand

determine what happens to my open
position. Signals are not going to come
when you want them to. You need to
be patient and wait for them, no mat-
ter how long it takes. In addition, it is
HPRWLRQDOO\GLIÀFXOWWROHWSURÀWVUXQ
but it is necessary to do so. Follow your FIGURE 5: PRICE TOUCHES BB UPPER BAND AND RSI IS ABOVE 70. When price surrounds the upper
strategies in a wholehearted manner so Bollinger Band and the RSI goes above 70, you want to sell short when price is in a downtrend (as revealed
by the EMA 50). In the GBPCAD market, a short trade was taken when the Bollinger Bands and RSI met entry
\RXFDQEHQHÀWIURPWKHUDQGRPDQG conditions. After one week, my target was met.
chaotic movements in the market. You
want continued success in the markets,
and for that, it’s necessary for you to follow your strategies. Do Strategy,” Technical Analysis of STOCKS & COMMODITIES,
WKHULJKWWKLQJDQG\RXZLOOÀQGFRQWLQXHGWUDGLQJVXFFHVV Volume 33: June.
[2015]. “Play The Markets And Keep Your Day
Azeez Mustapha is a professional forex trader, an analyst at Job,” Technical Analysis of STOCKS & COMMODITIES,
Instaforex Companies Group, a blogger at ADVFN.com, a Volume 33: March.
signals provider for some websites, and a freelance author. [2013]. “Keep Your Portfolio Safe,” Technical Analysis
His articles have been published at itulglobalforex.blogspot. of STOCKS & COMMODITIES, Volume 31: August.
com and in various trading magazines including this one. He >@´3URÀWLQJ)URP3URWUDFWHG&RQVROLGDWLRQVµ
can be reached via email at atazeez.mustapha@analytics. Technical Analysis of STOCKS & COMMODITIES, Volume
instaforex.com. 30: September.
‡MetaQuotes
FURTHER READING ‡See Editorial Resource Index
Mustapha, Azeez [2015]. “A Simple Positive Expectancy

June 2016 • Technical Analysis of STOCKS & COMMODITIES • 39

 Which Stock Is #1?
Build Your Own Technical Rating
Yes, it is possible to create a rating system with technical
indicators, one that could be as effective as a fundamental
analyst’s rating system. Here’s how.
by Domenico D’Errico
I
nvestors have a love–hate relationship with stock rat-
ings. On the one hand, stock ratings are loved because
they succinctly convey how an analyst feels about a
stock. On the other hand, they are hated because they
can often be a manipulative sales tool.
Generally speaking, traders don’t fully trust analysts
and prefer to apply their own logic and risk their money
on something they can fully understand and trust. On
the other hand, technical indicators rarely provide a
clear-cut recommendation valid for different markets
as a stock rating process does.
42 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
What if I replace the analyst with a technical algorithm and
build my own technical stock rating process? In this article I
will analyze how a technical stock rating system should work
and I’ll build a simple one based on common and customiz-
able technical indicators.
DIGITAL GRAPHIC: WHITEMOCCA/MORNING STAR: STUDIO BARCELONA/
HOW A RATING SYSTEM WORKS
Morningstar offers a popular rating service that assigns star
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON
ratings based on analysts’ estimates of fair value. A five-star
stock is a good value at its current price; a one-star stock isn’t.
Star ratings, which are updated daily, can change for three
reasons: when analysts alter their estimate of a stock’s fair
value; when a stock’s price changes; or both. In the ratings,
two different pieces of information—fair value and current
price—are combined.
Fair value is derived from an evaluation of the company’s
business and has nothing to do with price. It represents what
 CAT(D) - Weekly NYSE 100.00
TRADING SYSTEM
95.52

90.00

85.00

analysts think the company’s value is. So if the current price 80.00
is below fair value, the stock’s rating will be positive; the 75.00
lower the price, the higher the rating. If the current price 70.00
is above fair value, the stock’s rating will be negative. The
65.00
logic is straightforward—if price is below value, you buy, if
60.00
price is above value, you sell. The same logic is applied to
Linear Regression Slope
any market analyzed.
The two pieces of information are not updated at the same
Linear Regression Slope Histograms
time. Fair value depends on analysts’ fundamental evaluation,
which is updated quarterly or anytime there is a key change Lower High 100.00
related to the company’s business. The current price, on the
95.52
other hand, updates in real time.
In order to transfer the same logic to a technical stock rating Higher Low
90.00

system, you would need some kind of technical parameters Current 85.00

that indicate: Previous

Quarter 80.00

Quarter 75.00

• If a stock is good or bad 70.00

• How good or bad it is. In other words, it should allow 65.00

you to compare any stock against another to eventually 60.00

rank the stocks. Higher Lows Histograms

Higher Highs Histograms

RATE A STOCK’S TREND
Apr Jul Oct ’16 Apr Jul Oct ’17 Apr
Technical traders don’t consider fundamental information and
have no fair value to compare against price. As a result, they FIGURE 1: ONE-YEAR LINEAR REGRESSION SLOPE, 12-WEEK HIGHER HIGHS,
12-WEEK HIGHER LOWS. On the top chart, the slope is in the form of a two-color
cannot evaluate future price movement but can find, in past histogram (if slope is positive, the histogram is green and if slope is negative, the
data, some predictive information with a high probability of histogram is red). On the bottom chart, the green/red histograms show when higher
success that can help indicate future price movement. highs or higher lows are in place.
I evaluated several technical indicators and came up with a
combination of the following three technical indicators: • This is where the 12-week higher highs and higher lows
indicators come in. On the bottom chart in Figure 1, I
• One-year linear regression slope applied some green/red histograms to show when higher
• 12-week higher highs highs or higher lows are in place.
• 12-week higher lows. • When you combine the three indicators—slope, higher
highs, and higher lows—you can see why they work
These three indicators worked well together. well together (Figure 2). While the slope is still positive

• The one-year slope is a stable

indicator that can analyze CAT(D) - Weekly NYSE Trend Slope () Highs_Lows (12)
trends: a positive slope detects 110.00

an uptrend, a negative slope 105.00

100.00
detects a negative trend. On 95.52
the top chart in Figure 1, I 90.00
transformed the slope into a 85.00

two-color histogram (if slope is 80.00

75.00
positive, the histogram is green While Slope is Negative 70.00
and if slope is negative, the Higher Lows anticipate While Slope is Positive
Positive Slope: 65.00
an UpTrend Start Lower Highs anticipate
histogram is red). The reason an UpTrend Reverse Higher Highs and Lows 60.00
confirm the UpTrend 55.00
for having a stable trend indi- Stocks Technical Rating ("Slope")
cator is that you don’t want the Stocks Technical Rating ("HigherHighs")
indicator to change direction in
Stocks Technical Rating ("HigherLows")
case of pullbacks. The down-
’13 Apr Jul Oct ’14 Apr Jul Oct ’15 Apr Jul Oct ’16 Apr Jul Oct ’17 Apr
side of this is that a slow trend
indicator may have a lag in FIGURE 2: THE POWER OF THREE. Here’s how these three indicators complement each other: while the slope is
still positive (uptrend), lower highs are an early signal of a trend reversal; while the slope is still negative (downtrend),
detecting tops and bottoms. higher lows are an early signal of trend reversal.

July 2017 • Technical Analysis of STOCKS & COMMODITIES • 43

Indicator Condition Stars

1 Year Slope Slope > 0 ★★

12 Weeks High Higher Highs ★
12 Weeks Lows Higher Lows ★★
Maximum Stars ★★★★★
FIGURE 3: A SCORING SYSTEM. Two stars are
assigned to slope, one star to highs, and two stars
to lows, for a maximum of five stars.

(uptrend), lower highs are an

early signal of a trend reversal;
while the slope is still negative
(downtrend), higher lows are an FIGURE 4: STAR RATING. Here you see the three indicators’ histograms and the star ratings from 1 to 5.
early signal of trend reversal.

Assume these technical indicators hit the satisfactory mark.

The next step is to transform the three indicators into a star It is possible to build a technical
ranking from 1 to 5.
stock rating system based on
SCORING common and customizable
I’ll start by assigning two stars to slope, one star to highs, technical indicators.
and two stars to lows, for a maximum of five stars (Figure
3). I initially assigned a lower number of stars to higher highs
because I believe that in the markets, lows are more important
than highs. Later on, I will test this assumption to determine
if it is correct. In Figure 4 you see the three indicators’ his- Trading rules: Buy if the stock rating is above 2.5 stars,
tograms and the star ratings from 1 to 5. sell if it’s below 2.5
Benchmark: Buy & hold SPY
CRUNCHING THE NUMBERS Trade size: $1,000 per trade
Now it’s time to see if such a stock rating system makes sense
by running some backtests. Looking at the table in Figure 5 you can see that the stock
rating strategy has about the same profit as the S&P buy &
Settings and trading rules hold strategy, but the drawdown is lower ($19,897 for stock
Historical period: Jan 2005–Dec 2016 weekly bars rating versus $76,315 for buy & hold), with a reward/risk ratio
Symbols list: S&P 100 stocks of 4.4 versus 1.2, respectively.

Stocks Rating Strategy vs. Buy & Hold Indicator Simulation 1: Simulation 2: Simulation 3:
Underweight Highs Underweight Slope Underweight Lows
190,000

140,000
1 Year Slope ★★ ★ ★★
90,000
12 Weeks High ★ ★★ ★★
40,000
12 Weeks Lows ★★ ★★ ★
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Maximum Stars ★★★★★ ★★★★★ ★★★★★
Stocks Rating Buy & Hold
Total Profit 87553 93570 91791
Stocks Rating Buy & Hold
Max Portfolio
Total Profit $87,553 $88,696 -19897 -197291 -20984
Drawdown
Max Portfolio Drawdown -$19,897 -$76,315 Return On Max 4.4 4.7 4.3
Return On Max Portfolio Drawdown 4.4 1.2 Portfolio Drawdown
Number Of Trades 707 Number Of Trades 707 854 743
Average Trade $124 Average Trade 123.84 109 123.54
Percent Profitable 58% Percent Profitable 58% 57% 57%
FIGURE 5: STOCK RATING STRATEGY VS. BUY & HOLD. The stock rating strategy FIGURE 6: THREE DIFFERENT SIMULATIONS. In simulation 1, the highs are
has about the same profit as the S&P buy & hold strategy, but the drawdown is underweighted; in simulation 2, the slope is underweighted; and in simulation 3,
lower ($19,897 for the stock rating strategy versus $76,315 for buy & hold), with a the lows are underweighted. The lows are more important than slope and the highs
reward/risk ratio of 4.4 versus 1.2, respectively. are equally important as well.

44 • July 2017 • Technical Analysis of STOCKS & COMMODITIES

 Stocks Technical Rating: Stars Trigger Optimization
Net Profit ROA 5
4.9
150,000 5 4.8
4.7
4 4.6
100,000 4.5
3 4.4
2 4.3
50,000 4.2
1 4.1
4
- 0 3.9
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 3.8 Reward/Risk
3.7
3.6
3.5
3.4
Total Trades % Profitable 3.3
20 3.2
1000 58.00 25 3.1
800 30 20
56.00 35 18 19
600 40 16 17
54.00 45 14 15
50 11 12 13
400 Slope Length 8 9
10
52.00 55 6 7
200 60 4 5 Highs/Lows BarsBack
0 50.00
0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 FIGURE 8: MODIFYING PARAMETERS. The higher the slope length, the more the
Settings reward/risk means that the one-year (40 weeks) slope is a reasonable parameter.
Slope Length = 40; Highs/Lows BarsBack = 12; SlopeStars = 1; LowsStars = 2; HighsStars = 2
If you increase the slope, the result improves. The highs/lows BarsBack simulation
FIGURE 7: NET PROFIT, REWARD–RISK, TOTAL TRADES, AND PERCENT shows a visible peak of the reward/risk around 12 weeks.
PROFITABLE. Net profit is always positive, but it decreases when the trigger level
increases as the number of trades increase. Looking at the reward/risk and at
%Profitable, it seems that 2.5 is a good parameter.
is changed from four to 20 weeks.
In Figure 8 you see a 3D chart with slope length on the left
DIVE INTO MORE DETAILS axis, highs/lows BarsBack on the right axis, and reward/risk
I’ll try to answer some more questions about the rating system on the vertical axis. For any simulation, the risk–reward is
I built using the portfolio features in MultiCharts. For example, higher than for buy & hold (1.2).
is the stars scoring method correct? Is the slope more or less The higher the slope length, the more the reward/risk means
important than higher lows? How much do each of the three that the one-year (40 weeks) slope is a reasonable parameter.
indicators contribute to overall results? If you increase the slope, the result improves. The highs/lows
In Figure 6 you see the results of three different simulations.
In simulation 1, I underweighted the highs; in simulation 2, I
underweighted the slope; and in simulation 3, I underweighted
the lows. Here, unlike in my assumption, the lows are more
important than slope, but the highs are equally important as
well. In fact, the highest reward/risk ratio (4.7) comes from
simulation 2, which underweights the slope.
A question that could come up is whether the trigger of 2.5
stars is correct. What happens if the ratings are increased or
decreased in steps of 0.5?
In Figure 7 you see how NetProfit, reward/risk, TotalTrades,
and %Profitable change if there’s a change in the trigger level.
Net profit is always positive, but it decreases when the trigger
level increases as the number of trades increase. Looking at
the reward/risk and %Profitable, it seems that 2.5 is a good
parameter.
Is using one year for the slope and 12 weeks for the highs/
lows a reasonable parameter? What if those were changed?
Let’s see what happens to the reward/risk if the slope is
changed from 20 to 60 weeks and the highs/lows BarsBack

Psychological support to pull

the trigger can come only from
something the trader trusts and is FIGURE 9: A TRACKING SYSTEM. Here you see an example
of a TradeStation Radarscreen applied to the 30 stocks in
familiar with. the DJIA. It can easily track up to 1,000 stocks and ETFs.
You can rank them and focus on stocks with higher ratings
to find entry points.

July 2017 • Technical Analysis of STOCKS & COMMODITIES • 45

 BarsBack simulation shows a visible peak of the reward/risk
around 12 weeks. This makes sense since 12 weeks is exactly
a full quarter.
Now that the model passed the statistical tests, it’s time to
build a reporting system to monitor on a weekly basis.
In Figure 9 you see a TradeStation Radarscreen example
applied to the 30 stocks in the Dow Jones Industrial Average.
It can easily track up to 1,000 stocks and ETFs. You can rank
them and focus on stocks with higher ratings in order to find
entry points.
IT CAN BE DONE
Can you build your own technical stock rating process start-
ing from the indicators you are familiar with? Is it possible to
get rid of analysts? Is it possible to transform the information
provided by a technical indicator into a clear-cut recommen-
dation? In this article, I created a model and tested it from
different perspectives to validate it from a statistical point of
view. Almost any technical indicator could be put through a
similar process.
In spite of all the mathematical calculations that can be done
and the sophisticated trading platforms available to the trader
KAUFMAN / THE RETURN OF HIGH MOMENTUM
Continued from page 26
the way many professional traders sell high volatility. Figure
6 shows two trades using UVXY, although profit-taking is
also frequent.
The results for this strategy are shown in Figure 7. Profits
for UVXY are on the left, but only start at the beginning of
2012. Futures, VX, are on the right and begin in 2004. The
long trades using futures have a drawdown of about $5,000
in 2008, but the shorts, which account for most of the trades,
show steady gains. The returns of about $70,000 for futures
over 13 years are still significantly higher than $20,000 for
UVXY over five years.
IT ALL MAKES SENSE
For the pragmatists, that these two approach-
es have good returns and show consistency
should be convincing. For those needing a
fundamental explanation of why the index
market reacts in the opposite way to its own
volatility index, the statistics of up and down
price runs should help. Plus, there is a shift from short-term
random price movement to create the fat tail.
My own conviction is based on measuring noise. Index
markets are notoriously the noisiest of all markets, that is,
they have the greatest occurrence of erratic behavior. The
10-day average noise of S&P futures (ES) is 0.31 and VX
is 0.35, where a higher value means less noise, more trend.
In addition, VX is highly biased to the downside, while ES
46 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
to make everything easier, traders still need psychological
support to pull the trigger. Such support can come only from
something the trader trusts and is familiar with.
So forget about stereotypes and don’t be stopped by others
telling you that your way is not correct. The reality is, nobody
knows. I encourage you to build your own lens to look at the
markets with, and improve upon it, day by day.
Domenico D’Errico is an independent research & develop-
ment partner for investment management companies and
professional traders. He also runs his own research firm
and software house (www.Trading-Algo.com). D’Errico is
a TradeStation Open Platform Developer and a two-time
winner of the TradeStation developer contest. He is avail-
able for advisory and coaching through his website, www.
Trading-Algo.com.
‡TradeStation
‡See Editorial Resource Index
‡See Editorial Resource Index†See Traders’ Glossary for definition
is biased to the upside. Together, they make a good trading
combination.
Perry Kaufman is a trader and financial engineer. He is the
author of many books on trading and market analysis, in-
cluding Trading Systems And Methods, 5th ed. (with the first
edition published in 1978 as a seminal book in the field of
technical analysis), and most recently, A Guide To Develop-
ing A Successful Algorithmic Trading Strategy (2016). For
questions or for more information, visit his website at www.
KaufmanSignals.com.
FURTHER READING
Kaufman, Perry J. [2013]. Trading Systems And Methods,
5th ed., Wiley.
[2015]. A Guide To Creating A Successful Algorithmic
Trading System, Wiley.
[2003]. A Short Course In Technical Trading, Wiley.
[2017]. “VIX Or Historical Volatility?” Technical Anal-
ysis of STOCKS & COMMODITIES, Volume 35: March.
[2014]. “Timing The Market With Pairs Logic,”
Technical Analysis of STOCKS & COMMODITIES, Volume
32: March.
[2014]. “A Better Trend,” Technical Analysis of STOCKS
& COMMODITIES, Volume 32: April.
[2014]. “Slope Divergence: Capitalizing On Uncer-
tainty,” Technical Analysis of STOCKS & COMMODITIES,
Volume 32: June.
†See Traders’ Glossary for defi nition
 knowledge and self-trust that
you possess enough aptitude
to make decisions and the
steeliness of character to follow
through on your conclusions,
ignoring doubt and negative
self-talk. Not many people
are able to do this. There is
a plethora of information out
there such as 24-hour financial
news channels, newsletters, chat
rooms, gurus’ courses, analysts’
opinions, seminars, tutorials,
trading books, and on it goes.
Then there is the pervading
aura surrounding Wall Street
that you have to be very smart
to trade. This is reinforced
by the notion that as a small
trader you are competing with
the big institutions, which are
composed of extremely smart
people who know orders of
magnitude more than you. It
is therefore not surprising that
for many people who aspire to
trade successfully, acquiring
self-confidence is a challenge. It
is tempting for the small trader
to look to others for guidance
or confirmation. But analyst
and historical figure Richard
D. Wyckoff pointed to the
Free The Mind folly in this. He said that many
people who come to trading
Building fail because they think they
are studying the market but
“all they are doing is studying
Self-Confidence what someone has said about
the market … not what the
market has said about itself.”
There are certain traits a trader needs to succeed, and self-confidence is one of them. But Acquiring the confidence to
how do you develop it so that it benefits your trading skills? Let’s find out. block out the noise and listen
only to the market is the mark
by Stella Osoba, CMT of the self-confident trader.

In a previous article, I discussed the mastery of patience as an essential skill for

the successful trader to cultivate. This article focuses on another essential skill:
self-confidence. What is it, what isn’t it, and how do you go about becoming a
self-confident trader?
Once traders learn to trust
themselves, they can then free
their mind to focus on market
opportunities that present
SERGEY NIVENS/SHUTTERSTOCK

themselves instead of being

WHAT IS SELF-CONFIDENCE? wrapped up in a tight ball of
To put it simply, self-confidence is trust in one’s self, one’s abilities, and one’s own fear, frustration and doubt.
judgment. In trading, more than in almost any other endeavor in life, it is neces- —John F. Carter, Mastering
sary to align your perceptions with reality and then to rely on your interpretation The Trade
of what you are seeing to make decisions. This requires self-confidence—the
60 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
 AT THE CLOSE
WHAT IT IS NOT
Self-confidence must not be confused with self-esteem. The
former is an offshoot of the latter. While self-confidence comes
from a trust in your ability to perform a particular task or
reach a certain goal, self-esteem is an underlying confidence
in your own self-worth. Without self-esteem, there can be no
self-confidence. Sometimes, we will run into people who appear
to be extremely self-confident, but they may actually have low
self-esteem or what the psychotherapist Nathaniel Branden
called pseudo self-esteem, which he defined as a “pretense
at self-confidence or self-respect which they do not actually
feel.” This is because at our deepest level of consciousness,
there is a need for the mind to have learned to trust itself.
Sometimes, this need is not met, as when, for instance,
children are given messages that are designed to discount
their need for self-actualization. The messages they learn
tell them to discount who they really are because they are not
enough, and to be sufficient, they should look to something
outside of themselves. So they go through life looking for the
thing that will make them feel sufficient, whether it is status,
money, position, possessions, or the like. They may attain
what they seek, but it is never enough. And in the process,
they undermine further their self-esteem.
Because the mind is not rational, people often compound
matters by hiding from themselves their need for self-accep-
tance. The absence of self-esteem means the absence of true
self-confidence. While in most aspects of life it is possible to
successfully navigate your way through without self-esteem,
when it comes to trading, the market will often act as a mirror
to expose your deepest insecurities. This is a major reason
why so many people who come to trading fail. To trade suc-
cessfully, you must first get right with yourself.
Without self-confidence, you will live in constant fear of mak-
ing a wrong decision, and sooner or later the fear will paralyze
your ability to think and make decisions.
—Victor Sperandeo,
Trader Vic: Methods Of A Wall Street Master
BUILDING SELF-CONFIDENCE
To build the self-confidence you need to trade successfully,
you have to learn to do two things well: Manage your self-
talk, and trust yourself. Mark Douglas, author of Trading In
The Zone, puts it this way:
Confidence and fear are contradictory states of mind that both
stem from our beliefs and attitudes. To be confident, function-
ing in an environment where you can easily lose more than you
intend to risk requires absolute trust in yourself. However, you
won’t be able to achieve that trust until you have trained your
mind to override your natural inclination to think in ways that
are counterproductive to being a consistently successful trader.
Learning how to analyze the market’s behavior is simply not
the appropriate training.
—Mark Douglas, Trading In The Zone
Acquiring self-confidence as a
trader is a learnable skill.
MANAGING YOUR SELF-TALK
Have you ever decided to put on a trade and
then hesitated because a little voice somewhere
in the back of your mind says something like,
“It’s probably going to go up/down the moment
I put it on. Maybe I should get more information
(that is, see what others are saying about the
stock) … ?” If the self-talk is convincing enough, you might
decide to pass on the trade. Now what just happened? You had
a strategy, you analyzed the market. You reached a decision
and then your lack of self-confidence took over.
Self-talk is our inner dialogue, and negative self-talk is a
reflection of our lack of self-esteem. Branden said that:
Self-esteem reflects our deepest vision of our competence and
our self-worth…[it] is the disposition to experience oneself as
being competent to cope with the basic challenges of life and
of being worthy of happiness. It is confidence in the efficacy of
our mind, in our ability to think. By extension, it is confidence
in our ability to learn, make appropriate choices and decisions,
and respond effectively to change. It is also the experience that
success, achievement, fulfillment—happiness—are right and
natural for us. The survival value of such confidence is obvious;
so is the danger when it is missing.
If negative self-talk is devastating, positive self-talk is more
than the sum of its opposite. It can liberate us to move toward
goals as yet unseen. It can urge us to light fires that illuminate
the road to success. It can unlock doors to barriers that had
once seemed impassable. And more than that, it compounds;
the more you use it, the more positive you feel about yourself,
the more you are able to stick to your goals, and therefore
the more likely you are to achieve success. So if you know
on an intellectual level that the benefits of positive self-talk
are so obviously positive, why is it so hard to apply in real
life? Because habits, especially bad habits, are hard to break.
Negative self-talk is a habit and breaking a habit takes time,
persistence, and effort.
TRUST YOURSELF
Trusting yourself is about more than reciting affirmations and
thinking fleeting positive thoughts. It one of the psyche’s most
urgent needs, but it is something that is often neglected in
the superficial demands of our modern society. In the words
of Branden:
The root of our need for self-esteem is the need for a conscious-
ness to learn to trust itself. And the root of the need to learn
such trust is the fact that consciousness is volitional: we have the
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 61
 choice to think or not to think. We control the switch that turns
consciousness brighter or dimmer. We are not rational—that is,
reality-focused—automatically. This means that whether we
learn to operate our mind in such a way as to make ourselves
appropriate to life is ultimately a function of our choices. Do
we strive for consciousness or for its opposite? For rationality
or its opposite? For coherence and clarity or their opposite? For
truth or its opposite?
FINAL WORDS
Acquiring self-confidence as a trader is a learnable skill.
Strategy, technique, and picking the right security to trade
are all important, but none are more important than being
right with yourself. As you progress on this most lucrative
of journeys, the bonus will be if in the process, you are able
to examine the unexamined core of who you are and do the
work of aligning your reality with your perceptions. In see-
ing the truth of who you are as a whole person, and in that
truth, knowing that you are good enough as you are, you can
then begin to build trading knowledge on layers of strength,
not weakness.
Stella Osoba is a freelance writer and trader. She has earned
the Charted Market Technician designation and has writ-
ten for several financial websites and publications. She is
a frequent contributor to Technical Analysis of STOCKS &
COMMODITIES magazine and Traders.com Advantage online
publication. She may be reached via email at stellaosoba@
gmail.com.
MONTEVIRGEN / EXPLOITING GUTS, RISK,
AND DECAY
Continued from page 27
• Option contracts with a high level of open interest (be-
tween a minimum of 100 to 500)
• Contract expiration for both legs should be one month
or less to take advantage of decay
• Exposure to the spread should be one month or less, as
you would close the positions prior to expiration.
IS IT WORTH THE RISK?
It depends. Although every one of us
understands risk on an intuitive level,
the concept of risk is far more complex
and individualized than any term can
express. Trading short guts isn’t for
most traders. Not only must a trader
deal with the inherent risks of the
spread, but the trader him/herself will
often introduce degrees of risk that are
62 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
FURTHER READING
Branden, Nathaniel, www.nathanielbranden.com
Carter, John F. [2012]. Mastering The Trade: Proven Tech-
niques For Profiting From Intraday And Swing Trading
Setups, 2d ed., McGraw-Hill.
Douglas, Mark [2001]. Trading In The Zone: Master The
Market With Confidence, Discipline And A Winning At-
titude, Prentice-Hall.
Gopalakrishnan, Jayanthi [2003]. “Victor Sperandeo,” in-
terview, Technical Analysis of STOCKS & COMMODITIES,
Volume 21: July.
Hartle, Thom [1997]. “Mark Douglas And The Disciplined
Trader,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 15: January.
Osoba, Stella [2016]. “Cultivating Patience,” Technical Analy-
sis of STOCKS & COMMODITIES, Volume 34: October.
Sperandeo, Victor [1993]. Trader Vic: Methods Of A Wall
Street Master, John Wiley & Sons.
as unpredictable as the market dynamics he or she will face
while trading it.
But for those who have the experience, resources, and inclina-
tion to venture unlimited risk for a small profit, then short guts
may be the Faustian bargain you have been looking for.
Karl Montevirgen is a content designer/strategist at Halifax
America LLC, a stocks/option, futures, and forex brokerage
in Sherman Oaks, CA. In addition to creating and designing
content, he has extensive knowledge of and experience with
commodity futures and foreign exchange. He can be contacted
through the Halifax America website at www.halifaxamerica.
com or by email at kmontevirgen@halifaxamerica.com.
FURTHER READING
Montevirgen, Karl [2017]. “Use Seasonality To Optimize
Algorithmic Strategies,” Technical Analysis of STOCKS
& COMMODITIES, Volume 35: January.
†See Traders’ Glossary for definition
 up advising the firm on how to
make it even better. His pro-
fessional management experi-
ence includes both domestic
and foreign tours of duty at
IBM, Petrie Stores, PriceWa-
terhouseCoopers, and Unisys.
He presently serves as an
options consultant to hedge,
mutual, and pension fund
money managers, as well as
teaching options trading at a
new mentoring operation.

THE STORY BEHIND

KEVLAR
All the while, there was one
constant: He was trading
options himself, for his own
account, and all the while
honing, perfecting, and striv-
ing to perfect his methods.
The passion never subsided
through the serpentine path
of ups and downs that every
veteran trader knows. Capi-
tal preservation became his
focus and is what makes his
approach somewhat differ-
ent. Everyone talks about
capital preservation; Riggio
builds his unique strategies
around it.
“I realized,” he says, “in my
20 years of trading options,
almost every beat-down that
I ever received was because
of some combination of
my short gamma and short
vega. Since I, like most op-
Get Your Bullet-Proof Vest On tions traders, collect time
premium (positive theta), I

This Butterfly used to think that my short

gamma and short vega were
BUTTERFLY: BUTTERFLY HUNTER/YELLOW KEVLAR: HORBAN IRYNA/

just things that I would have

Wears Kevlar to accept. Which I did. Until

the implosion of 2008, when
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON

I made it my life’s mission

Butterflies are a well-known options trading strategy. But here’s one that’s a little different. to collect theta without, or at
least with drastically reduced,
by John A. Sarkett gamma and vega risk.”
Thus, the Kevlar butterfly
the history of options trading, Jim Riggio goes “way back.” He started trading more was born. The name came not

In than two decades ago. He was among thinkorswim’s first 100 clients; trained as
an engineer, with degrees in computer science and information management, he
admired their advanced platform so much he became a broker there, and wound
from Riggio himself but from
a student, who, on grasping
its power and efficacy, said,
18 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
 OPTIONS

“Wow, this butterfly can survive huge market Profit/Loss by Change in SPX Index Price
$
moves ... it’s like the butterfly is wearing 90000 +610%
T+37
a Kevlar jacket or something.” The name 81000
T+19
+550%

stuck. (Kevlar is the near-indestructible 72000 T+0 +490%

synthetic fiber used in helmets and bul- 63000 +430%

54000 +370%
letproof vests.)
45000 +310%
Most butterfly traders start with short
36000 +250%
strikes at-the-money (ATM). Most every 27000 +180%
options textbook or trainer depicts the but- 18000 +120%
terfly that way. The Kevlar butterfly is notably 9000 +61%
different. It starts with a below-the-money 0 0%
(BTM) butterfly that shows negative delta -9000 -61%
but neutral or positive gamma. So in that -18000 -120%

sense, it can be viewed as “bearish.” -27000 -180%

But there’s more, much more to the method -36000 -250%

-45000 -310%
than that, and it can generate profits in up 1832.50 1867.50 1902.50 1937.50 1972.50 2007.50 2042.50 2077.50 2112.50 2147.50 2182.50 2217.50 2252.50 2287.50
markets as well. Its success is based on a -10.9% -9.2% -7.5% -5.8% -4.1% -2.4% -0.7% +1.0% +2.7% +4.4% +6.1% +7.8% +9.5% +11.2%

profound respect for the destructive capabili- FIGURE 1: LOW IV AND STEEP PUT SKEW. Here you can see that puts well below-the-money are expen-
ties of vega and gamma: “The Kevlar’s risk sive compared to puts at-the-money (ATM). In this case, a symmetrical, below-the-money (BTM) butterfly
management methodology will exchange is paired with a deep in-the-money (ITM, with at least 60 delta) call.
theta (collecting time premium) for reduced
risk (gamma near zero and drastically lower short vega when He has two distinctly different approaches for the two main
IV is low). This had become an obsession of mine. If deltas market environments: low implied volatility (IV) (mode 1)
are under control, gamma is near zero, and vega is not too and high implied volatility (mode 2).
short when IV is low, the market is going to have a harder To determine low versus high IV, he looks at a VIX chart for
time defeating me.” the past year. Which quartile are we in, he asks: 0-25, 26-50,
With a dash of self-deprecation that gives his online dis- 51-75, 76-100? The skews he gets from a proprietary source.
courses appeal, he says: “Some people have called me paranoid Many platforms provide these as well: in thinkorswim, for
about the options market, to which I reply, ‘I may be paranoid, example, go to Trade ➞ All Products ➞ Product Depth ➞
but that doesn’t mean the market is not still trying to take my Options. Change the filter from “All” to “Puts,” and change
money away.’” the view to show implied volatility (“Impl Vol”). Under Setup
Currently, he is sharing the ins and outs of the Kevlar but- ➞ Application Settings ➞ Calculations, you can change which
terfly at Capital Discussions, a new trade education and alert volatility calculation method is reflected (such as volatility
service featuring several top mentors he cofounded with op- smile or individual implied volatility).
tions veteran Tom Nunamaker. To his method, which volatility environment he is in at a
given time makes a significant difference. Once he determines
HOW HE TRADES IT where we are in the volatility universe, he feels confident to
Riggio’s vehicle of choice is the monthly SPX. He aims for move to create a position. In Figure 1 you see the risk curve
no more than one or two adjustments per cycle, and he targets of mode 1, where volatility is low and the put skew is steep.
5% to 10% gains per trade on a $50,000 account with less Note that puts well below-the-money are expensive compared
than 5% loss. He will scale into and out of trades. Target exit to puts at-the-money (ATM). In this case, Riggio creates a
time occurs at about 14 days to expiration (DTE), but this is symmetrical, below-the-money (BTM) butterfly paired with
flexible. He explains: “The reason is that the risk, especially a deep in-the-money (ITM, with at least 60 delta) call. In the
the gamma risk, is much, much more as you get closer to SPX, he uses 100-point wings such as 1900/2000/2100.
expiration. I would prefer to take my measly 5% to 10% and In Figure 2 you see a risk curve of mode 2, or a high-
go home … and start the next trade with 60 to 80 days to volatility environment and normal-to-flat put skew. In this
expiration.” scenario, Riggio puts on a below-the-money (BTM) put broken
Indeed, in the Riggio schema, gamma is crucial. Riggio wing butterfly (BWB). The upper strike is usually 25 points
watches it like the proverbial hawk and he does whatever it above SPX price. This position has much more negative vega.
takes to keep it low. Here, the spacing is a right wing that is 75 points above the
All this seems sound and reasonable enough, but what short strike, and the left wing is 100 points lower. If the SPX
makes his approach unique is the entry scenario about which is 2050, then the BWB is put on at 1900/2000/2075. There’s
he is quite particular: operative entry elements are a) volatil- no long call this time.
ity and b) skew. It is best to enter both models on down days where implied
While other traders ignore these, he focuses on them like volatility is up. While it’s easier to trade all one type, for ex-
a laser. ample, all puts, he will employ iron butterflies (short put credit
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 19
 $ Profit/Loss by Change in SPX Index Price of rules ... for all the market conditions that
120K +240% I can think of, such as ... price, price trend,
110K T+56 +220%
T+28
speed of price move, greeks (today), greeks
100K +200%
90K
T+0
+180%
(in one week from now), strikes, expiration
80K +160% cycle, days to expiration, implied volatility,
70K +140% skew, term structure, kurtosis, trade con-
60K +120%
figurations, tape reading, knowing when you
50K +98%
40K +79% should be scared, and so on. These factors
30K +59% would all vary for every option structure.
20K +39% For example, if we had an existing broken
10K +20%
0K 0%
wing butterfly with 100 points left wing vs.
-10K -20% 75 right wing ... and when to adjust with a
-20K -39% symmetrical 25 wide wing put condor vs. a
-30K -59% 25/40 point asymmetrical condor ... and this
-40K -79%
-50K -98%
would be different if the center was 25 vs. 50
-60K -120% points below the current SPX point ... and this
1604.40 1639.40 1674.40 1709.40 1744.40 1779.40 1814.40 1849.40 1884.40 1919.40 1954.40 1989.40 2024.40 2059.40 2094.40 2129.40 2164.40
-16.2% -14.4% -12.6% -10.7% -8.9% -7.1% -5.3% -3.4% -1.6% +0.2% +2.0% +3.9% +5.7% +7.5% +9.4% +11.2% +13.0% would be different if the Brexit vote or US
FIGURE 2: HIGH IV AND NORMAL-TO-FLAT PUT SKEW. In this scenario, a below-the-money (BTM) put elections were tomorrow ... and this would
broken wing butterfly is put on. The upper strike is usually 25 points above SPX price. This position has be different if ... Do you get my point? There
much more negative vega. Here, the spacing is a right wing that is 75 points above the short strike, and are just too many potential ifs.”
the left wing is 100 points lower.

spread under a short call credit spread) to generate credits and
conserve capital. The Kevlar butterfly mitigates risk by hav-
ing a negative delta and a flat T+0 line. He says: “In a market
decline, the S&P 500 market price must travel through my
profit zone to get to my risk zone. This gives the Kevlar a strong
defensive position for a market selloff,” he says. Offense sells
tickets, he says, but defense wins championships.
MANAGING POSITIONS
While he is fairly rigid about entry, his adjustments are man-
aged by the options greeks. To lift his T+0 (today’s profit-loss
sum), he employs a variety of tools to flatten the profit peak
and generate credits. These might include “condorizing” his
position with additional credit spreads, moving his position
up or down, or just adding long puts or calls.
Veteran trader that he is, Riggio has a visceral reaction for
how fast a profit can turn into a loss in an otherwise “brilliant”
options strategy, so his first “adjustment” can be as simple as
taking a trade off when it reaches approximately 10% profit,
either entirely or by partials. For example, if a butterfly has 6
x 12 x 6 contracts, he might take off 2 x 4 x 2.
If he feels motivated to stay in a position—which, by the
way, is a function of the math, not a “feeling”—he will look at
a large variety of what ifs including but not limited to leaving
the position as is, selling calls, selling put condors (balanced
or unbalanced), adding put or credit verticals, and more.
What are his “rules?” He is not comfortable with the concept
of “rules,” per se, and tells why: “It is beyond naive to think
that if you can get the perfect set of rules you will conquer
the options game. Anyone who learns sound options trading
skills and who masters risk management methodology should
be able to become a profitable options trader.
“It is all about understanding the tradeoffs when you are
making decisions. I could put together a very, very long list
20 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
TRADE SMART
“I could write 100,000 rules, and the next day, something will
happen in the market that I will need to write another 20 rules
... and following that, another 30 rules ... and the week after
that ... well, you get the picture.”
For clients, he winnows down this mass of potentiality to a
simple, specific recommendation, sent out by email and text
as a real-time trade alert. And his platform keeps score with
a documented trade record and cumulative equity curve. “We
are transparent,” he says simply.
Most recently, while this piece was being written, in his
current live trade, he elected to do that simplest and easiest
adjustment: “This old geezer is going to close the Oct Kevlar,
pick up my piggy bank, get a glass of lemonade, go to the
bathroom (if I am going to get out of my rocking chair, why
waste the trip), and then go and sit back in my rocking chair
with my measly 10% profit for the month.”
Self-deprecating, humorous, but with decades of options
wisdom stuffed into one pithy statement, he says: “I know
I’m not smarter than the market.” Which is why he puts on
Kevlar garb when he ventures into it. And advises others
exactly how to do the same.
Continued on page 25
Anyone who learns sound
options trading skills
and who masters risk
management methodology
should be able to become a
profitable options trader.
 BEARISH CANDLESTICKS OR TOP REVERSAL PATTERNS BULLISH CANDLESTICKS OR BOTTOM REVERSAL PATTERNS

BEARISH-GRAVESTONE DOJI BEARISH-ENGULFING BULLISH-DRAGONFLY DOJI BULLISH-ENGULFING

BEARISH-EVENING DOJI STAR BEARISH-HARAMI BULLISH-MORNING DOJI STAR BULLISH-HARAMI

BEARISH-HARAMI CROSS BEARISH-SHOOTING STAR BULLISH-HARAMI CROSS BULLISH-INVERTED HAMMER

BEARISH-HANGING MAN BEARISH-KICKER BULLISH-HAMMER BULLISH-KICKER

BEARISH-DARK CLOUD COVER BEARISH-TWEEZER TOP BULLISH-PIERCING PATTERN BULLISH-TWEEZER BOTTOM

July 2016 • Technical Analysis of STOCKS & COMMODITIES • 17

 TRADING ON MOMENTUM

Consolidation Channel Breakouts

When price trends between two parallel trendlines it is said
to form a channel, and a consolidation channel is a sideways
action where price is in a trading range. This month, this
professional trader describes what to look for to have the
best chances of success when trading breakouts from this
pattern.
by Ken Calhoun
ntering breakouts above consolidation channels is a
Traders often get stopped out when trying to buy pivot entries
above consolidation areas for stocks that have sold down and
are starting to bounce. Instead, you are encouraged to look
for consolidation areas following earlier uptrends because
these are more likely to continue up once they break above
resistance levels. Think of it like price action is resting during
the channel, and when a new wave of buyers buy the stock,
the uptrending breakout continues, which provides you with
a solid trading opportunity.

E popular trading technique. The challenge you will face

when trading with real money is that these will also
often produce false breakouts, unless you know how
STEP-BY-STEP ACTION PLAN
Here’s how you can start using this strategy with your swing
trades:
to find specific, strong-trending patterns. The most important
criteria you should visually scan for is seeing a prior uptrend Step 1: Look for a 15-day 15-minute candlestick chart in
before the consolidation channel, above which a new trade can which price is in an uptrend, then consolidates sideways for
be entered. In this month’s column, I’ll demonstrate how to three to five days, as seen in the chart of Esperion Thera-
enter this specific consolidation channel breakout pattern. peutics, Inc. (ESPR) in Figure 1 (February 9–15, 2017).

SWING TRADING CONSOLIDATION CHANNEL BREAKOUTS
When it comes to trading strong breakouts, technical and
psychological factors come into play, which is why it is so
important that you only enter the strongest-trending charts.
Technical uptrends are easy enough to spot: higher highs and
higher lows are the classic definition. Bullish uptrends provide
buyers with confidence, which inspires new buying behavior
after a breakout above resistance is seen above consolidation
channels.
Step 2: The consolidation channel in this chart has sup-
port at $20 and resistance at $21.50. You may enter your
trade once price action has broken out above the upper
resistance line.
Step 3: To potentially avoid false breakouts, wait until
$0.50 above resistance before entering (in this case, that
is $21.50/share + 0.50 = $22 entry) as seen on February
16, 2017. Carefully note that a strong multiday preexisting
uptrend occurred from
February 3 to February 8.
Correct use of this strategy
requires this type of prior
uptrend to occur before the
consolidation channel.

Step 4: An initial and trail-

ing stop value of $2.00 per
share is used to manage
the trade.

INSIGHTS: WHY THIS

TECHNIQUE WORKS
The consolidation channel
breakout pattern is useful be-
cause it occurs in context of
an existing uptrend. By giv-
ing price action the chance to
rest and trade sideways, this
eSIGNAL

reveals any potential selling

FIGURE 1: CONSOLIDATION CHANNEL. On this 15-day, 15-minute chart of Esperion Therapeutics Inc. (ESPR), a swing trade
is initiated following a breakout above the consolidation channel’s resistance level. Continued on page 62
May 2017 • Technical Analysis of STOCKS & COMMODITIES • 45
 TC2000
Continued from page 48
basic questions; and finally, a live chat
option that puts you in direct contact
with a TC2000 technician.
In STOCKS & COMMODITIES’ annual
Readers’ Choice Awards, TC2000 has
won in the analytical software category
($500 or less) for 24 straight years.
The software comes in three different
plans, each with its own unique features
and pricing, all detailed at http://www.
tc2000.com/features/whatsnew17.
James E. Rich has been trading for
more than 30 years and currently trades
using a combination of technical, fun-
damental, and intermarket analysis. He
is cofounder of Palm Beach Traders, an
investment roundtable group that meets
monthly in Palm Beach Gardens, FL. Jim
Rich can be reached at Richtrader3@
gmail.com.
FURTHER READING
Faber, Bruce R. [2012]. “TC2000 Version
12.2 Update,” Technical Analysis of
STOCKS & COMMODITIES, Volume
30: November.
[2012]. “TC2000 Version 12,”
Technical Analysis of STOCKS &
COMMODITIES, Volume 30: January.
Rich, James E., with John B. Rich [2015].
“Simpify It,” Technical Analysis of
STOCKS & COMMODITIES, Volume
33: November.
Rich, James E. [2016]. “TC2000 Ver-
sion 16,” Technical Analysis of
STOCKS & COMMODITIES, Volume
34: January.
_____ [2016]. “The Palm Beach Trad-
ers,” Technical Analysis of STOCKS &
COMMODITIES, Volume 34: July.
‡TC2000 (Worden Brothers, Inc.)
‡See Editorial Resource Index

CALHOUN / CONSOLIDATION CHANNEL

BREAKOUTS
Continued from page 45
pressure that may exist: as long as price stays above support,
the supply & demand are in balance. Once price action takes
out new highs, current shareholders may wisely look to scale
in and buy additional shares, while new buyers are encouraged
to initiate new positions.
Look for consolidation areas following
earlier uptrends because these are
more likely to continue up once they
break above resistance levels.
stock or ETF priced $20–$70/share. As always, when trading
breakouts, tight, clean, focused charts are your best bet.

TRADE MANAGEMENT TIPS
Another useful insight is that the narrower the consolidation
channel, the better. In this example, the high–low range is a
tight $1.50, which is perfect for a $20 stock. You should not
try and enter above consolidation regions that are wide and
choppy. An example would be a high–low range of $4–$5 on a
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders. He
is the founder of TradeMastery.com, an educational resource
site for active traders, and is a UCLA alumnus.

FUTURES FOR YOU

GARNER
Continued from page 46
emini S&P, he shouldn’t have a trade
on. It is dangerous for the brokerage
and the client, and is in the best interest
of nobody.
Futures markets that have less liquid-
ity, and markets that are believed to pose
more risk to traders and brokers such as
crude oil, gold, and silver, are offered to
daytraders at much higher margin rates
than the stock indexes are. Most brokers
offer each of these markets for daytrading
at a rate of 50% of the overnight rate, but
there are a few brokers willing to offer
25% for such commodities. To illustrate,
62 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
the overnight margin rate to trade crude
oil futures is $3,190; a broker offering a
25% daytrading rate is essentially allow-
ing traders to buy or sell crude oil with
as little as $767.50, but a broker charging
a 50% daytrading margin would require
clients to have $1,595 in their trading
accounts to initiate the position. Brokers
rarely offer less than a 50% rate for gold
and silver due to their volatile nature.
If you wish to trade these markets in a
smaller account, it is best to use the mini
or emicro futures contracts as opposed
to the full-sized futures.
In my opinion, daytrading is the most
difficult way to make money in the fu-
tures markets so traders should approach
the strategy with a healthy amount of
caution. Accordingly, traders should re-
frain from maximizing leverage through
the use of highly discounted daytrading
margins. In fact, I recommend that day-
traders use full margin or more to start
out. In other words, if you plan on trading
a single emini S&P 500, it is probably a
good idea to have at least $5,500 in the
trading account despite brokerage mar-
keting gimmicks offering $500 margins.
Trading 11 contracts in this size of an
account might be allowed, but it comes
with a 99.9% chance of failure.
 The Finer Points
Critical MACD Levels
The MACD is a popular trend-following indicator from which
you can develop simple trading rules. Here are the results of
some in-depth research that reveals some interesting points
that will help you effectively apply the indicator.
by Kevin Luo
rend-followers are well acquainted with the mov-
T ing average convergence/divergence (MACD)
indicator—the one originally developed by Gerald
Appel in 1977. It’s great for identifying trends, but
occasionally, especially during extended downtrends
and choppy price action, it may not be an effective
tool for trend identification. However, the indicator is
too valuable to abandon. Is there a way to optimize
the indicator to improve its overall effectiveness?
24 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
BACK TO BASICS
The MACD is generally plotted on a chart with an MACD
line and a signal line. The line values are calculated using the
exponential moving averages (EMA) of the closing prices. In
Figure 1 you see a price chart and MACD chart for Apple Inc.
APPLE PHOTO: PIO3/SHUTTERSTOCK/SWORD: MIGUEL SALINAS/SHUTTERSOCK
(AAPL). The MACD line moves up and down faster than the
signal line, as the MACD chart shows. When the MACD line
crosses the signal line, it’s referred to as an MACD crossover.
When the MACD line climbs above the signal line from below
it, it’s called an upward crossover (or up crossover). Conversely,
when the MACD line falls across the signal line from above,
it’s called a downward crossover (down crossover). In the chart
in Figure 1, you see that the up crossover and down crossover
occurrences are delineated on the MACD chart by vertical
light blue and dark blue lines, respectively. The dates when
the crossovers occurred are marked by the same colors at the
 INDICATORS

corresponding prices on the price chart. The

default parameter settings for the EMA periods 140.00
in MACD value calculations is 12-26-9.
130.00
Both the MACD crossover and the MACD
value level play important roles in MACD
120.00
strategies. The MACD crossovers carry bullish
and bearish implications. The up crossover is
110.00
bullish because it’s an indication of further
price increases, and the down crossover is 100.00
considered bearish due to the anticipation of
a further price decline. Thus, those MACD 90.00
crossovers are commonly used as trading 01 MAY 15 01 JUL 15 01 SEP 15 01 NOV 15 01 JAN 16
signals by MACD followers. The basic MACD
trading strategy is simple: Buy when a bull- High-Low Price Bar Up Crossover Day Down Crossover Day
ish crossover occurs and sell when the next
bearish crossover occurs.
3
2
LET’S RUN SOME TESTS 1
MACD Chart

0
To determine whether the stated claims are

CUSTOM CHARTING SOFTWARE BY KEVIN LUO

-1
legitimate and the strategy works, I ran a series -2
-3
of tests. I looked at 500 US stocks and ETFs -4
with above-average volatility, those that, on -5
average, traded over $27 and had an average 01 MAY 15 01 JUL 15 01 SEP 15 01 NOV 15 01 JAN 16
of 16.6 years in listing history on the major
US exchanges. The historical data used in the MACD Line (12, 26) Signal Line (9) Up Crossover Down Crossover
tests was split-adjusted and dividend-adjusted.
The data consisted of daily data (open, high,
FIGURE 1: PRICE CHART WITH MACD. Here you see the up crossover and down crossover occurrences
low, and close) for up to 20 years ending on delineated on the MACD chart by vertical light blue and dark blue lines, respectively. The default setting
December 31, 2015. To carry out the tasks for used for the MACD value calculations is 12-26-9.
the test, I used an automated software system,
which I’ll refer to as “the software.”
In profiling MACD crossovers, the software located 84,034 cumulative returns for AAPL. On the top chart, each green
up crossovers from the dataset of 500 selected stocks. It found line connects the buy and sell prices of the sample trade. The
that a typical stock climbs 8.39% on average between an up blue line on the bottom chart shows the cumulative return
crossover and its following down crossover. This suggests that values, which change each time a test trade is completed. For a
after an up crossover you can expect a stock to move up 8.39% total of 194 AAPL trades, the cumulative return was 417.64%
before it turns bearish on the next downward crossover. This or 20.88% on an average annual basis. Its average per-trade
figure is a strong foundation for MACD crossover strategies. return is 2.15% (417.64 ÷ 194). Unfortunately, not all stocks
To find out whether the basic MACD strategy works, I ran a in the test responded to the strategy that well. Out of the 500
backtest (test 1). Backtesting is a commonly used method for stocks, 90 were unprofitable.
validating a trading system. It simulates a strategy and gener- In my previous S&C article on the MACD titled “MACD-
ates test trades on the historical data. In this way, you can test Suitable Stocks,” my study led to the decisive conclusion that
all stocks for any given period of time to evaluate a strategy. I an extraordinary relationship existed between MACD strategy
find that backtesting is also much more efficient than forward performance and stock trends that measure at least 20%. In
testing. Here are the backtesting rules I used: this study, the test statistics again demonstrate the existence
of such a relationship. The top 100 stocks with the larger
1. Buy at the open on the trading day following the up trends outperformed the bottom 100 stocks by 184.22% versus
crossover. 56.50% in terms of total return per stock. In the backtesting,
2. Sell at open on the trading day following the next down the typical stock generated an average 127.91% in cumulative
crossover. return or 7.71% annually based on the 16.6-year dataset. In
3. Use MACD setting 12-26-9. terms of average per-trade test return, it is only 0.76%. For
some traders, AAPL’s return of 2.15% is acceptable; however,
In this test, the software recorded the buy and sell prices the 0.76% figure appears to be very small. That may disappoint
of all 84,034 test trades and then summarized the outputs for even option traders, since it’s not enough to make the stock’s
me to review. In Figure 2 you see three graphs: a display of option prices move.
the test trades, the corresponding MACD crossovers, and the
October 2016 • Technical Analysis of STOCKS & COMMODITIES • 25
 uptrend (see the performance chart in Figure
100.00
2 for details).
How could this happen? Each MACD
90.00 value is calculated based on the prior MACD
value and the current close. There are fixed
80.00 calculation weights for the current prices in
the MACD formulas. These weights make the
70.00 MACD line more sensitive to current prices
than the signal line. A prolonged downtrend
60.00 such as the one in the AAPL example may
last for months. If you compare the MACD
50.00 to the length of the downtrend, you’ll realize
01 JAN 12 01 APR 12 01 JUL 12 01 OCT 12 01 JAN 13 01 APR 13 01 JUL 13 the MACD is responsive in the short term.
Frequently, stocks will tend to bounce up a bit
High-Low Price Bar Test Trade in a downtrend. A bounce up may not cause the
trend to reverse, but the “short-term” MACD
4 line is likely to pop up and cross over the sig-
MACD Chart

2 nal line. The crossover, in turn, triggers a buy

0 signal, which probably leads to an unprofitable
-2 trade. This tells you that if you can reduce the
-4 test trades in the downtrends to some degree,
01 JAN 12 01 APR 12 01 JUL 12 01 OCT 12 01 JAN 13 01 APR 13 01 JUL 13
the performance should improve.
MACD Line (12, 26) Signal Line (9) Up Crossover Down Crossover The second hurdle with the MACD strategy
is its whipsaw actions, something technical
Performance Chart

410 traders are familiar with. Whipsaws in the

400
390
380
370
360
350
01 JAN 12 01 APR 12 01 JUL 12 01 OCT 12 01 JAN 13
Cumulative Return (%)
FIGURE 2: TEST TRADES, CROSSOVERS, AND CUMULATIVE RETURNS. On the top chart, the green
lines connect the buy and sell prices of the sample trade. On the bottom chart, the blue line represents
the cumulative return values, which change after each test trade is completed.
MAKE IT BETTER
How can the average per-trade test return be improved? I’ll
start by investigating the problems tied to performance. All
trading strategies will generate some unprofitable trades.
If those bad trades can be linked to a designable element
of the strategy, then the problem could be rectified. As I’ve
said before, the MACD is a trend-following method and its
crossover strategy works better on stocks having large trends.
So on one hand, it is possible to achieve a number of highly
profitable trades during the larger uptrends. On the other
hand, those same stocks can also experience some large
downtrends, which is when performance suffers and you get
those unprofitable trades.
In the AAPL example (top chart in Figure 3), there are
five test trades located in the downtrend (the gray price
bars), which began at $94.19 and ended at $51.98 (split- and
dividend-adjusted prices). The test statistics indicate that the
test returns on the trades are -6.96%, -10.69%, -1.81%, -9.75%,
and -0.97%, respectively. The total loss amount in the down-
trend nearly wiped out the entire gains from the prior large
26 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
MACD are the result of choppy price action,
which can occur in any phase of a stock trend.
Although a bad trade from a whipsaw could
hurt the performance less than a bad trade
01 APR 13 01 JUL 13 during a downtrend, there could be over five
times more unprofitable trades in whipsaw
actions than in downtrends. This ratio is
stunning.
THE ROAD TO RECOVERY
Is there an easy way to reduce those unwanted
trades caused by downtrends and whipsaws? Since the MACD
is a trend-following method, its values tend to follow stock
trends up and down. From one perspective, the MACD value
levels carry some technical significance that is comparable
to the MACD crossover. In fact, many MACD followers use
the MACD levels, such as overbought and oversold, as trend
indicators. Perhaps by looking at these levels, it’s possible to
find some game changers for the development of the MACD
strategy.
In my study, the software found that many extensive
downtrends were associated with MACD values that were
-1.5 and lower. With this finding, you could simply set a filter
that accepts or rejects a crossover trading signal based on the
corresponding MACD value. In other words, you can accept
a buy signal when the MACD value is greater than -1.5 and
reject a buy signal when the MACD value is lower than -1.5.
In the AAPL example, there are five test trades (red-lined
trades) in the downtrend (top chart in Figure 3). In four out of
the five trades, the MACD value was less than -1.5 (refer to the
MACD chart in Figure 3). If I had placed the filter with -1.5
 double-edged sword that takes out the bad
100.00 trades along with a large number of good
ones. It could help to increase the per-trade
90.00 test return but could decrease the total return
at the same time because of the reduction in
80.00
the profitable trades. To see how well this set
of revisions works, I ran another backtest (test
70.00
2) using the following new rules:
60.00
1. Buy at the open on the next trading
50.00
day following the up crossover, with
01 JAN 12 01 APR 12 01 JUL 12 01 OCT 12 01 JAN 13 01 APR 13 01 JUL 13 the MACD value between 0 and -1.5.
2. Sell at the open on the trading day fol-
Uptrend Downtrend Test Trade in Uptrend Test Trade in Downtrend lowing the next down crossover.
3. Use MACD setting 12-26-9.
4
3 In the revised backtest, 116 out of 194 initial
2
MACD Chart

1 test trades for AAPL stock were filtered out.

0 The cumulative return dropped to 340.47%
-1
-2
from 417.64%, but the average per-trade re-
-3 turn rose to 4.37% from 2.15%. The change
-4 represents a 103% improvement. In Figure 4
01 JAN 12
01 APR 12 01 JUL 12 01 OCT 12 01 JAN 13 01 APR 13 01 JUL 13
you see the key statistics under “test 2” for
-1.5 MACD Value Level Rejected Buy Signals AAPL (green bars). For the 500 stocks (blue
bars), 41,862 original trades were rejected.
FIGURE 3: MACD DURING A DOWNTREND. The downtrend was significant enough that the total loss The per-stock average dropped from 127.91%
amount in the downtrend nearly wiped out the entire gains from the prior large uptrend. to 117.32% while the average per-trade return
improved by 83% (from 0.76% to 1.39%).
as the threshold, those trades could have been rejected. What if I had just used the -1.5 MACD level as the filter
To link the whipsaw problem to the MACD level is not instead of both -1.5 and 0? Only a small number of trades were
easy. However, the software provided some statistics which rejected so that the improvement was marginal. In Figure 4,
suggest that a significant number of the unwanted trades could I have labeled the results under this scenario as test 3. In the
be taken out by rejecting all buy signals with an MACD value case of AAPL, only eight of 194 original trades were rejected.
greater than zero. It may seem impossible. The solution is a Seven of them, including the four trades displayed in Figure 3,
were unprofitable and accounted for 42.72%
5.4 30 in loss. As a result, the cumulative return for
5.2
5.0 AAPL rose to 460.36% (or 23.01% annually)
4.8 4.36 from 417.64% (or 20.88% annually) and the
4.6 Test 2 23.02
4.4 25 per-trade average rose to 2.48% from 2.15%.
Test 3
4.2 20.88
4.0 Test 1 For the 500 selected stocks, 3,111 original
3.8 trades were rejected. The total return moved
Average Annual Return (%)
Average Per-Trade Return (%)

3.6 20 17.02
3.4
Test 2
up to 140.31% from 127.91% while the aver-
3.2
3.0 2.48
age per-trade performance changed slightly
2.8
2.15 Test 3 15 to 0.87% from 0.76%. These figures are also
2.6
2.4 Test 1 displayed in Figure 4.
2.2
2.0 8.45 The results you see in Figure 4 were gen-
1.39 7.71
1.8 10 7.07 Test 3 erated from a series of large-scale tests. The
1.6 Test 2 Test 1
1.4 Test 2 results offer sufficient and accurate statistics
0.76 0.87
1.2
1.0 Test 1 Test 3 to evaluate the MACD crossover strategy and
5
0.8 its optimization. It suggests a level of certainty
0.6
0.4 about what the MACD strategy could produce
0.2
0.0 0 for a group of stocks, not a specific stock. As
AAPL 500 stocks & ETFs AAPL 500 stocks & ETFs mentioned, in the initial backtest, 90 of the
FIGURE 4: COMPARING TEST RESULTS. Here you see the results of applying the basic MACD crossover
500 stocks did not produce a positive return.
strategy, plus two other tests where a filter was applied to reject losing trades. The results suggest that From a trading strategy development point
the MACD strategy can indeed be optimized. of view, the value of the MACD level is an
October 2016 • Technical Analysis of STOCKS & COMMODITIES • 27
 element you can incorporate in an MACD strategy.
ALL ENDS WELL
As I have shown with the results of test 2 and test 3, finding the
relationships between the MACD level and stock trend can lead
to an effective optimization of the benchmark MACD strategy
(the basic strategy). Keep in mind, though, that optimization is
a double-edged sword, to some extent. Although optimization
helps to improve the strategy on a group of stocks as a whole,
it may not help the strategy to work equally well on individual
stocks in the group. However, you have plenty of choices when
it comes to investing in a group of stocks—for example, just
think of how many ETFs are available for trading.
Kevin Luo is an independent technical analysis researcher
who focuses on automated price trend-related analysis and
generation of trading strategies. He and his project partners
developed an automated trend analysis and backtesting system
for high- and low-frequency trading. He may be reached via
email at kxluopub@gmail.com.
BULKOWSKI / MEASURE RULE
Continued from page 10
show a lot of price overlap from bar to bar. Loose regions also
show overlap, but not as much, because the tall price spikes
wander up and down further. The circled area at G is loose
but the red square at H is tighter.
Line F joins valleys going back months, and it would intersect
area G if I extended the line further to the left.
Looking at the entire chart, I would be most concerned about
E because it is close to the breakout. What does “close” mean?
Often, the answer is in the 5% to 10% range. Pullbacks (mean-
ing the stock breaks out downward but quickly returns to the
breakout price) bottom an average of 9% below the breakout
price. Any support area in that region could spell trouble.
F and G would come next in my list of concerns. I do not
like to see many valleys line up, as blue line F shows.
Because of the anticipated support at E, I would not have
shorted this triple top. In this case, the stock pierced E and
bottomed at F. Only after the stock began to pull back did it
pause (at I) near the zone at E and the bottom of candle D.
CLOSING POSITION
I use the measure rule to predict how far a stock might move.
Since the rule usually works between 50% and 75% of the time,
I sometimes adjust the target price. Then I look for underlying
support or overhead resistance to help determine where price
might turn along the way to the target.
Once I settle on a target price, I can use it as guidance to sell
a stock (this works especially well for swing trades), decide
to hold onto an existing position (often because of a meager
anticipated decline), or salivate at the opportunity of buying
28 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
FURTHER READING
Gopalakrishnan, Jayanthi [2003]. “Gerald Appel & The
MACD,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 21: September.
Hartle, Thom [1994]. “Gerald Appel, With Systems And Fore-
casts,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 12: March.
Luo, Kevin [2016]. “Falling In Love, With Trends,” Technical
Analysis of STOCKS & COMMODITIES, Volume 34: June.
[2015]. “Gap Trading,” Technical Analysis of STOCKS
& COMMODITIES, Volume 33: December.
[2015]. “MACD-Suitable Stocks,” Technical Analysis
of STOCKS & COMMODITIES, Volume 33: March.
[2015]. “The RSI & Price Trends,” Technical Analysis
of STOCKS & COMMODITIES, Volume 33: June.
Charts were created using custom charting software in R by Kevin Luo.
Use it not as a tool to get girls
but to help you determine how
far price might move.
in cheap after a decline.
Consider adding the measure rule to your trading toolbox, and
you may find it easier to predict next week’s stock price.
STOCKS & COMMODITIES Contributing Writer Thomas
Bulkowski (who may be reached via email at tbul@hotmail.
com) is a private investor and trader with more than 30 years
of market experience and considered by some to be a leading
expert on chart patterns. He is the author of several books
including Chart Patterns: After the Buy, Getting Started in
Chart Patterns, Second Edition and the Evolution of a Trader
trilogy. His website and blog, www.thepatternsite.com, have
more than 700 articles of free information dedicated to price
pattern research.
FURTHER READING
Bulkowski, Thomas [2016]. Chart Patterns: After The Buy,
John Wiley & Sons.
[2005]. Encyclopedia Of Chart Patterns, 2d ed., John
Wiley & Sons.
[2014]. Getting Started In Chart Patterns, 2d ed., John
Wiley & Sons.
‡TOM BULKOWSKI
‡See Editorial Resource Index
 DAYTRADING

Night Vision

Daytrading With Night Volume

Can the night session trading volume give you a hint 1. Night volume (that is, the traded volume from
as to what the market will do when the market opens? midnight to 8:30 am) vs. daily volume
Here’s one perspective. 2. Daily volume vs. daily volatility
3. Night volume vs. daily volatility

D
aytrading—it’s exciting and at the same time,
difficult. Intraday markets are often direc- As you can see, the three variables analyzed have a
tionless, overcrowded, and “noisy,” but as I consistent R2> 0.25 and a positive slope. Simply put,
am sure most of you know, it is possible to this means:
effectively use daytrading strategies even though it may • The model is statistically valid
be tough. Here are some clues you can use to navigate
• Daily volume statistically depends on night
the hurdles you may face when daytrading.
Night Volume vs Daily Volume
NIGHT VOLUME, DAILY VOLUME, VOLATILITY 90.0
I have spent years observing the US stock index 80.0
70.0
futures night sessions. Since I am based in Europe, 60.0
y = 4.4316x + 7.9949
50.0
it’s easy for me to view those markets. And thanks 40.0
R2 = 0.5637
30.0
to trading platforms, viewing the movement of the 20.0
10.0
indexes during the night is accessible and affordable -
- 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0
for US-based traders as well.
Is it possible to forecast the coming day’s volatility Daily Volume vs Daily Range
160
by observing night session volume? If night volume is 140
y = 1.2649x + 0.4124
R2 = 0.4383
unusually high, does it lead to a volatile day? If night 120
100
volume is low, does it lead to a low-volatility day? 80
60
Answers to such questions can be useful for daytrad- 40
ers since they can switch their approach according to 20
0
the daily volatility expectation. - 10.0 20.0 30.0 40.0 50.0 60.0 70.0

Night Volume vs Daily Range

REGRESSION ANALYSIS 160
y = 5.8454x + 10.057
140
I analyzed intraday data of emini ES futures contracts 120
R2 = 0.2687

from 2011 to 2016 and found that ES night volume is 100

80
generally 13% of the total trading session with an 8% 60
40
standard deviation, meaning night volume can vary 20
from 5% to 21% of the total volume traded. 0
- 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0
Let’s crunch some numbers to see if this intuition
ROY WIEMANN

FIGURE 1: REGRESSION ANALYSIS SCATTERPLOTS. Here you see three regression

makes sense. In Figure 1 you see three regression analysis scatterplots for night volume vs. daily volume, daily volume vs. daily volatility, and
night volume vs. daily volatility. The charts show that if night trading volume is higher than
analysis scatterplots made on: average, it’ll likely be higher during the regular trading session; the higher the volume, the
higher the daily range; and that you can predict daily range by measuring night volume.

by Domenico D’Errico
June 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 0
2,348.00 Legend 0 2,348.00
Night session from Sell Sell
2,346.00 midnight to 8:30 am First hour range 2,346.00
First hour trading:
2,344.00 8:30–9:30 am 2,344.00

2,342.00 Main session from 2,342.00

9:30–15:15
2,340.00 2,340.00
Night session from
2,338.00 15:15 to midnight 2,338.00
First hour break with low- Buy#2
2,336.00 volatility daily bias: the model 1 2,336.00
does not take the trade
2,334.00 2,334.00

2,332.00 First hour break with high- 2,332.00

Buy#2 volatility daily bias: the model
2,330.00 takes the price direction 2,330.00
1
2,328.00 Night volumes 2,328.00
average

TRADESTATION
140,000 164.994
140,000
60,000 60,000
02.00 04.00 06.00 08.00 10.00 12.00 14.00 16.00 18.00 20.00 22.00 2/16 02.00 04.00 06.00 08.00 10.00 12.00 14.00 16.00 18.00 20.00 22.00 2/17 02.00 04.00 06.00 08.00 10.00 12.00 14.00 2/19
4,804

FIGURE 2: THE DIFFERENT TRADING SESSIONS. The night session is colored in black, the first hour of trading is in red, the remaining main trading session is in blue,
and the session from 15:15 pm [CET?] to midnight is in gray. In the subchart is the night volume histograms and its five-day moving average (red dotted line).

volume—if volume is higher during the night session, it’ll night volume average of the last five days and provides
likely be higher during the regular trading session a volatility bias for the trading session about to start. If
• Daily range is highly correlated with daily volume: the a volatility bias is confirmed, the model switches into
higher the volume, the higher the daily range breakout mode; if the volatility bias is not confirmed, the
model switches off.
• Daily range statistically depends on night volume, which
implies that you can predict the daily range by measuring • 9:30 am—It calculates the first-hour trading range.
night volume. • 9:45 am to 14:45 pm—If the 15-minute bar breaks up the
initial range, a long position is opened; if it breaks down,
So, at 8:30 am Central European Time (CET), which is 2:30
a short position is opened.
am US Eastern Time, there’s a statistically significant predic-
tion on how the “about to start” trading session can evolve in • 15:15 pm—Open positions are closed.
terms of volatility.
The code for the night & day strategy can be found in the
TRADING RULES AND BACKTESTING sidebar “Easy-
I’ll now apply this trading concept to a potential daytrading Language Code First-hour Night and
strategy that I call night & day. In the chart of the S&P 500 For Night & Day Breakout Day
futures in Figure 2, the night session is colored in black, the first Strategy” as well Trades 1072 304
ES - Emini
hour of trading is in red, the remaining main trading session is as at the STOCKS S&P 500
Hit Rate % 48 53
in blue, and the session from 15:15 pm to midnight is in gray. & COMMODITIES Avg Trade -11.5 39
In the subchart, you see night volume histograms and their website at www. Trades 1038 312
YM - Emini
five-day moving average (red dotted line). The night & day Traders.com in Hit Rate % 46 52
Dow
strategy is mainly based on a first-hour breakout technique, the Article Code Avg Trade -10 5
which is when, after the first hour of trading is completed, you section. The in- Trades 1022 282
place a buy stop just above the opening hour’s high and a sell traday data can NQ - Emini
Hit Rate % 47 46
Nasdaq 100
stop just below the opening hour’s low. I filter night volume be exported into Avg Trade -19 1.5
by adding a volatility filter: if volume at 8:30 am CET is lower a text file so you Trades 1554 407
than average, the model assumes a low-volatility bias for the can easily import TF - mini
Hit Rate % 45 49
Russel 2000
session about to start and the system switches off for the entire it into an Excel Avg Trade 7.5 46
day. If the volatility expectation is high, the system switches spreadsheet for FIGURE 3: BACKTESTING RESULTS. The simple first-
on and takes the long/short price direction when price breaks statistical regres- hour breakout technique, with the exception of trading
the first-hour range. sion analysis. the mini Russell 2000 (TF) contracts, didn’t fare well
I ran the model in the last four years. The addition of the daily volatility
bias filter drastically reduced the number of trades and
Daytrading plan: on four main US improved the hit rate% and average trade for all four
• 8:30 am (CET)—The model compares night volume to the Globex Futures— markets analyzed.
10 • June 2017 • Technical Analysis of STOCKS & COMMODITIES
 Russell 2000 future: “Night and Day” strategy performance results
Max Equity curve detailed - @TFM17 15 min.(17/03/2013 20:15 – 15/03/2017 12:15)
Net Total Hit Avg Return on
VolTrigger Losing 16000
Profit Trades Rate % Trade Account
Trade
14000
1.0 15205 656 46 -1000 23 257 12000
1.1 18200 512 48 -1000 36 423
10000
1.2 18260 408 48 -1000 45 362

Equity ($)
8000
1.3 16685 324 50 -1000 51 321
1.4 10645 264 48 -1000 40 217 6000
1.5 10610 224 48 -1000 47 254 4000
1.6 12215 176 51 -1000 69 311 2000
1.7 14740 135 54 -1000 109 797 0
1.8 13485 116 57 -1000 116 739
1.9 10140 96 54 -1000 106 485 1/6/14 10/21/14 8/10/15 5/27/16 3/14/17
18/03/2013 08:45:00 – 15/03/2017 12:15:00
2.0 9540 65 57 -435 147 570 No commissions/slippage included

FIGURE 4: RUNNING A STRESS TEST. Running an optimization for VolTrigger with an interval of 1–2 in increments of 0.1 results in positive performance for any
parameter from 1 to 2 in 0.1 increments. This suggests that the Russell futures, during the night trading sessions, are less crowded than ES, YM, and NQ.

the ES, YM, NQ, and TF. The backtesting results in Figure 3
imply that:
• The simple first-hour breakout, with the exception of the
mini Russell 2000 (TF) contracts, didn’t fare well in the
last four years. That could be because US futures became
too crowded and such techniques are very common.
• An additional filter is necessary to avoid intraday noise.
• The daily volatility bias filter drastically reduces the
number of trades and improves the hit rate percentage
and average trade for all four markets analyzed.
FOCUS ON …
Why do the backtesting results for the Russell 2000 futures

EASYLANGUAGE CODE FOR NIGHT & DAY STRATEGY

var:CumulativeVol(0),NightVolumes(0); {Night And Day Demo Strategy //Signals

created on April 7th 2017 by domenico Input:Strategy(1),VolRatioUP(1) ;
If Time = 0000 then CumulativeVol=0; d'errico - www.Trading-Algo.com}
CumulativeVol=CumulativeVol+Ticks; //First Hour BreakOut
// Pay attention here, for intraday charts var:CumulativeVol(0),AvgNight(0); If Strategy=1 then begin
the reserved word Ticks should be used array:Night[5](0),Day_[5](0); If time>=0945 and time<1500 then
instead of Volume begin
If Time = 2300 then CumulativeVol=0; If close > Top then buy
If Time=0800 then begin CumulativeVol=CumulativeVol+Ticks; ("BrkUp") this bar close;
NightVolumes=CumulativeVol; If close < Bot then sellshort
End; If Time=0830 then begin ("BrkDn") this bar close;
Night[4]=Night[3]; End;
//This is to color sessions Night[3]=Night[2]; End;
If time<=0830 then begin Night[2]=Night[1];
plot2(h,"H",black); Night[1]=Night[0]; //Night And Day
plot3(l,"L",black); Night[0]=CumulativeVol; If Strategy=2 and Night[0] >
End; End; VolRatioUp*AvgNight then begin
If time>0830 and time<=0930 then begin If time>=0945 and time<1500 then
plot2(h,"H",red); AvgNight=(Night[4]+Night[3]+Night[2]+Nig begin
plot3(l,"L",red); ht[1])/4; If close > Top then buy
End; ("BrkUp_")this bar close;
If time>1500 then begin //Price Levels If close < Bot then sellshort
plot2(h,"H",darkgray); Var:Top(0),Bot(0),count(0); ("BrkDn_")this bar close;
plot3(l,"L",darkgray); End;
End; if time=2300 then begin End;
Top=0;
//This is to print data to export to Excel Bot=999999; If time=1515 then begin
spreadsheets for statistical analysis Count=0; If marketposition= 1 then sell this bar
If dayofweek(date)<>0 and time=2300 then End; close;
begin //this is to exclude Sunday If marketposition=-1 then buytocover
print(date,",",NightVolumes,",",Cumulativ If time>0830 and Time<=0930 then begin this bar close;
eVol,",",numtostr(HighD(0)-LowD(0),2)); if High>Top then Top=High; End;
End; If Low<Bot then Bot=Low;
Count=Count+1;
End;

June 2017 • Technical Analysis of STOCKS & COMMODITIES • 11

outperform the other stock index futures for the simple first-
hour breakout and night & day strategies? In Figure 4 you see
“stress test” backtesting results around the parameter VolTrig-
ger, a parameter that measures the ratio between night volume
and its five-day moving average. For example, if VolTrigger =
2, it means the model assumes a volatility bias only if night
volume is more than twice its five-day average. In Figure 4, an
optimization for VolTrigger is run with an interval of 1–2 in
increments of 0.1.
The performance is positive for any parameter from 1 to
2 in 0.1 increments. This suggests that the Russell futures,
during the night trading sessions, are less crowded than ES,
YM, and NQ. Traders outside the US, especially in Asia and
Europe, don’t put emphasis on small caps. Their focus is more
on the S&P and Nasdaq, since those markets may provide
them with additional clues to trade their own markets. So the
conclusions from the backtesting results suggest that crowded
markets can be a problem in today’s trading and because of
that, it probably makes sense to look at opportunities where
trading is less crowded.
DAYTRADING PITFALLS
If you look at the number of trades reported, you can see that
these types of daytrading strategies don’t overtrade. It is well-
known that there can be days when nothing happens for hours
in the markets. I am sure it has happened to you. The danger
of this is that after some days of not trading, traders tend to
forget about their trading rules just because they are bored or
tired of waiting for their signals. On the other hand, you know
very well that patience is the key to this business. So, instead
of being tempted to overtrade, pick up a book you’ve always
wanted to read or put on some music you enjoy—keep your
mind engaged and avoid staring at your monitor to look for
the next trade. Because markets often move together, if there’s
no volatility in the markets, you’ll be hard-pressed to find
something to trade.
SLEEPLESS, AT YOUR TRADING DESK
Any trading strategy will make sense if it has a rationale behind
it. And if you can explain the logic using a few words and without
Crowded markets can be a
problem in today’s trading and
because of that, it probably
makes sense to look at
opportunities where trading is
less crowded.
opening a chart, all the more power to you. Ultimately, it’s the
results that are important. In this article, I worked through the
idea of whether night trading volume can predict the coming
day’s volatility. This is just one method of many. I encourage
you to experiment with different strategies and run a regression
analysis and backtests. Trading platforms in conjunction with
spreadsheets can be powerful tools for statistical analysis.
Domenico D’Errico is an independent research & development
partner for investment management companies and profes-
sional traders. He also runs his own research firm and software
house (www.Trading-Algo.com). D’Errico is a TradeStation
Open Platform Developer and a two-time winner of the Trad-
eStation developer contest. He is available for advisory and
coaching through his website, www.Trading-Algo.com.
The code given in this article is available in the Article Code section
of our website, www.Traders.com.
See our Traders’ Tips section beginning on page 48 for commentary
and implementation of Domenico D’Errico’s technique in various
technical analysis programs. Accompanying program code can be
found in the Traders’ Tips area at Traders.com.
‡TradeStation
‡See Editorial Resource Index
†See Traders’ Glossary for definition

At-the-money (ATM)—An option whose
strike price is nearest the current price
of the underlying deliverable.
Binomial distribution—A sequence of
probabilities with each probability corre-
sponding to the likelihood of a particular
event occurring. An event is a sequence
of tries. Three coin flips with two heads
is an event.
Chi square—A statistical test to determine if
the patterns exhibited by data could have
been produced by chance. Also: Test of
statistical significance or confidence of the
expected mean and standard deviation.
12 • June 2017 • Technical Analysis of STOCKS & COMMODITIES
Fat tail—On a graph, a normal distribution
is seen as a bell curve, but when a lot
of events, values, or data points stray
widely from the average and give more
frequent high and low values, the opening
of the bell becomes stretched out, mak-
ing the opening “fatter.” Assets prone
to price jumps tend to exhibit fat-tailed
distributions.
In-the-money (ITM)—A call option whose
exercise (strike) price is lower than the
stock or future’s price, or a put option
whose strike price is higher than the
underlying stock or future’s price. For
example, when a commodity price is
$500, a call option with a strike price of
$400 is considered in-the-money.
Kondratieff, Nikolai—Developer of a wave
theory. The Kondratieff wave or K-wave
is a 54-year rhythm of wholesale prices,
politics, and culture.
Kurtosis—Descriptive measure of how flat
or pointed a distribution is.
Monte Carlo simulation—A statistical tech-
nique that simulates a series of random
events (such as a casino game).
Continued on page 38
 TRADING ON MOMENTUM
Daytrading Within
Whole Numbers
Keeping your entry and exits based
on simple concepts makes it easier to
manage your trades. Here’s a strategy
you can apply.
by Ken Calhoun
D eciding exactly where to enter
and exit stock daytrades can be
challenging. If you use whole
numbers to help manage your entries and
exits, you will likely find that it becomes
a favorite trading strategy, once you learn
the specific techniques explained in this
month’s column.
Traders often get into trouble when
they use subjective, overly complicated
technical signals to trade that are in-
consistent. These complicated signals
often lead to stop-losses caused by false
breakouts. Instead, traders may find that
using simple, strong price action signals
such as whole numbers is an easier,
potentially more successful approach to
managing their intraday trades.
eSIGNAL
FIGURE 1: WHOLE NUMBER SUPPORT & RESISTANCE. In this example of Twitter Inc. (TWTR), if the price continues its
current trend, you would enter just above a whole number and exit just below the next whole-number resistance level.
2017 WINNER
AI TRADING SOFTWARE
Winner
15 years
in a row!
DAYTRADING WHOLE-NUMBERS
STRATEGY Build powerful
When I first developed this technique in
1999 during the dotcom daytrading era,
trading systems in
my students found it extremely helpful. MINUTES
The goal is simply to buy a stock that
is breaking out to new two-day highs,
without coding
if that price level occurs within $0.20
above the whole number, then sell it
once it reaches $0.80 or so above the
next whole number. ®
Of course, you can test different spe-
cific entry and exit prices; strategically,
you are simply seeking to buy just above
a whole number and then sell once it has
moved in your favor, before it reaches
the next whole number. Daytraders lose
www.NeuroShell.com
money when they trade choppy, cheap 301.662.7950
stocks under $10 or overtrade weak entry
signals; this strategy is designed to help
you avoid making those mistakes. Step 1: Visually scan for stocks in
the $15–$50 per share price range,
STEP-BY-STEP ACTION PLAN that are in the process of taking out
Here’s how you can start using this a two-day high just above a whole
price action breakout strategy with your number, as seen in the chart of Twitter
daytrades: Inc. (TWTR) in Figure 1.
Step 2: Set a buy-stop order at
$0.20 above the whole number;
in this example, that would be
$17.20. Use an initial $0.20
stop at the whole number
($17.00 in this example).
Step 3: Your exit target is $0.80
above the whole number. In
this example, our exit target
is $17.80, which was hit suc-
cessfully for an exit.
INSIGHTS: WHY THIS
TECHNIQUE WORKS
Daytrading successfully de-
pends on entering using volatil-
ity, momentum, and price action
breakout signals combined with
extremely tight risk management.
Continued on page 62
September 2017 • Technical Analysis of STOCKS & COMMODITIES • 7
 more trades you place, the closer your winning percentage
will match the theoretical probabilities of each trade.
For example, If you place 10 trades with a 77% chance
of winning, but you lose eight of them, does that mean the
trading strategy doesn’t work? No, it just means you haven’t
made enough trades to complete a large-enough sample size.
Consider placing 100 or more trades to give yourself a chance
for the probabilities to play out.
IN THE END
You must put in consistent effort not only
to get in your hours of practice, but also to
place enough trades to achieve the average
winning percentage for your strategy.
I think I’m currently on my 9,999th hour
of trading … only one more to go!
Stephen Burnich is the cofounder and head instructor at
NavigationTrading, an options education firm. He can be
reached via the website at NavigationTrading.com or by email
at info@navigationtrading.com.
FURTHER READING
Chen, Jesse [2001]. “The Iron Condor,” Technical Analysis of
STOCKS & COMMODITIES, Volume 19: August.
Sarkett, John A. [2007]. “Double Calendars And Condors,”
Technical Analysis of STOCKS & COMMODITIES, Volume
25: June.
‡thinkorswim (TD Ameritrade)
‡See Editorial Resource Index
†See Traders’ Glossary for definition

TRADING ON MOMENTUM

DAYTRADING WITHIN WHOLE NUMBERS

Continued from page 7
This technique works because traders
use whole numbers for both swing and
intraday decision making. To capital-
ize on intraday momentum daytrading
volatility, entering slightly above whole
numbers and exiting slightly below
the next highest whole number makes
perfect sense, And the best part is, you
will find that it becomes much easier for
you to spot entries and exits when you
use whole numbers as default support &
resistance areas.
DON’T BE TEMPTED
The worst instruments to daytrade are
low-float, under-$10 stocks (or penny
stocks), because the upfront risk needed
to profit from these requires scalping for
tiny $0.20-type moves with thousands of
shares, which leads to account-destroy-
ing, expensive stop-losses and should
be avoided. Why? Because cheap stocks
seldom run for $0.50 cents or more in
a single direction, which is a necessary
component for successful daytrading.
There are educators who tend to mis-
lead the retail trading community into
believing that people can easily make a
fortune scalping cheap, under-$10 stocks
62 • September 2017 • Technical Analysis of STOCKS & COMMODITIES
Strategically, you are simply seeking
to buy just above a whole number
and then sell once it has moved in
with thousands of
shares; this is dan- your favor, before it reaches the next
gerous and false whole number.
(as any credible
expert will attest).
Professional daytrading depends on with stocks priced $15–$50 per share
wide-range, liquid, high-volatility instru- that trade at least 15K shares per min-
ments that have solid profit potential and ute (volume), because these are the best
tradable ranges. For example, it is much stocks to daytrade (they are much more
smarter to trade 300 shares of a $30 stock likely to run at least $0.50 compared to
with a two-point trading range than to dangerous under-$10 stocks, which are
trade 3,000 shares of a $3 stock with a choppy and have poor risk-to-reward po-
hard-to-trade $0.40 trading range, for tential). In my experience with day- and
the same amount of capital. swing trading several million dollars’
worth of real-money trades over the
TRADE MANAGEMENT TIPS years, I have found that simple, strong,
Hyperactive, coffee-drinking daytraders easily recognized technical breakout
(you know who you are!) may be tempted signals like these can produce the biggest
to enter too soon, for example, just $0.05 winning trades. I hope this helps you in
cents or $0.10 cents above a whole num- your trades as well.
ber. This is too early and often leads to
false breakouts that stop out. Similarly, Ken Calhoun is a producer of trading
traders may want to erroneously “let courses, a live trading room, and video-
their winners run” and wait too long based training systems for active traders.
to exit, which is also a mistake, since He is the founder of TradeMastery.com,
sellers come in at whole numbers more an educational resource site for active
often than not. traders, and is a UCLA alumnus.
One final important note: This tech-
nique is designed to be used specifically
 TRADING ON MOMENTUM

Daytrading Gaps & Cups

Learn to combine intraday gap and cup continuation a depth of less than $0.50 are ideal to trade above for continu-
patterns for strong entries. This professional daytrader ation breakouts. As a daytrader, your goal is to capitalize on
shows you how. momentum and volatility that is likely to continue in your
favor once you put on a trade.
by Ken Calhoun The key to success in daytrading is to use small <$0.20
stops combined with exceptionally strong technical entry

G
ap continuations are the single strongest trading pat-
tern you will find when day and swing trading stocks
and exchange-traded funds (ETFs). Daytrading stocks
can be frustrating, however, if you enter momentum
charts without specific technical entry signals, or try to day-
trade the cheap, under-$10 haphazard, risky instruments that
amateurs speculate (and usually lose) with. In this month’s
column, I will show you how to combine intraday gap and
cup continuation patterns for strong entries you can use for
intraday trading with stocks in the ideal $20–$70 range that
is favored by professional daytraders.
DAYTRADING GAP & CUP CONTINUATION BREAKOUTS
In my nearly two decades of making thousands of real-money
stock daytrades, I have consistently found that minor gap
continuations are the single best technical chart pattern to
enter. A good rule of thumb you can use is to enter your posi-
tion above new highs for stocks that have gapped less than $2
above the prior day’s high.
It is important to have premarket charts visible so that you
can see the magnitude of the gap, volume, trend and/or bullish
cups before the 9:30 am opening bell. Small bullish cups with
patterns like gaps, with charts trading on high volume over
15,000 shares per minute and wide trading ranges of at least
one point in the prior day’s high–low range.
STEP-BY-STEP ACTION PLAN
Here’s how you can start putting this strategy to work with
your daytrades:
Step 1: Find stocks priced $20–$70/share with minor pre-
market gaps of less than $2 using a two-day, one-minute
candlestick chart, as seen in the chart of Snap, Inc. (SNAP)
in Figure 1 before the opening bell.
Step 2: Set your buy-stop order above the premarket high,
for example $20.80 in Figure 1, before 9:30 am ET. You
may enter your trade once price action has broken out above
the upper resistance line at the top of the gap’s premarket
trading range.
Step 3: As price breaks to new highs, you can look for small
bullish cup patterns and enter above breakouts that continue
up ($21.10 and $21.50 in Figure 1).

Step 4: An initial and trail-

ing stop value of $0.20 is
used to manage the trade.
It is not uncommon to enter
and exit a strong breakout
several times during the
first hour of the trading
day, taking profits of from
$0.20 to $0.50 during each
new breakout.

INSIGHTS: WHY THIS

TECHNIQUE WORKS
As with all of the breakout
strategies you learn about
in this column, institutional
buying pressure is the prima-
ry price action driver. Simply
follow the money flow, using
eSIGNAL

technical analysis to reveal

FIGURE 1: SMALL STOPS AND STRONG TECHNICAL ENTRY PATTERN. Here you see three intraday trading entries after
breakouts above the initial gap and subsequent two bullish cups. Continued on page 41
June 2017 • Technical Analysis of STOCKS & COMMODITIES • 33
 Explore Your Options
more historically probable pattern. Onto
the currency markets we go!

Currencies (FXE)
The Eurodollar CurrencyShare (FXE) is
an ETF that tracks the eurodollar with
a high degree of correlation. This can
be traded in your equity account and is
optionable. This ETF is considered a risk
off asset, meaning that traders will buy
the euro when riskier markets such as the
US stock market are going lower. From
the chart in Figure 3, this seems to have
been true over the last 10 years.
FXE has a great bullish pattern the 30
days following Memorial Day. In nine
of the last 10 years, this ETF has risen
FIGURE 3: CURRENCIES (FXE). FXE has a great bullish pattern the 30 days following Memorial Day. In nine
an average of 1.06%. The best year of of the last 10 years, this ETF has risen an average of 1.06%. The best year of this pattern was in 2010 with a
this pattern was in 2010 with a 3.47% 3.47% move to the upside, while 2016 was the only year with a loss.
move to the upside, while 2016 was the
only year with a loss. Nevertheless, this 30-day options look like in terms of cost
pattern is the best in breed, with a 90% and risk for each. Summer patterns come
historical success rate.
Asset Option contract Cost and risk
with low volatility that
Trading summer patterns SPY 30-day ATM $350-$400 rises into the fall, which
Summer patterns come with low volatil- put option per contract means buying options
ity that rises into the fall, which means TBT 30-day ATM $100-$150 makes sense when you
buying options makes sense when you put option per contract
spot a price pattern going forward. FXE 30-day ATM $125-$175
spot a price pattern.
The ETFs discussed here have options call option per contract
on them, so you don’t have to go any because the expected move over the
further than a simple option purchase As you can see, the SPY will be the most timeframe is less.
to get the job done. The SPY, TBT, and expensive, since out of the three it moves Whatever you decide to do this sum-
FXE are liquid, diversified, and don’t the most. TB is the least expensive, with mer, consider patterns in your trading.
have the movement of a single stock FXE just above it when it comes to cost And throw another burger on the grill
and therefore, the options premiums are and risk. Keep in mind that cheaper isn’t for me!
cheap. Here are some examples of what always better. Options are cheaper only

CALHOUN / DAYTRADING GAPS & CUPS

Continued from page 33 I have consistently found that minor
simple, strong chart patterns that are worth trading. Another gap continuations are the single best
benefit is that this specific gap & cup breakout continuation technical chart pattern to enter.
pattern is relatively easy to recognize and has the potential
to work out a high percentage of the time.

TRADE MANAGEMENT TIPS
It should be noted that this pattern should not be used with
cheap, under-$10 risky stocks. You should also remember that
large gaps of over $2.00 per share may occasionally reverse, so
they should also be avoided. All daytrading should finish by
10:30 am, since volatility usually drops off sharply after the
opening hour. Small gaps with bullish cups like those shown
in Figure 1 are ideal for active daytrading.
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders. He
is the founder of TradeMastery.com, an educational resource
site for active traders, and is a UCLA alumnus.
‡eSignal
‡See Editorial Resource Index
June 2017 • Technical Analysis of STOCKS & COMMODITIES • 41
 Should I Or Shouldn’t I?
Decision-Making:
Why Is It So Difficult?
The answer may be simpler than it seems. Here’s what you
should be doing to make trading decisions less stressful.
by Claudio Demb
hether we like it or not, we have to make deci-
W
sions all the time. Some decisions are easy and
some are difficult. When it comes to trading,
decision-making is a skill that you must have
under your belt. And even then, it can still
present a challenge. I’ll take a closer look at
what causes the discomfort in it and what to
do about it.
WHAT’S IN A DECISION?
The process of making a decision contains a cognitive
component—let’s call it the knowledge part—and a psycho-
logical component—we’ll call it the emotional part. As a
trader for more than two decades, it’s been my experience
and observation that it’s the emotional component that gives
us the most trouble.
Why is that so? The answer may be simpler than it seems:
The trouble spot is the feelings evoked by the decision itself.
In trading, every decision you make has probable outcomes but
never certain outcomes. So when you open a trade, you may
be afraid of a possible loss. If you are already in a profitable
trade and you are faced with the decision to close it or raise the
stop, you may be thinking about the possible profits that could
be left on the table. In this way, feelings of loss—which are
uncomfortable feelings to have—will play in the background
of every trading decision you make.
Is there a remedy? Yes. The solution is a well-thought-
out plan that includes all the components of a good trading
strategy. That may sound good in theory, so let’s get “muddy”
60 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
and see how this works in the real world, because it turns out
that details matter.
SHOULD YOU WAIT OR SELL?
As I write this article, I have a trade on and I have already
decided to close the trade before market close. This trade is a
daily swing trade, and at the time I entered the trade, all the
components of my strategy had a checkmark next to them.
The stock symbol is MRO (Marathon Oil Corporation), and
I went long on March 16, 2018. I’ve described my trading
style in previous articles in this magazine, but as a refresher,
I divide my position into thirds and scale out at predefined
targets based on the average true range (ATR) for the first and
second third, leaving the last third for trend-following with
a trailing stop. Figure 1 shows a weekly chart and Figure 2
shows a daily chart. I always look at the weekly chart first
before moving on to the daily.
This trade has been a very profitable one, in fact, the most
profitable trade in my daily swing account for 2018 so far.
So why did I struggle a little with closing the trade that day?
For insight into that, I’ll look at the knowledge component
ETIAMMOS/SHUTTERSTOCK
first—that is, the trading plan. I traded according to my plan,
respecting the trading strategy fairly well. No issues here. So
why am I second-guessing myself?
The reason is because even though the trade was working
very well, I closed the trade without waiting for the hard stop to
In trading, every decision you
make has probable outcomes but
never certain outcomes.
 AT THE CLOSE

be hit (the dashed red line in the

daily chart in Figure 2). Thus, I
am naturally thinking about the
potential profit that I would miss
if next week the stock resumes
its uptrend. So evidently, it is Week of
the exit
the emotional component that’s
causing me pain.
The good thing is that I have a
Week of
written guideline in my trading the entry
plan that states if price closes
below the 8 EMA (and in Figure
2, you can see the blue line turn-
ing red on the day I closed the
trade), I may use my discretion
to close the trade. And that is
exactly what I did.

TRADESTATION
In the table in Figure 3, you
can see the results of my trade.
The three different exits reflect FIGURE 1: MRO, WEEKLY. I always look at the weekly chart first before moving on to the daily.
my approach of dividing my
position into thirds and scaling
3 Exit
out at different target prices to
protect profits and reduce the
stress of decision-making.
2 Exit
EXPERIENCE IS THE 1 Exit
BEST TEACHER Stop not
used
Experience, experience, and Entry
more experience is the greatest
teacher. However, taking a les-
son from others’ experience can
shorten the long learning curve
that experience involves. Take
it from me and my two decades
of experience: Following your
plan complete with what-ifs
can help with the difficulty of
decision-making.
And here’s something to
keep in mind: Knowing that FIGURE 2: MRO, DAILY. I closed the trade when price fell below the 8 EMA (the blue line turning red.) The dashed red
another trade is always around line shows my hard stop level.
the corner helps to minimize the
feelings associated with any single trade and helps you to move Stocks Entry Date Exit Date % return
on and be ready for your next one. Look forward to it!
MRO $15.23 3/16/2018 $15.85 3/21/2018 3.99%
MRO $15.23 3/16/2018 $16.96 4/5/2018 11.28%
Claudio Demb has been an independent trader and investor for
over 20 years. He is a practicing psychiatrist and the author MRO $15.23 3/16/2018 $20.54 5/25/2018 34.79%
of the blog “Trading Your A Game” at www.claudiodemb. FIGURE 3: TRADE RESULTS. Here are the details of my swing trade on Marathon Oil
Corporation, scaling out of the trade as price reaches each of my price targets.
com, He lives in Brookline, MA and can be reached via email
at claudiodemb@gmail.com.

FURTHER READING
Demb, Claudio [2017]. “The Pernicious Effect Of The Loss
Of Opportunity,” Technical Analysis of STOCKS & COM-
MODITIES, Volume 35: May.

November 2018 • Technical Analysis of STOCKS & COMMODITIES • 61

 TRADING OPTIONS
No direction? No problem.
Profiting With Delta
Neutral Positions
Trading delta neutral positions is a strategy that is
used by professional and nonprofessional traders
to produce profits with reduced risk. The idea is to
remove the directional component from the position
so that profits can be made whether the underlying
moves up or down. Here’s how to construct delta
neutral positions.
t’s not easy to make money trading, but when
I trading equities, at least the concept is clear:
buy low and sell high, or sell high and buy
low. When trading options, you have more alterna-
tives using spreads. It is not unreasonable to buy an
option that you expect will lose value and will result
in a loss while simultaneously selling an option that
you think will lose even more value and will result
in a gain. The combination of the gain and loss will
yield a net profit on the spread. Oftentimes, an option
trader will determine that he can’t accurately predict
which way a stock will move and so will want to
take the directional risk out of the equation. Employ-
ing this strategy is often referred to as delta neutral
(DN) trading.
DEFINING DELTA NEUTRAL
A DN position is an option position that may also
include stock, where the sum of the deltas of the puts,
calls, and stock is equal to zero or close to it. Since
deltas represent the risk associated with the directional
component of the position, more deltas (positive or
negative) represent greater risk. When I was a market
maker, I considered a position that was long or short
LISA HANEY
less than 500 deltas to be DN. For retail traders, I
consider a delta between -50 and +50 to be DN.
by Stan Freifeld
WHY DO YOU WANT A DN POSITION?
When you make a position DN, you are reducing the
directional risk the position carries and as you’ll soon
see in an example, the value of the position will not
change over a small range of stock prices. You are, in
effect, insuring the value of the position over a range
of stock prices. This insurance can be thought of as
an expense of the position and so the profitability of
the position may be reduced. The range of stock prices
where the position is protected can be extended further
by also making the position gamma neutral, although
I won’t be discussing that in this article. By reducing
the directional risk, you can base your strategy on
one of the other variables that determine the value of
the position—usually volatility, sometimes the time
to expiration, and rarely (especially in the current
economic environment) on interest rates.
In the past, traders used DN trading to take advan-
tage of mispriced options, although finding mispriced
options in today’s marketplace is not as easy as it
sounds. Others will make a position DN to protect
it from price swings over a short period of time.
Finally, DN trading is also used in conjunction with
gamma scalping, which is also beyond the scope of
this article.
To understand DN trading, you’ll need to know
the definitions of the five greeks and several of the
characteristics of delta and gamma (see sidebar
“Definitions.”)
CHARACTERISTICS OF DELTA AND GAMMA
Delta and gamma are generally expressed as per-
centages. For example, the delta for one option can
be shown as 80% or 0.80, meaning that if the stock
price changed by $1, the option price would change
February 2016 • Technical Analysis of STOCKS & COMMODITIES • 15
by $1 x 0.80, or 80 cents. However, the
delta for one option contract (represent- XYZ = 55.00 Position
ing 100 shares of stock) would be 0.80 Size Option premium Delta Delta $$$
x 100 or 80. When viewing delta this +6 Nov 50C @ 6.25 80 480 3,750
way, you can think of it as an equivalent -4 Jan 45P @ 2.10 -30 120 -840
stock position. -6(00) shares @ 55.00 100 -600 -33,000
Deltas for long call options range from 0 -30,090
zero for far out-of-the money (OTM)
options to 100 for deep in-the-money XYZ = 55.50 (+.50) XYZ = 54.00 (-1.00)
(ITM) options. Long put deltas range $$$ P/L $$$ P/L
from zero for far OTM options to -100 +6 Nov 50C@ 6.65 3,990 240 +6 Nov 50C@ 5.45 3,270 -480
for deep ITM options. Short options have -4 Jan 45P@ 1.95 -780 60 -4 Jan 45P@ 2.40 -960 -120
the opposite sign as long options. Long -6(00) shares@ 55.50 -33,300 -300 -6(00) shares @ 54.00 -32,400 600
calls and short puts will have positive -30,090 0 -30,090 0
deltas, whereas short calls and long puts FIGURE 1: DELTA NEUTRAL EXAMPLE. As the stock price increases to $55.50 or decreases to $54.00, the dollar
will have negative deltas. The delta of value of the position doesn’t change, so there is no gain or loss.
long and short stock is always 100 and
-100, respectively, and doesn’t vary as the price of the stock (remember the D and G are for one option contract)
changes. Here’s an interesting thought question: what is the
delta of cash? Answer: zero. ■ Jan 40 put @ $1.10, D = -25, G = 4
The gamma of a long put and its corresponding long call is
positive. In fact, the gammas are equal in value. So a position To form a DN position without stock, you just need to calcu-
gains positive gamma when options are bought and negative late a ratio of the deltas. So 60/25 = 2.4, which means you will
gamma when options are sold. Since the delta of stock is 100 need to trade 12 puts for every five calls. Let’s look at three
and doesn’t change, and we know that gamma is the change in ways to make DN positions.
delta, the gamma of stock is zero.
1. You can buy five calls for every 12 puts and the position will
FORMULAS FOR DELTA look like this:
AND GAMMA
We can always look at an option pricing calcu- +5 calls, D = 300, G = 40
lator to determine the greeks of our positions. +12 puts, D = -300, G = 48
However, to get a quick approximation, you 0 88
can use the following formulas:
2. Or you can also sell five calls for every 12 puts and the posi-
Let P = option premium, D = delta, G = gamma, and M = tion will look like this:
stock movement (+ for increase and – for decrease).
-5 calls, D = -300, G = -40
If the stock moves M, and assuming nothing else changes, -12 puts, D = 300, G = -48
the new P and D can be calculated using these formulas: 0 -88

P(new) = P(old) + M * D 3. Alternatively, if you are willing to add stock to the position,
D(new) = D(old) + M * G you can easily make any position DN:

Be careful to observe the signs of D, M, and G since they can be +5 calls, D = 300, G = 40
positive or negative depending on the position. Also, remember +8 puts, D = -200, G = 32
that a negative number multiplied by a negative number yields -100 shares D = -100, G= 0
a positive number. 0 72

HOW TO MAKE A DELTA NEUTRAL POSITION
There are a myriad of ways to make a DN position and it’s rela-
tively easy. Let’s look at an example using two options and see
how to combine them with and without stock to make some DN
positions. On XYZ stock we see the following two options:
■ Jan 50 call @ $3.00, D = 60, G = 8
16 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
Note that even though each of these positions is DN, the
gamma (and also the theta, vega, and rho) will be different in
each case.
In the DN example in Figure 1, you’ll notice that the dollar
value of the position doesn’t change as the $55 stock moves
up to $55.50 or down to $54. This is a nice and neat example
meant to illustrate a point. Of course, in real trading the deltas
are changing as the stock price changes due to gamma and so
the gain or loss may not be exactly zero. XYZ Change Stock Calls Position P/L
Now let’s look at an example of how you can use DN to make
some profit in real trading. Here’s the setup: 45 -15% 4,500 0.24 4,428 -191
47.68 -10% 4,768 0.50 4,618 B/E
• XYZ = $53 49 -8% 4,900 0.68 4,696 77
• Implied volatility normally trades between 35–55% 50 -6% 5,000 0.85 4,745 126
• Earnings are coming out tomorrow
51 -4% 5,100 1.05 4,785 166
• IV is high at 60% and you project it will fall to 50%
after earnings are released 52 -2% 5,200 1.28 4,816 197
• Jan 60 call = $2.27, D=33.3 53 0 5,300 1.55 4,835 216
54 +2% 5,400 1.85 4,845 226
You can put on a position like this: 55 +4% 5,500 2.18 4,846 227
56 +6% 5,600 2.55 4,835 216
Position delta Cost
57 +8% 5,700 2.96 4,812 193
+100 shares @ $53, D = 100 100 $5,300
-3 Jan 60 calls @ $2.27, D = 33.3 -100 -681 60.84 +15% 6,084 4.88 4,620 B/E
0 $4,619 61 +15% 6,100 4.97 4,609 -10
FIGURE 2: RESULTS. Here you see the results one day after earnings are released.
The next day, IV does drop to 50% as predicted. You can see One day later after earnings are released, the IV dropped to 50% as predicted.
from the chart in Figure 2 that the position will be profitable
over a wide range of price changes, from down 10% to up
15%. This results in a nice annualized rate of return for this
one-day trade.
An option trader may not be able
BE AWARE OF THESE PITFALLS to accurately predict which way
Does this mean you’ve found the holy a stock will move and so will
grail of trading? I don’t think so. The first want to take the directional risk
obvious problem is that the stock can move
too far to the upside or downside. Then
out of the equation.
you also have the volatility projection. If
volatility doesn’t come in enough, or worse
yet, increases, which may happen due to
a swift price move to the downside, the DEFINITIONS
position can suffer losses. Since two of the
three short calls in the example are naked, there is a margin Delta—The change in an option’s premium relative to a
requirement and you will need the highest option trading ap- change in the price of the stock.
proval level from your broker. Because of those naked calls, Gamma—The change in an option’s delta relative to a change
this particular strategy cannot be used in retirement or cash in the price of the stock.
accounts and you also have the usual commissions, spreads, Theta—The change in an option’s premium relative to a
and other expenses eating into the profits. change in the time to expiration.
As a final note, those of you who are familiar with syntheti- Vega—The change in an option’s premium relative to a
cally equivalent positions may realize that the results obtained change in the volatility.
in the example can be duplicated without having to purchase Rho—The change in an option’s premium relative to a change
stock. The equivalent position would be to sell the January 60 in the risk-free interest rate.
straddle and to sell one additional Jan 60 call.
Note that with the exception of gamma, each of the greeks
Stan Freifeld is a former market maker and white badge floor relates to a change in the option’s premium. Gamma relates
official on the American Stock Exchange. He is a frequent to a change in delta.
speaker at trading shows and now runs a one-on-one option
mentoring program at McMillan Analysis Corp. He can be
reached via email at stan@optionstrategist.com.

FURTHER READING
Gopalakrishnan, Jayanthi [2014]. “Learning The Ropes With
Stan Freifeld,” interview, Technical Analysis of STOCKS &
COMMODITIES, Volume 32: February.
18 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
 WAITING FOR THE
RIGHT WAVE
Why do stock prices move
in swings or waves? One
of the reasons could be that
large institutions—the main
market participants—tend to
wait for the right time before
they send their orders. If they
are on the long side they wait
for the price to go down, and
if they are on the sell side they
wait for the price to go up.
In other words, they execute
their orders only when their
target price has been reached.
It’s different from the retail
traders, who tend to make
their trading decisions much
more quickly. That could
be because they don’t have
to manage other people’s
money and don’t have to
engage in meetings before
getting approval of what to
trade, when to trade, and
how much to trade. There’s
a lot that goes on behind the
scenes of an institution’s
decision-making process.
Such a decision-making
approach tends to be typical
in any kind of organization.
Any experienced business
person will likely tell you that
when managing any business
transaction, you should never
be in a hurry to buy, or more
important, to sell. And if you
are in a hurry, keep your
urgency to yourself and train
Up & Down yourself to shield what your

Detecting Swings real intention is.

Large financial organiza-
tions give their trading desks
clear instructions regarding
entry/exit levels and provide
COMPASS: DONSKARPO/GOLFER: SATTAHIPBEACH/

They’re ubiquitous in price charts but how do you make sense of them? Here are four ways them with sophisticated tools
to help find price swings. to accomplish their tasks,
SHUTTERSTOCK/COLLAGE: NIIKI MORR

such as access to different

by Domenico D’Errico markets, and customized
algorithms to help them bet-

W hen you think swing, you think of a back-and-forth or a side-to-side move. In

the financial industry, a swing refers to price movement. This term is most com-
monly used when referring to a situation where the price of an asset experiences
a significant change over a short period of time.
ter hide their bids (and even
more so, their offers); they
rarely are in a hurry.

24 • May 2017 • Technical Analysis of STOCKS & COMMODITIES

 MONEY MANAGEMENT

HOW A SWING LOOKS ON A

CHART
While the big players wait, price oscillates
with little volume; when the big players
enter the market, they try to keep a low
profile, hiding their intentions as long
as possible until the dimension of their
orders will move price.
As you see in Figure 1, any price swing
is composed of two movements with op-
posite directions. In the middle, there is a
so-called pivot or swing point. Pivots are

TRADESTATION
price levels that large institutions target
to enter or exit.
Many technical analysis patterns such FIGURE 1: PRICE SWINGS. A price swing is composed of two movements with opposite directions. In the
middle, there is a so-called pivot or swing point.
as double bottoms or head & shoulders
can be justified by such explanations,
where bottoms, heads, and shoulders are price levels (or BACKTESTING STRATEGIES
price areas) targeted by large institutions for an extended I’ll now crunch some numbers on the nine US sector ETFs
period of time. for the last 20 years of weekly bars. I applied the following
rules:
IDENTIFYING SWINGS WITH ALGORITHMS
There are many ways to identify swings. Here, I’ll discuss • Long side
four. ￮ Open long positions when an upswing is detected by
one of the four models just discussed. Sell positions
• Pivot high/low after four weeks.
￮ A pivot low is when the previous bar’s low is lower • Short side
than the previous two bars and the current bar’s low. ￮ Open short positions when a downswing is detected
An upswing can be detected by a pivot low. by one of these four models. Cover positions after
￮ A pivot high is higher than the high of the previous four weeks.
two bars and current bar’s high. A downswing can be
detected by a pivot high.
• Bollinger Bands Pivot High-Low Bollinger Bands
￮ When price crosses over the
Pivot high
lower band, an upswing can
be detected.
￮ When price crosses below the
upper band, a downswing can
be detected.
• RSI cross
￮ An upswing can be detected
when the RSI crosses over the
oversold level. Pivot low
￮ A downswing can be detected
RSI Cross RSI + Higher Low / Lower High
when RSI crosses under the
overbought level.
• RSI + higher low/lower high
￮ An upswing can be detected
while the RSI is oversold and
there is a higher low. RSI overbought
RSI cross under + lower high
￮ A downswing can be detected RSI oversold
RSI cross over
while the RSI is overbought and + higher low
there is a lower high.

You can see what such patterns look

like on the chart in Figure 2. FIGURE 2: IDENTIFYING SWINGS. Here you see a theoretical look at four different ways to identify swings.

May 2017 • Technical Analysis of STOCKS & COMMODITIES • 25

 Backtesting Results on US Sector ETFs The Bollinger Bands
model is profitable
RSI + Higher Low /
Pivot High-Low Bollinger Bands RSI Cross on six ETFs, with a
Lower High
Volatility Number Hit Rate Average Number Hit Rate Average Number Hit Rate Average Number Hit Rate Average positive 0.33% aver-
% of Trades % Trade % of Trades % Trade % of Trades % Trade % of Trades % Trade % age trade and 51% hit
XLB 9.2 134 44 0.13 47 53 1.38 93 49 -0.10 71 46 0.50 rate.
XLE 10.4 136 38 -1.05 46 61 1.30 90 57 0.78 73 47 -0.37 The RSI cross is
XLF 10.4 136 42 -0.44 40 45 -1.37 90 52 0.74 67 49 -1.46
profitable on five out
XLI 7.8 130 53 0.65 46 57 1.30 90 44 -0.11 68 50 0.38
XLK 7.5 132 43 0.39 42 48 -0.23 87 38 -1.19 66 48 0.04 of nine sectors, with
XLP 5.4 131 36 -0.81 44 48 0.28 97 49 0.37 73 48 0.31 an 0.18% average trade
XLU 6.9 135 36 -0.81 49 51 0.17 87 51 -0.17 73 44 -0.03 and 49% hit rate.
XLV 6.7 138 43 -0.29 47 45 -0.03 89 47 0.16 71 48 0.19 The RSI + higher
XLY 7.5 124 48 0.14 48 54 0.13 88 52 1.10 71 52 0.15 low/lower high model
Average 43 -0.23 51 0.33 49 0.18 48 -0.03 is profitable on six
Correlation with
volatility %
0.09 -0.07 0.37 0.05 0.43 0.29 -0.01 -0.61 ETFs out of nine, with
FIGURE 3: BACKTESTING RESULTS OF THE FOUR MODELS. Different techniques may be suitable for different financial instruments. a slightly average nega-
Applying the four models on nine US sector ETFs shows the performance of the pivot high-low model is poor. The Bollinger Bands tive trade of -0.03%
model and the RSI + higher low/lower high model are profitable on six ETFs. and a 48% hit rate.
Different techniques
Figure 3 displays the backtesting results for each of the may be suitable for different financial instruments; for the
four models. purpose of this article, I’ll look at the correlation between
As you can see, the performance of the pivot high-low model the performance of the model and historical ETF volatility.
is poor. It performs only on four out of nine sectors, with an To calculate historical volatility, I used the ATR divided by
average trade of -0.23% and a 43% hit rate. the average of the last 120 monthly bars.
The pivot high-low performances are
uncorrelated with ETF volatility, which
TRADESTATION CODE FOR THE FOUR MODELS means that no matter what the volatility is,
Here are the EasyLanguage formulas for the four models discussed. the model’s performance is poor.
The Bollinger Band and RSI cross per-
//Pivot Low
Var: PivotLow(false); formances are positively correlated with
PivotLow = Low[1] < Low[2] and Low[1] < Low; the ETFs’ historical volatility. This means
//Pivot High
Var: PivotHigh(false); that these two swing strategies, with a four-
PivotHigh = High[1] > High[2] and High[1] > High; week target, perform better on more volatile
//Signals
ETFs.
Input:Strategy(1); The correlation results on the fourth strat-
Var:Qty(0);Qty=10000/Close; egy, the RSI + lower low/higher high, show
if date>1000101 then begin that its performance is negatively correlated
//Pivot High-Low with historical volatility. This suggests that
If Strategy=1 and marketposition=0 then begin
If PivotLow then Buy Qty Shares next bar open; such an approach is more suitable for less
If PivotHigh then SellShort Qty Shares next bar open; volatile markets.
End;
//Bollinger Bands
You can find the code for these four models
If Strategy=2 and marketposition=0 then begin in the sidebar “TradeStation Code For The
If close cross over bollingerband(close,12,-2) then Buy Qty Shares next bar open; Four Models.”
If close cross under bollingerband(close,12, 2) then SellShort Qty Shares next bar open;
End;
//RSI CROSS FINAL CONSIDERATIONS
If Strategy=3 and marketposition=0 then begin
If rsi(close,5) cross over 40 then Buy Qty Shares next bar open; Theoretically, trading strategies are generally
If rsi(close,5) cross under 60 then SellShort Qty Shares next bar open; divided into two categories: trend-following
End;
//RSI + higherlow / lower high
and swing trading. The trend trader takes
If Strategy=4 and marketposition=0 then begin risk in an uptrend or downtrend, and stays
If rsi(close,5) < 40 and L>L[1] then Buy Qty Shares next bar open; until the trend changes. In contrast, the swing
If rsi(close,5) > 60 and H<H[1] then SellShort Qty Shares next bar open;
End; trader works within the boundaries of range-
End; bound markets, buying at support and selling
//Exit after 4 weeks
If barssinceentry=4 OR date= 1161230 then begin at resistance.
If marketposition = 1 then sell next bar open; In this article I focused on the swing ap-
If marketposition =-1 then buytocover next bar open;
End;
Continued on page 39
26 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
 They’re Not So Rare
Diamonds Are
A Trader’s Best Friend
The diamond pattern is a classic chart formation yet it is
often misunderstood and underestimated. Here’s a deep dive
into diamonds.
by Igor R. Toshchakov
D ozens or perhaps even hundreds of books have
been written and published over the last several
decades depicting classic technical analysis pat-
terns and their practical application for trading
in various financial markets. Despite such a large
28 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
variety of reading choices and of what seems like plenty of
useful information readily available for market practitioners of
any kind, those books and other sources of information are often
full of misconceptions and factual errors. The information pro-
vided can be inaccurate, shallow, and sometimes misleading.
THROUGH THICK AND THIN
ILEYSEN/SHUTTERSTOCK
Among the classic pattern formations, the diamond pattern
is one of the most misunderstood and underestimated. While
many resources are dedicated to such technical formations as
head & shoulders formations, the double (triple) top (bottom),
 CHART PATTERNS

different types of triangle formations and so on, the diamond,

for some reason, still stands alone in obscurity and under a
dark cloud of misconception.
Ideas such as that of a flat earth standing on the backs of
three elephants and whales have been replaced over time by
more scientific concepts. The time has come to shed light onto
the diamond technical pattern and how it can be applied for
practical trading in the financial markets.
DIAGRAM 1 DIAGRAM 2
Let’s start with an overview of the diamond pattern.
1. Diamonds can be a continuation or reversal pattern. The
shape of the pattern is what will indicate whether it’s a
continuation or reversal.
2. Diamond patterns may not be as rare as perceived. Many
major reversal and continuation moves in the currency
market over the last several years have taken place
after the market broke out of a larger-scale diamond
DIAGRAM 3 DIAGRAM 4
formation.
3. I also don’t think diamonds should be considered a
“minor” pattern. Unlike other technical formations such
as double tops/bottoms or head & shoulders, diamonds
can usually be identified well in advance. This gives
traders the opportunity to plan their trades before the
pattern is fully formed.

DIAGRAM 5 DIAGRAM 6
POSSIBLE DIAMOND SHAPES
From a geometrical perspective, diamond formations look like a the breakout occurs in the direction opposite to the di-
rhombus. They are composed of two triangles bound together: a rection of the main diagonal. Because of its distinctive
broadening triangle is formed first and is immediately followed shape and the extended period of time usually required
by a regular triangle. Both triangles are often symmetrical to form such a pattern, it is relatively easy to project, in
but not necessarily so, and sometimes they can be shifted or advance, the next move’s direction, and to take a market
tilted in one direction. Contrary to general assumption, there position before the pattern gets fully formed.
is no such thing as a “typical” diamond formation.
There are at least four major kinds of diamond shapes • Two-diagonal diamonds have two subsequent main
and each has its own meaning. These shapes differ by the diagonals of relatively similar sizes. They can also be
sequences and lengths of the moves inside of a particular either “straight” or “inverted.” All types of two-diagonal
diamond pattern. diamonds can work as continuations (diagrams 3 & 4)
According to my own classification,
diamonds can be either “single-diagonal”
or “two-diagonal.”
• The single-diagonal diamond is a
rhombus in which the pattern’s top
and bottom are directly connected by
the longest single line, while all the
other price swings are substantially
shorter than the main one (diagrams
1 & 2). Whether the diamond will
become a continuation or reversal
ESIGNAL & FUTURESOURCE

depends on the main price move’s

direction of that single diagonal. If
the pattern’s bottom formed before
the top, then the main move’s direc-
tion of the diagonal is up, and vice
versa. In a single-diagonal diamond, FIGURE 1: SINGLE-DIAGONAL CONTINUATION DIAMOND ON USD/CHF WEEKLY. After price broke out
of the diamond pattern, USD/CHF continued its trend.

November 2018 • Technical Analysis of STOCKS & COMMODITIES • 29

 or reversals (diagrams 5 & 6). The eventual
breakout may occur in either direction.
Because of this complication, it isn’t always
possible to predict in advance the breakout
direction of the two-diagonal diamond.
Thus, you have to use some other clues to
project the next move’s direction. It is also
worth noting that this particular type of
two-diagonal diamond is often mistakenly
identified as a potential head & shoulders
pattern by less-experienced technical
traders. This may not be a big concern if
a diamond eventually turns into a reversal
pattern, but if the diamond is a continuation
pattern, it could cause problems.

FIGURE 2: DIAMOND IN THE DOW JONES INDUSTRIAL AVERAGE. Note how the single-diagonal diamond EXAMPLES OF DIAMOND
pattern that formed from 2014 to 2016 was an indication of the continuation of the bullish trend. FORMATIONS
Single-diagonal diamonds
Diamonds occur frequently, can be formed
on any timeframe chart, and in any financial
market. When diamonds form on bigger-
scale charts such as weekly and monthly,
they often define the direction of the fol-
lowing medium- and even longer-term
trend. Figure 1 depicts a single-diagonal
continuation diamond that formed on
the weekly chart of USD/CHF. After the
breakout occurred, USD/CHF continued
its trend.
To see diamonds in action, take a look at
the weekly chart of the Dow Jones Industrial
Average in Figure 2. On September 1, 2018,
the index was trading near its historic high.
On its way to this level, the index formed a
FIGURE 3: SINGLE-DIAGONAL REVERSAL DIAMOND ON EUR/USD WEEKLY. As expected, the breakout single-diagonal diamond in 2014–2016.
occurred in the direction opposite to the direction of the main diagonal. Given that such continuation diamonds
are usually formed mid-trend, you can fig-
ure out that the measured objective target
for the trend that started in 2009 should be
at around the 27,250 level. Such a situation
is a clear sign the US stock market is about
to run out of steam. A minimal correction
(which is a must under the circumstance)
should be back toward the diamond and to
at least the 19,300 area, which is the 38.3%
Fibonacci level, before the index possibly
enters a consolidation period. However, it
is unlikely that new historic tops will form
over that time period. Breaking below the
lowest point of the diamond (15,370 level)
is likely to lead to further losses if the index
retests the 2009 lows by dropping below
the 6470 level. Is it possible that a sizeable
FIGURE 4: STRAIGHT TWO-DIAGONAL REVERSAL DIAMOND ON GBP/JPY MONTHLY. Notice how it correction is in the cards?
can easily be mistaken for a head & shoulders pattern. In Figure 3, you see single-diagonal
30 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
reversal diamonds on a larger timeframe. Note that the
breakout occurred in the direction opposite to that of the
main diagonal. A single-diagonal type of
diamond may be easier to
Two-diagonal diamonds trade since it has a distinctive
Although two-diagonal diamonds can be a continuation or
reversal pattern, more often than not they are reversal patterns appearance and the breakout
that form at the top or bottom of a trend. Straight two-diagonal can be projected even before
diamonds are similar to head & shoulders formations but the the pattern is fully formed.
presence of an identifiable broadening triangle on the left
side of the formation can usually help identify whether it is
a diamond or a H&S.
Figure 4 shows an example of a straight, two-diagonal forms immediately after the main one with stops above or
reversal diamond on a monthly chart of the GBP/JPY. below the top or bottom of the main diagonal. This trading
In Figure 5, you see a unique situation: Three different types technique is riskier than the conservative one but can offer a
of diamonds are visible on the weekly chart of the USD/JPY much better risk/reward ratio.
from 2001 to 2005. A large, straight, two-diagonal reversal The most common complications and problems when trad-
diamond is immediately followed by a smaller-size inverted ing diamonds include:
two-diagonal continuation diamond, which is followed by a • Incorrect pattern identification by the trader
single-diagonal continuation diamond.
• The pattern’s exact borders can’t be precisely drawn
TRADING DIAMOND FORMATIONS before the breakout occurs
From the examples provided, you may have assumed that • The profit target can’t easily be set or projected in ad-
diamond formations are common in the currency markets. vance. That is because, contrary to general perception,
But this isn’t their only advantage. Unlike most other chart the diamond formation doesn’t have a measured objective
patterns, diamonds: target after a breakout. More often than not, it exceeds
the height of a diamond measured from the breakout
• Can usually be identified in advance
point by far. Trailing stops may not be as effective as
• Often have distinctive and relatively accurate borders you would want them to be.
• Have a low failure rate and a low rate of false breakouts.
This gives traders enough time to prepare for the im-
minent breakout and plan each trade without rushing YOUR BEST FRIEND
or added psychological pressure. All possible pitfalls of diamonds are relatively minor. Once
you start to experience the practical application of the
One point to keep in mind is that when you see a broadening
triangle on any of your charts, there is always a chance it can Continued on page 36
eventually turn into a diamond.
If you want to be conservative, you can
wait till the breakout occurs before entering
a position in the direction of the breakout,
and place stops above the extreme of the
last minor diagonal. This is especially
true for two-diagonal diamonds. With
single-diagonal diamonds, it may be a
different story.
A single-diagonal type of diamond may
be easier to trade since it has a distinc-
tive appearance and the breakout can be
projected even before the pattern is fully
formed. Since a sophisticated trader can
correctly identify such a pattern while it’s
still in progress, it might make sense to
consider entering a position in the direc-
FIGURE 5: MORE THAN ONE? It’s a unique situation when three different types of diamonds can be seen on
tion of the projected breakout a bit earlier. the same screen on the USD/JPY weekly chart. A huge, straight two-diagonal reversal diamond is immediately
Such a position can be taken closer to the followed by a much smaller-size inverted two-diagonal continuation diamond, which in turn is followed by a
top or bottom of the next diagonal that single-diagonal continuation diamond.
November 2018 • Technical Analysis of STOCKS & COMMODITIES • 31
 VERVOORT/THE V-TRADE
Continued from page 23
TRADE WITH CONFIDENCE
You should now have all the required knowledge to success-
fully trade using the many V-Trade rules. But you would
need to be in front of your computer at all times to manually
execute trades.
A trader needs to be flexible and I will show you a number
of tools I use to trade manually, automatically, or using a
mixture of both. These tools are built into an expert system
and I can give you a number of ideas that will be useful for
your own personal kind of trading.
You can expect the first article on the expert system in an
upcoming issue. At that point, I will start with an overview
of the current completed expert system and explain why dif-
ferent kinds of trading possibilities are integrated into this
system. Stay tuned!
Sylvain Vervoort is a retired electronics engineer who has
been studying and using technical analysis for more than
40 years. Currently, he experiments with trading forex and
CFDs with rule-based systems. His book Capturing Profit With
Technical Analysis received a bronze medal from the 2010
Axiom Business Book Awards in the category of investing.
His Band Break System Expert is available on DVD. More
information about the V-Trade System will become available
on his blog under construction at at http://blog.stocata.org.
Vervoort may be reached at sve.vervoort@scarlet.be or via
his website at http://stocata.org.
FURTHER READING
Frost, A.J., and Robert Prechter [2001]. Elliott Wave Principle,
John Wiley & Sons (first published in 1985).
Vervoort, Sylvain [2018]. “The V-Trade, Part 1: Five Basic
Trading Rules,” Technical Analysis of STOCKS & COM-
MODITIES, Volume 36: March.
TOSHCHAKOV/DIAMONDS
Continued from page 31
diamond pattern, you can overcome the pitfalls. The bottom
line is that diamond patterns are common, have a distinctive
and identifiable shape, and have a relatively low failure rate.
These characteristics make the diamond the king of all the
known technical patterns. They can be extremely profitable
and fun to trade.
Igor R. Toshchakov (a.k.a. L.A. Igrok) is a professional
trader of forex and other financial markets, analyst, and fund
manager since 1993. He is also the author of Beat The Odds
In Forex Trading: How To Identify And Profit From High
Percentage Market Patterns (Wiley, 2006).
36 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
[2018]. “The V-Trade, Part 2: Technical Analysis,”
Technical Analysis of STOCKS & COMMODITIES, Volume
36: April.
[2018]. “The V-Trade, Part 3: Technical Analysis—Fi-
bonacci Projections And Daily Pivots,” Technical Analysis
of STOCKS & COMMODITIES, Volume 36: May.
[2018]. “The V-Trade, Part 4: Technical Analysis—
Trends & Reversals,” Technical Analysis of STOCKS &
COMMODITIES, Volume 36: June.
[2018]. “The V-Trade, Part 5: Technical Analysis—
Moving Average Support & Resistance And Volatility
Bands,” Technical Analysis of STOCKS & COMMODITIES,
Volume 36: July.
[2018]. “The V-Trade, Part 6: Technical Analysis—
Divergence Indicators,” Technical Analysis of STOCKS &
COMMODITIES, Volume 36: August.
[2018]. “The V-Trade, Part 7: Technical Analysis—V-
Wave Count,” Technical Analysis of STOCKS & COMMODI-
TIES, Volume 36: September.
[2018]. “The V-Trade, Part 8: The Basic Trading Rules,”
Technical Analysis of STOCKS & COMMODITIES, Volume
36: October.
[2009]. Capturing Profit With Technical Analysis:
Hands-On Rules For Exploiting Candlestick, Indica-
tor, And Money Management Techniques, MarketPlace
Books, Inc.
[2012]. Ground-Breaking Band Indicators: Newly
Discovered Tactics for Timing Profit, DVD, http://stocata.
org. Includes an autotrading expert system.
‡MetaTrader4 (MetaQuotes Software Corp.)
‡See Editorial Resource Index
When you see a broadening
triangle on any of your charts,
there is always a chance it can
eventually turn into a diamond.
‡TradingView.com, ‡eSignal, ‡FutureSource
‡See Editorial Resource Index
 Creating Waves
That Dodd-Frank Act
How much of an impact does change in policy have on the
underlying technicals on a chart? Here’s an interesting
observation that looks at wave patterns.
by Koos van der Merwe
M
ost of us are familiar with the Dodd-Frank Act
and why it was brought into being. For those
who don’t know, here’s a brief explanation on
why it came into existence and why President
Donald Trump wishes to either revise it or cancel
it completely.
I’ll also revisit projections from some of the
wave analysis techniques I often employ—the
Kondratieff wave, the Paget cycle, and Elliott
wave—to see where we could be in these cycles
and how economic policy could influence or
delay how they play out.
22 • June 2017 • Technical Analysis of STOCKS & COMMODITIES
THE ORIGINS
The Dodd-Frank Wall Street Reform and Consumer Protection
Act was signed into federal law by President Barack Obama
on July 21, 2010. Its existence was in response to the financial
crisis of 2007–2008, which was a result of financial institutions
freely granting unlimited loans that led to the mortgage-backed
security crisis. At President Obama’s request, the Volcker
Rule, which restricted banks from making certain kinds of
speculative investments that do not benefit their customers, was
added. Paul Volcker was the chair of the president’s Economic
Recovery Board. He had argued that such speculative activ-
ity played a key role in the 2007–2010 financial crisis. The
mortgage-backed security crisis, for those who do not know,
can be explained simply using the following story.
IQONCEPT/SHUTTERSTOCK
On August 29, 2005, Hurricane Katrina passed southeast
of New Orleans. Hurricane-force winds were experienced
throughout the city, causing a great deal of damage. An invest-
ment advisor who worked for a major bank walked through
the city after the hurricane and found a young man sitting on
 KONDRATIEFF WAVE
III
Years in which panics have occurred 2144.70
and will occur again 2000.00
18 1999 20 2019
2008 2017 2018
IV
May 2007

1500.00
I

Years of good times and high value

Time to sell values of all kinds II
1989 10 1999 8 2007 9 2016 10 2026 1000.00

500.00

0.00

11 9 7 11
5 1996 2003 2004 2005 2009 2010 2011 2012 2016 2017 2023
Years to buy stocks and hold

ADVANCED GET
President Clinton President Bush President Obama President Trump -500.00

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

FIGURE 1: KONDRATIEFF WAVE. According to K-wave projections, a major correction could start in 2019, give or take a year. Could the Dow Jones Industrial Average
(DJIA) rise to new heights before then?

the sidewalk crying. the capital I needed, I would always go to the banks for an
“What is the problem?” he asked the young man. overdraft loan. My strategy was that as long as I could make
“The winds destroyed my apartment,” the young man replied. 3.5% interest above the interest that the banks charged me, I
“My family and I have nowhere to live.” was happy. Often, I would delay payment to the builder on the
“Not to worry,” the investment advisor comforted him. “The excuse that only when the person who rented the apartment was
bank I work for will grant you an interest-free mortgage so that happy with their accommodation would I pay them. This way,
you can purchase a new home for you and your family.” I received rental income before I borrowed the money from the
At that time, I was working for a major security firm in bank to pay the builder, and so increased my profit.
Canada, and I remember a salesman from one of the major US This is a strategy I believe Trump has followed in his past
banks giving a talk on how we should sell mortgage-backed real-estate dealings. He needed to borrow money from the
securities to our clients as a sound and solid investment. These banks after his numerous bankruptcies to help him out of
securities were a combination of a number of mortgages with his financial mess. The banks, because of the Dodd-Frank
various interest rate incomes and the mortgage-backed secu- Act, were restricted as to how much they could lend him. By
rities funds would pay a decent yearly interest to those who eliminating or revising the Dodd-Frank Act, he is lifting this
purchased them. restriction, allowing banks to grant unlimited loans and also
Because I was originally an emigrant from South Africa to start creating speculative investments that benefit the banks
where I had owned numerous businesses, this worried me. So more than their customers. The expectation of this coming
I did not advise my clients to purchase them. I also remember to pass has helped to boost the stock market to its current
that Paul Martin Jr., who was finance minister in Canada from height, and as I write this it looks as if the stock market will
1993 to 2002 and then became prime minister of Canada, get boosted even higher.
refused to allow the banks in Canada to merge and become Many advisors and technical analysts, including me, have
large banks similar to those in the US, even though this would been suggesting that a strong correction is in the cards. The
make it harder for them to compete with the larger US banks. Kondratieff wave is suggesting that this correction is due and
As a finance minister faced with tough financial decisions, his could occur in the near future. However, with the recent strength
results were financially spectacular, but he was not popular with in the market, it is beginning to look as if this correction may
the financial institutions. Under his guidance, though, Canada be delayed. How long it will be delayed is a “Trump” guess
was spared the mortgage-backed security crisis that led to the at the moment.
collapse of the US stock market in 2008.
READING THE CHARTS
FORWARD-LOOKING The chart in Figure 1 suggests that the major correction could
With President Trump’s aim to cancel or revise the Dodd-Frank start in 2019, give or take a year. The chart also suggests that
Act, financial institutions may no longer be restricted in their the WAVE 4 correction could be the correction suggested by
lending ability. As a businessman, I can understand why Trump the “Years of good times and high values—time to sell values
wishes to cancel the Dodd-Frank Act. Living in South Africa, I of all kinds” shown on the chart. If this is the case, then you
bought businesses that were going bankrupt and brought them can expect the Dow Jones Industrial Average (DJIA) to rise
back to profit. I also built numerous condominiums. To find to new heights.
June 2017 • Technical Analysis of STOCKS & COMMODITIES • 23
 ECONOMIC ANALYSIS

1 The Paget cycle shown in

9 2200.00
2000.00 Figure 2 suggests that the cor-
1800.00
5 10 rection should occur anytime
1 1600.00
7
3 2 1400.00
1300.00
soon. Roger Paget was a man
9 1200.00
1100.00 I met in South Africa in the
4 8 1000.00
900.00 1980s after I gave a lecture on
10
2
800.00
700.00
Elliott wave theory. After the
6 600.00 lecture, this scrumpy-looking
7 500.00 man approached me with
5 8 400.00
scrolls of charts going back
3 many years. He introduced me
6
300.00
to his cycle strategy that you
see in Figure 2. Note that he
4 200.00
suggested that a cycle repeated
1
9 itself every 16 years, as shown
2 by the red vertical line. His
7
Alan Greenspan Janet Yellen
Ben Bernanke
100.00
repetitive count is suggesting
10 a correction to come this year,
8
as shown by the 1-2 count
shown at the red vertical lines
1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020
in 2000 and 1984.
FIGURE 2: PAGET CYCLE. Paget’s repetitive 16-year count suggests a correction in 2017, as shown by the 1-2 count shown
at the red vertical lines in 2000 and 1984. Many analysts follow El-
liott wave theory to determine
where the stock market or share price is going. Ralph N. Elliott
5
developed his Elliott wave theory when he suffered a physical
B
malady and sat in a rocking chair in California. To keep his
Wave B
3 Wave 5 Wave A mind active, he started studying the history of the stock market
and developed his Elliott wave theory. In 1978, A.J. Frost and
A Wave C
R.R. Prechter wrote the book Elliott Wave Principle: The Key
Wave 4 C To Stock Market Profits. The book explained the basic theory
4
of Elliott wave theory in simplified terms and, where possible,
avoided areas of probable dispute.
Wave 3
Figure 3 is a representation of the basic Elliott wave pattern.
Waves 1, 3, and 5 are known as impulse waves, and Waves 2 and
1
4 are corrective waves. The corrective sequence after Wave 5 is
known as Wave A down, Wave B up, and Wave C down. Elliott
Wave Principle explains in explicit detail the waves outlined by
Wave 1 Wave 2
Ralph Elliott, and those readers interested in the theory should
2 consider reading it. Here, I am only going to refer to WAVE 5,
a wave that is currently being traced by the various indexes—a
wave that leads to a major market correction.
FIGURE 3: BASIC ELLIOTT WAVE PATTERN. Waves 1, 3, and 5 are known as Elliott theory states that, in terms of length, WAVE 5 is
impulse waves, and Waves 2 and 4 are corrective waves. The corrective sequence equal to WAVE 1. However, with computer trading, where
after Wave 5 is known as Wave A down, Wave B up, and Wave C down.
unemotional computers reacting to Trumponomics are becom-
ing more involved in stock market trading, the original basic
Elliott wave rules are changing. Recent history has shown
that a WAVE 5 can be less than or greater than a WAVE 1.
With the recent strength in the Predicting a target using Elliott wave theory is no longer as
market, it is beginning to look as accurate as it used to be.
Trump became president of the United States when the
if the expected correction may Dow Jones Industrial Average (DJIA) and the S&P 500 index
be delayed, although the Paget were both tracing a WAVE 5, a wave that anticipated, prob-
cycle suggests a correction ably because of computer trading, that Hillary Clinton would
could occur in 2017. win the presidential race. The indexes were in a WAVE 5 that
was trending sideways, waiting for her inauguration before
suggesting the start of a fall in a WAVE A.
24 • June 2017 • Technical Analysis of STOCKS & COMMODITIES
 -5- 21895 22000.00
DJIA
WAVE 5 top 21500.00

21000.00
5 20500.00
3 5-5-
v b 20000.00

a c 19500.00
iii 4
Jan 19
3 1i iv 19000.00
3 5 B 2 ii
a c 18500.00
1
3
i 4
b 18000.00
2 A C
4 17500.00
2 1 4
1 17000.00
1 2
4 4 2
16500.00
3 16000.00

Dec 28 15500.00
5 5
3
15000.00
RSI 14, 7, 3

50.00

Nov Dec 2016 Feb Mar Apr May Jun July Aug Sep Oct Nov Dec 2017 Feb 0.00

FIGURE 4: ADDING THE RELATIVE STRENGTH INDEX (RSI). Here you see how the RSI, which gave a sell signal on December 28, 2016, is acting a little hesitant in
its downtrend. The chart also suggests a Wave 5 target in the DJIA of 21895 as a likely possibility.

However, with Trump winning the presidency, WAVE 5 took its downtrend.
a rethink because of the promises he made and started rising. The monthly chart of the DJIA in Figure 5 suggests a WAVE
This can be seen in the daily chart of the DJIA in Figure 4. 5 top of 27784. The reversal of the RSI from a downtrend to a
The RSI indicator called for a WAVE 5 top on December 28, retest of the 70 horizontal line is positive, suggesting that the
2016. However, on January 19, 2017, as Trump’s presidency DJIA could rise to 27784. The length of Wave 1 was 6557.09
became more established as a business-friendly government, (12980 - 6422.91). Based on the original Elliott wave theory,
the DJIA continued with its WAVE 5, suggesting a possible where a wave 5 is equal to a wave 1, this suggests a target
top of 21895. of 21861.25 (15304.16 + 6557.09). The DJIA could rise to
Looking at the chart in Figure 4, a chart printed on Feb- either level and it depends on how computers interpret the
ruary 9, 2017, it’s evident how the RSI, which gave a sell
signal on December 28, 2016, is acting a little hesitant in Continued on page 46

-5- 27784
DJIA 21861.25
5
20000.00
3 3
iii v5

iv4
16004.48
5 15304.16 15000.00
5 4
1
3 B 12980 v5 1 i
3 v iii
5 2
iii v B iii
4 3 i 2 ii
A iv
3 i iv 1 ii 2 10000.00
v iv 1 i 4 1 4
iii ii A ii
4
2
C2 3
iv
i 4 5 6422.91
C
1 ii 5000.00
5 1 200-Day MA
1 3
2
2 4 2

RSI 14, 7, 3 95.64

70

50.00
32

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0.00

FIGURE 5: AND THE MONTHLY CHART SHOWS … that a WAVE 5 top of 27784 is possible. The reversal of the RSI from a downtrend to a retest of the 70 horizontal
line is positive, suggesting that the DJIA could rise to 27784.

June 2017 • Technical Analysis of STOCKS & COMMODITIES • 25

 TOOLS TAB
This tab contains five different non-
related but valuable functions. First is a
table of all ETFs hitting new highs/lows
(over the past 252 trading days) on the day
viewed, updated hourly. The new highs
list is a good prospecting tool for ETFs
with momentum over a one-year period.
Also, the momentum over more recent
periods is provided, so the leaders over
multiple timeframes can be pinpointed
without much difficulty.
Another useful tool is the ETF Moving
Average Comparisons found in the tools
tab, which lists the ETFs meeting the cri-
teria selected in a table format similar to
Figure 1, except there are added columns
to show the moving average price. Two
types of comparison are provided. The
first is to list the ETFs with a price above
or below a user-selected moving average.
The choices provided are seven common
simple moving averages (SMA) and four
common exponential moving averages.
Additionally, the second option is to
list ETFs based on selecting two moving
averages looking for a crossover in either
direction. For example, the
user can select a 10-day
SMA crossing a 50-day
SMA to see which ETFs
meet that criterion. During
trading hours, the data in FIGURE 4: CORRELATION OF RETURNS. The correlation coefficient
these tables is updated every of any number of ETFs can be compared. This is useful for building a
diversified portfolio, where low correlation may be desired. For example,
10 minutes. IWM and TLT have a -0.37 correlation.
Other tools include a
correlation matrix of any group of ETFs cal analysis tools in conjunction with a
you select (Figure 4), a risk-return that rules-based trading approach will enable
plots data points of one-year return vs. users to generate more consistent returns
volatility, and an array of user published than using less reliable strategies.
screens showing the selected parameter
and filters and performance table. Leslie N. Masonson is an ETF trader
and a columnist for this magazine who
TAKE A TOUR contributes bimonthly articles on ETFs.
This review did not cover all the screens He is the author of Buy, Don’t Hold, All
and tools available, as this software pro- About Market Timing, and Day Trad-
gram is too extensive. However, you can ing On The Edge. His blog is at www.
easily check out all the tabs and useful buydonthold.com. He can be reached
features of this comprehensive software, at lesmasonson@yahoo.com.
most of which are free. This software
offers investors and traders a quick and ‡ETFScreen.com
overall view of the ETF universe so they ‡See Editorial Resource Index
can cherry-pick the best of the bunch
for momentum investing. Using techni-

DODD-FRANK ACT / VAN DER MERWE
Continued from page 25
promises made by Trump.
The red moving average on the chart overlaid on the RSI
is the 200-day moving average of the RSI, which acts as a
strong foundation for the index. When the index rises too high
above the average, it is inclined to fall to the average. There
is no definite rule as to how high above the average the DJIA
can rise, but usually, market buyers become cautious when
it rises too high.
ONE DAY AT A TIME
Don’t forget that Trump is a businessman first and a politician
second. His desire to repeal the Dodd-Frank Act could benefit
businesses throughout the US. But will the banks gamble with
investors’ money as they did in the last decade and could this
end up being the cause of the anticipated market crash? Trump is
also suggesting he will usher in other economic policy changes
such as tax reform and his aim to bring back companies to
the US that are currently manufacturing products in foreign
countries where labor is cheap. This promise alone could boost
the US economy, and the indexes could continue to rise, but
as history teaches us, there is always a bug somewhere that
can be unexpected. So be careful out there, invest cautiously,
and analyze carefully.
46 • June 2017 • Technical Analysis of STOCKS & COMMODITIES
Koos van der Merwe has been a technical analyst since
1969, having worked as a futures and option trader at a stock
brokerage firm in Johannesburg, South Africa. He may be
contacted at petroosp@gmail.com.
FURTHER READING
Frost, A.J., and Robert Prechter [1978]. Elliott Wave Principle:
The Key To Stock Market Profits, New Classics Library.
Kondratieff, Nikolai [1925]. The Major Economic Cycles.
Kondratieff, Nikolai [1984]. Long Wave Cycle, Richardson &
Snyder. Originally published in 1925.
van der Merwe, Koos [2015]. “Where Is The Market Head-
ing?” Technical Analysis of STOCKS & COMMODITIES,
Volume 33: September.
[2014]. “Looking At Cycles,” Technical Analysis of
STOCKS & COMMODITIES, Volume 32: September.
[2011] “Today’s K-Wave And Beyond,” Technical
Analysis of STOCKS & COMMODITIES, Volume 29: April.
[2010]. “Kondratieff Wave Comeback,” Technical
Analysis of STOCKS & COMMODITIES, Volume 28: April.
[2008]. “My Kondratieff Wave,” Technical Analysis of
STOCKS & COMMODITIES, Volume 26: November.
‡Advanced GET, ‡eSignal
‡See Editorial Resource Index
 6.5” W X 6.5”H
PER CHRISTINE
Lines, Circles, And Waves
Trading Elliott Waves Using
A Top-Down Approach
When applying Elliott waves to your charts, one of the
challenges is to know which trend to use. Here is an approach
that could help you do just that.
by Mircea Dologa, MD, CTA
M
ost novice traders may not be aware of the
importance of identifying the origin of a trend
on the timeframe they are using. The top-down
36 • Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES
NEO GRAPHIC: SOFTULKA/WAVE: NATAWAT CHOTSUWAN/
SHUTTERSTOCK/COLLAGE:CHRISTINE MORRISON
Elliott wave approach is one of the best strategic tools when
practicing Elliott wave trading.
There are many advantages of using this top-down approach.
The easiest to understand would be never trade against the
trend. But which trend? Is it the ongoing trend on the opera-
tional timeframe, or is it the dominant trend, which is situated
on a higher timeframe? Can you rely on upper timeframes like
monthly, weekly, daily, and hourly to better understand the
kinematics of the market flow on the 15-minute chart?
 ELLIOTT WAVES

STATIC TOP-DOWN ANALYSIS

I start by looking at the static aspect of
analyzing the market. The first step here is
to do a top-down analysis where I search
for the static market characteristics to set
the stage for my trading decisions.
I first study the monthly chart and go
through this checklist, which I’ll walk you
through. See Figure 1 for the following:

• Dominant direction. There is a domi-

nant uptrend being corrected by the
current three-swing correction. The
market is in the process of terminating
its last local corrective swing.
• Elliott waves. There is a global impul-
sive pattern in progress, which is cur-
rently in v-subwave of (iii)-subwave
of C-subwave of W(4)-wave.

• Fibonacci price & time ratios. They
are used to establish clusters that will
reverse; temporarily halt, or cause a
trend continuation; or cause a side-
ways move in the market.
• Simple moving averages (SMAs).
There is a faithful follow-up of the FIGURE 1: STATIC TOP-DOWN ANALYSIS. On the monthly chart of crude oil from 2001–2015 you see most
50-SMA(C) and 200-SMA(C), with elements of a top-down analysis applied.
the market well below both of them.
This characterizes a strong down-
sloping momentum.
• End run—There is an efficient search for the elements of
the end of a run revealing support & resistance levels in
the immediate past, especially in front of the market sus-
ceptible to continue, reverse, halt, or move sideways.
￮ I use ahead-of-the-market levels to confirm a pullback
of a probable continuation in uptrend, or to ensure
a rally of a probable continuation in a downtrend.
You’ll need some knowledge of Gann and Elliott
wave analysis to understand the significance of
these levels.
• 3884 level – C = 0.666*A key level
• 3775 level – last low level
• 3700 level – G3 main Gann number
• 3507 level – 100% (i) subwave expansion level
and (iii)= 2.0*(i) level
• 3320 – A-wave terminal level
• 1065 – W(3) origin level
• 1042 – 261.8% (i) subwave expansion level.
￮ I use behind-the-market levels to confirm a
reversal.
• 5092 level – last high
• 6258 level – penultimate high
￮ Classic chart patterns – In Figure 1 there are three
patterns:
• There’s a regional ascending rectangular triangle
ESIGNAL / PITCHFORKTRADER.COM
with its two parallel trendlines of the hypotenuse,
encompassing the entire C-subwave of W(4)
wave.
• There’re local descending channels with their
two internal trendlines, embedding the iii, iv, and
v subwaves of (iii)-wave. The latter subwave is
developing on the upper half of this channeling.
• There’s a local mini descending channel with
its two limit trendlines visible on CL-monthly
time chart, encompassing the terminal swing,
the v-subwave.
￮ Confirming indicators – Again, there are three:
• On-balance volume (OBV) for confirming trending
or accumulation/distribution behaviours. The TL-
1, TL-2, TL-3, and TL-4 trendlines progressively
monitor future reversal or trend continuation.
• I use OSC (5, 35) to confirm the impulsive/correc-
tive waves with their correct labeling.
• I use the 14-period average true range, or ATR (14),
to confirm a reversal or sustained trend continua-
tion in a high-steamed momentum move. The TL-1
and TL-2 trendlines corroborate market behavior
and degree of momentum. The last registered
value of monthly ATR(14) on the chart is 9.26
pts, for a value of $9,260 (926 x $0.01 per barrel
x 1000 barrels).
Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES • 37
 Next, I turn to the weekly chart (Figure
2), which tends to magnify regional and
local parts of the market. I use the weekly
timeframe to enter the trade, calculate the
reward/risk value, and establish the initial
stop-loss and trailing stops.
• Dominant direction. The market is
in its last swing of the three-swing
correction.
• Elliott waves. The market is in the
terminal phase of the C-wave of
W(4)-wave, which is currently the
v-subwave of (iii)-subwave of C-
subwave of W(4)-wave.
• Fibonacci price & time ratios. There
aren’t any time studies on this weekly
chart.
• SMAs. There is a faithful follow-up of
50-SMA(C) and 200-SMA(C).
• End run. The search for the elements
of the end-run gives the same results
as the monthly timeframe (reveals
support & resistance levels in the
immediate past, especially in front
of the market susceptible to continue,
reverse, halt, or move sideways).

￮ Ahead of the market levels: FIGURE 2: TOP-DOWN ANALYSIS ON A WEEKLY CHART. The same elements as in the monthly chart
are analyzed. The weekly timeframe is used to enter the trade, calculate reward/risk values, and establish
• 3884 level – C= 0.666*A key initial stop-loss and trailing stops.
level
• 3775 level – last low level
• 3700 level – G3 main Gann
number
• 3507 level – 100% (i) subwave
expansion level and (iii)=
2.0*(i) level
• 3320 – A-wave terminal level
• 1065 – W(3) origin level
• 1042 – 261.8% (i) subwave
expansion level.
￮ Behind the market levels, used to
define a reversal:
• 5092 level – last high
• 6258 level – penultimate high
￮ Chart patterns – there are two:
• Regional ascending rectangu-
lar triangle with its two parallel
trendlines of the hypotenuse,
encompassing entirely the C-
subwave of W(4)-wave.
• Local descending channel with
its two internal trendlines,
embedding the iii-, iv- and
v subwaves of (iii)-wave of
C-wave. The v subwave is FIGURE 3: TOP-DOWN ANALYSIS ON DAILY CHART. The analysis is similar to monthly and weekly charts
developing on the upper half and is used to fine-tune entries, add to existing positions, and exit trades.

38 • Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES

 of this channeling.
￮ Confirming indicators – there are three I mainly use:
• OBV, as in the monthly chart
• OSC (5, 35) shows the impulsive structure of
(iii)-subwave of C: W(4)
• ATR (14), as in the monthly chart. The last
registered value of weekly ATR(14) in Figure
2 is 4.18 pts, for a value of $4,180 (418 x $0.01
per barrel x 1,000 barrels).

To fine-tune entries, add to trades, and to exit trades, I use

the daily chart. Even if I enter based on the weekly chart, I
find the daily chart helpful to be consistent in my profitable
trades. I use the same checklist and look for direction, Elliott
waves, Fibonacci price & time ratios, SMAs, and the end
run. I look for ahead of the market levels, behind the market
levels, chart patterns, and the confirming indicators.
In the chart in Figure 3, the market appears to be in its
terminal subwave of the last swing of a three-swing cor-
rection. The market is also in the terminal phase of the
last subwave of the v-subwave of (iii): C: W(4). It shows
that we are currently developing the iii-subwave of v: v:
(iii): C: W(4). The SMAs are indicating what they did in
the weekly chart.

￮ Ahead of the market levels are:

• 4045 level – Triple pivotal cluster (40.48, 40.47
& 40.41) - refer to Figure 4
• 3884 level – C= 0.666*A key level
• 3775 level – Last Low level (cluster 1)
• 3700 level – G3 main Gann number (cluster 1)
• 3507 level – 100% (i) subwave expansion level
and (iii)= 2.0*(i) level
• 3320 – A-wave terminal level
• 1065 – W(3) origin level (cluster 2)
• 1042 – 261.8% (i) subwave expansion level (clus- it will eventually go.
ter 2).
￮ Behind the market levels, used to define a reversal: the following:
• 4538 level – The 50-SMA (C) level
• 5092 level – Last High
• 6258 level – Penultimate High.
￮ Chart patterns – there are two:
• Regional ascending rectangular triangle (not
shown)
• Local descending channel with its two internal
trendlines, embedding the iii-, iv- and v subwaves
of (iii)-wave of C-wave. The v subwave is develop-
ing in the upper half of this channeling.
• Confirming indicators – there are three of them,
which are efficient, indispensable, and ergo-
nomic:
￮ On-balance volume (OBV)
￮ OSC (5, 17)
￮ The last registered value of daily ATR(14) is
1.785 pts, for a value of $1,785 (178.5 x $0.01
per barrel x 1000 barrels).
FIGURE 4: RESISTANCE LEVEL. The triple pivotal cluster at the 4045 level represents
a strong resistance area.
DYNAMIC TOP-DOWN ANALYSIS
Before making any trading decisions, the
astute trader must understand the context of
the market, that is, find out where the market
is coming from, where it is situated, and where
Going back into the top-down analysis study, we will find
• If you look at a chart of crude oil, you will see that it fell
from its highest high of $147.27 in July 2008 to $37.
• The highest high of the uptrend, which formed the
W(3)-wave, is corrected by the development of the
W(4)-wave.
• In retrospect, you understand that the most probable
scenario is the market flow sloping down through the
last subwave of W(4)-wave.
• When you know the price move is in the final phase of
its correction, you can utilize all your optimal tools to
take advantage of the market movements.
• Elliott waves will reveal the current market location: in
the iii-subwave of v: v: (iii): C: W(4). You can go to an
even lower timeframe than the daily, such as the 240-
or 120-min chart. It’ll give you better visibility of the
terminal phase of this subwave.
• 50-SMA(C) on the weekly chart is better positioned to
indicate increasing or decreasing down-sloping momen-
Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES • 39
 tum. This is done by evaluating the
distance between the price and the
SMAs on weekly and daily charts.
• Applying Fibonacci price & time
ratios could reveal the optimal levels
that can reverse the market.
• An overall evaluation of price will
reveal the different cluster zones
located in front of the market flow.
These cluster zones could be an
indication of an imminent market
reversal. These are the cluster zones
in decreasing order:
FIGURE 5: FIBONACCI LEVELS AND CLUSTER ZONES. This shows a strong chance that a price reversal
Cluster 1 will take place around December 2015.
• The triple pivotal cluster at the 4045
level, composed of 40.48, 40.47, and
40.41 key levels (see Figure 4). This
represents a strong resistance area.

Cluster 2
• 3775 level – Last low level
• 3700 level – G3 main Gann num-
ber

Cluster 3 labeled c.z. in Figure 5

• 3775 level – Last low level
• 3742 level – Fibonacci level: [(iii)=
1.875*(i)]
• 3634 level – Fibonacci level: [v= FIGURE 6: TIME/PRICE JENKINS CIRCLE. There is an almost perfect harmony with the market and the
1.25*i] Fibonacci ratio cycles. All important ratio cycles were tested.
• 3577 level – Fibonacci level: [v=
0.382*0-iii]
• 3507 level – Fibonacci level: [(iii)= 2.0*(i) - through able reversal that could take place around December 2015.
expansion] The timespan from the highest high on July 31, 2008 to end of
• 3320 level – B-wave origin level November 2015 is 88 months. If you include December in the
• 3243 level – Fibonacci level: [(iii)= 2.0*(i)] time calculation, there will be exactly 89 month bars, which
• 3110 level – Fibonacci level: [v= 1.5*i] is a strong Fibonacci number. There is a high probability of
• 2900 level – A forecasted reversal level (Figure 6) a reversal in December 2015 (89 bars), January (89+1 bar), or
• 2748 level – Fibonacci level: [v= 0.5*0-iii] February (89+2 bars) with an error margin of +/- 2 bars.
For a more accurate probability apply the same timespan
Far below the current market zone are techniques to weekly and daily timeframes.
• 1374 level – Fibonacci level: [C= 0.886*i] By studying the impact of the time/price Jenkins circle
• 1065 level – W(3)-wave origin level (Figure 6), I noticed in hindsight an almost perfect harmony
• 1042 level – Fibonacci level: [(iii)= 2.618*(i) - through concerning the market and the Fibonacci ratio circles (R= 1).
expansion] Almost all the important ratio circles were tested at 0.382,
0.618, 1.0, 1.236, and 1.382 levels. There is a high probability
What is the role of these clusters? In Figure 5 you can observe that a new event, probably a reversal, will occur at the conflu-
the status of the market via its downward-sloping development ence of next 1.5 ratio circular boundary with 3775, 3320, and
of W(4) wave, which reached the 0.886-1.0 time zone with 2900 key levels.
regard to the time span of W(2)-wave. In two to three monthly This needs to be confirmed by volume and OBV. I apply the
bars the market flow will reach the temporal cluster defined same timespan techniques as in the static top-down analysis
by C= 9.5*A and (iii)= 6.0*(i). At that period in time (Janu- to weekly and daily timeframes.
ary – February 2016) there is a high probability of a reversal. The chart patterns in Figure 3 show local descending chan-
That should be confirmed by volume and OBV. nels with this two internal trendlines embedding the iii-, iv-,
There is another confirming time factor for a highly prob- and v subwaves of (iii)-wave of C-wave. The v subwave is
40 • Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES
developing in the upper portion of this channel that is being
halted by the triple pivotal cluster at 4045. If price breaks
below this level, it’ll signal a strong downward market. If,
on the other hand, price breaks above the upper limit of the
channel, it’ll indicate a reversal, but the market must break
the 50-SMA (C) at the 4538 level and then at the 5092 level,
which is also the location of the 200-SMA (C).
Confirming indicators also play a role in price forecasting.
The OSC (5, 17) in Figure 3 illustrates the most probable sce-
nario of the market flow. A breaking down of the three clusters
will certainly confirm this scenario. It will be invalidated if
the market breaks up above the 5092 key level, which is the
terminal threshold of iv-subwave of v: (iii): C: W(4).
The OBV is valuable in making decisions because of its
ability to indicate market direction and the shift from trend
to reversal or a sideways-moving market. Because of its lower
fractal degree, the trendlines on the daily chart will be the first
to engage with the market flow, in case of a sudden movement.
It will then be followed by the weekly chart and then by the
monthly chart. If the market remains under the TL-2 trend
line, on the daily chart, it will serve as a signal for the con-
tinuation of the downtrend. If the market tries to approach the FIGURE 7: THE TRIGGER PHASE. Here you see a detailed analysis that led to
taking a short trade at 4248 on November 20, 2015.
TL-1 trendline without breaking above it, it means that it was
only a pullback. The concrete OBV values are less important
than some of the delimiting tools such as channels, trendlines, Mainly, the classic rule is that you should do your analysis on
pitchforks, rectangles, triangles, and so on. a lower timeframe chart than the one you trade. In this case, I
If the market breaks above the TL-1 trendline on the daily am trading on the weekly timeframe so I will study the static
chart, you could expect a market reversal. Keep in mind that elements and future kinematics on the daily chart.
OBV signal is only a confirmation factor, which has the double Here are the main reasons for executing this trade.
advantage of being, not only a faithful follower of the market • Accrued weakness of the market expressed by a second
flow, but also a concomitant trading signal. lower high, 4836 with respect to the first lower high, at
The daily ATR(14) is low, at 1.78, compared with its 5092 key level (Figure 4).
maximum value, which is over 3.0. If on the daily chart the • From the Elliott wave point of view, the market just
ATR(14) remains under 1.84, under the tl-3 and tl-4 trendlines, terminated a rally and started downwards the new iii-
it will serve as an excellent tool to signal the down-sloping subwave of v: v: (iii): C: W(4), giving the trader a high
continuation of the small-bar market flow. Once big bars start potential of profit.
to appear on the chart, it could mean there is an increase in • From the perspective of chart patterns, the market loca-
market volatility. Price could exceed the 2.13 threshold and tion tested the upper channel limit causing a test and
eventually break up the tl-2 and tl-1 trendlines. This signal is re-test from below (backwards down-sloping bounce).
only a measure of momentum strength. It does not indicate • All four indicators support this short trade: volume, OBV,
market direction, which is why it is a good idea to associate ATR(14), and OSC(5,35), respectively. The transition
the signal with a directional indicator such as RSI & OBV. from up to down volume is visible on Figure 3.
You should add another momentum indicator such as volume • There is a harmonious direct correlation between the
with its moving average and OBV. crude oil and its two correlated currencies ($CAD &
NOK).
THE TRIGGER PHASE • Apply money management practices by placing an initial
The typical rule of entering a short trade is to stop-loss with a R/R of 7.69.
wait for the end of a rally and then execute the
trade in association with confirming indica- Here’s how I would execute the trade (see Figure 4):
tors. The beginning and the termination of a • Enter short at 4745 on November 4, 2015 with a stop-loss
rally can be better seen on the lower timeframe rather than at 4836, which is located less than a quarter of the weekly
the operational timeframe. The problem is if there are support ATR(14) stop-loss of 4.18 value. The risk expressed by
& resistance levels at that end run, especially clusters in front the stop-loss would be 0.91, or $910.
of the market. That’ll make it more difficult to identify the • The first objective would be the triple pivotal cluster
beginning and end of a trend. at 4045 key level, resulting in a reward of 7.0 points,
Let’s analyze a short entry on a weekly chart (Figure 7). or $7,000.
Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES • 41
 • The current R/R ratio will be 7.69, ($7,000/$910).
If I were to add on to the trade, I would do it when the
market flow is testing the 50-SMA (C), from below, at 4564
key level. I would use a trailing stop (TS) as follows:
• The first TS is equal in size to the initial stop-loss,
meaning 0.75 – 1.5 of the ATR(14) of the operational
timeframe. The size of the stop-losses depends on the
trader’s capital. I recommend not going more than 2%
higher than the cost of the trade.
• As the market advances and multiple trailing stop-losses
are necessary, things become more complicated. You
will have to find the right equilibrium between the per-
centage of the ATR(14), which decreases from 100% to
25%; the latter is used as the last TS, at the end of the
trend. It automatically gets you out of the market near
the reversal zone.
Moving on to the indicators … looking first on the daily
chart.
• The OBV turned out to be quite helpful (Figure 3). On
the day of the short entry (November 4, 2015), the OBV
completed a double top, and at the same time executed a
failure with regard to the TL-1 trendline, falling under
the -10.7 M value. This shows a weakness, which is ideal
for a short trade.
• ATR (14) on the daily chart shows that on the day of
the short entry, the ATR(14) finished a double top and
tested the 1.84 value. It remains under the tl-4 trendline,
which signals a down-sloping continuation and is ideal
for a short trade.
• The OSC (5, 17) illustrates the most probable scenario
of market flow: the iii-subwave of v: v: (iii): C: W(4).
The breaking down of the three clusters will confirm the
labeling. It will be invalidated if the market breaks up
above the 5092 key level, which is the terminal threshold
of iv-subwave of v: (iii): C: W(4).
• Price is too close to the 50-SMA(C), less than a daily
ATR(14) of 1.7855.
To compare the trading results on two different timeframes,
I analyzed the same short trade on a weekly timeframe and a
daily chart. On the weekly timeframe, I entered the trade at
4248 key level on November 20, 2015, and on the daily, the
trade was executed at 4745 key level on November 4, 2015.
The price difference was 497 ticks, or $4,970.
ALL LINED UP
This top-down approach goes hand in hand
with Elliott wave practice and will prepare
the trader to access the highly sought-after
proficiency and profitability in the art of trad-
ing. In order to have optimal profits, the astute trader should
align trading direction on operational timeframe with those
of the upper timeframes.
42 • Bonus Issue 2017 • Technical Analysis of STOCKS & COMMODITIES
When the price move is
in the final phase of its
correction, you can utilize
all your optimal tools to take
advantage of the market
movements.
Mircea Dologa, MD, CTA, began his investment and trading
career in 1987 as a Commodity Trading Advisor and a regis-
tered general securities representative. He subsequently moved
into teaching practical aspects of trading using techniques
he developed. He is a contributor to many magazines around
the world, the author of several books published in several
languages, and is publisher of the monthly World Charting
Report, which covers international indexes, commodities, and
forex charts. He is a member of several technical analysis as-
sociations (ATAA & STA) and an MTA associate member. He
may be contacted at mircdologa@yahoo.com, via his website
at www.pitchforktrader.com, or via his YouTube channel at
https://www.youtube.com/watch?v=6NE3JIk8mzE.
FURTHER READING
Dologa, Mircea [2006]. “The Third Wave,” Technical Analysis
of STOCKS & COMMODITIES, Volume 24: May.
[2006]. “Trading the Trend in Wave 3,” Technical
Analysis of STOCKS & COMMODITIES, Volume 24: June.
[2006]. “Trading Wave 3,” Technical Analysis of
STOCKS & COMMODITIES, Volume 24: September.
[2008]. Integrated Pitchfork Analysis: Basic to Inter-
mediate Level-I, John Wiley & Sons Inc., London, UK.
[2008]. Integrated Pitchfork Analysis: Advanced Level-
II, Pitchforktrader.com.
[2009]. Integrated Pitchfork Analysis: Advanced Level-
III, Pitchforktrader.com.
[2013]. “Missing Link Between Time & Price,” part 1,
Technical Analysis of STOCKS & COMMODITIES, Volume
31: September.
[2013]. “Missing Link Between Time & Price,” part 2,
Technical Analysis of STOCKS & COMMODITIES, Volume
31: October.
[2015]. Elliott Waves: Beginner To Professional Level,
www.pitchforktrader.com.
[2016]. World Charting Report, monthly periodical,
http://pitchforktrader.com/reports.html.
Jenkins, Michael [2012]. “Square de Range Trading System,”
www.stockcyclesforecast.com.
Neely, Glenn [1990]. Mastering Elliott Wave: Presenting The
Neely Method, Windsor Books.
†See Traders’ Glossary for definition
 First, The Building Blocks
Elliott Waves:
How High Is High?
Part 1
One of the keys to profitable trading is identifying the lowest
low and the highest high. But how low is low and how high is
high? That’s a tough question to answer. The best you can do
is to apply proper tools and money management practices.
by Mircea Dologa, MD, CTA
M
ost of us know that the best and less difficult
profits to obtain are those from trading im-
pulsive waves; the ones that may belong to an
impulsive pattern or even to a corrective one.
If you know something about Elliott waves,
you’ll have W3-wave and C-wave, and to a
lesser degree, W1-, W5- and A-waves in mind.
Trading corrective waves is the privilege of
28 • November 2017 • Technical Analysis of STOCKS & COMMODITIES
experienced traders because the techniques are more difficult
to understand and their behavior is more dangerous. This
implicates far more risk and the necessity of solid money
management strategies. Even if the low of a W3-wave seems
visually obvious, it’s still difficult to determine if it’s as low
WAVE: CHRISTOS GEORGHIOU/ ROWERS: GABOR MIKLOS/
as it can go.
SHUTTERSTOCK/ COLLAGE: CHRISTINE MORRISON
Generations of novice traders have tried to hit a “home
run” and make a lot of money even if their entries and exits
were chosen erratically. They try to catch an optimal entry, as
close as possible to the lowest low of an upsloping trend and
then happily cruise it all the way up to the highest high. The
plan seems ideal, but there’s the question “How high is high?”
Unfortunately, this trading strategy is doomed to fail without
a precise plan. As a result, most novice traders invariably lose
their capital. The difficulty in getting an optimal profit from
 MONEY MANAGEMENT

the low-risk high-probability trade

setups is based on:

• A diagnosis of the highest

high in an uptrend (and vice
versa). But this implies that
the trader is at a high level
of his knowledge curve, thus
making him capable of apply-
ing optimal timing when the
weight of evidence signals the
reversal phenomenon.

ESIGNAL
• Even if early identification
of the incoming trend is
FIGURE 1: SWING DISTRIBUTION. Here you see two main swings in down and up directions. The lowest low is a
performed right after the decisional trading point that separates the two zones. It’s a good idea to focus on it because of its reversing trend op-
reversal was confirmed, there portunities. This swing distribution technique could assist you in establishing the contextual market flow.
is a big difference between
trend identification and entering the trade. The decisive ance Volume indicator, a jail-like burst of the Volume indicator
influencing factor is the degree of risk that the trader with the right calibration, a trend line breakout with a certain
wants to take or can afford. That risk could be conserva- percentage of penetration advance in the opposite direction.
tive or aggressive. The former choice is based on several The end-run phenomenon, something that’s precious to our
confirming factors of the reversal and the latter choice, mentors Robert D. Edwards, John Magee, and John J. Murphy,
is riskier, more profitable, being performed with far less is an efficient search for the key levels. This might be revealing
confirmations, if any. support & resistance levels in the immediate future, in front
• Money management, by applying constant small stop- of the market, which are susceptible to continue, reverse, halt
losses, but this implies to be as close as possible to the or lateralize market flow.
lowest low level. Now is a good time to mention the setup of a corrective
wave termination followed by an impulsive wave, whose
One of the keys to profitable trading is the identification of volatility has just sprung out of the terminal subwave of the
the lowest low together with the identification of the highest W2-wave zigzag. Its momentum will become visible when
high. I will present the tools to do this and the management the first volume bar exceeds the average size.
of the trades. It will enable the trader to take trading decisions Many traders believe the astute reading of price and volume
with more confidence and psychological comfort. And it’ll bars will replace all other trading techniques. And, did you
eliminate the “trigger shy’ syndrome. know that most indicators are derived from these two elements?
This article was purposely divided in two: Part 1 will de- In my opinion, without price and volume study together with
scribe the simpler methods of determining the landmarks of state-of-the-art trading tools, no trade will be profitable.
the market, with part 2 going even further to present modern
technical analysis techniques that will ensure a high profit- SYSTEMATIZED VISUALIZATION TOOL
ability at far lesser risk. The purpose is to present an array of If you continue to eyeball price movements in an educated way,
techniques from simple visualization to the state-of-the-art you will exercise what is called the Systematized Visualization
technical tools practiced by the professional trader. tool. If you correctly assimilate this tool, then I’m confident
you’ll agree that visually identifying price movement is one
WEIGHT OF EVIDENCE: of the best tools. However, everything has to do with how you
VOUCHING THE NEW TREND look at the charts. Two traders will have two distinct opinions
Before you enter a trade, you must be aware of the market’s about the same chart setup. If you don’t want to miss important
context. The first step will be to eyeball price movement. Some details and see what is important, it’s good to train your eyes
of you may be wondering about the term weight of evidence. to scan charts in a systematized manner.
This process identifies the termination of the previous swing The educated trader will always look at a chart in a routine
and building up of the incoming reversal. It will eventually way, following different learned modules that have become
signal the inception and development of the new swing. The like second nature in his mind. This analytical process will
sooner the weight of evidence is performed, the earlier the be the same, over and over again: the chart pattern; its size
trader will be able to enter the trade, and this increases the and morphology, the angle of the slope, and composition
likelihood of a profitable trade. of each swing; the estimation of Elliott wave labeling with
The weight of evidence could take the form of an end-run strict follow-up of the three distinct rules concerning the W2
phenomenon cluster or confluence, a candlestick reversing retracement, the W3 length, and W4 overlapping (or not) of
formation of one, two or several bars, a hook on the On Bal- the W1 and other parameters.
November 2017 • Technical Analysis of STOCKS & COMMODITIES • 29
 nique, which is the first study-
ing element that could help to
understand the contextual chart
concept. I’ll walk you through
this starting from left to right.

• A steep downsloping swing

that falls quickly and with
strong momentum, forming
a zigzag pattern made up of
swings n° 1, n° 2, and n° 3.
• A large strong upsloping
swing, which has a lesser de-
gree slope than the previous
FIGURE 2: SWING DISTRIBUTION, ONE STEP AT A TIME. First you have a steep downsloping swing made up of three
swings. This is followed by a strong upsloping swing with a less-steep slope, but the length of the swing is much longer.
one. It does two things—cor-
This larger upsloping swing is made up of five smaller swings. rects the previous downslop-
ing swing and is more than
double its length.

The upsloping swing is com-

posed of five smaller swings,
labeled from n° 1 to n° 5, whose
retracement almost reached the
100% landmark value.

Territorial distribution
technique
Once you have visualized the
swings, you’re ready to go to
the next step, which is identify-
FIGURE 3: TERRITORIAL DISTRIBUTION. The territories in the chart are characterized by a rectangular zone where ing the chart’s territories. The
height is the price element and length is the time element. territories are characterized by
a rectangular zone, with height
as the price element and length
as the time element. Compared
with swings, which give a linear
visualization, the marked ter-
ritories exteriorize the price/
time elements and look at the
space occupied by the market’s
evolution of price flow. This
allows you to better compare
the swings and the space size
of a trend. They are priceless
in labeling and trading the El-
liott waves.
FIGURE 4: SWING DISTRIBUTION AND TERRITORIAL DISTRIBUTION. Here you see the swing distribution in four The territorial distribution
territories. There are also two Elliott wave cycles, with their impulsive and corrective subcycles. technique presented in Figure
3 reveals the entire market
Swing distribution technique concept composed of multiple
In the chart in Figure 1, you see two main swings in up and territories, but there is no assistance from the swing distribu-
down directions. The lowest low is a decisional trading point tion technique. The two studying modules of the systematized
separating the two zones. This is something to focus on because visualization tool (swings and territorial techniques) can be
of its reversing trend opportunities. This swing distribution clearly seen on the chart in Figure 4.
technique will help to establish the contextual market flow. Here’s a closer look at the chart in Figure 4, from left to
The chart in Figure 2 uses the swing distribution tech- right:
30 • November 2017 • Technical Analysis of STOCKS & COMMODITIES
 • n° 1 territory is made up
of five swings (not all vis-
ible on the chart) whose
trend has a predominant
up-sloping bias.
• n° 2 territory is made up
of three swings (n°1 to
n°3) and has a steep down-
sloping movement. When
you compare time and price
of this territory, you real-
ized there’s a time failure
exteriorized by the standing
rectangle (height > width).
FIGURE 5: PEAKS & TROUGHS. Here, the troughs and peaks are eyeballed and clarify the current tendency of the
Be mindful that market market and the zone it is coming from.
flow is ideally formed of a
square where price meets
time, meaning a graphi-
cal equality of price and
time, even though the two
elements have two different
measure value units.
• n° 3 territory is made up
of five swings (n°1 to n°5)
and has a less steep down-
sloping movement. If you
compare time and price of
this territory, you’ll notice a FIGURE 6: PEAKS & TROUGHS AND ELLIOTT WAVES. Here, the troughs signal the termination of the corrective
slightly extended time exte- waves and their subwaves.
riorized by the horizontally
prolonged lying rectangle (height < width). swing or end of the first corrective subswing of the ongoing
• n° 4 territory is made up of five swings (not all visible primary impulsive swing that follows.
on the chart) whose trend has a predominant down- In other words, should you enter at the end of W(2)-wave or
sloping bias. at the end of w2: W(3)? Both choices help to catch the begin-
ning of the trend in its earliest phase and establish the smallest
A careful study of these territories will reveal two Elliott wave value of the initial stop-loss. Think of a classic stop-loss to
cycles, with their impulsive and corrective subcycles: have a value of one ATR(14) of the operational timeframe. If
you closely study the termination level of the corrective swing,
• Elliott wave cycle n° 1 made up of territories 1 and 2, you may diminish this value by at least 25%, and bring the
respectively impulsive and corrective waves, stop-loss to 0.75*ATR(14). I believe the trader’s mastery is
• Elliott wave cycle n° 2 composed of territories 3 and 4, measured by the size of the stop-loss. The smaller the stop-
respectively impulsive and corrective waves. loss, the better the trader will perform his/her job.
Going even deeper, the following elements can be re-
Systematized visualization vealed:
To be efficient, you should always think in terms of:
• Breaches of trending levels of:
• Peaks and troughs on the three main multiple time-
frames; the significance of a peak and trough reversal ⚪ Peak series alone are only half a reversal signal,
is determined by the strength, slope, and direction of but if synchronized with at least two indicators,
the ongoing swings and their reactions. they will probably signal an aggressive trade.
⚪ The added trough series complete the reversal
Studying the peaks and troughs in the chart in Figure 5 will signal and propose a conservative trade verified
help you make entry decisions. by price change and trend breach.
I strongly believe the most optimal trade entry is in an im-
pulsive wave. That’s after the corrective wave is terminated. • Fibonacci and Gann retracements applied to reveal the
The problem is entering at the end of the primary corrective exact trade entry at the terminal level of the corrective
November 2017 • Technical Analysis of STOCKS & COMMODITIES • 31
 swing: 0.382, 0.50, 0.618, and quarters/thirds forming
new peaks and troughs.
• Last close compared with the previous one, which must
be higher for a long trade and vice versa.
• Trendline drawings on primary, intermediate, and short-
term timeframes.
• Chart formations: reversal and continuation patterns
such as head & shoulders, double bottoms, double tops,
triangles, cup & handle, diamonds, etc.
• Reversal bars are to be closely watched, which means
relying on the best candlestick patterns.
The peaks in Figure 6 expose the termination of the impul-
sive waves and their subwaves:
• Peak 1 localizes the terminal level of W(1)-wave
• Peak 4 localizes the terminal level of W(3)-wave,
• Peak 2 localizes the terminal level of w1: W(3)-wave,
and
• Peak 3 localizes the terminal level of w3: W(3)-wave.
The troughs in Figure 6 have the same termination roles as
those of the peaks, but this time, they signal the termination
of the corrective waves and their subwaves:
• Trough 1 localizes the terminal level of W(2)-wave. No-
tice that its retracement complies with the classic value
of 50%, based on the formula W(2)= 0.50*W(1).
• Trough 2 localizes the terminal level of w2: W(3)-wave.
Note that its retracement complies with the classic value
of 61.8%, based on the formula w2: W(3)= 0.618*w1:
W(3).
• Trough 3 localizes the terminal level of w4: W(3)-wave.
Note that its retracement complies with the classic value
of 38.2%, based on the formula w4: W(3)= 0.382*w3:
W(3).
ALL THE UPS AND DOWNS
In this first part of a two-part series, I have tried to present
the advantages of using peaks and troughs as they apply to
making good trading decisions. I described some of the sim-
pler techniques used in Elliott wave analysis. In part 2, I will
discuss how these techniques can be used to come up with
some state-of-the-art trading techniques.
Mircea Dologa, MD, CTA, began his investment and trad-
ing career in 1987 as a Commodity Trading Advisor and
a Registered General Securities Representative. He subse-
quently moved into teaching practical aspects of trading
using techniques he developed. He is a contributor to several
magazines and the author of seven books. He publishes the
monthly World Charting Report, which covers international
indexes, commodities, and forex charts. He may be contacted
at mircdologa@yahoo.com or via his website at www.pitch-
forktrader.com.
32 • November 2017 • Technical Analysis of STOCKS & COMMODITIES
The weight of evidence
identifies the termination
of the previous swing and
building up of the incoming
reversal. The sooner the
weight of evidence is
performed, the earlier the
trader will be able to enter
the trade.
FURTHER READING
Dologa, Mircea [2006]. “The Third Wave,” Technical Analysis
of STOCKS & COMMODITIES, Volume 24: May.
[2006]. “Trading The Trend In Wave 3,” Technical
Analysis of STOCKS & COMMODITIES, Volume 24: June.
[2006]. “Trading Wave 3,” Technical Analysis of STOCKS
& COMMODITIES, Volume 24: September
[2008]. Integrated Pitchfork Analysis: Basic To Interme-
diate Level-I, John Wiley & Sons Inc., London, UK.
[2008]. Integrated Pitchfork Analysis: Advanced Level-
II, Pitchforktrader.com. Paris, France.
[2009]. Integrated Pitchfork Analysis: Advanced Level-
III, Pitchforktrader.com. Paris, France.
[2013]. “The Missing Link Between Time & Price,”
part 1, Technical Analysis of STOCKS & COMMODITIES,
Volume 31: September.
[2013]. “The Missing Link Between Time & Price,”
part 2, Technical Analysis of STOCKS & COMMODITIES,
Volume 31: October.
[2017]. “Trading Elliott Waves Using A Top-Down Ap-
proach,” Technical Analysis of STOCKS & COMMODITIES,
Volume 35: Bonus Issue.
[2017]. World Charting Report, monthly periodical,
http://pitchforktrader.com/reports.html.
[2016–17]. Elliott Waves Trading: A Nuts-And-Bolts
Professional Approach, Paris, France.
Jenkins, Michael [2012]. “Square de Range Trading System,”
www.stockcyclesforecast.com.
Neely, Glenn [1990]. Mastering Elliott Wave: Presenting The
Neely Method, Windsor Books.
• https://www.youtube.com/watch?v=6NE3JIk8mzE
 Time, Meet Price!
Elliott Waves: How High Is High? Part 2
In this second of two parts, we look at some trading tech-
niques that could result in higher-probability trades with
lower risk than those suggested by some of the classic trad-
ing techniques.
by Mircea Dologa, MD, CTA
I
will describe a series of techniques I consider state-
of-the-art technical tools that are practiced every day
by some professional traders. The build-up of the
two-dimensional chart space (the Cartesian space) is
one of the tools that can assist the trader in a precise
and efficient way. In this article, I’ll explain how.
In part 1 last month, you saw how the best and
least-difficult profits can be achieved by trading the impulsive
24 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
waves, which may belong to an impulsive pattern or a cor-
rective one. When we think of impulsive or corrective waves,
we think of the W3-wave and C-wave, and to a lesser degree,
W1-, W5-, and A-waves. Experienced traders are capable of
WAVE: CHRISTOS GEORGHIOU/ ROWERS: GABOR MIKLOS/ MAZE:
trading corrective waves because the techniques are more
THOR83/SHUTTERSTOCK/ COLLAGE: CHRISTINE MORRISON
difficult to understand and the behavior of these waves is
more dangerous, implicating more risk and more cumbersome
money management. Even if the low of this wave seems to be
visually obvious, the question “How high is high?” will still
go through your mind.
CARTESIAN SPACE—THE IDEAL WAY
TO SET THE TRADING ARENA
We know W(3)-wave is the strongest wave of the impulsive
non-overlapping pattern and it can’t be the shortest wave if it
 CHARTING

belongs to a non-overlapping impulsive

pattern. Once its development exceeds the
length of the first impulsive wave [W(1)-
wave], we can talk about the beginning
of the W(3)-wave.
With respect to the Cartesian space of
this wave, the following classical values
are to be noted:
• Price-wise W(3)-wave is equal to
1.618*W(1)
• Time-wise W(3)-wave is also equal
to 1.618*W(1).

ESIGNAL
However, traders must always consider FIGURE 1: THE TIME/PRICE RECTANGLE. Note the diagonal has a 45-degree angle, and time and price
have equal parameters. When time is less than price, you’ll have a long rectangle with a short horizontal edge
the possibility of an extended W(3)-wave and a long vertical edge. If time is greater than price, you’ll have a wide rectangle with a long horizontal edge
guided by the formula W(3)= (2.0- and a short vertical edge.
2.618)*W(1) and the possibility of a failed
W(3)-wave guided by the formula W(3)=
(1.0-1.50)*W(1). In the event these two W(3)

waves are equal, then base it on the equality

principle, which is to expect an extension
of W(5)-wave of this impulsive pattern, or
the contrary if the labeling is invalidated
then W(3)-wave is replaced with (C)-wave
belonging to a corrective pattern.
The Cartesian space illustrated in
Figure 1 is formed by a rectangle with
time (T) as the horizontal parameter and W(2)
price (P) as the vertical parameter. In a
non-overlapping impulsive pattern, the
diagonal of this quadrilateral, classified FIGURE 2: A WIDE RECTANGLE. Fibonacci ratios from zero to 1.618 are plotted to show how reversals take
as a square, has a slope of 45° if the two place close to the Fibonacci ratios and time/price confluences.
parameters are equal. But this case is an
W(3)
ideal one and it is even called “where
time meets price.” When a time failure
(T<P) occurs, the square changes to a tall
rectangle (horizontal edge shorter than
vertical edge). Price will be extended
and the diagonal’s slope will be superior
to the 45° angle. On the contrary, if the
price parameter fails, there will be a wide
rectangle (horizontal edge longer than
vertical edge) with T>P. In this case, time W(2)
will be extended and slope of the diagonal
will be inferior to 45° angle.
The Cartesian space illustrated in Fig- FIGURE 3: WIDE RECTANGLE WITH PRICE INFORMATION. Exposing price data helps to understand the
time and price relationships. You can say that W(3)-wave is slightly extended.
ure 2 is formed by a wide rectangle hav-
ing time (T) as the horizontal parameter
and price (P) as the vertical parameter. The quadrilateral is Frequently, the retracement of subwave w2: W(3) takes place
a wide rectangle, which indicates price failure. I have plotted at 66.6%, and commonly, the retracement of subwave w4:
the Fibonacci ratios from zero to 1.618 on the chart, vertically W(3) takes place at 38.2%. The diagonal of the rectangle has
for price (P) and horizontally for time (T). The market flow multiple functions:
of the same wide rectangle continues in Figure 3. Oftentimes,
• It acts as a symmetrical axis. The ascending market flow
the reversal levels of the subwaves of W(3)-wave occur at the
of W(3)-wave fluctuates on either side of the diagonal.
Fibonacci ratios and confluences where time meets price.
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 25

W(1)
W(2)
W2=0.5*W1
FIGURE 4: THE BEGINNING OF W(3)-WAVE. A conservative trade was placed at the 11942 key level, after
the termination of the subwave ii: w1: W(3) retracement, at the breakout of the beginning of subwave i: w1:
W(3) with an initial stop-loss snagged under the current bar’s low at 11934.
This situation is typical of a W(3)-wave, which has average
intensity momentum, characterized by a 45° angle.
• It acts as a support level that maintains the ascending
market flow above the diagonal. The only downward
breakout will occur when the W(3)-wave reversal takes
place, especially during the first wave of the descending
W(4)-wave. This situation is typical of a W(3)-wave,
which has high-powered momentum, characterized by
a steep slope, usually fluctuating between a 45° and
60° angle.
• It acts as resistance that maintains the ascending market
flow below the diagonal. This situation is typical for a
W(3)-wave, which has weak momentum, characterized
by a lean slope, usually fluctuating under 45° angle.
The Cartesian space illustrated in Figure 3 is similar to what
is displayed in Figure 2, except the market flow is exposed,
forming the same wide rectangle, having time (T) as the
horizontal parameter and price (P) as the vertical parameter.
The coordinates of the reversal of W(3)-wave are [1.166; 1.75]
meaning [T; P] guided by the two following relations: W(3)=
1.166*W(1) and W(3)= 1.75*W(1), time and price, respectively.
Time meets price at those coordinates. Also observe price
fluctuated above the 1.618 Fibonacci ratio level and the time
ratio value is inferior to this ratio. So, price-wise, the W(3)-wave
is slightly extended. The diagonal shows optimal symmetry.
The subwaves of W(3)-wave are also complying with the
time meets price relationship [T; P]:
• Subwave w1: W(3) reverses at the confluence whose
coordinates are [0.25; 0.666].
• Subwave w2: W(3) reverses at the confluence whose
coordinates are [0.382-0.50; 0.25].
It is important to note the retracement of the subwave w2
26 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
is guided by the relation w2: W(3)=
0.618*w1: W(3).
• Subwave w3: W(3) reverses at the
confluence whose coordinates are
[0.75; 1.50].
• Subwave w4: W(3) reverses at the
confluence whose coordinates are
[1.0; 1.0].
It is important to note the retracement of
subwave w4 is guided by the relation w4:
W(3)= 0.382*w3: W(3).
• Subwave w5: W(3) reverses at the
confluence, whose coordinates are
[1.166; 1.75].
This study confirms how powerful the
Cartesian space is in the process of detect-
ing the reversing levels of W(3)-wave and
its corresponding subwaves.
OPTIMAL LEVEL TO ENTER W(3) TRADE
Is there a way to pinpoint the optimal level for a trade entry?
I believe there is, but only under certain conditions, which
belong to the trading plan:
• Decide, in advance, what kind of strategy you wish to
utilize—aggressive or conservative. Aggressive implies
numerous trades with variable stop-loss values associated
with greater risks. Conservative demands a constant,
fixed-in-advanced stop-loss value well-adapted to the
fluctuations of market flow. The number of stop-losses are
less numerous and their value smaller and constant. They
are usually localized behind a topographical chart land-
mark pertaining to ongoing swings or previous swings or
gap levels. As an example, use an initial stop-loss equal
with 1 ATR(14) of the timeframe being used.
• List, in advance, the possible alternatives with their
adequate levels, which can be used as entries.
The chart in Figure 4 presents the beginning of the W(3)-
wave. There are several types of entries you could use to place
a W(3)-trade. They are characterized based on aggressive or
conservative strategies.
• An aggressive trade can be placed after the reversal pat-
tern, at 11928 key level with an initial stop-loss snagged
under the last low at 11924.50.
• The aggressive trader wants to make a quick profit and
is inclined to pay less attention to the big picture.
• A conservative trade is considered only after:
ô Characteristics of W(2)-wave have been evaluated
and weighted. This means

FIGURE 5: REENTERING THE TRADE. After the initial entry, additional trades were made based on the “breakout of the preceding high” principle applied to the fol-
lowing key levels: 11956, 11977, 11993, and 11977.
ß An occurrence of the five subwaves of C:
W(2)
ß A confirmation of the terminal descending
subwave (v): C: W(2) with the common charac-
teristic and progressive diminishing volume
ß Reaching the classic Fibonacci retracement in
0.50–0.66 ratio zone
ß Breakout of the (ii)-(iv) line of subwave C:
W(2).
ô Characteristics of subwaves of W(3)-wave: Once
these elements have occurred and have been strictly
monitored, perform the next step and verify condi-
tions that occur after the reversal, at the beginning
of the first subwave of W(3)-wave:
ß Exceeding upward, the beginning level of the
classic magnitude of subwave (v): C: W(2). If
magnitude is small, which could be labeled
as failure, wait until the ongoing ascending
swing reaches the subwave (iii): C: W(2), at
11951 key level
ß Breaking up the upper limit line of the descend-
ing channel
ß Breaking up the terminal level of subwave i:
w1: W(3)
ß Termination of subwave ii: w1: W(3).
After analyzing all these steps, the trader decides to enter
a conservative trade at the 11942 key level, after the termina-
tion of the subwave ii: w1: W(3) retracement, at the breakout
of the beginning level of subwave i: w1: W(3) with an initial
stop-loss snagged under the current bar’s low at 11934.
W(3)
W(1)
W(2)
W2=0.5*W1
This study confirms how
powerful the Cartesian space
is in the process of detecting
the reversing levels of W(3)-
wave and its corresponding
subwaves.
The conservative trader is interested in placing a good trade,
and pays more attention to the overall flow of the market and
less attention to making a quick profit.
In following the conservative approach, traders can enter
trades when the market reaches levels guided by the following
relations: W(3)=1.10*W(1) or 1.146*W(1). These trade entries
don’t perform as well in intraday trading because they can’t
take maximum advantage of W(3)-wave magnitude.
The chart in Figure 5 reveals how the profitability of W(3)-
wave is optimized. After the initial entry, add-on trades are
reentered when the development of the market flow allows
it. They are based on the “breakout of the preceding high”
principle applied to these key levels: 11956, 11977, 11993
and 11977.
OPTIMAL LEVEL TO EXIT THE W(3) TRADE?
Is there a way to pinpoint the optimal level for a trade exit?
I believe so, under certain conditions in a trading plan. The
exits are guided by the principle of using only trailing stops.
Otherwise, the trader risks losing a substantial part of their
profit potential.
It is a good idea to let the market dictate your exits through
progressively diminished 14-period ATRs on the prevailing
trading range. After the trader has placed the initial stop-loss,
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 27
 W(3)

W(1)

W(2)

FIGURE 6: USING CHANNELS. Here you see how channels contribute to establish reversal locations of the primary waves and their subwaves. Testing of the limit lines
are as important as testing of close failure, which signals a reversal [see the last bar of W(3)].

they should attentively monitor the ongoing market flow during

the development of the entire W(3)-wave. The trailing stop’s
value will be diminished from the entire ATR(14) value to Associating trading range
75%, 50%, and finally 25% as the trend develops. The small-
est value will be used toward the end of the trend, that is, the
breakouts with Fibonacci
terminal subwave w5: W(3). The procedure is prolific with ratios can help establish
regard to the trader’s profitability. confluences, which will
I will illustrate a few techniques to help quantify the entire mark reversal points of
wave’s magnitude. This makes the profit potential easier to
achieve. They go hand-in-hand with the strict monitoring of
W(3)-wave and subwaves.
subwaves of W(3)-wave and detection of pullbacks in uptrends
and rallies in downtrends. But how do you establish clusters
and confluences? There are several techniques that can be used

W(3)

W(1)

W(2)
P2

FIGURE 7: REGIONAL PITCHFORKS. Here, the regional pitchfork is applied to the W(1), W(2), and W(3) impulsive pattern to establish the terminal levels of the sub-
waves of W(3)-wave and its own reversing level. The latter is confirmed by the failure with regard to ascending trigger line and testing from underneath of UML. We also
noticed that almost all the subwaves are governed by the median lines and trigger line.

28 • December 2017 • Technical Analysis of STOCKS & COMMODITIES

to help find them and they are not limited
to the terminal waves of W(3)-wave and
its subwaves. The techniques help find
the optimal values of stop-losses and the
best position for setting the stop-loss. I’ll
provide a few examples:
• Using channels—center line, upper/
lower limit lines, and extensions
(Figure 6)
• Pitchforks with their median lines,
warning lines, and trigger lines
(Figure 7)
• Action and reaction setup with its
center line, upper/lower limit lines,
and extensions (Figure 8).
You can use breakouts out of a trading FIGURE 8: ACTION/REACTION SETUPS. If it is not possible to draw a pitchfork, the action/reaction setup
range (birthing rectangle with midline, can be efficient. It is similar to pitchforks. Bearish divergence of the OSC indicator has a high probability of
upper/lower limit lines, and extensions). confirming the reversal of W3-wave, even if it is lagging. Try to consider the A/R setups as the big brother of
regression channels. Price moving below the lower border can be a trading signal.
Associating these lines with Fibonacci
ratios can help establish confluences,
which will mark reversal points of W(3)-wave and subwaves. Dologa, Mircea [2006]. “The Third Wave,” Technical Analysis
Fibonacci arcs and circles create confluences if they are as- of STOCKS & COMMODITIES, Volume 24: May.
sociated with rectangle extensions and Fibonacci ratios. _____ [2006]. “Trading The Trend In Wave 3,” Technical
Analysis of STOCKS & COMMODITIES, Volume 24: June.
THE RESULT—BETTER TRADING DECISIONS _____ [2006]. “Trading Wave 3,” Technical Analysis of
In this two-part article, I have attempted to present the ad- STOCKS & COMMODITIES, Volume 24: September
vantages of certain trading techniques and how to determine _____ [2008]. Integrated Pitchfork Analysis: Basic To Inter-
optimal entry and exit points to help make effective trading mediate Level-I, John Wiley & Sons Inc., London, UK.
decisions. Developing the ability to make early entries and _____ [2008]. Integrated Pitchfork Analysis: Advanced Level-
recognizing the highest highs during uptrends elevates the II, Pitchforktrader.com. Paris, France.
trader’s status to a step higher on the knowledge ladder. Think _____ [2009]. Integrated Pitchfork Analysis: Advanced Level-
of this as an indication of applying optimal timing when the III, Pitchforktrader.com. Paris, France.
weight of evidence signals the reversal phenomenon. _____ [2013]. “The Missing Link Between Time & Price,”
The essence of becoming a consistent trader is to understand part 1, Technical Analysis of STOCKS & COMMODITIES,
the overall context of the market and specialize in one of the Volume 31: September.
techniques that are effective in various markets regardless of _____ [2013]. “The Missing Link Between Time & Price,”
whether they are in a trending or nontrending state. A study part 2, Technical Analysis of STOCKS & COMMODITIES,
of Elliott waves can best fulfill this goal. Volume 31: October.
_____ [2017]. “Trading Elliott Waves Using A Top-Down
Mircea Dologa, MD, CTA, began his investment and trad- Approach,” Technical Analysis of STOCKS & COMMODI-
ing career in 1987 as a Commodity Trading Advisor and TIES, Volume 35: Bonus Issue.
a Registered General Securities Representative. He subse- _____ [2017]. World Charting Report, monthly periodical,
quently moved into teaching practical aspects of trading http://pitchforktrader.com/reports.html.
using techniques he developed. He is a contributor to several _____ [2016–17]. Elliott Waves Trading: A Nuts-And-Bolts
magazines and the author of seven books. He publishes the Professional Approach, Paris, France.
monthly World Charting Report, which covers international _____ Jenkins, Michael [2012]. “Square de Range Trading
indexes, commodities, and forex charts. He may be contacted System,” www.stockcyclesforecast.com.
at mircdologa@yahoo.com or via his website at www.pitch- _____ Neely, Glenn [1990]. Mastering Elliott Wave: Present-
forktrader.com. ing The Neely Method, Windsor Books.
• https://www.youtube.com/watch?v=6NE3JIk8mzE
FURTHER READING • http://pitchforktrader.com/EXCERPTS/Excerpts_EW_
Dologa, Mircea [2017]. “Elliott Waves: How High Is High?” Volume_1_v2.pdf
(part 1), Technical Analysis of STOCKS & COMMODITIES,
Volume 35: November.
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 29
 TRADING SYSTEMS

Finding The Edges Of Trend

Exponential Standard
Deviation Bands
Traders hunt for volatility, but how can you find it? ing ESD Bands.” You’ll find that ESD bands look
Here’s one technique you can apply that’ll help you similar to Bollinger Bands in that they consist of a
see volatility while a stock is trending. middle band with two outer bands. The middle band
is an exponential moving average (EMA) that is set
ometimes you see it right in front of your at 20 periods. An EMA is used because the ESD

S
eyes. Other times you may have to look formula also uses an EMA. The lookback period
hard to find it. Either way, volatility needs for the ESD is the same as for the EMA. The outer
to exist if you want to make successful bands are usually set two ESDs above and below
trades. Lucky for you, there are many ways the middle band. You may adjust the settings to suit
to measure volatility. One way is the exponential the characteristics of particular securities or trading
standard deviation bands (ESD bands), which are styles. Changing the number of periods for the mov-
volatility bands placed above and below an expo- ing average also affects the number of periods used
nential moving average. The bands are based on to calculate the ESD.
the exponential standard deviation, which changes
as volatility increases and decreases. The bands INTERPRETING THEM
automatically widen when volatility increases and In Figure 1 you see a chart of the S&P 500 index from
narrow when volatility decreases. This means they May 2016 to October 2016 with the ESD bands (20,2)
can be used on different securities with standard overlaid on the price chart. The ESD bands indicator
settings.
ESDB(20,2), S&P 500 INDEX
2260
2250

CALCULATING THEM 2240

2230

Here is how the bands are formulated: Upper band 2220

2210
2200
2190
2180

Middle band = 20-day exponential 2170

2160

moving average (EMA) 20–day EMA

2150
2140
2130
2120
2110

Upper band = 20-day EMA + (20- 2100

2090

day exponential standard deviation 2080

2070

of price × 2) Lower band

2060
2050
2040
2030
2020

Lower band = 20-day SMA - (20- 2010

2000

day exponential standard deviation 1990

METASTOCK

1980

of price × 2) June July August September October

For more details on calculating ESD
bands, please see the sidebar “Calculat-
PATRICK KELLEY
FIGURE 1: WHERE DOES IT BEGIN AND WHERE DOES IT END? Trends often start with strong
moves in one specific direction. A surge above the upper band shows extraordinary strength while a
plunge below the lower band shows extraordinary weakness. Such strong moves can signal the end
of one trend and beginning of another.

by Vitali Apirine
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 CALCULATING ESD BANDS
Exponential standard deviation measures the amount of
variability or dispersion relative to the exponential moving
average (EMA). Generally speaking, ESD is the difference
between the actual value and EMA value. The larger this
dispersion or variability, the greater the exponential standard
deviation is. The smaller this dispersion or variability is,
the lesser the exponential standard deviation.
How to calculate exponential standard deviation
(ESD)
1. Calculate the exponential average price for the num-
ber of periods
2. Determine each period’s deviation (close minus
exponential average price)
3. Square each period’s deviation
4. Sum the squared deviations
5. Divide this sum by the number of periods
6. The standard exponential deviation is equal to the
square root of the number derived in 5.
(SMA), its true value will not be realized until 20 or so
periods later.
In Sidebar Figure 1 you see a spreadsheet example of
a 10-day standard deviation and a 10-day exponential
standard deviation for the S&P 500 large-cap index. The
spreadsheet also shows the 10-day standard deviation us-
ing the STDEVP function in Excel for comparison. The
values of the exponential standard deviation derived from
the spreadsheet are charted in Sidebar Figure 2.
Exponential standard deviation vs. standard deviation
Exponential standard deviation and standard deviation are
similar. Standard deviation measures dispersion around an
average. The chart in Sidebar Figure 3 of the Russell 2000
small-cap index shows the ExpStdDev(10) and StdDev(10)
in the subchart for comparison.
S&P 500 INDEX
1240
1230
1220
1210
1200
1190
1180
1170
1160

The lookback period for the exponential standard deviation 1150

1140
1130
1120
is the same as for the exponential moving average (EMA). 1110
1100
1090
The EMA starts with the simple moving average value 1080
1070
1060
1050
(1140.67) in the first calculation (see Sidebar Figure 1). 1040
1030
1020
After the first calculation, the normal formula takes over. 1010
1000
990
Because an EMA begins with a simple moving average ExpStdDev(10)
980

35
ExpStdDev values shown
in spreadsheet example 30

25

20

15

10

September October November December 2010 February March April May

SIDEBAR FIGURE 2: EXPONENTIAL STANDARD DEVIATION, CHARTED

RUSSELL 2000 INDEX

180

175

170

165

160

155

ExpStdDev(10), StdDev(10)
10.5
10.0
ExpStdDev(10) Standard Deviation and Exponential Standard Deviation 9.5
are similar 9.0
StdDev(10) 8.5
8.0
7.5
7.0
6.5
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
July August September October November December 1990 February March April May

SIDEBAR FIGURE 1: CALCULATION OF EXPONENTIAL STANDARD DEVIA- SIDEBAR FIGURE 3: EXPONENTIAL STANDARD DEVIATION AND STANDARD
TION BANDS USING A SPREADSHEET DEVIATION COMPARED

10 • February 2017 • Technical Analysis of STOCKS & COMMODITIES

 Noisy indicators
delay your analysis

A surge above the upper band

shows extraordinary strength
while a plunge below the lower
band shows extraordinary Jurik algorithms
weakness. Such strong moves deliver low lag,
can signal the end of one trend low noise analysis
and beginning of another.
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software

is designed to encompass most price action, which means that

Jurik Tools on live charts, on the web !
moves above or below the upper or lower exponential bands tinyurl.com/jurik-online
are relatively rare. Trends often start with strong moves in
one direction or another. A surge above the upper band shows
extraordinary strength while a plunge below the lower band
Jurik Research
shows extraordinary weakness. Such strong moves can signal
the end of one trend and the beginning of another.
ESD bands are a trend-following indicator and lag price 2010 -- 2011 -- 2012 -- 2013
action because they are based on the EMA. The direction of Add-In software

the EMA dictates the direction of the ESD bands. In general,

a downtrend is present when the bands move lower, while an jurikres.com • 800-810-3646 • 719-686-0074
uptrend exists when the bands move higher. The trend is flat
when the bands move sideways.
An upturn and break above the upper band can signal the Stock index (FTSE 100) started a downtrend with a decline
start of an uptrend. A downturn and break below the lower below the lower band in October 2000. After this initial break,
band can signal the start of a downtrend. Sometimes a strong the index met resistance near the upper band.
trend does not take hold after an upper or lower band break-
out, and prices will oscillate between the bands. Such trading Flat trend
ranges are marked by a relatively flat moving average. The A trading range can be identified with a flat moving average
band boundaries can then be used to identify overbought and and the average directional index (ADX). In Figure 5 you see
oversold levels for trading purposes. the S&P 500 index with ESD bands (20,2) and ADX(10). The
20-day EMA flattened out from February to early August.
Compare with Bollinger Bands
ESD bands use an EMA, which is more sensitive RUSSELL 2000 INDEX, ESDB(20,2)
than the simple moving average used in Bollinger 1255
1250
1245
BB(20,2)
Bands. In Figure 2 you see the Russell 2000 index ESDB(20,2)
1240
1235
1230
1225
with ESD bands (blue) and Bollinger Bands (red) 1220
1215
1210
1205
for comparison. 1200
1195
1190
1185
1180
1175
1170
Uptrend 1165
1160
1155
1150
The chart in Figure 3 is a display of the Dow Jones 1145
1140
1135

Industrial Average (DJIA) starting an uptrend 1130

1125
1120
1115
as the ESD bands turn up and the index surges 1110
1105
1100
1095
above the upper band. See how the DJIA was in a 1090
1085
1080
downtrend as prices continued to pierce the lower 1075
1070
1065
1060
band. With a strong thrust up, prices exceeded the 1055
1050
1045

upper band at the end of April and the bands turned 1040
1035
1030
1025
up to start a new uptrend. Prices held above the 1020
1015
1010
1005
lower band on dips in July and October. 1000
995
990
985
980
Sep Oct Nov Dec 2014 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Downtrend FIGURE 2: ESD BANDS VS. BOLLINGER BANDS. The Bollinger Bands are in red and the ESD
In Figure 4 you see the London Financial Times bands are in blue. There is a little bit of a difference between the two.

February 2017 • Technical Analysis of STOCKS & COMMODITIES • 11

 ESDB(20,2), DOW JONES INDU AVERAGE
10400
10300
ESDB(20,2) 10200
10100
10000
9900
9800
9700
9600
9500
9400
9300
9200
9100

The indicator window shows ADX (black line) uptrend starts holds above 9000
8900
8800
lower band 8700
confirming a weak trend. Low and falling ADX 8600
8500
8400
suggests the trend is weak. High and rising ADX 8300
8200
8100
indicates a strong trend. ADX was below 40 the 8000
7900
7800
entire time. In fact, it was often below 30. This holds above 7700
7600
lower band 7500
reflects the absence of trend. As you can see, the downtrend 7400
7300
7200
ADX peaked in January and fell until late May. 7100
7000
6900
6800
6700
AND THE VERDICT IS … 6600
6500

ESD bands are considered to be trend-following, 6400

6300
6200
so they can help identify the underlying trend. A 6100
6000

trend can be up, down, or flat. It is well-known 2009 February March April May June July August September Octob
that bullish trades are favored in an uptrend and FIGURE 3: IT’S AN UPTREND. The Dow Jones Industrial Average was in a downtrend as prices
bearish trades are favored in a downtrend. But continued to pierce the lower band. With a strong thrust up, prices exceeded the upper band at the
what about during a flat trend? This is when ESD end of April and the bands turned up to start a new uptrend. Prices held above the lower band on
dips in July and October.
bands can come into play. Prices often peak at the
upper band and trough at the lower band in a flat FTSE 100 IDX, ESDB(20,2)

trend. And if you use them together with other ESDB(20,2) 7000
6900
indicators or analytics, they can act as a strong uptrend holds below
upper band
6800
6700

confirming indicator. 6600

6500
6400
6300
holds below
Vitali Apirine is a programmer engineer with upper band
6200
6100

an interest in technical analysis, especially the downtrend

6000
5900
application of relative strength index to trading. starts 5800
5700
He may be reached at vitapirine@mediacombb. 5600
5500
net. 5400
5300
5200
See our Traders’ Tips section beginning on page 48 5100

for commentary and implementation of Apirine’s 5000

4900
technique in various technical analysis programs. 4800
Accompanying program code can be found in the 4700

Traders’ Tips area at Traders.com. 4600

4500

Jun Jul Aug Sept Oct Nov Dec 2001 Feb Mar Apr May Jun Jul Aug Sep

FURTHER READING
Apirine, Vitali [2016]. “The Middle-High-Low
Moving Average,” Technical Analysis of
STOCKS & COMMODITIES, Volume 34: Au-
FIGURE 4: WHEN THE TREND IS DOWN. Here you see the London Financial Times Stock index
(FTSE 100) started a downtrend with a decline below the lower band in October 2000. After this
initial break, the index met resistance near the upper band.
S&P 500 INDEX, ESDB(20,2)

ESDB(20,2)
gust. 1400

[2016]. “Higher Highs & Lower Lows,” 1350

Technical Analysis of STOCKS & COMMODI- 1300

TIES, Volume 34: February. 1250

breakout
[2015]. “Average Percentage True Range,” 1200
Technical Analysis of STOCKS & COMMODI-
TIES, Volume 33: November. 1150

1100

‡MetaStock
†See Traders’ Glossary for definition ADX(10)
‡See Editorial Resource Index 55
50
45
breakout 40
35
30
25
20

15

February March April May June July August

FIGURE 5: AND WHEN IT’S FLAT. Here you see the S&P 500 index with ESD bands (20,2) and
ADX(10). The 20-day EMA flattened out from February to early August. ADX was below 40 the
entire time. In fact, it was often below 30. This reflects the absence of trend. As you can see, the
ADX peaked in January and fell until late May.

12 • February 2017 • Technical Analysis of STOCKS & COMMODITIES

 TRADING ON MOMENTUM
Avoiding False
Breakouts: “No 9s”
Each month, this professional trader
offers insights into the professional
trading world with a different momentum
trading topic or breakout technique for
active traders. This month, the breakout
strategy discussed isn’t so much about
what to do as what not to do.
by Ken Calhoun
O ne of the biggest challenges you
will face as an active trader is
false breakouts, where a chart
pattern fails to continue once a trade is en-
tered. The best way to avoid these costly
trading errors is to become familiar with
specific strategies and technical patterns
that often lead to false breakouts.
Many of these signals, such as declin-
ing volume near a prior resistance area,
are relatively well known. You may
not, however, be aware of advanced
price-action warning signals, such as
the “don’t buy 9s” rule that you will be
learning about in this month’s column.
There’s a saying that goes “forewarned
is forearmed,” so arming yourself with
eSIGNAL
FIGURE 1: FALSE BREAKOUT ABOVE $49–$50 (ATVI). Here’s an example of avoiding a false breakout by waiting until
$50.50 to enter.
knowledge about how to avoid false
breakouts can be helpful.
“DON’T BUY 9s” FALSE BREAKOUT
AVOIDANCE STRATEGY
A little-known but very valuable strat-
egy I use in my own swing trading and
one that you may also find helpful is
to simply not enter a trade at any price
with the number “9” in it (for example,
19, 29, 39, 49, etc.). This is because, as
with whole-number resistance, profes-
sional traders also use every increment
of $10 as a price-action resistance level.
So prices with 9s in them often fail to
continue upward until after pullbacks
or congestion areas—and are therefore
best avoided.
Buying at price levels with a 9 in
them frequently lead to false breakouts.
Instead, you may wish to wait until after
price has moved up at least 50 cents above
the decade value—for example, entering
at prices such as $30.50, $40.50, and so
on, while avoiding entries at price levels
such as $29.40 or $39.60, since these will
often stall out and retrace at price points
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that are multiples of $10. So if a stock is
trading between $29–$30 per share, for
example, it is best to wait until it breaks
out above $30.50 to buy.
STEP-BY-STEP ACTION PLAN
Here’s how you can start using this
price-action strategy with
your swing trades:
Step 1: When considering a
trade using a 90-day daily
candlestick chart (for stocks
priced $20–$70/share), as
seen in the chart of Activision
Blizzard Inc. (ATVI) in Fig-
ure 1, visually mark out the
region between price levels
with the number 9 in them.
Step 2: Avoid entering your
trade until price has broken
out at least $0.50 above the
multiple-of-10 price point. In
Figure 1, this would be 50.50,
which triggered on April 24.
The red zone between $49
and $50 is avoided, as was the
Continued on page 43
• Technical Analysis of STOCKS & COMMODITIES • 7
Explore Your Options
During the days leading
up to Labor Day, gold
has a strong tendency
to increase in price.
You can trade spreads
that’ll help spread
your risk, reward, and
breakeven.
Day, then the cost of these calls would
consume most of—not all—the profits in
your trade. As GLD moves to $123, the
$120 call only has a real value of $3.00 at
expiration. How else can you profit from
such a small projected move? You can
do that by spreading your risk, reward,
and breakeven.
The bull call spread risk graph in
Figure 3 is one such idea. The idea is to
buy the lower strike ($120) calls and si-
CALHOUN / AVOIDING FALSE BREAKOUTS:
“NO 9s”
Continued from page 7
false breakout on March 30 and 31. We
use 0.50 above whole numbers as a price
action “safety buffer” to help avoid false
breakouts. So the next entry in Figure 1
would be $60.50, not entering between
$59 and $60.
Step 3: An initial and trailing stop value
of $2 is used to manage the swing trade,
with trades typically lasting from five to
15 days in duration.
INSIGHTS: WHY THIS TECH-
NIQUE WORKS
This is one of those technical patterns
based on human psychology that is
remarkably consistent, simply because
prices with the number 9 in them look
expensive. So those are places where
traders sell more often than they buy. To
check this for yourself, look through a
few dozen 90-day charts in the $20–$70/
share price range in an uptrend and
multaneously sell
the higher strike
($12 3) c a l l s.
Selling the $123
calls will bring
in enough cash
to lower the over-
all cost of this
spread to just
$1.00, which is
one-third the cost
of the $120 long
calls. If GLD
FIGURE 3: BULL CALL SPREAD. Here, you’re buying the lower strike ($120) calls
reaches $123 by and simultaneously selling the higher strike ($123) calls. Selling the $123 calls will
expiration of the bring in enough cash to lower the overall cost of this spread to just $1.00, which is
spread, this trade one-third the cost of the $120 long calls.
has a chance to
triple in value. then perhaps a call purchase makes sense.
Spreads will lower the cost and risk But for those of you who are trying to
of a trade, but the maximum returns figure out how to get a big return out of
are limited to the distance between the a small move, the call spread trade may
strikes that were bought and sold, minus just be your new best friend.
the cost of the spread. So if you believe
that your trade has room to accelerate,
TRADING ON MOMENTUM
This is one of those technical patterns
based on human psychology that is
remarkably consistent.
you’ll see consoli-
dations and pivots
for many of them at price points that setting entries and targets for intraday
include the number 9. Strong-trending trading, I use multiples of $10/share as
charts may eventually break out above box trading ranges to trade within, buy-
the multiple-of-$10 price level, though ing, for example, at a price like $42/share
often not until a false breakout has been and selling at $49/share (buying just over
overcome. $40 and selling just under $50). You can
easily remember this technique by keep-
TRADE MANAGEMENT TIPS ing in mind that “9” looks expensive, so
It is also a smart idea to use this one-point anything with a “9” in the share price
resistance area between 9s and multiple- should not be bought but rather used as
of-10 price points as an exit target price an exit target to sell into.
zone to sell into. So if, for example, you
had been long ATVI in Figure 1 from Ken Calhoun is a producer of trading
earlier, selling (or at least tightening a courses, a live trading room, and video-
trailing stop) once price breaks above based training systems for active traders.
$49 is a smart area in which to exit your He is the founder of TradeMastery.com,
position and lock in a profit. You can an educational resource site for active
always reenter if it eventually gets over traders, and is a UCLA alumnus.
the $50.50 price, which it did a month
after reaching $49/share. Just as whole-
number support & resistance helps for
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 43
 are two columns of posi-
tive numbers, one showing
today’s close minus yes-
terday’s close (changes on
up days or zero), and the
other featuring yesterday’s
close minus today’s close
(changes on down days or
zero). These two columns
of positive numbers are then
smoothed using a varia-
tion of exponential moving
averages, whose length
can be estimated as twice
the length of the lookback
period minus one.
So, for the 14-day period
popular everywhere, a 27-
day exponential average
(EMA) is used to smooth the
data in the two columns. In
an intermediate calculation
step, the smoothed data is
next used to compute the
ratio of the up-day average
to the down-day average
(called the relative strength).
This ratio is then converted
into an oscillator on a 0–100
A Quicker Reaction scale.

Buy & Sell Pressure THE TROUBLE WITH

RANGE COMPRESSION
The complaint arises be-
And A Faster RSI cause the intermediate ratio,
relative strength, is calcu-
lated using relatively long
EMAs, which therefore
Most of you are familiar with the relative strength index (RSI), but are you taking full advan- have a long memory (that
tage of it? Here, we deconstruct the RSI to lead to a more intuitive and symmetrical gauge of is, they need a lot of data
buying and selling pressure and a more responsive indicator. to stabilize and are heavily
influenced by old data) and
by Tushar S. Chande, PhD make the RSI practically
unresponsive as the length

M
BUY GRAPHIC: HANOHIKI/CHART HAND CLOUD: RA2STUDIO/

any novice and even intermediate traders have told me over the years that they find the of the lookback period in-
ever-popular relative strength index (RSI) indicator confusing. The RSI is an oscillator creases. I have previously
SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON

plotted on a scale of zero to 100, and is typically used as an overbought/oversold indica- proposed a solution to this
tor, which means that it is used to signal impending reversals in direction. However, during problem via the stochastic
strong trends, the RSI can remain at “extreme” levels, either high or low, for the duration of RSI or stochRSI.
the trend, and thus, it’s not precise as an indicator of impending reversals. This is partly due A bigger problem is that
to range compression, which I will discuss later in this article. because the RSI is plotted on
a fixed 0–100 scale, as op-
DIGGING DEEPER posed to an open scale with
Even expert technicians have expressed their concern about the smoothing built into the indi- no upper or lower limit, there
cator. In brief, calculations begin by separating daily changes into absolute values separated is massive range compres-
by days on which a market (or stock) closes up on the day or down on the day, so that there sion at the extremes, or the
26 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
 INDICATORS

area of the most interest. Visualize the two columns of daily RS decreases from Length Smoothing Effective Length
close-to-close changes described earlier as buying pressure 1 to 0.1, a 10-times of RSI Factor of EMA
or selling pressure. If there is strong selling pressure, the drop, the RSI itself
6 0.16667 11
absolute daily close-to-close changes on down days will be drops from 50 to 9
8 0.12500 15
much greater than the close-to-close changes on up days. So or so.
the ratio of selling pressure to buying pressure could be 10:1 The fixed range 10 0.10000 19
or greater (and vice versa). has two effects: 12 0.08333 23
Imagine a stock that surges on strong earnings, with strong nonlinear range 14 0.07143 27
buying over many days as investors follow through. In this compression, and 16 0.06250 31
case, the proportion of buying to selling pressure, that is, the asymmetric val- 18 0.05556 35
ratio of the average of up-day close-to-close changes to the ues. First, when the 20 0.05000 39
average of the down-day close-to-close changes, could move range compression
22 0.04545 43
from 3:1 to 12:1, a 300% increase, and yet the RSI would only is nonlinear, the
24 0.04167 47
shift from 75.0 to 92.31, a mere 23% increase. As a short-term greater the dif-
trader, you would rather be alerted to the 300% increase ference between 26 0.03846 51
in buying pressure than a 23% increase in RSI. The range the up-closes and 28 0.03571 55
compression gets even more extreme as the ratio of buying down-closes av- 30 0.03333 59
pressure to selling pressure increases. erages, which is 32 0.03125 63
In defense of the design of the RSI, it is a brilliant and precisely when the 34 0.02941 67
practical solution to the problems of its time, when computers indicator should 36 0.02778 71
were uncommon and data were plotted by hand. In order to be drawing your
38 0.02632 75
speed up hand calculations, the use of moving averages that attention to that
40 0.02500 79
required just one row to be calculated anew each day was most stock or market.
convenient, even essential. Similarly, the ability to plot RSI Second, though 42 0.02381 83
data on a fixed 0–100 scale greatly simplified the problem of the displacement FIGURE 1: SMOOTHING BUILT INTO THE RELATIVE
STRENGTH INDEX (RSI). The smoothing factor seen
updating a large number of charts by hand. However, today from the center in column 2 is an inverse of the length of the RSI.
we can rework the problem to overcome these computational is symmetric, the
or charting challenges. numeric readout

UNDERSTANDING RSI CALCULATIONS Up-closes Down-closes Relative Strength Relative Strength

I’ll illustrate the quirks of the RSI calculations using a few EMA EMA (RS) Index (RSI)
simple calculations. First, I show the smoothing factors built 10 1 10.0000 90.91
into the calculations (see Figure 1).
9 1 9.0000 90.00
The first column shows a range of lookback periods rang-
8 1 8.0000 88.89
ing from six to 42 days incremented in steps of two days.
The smoothing factor corresponding to each length of RSI is 7 1 7.0000 87.50
simply an inverse of the length (see column 2). The equivalent 6 1 6.0000 85.71
length of the corresponding EMA is shown in column 3, using 5 1 5.0000 83.33
the usual formula that the index of the EMA is given by (2/ 4 1 4.0000 80.00
(L+1)), where L is the length of the average. Clearly, if you 3 1 3.0000 75.00
want the RSI to respond more quickly to market changes, you 2 1 2.0000 66.67
can shorten the length, or simply change the type of moving
1 1 1.0000 50.00
average used to calculate the smoothed quantities used in the
1 2 0.5000 33.33
calculations.
In Figure 2, I illustrate the range compression feature of RSI 1 3 0.3333 25.00
calculations by constructing a series of hypothetical values for 1 4 0.2500 20.00
the up-closes and down-closes EMA. I first vary the up-closes 1 5 0.2000 16.67
EMA from 10 to 1 in steps of 1, while keeping the down-closes 1 6 0.1667 14.29
EMA fixed at 1 (see columns 1 and 2, and the first 10 rows in 1 7 0.1429 12.50
Figure 2). I compute the relative strength (RS) by taking the 1 8 0.1250 11.11
ratio of the values in the first two columns. The fourth column
1 9 0.1111 10.00
converts the RS values into the equivalent RSI values using
1 10 0.1000 09.09
the formula RSI = (1-(1/(1+RS))*100. Note the range compres-
FIGURE 2: RANGE COMPRESSION IN RSI CALCULATIONS. When the RS
sion: When the RS increases from 1:1 to 10:1, the RSI only increases from 1:1 to 10:1, the RSI only increases from 50 to 91, approximately.
increases from 50 to 91, approximately. The range compression When the RS decreases from 1 to 0.1, a 10-times drop, the RSI itself drops from
also works similarly on the downside. For example, when the 50 to 9 or so.

March 2017 • Technical Analysis of STOCKS & COMMODITIES • 27

 Up-closes Down-closes Relative RSI - Relative Chande Buy/Sell
EMA EMA Strength Strength Index Pressure (CBSP)
10 1 10.0000 90.91 10
9 1 9.0000 90.00 9
8 1 8.0000 88.89 8 to selling pressure, that is, buy/sell pressure or BSP. I
use the following formulas:
7 1 7.0000 87.50 7
6 1 6.0000 85.71 6
If RS < 1, CBSP = -1/RS and
5 1 5.0000 83.33 5 If RS >= 1, CBSP = RS.
4 1 4.0000 80.00 4
3 1 3.0000 75.00 3 You can just as easily rewrite the CBSP using the RSI
2 1 2.0000 66.67 2 values directly as follows:
1 1 1.0000 50.00 1
1 2 0.5000 33.33 -2 If RSI < 50, then CBSP = (0.01*RSI-1)/(0.01*RSI),
else
1 3 0.3333 25.00 -3
(RSI >= 50), then CBSP = (0.01*RSI)/(1-
1 4 0.2500 20.00 -4
0.01*RSI)
1 5 0.2000 16.67 -5
1 6 0.1667 14.29 -6 With this formulation, CBSP < 0 when RSI < 50, and
1 7 0.1429 12.50 -7 CBSP > 0 when RSI >=50, and the sign indicates which
1 8 0.1250 11.11 -8 is greater—the buying or selling pressure.
1 9 0.1111 10.00 -9 In Figure 3 I show how the RSI values can be
1 10 0.1000 9.09 -10 converted into BSP values using the same synthetic
data as in Figure 2. First, when you compare columns
FIGURE 3: BUY/SELL PRESSURE CONVERTED FROM RSI FIXED SCALE TO OPEN SCALE.
The open scale tells you instantly the relative magnitudes of the two pressures, and the sign 3 and 5, note that BSP is the same as RS when the
tells you which is greater. RS is >=1, but is equal to -1/RS when RS is < 1. The
convenience of this definition is that now you get an
is not. For example, a 4:1 upside ratio or 1:4 downside ratio open scale and symmetric values of buy/sell pressure that
produces a similar 30-point deviation from the center line at instantly communicate the relative magnitudes of buying or
50, but the readout is 80 or 20, not symmetric as 4:1 or 1:4. selling pressure. For example, from the first line, when the
Thus, the RSI numerical values are not intuitively related to RS=10 and buying pressure is 10 times the selling pressure,
the force of buying or selling pressure. BSP =10. Symmetrically, from the last line, when the selling
pressure is 10 times the buying pressure, BSP = -10.
CHANDE BUY/SELL PRESSURE (CBSP) Thus, the open scale instantly tells you the relative mag-
I would like to convert the usual RSI calculations away from nitudes of the two pressures, and the sign tells you which is
the fixed scale into an open scale to get away from range greater. This is a more intuitive formulation of buying and
compression and get a symmetric readout. I would also like selling pressure, and gets closer to the natural price action. I
to signal if buying pressure exceeds selling pressure or vice will now apply these calculations to a few real-life examples
versa. to appreciate their implications.
Recall that in the core RSI calculations, the RS = (up-day
average)/(down-day average). Rather than visualize the ratio THE 2015 RALLY IN DUPONT (DD)
as relative strength, I look at it as a ratio of buying pressure In the fourth quarter of 2015, Dow 30 component Dupont
(DD) had been falling steadily, past the Chinese
revaluation selloff in August into October. Then,
as the rest of the market rebounded in October,
90
70
DD gapped higher, and rallied hard through early
50.79
30
December, ending with an exhaustion gap. In Fig-
10 ure 4 you see a chart of the DD price action along
74
72
with the 14-day RSI in the upper panel. Observe
70
68
how the RSI values remained above 70 for more
66
65.42 than 45 days as DD trended higher.
64
62 I reproduced the RSI calculations from Figure
60
58
4 in an Excel spreadsheet (see Figure 5) to pro-
56 vide the bridge to a later discussion. The ending
54
52
value, on December 31, 2015, is 50.79, which is
STOCKCHARTS.COM

50 the same in Figure 4. Thus, I can cross-check my

48 calculations against a commercial package for
46
Jul 8 13 20 27 Aug 10 17 24 Sep 8 14 21 28 Oct 12 19 26 Nov 9 16 23 Dec 7 14 21 28 completeness. I can now use the RSI calculations
FIGURE 4: BUY/SELL PRESSURE IN DUPONT (DD). Dupont rallied in late 2015 and the RSI in Figure 5 and compare them directly to buy/sell
stayed above 70 for more than 45 days. pressure calculations (see Figure 6).
28 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
 Dupont: 14-day RSI with Wilder’s Smoothing Dupont Rally captured via Wilder’s RSI and Chande Buy/Sell Pressure
RSI Up Ref Dn Ref Wilder’s RSI Buy/Sell Pressure
100 120 12

Chande Buy/Sell Pressure with Wilder Smoothing

110 11
90
100 10

Wilder’s Relative Strength Index (RSI)

80 RSI Flattening
90 9
70 80 8
70 7
Relative Strength Index

60
60 6
50 50 5
40 40 4
30 3
30
20 2
RSI = 50.79 CBSP Surging
20 10 1

10 0 0
MICROSOFT EXCEL

15

15

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/07

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/23
FIGURE 6: WILDER’S RSI VS. BUY/SELL PRESSURE. The values are consistent
12

12
09

10

10

10

10

11

11

11

11

12

12

12

with those in Figure 3. The buying pressure was 10 times the selling pressure (values
FIGURE 5: 14-DAY RSI WITH WILDER’S SMOOTHING. Here, the RSI calculations
above 10) with RSI greater than 90 just before DD flattened out in mid-November.
were reproduced in an Excel spreadsheet. The RSI value of 50.79 on December
The acceleration in CBSP values makes the buying pressure more obvious than
31, 2015 is the same as in Figure 4.
the flattening out seen in RSI values.

The rapid acceleration in buying pressure is more intuitively should be expected since I am using a larger fraction of the
obvious in Figure 6, even as the RSI values begin to flatten incoming data (0.13 vs. 0.07) to update the new value for the
out, topping out above 90 for BSP > 10, as can be expected moving averages used to calculate the relative strength.
from the calculations in Figure 3.
I’ll now briefly revisit the internals of RSI smoothing. THE SPILL IN KIMBERLY CLARK
Wilder’s formulation does not quite follow the usual EMA The shares of Kimberly Clark (KMB) had a bit of a spill in
formula. For example, for a 14-day RSI, it adds 1/14 of the late 2016. These defensive stocks have been following the
new value to 13/14 of old value, instead of adding 2/15 of the bond market lower, after bonds peaked in the immediate
new value to 13/15 of the old value to compute the updated aftermath of the “Brexit” scare. I show in Figure 8 how the
averages. This subtle change slows down the RSI computations. selling pressure reached -4, with the RSI in the range below
I compared the RSI values during the DD rally using the two 20, as is expected from Figure 3. The CBSP instantly com-
different smoothing schemes in Figure 7. The “proper” EMA municates selling pressure four times the buying pressure,
formulation, denoted by “standard EMA smoothing” in Figure whereas the RSI readout is merely an oversold condition
7, responds more quickly than the Wilder formulation, which below 30. Thus, when you compare the pressure of buying

Dupont: RSI with Wilder’s vs. Standard EMA Smoothing Kimberly Clark: RSI vs. CBSP (1:4 Selling Pressure)
RSI Standard EMA Smoothing Wilder’s RSI RSI Up Ref Dn Ref CBSP
80 3
120

Chande Buy/Sell Pressure (Graph with open circles)

70 2
100
60 1
Relative Strength Index (RSI)
Relative Strength Index (RSI)

80 50 0

40 -1
60

30 -2
40
20 -3

20 10 -4

0 -5
0
10 3/20 6
10 4/20 6
10 5/20 6
/26 16
16
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6

/2 1
/2 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/0 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/1 1
/2 1
/2 1
/2 1
/2 1

/20
10 0/20
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/3
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09
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12

FIGURE 8: RSI CALCULATION AND CBSP. The selling pressure here is four times
FIGURE 7: WILDER’S RSI VS. STANDARD EMA SMOOTHING. The RSI calculation the buying pressure, giving a CBSP reading of -4, intuitively clarifying that the stock
using the standard EMA formula reacts faster because it uses a larger proportion is under significant selling pressure. The RSI readout at about 20 merely shows an
of new data to update its internal moving averages. The more responsive RSI can oversold condition. Thus, the CBSP gives symmetrical readings (4:1 or 1:4, that is,
be quite attractive to short-term traders. +4 or -4) for the intensity of buying or selling pressure.

March 2017 • Technical Analysis of STOCKS & COMMODITIES • 29

 NFLX: RSI with Wilder’s Smoothing and Standard EMA Smoothing Buy/Sell Pressure with Wilder vs. Standard EMA Smoothing
Standard EMA RSI RSI Wilder Smoothing UP Ref Standard EMA CBSP Wilder Smoothing
100 7

Chande Buy/Sell Pressure with different internal smoothing

90
6
80
Relative Strength Index (RSI)

70 5

60
4
50
3
40

30 2

20
1
10

0 0

10 1/20 6
10 2/20 6
10 3/20 6
/04 16

10 5/20 6
10 6/20 6
/07 16

10 8/20 6
/09 16

10 0/20 6
10 1/20 6
/12 16

10 3/20 6
/14 16

10 5/20 6
10 6/20 6
10 7/20 6
10 8/20 6
10 9/20 6
10 0/20 6
10 1/20 6
10 2/20 6
10 3/20 6
10 4/20 6
/25 16
16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/0 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/1 16
/2 16
/21 16
/2 16
/2 16
/2 16
/25 16
16

/0 1
/0 1
/0 1

/0 1
/0 1

/0 1

/1 1
/1 1

/1 1

/1 1
/1 1
/1 1
/1 1
/1 1
/2 1
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/2 1
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/2 1
10 /20

10 /20

10 /20

10 /20

10 /20

10 /20

/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
10 5/20
10 6/20
10 7/20
10 8/20
10 9/20
10 0/20
10 1/20
10 2/20
10 3/20
10 4/20
10 5/20
10 6/20
10 7/20
10 8/20
10 9/20
10 0/20
10 /20
10 2/20
10 3/20
10 4/20
/20

/30
/3

09
09

FIGURE 9: PRICE JUMPS AND RESPONSE TIME. The 20% or so jump in NFLX in
a single day was heavily damped in the RSI calculations using the Wilder smoothing
formula. However, using the standard exponential moving average formula led to
a faster response from the resulting RSI.
FIGURE 10: BUY/SELL PRESSURE WITH WILDER VS. STANDARD EMA
SMOOTHING. The Chande buy/sell pressure (CBSP) calculations using the regular
exponential average definitions responded more quickly to the one-day jump in
NFLX than the CSBP calculations using the Wilder smoothing method. The CBSP
intuitively shows the sudden surge in buying pressure, and shows that it is many
times the selling pressure.

Or they can recast it as Chande buy/sell pressure to get a

The open scale instantly tells
you the relative magnitudes of
the buying and selling pressures,
and the sign tells you which
is greater, making it a more
intuitive formulation of buying
and selling pressure, and closer
to the natural price action.
or selling, the CBSP gives a more intuitive readout of which
side is dominating and by how much.
A SURGE IN NETFLIX
Traders and investors rewarded Netflix (NFLX) with a 20%
or so jump in stock price when the company’s performance
exceeded expectations in October 2016. The sudden one-day
jump in price shows the lags due to the smoothing built into
RSI calculations. I first compared the standard 14-day Wilder
RSI calculations to the RSI calculations using a standard 14-
day EMA (see Figure 9). It is clear that the Wilder smoothing
built into the RSI is less responsive than the usual definition
of an EMA.
The corresponding buy/sell pressure calculations can be seen
in Figure 10. Once again, the calculations using the regular
EMA formula respond much more quickly. This intuitively
shows that the buying pressure is six times greater than sell-
ing pressure. This is easier to absorb than just an RSI reading
above 70, which merely indicates an overbought condition.
symmetric, open-scale variant that instantly summarizes the
relative magnitudes of buying or selling pressure. Remember
that because the core calculations are closely related, the
“shape” of the variations will look alike, though the numeri-
cal readouts will differ.
Tushar Chande, PhD, MBA, has two decades of experience
trading the futures markets as a CTA and hedge fund head of
research. He is the developer of numerous widely used origi-
nal technical indicators such as VIDYA, CMO, and AROON.
He is the author or coauthor of several books on technical
analysis. His website, ETFmeter.com, offers trend analysis
of more than 1,200 ETFs, stocks, and international indexes,
and buy/sell pressure data. Users can build and rebalance
risk-managed ETF portfolios.
FURTHER READING
Chande, Tushar, and Stanley Kroll [1993]. “Stochastic RSI
And Dynamic Momentum Index,” Technical Analysis of
STOCKS & COMMODITIES, Volume 11: May.
Chande, Tushar [2001]. Beyond Technical Analysis, 2d ed.,
John Wiley & Sons.
, and Stanley Kroll [1994]. The New Technical Trader,
John Wiley & Sons.
[2016]. “When Is Berkshire Hathaway Stock Good
Value?” Technical Analysis of STOCKS & COMMODITIES,
Volume 34: Bonus Issue.
‡StockCharts.com
‡See Editorial Resource Index

VARIATIONS ON THE EVER-POPULAR RSI

The ever-popular RSI indicator is used in many situations,
for both systematic and discretionary trading. Users can now
add a couple of variations to their menu. One, they can use
a different smoothing scheme, to get a more responsive RSI.
30 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
 TRADING ON MOMENTUM

Gaps & Bullish Cup

Breakouts
This monthly column written by a professional daytrader and educator covers the
general topic of breakout trading techniques. This month, he explains how you can
improve your chances for success in gap trading by combining gap trades with
easy-to-see cup entry patterns.

by Ken Calhoun

aps—they are one of the most TRADING STRATEGY: BUYING ABOVE

G powerful chart patterns you

can trade, but many traders are
uncertain about when to enter
new positions. A simple confirmation
signal you can use when trading gaps is
to wait until after a bullish cup breakout
forms. Entering your trade above this
bullish cup can be a particularly effec-
tive momentum daytrading and swing
trading strategy.
The reason this approach can be ef-
fective is because the left side of the cup
shows any initial selling pressure follow-
ing the gap up, while the right side of the
cup shows new buyers coming in. You
then wait and enter your long position
above the initial cup pattern resistance
level following the gap.
A GAP & BULLISH CUP HIGH
Trading gaps can be one of the core
technical patterns used in a successful
trading approach. But, as with any chart
trading pattern, if you trade gaps too soon
or too late, it can lead to losses. This
month’s technique can help you improve
your gap trading approach by combining
gap trades with easy-to-see cup entry
patterns. The goal is to minimize risk by
using two technical long entry patterns
occurring together.
When trading gap continuations, it
is important to only focus on gaps that
have gapped up 10% or less above the
previous day’s high. For example, a $30
Continued on page 18

34.00
33.50
33.00
Breakout 0.20
32.50
above bullish cup
32.00
31.50
31.00
30.50
Premarket 30.00
gap up 29.50
29.00
38.50

300K
250K
200K
150K
100K
50.0K
eSIGNAL

08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00
8-17-2016 8-18-2016

FIGURE 1: GAP UP WITH BULLISH CUP BREAKOUT. You should wait to enter until after a bullish cup
breakout following a gap up.

November 2016 • Technical Analysis of STOCKS & COMMODITIES • 15

 software. It’s a filter I created on a spreadsheet and I use it
as a guide to determine whether trading conditions might be
favorable or not. If the filter indicates conditions are not favor-
able, then that means I should stay out of the market. While
the filter isn’t perfect at predicting the future, by following its
guidance, I increased my overall profits by 25%.
LOW MAINTENANCE
I have used my trading system for the past four and a half years
and have been pleased with how well it has performed. The
best part is that it requires only a few minutes each evening
to update. So if you wish to trade like a professional — even
though you may not be one yet — developing a trading system
that can be traded automatically is worth exploring.
James Breen has been trading in the financial markets for
TRADING ON MOMENTUM
CALHOUN / GAPS & BULLISH CUP BREAKOUTS
Continued from page 15
stock can gap as high as $33 (or less). Gaps over 10% in mag-
nitude are more susceptible to “filling” or reversing, which
you want to avoid when going long. This strategy works best
with stocks priced $20–$70 per share, with daily volume of at
least one million shares per day. Stocks priced less than $20
per share, particularly those less than $10 per share, should
generally be avoided due to their haphazard and dangerously
unpredictable price action.
STEP-BY-STEP ACTION PLAN
Here’s how you can put this strategy to work in your trades:
Step 1: Using a two-day one-minute candlestick chart, find
gaps that are also forming a clearly defined bullish cup pat-
tern before the opening bell, as seen on August 18, 2016 in
the chart of NetApp, Inc. (NTAP) in Figure 1.
Step 2: Wait until after 9:30 am to see if price action breaks
out to new highs once the market opens.
Step 3: Set your buy signal to enter your trade once price has
moved at least $0.20 above the cup pattern high. You can
use this entry pattern for both day and swing trading.
Step 4: Once you get an order fill, set an initial stop $0.40
under your entry. This momentum entry pattern will usually
continue on up to new highs until midday.
INSIGHTS: WHY THIS TECHNIQUE WORKS
This technique is effective because it combines strong gap
18 • November 2016 • Technical Analysis of STOCKS & COMMODITIES
The main reason for the success
of the trading system I use is
that it is optimized frequently.
This allows the software to stay
in tune with ongoing changes in
the trading environment.
over 30 years. His proprietary, fully automated daytrading
software system has been providing above-average returns
for clients four years in a row. More information about it can
be found at www.AdvancedTradingTechnologies.com.
The left side of the cup shows
initial selling pressure following the
gap up, while the right side of the
cup shows new buyers coming in.
signals with a bullish long cup pattern. Experienced technical
traders know to look for multiple confirmation signals like
this when initiating new positions. Thus, the appearance of
this signal combination leads to additional buying, because
professional institutional traders will accumulate new shares
as this pattern emerges.
TRADE MANAGEMENT TIP: GAP & CUP
BREAKOUTS
You should decide on a clear, well–defined trading plan when
using this or any other momentum breakout trading strategy.
For example, once you are in a winning gap and cup posi-
tion, you may wish to add to your successful trade, to scale
in for larger share size. A popular Wall Street saying among
my institutional clients is “feed your winners, starve your
losers,” meaning you should usually seek to build up your
winning position and scale out of losing trades. Once you
learn how to spot this unique trading pattern, it may become
one of your favorites.
Ken Calhoun is a producer of trading courses, a live room,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for active traders.
 instead focus on the minute
details. But doing that could
lead us to believe that a market
is trending when in reality
it may not be, which is why
it’s a good idea to know the
long-term dominant bias of
the market. But how do you
determine the dominant bias
of the market?

LOOK FOR
THE OBVIOUS
One method I’ve found ef-
• 5.5” W x 7” H fective for determining the
dominant bias is to look for a
golden cross and death cross
on the chart. Once you’ve fig-
ured out the dominant bias, you
can move on to look for ways to
go long or short. I have found
that when it comes to trading
currencies, a strong move in
one direction is better than
trading when price zigzags in
a tight range. When the market
is trendless, there’s a lack of
strong momentum and this
causes stop-loss levels to get
tested often and price move-
ment to become choppy.
Many currency traders like
to use golden and death crosses
because they help to determine
whether the bulls or bears are
dominant. But you may find
slight variations in their defini-
tions. Sometimes, the golden
cross is defined as when the
X Marks The Spot 50-day exponential moving av-
erage (EMA) crosses above the
Golden Cross And 100-day EMA (and the other
way around for a death cross).

Death Cross
GOLD CROSS: POLYGRAPHIS/BLACK CROSS: SARININKA/SHUTTERSTOCK

Others define a golden cross

as when the EMA 50 crosses
above the EMA 200 (and the
other way around for a death
It’s all about finding the dominant bias of the market. Otherwise, you get caught up in the cross). Sometimes, simple
noise, which can be distracting. Here’s one strategy you can use when trading the currency moving averages (SMAs) are
markets to identify when a market is bullish or bearish so you know better when to go long used instead of exponential
or short. moving averages, but that dif-
ference is not too significant.

B
by Azeez Mustapha A death cross is the converse
of the golden cross.
ullish or bearish—these are general terms that identify the direction of the markets, Before a golden cross or
unless they’re forming a base. But oftentimes, we lose sight of the big picture and death cross is confirmed, you’ll
26 • September 2016 • Technical Analysis of STOCKS & COMMODITIES
 FOREX FOCUS

see that price often moves close to the 100 or

200 EMA, sometimes going above or below A Death Cross
it several times before it finally crosses over
or below it. Only after price has crossed one
of these EMAs will you look to pinpoint a
golden or death cross. In Figure 1 you see
a golden and death cross on the daily chart
of the AUDNZD. The EMA 200 shows a A Golden Cross

www.metaquotes.net
longer-term, more general picture than the
EMA 100. Once price crosses the EMA 200
to the upside or downside, you get an overall
view of the directional bias. Keep in mind
that since it’s a long-term moving average, FIGURE 1: GOLDEN CROSS AND DEATH CROSS. On the daily chart of the AUDNZD, the ovals show
where price crosses the EMA 200. The EMA 200 shows a broader picture than the EMA 100.
you can expect some lag, which means you
don’t want to wait too long before putting
on positions.

THE STRATEGY
In addition to using the EMA 200, I also use
the EMA 20, EMA 50, and the 14-period aver-
age directional movement index (ADX). For
a refresher on how the ADX functions, see
the sidebar “Average Directional Movement
(ADX).” A trend is particularly strong if the
ADX 14 is above the 30 level.
Assume that as long as price is above the
EMA 200, the dominant bias is bullish and
when price is below the EMA 200, the domi- FIGURE 2: ADDING OTHER INDICATORS. On this daily chart of silver, you see the EMA 20 (yellow), the EMA
50 (navy blue), the EMA 200 (red), the ADX (green), the +DI (blue), and the –DI (red). Combining all these
nant bias is bearish. To go long in a dominant indicators can act as a filtering tool so you enter and exit trades only when specific criteria are met.
bullish bias, the EMA 20 must be above the
EMA 50, ADX 14 must be above 30, and
+DI must be above the –DI for the ADX. The converse would don’t want to go long just because price is above the EMA
apply for going short. 200; you should use other indicators to support either the
In the daily chart of silver in Figure 2 you see these ad- golden or death cross.
ditional indicators on the chart. The objective of this trading plan is to have you look at
the big picture so you identify where the buying and selling
EMA 20: Yellow pressure is. It removes the noise you often see in smaller
EMA 50: Navy timeframes and prevents you from going short when the
EMA 200: Red dominant trend is bullish.
ADX line: Green (+DI: Blue, -DI: Red)
Strategy snapshot
It’s clear from this chart that for as long as price stays above Strategy name: Golden cross and death cross method
the EMA 200, taking long positions makes sense. But you Strategy type: Trend-following and indicator-based
Trading style: Swing and position trading
Suitability: Excellent for part-time traders
AVERAGE DIRECTIONAL INDEX (ADX) Time horizon: Daily charts
J. Welles Wilder Jr. developed the average directional index Indicators: EMA 20, 50, and 200; 14-period ADX
(ADX), the minus directional indicator (-DI), and the plus Bullish setup: When price is above the EMA 200 (a bullish
directional indicator (+DI). Although he had commodities bias), go long when EMA 20 is above the EMA 50, ADX
and daily prices in mind when he created it, the three 14 is above 30, and its +DI is above the –DI.
indicators can be applied to stocks as well. The objective Bearish setup: When price is below EMA 200 (bearish bias),
of the ADX is to indicate whether a trend exists and its go short when EMA 20 is below the EMA 50, ADX 14 is
strength. The other two lines, +DI and -DI, indicate if the above 30, and its -DI is above the +DI.
trend is moving up or down. Position sizes: Use 0.01 lots for each $2,000 (thus making it
Source: Stockcharts.com 0.05 lots for $10,000); or 0.1 lots for each 20,000 cents in a
cent account (making it 0.5 lots for each 100,000 cents)
September 2016 • Technical Analysis of STOCKS & COMMODITIES • 27
 Stop: For a long trade, set a stop level at the
low of the previous day’s candle. For a
short trade, set a stop level at the high of
the previous day’s candle.
Target: An open trade should be left for
about one month or more (two months
maximum).
Breakeven stop: A breakeven stop could
be used once a profit of 100 pips is at-
tained.
Trailing stop: A 50% trailing stop could be
used in case a trade goes in the forecasted
direction by 200 pips. FIGURE 3: EQUILIBRIUM PHASE. On this daily chart of the USDJPY, you see price is moving sideways.
There’s no dominant bias here. Notice that the ADX line is mostly below the 30 level, indicating there is no
Hit rate: At least 45%
momentum in the market. Although a golden cross remains valid, it’s not backed with momentum since
the EMA 20 and 50 crossings are giving bearish signals.
WHAT ABOUT DIRECTIONLESS
MARKETS?
Sometimes, the long-term movement in the
markets will be sideways. Price movement
Trade 3
in the short term could be erratic, making it
a difficult trading environment for a trend Trade 1 Trade 2 Trade 4
trader. Stops may get hit frequently and
profit targets may not be hit, which is one
of the factors that can create a lot of anxiety
for a trader.
One way to handle an equilibrium market
is to just stay out of it. In the daily chart of
the USDJPY in Figure 3, the red vertical line
at the left shows where an equilibrium phase FIGURE 4: WINNING TRADES ON USDCAD DAILY CHART. Here we see clear golden cross bullish signals
from July 2014–March 2015 that generated four entries. The fourth trade is still open.
begins and the red vertical line on the right
shows where it ends. You can see that the
ADX line is mostly below the 30 level, which suggests there
is no momentum in the market. Notice that the EMA 20 and
EMA 50 crossings are giving bearish signals while a golden Pinpoint the dominant bias, honor
cross remains valid. The bullish signals are not backed with it, and make profits from it.
momentum. If you are going to trade in such an environment,
you better have your stops and money management strategies
in place, since that’s what will save you. though the use of a trailing stop can sometimes take you out
of a position too early, you at least have the option to reenter
TRADING EXAMPLES a position when the dominant trend resumes.
In the USDCAD daily chart shown in Figure 4, you see clear
bullish signals from a golden cross in July 2014 to March 2015. CONCLUSION
The entry criteria had been met on each occasion. Here are The objective of any trade is to make a profit but at the same
the results of this currency trade up until March 2015. time not expose you to too much risk. Unless you’re an expe-
rienced trader, you’ll find it difficult to trade in a market that
Trade 1 = 290 pips is trendless and has choppy price movements. A safer bet is
Trade 2 = 200 pips to pinpoint the dominant bias, honor it, and make profits from
Trade 3 = 1,300 pips it. The trading method outlined in this article can guide you
Trade 4 = 300 pips, still open in that direction.

Some currency crosses such as GBPNZD, GBPAUD,
EURNZD, GBPCHF, EURAUD, NZDJPY, and AUDJPY tend
to move fast. If you can catch strong trends in these instruments,
you can sometimes gain thousands of pips in a few months.
Respect the position size recommendations in this strategy
and if you catch a strong movement, use trailing stops. Even
28 • September 2016 • Technical Analysis of STOCKS & COMMODITIES
Azeez Mustapha is a professional forex trader, an analyst at In-
staforex Companies Group, a blogger at ADVFN.com, a signal
provider for some websites, and a freelance author. His articles
have been published at itulglobalforex.blogspot.com and in vari-
Continued on page 49
 Q&A
in a more rapid style drift. Many times
this can happen during a period of
drawdowns or in a challenging trading
environment. Sometimes, when a trader
is suffering through a series of losing
trades (which may even be well within
the historical performance range for the
strategy), he can unconsciously begin
to modify his behavior and as a result,
incurs style drift.
In extreme cases, we have seen trad-
ers begin to develop a trading scotoma
(blind spot) and literally not see their
setups or their strategy entry or exit
points. This unconscious bias can cause
major issues with a trader’s performance,
and when discovered, needs to be ad-
dressed through disciplined adherence
As the CEO of your
trading business, you
should do what is best
for yourself.
to the original rules, that is, going back
to the basics.
Now you see why it is important for
traders to spend time every day of the week
reviewing their trading performance. This
trading performance review needs to take
place with respect to the expected strategy/
system performance and strategy rule
set to see if the trader was executing the
necessary and correct trades, or deviating
from his structured rule set.
As part of this review, the trader should
also investigate if he was missing valid
trades or executions. Identifying these
missed or incorrectly executed trades
can help a trader see if he has developed
some kind of unconscious cognitive bias
that is leading him to drift from his trad-
ing objective and thereby affecting his
trading returns.
The bottom line: Develop a positive
expectation for each trade, stick to your
plans, and constantly review them to
identify any drift or deviation from
your plans, whether it was consciously
or without your awareness.

TRADING ON MOMENTUM

CALHOUN / MULTIDAY SEQUENTIAL BREAKOUTS

Continued from page 47 To find long-term breakouts that
continue, look for a combination of
higher than prior days’ highs. Much like buying 52-week increasing volume with sustained
highs, a succession of ever-higher price-action days leads to day after day of new high prices.
additional buying pressure, which you can capitalize on.

TRADE MANAGEMENT TIP: ENTRIES AFTER
MULTIDAY HIGHS
It’s often smart to add to a winning breakout trade as long as
the trend continues up in your favor. When you find a chart
similar to what you see in Figure 1, you should consider us-
ing a sequence of two or three buy-stop orders to add to your
initial position every two points or so (for stocks priced up to
$70/share). Scaling into an uptrending chart whose closing
price is increasing day after day is an intelligent rules-based
approach favored by professional traders. Test it out for yourself
and see how well it works for you.
Ken Calhoun is a producer of trading courses, a live room,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for active traders.
FURTHER READING
Calhoun, Ken [2016]. “Price Projection Breakouts,” Techni-
cal Analysis of STOCKS & COMMODITIES, Volume 34:
August.
‡eSignal

MUSTAPHA / GOLDEN & DEATH CROSS [2015]. “A Simple Positive Expectancy Strategy,”
Continued from page 28 Technical Analysis of STOCKS & COMMODITIES, Volume
33: June.
‡MetaQuotes
ous trading magazines including this one. He can be reached via ‡See Editorial Resource Index
email at atazeez.mustapha@analytics.instaforex.com.

FURTHER READING
Mustapha, Azeez [2016]. “Bollinger Bands & RSI: A Magical
Combo,” Technical Analysis of STOCKS & COMMODITIES,
Volume 34: June.
September 2016 • Technical Analysis of STOCKS & COMMODITIES • 49
 TRADING ON MOMENTUM

Moving Average Breakouts

Welcome to a new column on techniques for active traders. Step 1: Locate a 90-day daily stock chart priced between $20
Each month, this daytrader and founder of TradeMastery. and $70 per share with a minimum range of at least 10 points,
com will cover topics such as momentum trading, breakout similar to the daily chart of E.I. DuPont de Nemours & Co.
trading, and other technical analysis–based techniques. This (DD) illustrated in Figure 1.
month, you’ll learn an updated trading technique with specific,
actionable technical analysis, and you’ll also learn how to Step 2: Set a buy-stop order to enter your trade when price
identify and manage the trade from start to finish. has moved at least $0.50 above the high of the days in which
price breaks over each of the 100 SMA and 200 SMA lines.
by Ken Calhoun In Figure 1, the 100 SMA breakout occurred on October 6,
2015 (entry trigger would be $58 + $0.50 = $58.50). The 200
TRADING STRATEGY: SMA breakout happened on October 28, 2015 (entry would
100- AND 200-PERIOD MOVING AVERAGE ENTRY be $63 + $0.50 = $63.50).
When price action on a 90-day daily candlestick chart breaks
out above major moving averages, institutional trading volume
usually lifts prices to new highs. You can capitalize on these This strategy works because hedge
breakouts by entering your trade once price moves above fund managers and other market
100-period and 200-period simple moving average (SMA) professionals use these same entry
lines.
signals to enter their positions.
STEP-BY-STEP ACTION PLAN
Here’s how you can put this strategy to work in your trades:
Continued on page 26

 




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February 2016 • Technical Analysis of STOCKS & COMMODITIES • 13

 MetaStock Code For HHS & LLS
MetaStock code for HHS:
HH:= Security(".SPX",H);
HHH:=If(HH>Ref(HH,-1),(HH-LLV(HH,20))/(HHV(HH,20)-
LLV(HH,20)),0);
Mov(HHH,20,E)*100;
MetaStock code for LLS:
LL:= Security(".SPX",L);
LLL:=If(LL<Ref(LL,-1),(HHV(LL,20)-LL)/(HHV(LL,20)-
LLV(LL,20)),0);
Mov(LLL,20,E)*100;
with a decline in LLS signals the emergence of an uptrend.
Conversely, a surge in LLS combined with a decline in HHS
signals the start of a downtrend.
The HHS/LLS divergences can be used to foreshadow re-
versals. Combining the HHLLS with other technical analysis
tools such as support & resistance levels can make it a useful
indicator for confirming your entry and exit decisions.
Vitali Apirine is a programmer engineer with an interest
in technical analysis, especially the application of relative
strength index to trading. He may be reached at vitapirine@
mediacombb.net.
The HHS and LLS are
momentum indicators, which,
when combined, make it easy
to determine trend bias.
The code given in this article is available at the Subscriber Area at
our website, www.Traders.com, in the Article Code area.
See our Traders’ Tips section beginning on page 50 for commentary
on implementation of Apirine’s technique in various technical
analysis programs. Accompanying program code can be found in
the Traders’ Tips area at Traders.com.
FURTHER READING
Apirine, Vitali [2015]. “The Money Flow Oscillator,” Tech-
nical Analysis of STOCKS & COMMODITIES, Volume 33:
October.
[2015]. “The Slow Volume Strength Index,” Technical
Analysis of STOCKS & COMMODITIES, Volume 33: June.
‡MetaStock
‡See Editorial Resource Index

TRADING ON MOMENTUM

CALHOUN / MOVING AVERAGE BREAKOUTS

Continued from page 13

Step 3: You can use a maximum $2 initial and trailing stop

value on all stock swing trades.

Step 4: To set your exit target, simply use 50% of the 90-day
trading range and add to your entry. In Figure 1, that would
be ($68 - $47 = 21 points)/2 = $10.50, or about 10 points.

INSIGHTS: WHY THIS TECHNIQUE WORKS
The main reason why this moving average crossover strategy
works is because hedge fund managers and other market
professionals use 100 SMA and 200 SMA entry signals to
enter their positions. Think of each major moving average
as a key support or resistance level. By waiting to enter your
trades until after price has moved above these useful lines,
you improve your odds of getting into a position that has the
benefit of institutional buying power in it—the wind beneath
the wings of a successful swing trading breakout. It’s important
to note that as with most strong technical chart patterns, you
should focus on wide-range, cleanly defined charts like what
you see in Figure 1, in which there’re virtually no pullbacks
or broken trendlines to contend with.
TRADE MANAGEMENT TIPS
It’s helpful to use the 100 SMA to initiate a small “pilot trade”
of less than several hundred shares. Then you can use the 200
SMA breakout to scale in and add additional shares. This
26 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 1: DUPONT (DD), 100- AND 200-SMA BREAKOUTS. Here you see how you
can enter new positions once prices break above major moving average lines.
two-step trading process minimizes initial risk and leverages
into a second trade only after your first entry has proven itself
profitable. You can then use a breakeven stop following your
second trade, once the 200-SMA position is entered.
Many traders struggle with deciding on their entry prices;
this dual 100 SMA and 200 SMA crossover technique can help
simplify your decision-making process for your short-term
swing trades. Look for an opportunity to enter your trades
following each breakout signal.
Ken Calhoun is a producer of trading courses, live rooms,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for active traders.
 INDICATORS

Teamwork

Moving Average Stochastic

Two can be better than one. This momentum-based
trading system uses two indicators and helps identify
divergences and trends.
not unusual to look at two indicators
Lowest 26-day EMA = lowest 26-day EMA for 19
days
Highest 26-day EMA = highest 26-day EMA for 19
days
MAS(12) and MAS(26) are multiplied by 100 to

It’s simultaneously to determine when

trends are about to begin, end, or
continue. Crossovers of indicators
move the decimal point two places

The values of 12, 26, and 19 are the typical setting

are a popular analytical method used by technical used with MAS. However, other values can be substi-
analysts. The moving average stochastic (MAS) is tuted depending on your trading style and goals.
one oscillator worth paying attention to. MAS is a The table in Sidebar Figure 1 (see sidebar “MAS
momentum indicator system that shows the location Calculation Example”) shows a calculation example
of two exponential moving averages (EMAs) relative MAS(12,26,19) for the Dow Jones Industrial Average
to the high–low range of the larger moving average (DJIA) using Excel. The exponential moving aver-
over a set number of periods. MAS is based on the age starts with the simple moving average value (for
stochastic oscillator, which was developed by George EMA(12) it’s 18261.22, and for EMA(26) it’s 18259.14)
C. Lane. There are two separate indicators: MAS(26) in the first calculation. After the first calculation, the
and MAS(12). MAS(26) measures the level of the normal formula takes over.
26-day moving average relative to its high–low range Because an EMA begins with a simple moving aver-
over a given period of time. MAS(12) shows the level age, its true value will be realized later. The values of
of the shorter 12-day moving average relative to the EMA(12), EMA(26), MAS(12,19), and MAS(26,19) on
high–low range of the larger 26-day moving average the Excel spreadsheet may differ from the chart values
over a set number of periods. There are three ways in Figure 1 because of the short lookback period.
to use MAS:
INTERPRETATION
1. MAS(12) signals can be generated by looking The shorter moving average, in this case 12 days, is
for divergences. faster. The longer moving average (26 days) is slower
2. Traders can also look for MAS(12) or MAS(26) and less reactive to price changes in the underlying
centerline crossovers. security. When the 12-day EMA is above the 26-day
3. MAS(26) and MAS(12) can also be used to EMA, MAS(12) is higher than MAS(26). MAS(12)
identify the general trend. begins to drop if the shorter EMA starts to diverge
from the longer EMA at a slower pace relative to the
Here’s how it’s calculated: high–low range of the larger moving average, or if the
moving averages move toward each other. When the
MAS(12) = ((12-day EMA - Lowest 26-day EMA)/ 12-day EMA is below the 26-day EMA, MAS(26) is
PATRICK KELLEY

(Highest 26-day EMA - Lowest 26-day EMA)) * 100 above MAS(12). MAS(12) begins to increase when
MAS(26) = ((26-day EMA - Lowest 26-day EMA)/ the shorter EMA starts to diverge from the longer
(Highest 26-day EMA - Lowest 26-day EMA)) * 100 EMA at a slower speed relative to the high–low range

by Vitali Apirine
May 2017 • Technical Analysis of STOCKS & COMMODITIES • 13
 DOW JONES INDU AVERAGE NDX, Moving Average
19400
EMA(12) 19,023.73
EMA(26) 18,793.25 19200
19000
18800
18600
18400
18200
The MAS indicator can be
18000
17800
used to identify bearish/
17600
17400 bullish divergences,
17200
17000 overbought/oversold levels,
and trend changes.
MAS(12,26,19) DJI
MAS(12,26,19) 100, 135.342 MAS values shown in 200
spreadsheet example
150

100

50

0
of the larger moving average, or if the moving averages move
-50
toward each other.
18 25 2 9
May
16 23 31 6
June
13 20 27 5 11 18
July
25 1 8
August
15 22 29 6 12 19
September
26 3 10 17
October
24 31 7 14 21 28
November
MAS(12) is an unbound oscillator. The MAS(12) is above
FIGURE 1: PLOTTING MAS ON A CHART. Here you see a chart of the Dow Jones Industrial
100 when the 12-day EMA is higher than the highest 26-day
Average (DJIA) with EMA(12) and EMA(26) overlaid on the price chart and the MAS (12, EMA for 19 days and below zero when the 12-day EMA is
26,19) plotted on the subchart. lower than the lowest 26-day EMA for 19 days. MAS(26)
oscillates between zero and 100.
RUSSELL 2000 INDEX
The MAS(26) is above 50 when the 26-day EMA is in the
1220 upper half of its range and below 50 when the 26-day EMA
1210
1200
1190
is in the lower half. MAS(26) low readings (0–10) indicate
1180
1170 that the 26-day EMA is near or equal to its lowest 26-day
1160
1150
1140
EMA for 19 days. MAS(26) high readings (90–100) indicate
1130
1120
that the 26-day EMA is close or equal to its highest 26-day
1110
1100 EMA for 19 days.
1090
1080

OVERBOUGHT/OVERSOLD
1070
1060
1050
1040
1030
Even though MAS(12) is an unbound oscillator, it generally
MAS(12,26,19) RUT
MAS(12,26,19) 100, 144.025
oscillates from -50 to 150. Securities can continue to move
overbought
150
higher after an indicator becomes overbought. Conversely,
100

50
securities can continue to move lower after an indicator be-
0
comes oversold.
oversold
-50 MAS(26) identifies overbought and oversold levels. The
December 2014 February March April May June July August September October Nov oscillator ranges from zero to 100. You can use 90 as the
FIGURE 2: OVERBOUGHT/OVERSOLD. On this chart of the Russell 2000 index, note how the overbought threshold and 10 as the oversold threshold. Note
oversold/overbought levels in MAS generally coincide with the price action of the index.
that you can adjust these levels to suit your analytical needs
and the characteristics of specific securities.
DOW JONES INDU AVERAGE NDX
18500
The chart in Figure 2 shows the Russell 2000 small-cap
18000
17500
index ($RUT) with MAS(12,26,19). The oversold/overbought
17000 levels in MAS generally coincide with the price action of the
16500
16000
index. For comparison, I have included a chart of the DJIA
15500 with MAS(12,26,19), CCI(20), and RSI(14) in Figure 3.
MAS(12,26,19) DJI
MAS(12,26,19) 100, 143.74 200
overbought 150
100
50
BULLISH/BEARISH DIVERGENCES
oversold
0
-50
Directional momentum doesn’t necessarily confirm price
CCI-Standard
CCI(20) 112.65 300
but divergences can signal a potential reversal point. A bull-
+100
200
100
0
ish divergence occurs when the underlying security makes a
-100 -100
-200
-300
lower low and MAS(12) forms a higher low, which shows less
-400
Relative Strength Index
RSI(14) 65.94 80
downside momentum. A bearish divergence forms when the
70 70
60
50
security records a higher high and MAS(12) forms a lower
30
40
30 high, which shows less upside momentum. Divergences show
20
18 26 1
June
8 15 22 29 6
July
13 20 27 3 10 17 24 31 8 14 21 28 5
August September
12 19 26 2
October
9 16 23 30 7
November December
14 21 28 4
2016
11 19 25 1 8 16 22 29 7
February March
a change in momentum that can foreshadow a trend reversal.
FIGURE 3: MAS VS. OTHER INDICATORS. On this chart of the DJIA you see the In this case, you need confirmation from MAS(12), MAS(26),
MAS(12,26,19), CCI(20), and RSI(14). Note how the MAS differs from the other two or the price chart. A bearish divergence in MAS(12) can be
indicators. confirmed with a break below 50 in MAS(12) or MAS(26), or
14 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
 Noisy indicators
delay your analysis
S&P 500 INDEX
1450
lower low
Bullish Divergence 1400
Bearish Divergence
lower high breakout 1350
breakout
bad signal higher highs
lower highs 1300
Bullish Divergence breakout lower low
breakout 1250
breakout
breakout 1200 Jurik algorithms
1150 deliver low lag,
lower low 1100 low noise analysis
1050
MAS(12,26,19) SPX
MAS(12,26,19) 100, 152.195 lower high lower high
lower high 150
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
break 100
below 50 NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
break break break
50
above 50 below 50 above 50 Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
break 0
above 50
-50
higher low higher low
July August September October November December 2012 February March April May June July
Jurik Tools on live charts, on the web !
FIGURE 4: BULLISH/BEARISH DIVERGENCES. On this chart of the S&P 500 large-cap tinyurl.com/jurik-online
index ($SPX) with MAS(12,26,19), there are three divergences over a 14-month period
(June 2011–August 2012).

S&P 500 INDX

Jurik Research
higher highs 1100

1050

1000
2010 -- 2011 -- 2012 -- 2013
950
MAS(12,26,19) SPX
Add-In software
MAS(12,26,19) 100, 142.084 lower high
150
100
50
jurikres.com • 800-810-3646 • 719-686-0074
0
-50
Relative Strength Index
RSI(14) 59.1 lower high lower highs 75
70
65
60 a break in the support level on the price chart. Conversely, an
55
50
45
40
MAS(12) bullish divergence can be confirmed with a break
35

MACD
30 above 50 in MAS(12) or MAS(26) or a break above a resistance
MACD(12,26,9) 5.701, 5.749
lower highs 25
20
level on the chart.
15
10
In Figure 4 you see the chart of the S&P 500 large-cap index
5
0
($SPX) with MAS(12,26,19). There are three divergences over
27 3
August
10 17 24 31 8
September
14 21 28 5
October
12 19 26 2 9
November
16 23 30 7
December
14 21 a 14-month period. A bullish divergence formed in August–
FIGURE 5: BEARISH DIVERGENCES. On this chart of the S&P 500 index, you can October 2011 as the index moved to a lower low, but MAS(12)
see that although price action in the S&P 500 is trending up, the MAS, RSI, and MACD formed a higher low. This divergence was confirmed with an
indicate otherwise. MAS(12) break above 50. Also notice that SPX exceeded the
August high in the middle of October. An MAS(12) bearish
NYSE COMPOSITE divergence formed in January–April 2012 as the SPX raced
10500
10000
9500
to new highs, but MAS(12) failed to exceed its January high.
9000
8500
8000
MAS(12) and MAS(26) move below 50 in the second half of
7500
7000 April and a break of the support level on the index chart two
6500
6000 weeks later confirmed this divergence.
5500
5000
Another bullish divergence formed in May–June 2012 as
4500 the index moved to a lower low, but MAS(12) formed a higher
4000
MAS(12,26,19) NYA low. This divergence was confirmed with an index move above
MAS(12,26,19) 100, 136.423 200
uptrend downtrend uptrend downtrend uptrend the May high and MAS(12) and MAS(26) break above 50 two
150
weeks later.
100
Also notice that MAS(12) confirmed a lower low in the index
50
in July 2011. It was confirmed with an MAS(12) and MAS(26)
0 move below 50 and index break support in the start of August
-50 2011. Also note that MAS(12,26,19) produced a bad signal,
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
which was confirmed with an index move to a lower low in
FIGURE 6: BULL MARKETS VS. BEAR MARKETS. On this weekly chart of the NYSE
the second half of November 2011. This signal was fixed in
Composite index, you can see how the MAS(12,26,19) behaved during the 2001–2003 bear early December 2011.
market, the 2003–2008 bull market, and the 2008–2009 bear market. A strong uptrend can show numerous bearish divergences.
May 2017 • Technical Analysis of STOCKS & COMMODITIES • 15
 Conversely, bullish divergences can ap-
MAS CALCULATION EXAMPLE pear in a strong downtrend. The chart
Here’s an example of calculating the MAS(12,26,19) for the Dow Jones in Figure 5 shows the S&P 500 large-
Industrial Average (DJIA) in a spreadsheet. cap index ($SPX) from July–December
2009 with MAS(12,26,19), RSI(14), and
EMA (26) EMA(26) MACD(12,26,9) for comparison. Note that
12-day 26-day MAS MAS
Date Close
EMA EMA
Highest Lowest
(26,19) (12,19)
MAS showed fewer lower highs than the
Value(19) Value(19) RSI and MACD did during the uptrend
09/02/2016 18491.96 in the S&P.
09/06/2016 18538.12
09/07/2016 18526.14 TREND IDENTIFICATION
09/08/2016 18479.91
MAS triggers a bullish signal when
09/09/2016 18085.45
MAS(26) exceeds 90 and MAS(12) moves
09/12/2016 18325.07
09/13/2016 18066.75
above or close to 150. Conversely, MAS
09/14/2016 18034.77 triggers a bearish signal when MAS(26)
09/15/2016 18212.48 and MAS(12) move below 10 and -50,
09/16/2016 18123.80 respectively.
09/19/2016 18120.17 The weekly chart of the NYSE Compos-
09/20/2016 18129.96 18261.22 ite Index in Figure 6 shows MAS(12,26,19)
09/21/2016 18293.70 18266.21 during bear market 2001–2003, bull
09/22/2016 18392.46 18285.64
market 2003–2008, and bear market
09/23/2016 18261.45 18281.91
2008–2009. Take note of how it behaves
09/26/2016 18094.83 18253.13
09/27/2016 18228.30 18249.31
during the 2003–2008 bull market. Can
09/28/2016 18339.24 18263.15 you identify any indications of an upcom-
09/29/2016 18143.45 18244.73 ing bear?
09/30/2016 18308.15 18254.49
10/03/2016 18253.85 18254.39 THE POWER OF MAS
10/04/2016 18168.45 18241.17 As I mentioned earlier, MAS shows the
10/05/2016 18281.03 18247.30 location of two trend-following indicators
10/06/2016 18268.50 18250.56
(moving averages) relative to the high–low
10/07/2016 18240.49 18249.01
range of the larger moving average over a
10/10/2016 18329.04 18261.32 18259.14
10/11/2016 18128.66 18240.91 18249.47
set number of periods. MAS(12) bearish/
10/12/2016 18144.20 18226.04 18241.67 bullish divergences produce some effective
10/13/2016 18098.94 18206.48 18231.10 buy/sell signals, the MAS (26) is effective
10/14/2016 18138.38 18196.01 18224.23 in identifying overbought/oversold levels,
10/17/2016 18086.40 18179.14 18214.02 and crossovers in MAS(12) and MAS(26)
10/18/2016 18161.94 18176.50 18210.16 can be used to identify trend changes. And
10/19/2016 18202.62 18180.52 18209.61 if you add an uncorrelated indicator to
10/20/2016 18162.35 18177.72 18206.10
your analysis, it may just add more power
10/21/2016 18145.71 18172.80 18201.63
to your trading results.
10/24/2016 18223.03 18180.52 18203.22
10/25/2016 18169.27 18178.79 18200.70
10/26/2016 18199.33 18181.95 18200.60 Vitali Apirine is a programmer engineer
10/27/2016 18169.68 18180.06 18198.31 with an interest in technical analysis, es-
10/28/2016 18161.19 18177.16 18195.56 pecially the application of relative strength
10/31/2016 18142.42 18171.82 18191.62 index to trading. He may be reached at
11/01/2016 18037.10 18151.09 18180.18 vitapirine@mediacombb.net.
11/02/2016 17959.64 18121.64 18163.84
11/03/2016 17930.67 18092.26 18146.57 18259.14 18146.57 0.00 -48.25
FURTHER READING
11/04/2016 17888.28 18060.88 18127.44 18249.47 18127.44 0.00 -54.54
Apirine, Vitali [2016]. “The Middle-High-
11/07/2016 18259.60 18091.45 18137.23 18241.67 18127.44 8.57 -31.50
11/08/2016 18332.74 18128.57 18151.71 18231.10 18127.44 23.41 1.09
Low Moving Average,” Technical
MICROSOFT EXCEL

11/09/2016 18589.69 18199.51 18184.15 18224.23 18127.44 58.59 74.46 Analysis of STOCKS & COMMODITIES,
11/10/2016 18807.88 18293.11 18230.35 18230.35 18127.44 100.00 160.97 Volume 34: August.
11/11/2016 18847.66 18378.42 18276.08 18276.08 18127.44 100.00 168.85
SIDEBAR FIGURE 1: CALCULATING MOVING AVERAGE STOCHASTIC (MAS)

16 • May 2017 • Technical Analysis of STOCKS & COMMODITIES

 TRADING ON MOMENTUM

Mean-Reversion Daytrading
Last month, this professional trader discussed swing trading
mean-reversion pivot entries. This month, he continues on
the same topic but this time for daytrading.
by Ken Calhoun
ne of the biggest challenges that daytraders face is
DAYTRADING STRATEGY:
BUYING AFTER A MEAN REVERSION
As with swing trading mean reversions, this strategy primar-
ily works for pullbacks of nearly exactly 50%—no more and
no less. Once you spot one of these mean-reversion patterns,
you simply enter your trade when a breakout moves above the
50% price level. From a scanning standpoint, it is smart to

O rapidly scanning for breakouts during the opening 30

minutes of each day’s trading session. If you have ever
overlooked a big opening breakout, you may find the
technique I’ll discuss here especially useful.
By waiting for a 50% retracement, also known as a mean
reversion, you can use this as a second opportunity to enter a
strong-trending stock following a pullback. This article will
show you how to daytrade mean-reversion pivot entries.
It is important to note that this strategy is best used with
stocks priced $20–$70/share with opening moves of at least
one point in a single direction, that then pull back to 50%
before pivoting. It is usually unwise to daytrade penny stocks
or other cheap, less-than-$20 stocks, because they exhibit
choppier, haphazard price action compared to professional
daytraders’ stocks with higher volume and sustainable vola-
tility. The best charts to daytrade are those with wide and
clean, well-defined technical momentum breakout patterns
that are relatively easy to enter and exit, unlike choppy, low-
priced risky stocks that amateurs and undercapitalized traders
unwisely seek to trade.
look at several charts within the same sector once you spot
a mean-reversion pattern, because intraday charts within the
same industry group often exhibit similar price-action patterns
that you can potentially capitalize on.
STEP-BY-STEP ACTION PLAN
Here’s how you can put this strategy to work in your intraday
trades:
Step 1: Look for a chart that has moved up at least one point
during the first 30 minutes of the trading day (9:30–10 am
Eastern Time), as seen in the chart of Harley-Davidson, Inc.
(HOG) in Figure 1 on the morning of October 18, 2016.
Step 2: Next, calculate the mean of this trading range (in
Figure 1, this is ($50 + $53)/2 = $51.50). This is your mean-
reversion pivot price. Wait for price to drop slightly below
this value.
Step 3: Enter a buy-stop order to enter your trade once
price breaks above the
50% mean-reversion pivot
price (in this example, it
is $51.50).

Step 4: A second entry oc-

curs once price action has
broken above the current
day’s high. Use this to add
to your winning position
($53.40 in this chart).

Tip: Although most day-

trades are best done inside
a 20-minute round-trip
timeframe, you may find
it useful to also test an
intraday swing trading
technique, in which you let
the position ride until right
before the closing bell, at
which time you close the
eSIGNAL

position (for example, at

FIGURE 1. MEAN-REVERSION DAYTRADING PIVOT. Here you see a trade entry for a daytrade after a 50% retracement. 3:50 pm Eastern Time).
48 • January 2017 • Technical Analysis of STOCKS & COMMODITIES
INSIGHTS: WHY THIS TECHNIQUE WORKS
The mean-reversion daytrading strategy works because it waits
until after the first major wave of short sellers are finished
exiting their positions. Once sellers are done, a “short squeeze”
as well as new buyers come in to start lifting price back up to
retest prior highs. By waiting for a full 50% pullback before
entering, you will find the likelihood of an upside reversal is
better for initiating a new long position, since this 50% mean
reversion is a favorite strategy of professional traders.
TRADE MANAGEMENT TIPS
From a risk management standpoint, you can use a tight $0.40
initial stop for risk management for stocks in the $40–$50/
share price range. Tighter stops of from $0.10–$0.20 are best
for stocks in the $20–$30/share range for daytrading. Trading
mean-reversion pivots like this can help simplify your ap-
proach for keeping tight stops, since the pivot low is an obvious
technical price support level. For those who like to daytrade
quickly, the initial exit target is simply the high of the current
day’s initial breakout resistance level ($53.25 in Figure 1) or
the nearest whole-number resistance level ($53 in Figure 1),
whichever gets hit first for your daytrading exit.
Ken Calhoun, a professional daytrader and educator, is a
producer of trading courses, a live room, and video-based
EHLERS & WAY/BE YOUR OWN HEDGE FUND
Continued from page 18
advance, for exercise at the market on the open of the next
trading day. All you have to do is monitor your own open
positions in each of the four channels, exit a trade when you
get a signal, and replace it with another buy signal on that
day. You can do this in the evening and place your market
orders. The whole process can be completed in less than 15
minutes per day.
AND THEN THERE’S CAPITAL
Like any business, trading your hedge fund
requires capital. Most brokerages require
a minimum account balance of $2,000 or
so. At this minimum level you would be
dividing your hedge fund into four $500
channels. Frankly, that’s a pretty small amount, and it leaves
you with no real initial margin of error for drawdown. Since
you would only be trading a few shares of many stocks with
this low level of funding, commission costs can become a factor
in your trading. All in all, we would recommend a minimum
$10,000 account for your “hedge fund.”
BYPASS THE LEGAL STUFF
This is the United States—you can do anything you want with
your own money. You can trade any way you like. To be clear,
The best charts to daytrade are those
with wide and clean well-defined
technical momentum breakout
patterns that are relatively easy to
enter and exit.
training systems for active traders. He is a UCLA alumnus
and is the founder of TradeMastery.com, an educational
resource site for active traders. In this “Trading on Mo-
mentum” monthly column, he covers the topic of breakout
trading techniques.
FURTHER READING
[2016]. “Mean-Reversion Swing Trading,” Techni-
cal Analysis of STOCKS & COMMODITIES, Volume 34:
December.
See our Traders’ Tips section beginning on page 50 for implementa-
tion of Calhoun’s idea (with a focus on his December 2016 column)
in various technical analysis programs. Accompanying program
code can be found in the Traders’ Tips area at Traders.com.
what we mean when we say “be your own hedge fund” is the
way you go about conducting your own trading, not accepting
somebody else’s money to trade. That way, you don’t have to
worry about the legal issues that come with managing other
people’s money. What we’ve described here is using proven
trading signals and employing diversity to reduce your risk
exposure.
TAKE OWNERSHIP
The concerns you may have about trading can be addressed
by treating your own money as if it were in a hedge fund with
you as the fund manager. This requires establishing your own
trading style, acquiring trading signals (if necessary, by lease),
and applying diversity to reduce risk. This is all very doable
with the technology available today.
S&C Contributing Editor John Ehlers is a pioneer in the use
of cycles and DSP technical analysis. He is president of MESA
Software. MESASoftware.com offers the MESA Phasor and
MESA intraday futures strategies. He is also the chief scien-
tist for StockSpotter.com, which offers stock trading signals
based on indicators and statistical techniques.
Ric Way is an independent software developer specializing
in programming algorithmic trading signals in C#. He may
be reached at ricway@live.com.
‡StockSpotter.com
January 2017 • Technical Analysis of STOCKS & COMMODITIES • 49
 TRADING ON MOMENTUM

Mean-Reversion Swing Trading

This month, we take a look at a technique for entering a long
position in a trend continuation following a pullback after
a breakout.
by Ken Calhoun
ntering new trades following a 50% retracement, also
pullbacks (that is, less than 50%) or major pullbacks (that
is, more than 50%) in uptrends is a hit-or-miss proposition.
Instead, if you enter after a “close-to-exact” 50% drop that
then starts to recover, you’ll find it may be a more successful
trading strategy.
When you see one of these mean-reversion patterns, you
can enter once a price-action breakout starts to emerge and

E known as a mean reversion, can provide you with a

second opportunity to enter a strong-trending stock
following a pullback. You can use this technical trad-
ing strategy with multiple timeframes, including both swing
and daytrading. This article will show you how to swing trade
mean-reversion pivot entries (I’ll cover intraday trading in an
upcoming issue).
If you have ever missed an initial strong breakout, this tech-
nique can help you enter a trend continuation, once you know
what to look for. Entering your trade after a reversion to the
mean during an upside recovery of price action can also help
when adding to winning trades or as the first trade in a new
position-sizing sequence. I call these simply “1-2-3 patterns”
since there are three major moves in the chart.
TRADING STRATEGY: BUYING AFTER A MEAN
REVERSION
It is important to understand that this strategy primarily
works for pullbacks of nearly exactly 50%, no more and no
less. It has been my experience that buying pivots of minor
recovers above the 50% technical support price. All you have
to do is find a strong trending chart that has pulled back to the
exact middle of the prior trading range and is now starting to
trend back up (preferably on increasing volume).
STEP-BY-STEP ACTION PLAN
Here’s how you can put this strategy to work in your swing
trades.
Step 1: Look for a chart that has trended up for at least five
days with a classic 45-degree angle uptrend, as seen in the
chart of Anadarko Petroleum Corp. (APC) in Figure 1 from
September 2–8, 2016.
Step 2: Next, calculate the mean of this trading range (in
Figure 1, this is ($59 + $53)/2 = $56). This is your mean-
reversion pivot price.
Step 3: Wait until a day after the 50% mean-reversion
pivot price to see if price goes up, as seen on September
15, 2016.

Step 4: Set your buy signal

to enter your trade once price
has moved at least $0.50
above the mean-reversion
pivot price (in this example, it
is $56 + $0.50 = $56.50).

Step 5: Use a $1 initial stop for

risk management. A second
entry occurs once price action
has broken above the prior
15-day high. Use this to add
to your winning position.

INSIGHTS: WHY THIS

TECHNIQUE WORKS
The mean-reversion technical
trading strategy uses a well-
known professional traders’
eSIGNAL

50% retracement pivot entry

FIGURE 1: MEAN REVERSION IN ACTION IN ANADARKO PETROLEUM CORP. (APC). Here you see an example of entering in an already-trending strong
a swing trade after a 50% retracement. stock chart. If you wait until
40 • December 2016 • Technical Analysis of STOCKS & COMMODITIES
 TRADING ON MOMENTUM

after a full 50% retracement before you enter a pivot long,

it helps you avoid weak bounces that do not continue up in
your favor.
TRADE MANAGEMENT TIPS
From a risk management standpoint, you can use a tight $1.00
initial stop-loss value (in this case, $56.50 - $1 - $55.50),
because a loss of the initial 50% mean-reversion support is a
price that proves the trade wrong. You can use this strategy
to build longer-term position trades as well as with opening-
range intraday breakouts. The best thing about this pattern is
its simplicity—you can instantly see if the 50% mean-reversion
pivot is developing, such as the one on September 15, 2016
in Figure 1.
There should be no ambiguity in seeing if a chart has pulled
back to 50% of its prior trading range and is now pivoting
upwards. As always, it is best to swing trade charts in the
$20–$70 price range and avoid cheap, haphazard sub-$20
stocks or poorly leveraged over-$70/share stocks.
If you enter after a “close-to-exact”
50% drop that then starts to recover,
you’ll find it may be a more successful
trading strategy.
Ken Calhoun, a professional daytrader and educator, is a
producer of trading courses, a live room, and video-based
training systems for active traders. He is a UCLA alumnus
and is the founder of TradeMastery.com, an educational
resource site for active traders. In this “Trading on Mo-
mentum” monthly column, he covers the topic of breakout
trading techniques.

BARONE / FUTURES MARGINS must understand how account margin affects your capital
Continued from page 9 requirements and leverage availability.

placed. Say the trade goes sour and the account
balance falls to $8,200, which is $200 below the
maintenance margin. You are now on a margin call of $1,120
($9,240 [initial margin] - $8,200 [new account balance]) and
therefore will need to add at least $1,040 to your account or
get out of one or both of your ES to meet the margin call.
So as you can see, the rules governing margins in futures
trading is different than for equities, and to trade futures, you
Roger Barone currently owns and operates a proprietary
trading firm specializing in futures options. He also regularly
consults with firms, funds, and individuals seeking to launch
new funds or improve returns of existing ones. He has over
10 years of experience in this current endeavor. He may be
reached via email at optproj@gmail.com.

FUTURES FOR YOU

GARNER
Continued from page 25
a catch. If for some reason the price of
the option explodes and cannot be filled
by the exchange at a price between 35.00
and 40.00, the order simply dies, leaving
the trader without a stop-loss order at all.
Option traders can reduce the odds of a
stop-limit order “dying,” leaving them
with unlimited risk, by stating a wider
stop-limit. For instance, a trader could
enter a stop-limit order at 35.00/60.00.
This version of the order leaves the trader
open for 25.00 in price slippage, which
is substantial, but it gives the exchange
more room to work to ensure the order
doesn’t simply go unfilled, leaving the
trader with “naked” risk.
Is it a good solution?
Hopefully, it is clear by now that while
stop-limit orders can be a useful tool for
option traders to keep tabs on risk, it is
not a perfect solution. Massive slippage
and the risk of having no protection at all
December 2016
leave the strategy of using stop-limit or-
ders for risk management a questionable
one. Perhaps a more efficient means of
risk mitigation is the use of long options
(preferably cheaply priced), antagonis-
tic short options, or even long or short
futures contracts to hedge option risk.
If you are interested in learning more, I
talk a lot about these strategies and others
in my latest book, Higher Probability
Commodity Trading.
• Technical Analysis of STOCKS & COMMODITIES • 41
 CYCLE ANALYSIS
Taking A Back Seat
Measuring Market Cycles
If you haven’t given much thought to why certain pa-
rameters are used in indicators, you may be interested
to know that it has a lot to do with measured cycle
periods. Here’s how you can use these measured
periods and apply them to your indicators.
W hy does the relative strength index (RSI)
use 14 bars in its calculation? That was the
question I asked when I first used techni-
cal analysis. The best answer my broker could give
me was “because Welles Wilder says so.” You have
no idea how dissatisfying that answer is to an engi-
neer! So I began my quest for a better explanation. I
discovered that the correct answer to this question is
about measuring the cycle periods that are obvious in
the data, and then tuning indicators to the measured
cycle periods. In this article, I will show you measured
cycles in the equity indexes that occurred in 2015 and
give some tips on how to use these measurements in
your indicators. I’ll also give some advice on how to
measure the cycle periods yourself.
IT’S NO EASY FEAT
Even the most casual inspection of price charts makes
it clear that there are cycles in the data. The problem
is they are frustratingly difficult to measure because
they are ephemeral. That is, the cycles come and go,
and their periods are constantly changing. And to make
things more complicated, market data is noisy, and a
low signal-to-noise ratio can cause cycle measurements
to be wildly inaccurate. In addition, the market data
is fractal. You can look at a chart of daily data and
then look at a chart of weekly data, and the charts
basically look the same if the scales are removed. In
other words, the amplitude of the cyclic swings scales
LISA HANEY
in direct proportion to the cycle period. I call this
effect spectral dilation because longer cycle periods
by John F. Ehlers
have larger swings.
Short-term measurement techniques such as the
phase accumulator, dual differentiator, or homodyne
attempt to measure the bar-to-bar phase shift and
then infer the cycle period from these measurements
because there are 360 degrees in one complete cycle
period. So if the phase shift is 20 degrees between
two bars, then the cycle period must be 360/20 = 18
bars. All such techniques fail because the market
data is so noisy.
Averaging over a longer data length increases the
signal-to-noise ratio. Thus, a longer sampling of data
is required to make a valid cycle period measurement.
Some digital signal processing (DSP) techniques, such
as the Pisarenko harmonic decomposition or Goertzel
algorithms, simply don’t converge to a good solution
because the market cycle period lengths are always
changing. Fast Fourier and discrete Fourier transforms
average the data and provide a measured result but
because the data length used must be relatively short,
the resolution is poor. Wavelets are another way to use
a small amount of data to obtain a valid measurement,
but their resolution is also poor.
The real kicker is that none of the listed techniques
or their cousins account for the effects of spectral
dilation (that is, fractal nature) of market data, and
therefore these techniques give answers that are skewed
toward the longer cycle periods. I know of only two
DSP techniques that consider all of the constraints
and provide reasonable results. These are the autocor-
relation periodogram and MESA.
AUTOCORRELATION PERIODOGRAM
Just as the name implies, the autocorrelation periodo-
gram is computed by first taking the autocorrelation
of the market data and then taking a Fourier trans-
form of the autocorrelation results. For the moment,
consider the market data as a pure cycle. If the data
September 2016 • Technical Analysis of STOCKS & COMMODITIES • 11
is compared to itself a full cycle period back, the result would THE PAST CAN BE USEFUL
be a perfect correlation. If the data is compared to itself a half The measured market cycles for SPY in 2015 are shown in
cycle period back, the result would be a perfect anticorrelation. Figure 1, where I used the autocorrelation periodogram for
Thus, the autocorrelation swings between the limits of -1 and the measurement. The spectral display is shown below the bar
+1, regardless of the length of the cycle period. This limited chart. The horizontal scale of the spectral display is exactly
swing strips away all of the spectral dilation in the original the same as the scale for the bar chart. The vertical scale is the
market data while retaining its periodicity. Then, taking the length of the cyclic components in the spectrum. The color on
Fourier transform of the autocorrelation function gives a true the display indicates the amplitude of the spectrum components
measure of the relative amplitude of all the cycle periods present as a continuum at every location of time and cycle period. The
in the data without bias. The EasyLanguage code to compute color ranges from white hot (yellow) at the maximum amplitude,
the autocorrelation periodogram and to display the spectral through red hot, to ice cold (black) over a 20-decibel range. The
results is given in the sidebar “EasyLanguage Code For The autocorrelation periodogram uses a 48-bar block of data for
Autocorrelation Periodogram” and is also available at http:// each day on the chart because the vertical scale has a maximum
traders.com/files/Ehlers1609.html. of a 48-bar cycle period and it is necessary to use at least one
full cycle period of the longest cycle for the measurement. If
AND NOW MESA the scale were limited to 24 bars, for example, the length of
MESA is an acronym for maximum the data used could be halved.
entropy spectral analysis and is a With reference to Figure 1, the year starts with a dominant
technique I developed more than 30 cycle period of about 22 bars, decreasing to about 18 bars
years ago. It is no longer a product by the end of January. The cycle period drops to be about 10
I offer; rather, it is embedded into bars during February when the prices had the short trend up.
most of the trading strategies I In March through May, the cyclic components were all over
now use to make them adaptive to the place. The smearing, or fuzziness, of the spectral display
current market conditions. means there just was no useful cycle during that timeframe.
MESA works by selecting a The dominant cycle period early in June was about 24 bars,
short segment of data and tuning a declining to about 18 bars in mid-August when the price drop
filter to it so the filter is an accurate replica of the data within occurred. The sharp drop basically destroyed any hope of a
the constraints of the size of the filter. The technique is called rational cycle measurement for a while, and the autocorrela-
maximum entropy because the tuning method basically squeezes tion periodogram responded by displaying a dominant 10-bar
out all the cyclic information it can from that data sample with cycle for about two months. Then, starting in mid-October, the
the residual having maximum noise, or entropy. Then the filter measured dominant cycle period ranged between 18 and 22
is examined offline to test its cyclic response. This technique bars for the remainder of the year.
enables the use of very short segments of data so that the cycle The picture of spectral activity can be enhanced by using
information is relatively stable within that sample. Thus, each MESA with the same conditions—using 48 bars of data to
measurement maximally responds to only that data sample make the measurements. The result is shown in Figure 2, where
and rejects all data outside that sample. Further, the cyclic each spectral line is shown with higher resolution because the
measurement has a high resolution because the display is made width of the yellow area is much thinner. Without going into
independently from the data length. details, there is an approximate 20-bar (monthly) cycle period
present most of the time,
with longer cycles also
present in the April and
September timeframes.
I glean from this, as well
as from many other mea-
surements, that there is
a relatively consistent
monthly cycle present
in the equity index
futures and exchange
traded funds (ETFs). I
do not ascribe causality
to market cycles, but this
certainly makes sense
FIGURE 1: MEASURED MARKET CYCLES FOR SPY IN 2015. Here you see the dominant cycle periods and periods where there
from a fundamental
were no useful cycles. The color ranges from white hot (yellow) at the maximum amplitude, through red hot, to ice cold (black) over a perspective. That is,
20-decibel range. As you see from the chart, the measured cycle periods change over time. from the middle manag-
12 • September 2016 • Technical Analysis of STOCKS & COMMODITIES
 Noisy indicators
delay your analysis
The value of knowing the
dominant cycle period is
the ability to adapt the data
length of an indicator to the
measurement of the cycle. Jurik algorithms
deliver low lag,
low noise analysis
ers on up, everyone has to make their numbers by the month in
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are more complex, traders can explore these using the autocor- Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
relation periodogram code in the sidebar.
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Just knowing the cycle period in market data is not very helpful
by itself. On the other hand, most indicators are sensitive to the
length of data used in their calculation. Therefore, the value of
Jurik Research
knowing the dominant cycle period is the ability to adapt the
data length of an indicator to the measurement of the cycle.
A stochastic indicator basically plots the current price rela- 2010 -- 2011 -- 2012 -- 2013
tive to the lowest price over the computation period. In the Add-In software
case of a pure sine wave, the maximum response extends from
the cycle valley to the cycle peak, a period of a half cycle. If jurikres.com • 800-810-3646 • 719-686-0074
too short a time is used, the indicator saturates and is stuck at
the top extreme or the bottom extreme over an extended time.
If too long a time is used, the stochastic is sluggish and does Clearly, the full length of the measured dominant cycle period
not respond well to shorter-term movements. Therefore, if the is the correct length to be used in this indicator.
dominant cycle period is known, the best data length to use in While synthesizing output waveforms from the multiple ma-
calculating a stochastic is half the dominant cycle period. jor measured cycles is theoretically possible, I do not find the
An RSI is computed by basically taking the difference of process to be practical. There are a triple infinity of parameters
the sum of increasing price deltas less the sum of decreasing describing cycles (period, phase, and amplitude). Of them, only
price deltas over the length of the data sample. In the case of the period is known with reasonable accuracy through spectral
a pure sinewave, all of the price deltas from the valley of the analysis, and adjusting the other two parameters for several
waveform to its peak are increasing and there are no decreasing different cycle periods is, at best, impractical. However, it is
price deltas. Similarly, in the next half alternation, there are no relatively simple to recover the phase of the dominant cycle by
increasing price deltas
and all the price deltas
are decreasing. There-
fore, the best data length
to use in the computation
of the RSI is half the mea-
sured dominant cycle.
If you use a data length
that is too long, the RSI
just averages the price
deltas up and price deltas
down, and is basically
nonresponsive near the
middle of the chart.
The commodity chan-
nel index (CCI) measures
FIGURE 2: ENHANCING THE SPECTRAL CHART. Using maximum entropy spectral analysis (MESA) with the same conditions, that is,
the variation of the prices using 48 bars of data to make the measurements, each spectral line is shown here with higher resolution than in Figure 1 because the
from the mean over width of the yellow area is much thinner. There is an approximate 20-bar (monthly) cycle period present most of the time, with longer
the period of the cycle. cycles also present in the April and September timeframes.
September 2016 • Technical Analysis of STOCKS & COMMODITIES • 13

The best data length to use
in the computation of the
RSI is half the measured
dominant cycle.
correlation after its period has been measured. Just knowing
the period of the dominant cycle is often “good enough” for
trading purposes.
TIPS ON USING INDICATORS
Traders don’t necessarily have to know or measure the dominant
cycle period to improve the usefulness of their indicators. As
Yogi Berra famously said, “You can see a lot just by looking.”
Here are a few useful rules of thumb to know when your indi-
cators are working properly.
1. If the indicator gets stuck at the top or bottom of its range,
then you know the data length used in calculating the
indicator is too short.
2. If the indicator is lethargic and does not swing fully
between the lower limit and the upper limit, then you
know the data length used in calculating the indicator
is too long.
3. Using a shorter data length causes the indicator to have
more of a leading function relative to the market cycle.
Conversely, using a longer data length causes the indi-
cator to have more of a lagging function relative to the
market cycle. Therefore, an effective composite indicator
can be created using the same indicator twice: one with
the optimum computation length and the other with a
computation length of about 60% of the optimum length.
The line crossings can be a clear indication of effective
buy and sell points.
4. Oscillator-type indicators are used to find the trade entry
and exit points for swing trading or reversion-to-the-mean
strategy algorithms. Conventional wisdom has the trader
waiting for confirmation of the turn before making the
trade. I have shown that the most effective swing trading
technique is to anticipate the cyclic turning point.
5. Market cycles are ephemeral. Don’t count on them being
there all the time. In particular, when the market is in a
trend, your cycles-based indicator will typically suggest
entering a countertrend position. It is prudent to not get
run over by that train.
6. Major moves in the market, such as what occurred in
August 2015, virtually destroy useful trading cycles in
14 • September 2016 • Technical Analysis of STOCKS & COMMODITIES
the data. In this case, the only action a trader can take is
to wait until that major move falls outside the computa-
tion window of his indicator.
CYCLES CAN BE MEASURED
There are many techniques to measure market cycles that have
been adapted from the sciences. Most perform poorly because
they fall apart in the low signal-to-noise environments, either
because they require too much stationary data, or because they
cannot converge to a useful solution in the presence of the
ephemeral cycles. Further, only the autocorrelation periodogram
has the capacity to handle the spectral dilation of the market
cycles due to the fractal nature of the data. I have provided the
autocorrelation periodogram code with this article so you can
measure the spectrum of your preferred trading instrument.
While measuring the dominant cycle is useful for maximiz-
ing the performance of indicators and filters, you can improve
the performance of your indicators just by being observant
regarding the indicator performance itself and noting if the
data length being used is too short or too long. If so, you don’t
have to stick to a fixed-length solution.
S&C Contributing Editor John Ehlers is a pioneer in the use
of cycles and DSP technical analysis. He is president of MESA
Software. MESASoftware.com offers the MESA Phasor and
MESA intraday futures strategies. He is holding a workshop
in California this October to fully disclose all his work; more
information on this can be found at MESASoftware.com.
The code given in this article is available at the Subscriber Area at
our website, www.Traders.com, in the Article Code area as well as
at http://traders.com/files/Ehlers1609.html.
See our Traders’ Tips section beginning on page 50 for commentary
on implementation of Ehlers’ technique in various technical analysis
programs. Accompanying program code can be found in the Traders’
Tips area at Traders.com.
FURTHER READING
Ehlers, John [2013]. Cycle Analytics For Traders, Wiley.
[2016]. “Whiter Is Brighter,” Technical Analysis of
STOCKS & COMMODITIES, Volume 34: January.
[2014]. “Predictive And Successful Indicators,” Tech-
nical Analysis of STOCKS & COMMODITIES, Volume 32:
January.
‡TradeStation
†See Traders’ Glossary for definition
‡See Editorial Resource Index
 TRADING ON MOMENTUM

Multiple-Gap Breakouts
This month, we present a breakout strategy for finding swing STEP-BY-STEP ACTION PLAN
trade entries based on a series of upward gaps in an uptrend. Here’s how you can put this strategy to work in your trades.
This professional trader explains what to look for.
Step 1: Scan through 15-day 15-minute stock charts priced
by Ken Calhoun between $20 and $70 per share with a minimum high-low
price range of at least 10% (for example, $3 or more for a
inding strong swing trading breakout charts becomes $30/share instrument) that show a minimum of two gaps

F easier when you find a chart with two or more price-

action gaps in an existing uptrend, occurring several
days apart. Since one of the strongest technical entry
up, similar to the chart of Medivation Inc. (MDVN) il-
lustrated in Figure 1. Note that the price-action gap needs
to be only a gap up from the prior day’s close (as seen on
signals you’ll find is gaps, a series of gaps up is an especially April 6, 2016), not a gap above prior day’s high (as seen
strong pattern that’s useful in locating new, long swing trad- on March 31, 2016 and April 13, 2016).
ing entries.
Step 2: Check that the sequence of two or more gaps is
TRADING STRATEGY: part of a continuous uptrend, in which the gap up prices
15-DAY MULTIPLE-GAP ENTRIES are sequentially higher, as seen in this example. You are
It’s common for traders to miss out on an initial price gap up, looking to enter on a day following either the second or
finding it late, several days after a first gap up is seen. The third gap-up day, at a new high breakout price.
good news is that strong breakout charts often have a series
of tradable in-trend gaps that occur during the days following Step 3: Set a buy-stop order to enter your trade on any day
an initial gap up day. For swing trades that could be of several following the second or third gap up day. Enter once
weeks in duration, it could give you new opportunities to enter price has moved at least $0.50 above the high of the gap
trades following second or third gap up days. If you follow up- up day (I use $0.50 above the current 15-day high as a
trending charts that exhibit this multiple-gap technical trading filter to help avoid false breakouts). In Figure 1, this signal
pattern, you’ll be able to capitalize on new momentum-based occurred on April 15, 2016 ($50 + 0.50) = $50.5.
breakouts as the trend continues upward.
Step 4: You can use
a maximum $2 ini-
tial and trailing stop
55.00
54.00 value on all stock swing
53.00 trades.
52.00
51.00
50.00
49.00
48.00 INSIGHTS: WHY
47.00 THIS TECHNIQUE
46.00
45.00
WORKS
Third long gap 44.00 Institutional pre-market
continuation breakout 43.00
42.00
large volume buy orders
41.00 is what causes price to
Second long gap 40.00
continuation breakout 39.00
gap up. When two or
38.00 more gaps are seen in
First long gap 37.00
an uptrend, it tells you
continuation breakout 36.00
35.00 that institutional demand
2.00M is so strong that price-
1.80M
1.60M
1.40M
action breakout strength
1.20M
1.00M
is likely to continue.
800K
600K You can trade break-
400K
200K outs above this series
eSIGNAL

09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30
3-29-2016 3-30-2016 3-31-2016 4-1-2016 4-4-2016 4-5-2016 4-6-2016 4-7-2016 4-8-2016 4-11-2016 4-12-2016 4-13-2016 4-14-2016 4-15-2016 4-18-2016 of gaps because buying
FIGURE 1: MULTIPLE LONG GAP CONTINUATION. Here you see a sequence of three gaps that provide a technical long breakout
signal. Continued on page 53
July 2016 • Technical Analysis of STOCKS & COMMODITIES • 45
of generating long or short entry signals.
For those crossovers where a trend appears to be in progress,
this seems to work well. In sideways patterns where a trend is
not well established, this technique can lead to whipsaws.
This indicator can give the trader a very early warning of
trend changes. For safety, one should look for additional entry
confirmations to control risk.
A note about the EMA calculations used in this article: In
this filter, Ehlers is using a more aggressive alpha calculation
to build his EMAs than is used in either of the perhaps more
familiar EMA versions. This EMA is significantly more
reactive to the most recent input value than a standard EMA
or a Wilders’ EMA.
Here is the formula for Wilders’ EMA:
α = 1/N
Using N = 40: α = 1/N = 0.02500, and (1 - α) = 0.97500
And finally, here is the formuala as used in the super band-
pass filter:
α = 5/N
Using N = 40: α = 5/N = 0.12500, and (1 - α) = 0.87500
The spreadsheet file for this Traders’ Tip can be downloaded
from www.traders.com in the Traders’Tips area. To successfully
download it, please follow these steps:

Generalized EMA formula = price today * α + EMA yesterday * • Right-click on the Excel file link (“SuperPassband-
(1- α) Filter.xlsm”), then
• Select “save as” to place a copy of the spreadsheet file
Here is the formula for a more standard EMA, as found in on your hard drive.
many software packages:
—Ron McAllister
Excel and VBA programmer
α = 2 / (N+1)
rpmac_xltt@sprynet.com
Using N = 40: α = 2 / (N+1) = 0.04878, and (1 - α) = 0.95121

Find the complete collection of Traders’ Tips

and code at our website, Traders.com.
Subscribers will also find code from past
articles (from Nov. 1999 onward) at our web-
site in the Article Code area, for downloading
or copy & paste.

TRADING ON MOMENTUM

CALHOUN/MULTIPLE-GAP BREAKOUTS Strong breakout charts often have a

Continued from page 45
pressure leads to a continuous price movement during this
uptrend. The multiple price gaps serve as technical alerts that
buy-sell imbalance is extremely strong (and likely to continue),
which is why this gap breakout pattern is a favorite among
professional traders.
TRADE MANAGEMENT TIP:
ENTERING AFTER EVERY GAP
As part of a position sizing approach, you should look to add
to any winning open swing trade on a day following a gap
up ($0.50 above the high of the gap up day), each time a gap
occurs. The reason for waiting to add to your position until the
day after a gap up is to avoid gap retracement (gap fill) days.
series of tradable in-trend gaps that
occur during the days following an
initial gap up day.
Trading several entries with a strong swing trading chart using
the help of multiple in-trend gaps can provide the foundation
of a successful swing trading approach.
Ken Calhoun is a producer of trading courses, live room,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for active traders.

July 2016 • Technical Analysis of STOCKS & COMMODITIES • 53


You have to have the
passion—not the passion
for making money, but a
passion for the game. You
have to have the passion
for trading.
tion! I tried out as many indicators as I
could and came to the realization that
it’s difficult to have them work the way
you want them to work. I don’t mean to
say they don’t work or that a combina-
tion of them doesn’t work well. As Jack
Schwager—trader and author of the
Market Wizards series—said, there are
a million ways to make money in the
market but they’re not easy to find. So
everyone has got to find what works for
them and what fits their personality. For
me, I had this realization, after two to
three years of trying just about every
possible indicator combination, when I
finally removed all the indicators from
my chart. I signed onto my trading plat-
form one day and cleared off my chart
of all the indicators. And that’s when I
had this “aha moment.” I was looking
at a naked chart and could see all these
levels on the chart because without
all the indicators I could now see the
candlestick bars.
You couldn’t do that before?
What I had on my charts were maybe
three or four indicators displayed in
subcharts below the price chart. That
made the chart so small and narrow that I
couldn’t clearly see what was happening
with the price action. When I removed
those indicators, I was looking at a chart
that was twice as big and I could see
some critical levels in the price action.
It was interesting in that they just started
popping out for me. And that’s when I
said, “Oh my gosh, there it is. What have
I been doing all this time?” So I think
that when you get back to basics, you
see the market for what it is.
That’s interesting. Was it this discovery
that led you to calling your blog “Daily
Price Action”?
34 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
Yes, exactly. I came to realize is persistence. I mean, that is the only
the importance of price action thing. But in order to do that, you have
trading and that’s all I discuss to have the passion. And it’s not a pas-
on my blog. sion for making money, it’s a passion for
the game. It’s a passion for trading. You
When you look at patterns such have to get excited about it. When you
as head & shoulders, ascending look at the markets and you don’t get
and descending channels, or the excited from watching the markets and
pin bar (see sidebar, “What’s A seeing how they react to news, then your
Pin Bar?”), you’re just focusing chances of succeeding are slim to none
on price action. What charts did because you’ve got to have that passion
you perform this type of analysis on? for the game. That passion is the only
I only started this when I was trading thing that’s going to get you through the
forex. Prior to that I was using anything tough times. A passion for the money
I could get my hands on. I also tried isn’t going do it.
fundamental analysis. I was determined
to make this work but everything I tried That’s a different outlook than most
wasn’t working. That’s why I went for people have. You teach people how to
something quite drastic, and that was to trade forex. Do you find there’re a lot
remove everything from the charts. of people who come in with the drive
to make money or do they really want
What I find interesting about your to learn?
trading journey is your perseverance. Oh yes, it’s quite pervasive. I would
For you it was the determination to find say that 80% to 90% of the people who
consistency through a technique that come to me, whether it’s somebody who
works for you. What kept you going? wants to join my community or an email
I always tell people that the only thing that I receive, do so based on the desire
that separates someone who succeeds in to make money. Everyone wants to know
this business and someone who doesn’t how they can make more money. They
WHAT’S A PIN BAR?
The pin bar, a candlestick pattern well known to forex traders, was originally
given the name Pinocchio bar by technician Martin Pring. Yes, it has a long
“nose,” or long wick, so the open and close are at either the top or bottom of the
candle’s range. The nose or wick has to be at least two-thirds of the range of the
entire bar, and a longer nose means the signal is more powerful. In some ways,
it’s identical to what’s known as a hammer, or the bearish version of it, which
is a shooting star. And there’s a reason why Pring called it a Pinocchio bar. It
deceives you into believing that price is breaking out and moving in a specific
direction. Alas, that’s not what it might end up doing. So when you see a pin bar
forming, chances are price will reverse.
Bullish Pin Bar Bearish Pin Bar
Bearish pin bar
Bearish candle Bullish candle
Bullish candle Bearish candle
Bullish pin bar
 OPTIONS

The Equalizer

VIX Or Historical Volatility?

Position sizing is an often overlooked variable when
it comes to strategizing your trades. There are differ-
ent ways to decide how big your positions should be
and here we look at a unique approach to size your
positions using volatility.
irst, let’s agree that always trading 100
you are counting on those trades being better. If you
knew that, you would only take those trades and skip
all the others.
ENTER VOLATILITY
Volatility is like a volcano—quiet for long periods,
and then violent eruptions. To use volatility success-

F shares, or one futures contract, isn’t as good

as varying your position size based on price
volatility. If you don’t agree, my first example
will show why it’s a problem. Until then, I’m going
to assume that we’ll use volatility. When markets are
quiet, positions will be larger; when they are volatile,
positions will be smaller. The key here is: How big
and how small?
The principle behind correct position sizing is called
volatility parity, that is, you equalize the volatility of
each trade, which in effect equalizes the risk, more or
less. There are more sophisticated ways to equalize
risk, but volatility parity is much simpler and gets you
90% of the solution.
By equalizing the risk of each trade, you give each
trade an equal opportunity to affect the results. From
that you can conclude you’ve maximized diversifi-
cation. If you concentrate your investment in a few
markets and trade larger positions in terms of risk,
fully, traders need to know which one—historical
(HV) or implied (IV)—is best. Historical volatility is
measured from actual prices, while implied volatility
(also tracked as the VIX index) comes from options
pricing. I would like to think that IV would be more
accurate because it represents what traders are will-
ing to pay today rather than the lagging calculation
represented by historical prices. You won’t really
know unless you try using it.
The chart in Figure 1 compares the long-term his-
torical and implied volatility (on the left) and 2008
on the right. The bigger picture makes it appear that
both methods produce close to the same values, but a
closer look at 2008 shows the differences. Historical
volatility continues to increase after implied volatility
has flattened. But this pattern is not always the case.
IV can spike on surprising news, then disappear the
next day when that news turns out to be only a rumor.
HV would show only a small change.

Historical and Implied Volatility Volatility Comparison, Jul-Dec 2008

120 120
100 100
80
80
60
60
40
20 40

0 20
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
/20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 /20 0
6 /23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23 6/23
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 07/01/2008 08/01/2008 09/01/2008 10/01/2008 11/01/2008 12/01/2008

VIX Historical volatility (annualized) Implied volatility Historical volatility

BRIAN TAYLOR

FIGURE 1: COMPARISON OF HISTORICAL AND IMPLIED VOLATILITY. The chart on the left looks at historical and implied volatility from 2000 to 2016. The
chart on the right looks only at 2008. The bigger picture makes it appear that both methods produce close to the same values, but a closer look at 2008 shows the
differences.

by Perry J. Kaufman
March 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 The principle behind correct
position sizing is called
volatility parity, that is, you
equalize the volatility of each
trade, which in effect equalizes
your risk, more or less.
pattern of tests 4 and 5 are similar, with a few added spikes in
test 4 that do not appear in test 5.
WHICH IS BETTER?
These tests were designed to show the ideal returns of each choice
rather than the practical application, where the size is limited
by the investment. In the first two tests, using 100 shares means
that a few trades taken under high volatility might have large
gains or large losses, overwhelming many trades that occur at
low volatility. In Figure 2 you see a summary of the results.
Intuitively, you expect the returns from the long positions
to be better than the shorts because of the upward bias of the
stock market. Still, the shorts were all profitable, which is a
good outcome. Trades that can be profitable on both the long
and short side show that the timing is good.
Tests 1 and 2: 100 shares, without and with capping
Tests 1 and 2 both trade 100 shares, but test 1 doesn’t care
if the 100 shares give an exposure of $500 or $100,000. The
higher price of the SPY in the more recent years will have
greater value and will influence the results to a much greater
degree. In 1998 the SPY traded at 80 and now trades at about
220. The five-year bull market that followed the financial
crisis will have a greater impact than the bear markets of
2001 and 2008. That creates a poor portfolio risk profile
because lower-priced stocks may be performing well but are
overwhelmed by losses in a high-priced stock. Even though
the profit factor of 2.14 is high, I see this case as highly risky
because it can be distorted by a few big trades.
In addition, you need an increasingly larger investment to
keep trading. In 2000 the SPY traded at 150, so 100 shares
Cumulative Profits, Tests 1, 2, and 3
25000
20000
15000
10000
5000
0 0
-5000
0 1 2 3 4 5 6 7 8 9
00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01
/ 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2
06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06
T1 PL T2 PL
FIGURE 4: VOLATILITY PARITY IS THE BEST SOLUTION. On the left, test 1 outperforms tests 2 and 3 (which overlap each other), but this is unrealistic because
the investment size exceeds the limit of $10,000 per trade. In this case, test 3 is the most practical. Test 5, using implied volatility, has some unacceptable rallies
and drawdowns from 2008 to 2010. Test 4 gives the best results overall, but the investment size varies enormously, making it impossible to implement.
12 • March 2017 • Technical Analysis of STOCKS & COMMODITIES
would cost $15,000. In mid-2016 it was 220, an investment
of $22,000 per trade.
When you cap the exposure in test 1 to $10,000 per trade,
which gives each trade equal impact, the results drop and are
far less attractive. Trades when SPY was under 100 will still
have smaller representation, but any trading priced over 100
will have its size reduced. As an aside, we can infer from this
that trades in SPY have been better at higher prices.
Test 3: Size by price
This is the most common way of sizing that achieves equal
risk in a simple way. The per-trade investment of $10,000
is divided by the current price of SPY to get the number of
shares. When you use this method for trading, you should
avoid stocks priced under $5. They are more volatile and
erratic, plus the position sizes expand rapidly as the price
falls under $5.
The results were nearly identical to test 2 because that
test had all trades that were entered when SPY was over
100 reduced to a total exposure of $10,000. That was most
of the trades.
Test 4: Real volatility parity
This is an interesting test because it is the ideal case, that is,
money-is-no-object case of volatility parity. Each trade size
creates exactly the same risk as every other trade. This means
that the position sizes are very large during low volatility,
and very small during high volatility.
The long profit factor of 3.50 is far above the others, showing
that, in theory, true equal risk is the best way to trade. On the
downside, it takes more than $1 million to trade this way.
Test 5: Using implied volatility
This is where I thought implied volatility could outperform
historical volatility by a large factor. Instead, it produced an
average result. My experience with this is that implied volatil-
ity jumps up quickly, avoiding the lag in historical volatility.
But then it also disappears quickly when nothing happens.
That results in a lot of false volatility spikes.
It may also be that my formula for turning the VIX price
Cumulative Profits, Tests 4 and 5
12000 1400000
10000 1200000
8000 1000000
800000
6000
Test 5
Test 4
600000
4000
400000
2000 200000
0
-2000 -200000
0 1 2 3 4 5 6 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6
00 00 00 00 00 00 00 00 00 00 01 01 01 01 01 01 01
/ 2 3/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2 /23/2
06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06 06
T3 PL T5 PL T4 PL
 (or volatility) into a sizing factor could
be flawed. It is simply F = 100 – VIX
or zero, whichever is larger. So when
volatility is very high we have no shares.
In reality, VIX has averaged 21% over
time, and most values stay in the range
13% to 30%, rarely going over 50%. But
the sizing using VIX should be different
from using price. It would have cut size
dramatically during 2008 and would
have increased significantly during the
long bull rally that followed.

VISUALIZING
THE RESULTS
Sometimes numbers
aren’t enough. In Figure
4 you see the cumula-
tive profits for each of
the five tests. On the left,
test 1 outperforms tests
2 and 3 (which overlap each other), but is
unrealistic because the investment size
exceeds the limit of $10,000 per trade.
From these tests you would conclude that
test 3 is the most practical.
Tests 4 and 5 (on the right) are more
difficult to interpret because position sizes have been allowed Perry Kaufman is a trader and financial engineer. He is the
to exceed the $10,000 investment. Here you are looking for the author of many books on trading and market analysis, including
smoothness of the returns. This shows that test 5, using implied Trading Systems And Methods, 5th ed. (with the first edition
volatility, has some unacceptable rallies and drawdowns from published in 1978 as a seminal book in the field of technical
2008 to 2010, while using the ideal volatility parity sizing based analysis), and A Guide To Creating A Successful Algorithmic
on historical volatility (test 4) gives the best results overall. Un- Trading System (2016). For questions or comments, please go
fortunately, with test 4 the investment size varies enormously, to www.kaufmansignals.com.
making it impossible to implement. However, it does prove that,
theoretically, volatility parity is the best solution. FURTHER READING
Kaufman, Perry J. [2013]. Trading Systems And Methods, 5th
MAKING THE CHOICE ed., Wiley.
Except for test 5, which uses IV, the others are extremely close. [2015]. A Guide To Creating A Successful Algorithmic
As a final measurement, I calculated the ratio of the total profits Trading System, Wiley.
divided by the standard deviation of the daily profits and losses, [2003]. A Short Course In Technical Trading, Wiley.
a reward-to-risk ratio similar to the Sharpe ratio. Results are [1995]. Smarter Trading, Wiley.
shown in the table in Figure 5. [2014]. “A Better Trend,” Technical Analysis of STOCKS
To be practical, test 3 is the easiest choice because you simply & COMMODITIES, Volume 32: April.
divide the investment per stock by the current price. While test 2 [2014]. “Timing The Market With Pairs Logic,” Technical
may have a slight edge because it trades smaller exposure when Analysis of STOCKS & COMMODITIES, Volume 32: March.
the value of 100 shares is less than $10,000, it wouldn’t apply
to SPY now. Given a choice, I always prefer simpler.

Test 1 Test 2 Test 3 Test 4 Test 5

0.577 0.546 0.540 0.596 0.462
FIGURE 5: REWARD-TO-RISK RATIOS FOR ALL TESTS. Test 3 is the easiest choice
because you simply divide the investment per stock by the current price. Test 2 may
have a slight edge because it trades smaller exposure, but because the value of 100
shares is less than $10,000, it wouldn’t apply to SPY now.

March 2017 • Technical Analysis of STOCKS & COMMODITIES • 13

 Which Bar Do You Like?
Price Action Analysis
Using Candlesticks
Yes, it is possible to analyze price charts without using any
indicators. Here’s the raw deal.
by Solomon Chuama
pen up a candlestick chart of any stock with no
O indicators and analyze the price action on that chart
for a certain period of time. This is known as price
analysis using naked charts. You’re using natural
or “raw” price movement of the market to analyze
and make all your trading decisions. You can use
this raw price action analysis to trade any financial
market, whether it is forex, futures, or equities. The
market oscillation “footprints” that are left behind give you a
clue to the market’s direction.
You’re familiar with candlestick patterns. These patterns
are a good way to analyze price action. A description of
44 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
some candlesticks is given in the sidebar “Bullish & Bearish
Candlesticks.”
APPLYING PIN BARS
BULL FOOTPRINT: WIKTORIA MATYNIA/BEAR FOOTPRINT: NEVENA BARBERIC/
Pin bars are referred to by other names in the candlestick
DRAGONFLY: SINNA NYAN/SHUTTERSTOCK/COLLAGE JOAN BARRETT
world. For example, a bearish pin bar is called a shooting star,
gravestone doji, or inverted hammer. A bullish pin bar can be
a hammer or dragonfly doji. These patterns can be identified
because they protrude significantly from the surrounding
price bars. When they occur at the support & resistance levels
or at confluent levels, you can consider them to be relatively
accurate setups.
In Figure 1 you see a daily chart of CADCHF. There are three
pin bars: a long tail pin bar buy signal, a pin bar buy signal,
and a pin bar sell signal. In every bullish pin bar reversal setup,
the pin bar tail usually points down, which indicates rejection
of lower prices or support level. This setup often leads to an
 TRADING FOREX

upward move in price.

The long tail pin bar buy signal
is more significant than the others.
This is because the longer the tail,
the more powerful the price rejec-
tion. It helps to push prices in the
opposite direction. The next pin
bar buy signal also pushed price

IFX TRADER (METAQUOTES SOFTWARE CORP.)

upward. The pin bar sell signal is
a bearish pin bar reversal setup,
where the pin bar’s tail points
up, indicating rejection of higher
prices or level of resistance. This
setup often leads to a fall in price.
Not all long tail pin bars are going
to work perfectly, which is why
you need to place your stop orders FIGURE 1: APPLYING PIN BARS. On this chart of CADCHF, you’ll notice there are three pin bars; a long tail pin bar buy
when you act on one of them. signal, a pin bar buy signal, and a pin bar sell signal. The long tail pin bar buy signal is more significant than the others,
because the longer the tail the more powerful the price rejection. It helps to push prices in the opposite direction. The pin
bar sell signal is a bearish pin bar reversal set up, where the pin bar’s tail points up indicating rejection of higher prices
HOW TO OPEN A or level of resistance. This set up often leads to a fall in price.
PIN BAR TRADE
As per the chart in Figure 1, you
should be able to identify the
bullish pin bars which require a
buy order. You can buy CADCHF
currency pair after the first candle-
stick closes above the small wick
(tail) of the pin bar as per the blue
line. Similarly, in Figure 1, as per
the bearish pin bar, you can sell
CADCHF after the pin bar closes
as per the blue line.

PLACING YOUR STOP-LOSS

ON A PIN BAR
In a bullish pin bar, you place the
stop-loss below the longer candle-
wick of the pattern as per the red
FIGURE 2: THE INSIDE BAR IN AN UPTREND. Inside bars provide visual evidence the market has contracted and
line. For the trade to work, do not may be ready to reverse the current trend. Here you can buy AUDNZD when the price action breaks the upper level
use the exact high or low of the of the inside bar range (blue line). Your stop-loss should be located below the lowest point of the inside bar of the buy
wick when placing the stop-loss order (red line).
but give additional room to avoid
being caught up in the run. In a bearish pin bar, place your two candlesticks. The first candlestick engulfs the range of
stop-loss above the longer candlewick of the pattern as per the entire subsequent candlesticks. It is similar to a bearish
the red line. or bullish harami candlestick pattern. The difference with an
inside bar is that the highs and lows are considered while the
SETTING PROFIT TARGETS IN PIN BAR TRADES real body is ignored.
Setting a profit target is one way to exit a trade. Another way The inside bar is also different from the “engulfing pattern”
is through a stop-loss. One way to determine your take-profit because the inside bar engulfs the entire range of the bar
is to multiply the size of your pin bar by three. You can close from high to low, whereas the engulfing pattern includes the
your trade if you spot another reversal candlestick while in engulfment of the real body of the candle. Inside bars have
a trending market. A third way is to close your trades at the the following features:
next support or resistance level.
• It is a trend continuation signal.
APPLYING INSIDE BAR PRICE ACTION STRATEGY • They occur at major turning points and at support &
An inside bar is a candlestick pattern that is made of at least resistance levels. They provide visual evidence the
October 2017 • Technical Analysis of STOCKS & COMMODITIES • 45
 BULLISH & BEARISH CANDLESTICKS
Bearish candlesticks include:
Shooting Star: It has an upper shadow and no lower
shadow but has a small body. At the support level it is
called an inverted hammer and at the resistance level
it is called shooting star. It is also called a pin bar.
Bearish Engulfing Pattern: This candlestick consists
of a large black real body that engulfs a small white real
body in an uptrend. The second candlestick must engulf
the prior candlestick, and not necessarily its shadow.
Also, the second real body of the engulfing pattern should
be the opposite color of the first real body.
Gravestone Doji: This consists of an upper shadow,
open, low, and close at or close to the session low. It
signals the reversal of an uptrend.
Dark Cloud Cover Pattern: It appears as two candle-
sticks at the resistance level. The black candlestick will
cover 50% and more of the white candlestick. In other
words, the black candlestick close must be the half way
point of the white candlestick’s real body, otherwise a
bearish confirmation would be required.
Hanging man: Hanging man is like a hammer; it has
little or no upper shadow. The lower shadow is twice
the real body. It can be found at the resistance level
and is also called a pin bar.
Tweezers Tops and Hanging man: Tweezers tops are
two or more candlestick lines with matching highs. They
are called tweezers because they are compared to the
two prongs of a tweezers. In a rising market, a tweezer
top is formed when the highs match.
Bearish Harami Cross: A harami cross includes a
long real body and a doji candlestick. A harami cross
is a potent cross which warns that there would be a
significant trend change. The harami cross is a major
reversal pattern unlike the regular harami pattern; this
is found in an uptrend.
Bearish Harami Pattern: It is found in an uptrend at the
resistance level. The body of the first candle is the same
color as the current trend. The first body of the pattern is
a long body, the second body is smaller. The open and
close occur inside the open and close of the previous
day. Its presence indicates the trend is over.
46 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
Bullish candlesticks include:
Hammer: This pattern has little or no upper shadow.
The lower shadow is twice the real body. It is also
called a pin bar.
Inverted Hammer: It has an upper shadow and no lower
shadow but has a real small body. At the support level it
is called an inverted hammer but at the resistance level
it is called Shooting Star. It is called a pin bar.
Dragonfly Doji: It has a long lower shadow. The open,
high, and close are near session’s high. When a doji
forms after a series of bullish candlesticks with long
hollow bodies, it signals that buyers are becoming
exhausted.
Bullish Engulfing Candles: The candlesticks are
dual in nature. The white real body engulfs the black
real body when the market is in a downtrend. The two
candles must have opposite colors.
Piercing Pattern: The candlesticks in this pattern are
dual in nature. The white candlestick will cover 50% and
more of the black candlestick. The white candlestick
opens at the lower of the black candlestick and closes
above the midpoint of the black real body.
Tweezers Bottom and Hammer: These are two more
candlesticks in a downtrend where the individual lower
shadow of the candlesticks is the same. They are not
usually significant reversal candlesticks.
Bullish Harami Cross: Harami cross includes a long
real body and a doji candlestick which warns of a
significant trend change. The Harami cross is a major
reversal pattern unlike the regular Harami pattern; this
is found in a downtrend.
Bullish Harami Pattern: This is found in a downtrend
at the support level. The body of the first candle is the
same color as the current trend. The first body of the
pattern is a long body, the second body is smaller. The
open and close occur inside the open and the close of
the previous day. Its presence indicates that the trend
could be over.
 market has contracted and
may be ready to reverse the
current trend.
• If the preceding period is
a black candle, the inside
bar must be white and vice
versa.
• In an uptrend, each expan-
sion candle will make a
higher high than the previ-
ous day. Then the inside
candlestick pattern shows
the market has contracted.
Similarly, in a downtrend,
each expansion candle will
make a lower low than the
previous day. Then inside FIGURE 3: THE INSIDE BAR IN A DOWNTREND. In a downtrend, each expansion candle will make a lower low than
candlesticks show the mar- the previous day. Then inside candlesticks show the market has contracted. You can sell GBPUSD when the price ac-
ket has contracted. tion breaks the lower level of the inside bar range (blue line). Your stop-loss should be located above the highest point
of the inside bar of the sell order (red line).

HOW TO OPEN AN
INSIDE BAR TRADE
In the example provided in Figure 2, you can buy AUDNZD
when the price action breaks the upper level of the inside bar
range (blue line). Similarly, in Figure 3, you can sell GBPUSD
when the price action breaks the lower level of the inside bar
range (blue line).
PLACING YOUR STOP-LOSS ON AN INSIDE BAR
In Figure 2, your stop-loss should be located below the lowest
point of the inside bar of the buy order (red line). In Figure
3, your stop-loss should be located above the highest point
of the inside bar of the sell order (red line). Your profit target
should be twice the size of your initial risk.
PIN OR INSIDE?
Pin bars work in all timeframes, especially in one-hour, four-
hour, and daily charts, but for a price action trader, a daily
chart is preferable. However, when price action signals form
on the one- and four-hour charts that agree with your entry
criteria, then you can trade them. Consistent profits can be
made by trading pin bar formations, especially at support &
resistance levels. In other words, pin bar trading is more ac-
curate if the formation is clear, combined with solid support
& resistance confirmation. The more confluence added to a
pin bar formation, the more accurate it becomes.
One good thing about inside bar setups is that they provide
visual evidence the market has contracted and may be ready
to reverse the current trend. You can see an inside bar form
as a continuation signal or as a turning point signal. You can
use both setups but the continuation signal is more reliable
for new traders.
I have provided examples of charts for pin bars and inside
bar candlesticks. The other bullish and bearish reversal
candlesticks follow the same entry criteria. You can zoom in
the chart for proper candlestick identification.
Solomon Chuama has been working in the financial industry
for 16 years. He is a training seminar organizer and instructor
who tries to pass on to students his passion and knowledge
of forex trading.
FURTHER READING
Chuama, Soloman [2016]. “Trade Using Pure Price Action,”
Technical Analysis of STOCKS & COMMODITIES, Volume
34: July.
‡IFX Trader (Metaquotes Software Corp.)

When price action signals

form on the one- and four-hour
charts that agree with your
entry criteria, then you can
trade them.

October 2017 • Technical Analysis of STOCKS & COMMODITIES • 47

 TRADING ON MOMENTUM

Price Projection Breakouts

In this regular column covering the topic of breakout trad- If you use these box ranges to help you project price targets, it
ing techniques, this professional daytrader and educator will soon become a trusted part of your approach to managing
explains how looking for prior trading ranges can help you your trades. It will also provide you with new opportunities
manage new breakout entries by helping you determine how to enter second or third trades for swing trades as a breakout
far a new swing trading breakout is likely to trend before trend continues. Equally important, by using price projection
consolidating or reversing. breakout ranges you can avoid buying near price exhaustion
areas just under anticipated resistance areas. This technique
by Ken Calhoun can also help you avoid entering false breakouts.

raders often struggle when deciding exactly when to STEP-BY-STEP ACTION PLAN

T enter and exit their trades. If you use price elasticity

as a guide to managing your trades, you can simplify
this task. A professional trading technique you may
Here’s how you can put this strategy to work in your trades:

Step 1: Scan through 15-day 60-minute stock charts priced

find helpful is price projection, which is when you use prior between $20 and $70 per share that show a bullish cup
trading ranges to forecast how to manage a new breakout pattern occurring in the first five to 12 days, similar
entry as it occurs. to the chart illustrated in Figure 1 of NVIDIA Corp.
(NVDA). A bullish cup looks like the letter “U” with
TRADING STRATEGY: a clearly defined top and bottom, as indicated by the
15-DAY PRICE PROJECTION ENTRIES price action seen inside the “box trading range” marked
By looking for these trading ranges, referred to as box trading in this chart.
ranges, with obvious support & resistance levels, you can spot
how far a new swing trading breakout is likely to trend before Step 2: Identify how many points of high–low range
consolidating or reversing. A box range is found by looking this first cup has, to the nearest $0.50. In Figure 1, it’s
for the high and low of a major cup pattern (or consolidation ($37.50 - $34.50) = 3 points. Now mark out these price
region) and making a mental note of how many points are projection values on the chart.
seen in this trading range.
Step 3: Enter your trade on any day following either a
gap or breakout that
takes price to a new
44.00
43.50
high above the prior cup
43.00 pattern high. If you miss
Price projection #2: 42.50
42.00
the first price projection
($40.5 + $3) = $43.5
41.50 entry (in this case that’s
41.00
40.50
a long over $37.50 on
Box Trading Range: 40.00 May 13, 2016), set a new
($37.5 - $34.5) = 3 points Price projection #1: 39.50 entry above the second
39.00
($37.5 + $3) = $40.5 38.50 price projection. In Fig-
38.00 ure 1 you can see that
37.50
37.00 would be over $40.50.
36.50 A third entry would
36.00
35.50 be over $43.50, and a
35.00 fourth entry would be
34.50
34.00 over ($43.50 + $3) =
14.00M
$46.50, and so on.
12.00M
10.0M
8.00M Step 4: You can use a
6.00M
4.00M maximum $2 initial and
2.00M trailing stop value on all
eSIGNAL

09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30 09:30 13:30
4-28-2016 4-29-2016 5-2-2016 5-3-2016 5-4-2016 5-5-2016 5-6-2016 5-9-2016 5-10-2016 5-11-2016 5-12-2016 5-13-2016 5-16-2016 5-17-2016 5-18-2016 stock swing trades.
FIGURE 1: NVIDIA CORP. (NVDA), Multiple Price Projection Entries. This series of two price projection entries provides two techni-
cal long breakout signals. Continued on page 46
August 2016 • Technical Analysis of STOCKS & COMMODITIES • 13
 Q&A
that are possibly on the mend and have
significant upside potential. These stocks
cover a variety of industries over a few
different sectors. This is diversified but
still a performance related basket for
long trades.
Preliminary choices for trader to
make
Action 1: Execute all stocks at open
using a market-on-open order
Benefit 1: Good liquidity and no slip-
page
Problem 1: May pay too much premium
for any one stock.
Action 2: Execute all stocks at open
using a limit-on-open order
Benefit 2: Good liquidity and no slip-
page
Benefit 2a: Receive your price or
better
Problem 2: May miss some trades when
stock opens above your limit price.
Action 3: Execute throughout the day as
desired prices come into view
Benefit 3: “Chess-like” strategic game
of position
Problem 3: Lower liquidity, slippage,
and paying the spread
Problem 3a: May miss some trades that
rallied after the open
Problem 3b: Stock may never move to
desired entry price.
Post-market study #1
How did action 1 perform against ac-
tion 2 or 3?
Which benefits or problems were high-
lighted?
Variables during the day after positions
have been taken
Action 1: Could leave all positions until
close and execute market-on-close (note:
orders must be entered before 3:45 pm
ET)
Benefit 1: Get position closed at clos-
ing price
Benefit 1a: Liquidity, no slippage, or
paying the spread
Problem 1: May have missed peak
return-on-capital intraday on your
basket.
Action 2: Could take stocks off as they
reach target prices or expected return,
for example 100% of ATR
Benefit 2: Each individual stock return
can be optimized
Problem 2: May make the mistake of
taking off winners and leaving the
losers to get worse
Problem 2a: May miss out on the outlier
performance of your winners
Problem 2b: Still have liquidity issues,
slippage, and the bid–ask spread.
Post-market study #2
How did action 1 perform against ac-
tion 2?
Which benefits or problems were high-
lighted?
The feedback-loop process will assist
you in determining which strategy-based
decisions worked the best as well as how
the outcomes fared for any discretionary
decisions for the basket as a whole or for
each individual stock. It is a valuable
component and building block of your
success, which is defined as preserving
your capital and earning money from
the market consistently.
Limit the amount of changes to your
plan or variables you introduce at any
given time. Be patient and disciplined
and gather the data precisely using the
feedback-loop process strategically.

CALHOUN/PRICE PROJECTION BREAKOUTS

Continued from page 13
INSIGHTS: WHY THIS TECHNIQUE WORKS
Price action patterns tend to repeat themselves, which is a
foundation for professional technical analysis of stock and
other charts. You should always be on the lookout for how far
prior trends ran before reversing or consolidating in the charts
you trade. Professional traders rely heavily on price elasticity
to help make smart, profitable trading decisions.
As with most of the momentum breakout strategies that I’ve
discussed in this column, the primary reason this strategy has
a high potential success rate is because it’s what institutional
professional traders do when developing technical trading
plans. When you mark out price projections, it can help you
develop a sensible, rules-based trading approach based on facts
(price elasticity history) as opposed to opinion or uncertain
entry patterns.
TRADE MANAGEMENT TIP:
MULTIPLE PRICE PROJECTION ENTRIES
This stepwise progression is a core approach to help you when
46 • August 2016 • Technical Analysis of STOCKS & COMMODITIES
Box ranges help you project price
targets and will also provide you
with new opportunities to enter
second or third trades.
position sizing to decide when you should add to a winning
breakout trade. By waiting to enter on days that break out to
new highs above price projection values, you can avoid false
breakouts and enter instead at price-action entry values that
are more likely to continue in your favor. If you set up a series
of buy-stop orders using price projections, you will have a
clearly defined trading plan.
Ken Calhoun is a producer of trading courses, a live room,
and video-based training for active traders. He is a UCLA
alumnus and is the founder of TradeMastery.com, an edu-
cational resource site for active traders.
 TRADING ON MOMENTUM

Price Projection Swing Trades

Finding technical breakout entries using the patterns we
covered in earlier columns can be helpful. It is equally im-
portant, if not more so, to know your exits by identifying
likely technical targets when you are managing your trades.
Using box trading ranges can help you identify where to exit
winning trades or when to tighten trailing stops.
range is a visual technical pattern that helps astute technical
traders identify entry and exit strategies based on directional
trend strength. This strategy is also helpful in managing
your entries and exits if you missed the first big breakout in
a chart, so that you can visually plan your trading approach
on a continuation trend.

by Ken Calhoun STEP-BY-STEP ACTION PLAN

Here’s how you can use this box trading range strategy with
this month’s strategy will provide you with tips for your swing trades.

T how to exit swing trades by using box trading ranges

to price-project your exit targets. Understanding
where to lock in profits for winning trades can help
you avoid the common error of waiting too long to
exit after a reversal occurs.
USING BOX TRADING RANGES FOR PRICE PROJECTIONS
On a 90-day daily candlestick chart, it is easy to spot box trad-
ing ranges, once you know what to look for. A good starting
place is to mark out the low of the chart at the far left, and set
the box trading range high at the price that occurs just before
the first major pullback. This will tell you how many points of
price action this particular chart has in the single most recent
major trend, prior to exhaustion.
Like bricks in a wall, you simply stack the number of points
that this first box range (high minus low) traveled upwards,
and add this value to the recent box range high to identify your
exit target for the second box trading range. A box trading
Step 1: Visually scan for stocks in the $20–$70/share price
range. Begin by finding a chart whose 90-day low is in
the bottom left area and that is in a current uptrend. You
can see this pattern illustrated in Figure 1, on the chart of
Socieded Quimica y Minera De Chile S.A. ADR (SQM).
The first box trading range went from $33 to $43/share, for
a 10-point range.
Step 2: Set a buy stop order at $0.50 above the high of this
first trading range as an entry signal.
Step 3: Use the initial box trading range value to price-project
your exit target. In this example, you would simply add $10
to the high of the first box range, $43, to price-project an
exit target of $53.
Step 4: Once your exit target is hit, you can either exit the
entire trade for a profit, or close
part of the position and tighten
your trailing stop on the remain-
der (use a $2 trailing stop once
your exit target price has been
reached).

INSIGHTS: WHY THIS

TECHNIQUE WORKS
Traders look at prior support and
resistance areas and anticipated
price action trading ranges to
help manage entries and exits.
Experienced professional traders
use these ranges as the foundation
to develop a trading plan for that
particular stock or ETF.
Box trading ranges answer the
technical question, “How far will a
trend run before it stops?” based on
eSIGNAL

immediate past history. Obviously,

FIGURE 1: SWING TRADING BOX TRADING RANGES (SQM). On this chart of Socieded Quimica y Minera De Chile trends will not repeat themselves
S.A. ADR (SQM), exit targets are set in an uptrend continuation using box trading ranges. every single time, but it’s our best
42 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
 TRADING ON MOMENTUM

set of data available upon which we make smart trading deci-

sions. Using price projections is a common approach used by Figuring out where to lock in profits
institutional traders, so it belongs in your toolbox as well. It for winning trades can help you
will help assist you in managing entries and exits based on avoid the common error of waiting
repeatable price action patterns.
too long to exit.
TRADE MANAGEMENT TIPS
In addition to using box ranges to project exit targets, you can
also use this technique to identify position-sizing entry zones Ken Calhoun is a producer of trading courses, a live trading
as well. You simply add to winning positions as they break out room, and video-based training systems for active traders. He
above new box trading range highs. This helps capitalize on is the founder of TradeMastery.com, an educational resource
sustained longer-term trends that develop in especially strong site for active traders, and is a UCLA alumnus.
breakout charts. You can use a sequence of new entries above
each new box trading range high to build a larger winning
position over time.

ICHIMOKU MASTER SUMMARY the ichimoku method, quickly analyze

Continued from page 40
as in Figure 3. The sort can bring to the
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Backtesting: For traders who wish to Even though the color Barbara Star, PhD, is a retired university
experiment with entry and exit methods cues and arrows professor and a Contributing Writer for
other than those used in the original this magazine. She can be reached by
ichimoku method, the developer of
are helpful, it is email at star4070@aol.com.
Ichimoku Master has included open- the commentaries
source coding and five system tests. Two provided in Ichimoku ‡MetaStock
of the backtests identify reversals and the Master that are ‡See Editorial Resource Index
remaining three test components that are
all moving in the same direction.
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December 2017 • Technical Analysis of STOCKS & COMMODITIES • 43
 Dickover: 6” W, bleed L, x 6” H
Slow & Steady
Reacting To Market Moves
Part 1
The reason we make counterproductive trading decisions is
because of our biases and flawed intuition. In this first part
of a two-part series, we analyze and try to understand these
trading behaviors so we can avoid costly mistakes and become
more effective traders.
by Melvin E. Dickover
our reaction to market moves is driven by several
cognitive biases that affect every part of technical
Y trading. You need to understand these biases. In this
article, I first describe the origin of the problem in
human intuition, and then use the example of expert
prediction and then probability and gambling to illustrate a
series of cognitive biases needed to understand the rest of
the material. Following that I analyze a series of familiar
trading behaviors, introducing more cognitive psychology
as needed.
32 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
THE TROUBLE WITH INTUITION IN TRADING
The root of most of the explanations in this article lies in the
nature of human intuition. In his book Thinking, Fast and
Slow, Daniel Kahneman shows us that there are two kinds
of thinking. Intuition is fast thinking—effortless, automatic,
based on heuristics, and the result feels right in our gut. Slow
thinking is conscious thought that requires effort, discipline,
possibly scientific or mathematical training, and the result
feels uncertain.
In Nate Silver’s book The Signal And The Noise, two
kinds of environments are described: normal and complex.
Normal environments can be learned through experience and
IVSANMAS/SHUTTERSTOCK
repetition because they have dependable, regular patterns.
Examples include hunting, fishing, firefighting, bargaining, and
the building trades. In these environments, intuition works.
These are the environments most similar to those our brains
evolved to survive in.
Complex environments are probabilistic, or have feedback
 TRADING PSYCHOLOGY

loops, or chaotic aspects (the butterfly

effect.) Examples are weather, financial
markets, the economy, earthquakes,
and human relationships. In complex
environments, prediction is difficult.
Regardless of our education, training,
and experience, our intuition is consis-
tently invalid when making judgments
about complex environments.
All your life you have been told to trust
your gut feelings. You naturally want to
use your intuition to make judgments
because it is effortless and you feel
confident you are right. To use slow think-
ing, you must have acquired expertise Risk-
(perhaps some statistics or mathematics)
and you must focus your attention on
FREE
developing and evaluating alternatives. 30-Day
You must decide consciously what is Trial
relevant and what is not, and work your
way to a conclusion. Regardless of
considerable effort, you might still get
a conclusion that feels uncertain. The
people most likely to get a rude shock
when they begin trading are those who
come to trading with success in other
professions where their intuition has
been trustworthy.

PROBABILITY BIASES
People’s intuitive understanding of
randomness is invalid. You intuitively
believe that for something to be random,
it should look random. When a pattern
is discernible, it intuitively seems non-
random. For example, if you see a string
of heads in a series of coin flips, you
intuitively suspect that series is not ran-
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lotteries. Their probability estimates for
the likelihood of these events occurring
February 2016 • Technical Analysis of STOCKS & COMMODITIES • 33

Following your trading plan
means you take all the trades
your strategy generates, and
none that it does not.
is off by orders of magnitude because these events are easy
to recall.
There are other peculiar trading beliefs caused by probability
biases. One I sometimes see in forex forums is the intuition
that if you have a strategy with lots of losing trades, you can
make money by reversing the signals. The reason you get a
lot of losing trades is that your system is generating random
trades, and reversing a random trade generator still gives
random losing trades.
THE TROUBLE WITH PREDICTIONS
Intuition evolved to keep us alive in a normal environment
that required a lot of quick decisions to avoid dangers and
exploit opportunities. Even though traders face complex and
unpredictable environments, traders tend to trust their intuition.
That intuition is subconscious and impossible to turn off.
People are not good at making predictions about complex
environments. Expertise and experience do not help. Evidence
shows that sergeants can’t predict who will be good soldiers,
but they believe they can. Evidence shows that psychologists
can’t predict which marriages will succeed or who will be
best for a job based on their interactions with the subjects,
but they believe they can. Evidence shows that market ex-
perts do no better than random in their predictions, but they
stubbornly believe they can. In December 2007, economists
in the WSJ forecasting panel predicted a 38% chance of re-
cession. Data later showed that the economy was already in
recession at the time. For an entertaining selection of horrible
predictions, read The Experts Speak by Christopher Cerf and
Victor Navasky.
WHY DO EXPERTS KEEP MAKING PREDICTIONS?
A series of cognitive biases are the reason you and experts
completely misjudge your ability to predict. The human belief
that an event could have been predicted all along if “all the
dots had been properly connected” is called hindsight bias
by cognitive psychologists. When you (or an expert) con-
front a surprising outcome different from your prediction,
your brain readjusts your view of the world to accommodate
the new reality. In the readjustment process, hindsight bias
causes you to experience an “I knew it all along” effect that
alters your memory in such a way that your ability to recall
past knowledge or beliefs that conflict with the revised view
is suppressed. You find it hard to remember that you were
wrong; indeed, you often firmly believe you were right all
along, and are shocked at videos or other evidence that show
34 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
you were in fact wrong.
Contrary to evidence, experience, and repeated failures,
experts continue to believe they make valid predictions. Over-
confidence bias is a measured (large) discrepancy between how
experts view their ability and how good their ability actually
is in practice. CEOs, doctors, stock pickers and many others
suffer from this “Lake Wobegone” effect in which everyone
thinks they are above average. Market experts are grossly over-
confident in their ability to predict the market, and believe the
uncertainty range of their predictions is small. Overconfidence
bias can arise from the WYSAITI illusion (What You See Is
All There Is). In analysis and decision-making, if information
isn’t easily recalled, it is ignored as if it did not exist. Predic-
tions are made based on what comes to mind.
Once a prediction is made, confirmation bias causes the
expert to search for confirming information and ignore the
rest. Unfortunately, people think all their beliefs are true.
The illusion of validity is the bane of stock pickers. Stock
pickers exercise high-level professional skills requiring ex-
tensive training. They gather and analyze extensive data that
generates new information they use to make stock predictions.
They are supported by a strong professional culture that re-
inforces their belief that the additional information enhances
the validity of their predictions. Expertise in analyzing the
prospects for future earnings is not the same as knowledge
of how much of that information is already priced into a
stock. The analyst does not know this, and does not know
that it is unknown. The idea that the future is unpredictable
is undermined by the ease that the same kind of analysis used
to make predictions can so easily and accurately be used to
explain the past (hindsight bias.)
WIRED TO BELIEVE EXPERT
PREDICTIONS
You intuitively believe a prediction
from an expert who exudes confidence
and has a coherent story that explains
the prediction. This is automatic—
you aren’t aware of it, you can’t help
it, and you can’t turn it off. You get
a gut feeling that the expert is right.
Only conscious effort can overcome
this built-in bias, and that requires knowledge, discipline, and
forcing your attention on the problem.
You want to believe the future is predictable to feel that you
have control. Probabilistic systems like markets have long runs
of coincidental-seeming events that you instinctively believe
must have a reason, when it is simply the odds playing out
normally. You may believe that “everything happens for a
reason” but in a probabilistic system, no single event happens
for a reason. Your choice is to stay with your effortless false
intuition from fast thinking, or put in the much greater effort
to do the slow thinking that can lead to valid results.
And worst of all, your trading is affected. Once you hear
an expert prediction, you unconsciously anchor to it. If the
prediction conflicts with your trade plan, it undermines your
ability to follow your trade plan. It
automatically, unconsciously biases
the way you interpret the information
you normally use to make trading
decisions.
If a prediction is about a complex
(unpredictable) system like the market,
you are better off treating the prediction
as nonsense, neither right nor wrong,
regardless of the outcome. So market
predictions are nonsense, and once you
hear them, you act as if you believe
them, even if you don’t want to, and they
affect how you trade, and you can’t help
it. That is the vulnerability you must
overcome. Don’t believe anything you
are foretold. Easier said than done!

GAMBLING, THE EDGE, LUCK,

AND BEING RIGHT
Many more cognitive biases can best be
illustrated through gambling examples.
The common belief is that longer-term
traders (fundamental investors) are
not gamblers, but shorter-term traders
(technicians, sometimes called specula-
tors) are gamblers. My opinion is more
nuanced, and it is based on an analogy to casinos. The casino
has an edge over the gambler, and always makes money over
time. Casinos have a concept called “the grind” that refers to
the inexorable accumulation of losses from a long string of
gambles that eventually erodes the gambler’s stake to zero,
or worse. Because the casino has the edge, the gambler has a
negative expectancy. Here is an example of the grind, using
a roulette table.
Roulette tables commonly have about a 5% edge favoring
the casino. Assume there is a spin every two minutes. Assume
you start playing with a $1,000 stake, and you bet $50 every
spin. If there is a spin every two minutes, then at 30 spins an
hour, you are wagering 30*$50 = $1,500 dollars each hour.
You win some bets, you lose some bets, but at a 5% loss rate
(the grind), you would lose an average of $75 per hour. At
this rate, your $1,000 would last between 13 and 14 hours
before it is completely gone. In Skinners’ theory of operant
conditioning, he found that occasional reinforcement was
the most effective in maintaining a behavior. That is what
is happening in gambling games—the occasional wins keep
the gambler playing. Traders without an edge also face the
grind, and will eventually blow up their account. Your goal
as a trader is to be the casino, not the gambler.
THE TRADER’S DELUSION
The gambler’s fallacy is the delusion that if something happens
more frequently in the present, the future is ever more likely
to balance it. That is why gamblers in front of a particular slot
machine believe that a string of losses makes that machine more
likely to pay off sooner than another machine that has paid off
recently. The fallacy arises from intuitively misunderstanding
the significance of a random series of independent events.
The trader’s delusion is the false intuition that random trade
events have an explanation that can be found in the market
data. A trade goes bad, and the trader looks at the chart and
indicators to see if there is an explanation for what went
wrong. There are hundreds of indicators and patterns for the
trader to use in constructing an explanation, one that will be
a one-off curve fit. Hindsight bias creates the belief that an
event could have been predicted all along if “all the dots had
been properly connected.” In the market there are so many
dots to connect that you can always find an explanation. The
explanation is always false, since the outcome of a single trade
is a probabilistic event, and can no more have an explanation
than can the result of a dice roll. Such false explanations are
particularly pernicious since confirmation bias causes you
to focus on the evidence you can always find to support this
false belief while ignoring conflicting evidence.
Recording the process you used to devise false causes for
uncaused events in a journal is your tool for creating and
maintaining delusions about the market. A journal can be
valuable, but the value of a journal lies in tracking whether
you are following your trading plan, and if not, why not.
WHAT IS LUCK?
Luck is a word we apply after the fact to describe how favorable
or unfavorable the outcome of a probabilistic event was. Luck
is not a property you can have ahead of a probabilistic event.
February 2016 • Technical Analysis of STOCKS & COMMODITIES • 35
 Having luck beforehand implies either fated outcomes arranged
to benefit you or an invisible magical creature has noticed that
you have the luck attribute, possibly because you are wearing
your lucky sweater. The magical creature alters the laws of
physics in such a way as to make the outcomes favorable for
you. This is of course done is such a way that the tampering
with physics is undetectable. Many people behave as though
this sort of thing is real. The belief that you are lucky (rather
than you had luck) based on past events is another example of
how misleading our intuition is regarding probability.
WHEN ARE YOU RIGHT AND WHEN ARE
YOU WRONG?
The concept of being right or wrong beforehand only makes
sense if interpreted in the context of the edge. Regardless of
the outcome of the trade, if you were with the edge, you were
right. Casinos are always right. If you went against the odds,
you were wrong. Gamblers are always wrong.
Research shows that the mind is
capable of dealing with two or
three varying indicators or data
sources at once. More than three
are on the average trader’s chart.
BLACK SWANS
A misleading probability intuition is associated with risk.
This is exacerbated by the widespread use of the Gaussian
(bell curve) distribution to compute all sorts of things in
trading, including risks. The bell curve reinforces our false
intuition. We know that market data do not follow a Gaussian
distribution, and we do not know what distribution the data
do follow. Using the hypothesis that the market is Gaussian,
we can compute that the 1987 stock market crash was a more
than 20-sigma event, an event that should not happen during
the lifetime of the universe. Figure 1 is a table created from
data in David Hand’s book The Improbability Principle. The
Cauchy distribution is similar in shape to the bell curve, and
most people could not tell the difference by looking at plots
of them. However, the Cauchy distribution varies dramatically
in the long-tail odds where the black swans live.
The point of the table is that our way of estimating long-tail
risk is wrong and the truth is likely closer to a Cauchy distri-
bution than a Gaussian one. As Figure 1 shows, a five-sigma
event is more than 200,000 times more likely in a Cauchy
distribution.
The trader cannot trust his intuition that certain market
events are highly improbable and won’t happen and need not
be planned for. It is possible to trade hedged, especially with
options, in such a way that most long-tail risk is eliminated.
You might apply modern portfolio theory and diversify. The
problem with that is portfolio theory assumes stable correla-
36 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
Event Gaussian probability Cauchy probability
5 sigma 1 in 3.5 x 106 1 in 16
23
10 sigma 1 in 1.3 x 10 1 in 32
20 sigma 1 in 3.6 x 1088 1 in 63
197
30 sigma 1 in 2.0 x 10 1 in 94
FIGURE 1: GAUSSIAN VS. CAUCHY. Here you see the probability of black swan
events occurring. They happen, and you can’t ignore them.
tions among symbols, but in a crisis, everything becomes cor-
related and goes down together. Goldman Sachs’ CEO referred
to the 1997–98 fall of Long Term Capital Management as a
series of 10-sigma events, several days in a row. The 2010 Flash
Crash has been called a 12-sigma event. These supposedly
impossible black swans keep appearing regularly.
FEAR
In the conventional view, fear in traders is a bad thing, an emo-
tion that you must overcome. Many mentors offer courses and
coaching to help you overcome your fear so you can trade. The
supposed fear-driven behaviors include a variety of indecision
or poor decisions, including a crippling inability to “pull the
trigger.” Fear is a learned response. A set of environmental
cues associated with a threat or loss situation are wired into
the brain, according to Pavlovian learning. A situation per-
ceived to be similar to a previously learned threat will trigger
the emotional state of fear, whether or not the fear is rational
in the current situation. Carried to the extreme, the fear is a
phobia. The fear response evolved to protect you from lions
and snakes; it works well for lions, but not for trading.
Cognitive psychology shows that high fear shuts down
exploratory thinking and risk-taking. Neuroimaging studies
show that a strong effect of fear on decision-making is to am-
plify the endowment effect that causes you to value something
more once you own it. Brain scans show that the same group
of cells associated with the endowment effect is activated by
fear. When your brain fears loss, you hold onto what you have
more tightly. This is why people in a high state of fear cannot
pull the trigger on a trade.
Some argue that this amplified endowment effect in hard
economic times can affect the broader economy because people
fear the consequences of their expectations, hold their money,
and slow the economy from recovering. People in a state of
fear generate pessimistic assessments of their risk. Moderate
fear improves financial decision-making by causing caution
and causing more mental resources to be allocated to the
slow thinking decision process. Anger works the opposite of
fear. People in an angry state discount risks in their decision-
making, and make irrational, risky decisions.
Emotional states like strong fear, anger, and stress all cause
the brain to fall back to intuitive fast thinking decision-making,
foreclosing the possibility of the much better (in financial
decisions) conscious, slow thinking decision-making.
Fear is more a symptom than a cause. Fear is generated by

our intuition to mobilize our resources to avoid threats, and
in trading, to protect traders from the threat of losses. Fear
can be justified, or unjustified. Probably, most of your trading
fear is justified, because you suspect you are gambling against
unknown odds. In the worst case, you overcome justified fear
and confidently gamble, incurring large losses. I will describe
what makes fear justified in more detail.
THE BANE OF DISCRETIONARY TRADING:
CUTTING PROFITS, LETTING LOSSES RUN
You are told to cut your losses and let your profits run. Yet,
most people do the opposite. When a trade goes bad, you
begin to hope for a turnaround. Losses accumulate, and at
some point, you freeze, unable to do anything about the
trade. When a trade gets a small gain, you begin to fear that
you could lose it, so you exit the position early, missing out
on a big gain. The explanation of this behavior also lies in
cognitive psychology.
WHY DON’T YOU CUT LOSSES?
One root of this behavior is the intuitive belief that you can
be right or wrong about a probabilistic event; you interpret a
loss as “I am wrong about this trade, and thus I am a failure.”
If you believe the outcome of a trade has a discoverable cause
(the trader’s delusion) then when an important trade is going
bad, it is because you are doing something wrong—something
you should have controlled. To avoid being a failure, you are
likely to seize on the illusion that failure has not occurred
until the position is closed. You believe “I still haven’t taken a
loss.” Unfortunately, losses tend to accumulate, and cognitive
psychology tells us that the response to bad news is ampli-
fied loss aversion and an amplified endowment effect. At the
extreme, the loss can trigger the freeze part of the fight, flight,
or freeze reaction, creating a paralysis that prevents any action
on the position. Brain damage to the amygdala can make you
a better investor by disabling the normal way risk is perceived.
In healthy brains, prior losses adversely affect judgment for
the next trade, and you become excessively risk-averse. In-
vestors with a damaged amygdala perceive each opportunity
independently without being affected by prior losses.
The attempt to avoid admitting a loss can lead to counterpro-
ductive schemes like cost averaging, which keeps increasing
risk. It causes some people to attempt complicated option
schemes to repair trades when logic would dictate otherwise.
It causes people to embark on unwise Martingale schemes.
Not cutting losses is also related to the peculiar advice that
you get from investment advisors as your account goes way
down, “It will come back, so you really haven’t lost anything.”
For me this is equivalent to telling a man working at a job that
pays $1,000 a week that he will not be paid for this week’s
work but he really hasn’t lost anything. That’s because next
week he will (probably) be paid for next week’s work. Losses
occur at the instant the value of asset decreases, not at the
time the trade is closed. This is at the heart of the difference
in market view between technicians and long-term investors.
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WHY DON’T WE LET PROFITS RUN?
There is a concept in psychology called prospect theory, dis-
covered by Kahneman and Tversky, that launched behavioral
economics. Prospect theory experiments found that you give
avoiding a threat twice the importance as maximizing an oppor-
tunity. In trading, you fear a loss twice as much as you hope for
a gain. This means that when you watch the daily variations of
your account, you get twice as much pain from the small losses
as you get pleasure from the small gains. So you tend to make
certain that small profits are not lost. You take the bad advice
of trading gurus based on this cognitive bias such as “never let
a profit turn into a loss” or “you cannot go broke taking prof-
its.” That last piece of advice is flat wrong. If you are trading a
typical profitable trend-following system, you will have a low
hit rate and make very big profits on just a few trades. Getting
out of those trades early will turn your profitable strategy into
a losing one that will cause you to go broke.
The idea that exiting a trading session when you get ahead
will improve your bottom line is the same behavior as cutting
your profits short and is rooted in the same cognitive bias.
You are missing opportunities in order to protect small profits,
harming your bottom line.
WHY YOU DON’T FOLLOW YOUR TRADING PLAN
Following your trading plan means you take all the trades
your strategy generates, and none that it does not. You do
not take a trade as your plan decrees when you believe you
have important information that the strategy does not have.
Therefore, you believe you can improve on the performance
February 2016 • Technical Analysis of STOCKS & COMMODITIES • 37
 or eliminate risks or bad trades. Also, most people are uneasy
about robots (your strategy coded into a trading platform is
a robot) making important decisions, and instinctively you
think human intuition can improve robotic results. Various
cognitive biases contribute to this belief.
The knowledge illusion gives false confidence in what we
know, both in quantity and quality. It arises from the false
belief that additional information automatically translates into
more knowledge. Evidence shows it does the opposite. Nicholas
Darvas wrote a book, How I Made 2 Million In The Stock
Market. Darvas was a dancer who traveled and performed
around the world. His broker sent him daily telegrams with
quotes on four symbols, and he successfully traded his system
from that meager information. When he quit traveling, he
came back to the states, set up an office in New York with all
kinds of information coming in that was previously unavail-
able. He started losing money. More information destroyed
his performance because it was irrelevant to his method and
disrupted his decision-making process.
Overconfidence bias is one result of expertise and the knowl-
edge illusion. Evidence shows that algorithms do better than
people at prediction regarding probabilistic systems.
You need to ask yourself if your intuition really can improve
the results of a validated strategy, in spite of all the evidence
that it will not.
If you do not take all the trades your strategy generates, you
destroy your statistics and you can no longer be certain that
you have an edge. You may be transforming yourself into a
gambler. If your strategy generates too many trades, develop
one that trades at your desired frequency.
THE HERD INSTINCT
Humans, like many other species, have a strong herd instinct.
The herd instinct is probably responsible for the unprofitable
phenomenon of “chasing trades.” It also causes you to exit
the market when you see others exiting. It is difficult to be
a fast thinking contrarian due to the herd instinct. A longer
term contrarian is a slow thinking investor who consciously
knows what he is doing. The herd instinct makes it too dif-
ficult for most people to be contrarians. Going against the
herd generates fear.
A DIFFERENCE BETWEEN YOU AND
A PROFESSIONAL TRADER
Kahneman says that professional traders think differently in
important ways. They have a broad frame of reference, that
is, they do not focus on individual trades, and are thus not
emotionally invested in the outcomes of individual trades,
The value of a journal lies
in tracking whether you are
following your trading plan,
and if not, why not.
38 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
in particular, losses. Professional traders tend to be rational
agents in the sense that the acquisition price of the asset is
irrelevant history to them. They ask, “How much do I want
to be in this position compared to other opportunities?” They
seem not to be affected by the endowment effect or the sunk
cost effect.
THE CHALLENGE OF DISCRETIONARY TRADING
As you look at your screen covered with indicators, you just
hear a confident prediction with compelling rationale from an
authoritative expert on CNBC regarding the market you are
trading. The prediction colonizes your mind and you anchor
to it. You look back through the chart, and confirmation bias
guides you in selecting just the evidence you need to support
the prediction, and to ignore the rest. Now you are looking
for an excuse to take a trade in the direction of the predic-
tion. With a little creative fudging, you decide a particular
chart formation is “close enough” to a pattern that points in
the predicted direction and you enter the trade, against your
normal indicators that you are now temporarily discounting.
At this point, the worst thing that could happen is for the trade
to succeed, because then you get the occasional reinforcement
(more powerful than regular reinforcement) necessary to install
a false belief about the predictor and market.
If you are daytrading, you need to react instinctively to
multiple simultaneously changing indicators and quickly
decide if a good opportunity is presenting itself. Research
shows that the mind is capable of dealing with two or three
varying indicators or data sources at once. More than three
are on the average trader’s chart. If you try to make trading
decisions consciously (slow thinking), your brain is likely to
be stressed by the complexity of the evaluation, decide it does
not have the resources to do a slow thinking decision in time,
and resort to its backup plan to get a quick decision. Its stress
mode backup plan is to abandon the conscious evaluation
of alternatives and narrow its focus to one or two decision
cues. These cues may not be relevant to the decision; they
are chosen because they come to mind easily. The judgment
that results will be affected by the array of cognitive biases
I discussed earlier.
Compare your trading situation to that of an airplane pilot.
The pilot sits in front of a large array of gauges (indicators)
and is looking out the window (the chart.) The pilot must have
the ability to glance at the array of gauges (that are moving
and sometimes in apparent conflict) and intuitively be aware
of the situation and quickly take the appropriate action. To
develop this intuitive ability could have taken the pilot a thou-
sand hours or more, in flight and in simulators. I have known
price-action traders who have taken as long or longer to be
able to react intuitively to Brooks’ patterns before they made
themselves into consistently profitable traders.
Unlike most traders’ screens, the pilot’s gauges and dials
look the same every time the pilot enters the plane—they don’t
change size, move about, change color, or vanish and reappear
later, or become completely different every now and then. The
changing part is the view out the window. The trader who
 TRADING PSYCHOLOGY
keeps trying new indicators, layouts, colors, and strategies has
no stable dashboard. To develop the “gut feel” about what it
means will take much longer, if it can be done at all.
PERCEPTUAL LEARNING
There is a technique called perceptual learning that is ca-
pable of speeding up the acquisition of the intuitive gut feel
for piloting and other skills. It is amazingly fast because it
works directly with visual perception rather than using the
slow thinking conscious mind to do enough repetitions to
wire in the intuition. In perceptual learning by direct visual
perception, the conscious slow thinking mind is completely
bypassed. A pilot dashboard is present, a question about status
is asked, and the student answers or takes an action, and gets
immediate feedback about whether the answer or action is
right or wrong. No explanation is given as to why the answer
is right or wrong. This feedback loop causes the subject to
acquire the ability to read the combination of dials and window
view as a gestalt and to automatically and correctly categorize
the situation. After an hour of perceptual learning training, a
novice pilot develops the intuition and gut feeling accuracy
comparable to a pilot with 1,000 flight hours of conventional
training. I have based this example of perceptual learning
from Benedict Carey’s book How We Learn.
The great advantage of those who have correct gut feeling is
they have sufficient cognitive resources in times of stress that
the brain does not get overloaded and cause the undesirable
stress mode decision process to trigger. If you are a novice
trader trying to learn to daytrade and you choose to trade with
the five minute emini S&P (ES), you are like a novice athlete
who, after a couple weeks of training, enters Ironman triathlons
and bets on himself to win. ES is possibly the most difficult
symbol to make money on—the possible market inefficiencies
to exploit are the least because of the number of professional
and automated traders, and because the quarter-point tick is
larger relative to the moves compared to other futures, so it
is jerkier and noisier. And since the automated competition is
so fast, by the time you get in, some or most of the available
market inefficiency has already been extracted. First ones in
get the most profit, last ones in lose money. For best results, you
must get in predicatively; that is one reason why my previous
article, “Seeing Clearly,” sought predictive indicators and was
skeptical of confirmation delays. The short time frame and
need for speedy decisions puts the most stress on the trader,
and forces the novice into intuitive backup stress mode. The
stress matters only at the time you make decisions. It doesn’t
matter if you’re relaxed at other times.
To apply perceptual learning to trading offers a way for dis-
cretionary traders to operate effectively at short time frames,
and perhaps even have something of real value to contribute
to a trading algorithm. Algorithms are rule-based. Much of
what we learn to do we cannot explain. Perceptual learning
modules would need to be developed, and an unambiguous set
of categorization rules would be necessary. Then, in an hour
or two, you would become an intuitive chart reader.
If you have not developed the intuitive chart-reading skill,
If you are trading a typical
profitable trend-following
system, you will have a low hit
rate and make very big profits
on just a few trades.
and few have, you should always trade in the slow thinking
mode. That means the combination of the time frame you trade
and the complexity of your system must not add up to so much
analytical work per unit time that your brain goes into stress
mode for decision-making. The shorter the time frame and the
more complex your chart display, the more likely you are to
overwhelm your mental resources and trigger the unprofitable
intuitive backup mode. Being human, you do not have Spock’s
cool, emotionless logic, regardless of stress.
In part 2, I will explore ideal technical trading as Spock
would do it, and discuss how you can succeed using quantita-
tive techniques.
Mel E. Dickover has been an active trader for about 15 years,
focusing on technical analysis. He is an active member of his
local Society of Market Technicians. He is a retired system
designer and builder, and holds a bachelorís of science in
physics from Purdue University and a masterís of science in
physics from Trinity College. He has programmed several
indicators in OmniLanguage script, including his Defended
Price Line (DPL) and Freedom of Movement (FoM), both of
which he has trademarked. He may be reached at MDick-
over@verizon.net.
FURTHER READING
Carey, Benedict [2015]. How We Learn: The Surprising Truth About
When, Where, And Why It Happens, Random House.
Cerf, Christopher, and Victor Navasky [1998]. The Experts Speak:
The Definitive Compendium Of Authoritative Misinformation,
Random House.
Darvas, Nicholas [2011]. How I Made $2,000,000 In The Stock
Market, Marlino Fine Books.
Dickover, Melvin E. [2014]. “Evidence-Based Support & Re-
sistance,” Technical Analysis of STOCKS & COMMODITIES,
Volume 33: April.
[2015]. “Understanding Causes Of Market Movements,”
Technical Analysis of STOCKS & COMMODITIES, Volume 33:
June.
[2015]. “Seeing Clearly,” Technical Analysis of STOCKS &
COMMODITIES, Volume 33: July.
Hand, David J. [2014]. The Improbability Principle: Why Co-
incidences, Miracles, and Rare Events Happen Every Day,
Scientific American.
Kahneman, Daniel [2013]. Thinking, Fast And Slow, Farrar, Straus
and Giroux.
Silver, Nate [2012]. The Signal And The Noise: Why So Many
Predictions Fail–But Some Don’t, Penguin Books.
February 2016 • Technical Analysis of STOCKS & COMMODITIES • 39
 It’s All About Chart Patterns
Recognizing Price Action
Here’s a look at the anatomy of one trader’s winning trade.
by Matt Blackman
n the first of two interviews I conducted with stock
I
trader Dan Zanger for this magazine in 2003, I asked
him what indicators he used to amass $18 million
trading stocks in less than two years. His answer was
surprisingly simple. “I use absolutely no indicators
whatsoever. I simply rely on chart patterns, price,
and volume. Who has the time to look at so many
indicators when you scroll through 400 stocks a night?”
But the obvious question is, if it’s so simple, why don’t more
people do it this way? Clearly, there’s more to Zanger’s success.
To use a baseball analogy, while hitting the ball hard and in
the right direction may seem simple enough, it certainly isn’t
easy. But unlike raw physical prowess, trading technique can
be taught to anyone dedicated enough to learn the ropes.
Much has changed in the markets since that first interview
28 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
with Zanger, but over the years he has remained true to his
trading style. He continues to seek out those stocks with the
best potential to explode higher when markets are in the
right mood, ever on the hunt for the telltale signs that the big
move is afoot. This was never more evident than in his calls
on Acacia Communications (ACIA) in 2016. So what was it
about Acacia that attracted his attention?
ANATOMY OF A WINNER
In 2016, while there were a few stocks that made big moves,
the ACIA initial public offering (IPO) particularly intrigued
Zanger. “Had I gone on vacation in May prior to the IPO, I
would have never picked it up for $32,” he explains.
ZSOLT–UVEGESA/SHUTTERSTOCK
So what was it that caused him to start advising his subscrib-
ers to watch it in mid-May? As far as IPOs were concerned,
2015 had been a dud, with no high-profile deals hitting the
market, due in large part to the strength of the venture capital
market. With lots of private money available, companies had
little reason to go public. As a result, 2016 was the slowest
WWW.CHARTPATTERN.COM
REAL WORLD
FIGURE 1: IT’S A BUY. Following a successful IPO launch for Acacia Communica-
tions (ACIA) on May 13, the May 23rd Zanger Report gave Dan Zanger’s technical
buy area (TBA) of $32.
start for IPOs since 2008.
“Prior to the ACIA launch, there had been almost no IPOs. It
was no surprise that the ACIA IPO was cheap. It was only the
second tech IPO of the year and most investors avoided it alto-
gether.” He had a point. The only other technology IPO in 2016
had been Secure Works, a Dell spinoff that was priced below its
target but then dropped immediately after it hit the market.
But Zanger was confident that ACIA was different. Two days
after it hit the market on Friday, May 13, 2016, the Zanger
Report newsletter included a chart showing the first day’s
action. Initially priced at $23, ACIA opened the day at $29
and had traded as high as $31.94 before closing at $30.95. A
total of 4.2 million shares traded hands.
His chart included the comment, “A move above $32 would
be a good speculative TBA (technical buy area) for this IPO.”
(A TBA is when price is above a bullish chart pattern or re-
sistance area where breakouts can occur.) And on Monday,
May 15, Zanger discussed the stock in greater detail with the
members of his live chatroom.
Little more than a week later on May 23, ACIA hit Zanger’s
TBA as it moved above $32 on good volume with 1.2 mil-
lion shares trading hands. The stock closed the day at $32.70
(Figure 1).
LET’S LOOK AT HOW IT MOVED
On June 1, ACIA closed just below $40 after hitting an intraday
high of $43.10 per share (Figure 2). After an $11 gain from the
TBA, the stock reversed down on heavy volume. This could
FIGURE 2: AFTER A RISE. By June 1, ACIA closed near $40. Zanger’s comment
at that point notes the stock could be stalling after a gain, but traders who bought
around $32 were already well in the green.
mean the up move may have stalled and it would be a good
idea to reduce position size.
By August 1, ACIA was trading above $62. Then on Au-
gust 11, earnings exceeded expectations, causing the stock
price to jump $28 in one day and volume spiked up. You can
see this on the chart in Figure 3 (from Zanger’s August 14th
newsletter). Following its monster move, ACIA paused for a
day before continuing to march higher.
The pullback that Zanger and his subscribers had been
waiting for finally started to unfold on August 22. But in the
subsequent rally, the stock never hit Zanger’s next TBA of
$129. After peaking at $128.73 on September 7, it rolled over
and began its long slide lower.
Zanger issued the following proviso to his readers in the Sun-
day, August 21st newsletter (see Figure 4): “Thursday’s spike
to $124.90 was a good reason to reduce into strength.”
Recognizing the chart patterns,
volume profiles, and momentum
action that make them standouts
are just the tip of the Zanger
method iceberg.
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 29
 FIGURE 3: POST-EARNINGS. On August 11, earnings exceeded expectations in FIGURE 4: A PAUSE IN THE ACTION. The next good setup approaches as ACIA
ACIA, causing the stock to rocket. This chart from Zanger’s August 14th newsletter takes a break from its rally.
shows the move.

FINDING STOCKS IN THE WINNER’S CIRCLE

ACIA was a stock that had a number of factors Zanger looks
for in a market-leading stock. First, it was experiencing
exceptional growth. It also had phenonomenal earnings and
market-leading products. And it was in the communications
space, a strong industry.
And once the stock hit the market after it went public, it
exhibited a number of the compelling bullish chart patterns
that Zanger looks for (such as bull flags and bull pennants; cup
& handles; and head & shoulders), supported by large volume
spikes during the big moves. Until it didn’t. His October 3,
2016 comment to subscribers included the pronouncement
“avoiding for now.” (Figure 5).

TRADING WHAT WORKS

While markets have changed, how to find the next market
leaders has not. But recognizing the chart patterns, volume
profiles, and momentum action that make them standouts are
just the tip of the Zanger method iceberg.

Trading technique can be

FIGURE 5: END OF THE RUN? This chart from Zanger’s newsletter shows that
taught to anyone dedicated
the rally appears to be coming to an end, with Zanger warning his subscribers on enough to learn the ropes.
October 3, “avoiding for now.”

30 • April 2017 • Technical Analysis of STOCKS & COMMODITIES

 What isn’t readily visible in media
soundbites is that it took Zanger years
to develop his technique to search and
find stocks like ACIA that have the
key components, both technically and
fundametally, to make them explosive
stockmarket outperformers.
But his is no get-rich-quick scheme.
Once you have found potential winners,
you need to have developed the patience
to wait for the move; the laser-like focus
to recognize that the move has begun; the
timing to know when to strike; and the
emotional control to manage the trade.
And finally, you need to have nurtured
the well-honed discipline not only to wait
for the move to unfold, but also to know
when to take profits. The only question
that remains for would-be successful
momentum traders is, do they have what
it takes to meet the challenge?

Matt Blackman, is a technical trader,

author, reviewer, keynote speaker and
regular contributor to a number of trad-
ing publications and investment/trading
websites in North America and Europe. He also writes client
newsletters and assists clients in building their professional
profiles through various financial and mainstream media
outlets as well as client resource management. He earned the
Chartered Market Technician (CMT) designation from the
Market Technicians Association (MTA). Follow Blackman
on Twitter @RatioTrade or email him at indextradermb@
gmail.com.
FURTHER READING
Blackman, Matt [2003]. “Chart Patterns, Trading, And Dan
Zanger,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 21: August.
[2014]. “Seeing The Patterns With Dan Zanger,” in-
terview, Technical Analysis of STOCKS & COMMODITIES,
Volume 32: Bonus Issue.
Bulkowski, Thomas N. [2005]. Encyclopedia Of Chart Pat-
terns, 2d. ed., Wiley Trading.
Zanger, Dan, and Matt Blackman [2010]. “Is Trading That
Simple?” Technical Analysis of STOCKS & COMMODITIES,
Volume 28: August.
‡ChartPattern.com

CALHOUN / ASCENDING TRIANGLE BREAKOUTS

Continued from page 17
tries. Remember, the reason for your entry is because buyers
are winning control of price action once it breaks above new
highs. If price drops $2.00 or more beneath your initial entry,
then it is smart to take a small stop, since the reason for your
initial entry is no longer valid. If price continues to move up,
it is often helpful to add shares to a winning position to scale
in every two points or so, with a two point trailing stop.
As with all of our professional swing and intraday charts,
it is best to use this strategy with stocks and ETFs priced in
the $20-$70/share range, because these charts tend to have
stronger, more sustainable breakout trends than cheap, choppy
stocks priced under $10/share. As with other bullish patterns
such as cups, gap continuations, and 45-degree angle uptrends,
The ascending triangle visually
shows the forces of demand
overpowering supply, which leads to
an increase in price.
you will find that ascending triangles can help you spot strong
breakout trading opportunities as they occur.
Ken Calhoun is a producer of trading courses, live trading
room and video-based training systems for active traders.
He is a UCLA alumnus and is the founder of TradeMastery.
com, an educational resource site for active traders.
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 31
 Through The Looking Glass
Reflecting On Price Mirrors
Can we use prior price movement to predict the future?
by Thomas Bulkowski
W
here will price be a week or a month from now?
Here is a simple technique that will give you an
answer. I call it a price mirror.
Figure 1 shows an example of the chart pattern
head & shoulders top. The left shoulder (LS) is
on the left side of the head. The right shoulder
(RS) is approximately the same distance from the head, but
on the right side, topping out near the same price, too. I drew
a vertical blue line to illustrate how the left side of the pattern
mirrors itself on the right, reflected across the line.
Look where the rise to the head & shoulders top begins
in October (launch price). Also note that after price reverses
at the head & shoulders, it bottoms (landing) near the same
price where it began. The circuit from launch to landing looks
symmetrical about the blue line in both time and price.
This chart is an excellent example of a price mirror—that is,
8 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
how the movement of the stock on one side of a line reflects on
the other side of the line. If you bought the stock anywhere on
the rise to the head, you could guess where price might be in
the future, just by reflecting the chart across the blue line.
Let’s look at a few more examples on this chart. Point 1 OFFICES: HFZ IMAGES/ CHARTS: ALEX MIT/SHUTTERSTOCK/COLLAGE: JOAN BARRETT
on the left mirrors point 1 on the right. The top price is al-
most identical and the peaks look similar, too—an inverted
V-shape.
The peak at point 2 on the left mirrors the one on the right.
This time, however, the right peak springs from a congestion
area (the green circle). In fact, the right congestion area also mir-
rors the loose sideways move circled in green on the left.
Finally, the two congestion areas shown at 3, on the left
and right of the blue line, form at almost the same price and
distance from the blue line.
By looking at this chart, you could say that price mirrors
(reflects) across the blue line. You can also say that where price
turns will be more accurate than when it turns. For example,
the two peaks labeled 1 top out near $63, but the left peak is
farther away from the blue line (about seven months) than the
 CHART PATTERNS

right peak (about five months). Autodesk Inc (ADSK)

66
Head
65 LS RS
SUPPORT & RESISTANCE 64 1
63 1
62
Price mirrors, such as the reflections 61
60 2 2
shown in the chart around the blue 59
58
line, may sound like a profound 57
56
discovery, but it is not. Mirrors are 55
54
just a different way of looking at 53
52
charts. Think of price mirrors as 51
areas where support & resistance 50
49
might cause price to stall or turn. 48 3
3
47
For example, the head & shoulders 46
top has two shoulders that bump 45

THOMAS BULKOWSKI
44
up against overhead resistance in 43
the mid $60s. 42
Launch Landing
41
The stock at 2 on the left finds sup- Apr 15 May
Jun Jul Aug Sep Oct Nov Dec Jan 16 Feb Mar Apr May

port at $56–57 and moves sideways FIGURE 1: MIRRORED PATTERN. Here’s a symmetry setup by a head & shoulders top chart pattern. See how the
for a time until it resumes its down- left side of the pattern mirrors itself on the right, reflected across the vertical blue line.
ward trek. On the right, the stock
hits the high $50s (green circle) Exelon Corp. (EXC) 1
and lines sideways for a spell before 38 1
busting through overhead resistance 37

and soaring to point 1. 36

35
The chart in Figure 2 shows
34
another example using the weekly
33
scale. The stock bottoms at point 3
32
in December 2015. I drew a verti- 31
cal blue line to illustrate how price 30 2
reflects around that line. 2
29
The two green circles mark con-
28
gestion areas where the stock strug-
27
gled to find a direction. The circles
are not at the exact same price, but 26

they are close. The distance from 25

3
14 M J J A S O N D 15 F M A M J J A S O N D 16 F M A M J J A S O N D 17
the blue line to the circles is also not
FIGURE 2: SYMMETRY ON THE WEEKLY SCALE. Here you see how price hit overhead resistance near where it
symmetrical (just like in the prior had previously found support. Although the two peaks marked 1 do not stop at the same price nor are they the same
chart), but you get the idea. distance from the blue line, the overall chart has a symmetrical appearance.
The two peaks marked 1 do not
stop at the same price nor are they the same distance from overdosed on alcohol and started to see double. Set the beer
the blue line, and yet the overall chart has a symmetrical aside and look closer.
appearance. If you reflected the left part of the chart across The double bottom at 1 is a good example of a small price
the blue line, you would have a good indication of where and mirror. The two valleys bottom near the same price. Even
when price would actually go. the approach to the bottom from C to point 1 on the left is
For example, look at the twin bottoms marked “2.” They similar to the rise from point 1 on the right to D. Other than
share similar prices, but are not the same distance from the that example, you would be hard-pressed to find mirrors that
blue line. If you fold the chart vertically at the blue line and
flip the left side onto the right, you would have a good idea of
what the price will be at the bottom at point 2 on the right side.
The timing would be off, but the price would be similar.
Price mirrors work best and
DO MIRRORS WORK? appear most often when price
Based on the first two charts, it appears that mirrors do work. is choppy, and they hibernate
However, the charts were cherry-picked from the stocks I fol-
low. I chose them because they did look symmetrical. Now
when price is trending.
consider the chart in Figure 3 (weekly scale).
The only way this chart would look symmetrical is if you
May 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 CF Industries Holdings, Inc. (CF) B
70
65
60
55
50
C D
45 worked. However, the chart does
40
offer a lesson.
35
1 1
Compare the predominantly ris-
30 ing price trend from A to B in this
25 chart with the other two charts. The
prior charts showed price waving
20 up and down, but Figure 3 shows
18
16
an upward trend.
15
14
Simply, price mirrors work best
13 and appear most often when price
12
11 A is choppy. They hibernate when
10 M M J S N 11 M M J S N 12 M M J S N 13 M M J S N 14 M M J S N 15 M M J S N 16 M M J S N 17
price is trending. For example, in
FIGURE 3: PRICE MIRROR. It may be small but it’s there at a double bottom marked “1” on the weekly scale. The a moon shot like the one from the
two valleys bottom near the same price. Even the approach to the bottom from C to point 1 on the left is similar to the
rise from point 1 on the right to D. launch to the head in Figure 1, use
price mirrors as the stock drops to
support.
Helmerich and Payne Inc. (HP) )PH( .cnI enyaP dna hciremleH Figure 2 shows an example. When
F G
70 07 a sinkhole forms (point 3), expect
69 96 price to mirror the rise to recovery
68 86 (the two green circles). When decid-
67 76 ing where price might turn from up
66 66 to down, think double tops, triple
65 56 tops, and head & shoulders tops.
64 B C 46 When price drops, think of mirrors
63 36 formed by double bottoms, triple
62 26 bottoms, and head & shoulders
61 16 bottoms. There is no need to draw
60 06 a vertical line on the chart. Just
59 D E 95 imagine where price might go from
58 85 today’s price into the future by using
57 75
the past as a guide.
56 A 65
Jun 16 Jul Aug Sep peS guA luJ 61 nuJ TRADING US-
FIGURE 4: LITERALLY SPEAKING. By taking the mirror image of the chart it is possible to guess where the stock ING MIRRORS
might go. If you bought the stock at A and saw it begin to recover, you would expect to see it rise to peak at C, mirroring For both up and
the peak at B. Following that move, a retrace should take the stock from C to E, mirroring the rise from D to B. With
down directions,
any luck, the stock would reach a high of G, mirroring the left peak at F.
expect price to stall
on the right side
Helmerich and Payne Inc. (HP) of the chart near
85
84
83 where it did on
82
81
80
the left. The turns
79
78 might be sooner or
77
76 later than expected,
75
74
73
but often, future price will be close
72
71 F G J to the mirror image on the left of
70
69 your chart. By guessing where the
68
67 stock might stall or turn weeks or
66
65
B K L months before it actually does, you
64 C
63 can plan your trade accordingly.
62
61 This is especially helpful for specu-
60
59 H E I lative trades such as options.
58
D
57 In Figure 4 I show an example
56 A of literally taking the mirror image
Jun 16 Jul Aug Sep Oct Nov Dec Jan 17

of a chart. I used Paint (a simple

FIGURE 5: HOW’D IT DO? This is how the stock actually performed. The stock should have climbed from A to C, and
it did, but much faster than predicted. From C, it was supposed to retrace back to E. Instead, it kept rising, peaking at graphics program that comes with
G to mirror the peak at F. The drop from G to I mirrors the move from F to H. the Windows operating system) to
10 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
duplicate the chart on the right side Come visit one of the most popular trading
of the vertical blue line by flipping chat rooms for Breakout Trading.
it. I left the title and dates reversed,
intentionally.
If I bought the stock at A and saw
it begin to recover, I would expect to
see it rise to peak at C, mirroring the
Breakout Trading Bull Flags
peak at B. As we have seen, I would
expect the move to be a fast one, but
maybe not. Momentum Stocks Pivot Points
Following that move, a retrace should
take the stock from C to E, mirroring
the rise from D to B. If I was lucky,
the stock would reach a high of G, Swing Trading Key Reversals
mirroring the left peak at F.
How did this work out? Figure 5
shows the answer. I did not cherry-pick
this chart. That is clear from all the Home of DAN ZANGER, world record holder for
misses the guesses suffered. The stock
should have climbed from A to C, and parlaying $10,775 into $18 million in 18 months!
it did, but much faster than predicted.
From C, it was supposed to retrace back Home of T Z
HE ANGER EPORT R .
to E. Instead, it kept rising, peaking at
G to mirror the peak at F.
At least I got the big target (G) right,
which is important when you are in a
bullish trade. The drop from G to I
mirrors the move from F to H. I did not discuss this move, expert on chart patterns. He is the author of several books
but I show it with two circles in Figure 4. including Chart Patterns: After The Buy, Getting Started In
The HAI pattern in Figure 5 is a head & shoulders bottom. Chart Patterns, Second Edition, and the Evolution Of A Trader
By drawing another vertical line at I, you can see that peak J trilogy. His website and blog, www.thepatternsite.com, have
mirrors the one at G and valley L mirrors the one at K. This more than 700 articles of free information dedicated to price
forms another head & shoulders bottom, KIL. pattern research.

MIRROR, MIRROR ON THE WALL FURTHER READING

By using price mirrors, traders can guess where a stock might Bulkowski, Thomas [2016]. Chart Patterns: After The Buy,
be headed in the future and trade accordingly. Sometimes, John Wiley & Sons.
but not always, the estimated price target may be close to the [2005]. Encyclopedia Of Chart Patterns, 2d ed., John
actual one but the time target is frequently off. Nevertheless, Wiley & Sons.
price mirrors give traders another tool to determine price [2014]. Getting Started In Chart Patterns, 2d ed., John
targets and how long it may take to reach the target. Be care- Wiley & Sons.
ful using this approach, because the actual results may fall [2016]. “The Measure Rule For Price Prediction,”
short of expectations. Technical Analysis of STOCKS & COMMODITIES, Volume
34: October.
STOCKS & COMMODITIES Contributing Writer Thomas ‡THOMAS BULKOWSKI
Bulkowski (who may be reached via email at tbul@hotmail. ‡See Editorial Resource Index
com) is a private investor and trader with more than 35 years
of market experience and considered by some to be a leading

May 2017 • Technical Analysis of STOCKS & COMMODITIES • 11

The Relative Strength Index, or RSI is among the most popular indicators
used by traders. The RSI provides information about the strength of the price
movements on your charts, hence the name. In this article, we will learn what
the RSI really does, how to understand the information it provides and how
to use it in our trading.

The introduction – Understanding the RSI

indicator
The standard setting for the RSI is 14 periods which means that the RSI
evaluates the last 14 candles, or time periods.

The RSI compares the average gain and the average loss and analyses how
many of the past 14 candles were bullish versus bearish and it also analyses
the candle size of each candle.

For example, if all 14 price candles were bullish, the RSI would be 100 and if
all 14 price candles were bearish, the RSI would be 0 (or relatively close to 100
and 0). And an RSI of 50 would mean that 7 past candles were bearish, 7 were
bullish and the size of the average gain and loss was equal. The more candles
were bullish than bearish, the higher the RSI generally speaking is.

Example 1

The white highlighted area includes the past 14 price candles which the RSI
analyzes. Out of those 14 candles, 13 were bullish and only 1 was bearish
which resulted in a RSI of 85.
 

 
  
 

Example 2

Here are 3 more case studies to help us understand the RSI and how it
forms:

1. The first area marks a very bearish period with 9 bearish candles, 4
small bullish candles and 1 Doji. The RSI of this period was 15 which
signals a very strong bearish phase because the bears outnumbered
the bulls.
2. The second are includes 9 bullish candles and 5 (mostly small)
bearish candles. The RSI of this period was 70 which is a relative strong
bullish move because the bulls were in control here.
 3. The third area includes 6 bullish candles, 8 bearish candles and 1 Doji,
resulting in an RSI of 34 which signals moderate bearish strength as
the balance is equal with just a slight bearish surplus.

As you can see, just by analyzing the 14 candles you would be able to very
accurately guess the RSI for a given period. However, using an indicator can
still be beneficial because it takes out the guesswork and you can process the
data faster.
 

 
 

Oversold and Overbought – The myth!

The general idea is that when the RSI shows extremely high or extremely low
values (higher than 70 or lower than 30), price is said to be oversold or
overbought. But, let’s recap what we have just learned to see if this is really
true:

A high RSI simply means that there were more bullish candles than bearish
candles. And although price can’t go on printing only bullish candles forever,
it can be dangerous to believe that just because the RSI shows overbought
conditions that the price is likely to reverse. Once we understand what the
RSI does, we can see that overbought and oversold and NOT signals that
indicate that price will turn.

It’s a myth and it shows misinformation when traders refer to

overbought and oversold to define markets which will reverse!

Let’s take a look at some chart studies:

1. The first scenario shows a period in which the price kept falling for 16
days before the RSI turned back above 30 and left the oversold area.
And still there was no rally afterward. A trader who buys such a market
just because the RSI is showing oversold conditions will accumulate
huge losses.The RSI does NOT provide signals to buy when it is
oversold. It simply means that the price is very weak as we have
learned above.
2. During the second period, price kept falling for 8 days when the RSI
was oversold and even afterward, the price did not rally. The oversold
condition ust confirmed that the chart showed more bearish than
bullish candles.

 
 
RSI For Support and Resistance
We have just discovered that the RSI identifies strong trending price
movements when it moves at the extremes. And with this knowledge the RSI
can be used when it comes to support and resistance and breakout trading.
The screenshot below shows with a strong resistance level marked in black.
Now let’s observe what happened when price traded into the level.

You can see that price went back to the level several times. During the first
time, the RSI showed values of 63 and 57 which meant that although the
power was more bullish than bearish, the bulls were not in full control. A
strong resistance level does usually not break easily and it requires a strong
trend to make it past the price barrier.

The second time price went back to the level, the RSI was at 71, indicating a
fairly strong bullish trend, the resistance level held again. It wasn’t until the
last time when the RSI showed a value of 76 that the resistance level broke
and price held above it with the RSI going all the way to currently 85.
 

 
 

The RSI can be a useful tool when it comes to quantifying price strength
because that is what the RSI does: it analyzes momentum and price strength.
The RSI Divergence

And, finally, another way of using the RSI to identify turning points is by
finding divergences. A divergence signals that what price is showing you, is
usually not supported by the underlying price dynamics – we will see what
this means now.

Let’s follow the price action and we will see how a RSI divergence can be a
great way of making sense of trend strength.

First, we see that the downtrend is strong and clearly defined by lower lows
and lower highs. The RSI confirms that by showing a lower RSI when it fell
from 22 to 18 which means that the downtrend was accelerating.

Then, although price made a new lower low, we can already see that the
price wasn’t able to push as low anymore and price just barely broke the
previous low. The RSI confirmed that by showing a higher RSI and a value of
38 which means that during the last bearish trend wave, the sellers weren’t
as strong.

When the price action and the indicator show opposite signals, we call that
a divergence. A divergence can help us understand that trend strength is
fading and that one side of market participants are slowly leaving the arena.
Conclusion: Know what price is doing
The RSI is a great tool and although you could easily guess the RSI value by
looking at the past 14 candles, plotting the RSI on your charts can add
stability and guidance to your trading. If you can quantify price strength and
translate it into interpretable numbers, you can make trading decisions more
effectively and avoid guesswork and subjective interpretations.

Whether you are using the RSI to identify strength, look for turning points or
as a breakout trader, the RSI is your universal weapon.

https://www.tradeciety.com/rsi-indicator-tips/
 

 
 Thoroughly Modern Pivots
RSI & Livermore Pivotal Points
Knowing when to sell and take a profit on a successful
trade is a difficult skill to master. Sometimes you may get
out of a trade too early, other times you can’t tell if prices
are moving in an uptrend or downtrend, and sometimes you
just don’t know when to exit. Here’s how you can combine a
classic indicator with a classic technique and come up with
a sensible exit strategy.
by Mark Jahn
T here are so many choices when it comes to indica-
tors. Which ones do you use? That’s a question most
technical analysts face. For example, many of the
better relative strength index (RSI)–based techniques
will get you out of a trade with a good profit, but sometimes
this profit-taking will cost you a big win by getting you out
too soon. Jesse Livermore’s classic pivotal point technique is
one I like to use for identifying the precise moment to buy or
sell, but it can be difficult to determine whether the market
is in an uptrend or downtrend. Worse, sometimes the stock
20 • September 2016 • Technical Analysis of STOCKS & COMMODITIES
will turn without ever giving you a clear exit signal. But if
you combine the smoothed RSI with a simplified version of
Livermore’s pivotal points, it will often tell you almost exactly
the right time to sell an asset and take a profit.
ARROWS: ARTHIMEDES/GOLD PENCILS: ARSGERA/SHUTTERSTOCK/COLLAGE: NIKKI MORR
ONE STEP AT A TIME
I will first go over Livermore’s techniques and some of the
common issues that arise in practice when attempting to apply
them. I will then show how these issues are resolved by using
the smoothed RSI with simplified pivot points to decide when
to sell. I’ll use the smoothed RSI strategically to determine
when an asset is in an uptrend and simplified pivotal points
tactically to attempt to determine the exact right time to sell
given that the asset is in an uptrend. The natural approach is
to consider the smoothed RSI first, then consider simplified
pivotal points, and finally, combine the two techniques.
LIVERMORE’S MARKET KEY
Jesse Livermore was one of the greatest traders of all time.
The method I present here is only a relatively easy-to-interpret
 INDICATORS

adaptation using modern tools and tech- SPY daily closing price 205
niques. This is in keeping with Livermore,
who emphasized that traders should follow 200
their own guides. These are guides that I 195
developed based on Livermore’s methods,
and I hope that you will be able to use them 190

to develop or improve your own interpreta- 185

tion of Livermore.
180
Easily, the most frustrating aspect of
Livermore’s How To Trade In Stocks is 15 22 29Oct ’14 6 13 20 27 Nov ’14 10 17 24 Dec ’14 8 15 22 29Jan ’155 12 20 26 Feb ’15 9 17 23 Mar ’15
trying to determine if you are in an upward SPY daily smoothed RSI
80
or downward trend. If you were to literally
apply Livermore’s market key, you would 70
have to go back and consider the entire price
history of the asset, working out each and 60

every pivotal point to determine when the

50
trend switched so you can figure out the

QTSTALKER
current trend. There are many times when 40
it is obvious to anyone that the market is
going up or down, and Livermore stresses FIGURE 1: RELATIVE STRENGTH INDEX (RSI) SMOOTHED. The smoothed RSI in the lower graph moves
in the main text that the whole point of up and down with the price of SPY in the upper graph. Trends are easier to see because the smoothed RSI
operates on a constant scale.
the system is to determine when the trend
changes. I believe Livermore looked at
prices that were in an obvious trend and then used his methods The smoothed RSI is easily obtained by taking a simple mov-
to determine the exact time that the trend changed. ing average of the RSI technical indicator. I generally use a
Today, we can all easily compute the RSI, which takes into 10-day simple moving average of the standard 14-day RSI,
account the entire price history of the asset, and frequently but different values may work better for others. An example
we can use it to label “obvious” price movements. I use the of RSI with 10-day smoothing and the corresponding stock
term “obvious” here because what is obvious in retrospect chart can be seen in Figure 1. Notice how the smoothed RSI
is seldom obvious at the time that it occurs without using an is much less jumpy than the standard RSI you see in Figure
objective, numerical signal. 2. If you look at it over a period of time, the smoothed RSI
Livermore’s description of when a pivotal point occurs is indicator usually tells you when the price of the asset is in an
also somewhat vague and subject to interpretation. Some of uptrend or downtrend. Like RSI, the smoothed RSI over 70
this is by design. Livermore clearly talks
about several different types of pivotal
points. The pivotal points given in the Liv- 205
SPY daily closing price
ermore market key are defined somewhat 200
more precisely, but there is still room for
195
interpretation. I have found that William
O’Neil’s analysis of double-bottom price 190
patterns is applicable to Livermore’s pivotal 185
points. Pivotal points should cut through,
just as the second bottom should undercut 180

the first in a double-bottom pattern. Accord- 15 22 29Oct ’14 6 13 20 27 Nov ’14 10 17 24 Dec ’14 8 15 22 29Jan ’155 12 20 26 Feb ’15 9 17 23 Mar ’15
ing to the Livermore market key, you may 90

find a pivotal point even when the price only SPY daily RSI
80
comes close to undercutting (or overcutting
70
in the case of selling). While this sometimes
occurs, it appears to be less reliable, and 60

the simplified pivotal points that I use in 50

this article require a full cut.
40

SIMPLIFIED TECHNIQUE 30

I will use the smoothed RSI as an indica- FIGURE 2: THE STANDARD FLAVOR. The RSI shown in the lower graph is far more volatile than the
tor that the asset is in an uptrend and you smoothed RSI shown in Figure 1. Although RSI is also on a constant scale, its higher volatility makes it less
should begin looking for a pivotal point. suitable for determining trends.

September 2016 • Technical Analysis of STOCKS & COMMODITIES • 21

 New High
Combining the smoothed RSI
with a simplified version of
Livermore’s pivotal points will
Old High Pivot Point often tell you almost exactly
the right time to sell an asset
and take a profit.

rather than to go short. You can see in Figure 4 that TLT

hit several simplified pivotal points before falling. The first
simplified pivotal point is only a signal that the uptrend has
FIGURE 3: THEORETICALLY SPEAKING. When an old high is replaced by a come to an end. Major movements in the market generally
new high, draw a horizontal line from the old high forward in time along the x-axis. take time to fully play out. Knowing the end of a trend is valu-
When the price of the asset falls below the horizontal line, a cut is made and a
pivotal point is created. able information for option traders and others with limited
time horizons. Moving averages and other simple technical
indicators only signal a downtrend after it has begun and time
is considered high. However, it is usually not the best time decay has taken its toll.
to exit a trade. Putting it all together, you can say that there has been an
Livermore’s pivotal points often signal the right time to uptrend whenever the smoothed RSI is over 70 and that the
exit a trade if you know where to look for them. A simplified uptrend ends when a simplified pivotal point occurs. You
pivotal point occurs when the price of an asset reaches a new should not start looking for a simplified pivotal point until
high and then falls below the old high. Figure 3 shows how the smoothed RSI has increased substantially. Livermore
this should work in theory, while Figure 4 shows an example only considered lively, active stocks. Attempting to use these
of a trade I made with iShares 20+ Year Treasury Bonds pivotal points in a flat market will only lead to a bad case of
(TLT) in 2015. Also note that a simplified pivotal point does whipsaw.
not occur if additional highs are made in the interim. Another Returning to Figure 4, you see that there are several pivotal
important point to remember is that this is a signal to get out points before the actual reversal. There is generally plenty of
time to exit the trade after the first simpli-
fied pivotal point. However, it is possible
126
TLT daily closing price that a reversal will occur without any
125 pivotal points.
124
You could use a downward turn in the
Pivot point 2 Pivot point 3 smoothed RSI as a type of failsafe signal
123 to get out if a simplified pivotal point does
122
not occur earlier. This will allow you to
Pivot point 1 take some profits, but the best time to
121
get out will have slipped away. A good
120 example of a situation where the market
turned without giving a simplified pivotal
119
point can be seen in Figure 5 where you
Aug ’15 10 17 24 see another TLT trade I made in early
72 2016. You can see that this exit was slightly
TLT daily smoothed RSI after rather than slightly before the optimal
70 time to sell.
There are some other limitations to
68
the usefulness of these techniques. As all
66 traders familiar with RSI know, there is no
guarantee that RSI will go over 70. Natu-
64 rally, there is also no guarantee that the
FIGURE 4: KNOW WHEN TO SELL. Pivotal point 1 was the first pivot point made after the smoothed RSI
smoothed RSI will go over 70 and you must
went above 70 and indicated the correct time to sell. Two subsequent pivot points were made as the price of use another strategy for deciding when to
TLT peaked. abandon a trade as unprofitable.
22 • September 2016 • Technical Analysis of STOCKS & COMMODITIES
 The technique I have presented in this
134
article is also applicable to individual TLT daily closing price
stocks and commodities. I’ve mostly been
Sell at smoothed RSI downturn
taking profits in TLT of late, as bonds have 132

been much kinder to bulls in recent years.

It should also be noted that in theory the 130
procedure can be reversed and used by bears
as a signal to buy back assets that they have
sold short or sell back puts that they have 128

purchased. In actual practice, I have not

had success with the procedure as a bear. 126
This is probably because bear markets are
more volatile and there is not enough time 8 16 22 29 Mar ’16
Feb ’16
for a proper signal, at least not at the daily
level. Daytraders and others willing to TLT daily smoothed RSI
72
watch stock and commodity prices minute
by minute may have better luck reversing 70
these methods in bear markets.
68
WHEN TO SELL
It is often a good time to 66

sell when the smoothed RSI FIGURE 5: REALISTICALLY SPEAKING. In this case, I sold TLT call options after the RSI turned downward
goes over 70 and a simpli- because no pivotal points occurred earlier. The sell point shown here is where you should theoretically sell.
fied pivotal point occurs. The price of TLT when I sold the options was closer to $130 because of time delays.
The smoothed RSI is just
the 10-day simple moving average of the RSI, FURTHER READING
while simplified pivotal points occur when the Ehlers, John F. [2002]. “The RSI Smoothed,” Technical Analy-
price of an asset reaches a new high and then sis of STOCKS & COMMODITIES, Volume 20: October.
falls below the old high, as shown in Figure 3. Gopalakrishnan, Jayanthi [2000]. “Pivot Points,” Technical
There is certainly room for expanding this mod- Analysis of STOCKS & COMMODITIES, Volume 18: Febru-
ern simplified treatment of Jesse Livermore’s ary.
methods. In particular, it may be profitable to develop a system Livermore, Jesse L. [2001]. How To Trade In Stocks, Richard
where the uptrend is determined by a significant increase in Smitten, ed., McGraw-Hill (update of 1940 original).
the smoothed RSI. An increase in the smoothed RSI by 20 O’Neil, William J. [2009]. How To Make Money In Stocks,
points or more might be a better indicator of an uptrend than McGraw-Hill.
the smoothed RSI going over 70. Remember, the best systems Peterson, Dennis D. [2002]. “What Are Pivots?” Technical
are the ones that you redesign for yourself to suit your own Analysis of STOCKS & COMMODITIES, Volume 20: Febru-
purposes and no system should ever be taken literally to the ary.
exclusion of common sense. Teseo, Rudy [2006]. “Pivot Points, Stop-Losses, & Buy-Stops,”
Technical Analysis of STOCKS & COMMODITIES, Volume
Mark Jahn is a freelance writer with an MA in economics 24: June.
from Michigan State University and a BA in economics from ‡Qtstalker
Western Michigan University. He worked in accounting and
business law for several years before taking up writing. He can †See Traders’ Glossary for definition
‡See Editorial Resource Index
be contacted through his website at www.markjahn.net.

September 2016 • Technical Analysis of STOCKS & COMMODITIES • 23

 TRADING ON MOMENTUM

Scanning for Swing Trades

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GD\SULFHUDQJH7KLVSURIHVVLRQDOWUDGHUH[SODLQVZKDW
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by Ken Calhoun
especially those under $10 a share, because of the potential
for overly volatile price action and weak, choppy, unsustained
trends. Similarly, high-priced stocks over $70 a share don’t
offer good leverage. The $20–$70 per share range is the
“sweet spot” for volatility, price action, and trend strength
when swing trading.

hen you visually scan through swing trading breakout STEP-BY-STEP ACTION PLAN

W FKDUWVLWLVLPSRUWDQWWRIRFXVRQÀQGLQJWKRVHZLWK
strong technical uptrends, increasing volume, and
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Here’s how you can put this strategy to work in your trades.

Step 1: Scan through 15-day 15-minute stock charts priced

criteria I will outline here to help you narrow your trading between $20 and $70 per share with a minimum high–low price
DSSURDFKWRÀQGWKHEHVWFKDUWVWRHQWHUZKHQVZLQJWUDGLQJ range of at least 10% (for example, $3 or more for a $30 per
(that is, round-trip trades lasting several days to several weeks share instrument) and minimum daily volume of at least one
in duration). million shares per day, similar to the chart of Silicon Motion
Technology Corp. (SIMO) illustrated in Figure 1.
TRADING STRATEGY: 15-DAY 10% RANGE WITH 45-DEGREE
MOVING AVERAGE UPTREND CONFIRMATION Step 2: Check that the 50-period simple moving average (SMA)
Increasing volume, volatility, and trend strength will provide OLQHLVLQDGHJUHHDQJOHXSWUHQGGXULQJWKHPRVWUHFHQWÀYH
the strongest combination of entry signals when used together. to seven days of chart history. You are looking to enter 15-day
In testing this strategy with several thousand real-money high breakouts, so the most recent day’s price action must be
trades over many years, I have found that this breakout entry a 15-day high (as in Figure 1 on March 23, 2016).
strategy works best with stocks and ETFs priced between
$20 to $70 per share with at least one million shares per day Step 3: Set a buy-stop order to enter your trade on any day
of volume. following this combination of signals, once price has moved
It is wise to avoid swing trading low-priced small-cap stocks, at least $0.50 above the most recent 15-day high. In Figure
1, this signal occurred
on March 18, 2016 and
again on March 23, 2016.
On this chart, a new
entry price is ($37.40
+ 0.50) = $37.90. I use
$0.50 above current
KLJKVDVDÀOWHUWRKHOS
avoid false breakouts.
Minimum 10%
high-low range Step 4: You can use a
on 15–day chart maximum $2 initial and
trailing stop value on all
stock swing trades.
50SMA in 45–degree
angle uptrend INSIGHTS: WHY
THIS TECHNIQUE
WORKS
The key to trading break-
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enough uptrends that
continue up after you
eSIGNAL

enter your trade. By

FIGURE 1: WIDE-RANGE UPTREND CONTINUATION. Here’s an example of using a 45-degree uptrend with >10% high–low price combining a sustained
range to enter a breakout. uptrending chart with a
June 2016 • Technical Analysis of STOCKS & COMMODITIES • 45
 TRADING ON MOMENTUM

ZLGH!KLJK²ORZUDQJH\RX·OOÀQGWUDGDEOHFKDUWVWKDW
are powerful and volatile enough to make for technically
Increasing volume, volatility, and
strong trade entries. Resist the temptation to overtrade cheap, trend strength will provide the
FKRSS\FKDUWVLQVWHDGWDNHWKHWLPHWRÀQGSURIHVVLRQDOJUDGH strongest combination of entry
WHFKQLFDOFKDUWVZLWKEHWWHUSURÀWSRWHQWLDO signals when used together.
TRADE-SCANNING TIP: 52-WEEK HIGHS
An even stronger likelihood for potential breakout trading 8&/$DOXPQXVDQGLVWKHIRXQGHURI7UDGH0DVWHU\FRPDQ
VXFFHVVLVIRXQGE\XVLQJWKLVVWUDWHJ\VSHFLÀFDOO\IRUVWRFNV HGXFDWLRQDOUHVRXUFHVLWHIRUDFWLYHWUDGHUV
that are also making new 52-week highs. This is because 52-
week highs attract institutional buying volume, which you can FURTHER READING
capitalize on by using this momentum swing trading breakout Calhoun, Ken [2016]. “ATR Breakout Entries,” Trading On
strategy for new entries. Momentum, Technical Analysis of STOCKS & COMMODI-
TIES, Volume 34: May.
.HQ&DOKRXQLVDSURGXFHURIWUDGLQJFRXUVHVDOLYHURRP
DQGYLGHREDVHGWUDLQLQJV\VWHPVIRUDFWLYHWUDGHUV+HLVD

holding cash. While I do not condemn

this outright, the yield spread is simply
+35% +2% an indicator, and results do not show that
gains in shorting are as automatic as hold-
ing long positions. When a moving aver-
+10%
age crossover to the downside does occur
+10% S&P 500 = +60% in the indicator, holding long has rarely
~30% Yield Curve Strategy = +81% come alongside major initial drawdowns
+2% that could cause the trader to question
+22% his position.
Conversely, the crossover to the upside
in the middle of 2014 coincided with
markets continuing to reach new highs in
subsequent years, albeit amid a much more
FIGURE 3: APPLYING THE SYSTEM TO THE S&P 500. When the arrow signals down, it means the yield GLIÀFXOWWUDGLQJHQYLURQPHQW7KHUHIRUH
spread indicator is advising to sell. An up arrow signals to buy.
for best results, going long or holding cash
seems to be the best strategy.
The great part about this indicator is that it can be replicated
SACHAIS / JUNK BONDS and tested by basically any market participant, given the large
&RQWLQXHGIURPSDJH quantity of charting platforms that exist today. You can simply
backtest the strategy on your own, and determine whether it
have made 81% by buying S&P 500 futures starting in late can help your current trading approach.
2008, while only making a still-respectable 61% using the When junk bonds appear in the news often, you’ll know that
EX\ KROGDSSURDFK7KHUHDOEHQHÀWLVWKDW\RXFDQEHRXW ZLGHQLQJ\LHOGVSUHDGVLQGLFDWHKHLJKWHQHGÀQDQFLDOPDUNHW
of the market during times of increased volatility, and thus volatility. Whether spreads are widening, say, due to a com-
sleep easier at night. modity price collapse, or a company’s exposure to Greece,
or any other reason, in any case, you will now be able to use
IT’S VERSATILE such information to your advantage.
The concept of yield spreads is simple
yet powerful. It is a proven correlation $QGUHZ6DFKDLVSUHYLRXVO\DORQJVKRUWWUDGHUDW6FKRQIHOG
that during times of market stress, in- *URXS+ROGLQJVFXUUHQWO\UXQVDQLQGHSHQGHQWIXQGXWLOL]LQJ
vestors will dump junk bonds, and thus D PXOWLVWUDWHJ\ DSSURDFK +H KDV D GHJUHH LQ HFRQRPLFV
yield spreads will increase. Considering IURP*HRUJHWRZQ8QLYHUVLW\. +HFDQEHUHDFKHGYLDHPDLO
this is a structural phenomenon in our DWDQGUHZVDFKDLV#JPDLOFRP
current economy, this indicator’s validity looks to continue
into the future. ‡Tradingview.com
Traders may question whether it is appropriate to short the Â6HH(GLWRULDO5HVRXUFH,QGH[
market during times of increasing yield spreads, instead of
46 • June 2016 • Technical Analysis of STOCKS & COMMODITIES
 What’s Beneath Price Movement?
Seasonality Pivot Points
Markets, some more than others, are impacted by seasonal
tendencies such as production schedules, weather, and sup-
ply/demand conditions. A deeper analysis into these seasonal
patterns can help reveal the reality behind price movements
and could help in your strategy development. Here’s how.
by Karl Montevirgen
arket seasonality is essentially a history of price
M movements, but one whose sole aim is to record
patterns of consistency. These patterns, often ap-
pearing cyclical, may have some basis in actual
supply/demand conditions. It is because of this possibility
alone that some traders are tempted to view these patterns
as market “tendencies.” Sadly, seasonality analysis has been
slightly stigmatized by this erroneous and popular view. To
address the elephant in the room, it’s important to point out
that an undefinable portion of these “repetitive” patterns just
may be purely coincidental.
Seasonality analysis is not designed to distinguish eco-
nomically driven events from random ones. Its merit rests
on its sole objective to pinpoint and map out recurring price
20 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
patterns, patterns that often escape more traditional modes
of market analysis.
For seasonality research to become more useful and ac-
tionable, it requires a greater degree of rigor in approach. It
needs to undertake its project with greater detail and com-
prehensiveness. Most important, it must offer multiple and
comparative perspectives toward any single object under its
analytical scope.
A MAP OF POTENTIAL EVENTS
Contrary to popular opinion, seasonality is not about predic-
tion. If anything, it’s analogous to a temporal cartography: It
maps events that seemingly tend to recur across the calendar
year. Once these events have been identified and recorded, it’s
the trader’s job to interpret the significance of these events,
filtering random instances from those that present viable op-
ART: MINDSCANNER/SHUTTERSTOCK
portunities and risks.
Take an assortment of specialized maps that highlight
characteristics of a given environment, for example, traffic
congestion, accident-prone areas, foot traffic, high-risk neigh-
borhoods in a city, and so on. These maps don’t predict events;
they warn. Analogous to these maps, seasonality research
 INDICATORS

highlights the possibility of certain price AR < AD unless you establish a set of heuristics to
movements occurring based on historical
“repetition.”
LR < LD Ch + % aid interpretation (such as the one shown
in Figure 1). It’s important to note that each
FIGURE 1: POSITIVE CHANGE DUE TO UPSIDE
For traders who specialize in markets FREQUENCY. Even though there’s a seasonal
permutation tells a story, providing valu-
affected by seasonal factors—namely tendency for prices to rise, the average decline able details about each market outcome.
weather, production schedules, and was greater than the average gain. The reason Let’s get back to our coffee example.
various calendar-driven supply/demand for the positive change is that there were more up Here are the abbreviations used in
days than down days.
conditions—seasonality research can be a Figures 1 & 2:
valuable “map” for strategy development.
AR < AD
PROBLEMATICS OF LR > LD Ch + % AR = Average rise
AD = Average decline
SEASONALITY RESEARCH FIGURE 2: BULLISH OR BEARISH SCENARIO? If LR = Largest rise
Seasonality projections come in various there are more down days than up days, the average LD = Largest decline
declines are greater than average rises, the largest
forms. More commonly, they are pre- rise is significantly higher than the largest decline, Ch + = Positive change
sented as charts illustrating average returns and the net change is positive, it could obscure the Arrows up or down % = Frequency of
over a calendar year, or event-specific bearishness of the market. rise or decline
projections—for example, the Halloween
effect, Santa Claus rally, presidential cycles, and so forth. As Week 9 exhibited a “seasonal” tendency to rise, with the
helpful as these projections are in alerting us to consistencies average decline being greater than the average gain. The posi-
in market behavior, they nevertheless lack the adequate detail tive change is attributable to the frequency of up days—the
and specificity necessary for strategy integration. only factor sustaining week 9’s positive levels.
Suppose you came across a projection that stated a 70% For the sake of further elaboration, let’s imagine a differ-
probability of a market rising in a given month based on his- ent scenario. What if there were more down days than up
torical cycles. Is it a steady rise, or did that rise take place in, days, with average declines being greater, largest rise being
say, the last week of the month? Was the average rise greater significantly higher, and a positive net change?
or lesser than the average decline? Let’s take another example In this variation (see Figure 2), perhaps the largest rise
to go further into this matter. skewed the data, in which case the scenario’s bearishness
Suppose that a given market rose only 0.8% historically in would be obscured by the positive net change.
the fifth week of the year for the last 25 years. It may not seem Ultimately, adding greater detail and interpretability to
very bullish. But what if, during that particular week of the seasonal data can make research efforts more relevant to trad-
year, markets had actually risen 80% of the time throughout its ers. But how can we make this data immediately applicable
25-year span? That figure alone may seem bullish, but it still to current markets? One solution is to convert seasonality
doesn’t explain the low return. So what if we found out that data into pivot points.
during one of the years, week 5 experienced a rare substantial
decline large enough to skew the data to the downside? And WEEKLY SEASONALITY PIVOT POINTS
in addition to this one-time event, what if week 5’s average Pivot points provide a technical framework from which to
rise was significantly greater than its average decline? gauge trends and anticipate potential support & resistance
In this case, the figure of 0.8% conceals particular data levels. There are several “types” of pivot points. And although
that might be considered exceedingly bullish. It hides the real their calculations differ, their means of abstracting data are
dynamics behind the commodity’s price history. paradigmatically similar.
In short, a solid seasonality analysis requires not only more Seasonality pivot points take a different approach: support
detail, but also the means to interpret the variations of stats & resistance projections are based on historical averages and
that make up that detail. It needs a basic framework to render extremes. Beyond this, there are no further abstractions save
the data and all its permutations more interpretable. one: the actual pivot level, which is determined by averaging
the average change and median return.
INTERPRETING SEASONALITY STATS In addition to these price levels, the data are also used to
FROM MULTIPLE ANGLES determine the percentage frequency in which markets had risen
Viewing statistics on price movements from multiple angles can
be confusing. Take Coffee C futures. From 1980–2016, trading
during the ninth week of the year has shown that prices had Seasonality pivot points serve
risen 65% of the time with an average change of 0.53%. The
average price rise of 3.17% is smaller than the average decline
as a bias for which trades are
of -4.35%. The largest rise of 8.69% is dwarfed by the largest initiated based on the trader’s
decline of -16.93%. What “story” do these stats tell us? individual strategy.
As an aside, if you were to consider stats for every market
you trade, the number of permutations can cause confusion
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 21
 R2 = Largest Rise 77.88 Historical Historical
Rise Decline
R1 = Average Rise 70.71
Pivot 69.03
S1 = Average Decline 65.90 64% 36%
S2 = Largest Decline 57.90
FIGURE 3: CONVERTING SEASONALITY DATA INTO PIVOT
POINTS. Here you see an example of the calculation of seasonality
pivot points in the June 2017 lean hog contracts. The average and
extreme price rises and declines are used in the calculations of the
support and resistance levels. The pivot point is the average of the
median return and average change.
or fallen. So if a market had risen in a given week 18
times out of 25 years, the frequency of markets rising
is, of course, 72%, which is a bullish figure.
In short, we plot the following points:
R2 = Largest historical (%) rise
R1 = Average rise
Pivot = Average of the median return and average
change
S1 = Average decline
S2 = Largest decline
% markets up and down.
Example:
From 1973 to 2016, week 17 for lean hogs had been tepidly
bullish. With an average change of 0.94%, the average gains
(3.50%) are lower than the average losses (-3.54%), and the
largest gain (14%) is slightly smaller than the largest decline
(-15.25%).
Yet the lean hogs market had risen 64% of the time in week
17. Similar to our earlier coffee example, we can assume
that the positive average change was due to the frequency of
markets rising.
Now let’s take these figures and plot them across the current
market. At the time of this writing, the June contract HEM17
had opened at 68.32 at the beginning of the week.
I will use the following calculation:
R2 = Weekly close × (1+LR) or 68.32 × 1.14
R1 = Weekly close × (1+AR) or 68.32 × 1.035
Pivot = (Weekly close × [1+Average change or
1-Average change if negative]) +
(Weekly close × [1+Median])/2 or
(68.32 × 1.0094) + (68.32 × 1.0113)/2
S1 = Weekly close × (1-AD) or 68.32 × (1-0.0354)
S2 = Weekly close × (1-LD) or 68.32 × (1-0.1525)
The results are shown in the table in Figure 3.
Currently, lean hogs had exceeded R1. Of course, the chart
in Figure 4 isn’t intended to demonstrate a predictive outcome
but to show how seasonal pivot points can be used as a visual
framework or point of reference (R1 = green, S1 = red; R2
and S2 are not shown).
22 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
72.400
72.000
71.600
71.660
71.200
70.926
70.800
70.400
70.000
69.600
69.200
68.800
68.400
68.000
67.600
67.200
66.800
66.400
66.000
65.600
Apr 24 07:30 08:30 09:30 10:30 Apr 25 07:30 08:30 09:30 10:30 Apr 26 07:30 08:30 09:30 10:30
FIGURE 4: APPLYING SEASONAL PIVOT POINTS. Seasonal pivot points can be used as a
visual framework or point of reference. Here, the green horizontal line represents R1 and the
red horizontal line represents S1. Traders could use R1 and S1 as anticipatory price targets
and base their trading strategies on these levels.
HOW TO USE SEASONALITY PIVOT POINTS
You can integrate seasonality pivot points into your market
analysis or trading strategy the same way you would with
other pivot points.
Some traders might view R1 and S1 as potential price lev-
els to anticipate. Depending on the individual strategy, these
levels serve as a bias for which trades are initiated based on
the trader’s individual strategy.
Traders might also view R2 and S2 as price thresholds
from which, depending on weekly ATR, short outright futures
or options might be initiated, or long breakouts anticipated
and traded.
The historical rise and decline percentages serve as a fur-
ther directional bias, but only to the extent that the statistical
returns support their favorability (in other words, a market that
rises 55% of the time might not be so bullish if the average
decline is three times that of the average rise).
The main differences in using seasonality pivot points can
be summarized as follows:
1. If you were to use R1 and S1 as anticipatory price
“targets,” you would base your benchmarks on histori-
cal average gains and losses (as opposed to an abstract
calculation).
2. If you were to use R2 and S2 as anticipatory price
thresholds, you would base your benchmarks on historical
limits rather than an abstraction of price data.
3. Percentage of rising and falling weeks may be read as a
mere “bias” but one derived from actual price history.
Continued on page 46
 that short sellers know everything and indeed, there have been
many cases of heavy short sellers watching as a stock runs
upward, forcing them to cover.
One final way to look at short interest is as a contrarian
sign, and many contrarian investors and traders view it as
getting a stock at a discount. If you believe the price will
move upward, a high short-interest number is not the end of
the world; remember, the more shorts, the bigger the move
to the upside that the stock will have to achieve in order to
overcome the shorts and push the stock price higher.
DON’T OVERLOOK IT
Float may seem like a simple term, but we often have a
tendency to pay little or no attention to the simple terms,
especially when it comes to trading. Float is one figure that
the astute investor or trader, regardless of size, should keep an
eye on. Float gives you an idea of how many stock shares are
MONTEVIRGEN/SEASONALITY PIVOT POINTS
Continued from page 22
DOES MARKET HISTORY PROVIDE
A BASIS FOR ACTION?
History never repeats itself in exactly the
same manner. The slightest similarities will
always reveal heterogeneous differences
and discontinuities in anything resembling
a simple cause or effect. With regard to
seasonality research, terms like “cyclical-
ity” and “recurrence” are used loosely and frequently, as
they are hard to avoid. Unfortunately, these terms tend to do
more harm than good, as both can be taken a step too far as
to imply “prediction.”
Once again, seasonality research is not about prediction—it’s
about scenario planning. It’s about mapping potential outcomes
— “outcomes” with emphasis on plurality, and “potential” stand-
ing as its critical modifier. At times, certain market outcomes
will resemble the past, at other times they won’t.
Either way, if you value what historical consistencies may
reveal, despite the fact that patterns may not always repeat,
having a map that clearly illustrates historical patterns will
only keep you more informed and prepared. After all, it helps
to know what has consistently happened, in which market, in
what week or month, and by how much. It gives you a “road
map” of potential things to anticipate, things that you may
choose to avoid or act upon.
This is what seasonality research is all about—anticipating
46 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
The more supply there is, the
more demand it can meet
without massive changes in
the price.
available to trade. The bigger the order, the more important
the float is. Keep an eye on both float and short interest in the
stocks you own or plan on trading. It’s another analytical tool
to help keep your boat afloat.
John Devcic is a market historian and freelance writer. He
may be reached at drmorgus@gmail.com.
Seasonality research is not
about prediction—it’s about
scenario planning.
potential events based on historical patterns. And making these
histories clearer, more interpretable, and actionable are what
seasonality profiles and pivot points can help you achieve.
Karl Montevirgen is a content designer/strategist at Halifax
America LLC, a stocks/option, futures, and forex brokerage
in Sherman Oaks, CA. In addition to creating and designing
content, he has extensive knowledge of and experience with
commodity futures and foreign exchange. He can be contacted
through the Halifax America website at www.halifaxamerica.
com or by email at kmontevirgen@halifaxamerica.com.
Halifax America’s seasonality website can be found at www.
actionablemarkets.com.
FURTHER READING
Montevirgen, Karl [2017]. “Use Seasonality To Optimize
Algorithmic Strategies,” Technical Analysis of STOCKS
& COMMODITIES, Volume 35: January.
 CHARTING

As The Crow Marches

A Candlestick Strategy
With Soldiers And Crows
Traders want to get in earlier and have more frequent crow pattern of 529 confirmed signals on the NYSE
trading opportunities. Here are two patterns that can with about 59% profitable or the 479 confirmed ap-
point you in that direction. pearances on the Nasdaq with 67% profitable.
Those compelling statistics led to this article, which
mong the more well-known candlestick is geared toward the more active trader who wishes

A reversal patterns are soldiers and crows. to take advantage of earlier and more frequent entry
These occur in a three-candle pattern opportunities. This article describes each pattern, the
such as three white soldiers or three pattern confirmation, entry and stop-loss placement,
black crows. Recently, on the website and suggestions for combining the patterns with other
Candlesticker.com, we learned of two other candle indicators.
reversal patterns—a bullish one white soldier and a
bearish one black crow—that require fewer candles. THE PATTERNS
But what really caught our attention were the back- The Candlestcker.com website describes the patterns
testing results provided on the website. As might be using the more traditional candle colors of black and
expected, both patterns occur more frequently than white real bodies. That is how they will be described
their more well-known three-candlestick counter- in this article. However, we will illustrate the patterns
parts, but they also share similar high-profitability using VectorVest charts with red and green candles.
percentages. The VectorVest software offers the additional edge
As of December 2016, Candlesticker.com reported of integrating both the Japanese and Western charting
that since January 1, 2013, the bullish one white soldier styles to provide more information than a candlestick
has been profitable more than 60% of the time on New alone. Like the traditional candlestick, a hollow real
York Stock Exchange stocks and also on Nasdaq stocks body (one that shows the chart background color)
when it appeared as a confirmed candlestick pattern. means it closed higher than it opened and a filled real
That included more than 22,000 confirmed instances body closed lower than it opened. In VectorVest, a
on the NYSE and close to 14,000 confirmations on hollow real body in green not only identifies a candle
the Nasdaq. By comparison, the bullish three white that closed higher than it opened but also one that
soldiers had 594 confirmed signals on the NYSE with closed higher than the prior candle’s close. A filled
approximately 57% profitable, and the Nasdaq’s 302 green real body shows that the real body closed lower
confirmed signals of which 63% were profitable. than it opened but that its close was higher than the
Within the same time period, the bearish one black prior candle’s close. A red candlestick with a hollow
crow pattern had been profitable for close to 59% of its body indicates a close higher than the open but a
more than 17,000 confirmed appearances on the NYSE close lower than the prior candle’s close. A filled red
JOSE CRUZ

and 60% profitable in 11,000 confirmed appearances candle closed lower than it opened and also closed
on the Nasdaq. Contrast this to the bearish three black lower than the prior candle.

by Jerry D’Ambrosio and Barbara Star, PhD

October 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 The chart of Quanex Corp. (NX)
2 in Figure 1 illustrates the bullish
1 one white soldier pattern. As men-
tioned in the prior section, red and
VECTORVEST

green candles will be used in our

charts instead of black and white
candles in this article. Following
FIGURE 1: A BULLISH ONE WHITE SOLDIER PATTERN. The bullish one white soldier seen with the daily price chart of a price decline, the candlestick
Quanex Corporation (NX)is a reversal pattern that occurs following a price decline and warns of a potential change in trader
sentiment. The candlestick labeled “1” is the pattern. Candlestick #2 confirms the pattern and also serves as an entry for labeled #1 is the one white soldier
the trade. that followed a dark (in this case
red) candle. Candlestick #2 became
the confirmation of the pattern
as soon as it cleared the close of
12 candle #1.
The trade entry occurs at the
point where price confirms the
X
pattern. A stop-loss is placed below
the low of candlestick #1. Ideally,
prices complete the reversal by
continuing to rise. However, the
trade is terminated if price either
closes below the stop-loss or makes
FIGURE 2: A BEARISH ONE BLACK CROW PATTERN. The bearish one black crow illustrated on this daily price chart of two consecutive lows below the
American Campus (ACC) is a reversal pattern that indicates a change of sentiment following an uptrend. Candlestick #1
stop-loss level.
in August 2016 is the one black crow pattern. Candlestick #2 is the pattern confirmation, which also serves as the entry for
the trade. An “X” under the red candlestick in June shows a bearish one black crow. However, it was not confirmed, so a
trade was not triggered. Bearish one black crow
The bearish one black crow signals
a potential reversal in a rising mar-
ket. It consists of a black candlestick
that follows a white candlestick.
B The black candlestick opens below
the close of the white candle and
closes below the open of the white
E candle. That is, it opens inside the
A
real body and closes outside and
below the real body of the white
candle. The candle lengths should
not be short.
C The pattern is confirmed when
D
price falls below the close of the
FIGURE 3: BULLISH AND BEARISH PATTERNS ON ALASKA AIR. Patterns can occur at various locations on a price chart. black candlestick, preferably on
During August and September 2016, several bullish and bearish patterns appeared on the daily chart of Alaska Air (ALK). the next candle. Figure 2 illustrates
Some were profitable and some were not. the pattern on American Campus
(ACC). Price made a double top
Bullish one white soldier at the end of October 2016 but on
The bullish one white soldier alerts sellers to a potential re- November 1 a bearish one black crow (#1) candlestick formed,
versal in a declining market. It consists of a white candlestick indicating a potential reversal. The pattern was confirmed
that follows a black candlestick. The white candlestick opens when the next candlestick (#2) fell below the close of candle
above the close of the black candle and closes above the open #1. Another one black crow pattern had formed earlier in June
of the black candle. In other words, it opens inside the real body but the “X” under the pattern shows that there was no confir-
and closes outside and above the real body, but not necessarily mation followthrough.
above the high of the black candle. Enter on the confirmation and place a stop-loss above the high
The description also states that the length of the candlesticks of candlestick #1. The reversal completes if prices continue to
themselves should not be short. The pattern is confirmed fall. The trade is terminated if price either closes above, or makes
when the next candlestick crosses above the close of the white two consecutive daily highs, above the stop-loss level.
candlestick.
10 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
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PATTERN LOCATIONS
Both the bullish one white soldier
and the bearish one black crow
may be found at price tops and
bottoms, at retests of tops and
bottoms, and at countertrend price
FIGURE 4: SCAN LIMITATIONS. The use of scans allows a rapid search for patterns, but for it to indicate a pattern, every
moves. The daily chart of Alaska scan parameter must be met. The arrow on this chart of MicroStrategy (MSTR) points to a profitable bearish one black crow
Airlines in Figure 3 contains sev- in July 2016 that was missed by our scan because it did not meet one of the parameter criteria.
eral examples.
As prices rose in August, 2016,
a bearish one black crow formed at
the beginning of a pullback (point
A). The pattern was confirmed Exit
2
by the following candle but the 1
decline did not continue. Instead,
prices curved upward, hitting the
stop-loss above the high of the
candlestick at point A as it resumed
the uptrend.
The uptrend came to an abrupt
halt with the reversal formation of
another bearish one black crow at FIGURE 5: AIG WITH EXIT INDICATORS. The use of indicators such as Lane’s stochastic or Wilder’s RSI provides goals
point B. Even though the candle- for partial profit-taking or exits. This chart of AIG offers an example of a good place to exit the confirmed bullish one white
stick that followed point B was a soldier trade.
green hollow candle, it triggered
a pattern confirmation and entry
by falling below the close of the
point B candlestick during that 1
trading day without hitting the
stop-loss.
Then price declined until it
Exit
reached the bullish one white
soldier reversal at point C. The
Exit
pattern was confirmed by the next
candlestick, but with no further
followthrough, the attempted
countertrend rally fizzled and was
stopped out as price terminated the
FIGURE 6: CHIPOTLE MEXICAN GRILL (CMG) WITH STOCHASTIC AND RSI. Both indicators are shown during the
pattern two days later by breaking October 2016 decline in CMG to illustrate the different points at which they reach their exit or profit-taking levels. Individual
below the low of the candlestick traders may find one indicator more preferable than the other depending on their risk tolerance.
at point C.
The September low marked a
bottom that found support at the lows made in August and both patterns, we had to deal with some vagueness in the pat-
was followed by a bullish one white soldier (point D). The tern descriptions. For example, all candlestick reversal patterns
price breakout above the close of the point D candlestick on require the existence of a trend prior to the change in direction.
the following day confirmed the pattern and a few days later, The only information provided in the description is that the
price gapped up. market has been declining or that it has been rising prior to
The brief pullback at point E formed a bearish one black crow. the reversal candle. No mention is made of the length of that
However, pattern confirmation and entry did not occur because trend or its strength.
price never dropped below the close of the point E candlestick The scan used here was based on an arbitrary decision that
and after a brief sideways pause, price continued to rally. the stock had been trending higher or lower for three bars
prior to the reversal candle. In this case, we would usually see
SCANNING FOR PATTERNS at least three green candlesticks prior to the bearish one black
Pattern scans eliminate the need for time-consuming manual crow candle, or three red candlesticks preceding the bullish one
chart searches. However, in attempting to set up scans to find white soldier. Some traders might prefer experimenting with
12 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
 Noisy indicators
delay your analysis
other time lengths or other criteria, such as above or below a
moving average.
And even though the description states the total candlestick
lengths from upper wick to lower wick “should not be short,”
the actual range from high to low is not specified. We decided
not to include a candlestick range in our scan, preferring instead
to base the decision about candle length on an examination of Jurik algorithms
the chart itself. deliver low lag,
In creating a scan, each trader may also choose to specify low noise analysis
a minimum price level and the average volume of the stocks
to be included in the scan. For the bullish one white soldier,
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
we used a minimum price of one dollar to give price plenty NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
of room to rise. For the bearish one black crow, we increased Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
the minimum price to $10.00, which allows a larger potential
trading profit during a decline.
Jurik Tools on live charts, on the web !
In both scans, we required a 50-day average minimum volume tinyurl.com/jurik-online
of 100,000 in order to produce a larger list of candidates. But an
average daily volume of at least 500,000 shares is more likely
to produce more liquid and possibly higher-caliber stocks.
Jurik Research
The scans described in this section were developed in the
VectorVest program for use with daily data and can be applied
to stocks, ETFs, and indexes. The VectorVest code for the bull- 2010 -- 2011 -- 2012 -- 2013
ish one white soldier and the bearish one black crow is located Add-In software

within the Unisearch feature of VectorVest. For those who wish

to reproduce the scans in other charting programs, the sidebar
“Candle Scans” offers a non-coded, English translation of the
scan parameters.
Scan limitations
Scans have their pros and cons. The time-saving benefit of
quickly sorting through hundreds of charts must be weighed
against the fixed nature of the parameters. Some potentially
good trades may be eliminated because they fall just outside
one of the fixed parameters.
A case in point is the July 2016 retest of a June high of the
stock MicroStrategy (MSTR). Our scan failed to signal a bearish
one black crow that led to a major price decline because our
scan required three rising closes prior to the one black crow
candlestick. The arrow in Figure 4 points to the bearish one
black crow candlestick that was preceded by a slightly lower
close one candle prior to the retest top.
Confirming the patterns
The scan identifies the bullish or bearish candlestick but not
whether the pattern is confirmed. That was intentional on our
part because the pattern confirmation also triggers the entry.
A scan that waits until confirmation has occurred would mean
the entry would be missed or delayed. Instead, our scan allows
us to set up a daily watchlist, which gives us time to prepare
for the trade in advance.
TRADING THE SIGNALS
The bullish one white soldier and bearish one
black crow are easy patterns to spot because they
both begin inside the real body and end outside the
real body of the preceding candle. This is unlike
jurikres.com • 800-810-3646 • 719-686-0074
the piercing or dark cloud patterns that begin outside the real
body and end inside the real body of the preceding candle.
The information given on the Candlesticker.com website
also makes them easy patterns to trade without the need for
indicators. They are simple breakout patterns with entries at
the point where price crosses the prior candles’ closing price
and with stop-losses either above the one black crow high or
below the one white soldier candle.
Exit suggestion
The one thing missing is determining a target or an exit method
other than a stop-loss. Using a trailing stop is one method.
However, because these patterns lend themselves more to
short-term rather than longer-term trading, we found that the
stochastic oscillator or Wilder’s RSI work well to identify
potential targets for exits.
Both the bullish one white
soldier and bearish one black
crow may be found at price
tops and bottoms, at retests
of tops and bottoms, and at
countertrend price moves.
October 2017 • Technical Analysis of STOCKS & COMMODITIES • 13
 Bullish: Following an entry on a confirmed bullish one
white soldier, we look for prices to rise. If the pattern is not
terminated by a stop-loss or two lower lows, then we can
take profit or exit when either a 14-period stochastic reaches
a level of 80 or above and/or a 14-period RSI reaches a level
of 70 or above.
The daily chart of the insurance company AIG in Figure
5 provides an excellent example. Following a price decline
in early November, a bullish one white soldier appeared on
our November 7, 2016 scan list. It was confirmed on the next
bar when price rose above the 59.28 close of the one white
soldier. Entry at that price would have led to a nice five-point
move up to 64.45 on November 14, 2016, where the stochastic
reached its 80 level (first arrow) or to 64.60 on November 15
(second arrow) when the RSI reached its 70 level.
Bearish: Following an entry on a confirmed bearish one black
crow, price should decline. If the pattern is not terminated
by a stop-loss or price does not make two higher highs, then
we can take some profit or exit when the 14-period stochas-
tic falls to a level of 20 or below and/or the 14-period RSI
declines to 30 or below.
On October 11, 2016, Chipotle Mexican Grill (CMG) in
Figure 6 opened just a little lower than the close of the prior
day’s double top and formed a bearish one black crow pattern
(#1). It was confirmed when the following candle fell below
the close of the bearish one black crow at $423.02. Price had
declined to a close of $394.35 when the stochastic oscillator
fell below its 20 level five days later on October 17 (first ar-
row). This turned out to be a good place to take some profit or
to exit because price rallied from there. The RSI had not yet
reached its 30 level. The RSI did not fall below its 30 level until
October 26 when price gapped down and closed at 386.02. It
is up to the trader to decide whether the additional eight-point
profit was worth the risk of uncertainty and a potential price
reversal while waiting for the RSI to drop below its 30 level
(second arrow) prior to exiting.
THEY’RE VERSATILE
The examples in this article have all
focused on daily price charts. How-
ever, both patterns also can be found
on weekly charts. Sometimes weekly
charts provide patterns not seen on the
daily charts, as happened during the
first week of November 2016 when a
bullish one white soldier kicked off a
rally that lasted into December. Interested traders may wish to
compare the daily and weekly charts of the S&P 500, the Dow
Jones Industrial Average, and their ETF counterparts during
that timeframe.
The frequency of the patterns, the clear stop-loss criteria,
and exit criteria make the bullish one white soldier and bearish
one black crow definite contenders for short- and intermediate-
term traders.
14 • October 2017 • Technical Analysis of STOCKS & COMMODITIES
CANDLE SCANS
Bullish one white soldier scan parameters:
• Stock price greater than $1
• 50-day average volume is greater than 100,000
• Yesterday’s close was less than the day before
• Yesterday’s close was less than its open
• Today’s open is greater than yesterday’s close
• Today’s close is greater than yesterday’s open
• Today’s open is less than yesterday’s open
• As of yesterday’s close, price had been closing
lower for three days.
Bearish one black crow scan parameters:
• Stock price is greater than $10
• 50-day average volume is greater than 100,000
• Yesterday’s close was higher than the close the
day before
• Yesterday’s close was greater than yesterday’s
open
• Today’s open is less than yesterday’s close
• Today’s close is less than yesterday’s open
• Today’s open is higher than yesterday’s open
• As of yesterday’s close, price had been closing
higher for three days.
Jerry D’Ambrosio is a senior instructor with VectorVest and
trains users how to invest and trade with the VectorVest sys-
tem of stock analysis and portfolio management. He is also a
trader who, for 10 years, has educated investors around the
world about stock market strategies and money management
techniques. He can be reached at JerryD@VectorVest.com or
888 658-7638.
Barbara Star, PhD, is a frequent contributor to Techni-
cal Analysis of STOCKS & COMMODITIES magazine. She is a
part-time trader and provides technical analysis instruction to
individuals and small groups. She lives in Southern California
and can be reached at star4070@aol.com or 818 224-4070.
The authors wish to thank the website Candlesticker.com for
permission to use information from their website.
See our Traders’ Tips section beginning on page 50 for implementa-
tion of Jerry D’Ambrosio and Barbara Star’s technique in various
technical analysis programs. Code given in the Traders’ Tips section
can be found in the Traders’ Tips area at Traders.com.
‡VectorVest
‡See Editorial Resource Index
 It’s A Stochastic
Higher Highs & Lower Lows
Spotting emerging trends, defining correction periods, and
anticipating reversals can benefit your trading in many ways.
Here’s a look at a trading system that uses momentum indica-
tors to define trend direction.
by Vitali Apirine
he higher high lower low stochastic (HHLLS) is a mo-
T mentum indicator–based system that helps determine
the direction of a trend. It is made up of two separate
indicators: the higher high stochastic (HHS) and lower
low stochastic (LLS). These two indicators can be used to
spot emerging trends, define correction periods, and anticipate
reversals. Signals can also be generated by looking for diver-
gences and crossovers. Because the HHLLS is range-bound, it
can also be used to identify overbought and oversold levels.
CALCULATION
HHS is based on price highs, while LLS is based on price
lows. These two indicators are plotted side by side so they can
be easily compared. The default parameter setting is 20 and
you’ll notice that the example shown in the sidebar “Calculat-
ing HHLLS” is based on 20 days. The MetaStock code for
HHS and LLS can be found in the sidebar “MetaStock Code
For HHS & LLS.”
INTERPRETATION
HS reflects how high the higher high is relative to the lowest
high in a specific lookback period. In contrast, LS reflects
20 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
the level of the lower low relative to the highest low. The HS
formula is similar to the stochastic oscillator, which was de-
veloped by George C. Lane. The LS formula is analogous to
Williams %R, which was developed by Larry Williams.
◆ The HHS and LLS are 20-day exponential moving
averages (EMA) of HS and LS. Thus, the HHLLS
indicator is more sensitive to recent higher highs or
lower lows.
◆ The HHS and LLS are bound between zero and 100.
Rarely, if ever, will the HHLLS indicator reach these ex-
tremes. It would take 20 consecutive highest highs (lowest
lows) for the 20-day HHS/LLS to reach 100. It would take
20 consecutive lower or equal highs (higher or equal lows)
for the 20-day HHS/LLS to reach zero. Typically, the HHS/
LLS is considered overbought when above 60 and oversold
when below 10.
These levels can be adjusted to suit analytical needs and
security characteristics. At its most basic, the bulls have the
edge when the HHS is above 50 and the LLS is below 50.
Conversely, the bears have the edge when the HHS is below
50 and the LLS is above 50. Consistently high readings mean
prices are regularly hitting new higher highs or new lower
Dirk Erken/Shutterstock
lows for the specified period. Conversely, consistently low
readings indicate that prices are seldom hitting new higher
highs or lower lows.
To get a better understanding of how the HHS and LLS
 TRADING SYSTEMS

work, take a look at the chart in

Figure 1. The chart displays the
DJIA with its 20-day HHS/LLS
from May 1998 to January 1999.
The HHS is represented by the
green line and the LLS, the red
line. There are different ways to
use the HHLLS indicators.

ANTICIPATE REVERSALS
Divergences form when a new
high or low in price is not con-
firmed by the HHLLS indicators.
A bullish divergence forms when
price records a lower low but the
LLS forms a higher high. This
shows less downside momentum,
which could foreshadow a bullish
reversal. A bearish divergence oc-

METASTOCK
curs when price records a higher
high but the HHS forms a lower
high. This shows less upside mo- FIGURE 1: DOW JONES INDUSTRIAL AVERAGE (DJIA) WITH 20-DAY HHS/LLS (MAY 1998–JANUARY 1999).
mentum and could foreshadow a Notice how when the HHS moves above the 50 level, the DJIA is in a bullish trend. When the LLS moves above 50, the
bearish reversal. index is in a bearish trend.
Chartists should look for a con-
firmation to signal an actual reversal. A bearish divergence When the market exceeded its late January high and HHS
can be confirmed with a break of a support level on the price broke above LLS (see blue lines), SPX started to rise again.
chart or an LLS break above 50. A bullish divergence can be Before the market correction (second half of August 2015
confirmed with a break of a resistance level on the price chart to first half of October 2015) LLS started to rise from the
or an HHS break above 50. second half of May 2015 (see blue line). HHS made a lower
high (blue line) when the index formed a double top (May–
UPTREND
The chart in Figure 2 shows the
S&P 500 index from August 2014
to November 2015, which happens
to be a major uptrend in the index.
The display above the chart is of
the 20-day HHS/LLS. During
September 2014, the HHS formed
a lower high (bearish divergence)
and LLS formed a higher low.
They didn’t confirm the SPX
52-week high and foreshadowed
the SPX pullback in September–
October 2014. LLS broke above
50 in the middle of October 2014
(red ellipse). This signal was ne-
gated when the HHS exceeded
50 (green ellipse) at the end of
the same month. Another HHS
lower high (bearish divergence)
and LLS higher low formed in
December 2014. It foreshadowed
the choppy market move from the FIGURE 2: UPTREND. Here you see the S&P 500 index from August 2014 to November 2015 with its 20-day HHS/LLS.
beginning of January to the first Note how divergences between the index and the HHS/LLS and the breaks of support levels can contribute to anticipating
half of February 2015. reversals, spotting emerging trends, and defining correction periods.

February 2016 • Technical Analysis of STOCKS & COMMODITIES • 21

 CORRECTION PERIODS
The chart in Figure 3 shows the
DJIA from June 2011 to Decem-
ber 2011 with its 20-day HHS/
LLS. The LLS drop and HHS rise
(second half of June 2011) fore-
shadowed the bounce in the DJIA.
HHS made a lower high (bearish
divergence) and didn’t confirm the
DJIA top of July 2011. This top that
formed was a double top, which
would have been another indication
that a correction was forthcoming.
The DJIA broke its support level
and LLS broke above 50 (dashed
vertical red line). This signaled the
start of a correction (beginning
of August 2011). The LLS lower
high (bullish divergence) and HHS
higher low didn’t confirm the DJIA
lower low (August–October 2011).
FIGURE 3: CORRECTION PERIODS. On this chart of the DJIA from June 2011 through December 2011, you see how After the trendline break in the
the decline in LLS and bearish divergence between the index and HHS didn’t confirm the top reached by the DJIA. DJIA (blue line), the index started
to bounce (October–November
2011). The index trendline breakout
July 2015). SPX broke support on August 20, 2015 and four and HHS break above 50 in December 2011 signaled the end
days later, LLS moved above 50 (see red ellipse). When the of the correction (dashed green vertical line).
stock market exceeded its mid-September peak on October
13, 2015 and the HHS exceeded 50 three days later (green DOWNTREND
ellipse), it negated the LLS bearish signal. The chart in Figure 4 shows the S&P 500 index from May
2008 to April 2009 with its 20-day HHS/LLS. When LLS
broke above 50 in the second half of
June 2008 it generated a sell signal
(red vertical dashed line). Lower
highs in the LLS and higher lows in
HHS didn’t confirm the index lower
lows (October–November 2008)
and foreshadowed the S&P 500
bounce (November 2008–January
2009). HHS broke above 50 (green
vertical dashed line) and signaled
the end of the correction at the end
of March 2009.
Typically, an HHS cross above
50 works well during an uptrend.
Conversely, an LLS cross above 50
works better in a downtrend.

HHS/LLS CROSSOVERS
The chart in Figure 5 is of the
Russell 2000 index from January
to December 2001 with its 20-day
HHS/LLS. This was during the
FIGURE 4: APPLYING HHS/LLS IN A DOWNTREND. On the chart of the S&P 500 index (May 2008–April 2009),
2001–2003 bear market. The green
lower highs in LLS and higher lows in HHS didn’t confirm the lower lows in the index. Sure enough, the index continued and red arrows indicate buy/sell sig-
lower. nals based on HHS/LLS crossovers.
22 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
 Each of those signals could have
generated profitable trades.

EMERGING TRENDS
There are two stages to an emerg-
ing trend signal. One is the cross-
ing of the HHLLS lines. The other
is the HHLLS lines crossing above
50. For example, the first stage of
an uptrend signal is when HHS
moves above LLS. This shows that
new higher highs are more recent
than new lower lows. The second
stage is when HHS moves above
50 and LLS moves below 50. The
first and second stages do not
always occur in that order. Some-
times HHS will break above 50
and then above LLS. Conversely,
LLS will rise above 50 and then
break above HHS to generate the
emerging downtrend signal.
FIGURE 5: HHS/LLS CROSSOVERS. Crossovers of the HHS and LLS can generate profitable buy/sell signals.
The chart in Figure 6 shows the
S&P 500 index from May 2002
to January 2010 with its 20-week HHS/LLS. You can see the S&P 500 index broke its resistance level at the start of
on the chart that before the start of a bull market, the LLS August 2009.
starts to drop and HHS starts to rise. This took place from
October 2002–April 2003 and was confirmed by the S&P CONCLUSIONS
500 breaking above its resistance level at the end of May The HHS and LLS are momentum indicators. They are
2003 together with the HHS break above 50 (green dashed shown together so it is easy to identify the stronger of the
line) at the beginning of June 2003. The falling channel in two and determine the trend bias. A surge in HHS combined
the S&P 500 from January to
October 2004 was broken by SPX
at the beginning of November
2004 and confirmed by an HHS
break above 50 (green ellipse) in
the middle of November 2004.
The end of the pullback (May–
September 2006) was indicated
when HHS exceeded LLS (blue
line) in the beginning of Sep-
tember 2006 and when the S&P
500 index moved above the May
52-week high three weeks later.
The HHS lower high (bearish
divergence) and LLS higher low
foreshadowed the 2007 market
top, which was confirmed by
the index breaking its support
level in the middle of January
2008 and the LLS break above
50 (red dashed line) at the end of
the same month. The end of the
bear market was signaled when FIGURE 6: EMERGING TRENDS. Divergences between LLS and HHS; crossovers between HHS and LLS; the HHS and
HHS exceeded 50 (green dashed LLS crossing above 50; breakouts in the index above resistance; and breaks below support all play a role in identifying
line) at the end of July 2009 and emerging trends.
24 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
Calculating HHLLS

The spreadsheet in Side-

bar Figure 1 shows an
example of how the 20-
day HHLLS is calculated
for the Dow Jones Indus-
trial Average (DJIA) using
Excel.

◆ The lowest and

highest highs are
the lowest and high-
est high for 20 days

◆ The lowest and

highest lows are the
lowest and the high-
est low for 20 days.

The first entered expo-

nential moving averages
(EMA) of HS and LS are
averages of the first 20
HS and LS values, respec-
tively. The real HHLLS
formula does not kick
in until day 21 (see blue
rows). EMA(HS,20) and
EMA(LS,20) are multi-
plied by 100 to move the
decimal point two places.
Note that the spreadsheet
values for a small subset
of data may not match ex-
actly with what is seen on
the price chart. Decimal
rounding can also affect
HHLLS values slightly.
—V. Apirine
SIDEBAR FIGURE 1: CALCULATING 20-DAY HHLLS USING EXCEL

If the current high is above the prior high then: If the current low equals or is above the prior
HS = (Current High - Lowest High)/(Highest High - Lowest High) low then:
LS = 0
If the current high equals or is below the prior high then:
HS = 0 Lowest Low = Lowest low for 20 days
Highest Low = Highest low for 20 days
Lowest High = Lowest high for 20 days
Highest High = Highest high for 20 days HHS: 20-day EMA of HS
LLS: 20-day EMA of LS
If the current low is below the prior low then:
LS = (Highest Low - Current Low)/(Highest Low - Lowest Low) HHS/LLS is multiplied by 100 to move the decimal
point two places.

February 2016 • Technical Analysis of STOCKS & COMMODITIES • 25

 MetaStock Code For HHS & LLS
MetaStock code for HHS:
HH:= Security(".SPX",H);
HHH:=If(HH>Ref(HH,-1),(HH-LLV(HH,20))/(HHV(HH,20)-
LLV(HH,20)),0);
Mov(HHH,20,E)*100;
MetaStock code for LLS:
LL:= Security(".SPX",L);
LLL:=If(LL<Ref(LL,-1),(HHV(LL,20)-LL)/(HHV(LL,20)-
LLV(LL,20)),0);
Mov(LLL,20,E)*100;
with a decline in LLS signals the emergence of an uptrend.
Conversely, a surge in LLS combined with a decline in HHS
signals the start of a downtrend.
The HHS/LLS divergences can be used to foreshadow re-
versals. Combining the HHLLS with other technical analysis
tools such as support & resistance levels can make it a useful
indicator for confirming your entry and exit decisions.
Vitali Apirine is a programmer engineer with an interest
in technical analysis, especially the application of relative
strength index to trading. He may be reached at vitapirine@
mediacombb.net.
The HHS and LLS are
momentum indicators, which,
when combined, make it easy
to determine trend bias.
The code given in this article is available at the Subscriber Area at
our website, www.Traders.com, in the Article Code area.
See our Traders’ Tips section beginning on page 50 for commentary
on implementation of Apirine’s technique in various technical
analysis programs. Accompanying program code can be found in
the Traders’ Tips area at Traders.com.
FURTHER READING
Apirine, Vitali [2015]. “The Money Flow Oscillator,” Tech-
nical Analysis of STOCKS & COMMODITIES, Volume 33:
October.
[2015]. “The Slow Volume Strength Index,” Technical
Analysis of STOCKS & COMMODITIES, Volume 33: June.
‡MetaStock
‡See Editorial Resource Index

TRADING ON MOMENTUM

CALHOUN / MOVING AVERAGE BREAKOUTS

Continued from page 13

Step 3: You can use a maximum $2 initial and trailing stop

value on all stock swing trades.

Step 4: To set your exit target, simply use 50% of the 90-day
trading range and add to your entry. In Figure 1, that would
be ($68 - $47 = 21 points)/2 = $10.50, or about 10 points.

INSIGHTS: WHY THIS TECHNIQUE WORKS
The main reason why this moving average crossover strategy
works is because hedge fund managers and other market
professionals use 100 SMA and 200 SMA entry signals to
enter their positions. Think of each major moving average
as a key support or resistance level. By waiting to enter your
trades until after price has moved above these useful lines,
you improve your odds of getting into a position that has the
benefit of institutional buying power in it—the wind beneath
the wings of a successful swing trading breakout. It’s important
to note that as with most strong technical chart patterns, you
should focus on wide-range, cleanly defined charts like what
you see in Figure 1, in which there’re virtually no pullbacks
or broken trendlines to contend with.
TRADE MANAGEMENT TIPS
It’s helpful to use the 100 SMA to initiate a small “pilot trade”
of less than several hundred shares. Then you can use the 200
SMA breakout to scale in and add additional shares. This
26 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 1: DUPONT (DD), 100- AND 200-SMA BREAKOUTS. Here you see how you
can enter new positions once prices break above major moving average lines.
two-step trading process minimizes initial risk and leverages
into a second trade only after your first entry has proven itself
profitable. You can then use a breakeven stop following your
second trade, once the 200-SMA position is entered.
Many traders struggle with deciding on their entry prices;
this dual 100 SMA and 200 SMA crossover technique can help
simplify your decision-making process for your short-term
swing trades. Look for an opportunity to enter your trades
following each breakout signal.
Ken Calhoun is a producer of trading courses, live rooms,
and video-based training systems for active traders. He is a
UCLA alumnus and is the founder of TradeMastery.com, an
educational resource site for active traders.
 AT THE CLOSE
Regardless of the financial instru-
ment you are trading or the time
horizon for which you plan to hold
the security, trading with the larger
overall trend for your holding time is
the safest and least risky of trades to
take. Whether bear or bull, long-term
or scalp trading, it is best to follow
the market instead of fighting it.
So why do so many traders take
countertrend trades when the odds
are stacked against them? Many are
not aware of the reasons or motiva-
tions that lead them to take such
low-probability trades.
Here is a list of possible explana-
tions of why countertrend trades
are taken.

1. There has been a small pull-

back or hesitation, so the trend
has ended.

2. A countertrend trade was prof-

itable, so it will work again.

3. The indicators for a trend trade

have not reached the levels
needed, so a countertrend
trade is called for.

4. I was in a trend trade and exited

when my target was hit, so the
market has exhausted itself.

5. The market has reached prede-

termined support or resistance
levels and so should start to move
in the opposite direction.

Yes, It Hurts 6. A trend trade was stopped

out, signifying the end of the
Stop Shooting Yourself trend.
PHOTO: JOSE GIL/NO SIGN: CARLA DONOFRIO/SHUTTERSTOCK

7. The trend has lasted a defini-

In The Foot tive amount of time and should
start to reverse itself.

The idea of following the trend is nothing new, yet we often tend to ignore it. Here’s These are not valid reasons for coun-
why you shouldn’t. tertrend trading. So how does a trader
stop this damaging behavior?
by Alan Kindrick It would be great if a trading plat-
form would flash a red warning sign

If you have read anything about trading, you will come across the mantra “the when a trader is initiating a coun-
trend is your friend.” It is a cliché as old as the markets themselves and as true tertrend trade before it is executed,
today as it was when it was first stated. but this is not the situation. The best
February 2016 • Technical Analysis of STOCKS & COMMODITIES • 61
 AT THE CLOSE
Trade 60-minute 15-minute 1-minute Safest
setup chart chart chart direction
1 Long Long Long Long

2 Short Short Long Short

3 Short Long Short None
FIGURE 1: WHICH DIRECTION ARE PRICES TRENDING? Having a simple table
will help you note which direction charts of different time frames are moving.

remedy is to be aware that you are taking countertrend trades

that are positioned against the overall larger trend. Sneak preview …
HOW DO YOU GAIN THIS SELF-AWARENESS?
You need to keep track of what the market is doing for each Where Price Action Meets Momentum Trading
by Paul Langham
time frame that you monitor. As an example, assume a trader
What are the possible price patterns that you should combine
wants to scalp trade a financial instrument. He utilizes a with the concept of momentum trading to know which ones will
one-minute, 15-minute, and 60-minute chart. Each chart has respect the rules of price action? We’ll find out.
a five-period simple moving average (SMA) and a 15-period
SMA. If the SMA(5) is over the SMA(15), it signifies that the A New Method For Picking Stocks
market is in an upward trend, whereas if the SMA(5) is under by Martii Luoma & Jukka Sihvonen
the SMA(15), it signifies a downward trend. Using screening criteria that incorporate stock valuation
Before executing a trade, you should note what each chart variables can prove to be an asset to a technical analyst.
is signaling. All you need is a simple table such as the one Here’s an intuitive and simple technique you can incorporate
displayed in Figure 1. If you took the time to fill out such a into your stock selection process.
table before initiating a trade, you could easily determine
Reading An Option Chart
whether the higher-probability trade is long or short. Under by Jayanthi Gopalakrishnan
trade setup #1, what advantage would you have going short An interview with veteran option trader Price Headley of
when all trends are pointing long? For setup #2, is a trader will- BigTrends.com.
ing to initiate a short position solely based on the one-minute
chart, knowing that it conflicts with the 15- and 60-minute Readers’ Choice Awards
chart? With setup #3, is any trade—long or short—worth the In addition, look for our annual Readers’ Choice Awards for
risk with such conflicting data? favorite products and services, coming in the 2016 S&C
Trading is difficult enough without fighting the greater Bonus Issue.
movement of the market. Knowing how the market is acting ...Coming soon!
in each time frame along with information such as time of
day and trade results should provide you with information that
increases your chances of having a successful outcome.

GO WITH THE FLOW

Are you fighting the larger time frame you are working in?
What are your results when you take trades that counter the
smaller time frame? What results are achieved when you trade
with the larger time frame? Maybe you need to remember that
your best friend in trading is the trend.
Alan Kindrick is an independent index futures trader utiliz-
ing technical analysis. He may be reached at akindrick@
aol.com.
Continued from page 9
Comment 2: Based on this material, the cost range is very
wide (my assumption is the higher cost is associated with
drilling/fracking), which would require the price of oil to be
over $80 long-term.
Comment 3: Historically, whenever oil prices drop (as OPEC
increases supply), it can push high-cost producers out of the
supply side.

Keep track of what the market is doing Comment 4: Lower-cost producers (and stock price) have an
for each time frame that you monitor. advantage during dips in price.
ED

62 • February 2016 • Technical Analysis of STOCKS & COMMODITIES

 What Zone Are You In?
Supply & Demand Trading
What is it? How effective is it? How can you apply it to your
trading? Let’s find out.
by Reza Javaheri
A
ny school of thought or set of guidelines—from a
marketing strategy, to a test-taking strategy, and
everything in between—will always have a base set
of assumptions underlying it, upon which the theory
can be built. Any technical analysis strategy will
require you, as a technical trader, to assume certain
things before the actual meat and potatoes of the strategy is
laid out; this is constant. However, what isn’t constant is the
credibility of these assumptions. The good news is, as a sup-
ply & demand trader, you recognize and operate under only
one assumption, and that assumption happens to be the basic
principle that underlies any market:
16 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
Where demand exceeds supply, price will rise; and where
supply exceeds demand, price will fall.
Yes, we have taken a stroll down memory lane back to Econ
101. Yet the simplicity of this assumption is also the reason
for its corresponding strategy’s power and consistency. As
premises and techniques get complicated, any trading style
based on them will inevitably become more susceptible to
breaking down and crumbling under its own weight and
complexity.
MARIA MAARBES/SHUTTERSTOCK
WHERE’S THE IMBALANCE?
If we know what could cause price to move—namely, imbal-
ances in supply & demand—our job then is to identify, on a
price chart, where these imbalances lie. That’s because, we
would think, when some asset falls to a price where there
are more buyers than sellers, we should buy, since price
 CHARTING
FIGURE 1: PRICE RALLYING STRONGLY OUT OF A DEMAND ZONE. This is a rally-base-rally pattern where price rises, then stops and goes sideways for some time,
then continues on with a strong rally.
should turn around and rise from that level, and vice versa
for supply and shorting. Over the course of this article, I will
do just that—indicate these areas of imbalance through the
identification and explanation of various chart patterns (these
chart patterns will be named and defined as they are brought
up), and thus show examples of supply & demand at work in
the markets.
For starters, the idea that chart patterns are the ultimate
indicators of optimal buying and selling levels, and that the
asset being traded is therefore secondary in importance, is a nice
by-product of subscribing to this brand of technical analysis.
Regardless of the asset (assuming it meets certain criteria such
as minimum volume, price range, and so on)—from a gold
ETF, to a futures contract, to a forex pair, and everything in
between—the charts will be able to tell you what’s most crucial
to where price turns and how far price moves; that is, where
large institutional players are stepping in to buy and where
they are stepping in to sell. It is the actions of these players
(the inflows of buy and sell orders from these investors) that
are responsible for the significant moves in any market they
play in. It’s important to make sure institutional players are
buying and selling a particular vehicle before we trade it.
My thoughts thus far can be summarized as follows:
1. Prices move because of an imbalance in supply & de-
mand. If there are more willing buyers than sellers at a
particular price, price will not stay at this level, but will
instead rise, to find more willing sellers (the opposite
occurs at a price where there are more willing sellers
than buyers). This principle dictates price in any market
whether it be T-shirts, books, or stocks.
TRADESTATION
2. The most significant moves in price for any investment
vehicle that are caused by the most significant imbalances
in supply & demand come at points where institutional
investors and other large players in the markets are buying
and selling heavily. These market participants are the
ones with the most capital, and they are the ones capable
of creating the largest moves in price in the markets and
the largest imbalances in supply & demand.
3. These market turning points—prices where demand
greatly outweighs supply or supply greatly outweighs
demand—are the lowest-risk, highest-probability,
highest-profit-potential entry points into any market
with significant institutional order flow.
4. It is the trader’s job, therefore, to identify these points
of institutional supply & demand, where these large
numbers of (unfilled) institutional buy and sell orders
lie, and where there is therefore a strong imbalance of
supply & demand. Doing so minimizes risk, maximizes
reward potential, and maximizes the probability of a
successful trade.
5. Note that throughout this entire process, the name of
the security, the company’s earnings, its competitive
landscape, the latest OPEC meeting—none of this fac-
tors in. No matter what company, what commodity,
what forex pair, its price will move based on supply &
demand. Only the price is needed to identify trading
opportunities. Large banks and financial institutions
may have their reasons for buying and selling at certain
prices, but to us, what is most important is identifying
areas of institutional supply & demand and recognizing
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 17
 FIGURE 2: SUPPLY & DEMAND TRADING CAN BE PROFITABLE. Two rally-base-rally demand zones formed at the 240.02 to 246.73 and 257.30 to 263.26 areas,
and a rally-base-drop supply zone formed at the 307.28 to 302.58 area. Price will simply move between areas of supply & demand, dropping out of supply until it hits
demand, and rallying out of demand until it hits supply.

that, above all, this is what drives the largest movements
in price.
Now that the premise has been laid out, let’s move on to some
examples and how they can be applied to the markets. The
following demonstration will consist of charts, both naked
and marked with a few simple tools/indicators, accompanied
by explanations of anything on the charts.
URANIUM, BRITISH POUND, AND BIOTECH
I will look at a range of investment vehicles over a variety
of timeframes. Supply & demand trading is ubiquitous and
can be applied to any timeframe, as long as an asset meets
certain basic criteria.
So then, let’s get to the charts. There won’t be too much
explanation outside of the charts themselves, because, as you’ll
see, plenty of explanation is done in the chart annotations.

FIGURE 3: SUPPLY & DEMAND ZONES AT WORK. On this weekly chart notice how prices react when they enter a supply or demand zone.

18 • December 2017 • Technical Analysis of STOCKS & COMMODITIES

FIGURE 4: 60-MINUTE CHART. It works on a shorter timeframe as well.

Biogen, Inc.
In Figure 1 you see a monthly chart, with a textbook example
of price rallying strongly out of a demand zone, where buyers
dominate sellers. The pattern is a “rally-base-rally,” which
simply means that price was rising, then stopped and went
sideways for some time, then continued on with a strong rally
as the battle between buyers and sellers at that price ended,
with sellers running out. We therefore expect price to hit the
leftover buy orders in that area if/when it retraces there, and to
rally out as a result. That is precisely what happened here.
Next, we move on to a daily price chart (Figure 2). There
is a lot going on here, but it follows a simple pattern. We see,
for starters, that two rally-base-rally demand zones formed at
the 240.02–246.73 and 257.30–263.26 areas, and that a rally-
base-drop supply zone formed at 307.28–302.58. (I’ve pointed
out these three zones in the order they formed chronologically.
That is, the lower demand zone formed first, then the higher
demand zone, then the supply zone.)

FIGURE 5: DAILY CHART OF BRITISH POUND FUTURES. From December 2016 to February 2017, price retracements in the supply zone led to significant drops in
price. In April 2017, when price retraced into the demand zone, it was followed by a price rally.

December 2017 • Technical Analysis of STOCKS & COMMODITIES • 19

 Looking at how these zones played out, price first
(chronologically) returned to the supply zone. Price gapped
up heavily from the previous day’s close, and opened in the
middle of the supply zone. From there, it proceeded to sell off
for the entire rest of the day, dropping almost 6%.
We see almost the exact opposite picture with the 263.26
demand zone: price gapped down big-time from the day
before to open right at the top of the zone. Price went into
the demand zone a couple of times over the next two days,
continually hitting the massive number of buyers sitting in
that area in price, and went on to rally strongly for the next
week of trading.
We see here a real-life, classic illustration of what makes
supply & demand trading so profitable:
1. Price will simply move between areas of supply &
demand, dropping out of supply until it hits demand,
and rallying out of demand until it hits supply. This
means that…
2. All big moves in the markets—not the small, interim
price fluctuations and movements that occur in the
process—are not only caused by supply & demand
levels, but are exact moves from the closest level of
supply/demand to the closest opposing level of demand/
supply. And finally…
Market turning points are the
lowest-risk, highest-probability,
highest-profit-potential entry
points into any market with
significant institutional order flow.
FIGURE 6: 60-MINUTE CHART OF BRITISH POUND FUTURES. Using supply & demand zones to trade offers profit potential while minimizing risk.
20 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
3. As a result, the lowest-risk, highest-probability, highest-
profit-potential trades are those with entry points at sup-
ply & demand zones. This is because, as we’ve alluded
to already, supply & demand zones are the big-picture
turning points in a market. That they are turning points
makes them the lowest-risk, highest-probability entry
points for a trade, while the big-picture, big-moves nature
of supply & demand zones make them the highest-profit-
potential entry points for a trade.
The discovery we’ve made and put to words here is paramount,
and is what makes supply & demand trading so lucrative, so
consistent, and so profitable.
To finish the picture and to show you supply & demand
at work in the assets I’ve promised in the heading of this
section, I’ll present some more charts. At this point, I won’t
include any explanation aside from what’s written on the
charts. Here we go.
Global X Uranium ETF
In Figure 3 you see a weekly price chart. Note the 28.38
supply zone and the 12.68 demand zone. On the 60-minute
chart in Figure 4, note the 13.81 supply zone and the 13.11
demand zone.
British pound futures
On the daily chart in Figure 5, note how prices respond in the
supply & demand zones. From December 2016 to February
2017, price retracements in the supply zone led to significant
drops in price. In April 2017, when price retraced into the
demand zone, it was followed by a price rally. Another price
action of note is during June 2017 when price enters the supply
zone and then leaves that zone with a significant down gap.
On the 60-minute chart of the British pound futures in
Figure 6, note the profit potential and minimized risk that
comes with trading supply & demand Come visit one of the most popular trading
zones. chat rooms for Breakout Trading. g
SUPPLY & DEMAND PRINCIPLES
TO PUT INTO PRACTICE
To briefly recap, we’ve got an overview of
supply & demand trading (including the
Breakout Trading Bull Flags
one basic principle that underlies it), the
main arguments, and the basic thought
process that any trader should follow Momentum Stocks Pivot Points
in order to identify opportunities in the
markets. From there, we took a look at
some proof of product, looking at a variety
of charts across a variety of asset classes, Swing Trading Key Reversals
to wrap our heads around some concrete
examples of supply & demand at work
in the markets.
Next, I hope to leave you with a few Home of DAN ZANGER, world record holder for
takeaways, a few principles of supply &
demand trading that can perhaps help you parlaying $10,775 into $18 million in 18 months!
be conscious of areas of imbalance as
you trade. If you can better identify areas Home of T Z
HE ANGER EPORT R .
of imbalance and areas of institutional
supply & demand, you can gain a better
picture of where a high-probability, low-
risk entry opportunity may be, where a
good target for an existing position may
be, or even just where you’ll likely see some buying/selling upon further retests.
pressure as price arrives at that area. I don’t claim to have turned you into an expert in S&D trad-
Thus, here are a few things to keep in mind that can be ing over the course of a few pages, nor do I claim you can now
helpful in many different situations: go out and turn an account into a cash machine after reading
this article. If there’s anything you do go out and do, please be
• Look for strong, explosive, and prolonged moves in
safe. If you’re going to trade, protect your account, and always
price;
go into any trade knowing exactly how much you’re willing
• Then, go to their origins. to lose, and exactly how much is at stake. And if you feel so
inclined, see if you can take a few of the concepts discussed
If price left that area with strength, don’t you think there should and illustrated in this article and use them to better inform
be an imbalance of buyers and sellers in that area? There very and educate your trading decisions as you move forward in
well could be. So plan accordingly, maybe adjust a target so that your trading career.
it comes before that area in price (and you’re not in a position
where you’re waiting for a trade to hit a target, only to have it Reza Javaheri is currently studying economics and chemistry
come close and then turn right back against you). at the University of Pennsylvania. He primarily trades futures
Zoom out to a bigger timeframe, maybe five to seven times using technical analysis.
what you trade on, and take a look at the bigger picture. Overall,
where does price seem to be headed? Are there any areas on ‡TradeStation
the higher-timeframe chart that price fell out of explosively?
That it went into and rallied out of? Getting a sense of where
you are on the higher timeframe can let you know if you’re
swimming with the tide, or, for example, if you’re a buyer near
an area in price where big money seems to be a seller.
Go past what many would identify as areas of “support”
and “resistance” and see if these levels are a function of
price testing and retesting what you think to be a supply
or demand zone. If so, keep in mind the more a zone gets
retested, the more of the unfilled orders sitting in that zone
get used up, and the less likely the zone is to keep holding
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 21
 TRADING ON MOMENTUM

Flying Mighty High

Swing Trading Bull Flags

& Pennants
Finding strong swing trading breakouts is often a matter
of looking for exceptionally volatile chart patterns, like the
flags and pennants you’ll be learning about in this month’s
column.
by Ken Calhoun
lthough you may often miss out on an initial breakout
My biggest lesson learned in trading these over the years
is to be patient and wait for a clear breakout signal above re-
sistance, and not to enter too early. As a technical trader, you
probably have the same challenge that many of my students
do, which is uncertainty when it comes to identifying the
nuances of specific patterns worth trading.
One helpful technique is to simply wait until the day after
you believe a bull flag or pennant is potentially forming, and

A move, the good news is that strong, trending breakout

charts tend to attract new buyers. You can capitalize
on this by entering after a first strong breakout has
already occurred, in anticipation of further uptrending price
action. Entering above the highs of flags and pennants, similar
to entering after gaps, can often provide you with excellent
trading opportunities.
BULL FLAG AND PENNANT BREAKOUT
STRATEGY
Bull flags and pennants start off with an initial breakout pat-
tern called a flagpole, which is simply a sharp upward move
in price action. A bull flag is formed when a congestion zone
appears, often with a minor downward slope, at the top of
the flagpole. A pennant pattern simply looks like a triangle
at the top of the flagpole, with price action narrowing to a
point on the right side of the pennant. Strategically, your
main objective is to look for a new trading entry above the
high of either pattern.
use a buy-stop trading order $0.50 above the high of the day
during which either of these patterns is observed. That will
give you enough time to confirm whether the breakout pat-
tern is valid.
STEP-BY-STEP ACTION PLAN
Here’s how you can apply this trading strategy with your
swing trades:
Step 1: Using a 15-day, 15-minute candlestick chart, find
stocks priced $20–70 per share with either a bull flag or
pennant pattern, as seen in the chart of Take-Two Interactive
Software, Inc. (TTWO) in Figure 1. You do not need to see
both patterns in the same chart. Either one is sufficient.
Step 2: Set your buy-stop order $0.50 above the high of the
day during which either pattern is seen.
Step 3: An initial and trailing stop value of $2 is used to
manage the swing trade,
with trades typically last-
ing from five to 15 days in
duration.

INSIGHTS: WHY THIS

TECHNIQUE WORKS
The key to this strategy is to
observe a flagpole prior to
the consolidation formed by
either a bull flag or pennant.
Note that this strategy works
best when the flagpole is at
least as tall as or taller than the
previous day’s trading range.
This is because expanding
trading ranges catch the atten-
tion of algorithmic program
trading systems and individ-
ual traders. A strong flagpole
eSIGNAL

FIGURE 1: BULL FLAG AND PENNANT (TTWO). Two strong sequential long entry patterns lead to breakouts. Continued on page 37
20 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
term performance. High relative safety
stocks excel in long-term performance.
Portfolios made up of high VST-Vector
stocks would give us 88–90% winners
but relative safety gives us 98%.
When you started trading, what did
you trade?
The first stock I bought was IBM in
1978 and it was $500 a share. Back in
those days, I wasn’t about to throw $500
into a single stock. But my broker at Mer-
rill Lynch told me they had a program in
which you could invest as little as $50 a
month. He set me up with that program.
But after about six months I realized that
by the end of the year I’d only have one
share of IBM stock.
You can’t make a whole lot of money
with one share so I went with stocks in the
$20 to $30 range. Occasionally I would
go with higher-priced stocks, but that’s
the range I usually went with. I liked
the idea of having high growth rates and
low P/Es. I thought I had the best of both
worlds. And if I knew anything about
markets at the time, I could have made
some real money, but I didn’t.
When I created VectorVest and had
the buy/sell ratio, it was as good as
gold. We started in 1988 and in 1990 a
young man called me and said his dad
bought him a subscription to VectorVest
and he noticed we were printing this
on a Hewlett-Packard printer. He was
a computer programmer working for
Electronic Data Systems at that time.
The kid, whose name was Gary, was a
genius and he said, “You know, if you
can send that signal to a Hewlett-Packard
printer, I could capture it electronically
and deliver it for you electronically.”
We talked about it, he wrote a program,
and we called this format VectorVest
Electronic. The printed version was
VectorVest Stock Advisory. In 1992, a
colleague and I attended the Las Vegas
Money Show with VectorVest Electronic.
We had a computer and a CRT, and we
set it up and showed people that we could
analyze, sort, and rank stocks with the
click of a mouse.
We didn’t know it then but we were
the only people there with an electronic
service, since we could deliver the infor-
mation via modem (1200 bit). We had a
ball. We had a good show and it gave us
the courage to move ahead. I would also
present VectorVest Electronic at AAII
meetings, and people were fascinated
by it.
But they wanted graphics. Once
Windows came out, Gary wrote another
program and we called it VectorVest
ProGraphics. In the summer of 1994 I
was testing it and it was as if it could
see in 3D. I had the dimension of time.
With VectorVest ProGraphics you could
see the data points strung together on
a graph. And you could backtest your
ideas and see how they did. This made
the product so much more powerful.
We released VectorVest ProGraphics
in January 1995 and it was a whole new
world for us. We were off to the races.
So we went from VectorVest Electron-
ic to VectorVest ProGraphics, and then
we added the analysis of dividend safety,
yield, and growth, and started develop-
ing new tools, including a search engine
that we call VectorVest UniSearch. It
will give you answers in a matter of
seconds to all kinds of searches. It also
has an automated backtester. You can
go back 10–15 years and it’ll do all the
backtesting for you. We also developed
portfolio managers and trading systems
that automatically buy and sell stocks.
If you were to give one piece of advice
to traders, what would it be?
Buy the best stocks you can find. Then
you won’t be hurt. Once you’re ahead of
the game, then have some fun. Never, ever
invest money you can’t afford to lose.
FURTHER READING
Blackman, Matt [2016]. “VectorVest 7,”
product review, Technical Analysis of
STOCKS & COMMODITIES, Volume
34: June.

CALHOUN / SWING TRADING BULL FLAGS

& PENNANTS Entering above the highs of flags and
Continued from page 20 pennants, similar to entering after
gaps, can often provide you with
is second only in strength to a gap when trading momentum
breakouts, and is well worth learning how to trade. excellent trading opportunities.

TRADE MANAGEMENT TIPS
In addition to using a maximum initial stop of no more than
$2, it is often wise to add to your winning position as price
trends up every two dollars. If you follow your swing trade
throughout the day during which you entered your position,
you may want to alternatively use an even tighter stop of right
below the bull flag or pennant low, since the reason for the
initial entry is a breakout above the high. You may also want
to use increasing volume as a technical confirming signal.
For example, if volume is at least 30% higher than average
on the day the breakout is seen, you may want to trade larger
share size than normal, due to the strong breakout volume
that confirms your entry.
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders. He
is the founder of TradeMastery.com, an educational resource
site for active traders, and is a UCLA alumnus.
FURTHER READING
Bulkowski, Thomas [2009]. “Highs & Tight Flags,” Techni-
cal Analysis of STOCKS & COMMODITIES, Volume 27:
December.
‡eSignal
‡See Editorial Resource Index
July 2017 • Technical Analysis of STOCKS & COMMODITIES • 37
 TRADING ON MOMENTUM

Swing Trading 100SMA Pivots

Learn to combine a classic moving average crossover is often too early, getting you in prematurely on nonworking
technique with a specific daily candle signal to confirm a “dead cat bounces,” and the 200 SMA can be too slow.
pivot entry. Price-action recovery trading with pivot signals can be un-
certain, which is why I specialize in breakouts instead as my
by Ken Calhoun dominant trading style. On those rare instances where I look
to swing trade pivots, I like combining this 100SMA pivot

T rading pivot entries correctly often requires you to

look for a combination of two or more technical entry
signals. Traders often take stop-losses by trying to enter
pivots too early, before significant buying strength emerges.
entry technique with the momentum candle pattern technique
that you will learn about.

STEP-BY-STEP ACTION PLAN

Because pivots are inherently riskier than simple breakouts,
you will find that combining two or more technical signals
can create better pivot entries.
This month’s strategy will show you how to combine a clas-
sic moving average crossover technique with a specific daily
candle signal to confirm a pivot entry. The biggest takeaway
from this swing trading pivot technique is that you should
wait until you see multiple technical signals prior to entering
your positions.
SWING TRADING 100SMA PIVOTS
On a 90-day candlestick chart, plot your 50-, 100-, and
200-period simple moving averages (SMAs). When it comes
to choosing which moving average signal works best for swing
trading pivots, I have found that the 100SMA produces the best
results with the least amount of false breakouts. The 50 SMA
Here’s how you can use this pivot strategy with your swing
trades:
Step 1: Visually scan for stocks in the $20–$70/share price
range which have traded down to the 200 SMA and are
recently showing a price recovery pivot that breaks out
above the 100SMA line. Look for those with a candle whose
height is at least twice the height of the previous week’s
candles on the day of the breakout. You can see this type
of pattern illustrated on the 90-day daily chart of Pilgrim’s
Pride Corp. (PPC) in Figure 1. The blue box highlights this
tall green candle day as it breaks out above the 100SMA
line (the blue line in this example).
Step 2: Set a buy stop order at $.50 above the high of large
candle that has pivoted above the 100SMA line. This par-
ticular combination tells you
that new institutional buyers are
coming in above the 100SMA
breakout signal.

Step 3: Use an initial $2 stop

(and trailing stop) for all swing
trades.

INSIGHTS: WHY THIS

TECHNIQUE WORKS
Every time you evaluate a chart
to find technical trading signals,
your goal should be to identify
patterns that are most likely to
continue after you put on the trade.
In this strategy, for example, if
price action had merely touched
or broken above the 100SMA with
an average-size candle, the odds of
eSIGNAL

the continuation upwards would be

much lower.
FIGURE 1: SWING TRADING 100SMA PIVOTS. Look for candles with a height that is at least twice the height of the
previous week’s candles on the day of the breakout. The blue box highlights this tall green candle day as it breaks
Seeing a large, technically sig-
out above the 100SMA line (blue line). Here, you’re combining a pivot crossover with a large green candle day for a
momentum entry signal. Continued on page 62
48 • November 2017 • Technical Analysis of STOCKS & COMMODITIES
 N
o sound trading plan
“Failing to plan is planning to fail.” You need to have Proper management of
a good trading plan that focuses on identifying which resources, training, developing
markets to trade, the correct expected amount of leverage to
use, the amount of time devoted to trading, and entry & exit
trading skills, and knowing the
criteria for each trade. Your trading plan should also indicate nitty-gritty of the forex market
the return you expect to achieve and risk management strate- will help you better manage
gies to implement. Trading plans will differ from one trader your trades.
to another but most trading plan will include the following:
Trading goals and educational commitment, broker choice,
market analysis, risk identification, trade entry & exit crite-
ria, position sizing, money management, and trade journal
entries. The workability of this trading plan will depend on BETTER MANAGEMENT
your ability to stick to it. All reasons given in this article are relevant and can help you
protect your funds. But ultimately, your success depends on

T
ake profit and stop-losses
New traders have a tough time figuring out when to
exit a trade. When should they take profits and when
should they be stopped out? You’ve heard the saying, “Never
let a winning trade turn into a losing trade.” New traders will
have a desire to make more profits and will leave a winning
trade on for too long. Yes, those winners can turn into losers
on a dime. Also, new traders open a market order and leave
the trade open without a stop loss. This could chop up their
equity in a trade.
Earlier I mentioned you should use trailing stops to lock
your profits on winning trades to protect yourself from losing
all your profits. Alternatively, you can close your positions
when you see reversal candlesticks or patterns, or even at
key levels. Stop losses are better placed below support levels
or price action pin bars. And if you have a short position,
you could place stop losses above resistance levels or price
action pin bars.
your mindset, that is, how you think and react to the markets.
Human behavior and actions act as the catalyst that drives
our results; not the markets. Professional traders believe
that success comes from within, which is why they practice
mental training. They have to recognize their subconscious
values that prohibit their success. Once they do that, they
can transform their emotions and channel it towards a more
successful career.
Solomon Chuama has been working in the financial industry
for 16 years. He is a training seminar organizer and instructor
who tries to pass on to students his passion and knowledge
of forex trading.

CALHOUN / SWING TRADING 100SMA PIVOTS

Continued from page 48
nificant candle form the breakout day at the 100SMA reveals
that institutional buyers are coming into the stock, hence the
subsequent five-point winning breakout after the signal. If your
experience is like mine, you will find a big difference exists
between mere technical pattern recognition skills, compared
to trading skills needed to extract profits from the markets.
Being able to recognize correct technical signals is just the
first step. Identifying signals that then lead to continued price
trends that are tradable, like this one, is a key skill to work
on developing as a professional trader. There is a difference
between being an analyst and a trader.
Wait until you see multiple technical
signals prior to entering your
positions.
got you into the trade in the first place. So using either that
price or a $2 initial stop (whichever is tighter) makes sense.
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders. He
is the founder of TradeMastery.com, an educational resource
site for active traders, and is a UCLA alumnus.

TRADE MANAGEMENT TIPS

In this strategy, the price that’ll prove you wrong for a long
position is if it drops back down under the 100SMA line that
62 • November 2017 • Technical Analysis of STOCKS & COMMODITIES
 TRADING ON MOMENTUM
Swing Trading
Four-Day Breakouts
When trading breakouts, one challenge
is to find charts that will continue to
move in your favor. Here’s one pat-
tern that could help you identify those
strong moves.
by Ken Calhoun
Y
our biggest challenge in swing
trading breakouts will be to find
charts that continue up strongly
after you enter your trade. A
favorite strategy used by experienced
traders is to look at the ratio of green to
red candles in recent days’ trading for
clues of the underlying technical trad-
ing strength.
This month, I’ll demonstrate how to
use a simplified breakout pattern where
you enter after four daily green candle
days in a row have been observed. This
can be an effective strategy because when
buyers are consistently in charge of price
action for four or more days in a row,
price will often continue upward.
SWING TRADING FOUR-DAY BREAKOUT
STRATEGY
This strategy is easy enough to under-
stand: You visually scan for charts that
are in a clearly defined uptrend in which
you see a sequence of four or more green
candle days in a row. This tells you buy-
ing pressure is especially strong and is
likely to continue.
As a former corporate statistician and
quality engineer, one thing I learned
early on was to look for exceptional
“outlier” data signals. Similarly, when
it comes to swing trading, you should
always be on the lookout for extremely
strong breakout patterns that work out
most of the time, using price action for
momentum trade entries.
STEP-BY-STEP ACTION PLAN
Here’s how you can start using this
price-action breakout strategy with your
swing trades:
2017 WINNER
AI TRADING SOFTWARE
Winner
15 years
in a row!
Step 1: Visually scan for stocks in the
$20–$70/share price range that are in Build powerful
uptrends and have a recent sequence
of four or more green candles in a
trading systems in
row on a 90-day daily candlestick MINUTES
chart. You can see this type of pat-
tern illustrated in the chart of Weight
without coding
Watchers International Inc. (WTW)
in Figure 1.
Step 2: Set a buy stop order at $0.50 ®
above the high of the highest of the
four candles seen in the series.
Step 3: Use an initial $2 stop (and
trailing stop) for all swing trades.
www.NeuroShell.com
Step 4 (for experienced traders): 301.662.7950
Add to winning trades after each new
four green-day series is seen. This is
to build your position over time (also right, versus uncertain or wrong? This
known as position sizing). technique is effective because it buys
into continuous strong momentum. I
INSIGHTS: WHY THIS have found in testing with numerous
TECHNIQUE WORKS trades that lower values, such as just two
Whenever you evaluate a chart for tech- or three green candles in a row, is much
nical strength, it helps to have clearly less consistent and does not work out
defined reasons for your entry and exit.
What is the price that proves the trade Continued on page 37
eSIGNAL
FIGURE 1: SWING TRADING FOUR-DAY BREAKOUTS. On this 90-day daily chart of Weight Watchers Inter-
national Inc. (WTW), you would enter a trade just after each sequence of four green candle days in a row.
October 2017 • Technical Analysis of STOCKS & COMMODITIES • 7

CALHOUN/SWING TRADING
FOUR-DAY BREAKOUTS
Continued from page 7
nearly as often. When using four or more
candles to identify trend strength, you are
buying into sustainable buying pressure
that is more likely to continue.
From a practical standpoint, the
challenge is that you do need to visu-
ally scan through 90-day candlestick
charts to manually locate these types
of patterns. The good news is that once
you practice visual scanning for strong
Q&A
FRIESEN
Continued from page 15
company has no ability to compete
with others in its space.
• When we bet on a company, we bet
on management. Hasn’t this been the
case with so many of the amazing
companies that became significant
leaders in the past 50 years? Manage-
ment took the resources they had and
converted them to growth, retained
earnings, and increased their com-
pany’s book value.
• Are there internal or external catalysts
for change? Since you are considering
a stock that is on the bottom of the
ladder, what is going to cause it to
rise? Is there potential for the removal
of an issue that will allow the stock
to finally rise?
How do we get baited into or talk
ourselves into buying a “value trap”?
• You might hear a compelling argu-
ment for a stock by a talking head in
the media.
• You may base it on your life experi-
ence and world view.
• You may think that because the stock
price has fallen so much, it has to go
back up.
• You may be using a simplified value
finding method, possibly borrowed
and not thought through properly.
TRADING ON MOMENTUM
breakouts using this technique as well as
strategies covered in my earlier articles,
you will find yourself starting to be more
focused and demanding when it comes
to finding exceptionally strong charts
worth trading.
TRADE MANAGEMENT TIPS
As with all trading, it is a smart idea to
“trade wide, not deep,” meaning you
should look to trade a minimum of
three to five positions simultaneously
on smaller share size to test breakout
strength before trading larger share
size. Adding to winning trades while
• You may be assuming things from a
positive skew, and as you are hopeful
to make money, you are unwilling to
consider negative influences.
The same thing can happen when you
already own a stock that has been go-
ing down.
• You look for supporting information
to give you hope about the future.
You should know that the future is
uncertain.
• You look for ways to defend the value
you see. What you are really defending
is pride, stubborn opinion, having to
be right, or there is denial or an un-
willingness to take a loss and a belief
it will all turn out okay. (Remember,
“hope” is not a strategy.)
When a trader or investor is in the stock
before its demise and chooses to stay in
it—or worse, buy more of it—rarely does
it work out. I believe there are warning
signs and red flags that provide enough
notice and information. Traders need to
be open to them and look for them.
I believe that we can tap into real
value—the type of value that converts
to growth. It’s the type of growth that
impacts the bottom line; it eventually
increases the worth of the company
and then the stock tracks that. Yes, the
stock price could get ahead of the worth
of the company, as in the example of
October 2017
taking very small stops on those that
don’t work out is a key to professional
trading success.
Ken Calhoun is a producer of trading
courses, a live trading room, and video-
based training systems for active traders.
He is the founder of TradeMastery.com,
an educational resource site for active
traders, and is a UCLA alumnus.
AMZN, but it does appear that the gap
between price and earnings disparity is
narrowing.
If someone wanted to write a great
screenplay, then it would be worthwhile
to study the composition of other winning
screenplays. If someone wanted to com-
pose a song with significant appeal, then
it would be of great benefit to study the
hits in that genre of music. This doesn’t
mean there is an exact science to art,
but there are some key components that
appeal to the masses. A person can start
with a formula, but it has to be flexible,
pliable, and act as a guide rather than
an absolute. In trading and in investing,
it is still all about probabilities and not
guarantees.
I recommend studying the ingredients
of past stock performance that have re-
sulted in excellent performance for share-
holders. Drill down to the “what was it”
about the companies, the management
teams, the products, the services that
drew investors in, and increased demand
for the stock over the long sample.
My writing style is an effort to stimu-
late thought, provide you with ideas you
can build on, have you question things,
research items and backtest for yourself
to identify patterns and anomalies. As
always, start simple, start small, and build
a scalable trading business.
• Technical Analysis of STOCKS & COMMODITIES • 37
 Finding Momentum Early
The Alter Ego Of Swing Trading
With so much coverage of blue-chip companies coming from
popular media channels, tweets, or social chat rooms, traders
often overlook small-cap stocks, which provide wider spreads
and more liquidity. Find out how to capitalize on them.
by Martha Stokes, CMT
hile most retail traders continue to trade only
W Dow 30 stocks or large blue-chip stocks, they
are missing out on an opportunity for swing
trading. Why opportunity? In October 2016,
a major internal change in market structure
was set in place. For the first time in over a
decade, spreads widened, as the Small Cap
Pilot Test Program that had been going on
30 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
behind the scenes was finally approved by the Securities and
Exchange Commission (SEC). Since then, professional traders
have been highly active in small caps as liquidity increases
with wider spreads.
At the same time, the SEC also started another test program
that is currently being evaluated called the Tick Size Pilot Pro-
gram. This program includes a much larger base of securities
in order to expand on the original concept that wider spreads
in a broader base of stocks could provide more liquidity for
TARGAYGUNDOGDU/SHUTTERSTOCK
all short-term traders.
These two changes are extremely important for retail and
technical traders. The test program uses five-cent increments
instead of the penny spread. With wider spreads and more
liquidity, coupled with the smaller number of outstanding
shares typical with most small-cap companies, the opportu-
 SWING TRADING

nity for swing trading has grown in just a few short months.
However, there are some differences and variables in trading
small caps to be aware of.

WHAT ARE THESE DIFFERENCES?

Unlike with large blue chips, choosing a small cap with a
wider spread is not going to be based on news, tweets, chat
rooms, or social media posts. These small caps rarely come up
as recommendations or in retail news. Instead, choose small
caps to trade based on pure relational technical analysis.
The key elements of swing trading these wider-spread
stocks are:

1. Small number of outstanding shares. The limited

shares provide momentum energy, as demand for the
stock increases during speculative activity.
2. High percentage of shares held by institutions. The

higher the percentage of shares held by institutions,
the more energy and momentum they can have, be-
cause stocks held for charters and trusts increases the
demand-to-supply ratio. Dark pool buy-side institutions
invest heavily in small-cap stocks that have huge growth
potential. As exchange traded fund developers buy small
caps to fill niches of their inventory for exchange traded
derivatives, more shares are held in trusts.
3. Market participant groups actively trading the small-
cap stock. Professional traders prefer small caps, as
runs can be controlled and tend to sustain longer. High-
frequency trading firms are also taking advantage of the
five-cent spread for faster profits.
4. Liquidity is also important. Not every small-cap com-
pany is a good candidate for swing trading, just as not
every large blue-chip company is ideal for short-term
trading. Liquidity equates to whether or not there is a
high interest from the buy-side institutions.
5. Market conditions are also a factor. The dark pool quiet
accumulation patterns show up best during bottoming,
platforming, and quieter market conditions. Dark pools
tend to cease their buying during speculative market
conditions.
To identify key elements in stock charts for small-cap swing
trading, additional indicator tools are necessary to reveal where
dark pools (which are basically bids and offers by brokerages
and exchanges that are not displayed to the public) are quietly
accumulating, where professional traders are moving in with
end-of-day buying or selling in anticipation of high-frequency
trader trigger action, and to confirm the run has sufficient
underlying energy to sustain excellent point-gain potential
for higher profits.
An example of a small-cap stock that moved with momen-
tum out of a bottom is Silgan Holdings Inc. (SLGN) with 55
million shares and just under 80% institutional ownership
(Figure 1).
To trade these sudden momentum moves with the run
rather than chasing the run, you would need to use alterna-
STOCKCHARTS.COM
FIGURE 1: A POTENTIAL BOTTOMING PHASE. Here, SLGN is attempting to
develop a bottom formation. It may be necessary to use alternative indicators that
can reveal quiet accumulation by dark pool buy-side institutions, professional trader
footprints, and potential high-frequency trader triggers.
tive indicators that can reveal quiet accumulation by dark
pool buy-side institutions, professional trader footprints, and
potential high-frequency trader triggers. These three market
participant groups work in tandem to create the huge sudden
runs that are highly profitable for retail traders, if they learn
what to look for in the stock chart and enter the trade prior
to the sudden momentum action.
FINDING MOMENTUM
The analysis includes a relational interpretation and summation
of what has occurred during the potential bottoming phase.
Analysis is therefore first on price action, using candlesticks
that are unimpeded by any indicators on the candles, which
provides better readability of the price action. Second, we
can then look at several indicators that reveal accumulation
by dark pools, professional trader trading activity, and trigger
areas for high-frequency traders. Let’s review what some of
these indicators are.
In Figure 1, we can see dark pool quiet accumulation un-
Huge, sudden runs in price can
be highly profitable for retail
traders, if they learn what to
look for in the chart and enter
the trade prior to the sudden
momentum action.
May 2017 • Technical Analysis of STOCKS & COMMODITIES • 31

FIGURE 2: A MOVE DOWN BEFORE CYCLING BACK UP? For SLGN, accumulation
is set in a specific range. The accum/dist indicator warns that it is premature to buy
this stock. The Chaikin oscillator (ChiOsc) is also a good indicator for analyzing
a bottom formation.
FIGURE 3: THERE SEEMS TO BE A SHIFT IN THE DYNAMICS. SLGN is working
on its bottom and continues to move up and down in a range-bound fashion. This
reveals continued accumulation within that range.
derway in SLGN. The range for the dark pool time-weighted
average price (TWAP) orders is clearly defined. TWAP is a
highly flexible professional order type that has a distinct price
pattern on charts when being used as an incremental method
of accumulating stock over an extended period of time. TWAP
is the favored order type by many professionals. It allows them
to route their order and control the entry in a variety of ways.
It automates accumulation over time.
32 • May 2017 • Technical Analysis of STOCKS & COMMODITIES
Next, the accumulation/distribution line (accum/dist) is an
indicator that is available in many charting software programs.
When read properly, it provides invaluable information as to
whether the order type used is a TWAP or volume-weighted
average price (VWAP), which is another professional order
type that also reveals which market participant group is ac-
cumulating. Smaller funds prefer using VWAP order types.
The TWAP order instructs to buy x number of shares when
the stock hits a low, and then continue incremental buying over
time until the stock reaches a specific high price. At that time,
the TWAP order ceases to enter incremental orders. The range
for this bottoming stock is clearly defined by price and how
the accum/dist indicator is behaving. Note that as the stock
reaches the high of the range, accum/dist declines even though
price holds in a consolidation pattern near that high.
Volume bars are another key element of the analysis. Note
the high volume surges as the stock bounces off the low in
October as TWAP orders trigger. High-frequency traders
(HFTs) create surges of one-day volume due to their milli-
second trading. The gap is caused by HFTs but as soon as the
stock reaches the high of the range, dark pool TWAPs stop and
professional traders take profits. Meanwhile, smaller funds’
VWAP buy orders are firing off at the highs of the range due
to the HFT spikes of volume.
The accum/dist warns that it is premature to buy this stock,
as the stock is likely to move down before cycling back up
(Figure 2). The Chaikin oscillator (ChiOsc) is also a good
indicator to use in this Relational Analysis (the name I gave
to this analysis technique I developed) of a bottom. Volume
oscillators are essential for the new market structure, as these
indicators provide more valuable information on volume action
in relation to price. With the chart in Figure 2, right at this
point, the volume oscillator has formed a negative divergence
from price, which is a clear signal not to enter the stock yet.
Building watchlists for stocks undergoing a bottoming
formation is a good habit to develop. These are not stocks to
discard out of hand.
But the dynamics between the three volume/time-based
indicators has changed. The indicators hit an extreme low
and moved up even while an attempted sell down by a high-
frequency trader trigger failed (Figure 3). The extraordinarily
long red volume is due to a premarket flood of HFT orders
attempting to sell the stock down. However, dark pools have
raised the entry trigger level for their TWAP orders. The base
of the bottom has been moved up. This is a significant devel-
opment for this bottom. The sideways pattern is compressing
but is still rather wide for an entry. The volume weight has
shifted to the buyers. Watching the stock more closely for an
entry is important at this juncture of the bottom.
Price has compressed from a wide sideways pattern to a
consolidation. Like a compressed spring, this action is con-
trolled by professional traders who have been monitoring the
progress of dark pool quiet accumulation (Figure 4). Dark
pools have completed their accumulation and soon the news
will leak out of their interest in this stock, similar to retail
gurus’ recommendations. The stock is hovering close to the
highs of its range, which is another significant price-to-volume
indicator relationship.
ChiOsc is oscillating consistently above its center line, which
is indicative of professional traders entering in anticipation
of a sudden momentum run. Accum/dist is holding steady,
because professional traders tend to pack large lot orders. It
is not uncommon for volume bars to drop below their average
just prior to a momentum run.
SLGN shows the results of dark pool quiet accumulation,
which is a liquidity draw on small-cap stocks with limited
outstanding shares; the activity of professional traders reacting
to the liquidity draw, which they can easily identify on their
professional software and platforms; and the energizing of
HFT algorithm automated triggers.
The acceleration and angle of ascent of price and volume
indicators is created by smaller funds’ VWAP orders trigger-
ing on HFT volume surges.
For the retail trader who wants to enter this type of trade at
the onset of the momentum run rather than chasing the run, it
is merely a matter of learning to read the following:
FIGURE 4: A COMPRESSED SPRING ABOUT TO LET GO. SLGN has the pattern
of price and volume indicators that swing traders can extract a lot of information
1. Price patterns in relation to volume indicators, which
from. This action is controlled by professional traders who have been monitoring
reveals who controls price, and how price is being the progress of dark pool quiet accumulation.
controlled
2. Understanding the dynamics of sideways price action,
and what it means in relation to the current market “Cycle Evolution Theory.” She may be contacted via www.
condition and trend patterns for that stock TechniTrader.com.
3. The influence of professional traders and how they track
liquidity draws FURTHER READING
4. How professional trader buying patterns trigger high- Bright, Don [2015]. “Q&A: Market Liquidity And The Tick
frequency traders Size Pilot Program,” Technical Analysis of STOCKS &
5. When smaller funds and the retail crowd are likely to COMMODITIES, Volume 33: May.
chase the run. [2011]. “Routing Your Orders,” Technical Analysis
of STOCKS & COMMODITIES, Volume 29: June.
STUDY YOUR CHARTS [2008]. “Q&A: Dark Pools Of Liquidity,” Techni-
Relational Analysis is a way to study charts that uses all three cal Analysis of STOCKS & COMMODITIES, Volume 26:
data sets of price, volume, and indicators such as accum/dist October.
and ChiOsc in ways that allow the retail trader to understand Gopalakrishnan, Jayanthi [2016]. “A Chat With Stefanie
what is going on, so that the entry for a swing or momentum Kammerman,” interview, Technical Analysis of STOCKS
trade can be better controlled and is at the optimum entry & COMMODITIES, Volume 34: October.
price. [2013]. “Uncovering The Layers With Jea Yu,” inter-
Although this type of analysis is more sophisticated than view, Technical Analysis of STOCKS & COMMODITIES,
some approaches, it does not require any more time. Rather, Volume 31: December.
it is a matter of altering your perspective of an approach to ‡StockCharts.com
selecting stocks to trade. Small-cap stocks now offer wider ‡See Editorial Resource Index
†See Traders’ Glossary for definition
spreads, which results in longer runs, higher point gains per
run, and, if properly executed, a higher-profit trade.
Taking fewer higher-profit trades will earn far more income
annually than taking numerous low-profit to small-loss trades.
Most retail traders trade too often and lose money rather than These two changes by the SEC
watching for high-profit trades and entering earlier. are extremely important for
Martha Stokes, CMT, is cofounder and CEO of TechniTrader.
retail and technical traders.
She is a former buy-side technical analyst. She has authored
over 40 stock and options courses for beginners to profes-
sionals. She earned her CMT designation with her thesis
May 2017 • Technical Analysis of STOCKS & COMMODITIES • 33
 Noisy indicators
delay your analysis

Jurik algorithms
deliver low lag,
low noise analysis

Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,

NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software

Jurik Tools on live charts, on the web !

tinyurl.com/jurik-online

Jurik Research

2010 -- 2011 -- 2012 -- 2013

Add-In software
 Know What You Should Expect
The Edge In Chart Patterns
Part 1
When you see a chart pattern forming, most likely, others
will see it too. What gives you an edge when you trade a
chart pattern? This two-part article will help answer that
question.
by Giorgos E. Siligardos, PhD
It
is true that most technical methods involving chart
patterns are based on simple observation and are not
rigidly tested from a statistical point of view. What
you read on the Internet, in books, or in magazines
about chart patterns mostly discuss observations by
the authors who notice something they believe to
be valuable and share it with the public. Tom Bulkowski (a
Contributing Writer to this magazine) is one of the few authors
who provides success/failure statistics for chart patterns.
Before putting money in any pattern, you should first ask
12 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
yourself if trading this pattern produced an edge historically,
what the arithmetic value of this edge is, what overall edge
could you infer from the pattern’s historical performance, and
what the difference is between the theoretical edge and the
real edge you get when you trade the pattern in real time. This
two-part article will help you answer these questions.
FIRST, THE BASICS
HAND/COINS: DENPHUMI/DICE: COPRID/CUP: DENZ/
When do you call a game of luck “fair”? The short answer
is “when all the opponents have an average expected gain of
SHUTTERSTOCK/COLLAGE: JOAN BARRETT
zero for each play.” When the average expected gain from each
play is not zero for one of the players, you can consider that
he has an edge (positive or negative) over the other players.
To put it simply, what you expect from a game is that on the
one hand, it is not fair and on the other hand, you are allowed
to play it from the side of the positive edge.
For simple games of luck where the probabilities of outcomes
 CHART PATTERNS
Noisy indicators
delay your analysis
are known, it is easy to calculate whether a player has an edge
and the exact value of the edge. For example, in double-zero
roulette it can be calculated that a player has a negative edge
of -5.26% (and of course the casino has a positive edge of
5.26%). This means that on average, for every $x bet at the
roulette wheel, the casino expects to get 5.26% of that $x as
pure profit. Jurik algorithms
I will present two examples without using rigid mathemati- deliver low lag,
cal formulation to help the uninitiated grasp the main idea, low noise analysis
which I will later expand to the chart patterns case.
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
Example 1: The coin game NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
You are offered a game where a coin is flipped and you place Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software
notional bets before the flip. A notional bet (NB) is the base
upon which the profit or loss will be calculated. If the coin
Jurik Tools on live charts, on the web !
lands tails then you lose 1.2 times the NB (or $1.2 for an NB tinyurl.com/jurik-online
of $1) and if it lands heads then you get 2.3 times the NB (or
$2.3 for an NB of $1). Assume further that the coin has a 50%
probability of landing heads (and of course a 50% probability
Jurik Research
of landing tails). This means the coin itself is fair as it doesn’t
show any preference for heads or tails.
But is this coin-flipping gambling game fair for you? If you 2010 -- 2011 -- 2012 -- 2013
always bet $1 then after every two flips you expect to get on Add-In software

average one heads and one tails. From the tails you will lose
$1.2 and from the heads you will gain $2.5. So after two flips
and a sum of $2 NBs, you will end up having a net profit of
$0.30. This means that the game is not fair since, on average,
for every two flips you expect to get $0.30 as profit. Now, if
you divide the profit $0.30 by the sum of NBs of $2 you get
0.15 or 15%. This 15% is the edge this games offers you as a
player. From a practical standpoint, when your notional bet
is $x in each flip, then you expect to get on average 15% of x
(or $0.15x) as profit from each flip.
jurikres.com • 800-810-3646 • 719-686-0074
Monte Carlo simulation of the game assuming constant NBs
to calculate the total net profit and then divide it by the sum
of NBs to arrive at the edge of the game. In the case of chart
patterns, there are many historical cases of patterns that can
be used to estimate its historical edge and derive estimations
about its overall edge.

Example 2: The dice game THE CASE OF CHART PATTERNS

In this game, you place your NB and throw a dice. If the dice To calculate the edge of a pattern you must keep in mind the
shows a 1 or 2 then you lose money equal to the NB. But if it following:
produces 3 or higher you get 55% of the NB. Does this game
offer you an edge? Assume you always place an NB of $1. • Steer away from a vague definition of the pattern. With
Then, on average, after six throws of the dice you expect all a vague definition, you run the risk of making vague
different faces of the dice to come up and you will have lost
a total of $2 ($1 for each of the outcomes 1 and 2) but you
will also have gained a total of $2.20 ($0.55 for each of the
outcomes 3, 4, 5, 6). So, on average, for every six throws you The results of this system suggest
would have placed a total of $6 as NBs ($1 NB for each bet) that for every $1 you bet in the
and have an overall net profit of $0.20 ($2.20 - $2.00). This bullish implications of the cup
means that again this game is not fair, and it offers you an
edge. To calculate the edge you divide the net profit of $0.20
pattern, you would receive on
by the sum of NBs of $6, which produces approximately average $0.16 back as profit. Only
0.0333 or 3.33%. 39% of the trades were profitable
In the examples I discussed, you knew the exact probabilities meaning that losses were plenty
of outcomes for the coin and the dice (the probability of getting
2 for a dice throw was 1/6) and also knew the payoff for each
but small and winnings were less
outcome. In such cases the calculation of the edge is simple. but big enough.
For cases where there is neither knowledge of the probabili-
ties of outcomes nor the payoff for NBs you must perform a
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 13
 conclusions about the pattern. Patterns that can be
algorithmically defined by a computer are the best way
to go since they give an objective method to quickly
collect several cases for your research.

• You must have a definite price threshold level that

will signal when the pattern has failed to do what it
Cup after a Cup after an Cup after a
was supposed to do. An example would be a “stop-
downtrend uptrend sideways market loss” level. This is important for determining the loss
when the pattern fails. (For a head & shoulders top,
FIGURE 1: TEXTBOOK EXAMPLES OF CUPS OR ROUNDING BOTTOMS. Here
you see diagrams of cups after a downtrend, after an uptrend, and after a sideways for example, the passing of price above the level of the
market. head is traditionally considered the end of the bearish
implications of the pattern). Considering how technical
analysis views chart patterns, and to avoid favoring
Big Lots Inc (Daily) specific manifestations of one pattern over others, the
stop should take into account the dimensions of the
pattern to facilitate general conclusions and provide a
uniform way to judge it.

• You must have a rigid definition of what the pattern

is supposed to produce (the hit of a target price, for
30 bars
example). If you believe a pattern is expected to pro-
duce a price move but it has no specific price target,
95 bars
then you must specifically declare what this move is
Apr May Jun Jul Aug Sep Oct Nov 2009 Feb Mar Apr May Jun Jul Aug Sep Oct Nov
about and how it is defined. This will ensure a clear
method to calculate profit consistently. As an example,
FIGURE 2: CUPS IN BIG LOTS INC. (BIG). The algorithm identified two cups in the an easy way to define directional moves is through the
daily chart of Big Lots for the year 2009.
magnitude of retracements. Any retracement larger than
a specific threshold automatically signifies the end of
the directional move.
Number of Cups Identified
250
This basically puts the pattern in the context of a trad-
Number of Cups

200 191 191

186 184
173 176 177 170
153
173 ing system and is how you should view the pattern if you
150 153 150
150
122
134
124 120 want to calculate whether it provides an edge for you in
114 118 114 115
103 106 108
100 93
81
your trading. You assume entering the market when spe-
53
65
54 cific conditions are met, and assume exiting the market
50 36 39 37
28
when, again, specific conditions are met. You also know
0 beforehand the money you are about to lose when the
1982
1983
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
2009
2010
2011
2012
2013
2014

Year
pattern fails.
Once you have defined the entry price, stop-loss level,
FIGURE 3: DURATION OF CUPS IDENTIFIED PER YEAR. Here you see how many and how the profit from trading the pattern is calculated,
cups were identified each year from 1982–2014.
you can backtest as many historical manifestations of the
pattern as possible. Let P be the profit (either positive or
negative) from a pattern defined as:
% Frequencies of Durations of Cups
50%
45%
46%
• P = (Exit price - Entry price) for long trades on patterns
40% that are considered bullish
% Frequency

35%
Mean duration: 52 bars
30%
Median duration: 32 bars • P = (Entry price - Exit price) for short trades on pat-
Min. duration: 20 bars
25%
20%
Max. duration: 1162 bars terns that are considered bearish.
17%
15%
10% 8%
10%
5%
7%
5%
2% 2% 2%
Let S be the distance of the stop-loss level from the entry
1% 1%
0% price:
20–30 31–40 41–50 51–60 61–70 71–80 81–90 91–100 101–110 111–120 121–130

Duration
S = | Entry price - Stop-loss level |
FIGURE 4: %FREQUENCY DISTRIBUTION CHART OF CUPS PER DURATION.
Almost half (46%) of the cups identified lasted from 20 to 30 daily bars.
(where | ⋅ | stands for the absolute value).
14 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
The fraction:
Cumulative % Frequency of Durations
P 100%
PF =
S
is then exactly the profit (in dollar terms) for the pattern if 80%

Cumulative % Frequency
you were to trade it by using notional bets of $1 for each
80% of all cups
trade. This offers the same normalization as the constant $1 60%
identified were less
notional bet in the examples of the coin and dice I presented than 3 months long
earlier in the article. 40% (75 trading days)
Note that if the stop-loss is hit and you exit the trade at Mean duration: 52 bars
exactly the stop level, then PF will always be greater or equal 20% Median duration: 32 bars
to -1. However, when your exit based on the stop-loss value
is not predetermined (for example, taking into account gaps 0%
past the stop to simulate real-world conditions, or you require

5
0
5
0
5
0
10 5
10 0
65
20
0
5
0
5
0
5
0
5
0
20
75

68
73
79
84
90
95
1
13
18
24
29
35
40
46
51
57
62

the closing price to penetrate the stop for the pattern failure
to be considered valid) then the S and the PFs can be lower
than -1. Note also that the PF practically plays the role of a
profit factor (hence the name PF) because if your notional
bet is $A when the stop-loss is hit, then the profit will be PF
times that $A.
The simple arithmetic average (mean) of the PFs over all
historical patterns provides the implied historical edge for the
pattern based on the backtest.
THE EDGE OF A CUP PATTERN
This is an example I presented at the Inter-
national Federation of Technical Analysis
(IFTA) conference in 2014 in the context of
a broader theme to point out the merits of
algorithmic identification of chart patterns.
You can tweak the ideas in this example to
match your preference for the patterns you want to examine.
The pattern I dealt with was the cup, which is a rounding base
or rounding bottom that shows up after a downtrend (Figure 1).
The cup is generally believed to have bullish implications for
price movement. Although the behavior of volume during the
cup is considered important and variations of the cup (like the
“cup with handle” pattern) are also popular, for simplicity, I
chose to eliminate volume and variation issues from the study
and concentrate on the implications of the price formation.
In my IFTA presentation I used a slight modification of the
identification algorithm for cups that I had initially described
in my February 2006 article for this magazine, “Identifying
The Cup” (see further reading at end).
I used daily charts of S&P 500 stocks from 1982 to 2014
and captured a total of 3,991 distinct cups of various dura-
tions (“distinct” means there was no time overlap of more
than 70% between any two cups in the same chart). Figure
2 shows examples of cups identified by the algorithm in the
daily chart of Big Lots Inc.
In Figure 3 you see the number of cups identified per year
and in Figure 4 you see the %frequency of cups per dura-
tion, respectively. The minimum duration was 20 bars and
the maximum was 1,162 bars. The median duration was 32
bars and 80% of all cups identified lasted no more than 75
bars (see Figure 5).
11
Duration (Bars)
FIGURE 5: CUMULATIVE %FREQUENCY DISTRIBUTION CHART OF CUPS PER
DURATION. 80% of all cups identified lasted less than 75 daily bars.
H
Entry price
200
-21%
-30% Initial stop
158
140
L
FIGURE 6: SETTING THE INITIAL STOP-LOSS. The initial stop-loss starts at
a value defined by 0.7 times the percentage height of the cup. If the percentage
height is 30% then the initial value for the stop is set at 0.7 times 30% (or 21%)
below the entry price. Once set, the initial stop-loss then becomes a trailing stop
as price advances.
Here is how I identified the stop-loss for the cup. Let H be
the high of the identification bar (the high of the bar when
the cup was identified) and L the lowest low during the cup.
The percentage height from H to L is therefore:
(H - L)
100%.
H
The stop-loss value is then set by taking 0.7 times that
percentage height below the entry price. So, for example (see
Figure 6), if H is 200 and L is 140, the percentage height
from H to L is 30%. Taking 0.7 times 30% gives you 21%.
The stop-loss level therefore is 21% below the entry price of
200, or 158.
Since the cup pattern is generally believed to produce upward
price moves and there is no standard price target associated
with it, I assumed a buy-only trading system that goes long
at the high of the identification bar with the initial stop-loss
April 2017 • Technical Analysis of STOCKS & COMMODITIES • 15
 tribution of PFs is not extremely different from the normal
Frequency Duration of PF for Cups
1200 distribution, a statistical test called a “student’s t-test” (practi-
1000
cally the same as the statistical z-test for large samples) can be
applied to derive what is called a “confidence range” for the
Frequency

800
mean PF (that is, a confident range for the edge of all cups).
600 For example, assuming that the 3,991 historical cups used
400
in this study is a nonbiased sample of the population of all
cups (since the time period from 1982 to 2014 is long enough
200
and covers many market conditions), the t-test showed that
0 a confident range for the overall edge of the cup pattern is

4)

.5)

5)

re
.5)

1)

.5)

2)

.5)

3)

.5)
(-3 3)

(-2 5)

(-2 2)

(-1 5)

(-1 1)

(-0 )
0)
(-5 5)

(-4 5)

(-4 4)

(-3 5)

0.5

Mo
-
2.

-
1.

-
-
4.

-
3.

,2

.5,

,3

.5,

,4

.5,
.5,

,0

.5,

,1

.5,
from 9.1% to 24% with 99% confidence. In other words, the
.5,
.5,

.5,
.5,

.5,

,-
,-

,-
,-

,-

(4

(4
(0

(0

(1

(1

(2

(2

(3

(3
(-5

FIGURE 7: FREQUENCY DISTRIBUTION CHART OF THE PFS OF THE CUPS FROM historical PFs calculated suggest that there is a 99% confidence
1982–2014. The distribution of PFs for the cups is somehow positively skewed. It that the true edge of the cup as a bullish pattern is between
has a mean value of 0.166 which means the historical edge of the cups when used 9.1% and 24%.
as bullish formations (at least as seen from the eyes of the trading system used in
the study) is 16.6%. Bars that correspond to negative or zero PFs are colored red
whereas bars that correspond to positive PFs are colored blue. MOVING ON
These findings are impressive and encouraging, but don’t rush
to celebrate yet, as there are many issues that still need to be
being trailed. The trade is exited only when the trailing stop considered to get the whole picture, especially from a practical
is hit. Note that the trailing stop is naturally related to the standpoint. I will tackle these issues in part 2. Stay tuned.
percentage height of the cup to assume a uniform way of
judging the cups. Giorgos Siligardos holds a PhD in mathematics and a Market
Why did I use the 0.7 value as a factor for the initial stop Maker certificate from the Athens Exchange. He is a finan-
and not 0.5 or 0.8 or 1? There’s no mandatory reason. This is cial software developer, a frequent contributor to Technical
just an example. Since the initial stop-loss becomes a trail- Analysis of STOCKS & COMMODITIES magazine, and for many
ing stop, using different values for the factor will examine years a scientific contributor in the Department of Finance
the bullish implications of the pattern from different points and Insurance at the Technological Institute of Crete. His
of view. More precisely, the value of the factor defines the academic website is http://www.tem.uoc.gr/~siligard and he
retracements you allow the bullish move to produce. For ex- may be reached at siligard@tem.uoc.gr.
ample, by setting it to 0.2 you will examine if the cups produce
immediate and strong trends (small retracements in relation FURTHER READING
to the percentage height of the cups). The 0.7 value seemed Bulkowski, Thomas N. [2005]. Encyclo-
okay for providing a general idea, since it allowed room for pedia Of Chart Patterns, 2d ed., John
retracements without being too pliable. Nobody is stopping Wiley & Sons.
you from examining various factor values to see which of Kuhn, Gregory [1995]. “The Cup-With-
them produce important and nice results. To determine profit/ Handle Pattern,” Technical Analysis
loss, I took into account gaps that formed past the trailing of STOCKS & COMMODITIES, Volume
stop. I also placed a requirement that the trailing stop had to 13: March.
go through the closing price to signal exits. The exit value I Murphy, John J. [1986]. Technical Analysis
used was the low of the exit bar (to account for slippage) so Of The Futures Markets, New York
the PFs could take values lower than -1. Institute of Finance.
The distribution chart for the PFs for all the cups is shown O’Neil, William [1999]. 24 Essential
in Figure 7. The mean value is 0.166 or 16.6% and this is Lessons For Investment Success,
therefore the historical edge of the cup pattern for the period McGraw-Hill.
1982–2014. Mind you, this is from the point of view of the [2002]. How To Make Money In
system used to estimate its bullish implications. Stocks, 3d ed, McGraw-Hill.
The results are interesting in that they suggest that for Siligardos, Giorgos [2006]. “Identifying
every $1 you would bet in the bullish implications of the cup The Cup (With Or Without The Han-
pattern, you would receive on average $0.16 back as profit. dle),” Technical Analysis of STOCKS &
What is also interesting is that only 39% of the trades with this COMMODITIES, Volume 24: February.
system were profitable. This means that the losses were plenty [2011]. “Identifying Cup Formations
but small, and the winnings were less than the losses but big Early,” Technical Analysis of STOCKS &
enough, as can be seen in Figure 7. This was to be expected, COMMODITIES, Volume 29: April.
since applying an initial stop-loss prevented huge losses from †See Traders’ Glossary for definition
occurring while the trailing stop let the profits run.
If the number of historical PFs is quite large and the dis-
16 • April 2017 • Technical Analysis of STOCKS & COMMODITIES
 Look Back To See Forward
The Measure Rule For
Price Prediction
You stare at a chart to try and figure out where prices will go.
Will they go up or down? Here’s one way to make a prediction
using the height of common chart patterns, and the nice thing
is, you can do it with a high degree of probability.
by Thomas Bulkowski
ant to know what next week’s stock price will be?
W Me, too. No one knows for sure, of course, but we
can make an educated guess. One way to do that
is to use the measure rule for chart patterns.
When people and institutions trade stocks, their
transactions form peaks, valleys, and straight-line runs. If
you connect those squiggles on the chart, they form what is
known as chart patterns.
For example, suppose the stock shown in Figure 1 makes
8 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
you drool when it bottoms at $38.30 (A), a price you think
is a bargain. You buy 1,000 shares and hope that the stock
climbs to 45. In the following weeks, the stock behaves and
peaks near 41 (C).
On paper, you’ve made money, but then comes the thought,
LASER: PAVEL K/CHARTS: SUMIKIM/SHUTTERSTOCK/COLLAGE: JOAN BARRETT
“If only I had bought more.” You vow that should the stock
return to $38, you will purchase additional shares.
In the coming weeks, the stock eases lower and is again
trading near 38 (B). Seizing the opportunity, you and others
buy the stock. The buying demand forces the price to rise
again (to D and above).
The twin valleys near 38 form a chart pattern called a double
bottom (AB). The squiggles on the chart only become a valid
double bottom chart pattern when price closes above the price
of peak C. In this example, that confirmation event happens
on candle D (a close above the dashed blue line).
 CHARTING

THE MEASURE RULE Electronics For Imaging, Inc. (Computers and Peripherals, EFII)
We can now use the height of the double 47
bottom to help determine a price target. 46
The method uses what is called the mea- 45
Target
sure rule, but it is not actually a rule at 44
all. Rather, it is a guideline that works, 43
though not all of the time. The measure 42 D
C
rule does not set a minimum or maximum 41
target. Use it not as a tool to get girls, 40
but to help you determine how far price 39
might move. 38
In this example, measure the height A B
37

THOMAS BULKOWSKI
of the double bottom from the peak at C
(41.29) to the lower of the two bottoms, B 36
(38.00). Add that difference (3.29) to the 35
Jan 16 Feb Mar Apr May Jun
price of the peak at C to get a target of
44.58. I show the approximate location FIGURE 1: THE DOUBLE BOTTOM PATTERN. Here, price rises after the breakout (D) to reach the predicted
price target.
of the target on the chart.
My new book, Chart Patterns: After
The Buy, says that the measure rule for Interpublic Group of Companies (Advertising, IPG)
25
over 2,700 double bottoms in bull markets
works 68% of the time. 24 Target

HEAD & SHOULDERS BOTTOM 23 D

F
Consider another example, which is
22 E
shown in Figure 2. A head & shoulders
bottom appears with the left shoulder at G
21
A, the head at B, and the right shoulder at C
A
C. A blue neckline joins armpits D and E. 20 Left
Right
In this case, the squiggles become a valid Shoulder
Shoulder B
chart pattern when the stock closes above Head
19
the neckline at G. If the neckline were to
slope upward, then I would use the right
18
armpit high (E) as the confirmation price. Oct 15 Nov Dec Jan 16 Feb Mar Apr May Jun
Why? Because price might never close FIGURE 2: HEAD & SHOULDERS BOTTOM PATTERN. Measure the height of the head & shoulders bottom
above a steeply sloping neckline. from the head to the neckline directly above, and add it to the breakout price to get a target.
The measure rule for head & shoulders
is different than it is for double bottoms.
Measure the height from the low at the Lockheed Martin Corp (Aerospace/Defense, LMT)
235
head (B) to the neckline directly above
(F). I highlight that on the chart with 230 E
two green dots. Add the height to the
breakout price (or confirmation price, G) 225
to get a target. In this example, B bot-
220
toms at 19.79, and the neckline directly D
above (F) is at about 22.35 for a height 215
of 2.56. The breakout is at 21.30 for a F
target of 23.86. 210 C
The measure rule for head & shoulders
bottoms worked 73% of the time in the 205
B Target
2,866 patterns I found in bull markets.
200
A
TRENDLINE MEASURE RULE Sep 15 Oct Nov Dec Jan 16 Feb Mar Apr
The measure rule works for trendlines,
FIGURE 3: TRENDLINE MEASURE RULE. Here you see how to calculate the price target using trendlines.
too. Figure 3 shows an example of an For upsloping trendlines, the measure rule works 63% of the time, and for downsloping ones, it works 80% of
upsloping trendline. the time.

October 2016 • Technical Analysis of STOCKS & COMMODITIES • 9

 HON Industries (Furn/Home Furnishings, HNI)
For upsloping trendlines, the measure
52 rule works 63% of the time, and for
50 downsloping ones, it works 80% of the
48 A time.
46
44
B C
BUT WAIT, THERE’S MORE
42 Close Target Since the measure rule doesn’t work all of
40 Target the time, how can we compensate for this?
38 Consider Figure 4. You may not recognize
36 this chart pattern as a descending triangle,
but it is one. You can call it a rectangle if
34
you wear glasses. The bottom trendline
32 is flat and the top one slopes lower. Price
30 breaks out downward when it closes below
the bottom line at C.
Jul 15 Aug Sep Oct Nov Dec Jan 16 Feb Mar
The height of this triangle is A (46.94)
FIGURE 4: PRICE TARGETS FOR DESCENDING TRIANGLES. Here you would use a closer measure rule
minus B (43.84) or 3.10. Subtract the
target for a higher success rate.
height from the price of the bottom
trendline for a target of 40.74. Notice
price does not reach the target until after it closes above the
top of the triangle. If you had placed a stop there, you would
For upsloping trendlines, the have been stopped out.
measure rule works 63% of the My research says that the measure rule for descending tri-
time, and for downsloping ones, angles with downward breakouts in bull markets works just
it works 80% of the time. 49% of the time. So let us multiply the height by 49% to get a
closer target: 43.84 – (3.10 x 49%) or 42.32. The closer price
will reach the target 74% of the time. It worked in this case,
as the chart shows (see the point labeled “closer target”).
I drew a line connecting valleys A, B, and C, and extended
the line into the future until after the stock closed below it. TRADING TIPS
Let’s use the last significant hump (CED) along the trendline When using the measure rule, common sense should prevail. If
to get the height. Peak E is at 227.91 and the trendline directly the computed target price for a downward breakout is negative,
below it (F) is at about 214.75 for a height of 13.16 (the height then disregard it. The stock price will not go below zero.
between the two green dots). Subtract the difference from the Convert the pattern’s height into a percentage to see if it
price where the stock first closes below the trendline (D, at represents a reasonable move. For example, Figure 4 shows a
216.70) for a target of 203.54. I show the approximate price drop of 3.10/43.84 or 7%. Values above 15% (such as 20% or
of the target on the chart. 40%) are likely too high to be achievable without first suffer-
ing an adverse move in the stock (such
as a close on the side opposite the chart
30
Cisco Systems, Inc. (Computers and Peripherals, CSCO) pattern’s breakout).
Figure 5 shows how I use the measure
29 A BC rule for trading. Triple top ABC confirms
28 as a valid chart pattern when the stock
H closes below the price of D, the lowest
27 valley between the three tops. The target
D I
E is 25.20 (D - (A - D)), which I show in
26 F
G the figure.
25 Target The percentage decline is reasonable,
about 6%. I then look for underlying
24 support near the target or along the way
to the target.
23
The loose cluster at E would concern
22
me, especially if it were tighter. Tight and
Jun 15 Jul Aug Sep Oct Nov Dec Jan 16 Feb Mar Apr May Jun loose are hard to define, but tight regions
FIGURE 5: APPLYING THE MEASURE RULE TO YOUR TRADING. To figure out when the stock price might
turn, look for underlying support near the target or along the way to the target. Continued on page 28
10 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
 element you can incorporate in an MACD strategy.
ALL ENDS WELL
As I have shown with the results of test 2 and test 3, finding the
relationships between the MACD level and stock trend can lead
to an effective optimization of the benchmark MACD strategy
(the basic strategy). Keep in mind, though, that optimization is
a double-edged sword, to some extent. Although optimization
helps to improve the strategy on a group of stocks as a whole,
it may not help the strategy to work equally well on individual
stocks in the group. However, you have plenty of choices when
it comes to investing in a group of stocks—for example, just
think of how many ETFs are available for trading.
Kevin Luo is an independent technical analysis researcher
who focuses on automated price trend-related analysis and
generation of trading strategies. He and his project partners
developed an automated trend analysis and backtesting system
for high- and low-frequency trading. He may be reached via
email at kxluopub@gmail.com.
BULKOWSKI / MEASURE RULE
Continued from page 10
show a lot of price overlap from bar to bar. Loose regions also
show overlap, but not as much, because the tall price spikes
wander up and down further. The circled area at G is loose
but the red square at H is tighter.
Line F joins valleys going back months, and it would intersect
area G if I extended the line further to the left.
Looking at the entire chart, I would be most concerned about
E because it is close to the breakout. What does “close” mean?
Often, the answer is in the 5% to 10% range. Pullbacks (mean-
ing the stock breaks out downward but quickly returns to the
breakout price) bottom an average of 9% below the breakout
price. Any support area in that region could spell trouble.
F and G would come next in my list of concerns. I do not
like to see many valleys line up, as blue line F shows.
Because of the anticipated support at E, I would not have
shorted this triple top. In this case, the stock pierced E and
bottomed at F. Only after the stock began to pull back did it
pause (at I) near the zone at E and the bottom of candle D.
CLOSING POSITION
I use the measure rule to predict how far a stock might move.
Since the rule usually works between 50% and 75% of the time,
I sometimes adjust the target price. Then I look for underlying
support or overhead resistance to help determine where price
might turn along the way to the target.
Once I settle on a target price, I can use it as guidance to sell
a stock (this works especially well for swing trades), decide
to hold onto an existing position (often because of a meager
anticipated decline), or salivate at the opportunity of buying
28 • October 2016 • Technical Analysis of STOCKS & COMMODITIES
FURTHER READING
Gopalakrishnan, Jayanthi [2003]. “Gerald Appel & The
MACD,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 21: September.
Hartle, Thom [1994]. “Gerald Appel, With Systems And Fore-
casts,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 12: March.
Luo, Kevin [2016]. “Falling In Love, With Trends,” Technical
Analysis of STOCKS & COMMODITIES, Volume 34: June.
[2015]. “Gap Trading,” Technical Analysis of STOCKS
& COMMODITIES, Volume 33: December.
[2015]. “MACD-Suitable Stocks,” Technical Analysis
of STOCKS & COMMODITIES, Volume 33: March.
[2015]. “The RSI & Price Trends,” Technical Analysis
of STOCKS & COMMODITIES, Volume 33: June.
Charts were created using custom charting software in R by Kevin Luo.
Use it not as a tool to get girls
but to help you determine how
far price might move.
in cheap after a decline.
Consider adding the measure rule to your trading toolbox, and
you may find it easier to predict next week’s stock price.
STOCKS & COMMODITIES Contributing Writer Thomas
Bulkowski (who may be reached via email at tbul@hotmail.
com) is a private investor and trader with more than 30 years
of market experience and considered by some to be a leading
expert on chart patterns. He is the author of several books
including Chart Patterns: After the Buy, Getting Started in
Chart Patterns, Second Edition and the Evolution of a Trader
trilogy. His website and blog, www.thepatternsite.com, have
more than 700 articles of free information dedicated to price
pattern research.
FURTHER READING
Bulkowski, Thomas [2016]. Chart Patterns: After The Buy,
John Wiley & Sons.
[2005]. Encyclopedia Of Chart Patterns, 2d ed., John
Wiley & Sons.
[2014]. Getting Started In Chart Patterns, 2d ed., John
Wiley & Sons.
‡TOM BULKOWSKI
‡See Editorial Resource Index
 It’s In Between
The Middle-High-Low
Moving Average
Sure, you know moving averages inside out, but maybe it’s
time to change things up a bit. Here, we look at how you can
apply a moving average to an existing moving average.
by Vitali Apirine
iddle, high, low? It may sound odd, but it’s actu-
M ally not. Just as other types of moving averages
do, the middle-high-low moving average (MHL
MA) smoothes the price data to form a trend-
following indicator. So how is it different from
other moving averages? The main difference is
that it’s based on the middle of the high–low range. Also, it
can be used in combination with the most popular types of
moving averages, such as the simple moving average (SMA) or
exponential moving average (EMA). For example, you could
use the MHL EMA and EMA together, or the MHL SMA
alongside the SMA to generate crossover signals. The pairs
of moving averages will have the same length.
26 • August 2016 • Technical Analysis of STOCKS & COMMODITIES
CALCULATING MHL MA
MHL MA is based on the middle of the high–low range (three
to 50 periods). Here’s how you calculate it:
MHL = (Highest high + lowest low)/2
RUNNING FIGURE: KATTY2016/SHUTTERSTOCK/COLLAGE: CHRISTINE MORRISON
Lowest low = Lowest low for the lookback period
Highest high = Highest high for the lookback period
An SMA is the average price of a security over a specific
number of periods. The EMA reduces lag by applying more
weight to recent prices.
In Figure 1 you see an example of the calculation of the
MHL SMA(3,10) & SMA(10) as well as the MHL EMA(3, 10)
& EMA(10) for the S&P 500 index. I used the closing price
to calculate the SMA and EMA. The MHL SMA(3,10) moves
as new prices (middle of high–low range) become available
and old prices drop off. The MHL EMA(3,10) starts with the
MHL SMA value (1924.59) in the first calculation. After the
first calculation, the formula takes over. Because the MHL
 INDICATORS

EMA begins with an SMA, its true value will not be

realized until bar 20. The value on the spreadsheet
may differ from the chart value because of the short
lookback period. The Metastock code for MHL MA can
be found in the sidebar “Metastock Code For Middle
High Low Moving Average MHL (15,50).”
In Figure 2 you see a chart with the 10-day SMA
and an MHL SMA(3,10) overlaid on the price chart.

MICROSOFT EXCEL
To select the parameters for the moving averages, I use
a general method:

FIGURE 1: CALCULATING THE MIDDLE-HIGH-LOW (MHL) SMA(3,10) & SMA(10)

Proposed number of periods for high–low COMBINATION, AND MHL EMA(3,10) & EMA(10) COMBINATION FOR THE S&P 500
range for different moving averages INDEX USING A SPREADSHEET. The closing price is used for the calculation of the simple/
exponential moving averages. The MHL SMA(3,10) moves as new prices (middle of high–low
Number of periods Moving average range) become available and old prices drop off. The MHL EMA(3,10) starts with the MHL
for high–low range length simple moving average value (1924.59) in the first calculation. After the first calculation, the
normal formula takes over.
3–15 Shorter or equal to 50
15–50 from 50 to 200 MHL SMA(3,10), S&P 500 INDEX
SMA(10) 2100

You can, of course, adjust the number of periods MHL SMA(3,10) 2080

for the high–low range to better fit the security you’re 2060

2040
trading or to correspond with whatever analytical
2020
requirements you need to suit.
2000

1980
LENGTHS AND TIMEFRAMES 1960
The length of the MHL moving average depends on 1940
your analytical objectives. Short MHL moving aver- 1920
ages (5–20 periods) are best suited for short-term 1900
trends whereas longer MHL moving averages (20–60 1880
periods) can be used for medium-term trends. A long- 1860
term investor may prefer MHL moving averages using 1840

METASTOCK
a lookback period of 100 or longer. 1820
20 27 3 Nov 10 17 24 1 Dec 8 15 22

MHL EMA & EMA vs. MHL SMA & SMA double FIGURE 2: 10-DAY SMA & MHL SMA(3,10). Here you see the values plotted on a daily
crossovers chart of the S&P 500. A short lookback period was used.
The chart in Figure 3 shows the S&P 500 with a 20-day
EMA (green line) & MHL EMA(10,20) (red line) in S&P 500 INDEX, MHL EMA(10,20)
EMA(20) 1500
the top pane. In the bottom pane is the same index with MHL EMA(10,20)
1450
a 20-day SMA (green line) & MHL SMA(10,20) (red
1400
line). As you may have expected, the EMA & MHL
1350
EMA generated cross signals a little faster than the
SMA & MHL SMA. 1300

1250

MHL EMA & EMA vs. EMA double crossovers S&P 500 INDEX, MHL SMA(10,20)
1200

A bullish crossover occurs when the moving average SMA(20) 1500

MHL SMA(10,20)
crosses above the MHL MA. A bearish crossover 1450

occurs when the moving average crosses below the 1400

MHL MA. 1350

The chart in Figure 4 shows the S&P 500 with a 1300
20-day EMA (green line) & 50-day EMA (red line) 1250
in the top window and the same index with a 30-day 1200
EMA (green line) & MHL EMA(7,30) (red line) in Apr May Jun Jul Aug Sep Oct Nov Dec 2007 Feb Mar Apr

the bottom window.
You can see from the chart that the crossovers gener-
ated by MHL EMA(7,30) & 30-day EMA are faster
than those generated from the 20- and 50-day EMAs.
FIGURE 3: MHL EMA & EMA VS. MHL SMA & SMA, DOUBLE CROSSOVERS. In the top
window you see a 20-day EMA (green line) & MHL EMA(10,20) (red line) overlaid on a chart
of the S&P 500 index. In the bottom window is the same index with a 20-day SMA (green
line) & MHL SMA(10,20) (red line). The EMA & MHL EMA combination generated crossover
signals a little faster than the SMA & MHL SMA combination did.

August 2016 • Technical Analysis of STOCKS & COMMODITIES • 27

 Moving Average, Moving Average, S&P 500 INDEX
EMA(20)
EMA(50) 1500
The double crossover combined
1450

1400
with other charting tools can
1350
be effective in identifying the
1300
beginning or end of a trend.
1250
S&P 500 INDEX, MHL EMA(7,30)
EMA(30)
MHL EMA(7,30) 1500
EMA(15,50) (red line) & SMA(200) (black line). The
1450
50-day EMA is above the rising 200-day SMA. From
1400
looking at the chart you see that double crossovers
1350 of EMA(50) & MHL(15,50) work better when in the
1300 direction of the trend (see red/green arrows). But what
1250
about when price movement is in a trading range?
Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 Feb The daily chart of the Russell 2000 in Figure 7
FIGURE 4: MHL EMA & EMA CROSSOVERS. Here you see the S&P 500 with a 20-day EMA shows an EMA(100) (green line) & MHL EMA(35,100)
(green line) & 50-day EMA (red line) in the top window and the same index with a 30-day EMA (red line). Here you see how you can combine double
(green line) & MHL EMA(7,30) (red line) in the bottom window. The crossovers generated by
the MHL EMA(7,30) & 30-day EMA combination are faster than those generated from the
crossovers with chart patterns when prices are moving
20- & 50-day EMAs. within a trading range (see June–September 2010).
The double crossover combined with the breakout
Moving Average, Moving Average, RUSSELL 2000 INDEX from a double-bottom chart pattern was effective in
EMA(50)
EMA(200) 500
identifying the beginning of a trend.

450
TREND IDENTIFICATION
400 The chart of the S&P 500 in Fig-
ure 8 has a 200-day EMA (green
350
line) and MHL EMA(50,200)
(red line) overlaid on it. Double
RUSSELL 2000 INDEX, MHL EMA(30,150) RUT
EMA(150) crossovers and rising long-term
MHL EMA(30,150)
500 moving averages reflect a long-
450 term uptrend. Conversely, double
crossovers and falling long-term
400
moving averages reflect a long-term downtrend. Cross-
350
overs are prone to whipsaws. Notice that the 200-day
EMA broke above the MHL EMA(50,200) during the
Nov Dec 2002 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2003 Feb Mar Apr May Jun Jul Aug Sep bounce in spring 2008 in that bear market. Then there
FIGURE 5: EMA DOUBLE CROSSOVERS. Here you see a chart of the Russell 2000 index was another whipsaw during the second half of 2011
with a 50-day EMA (green line) & 200-day EMA (red line) in the top window, and in the bot- when a correction was taking place in the S&P 500
tom window a chart of the same index with a 150-day EMA (green line) & MHL EMA(30,150) during the last bull market. The MHL EMA(50,200)
(red line). Note that the crossovers in the bottom window occur earlier than the ones in the
top window.
moved above the 200-day EMA at that time.

TRADE THE TREND

You can increase the number of periods for the high–low range
to widen the spread between the MHL EMA and EMA, but
bear in mind that doing so will increase the lag.
In Figure 5 you see a chart of the Russell 2000 index with
a 50-day EMA (green line) & 200-day EMA (red line) in the
top window and in the bottom window is a chart of the same
index with a 150-day EMA (green line) & MHL EMA(30,150)
(red line). Notice that the crossovers in the bottom window
occur earlier than the ones in the top window.
Other useful MHL EMA & EMA double crossovers
On the daily chart of the Dow Jones Industrial Average
(DJIA) in Figure 6 you see an EMA(50) (green line) & MHL
28 • August 2016 • Technical Analysis of STOCKS & COMMODITIES
Just like other moving averages, the MHL MA is a trend-
following indicator and will not be effective when prices are
moving in a trading range. The moving averages used for the
double crossovers must have the same parameters. The number
of periods for high–low range can be increased to make the
spread between MHL moving average and moving average
wider, but it makes lag bigger. When you combine the MHL
EMA & EMA pair with other indicators, you could get some
effective trading signals. Try different combinations and see
which one works for you.
Vitali Apirine is a programmer engineer with an interest
in technical analysis, especially the application of relative
 DOW JONES INDUSTRIAL AVERAGE INDEX, MHL EMA(15,50) DJI
EMA(50)
15800
MHL EMA(15,50)
15600
SMA(200)
15400
15200
15000
14800
14600
METASTOCK CODE FOR MIDDLE-HIGH-LOW 14400
MOVING AVERAGE—MHL MA(15,50) 14200
14000
13800
13600
HH:=Security(".DJI",H); 13400
13200
LL:=Security(".DJI",L); 13000
12800
MHL:=(HHV(HH,15)+LLV(LL,15))/2; 12600

Mov(MHL,50,S); {MHL SMA} 12400

12200
Mov(MHL,50,E); {MHL EMA} 12000
11800
Mar Apr May Jun Jul Aug Sep Nov Dec 2013 Feb Mar Apr May Jun Jul

FIGURE 6: USING DIFFERENT MOVING AVERAGE PARAMETERS. On this daily chart of

the Dow Jones Industrial Average, the 50-day EMA is above the rising 200-day SMA. From
strength index to trading. He may be reached at vi- looking at the chart you see that double crossovers of the EMA(50) & MHL(15,50) work better
tapirine@mediacombb.net. when in the direction of the trend (see red/green arrows).

FURTHER READING RUSSELL 200 INDEX, MHL EMA(35,100) RUT

EMA(100)
Apirine, Vitali [2015]. “Average Percentage True MHL EMA(35,100) 750
Range,” Technical Analysis of STOCKS & COM-
Breakout 700
MODITIES, Volume 33: November.
650
[2015]. “The Money Flow Oscillator,” Techni-
600
cal Analysis of STOCKS & COMMODITIES, Volume
33: October. 550

[2015]. “The Slow Relative Strength Index,”

500
Technical Analysis of STOCKS & COMMODITIES,
Volume 33: April. 450
[2015]. “The Slow Volume Strength Index,”
Technical Analysis of STOCKS & COMMODITIES, 400

Volume 33: June.

‡MetaStock, ‡Microsoft Excel 350

†See Traders’ Glossary for definition Feb Apr May Jun Jul Aug Sep Nov 2010 Feb Apr May Jun Jul Aug Sep Nov

‡See Editorial Resource Index FIGURE 7: DOUBLE CROSSOVERS IN TRADING RANGES. On this daily chart of the Rus-
sell 2000, you see an EMA(100) (green line) & MHL EMA(35,100) (red line). The double
See our Traders’ Tips section beginning on page 48 for crossover combined with the breakout from a double-bottom chart pattern was effective in
commentary on implementation of Apirine’s technique identifying the beginning of a trend.
in various technical analysis programs. Accompanying
program code can be found in the Traders’ Tips area at S&P 500 INDEX MHL EMA(50,200)
2300
Traders.com. EMA(200)
MHL EMA(50,200)
2200
2100
2000
1900
1800
1700
Bounce spring 2008 1600
Correction 2011 1500
1400
1300
1200
1100

1000

900

800

700

2008 2009 2010 2011 2012 2013 2014 2015

FIGURE 8: DOUBLE CROSSOVERS IN LONG-TERM TRENDS. During the 2008 bear market,
the 200-day EMA broke above the MHL EMA(50,200) during the bounce in spring 2008. There
was another whipsaw in the second half of 2011 when the S&P 500 was going through a
correction. The MHL EMA(50,200) moved above the 200-day EMA at that time.

August 2016 • Technical Analysis of STOCKS & COMMODITIES • 29

 S&P & VIX Come Together

The Return Of
High Momentum
There’s no right or wrong way to look at the market. The reality
is that with so many choices, you can get creative with your
analysis techniques. Here’s a look at how to combine two
related indexes and use opposite strategies for each.
by Perry J. Kaufman
S&P will be traded as mean reverting and the VIX as high
momentum. I’m looking at the same market from two distinct
angles—price movement and volatility. But before doing that,
it’s important to justify the reasoning based on the nature of
price movement. I’ll use the exchange traded fund (ETF) SPY
for the S&P, the VIX index for statistics, and the ETF UVXY

A
for trading.
long, long time ago, back in the 1990s, we had a To understand the SPY VIX
method called high-momentum trading. It was a difference between
Up Days 3193 2147
short-term strategy that took advantage of over- these markets, you can
bought and oversold conditions—not by fading them add the number of up Down Days 2769 2452
(selling overbought and buying oversold values), but and down days as well Avg. Up 0.92 1.11
by buying overbought and selling oversold situations. as the average daily Avg. Down -0.99 -0.99
It seems contrary to the concept of being overbought moves up and down. FIGURE 1: AVERAGE UP AND DOWN DAILY
1599686SV/SHUTTERSTOCK

or oversold, but it’s all about timing.
PROFILING THE MARKETS
In this article, I’ll look at two strategies, both based on pat-
terns and with rules that are essentially the opposite. The
24 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
The table in Figure MOVES IN SPY AND VIX. From August 1998
1 shows that these through February 2017, the SPY has more up
numbers are opposite days and VIX has more down days. The aver-
age size of the daily moves is also reversed,
for SPY and VIX (us- with the SPY having larger down days and VIX
ing data from August larger up days.
 TRADING STRATEGIES

1998 through February 800

2017). SPY has more up SPY Sequence of Runs VIX Sequence of Runs
700 700
days and VIX has more
600 600
down days. The average
size of the daily moves 500 500

is also reversed, with 400 400

the SPY having larger 300 300
down days and VIX
200 200
larger up days. You

MICROSOFT EXCEL
100 100
should then expect the
rules for a short-term 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14
strategy to also be dif- RunUp RunDown RunUp RunDown
ferent. FIGURE 2: SEQUENCES OF RUNS. Here you see that the SPY has runs up of 12 and 14 days, and VIX has runs down of 10 days.

SEQUENCE Runs Up Runs Down

1200 1200
OF RUNS
1000 1000
The two trading sys-
tems are going to use 800 800
patterns—sequences 600 600
of up and down days—
to trigger signals. It 400 400

could be helpful to see 200 200

how these sequences
0 0
distribute for SPY and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 2 3 4 5 6 7 8 9 10 11 12 13 14
VIX. Figure 2 shows SPY VIX Random SPY VIX Random
the frequency of up FIGURE 3: DISTRIBUTION OF RUNS COMPARED TO RANDOM DATA. For the SPY and VIX there are fewer one- and two-sequence
and down runs for moves than expected with random data. Upward runs have a very long tail to the right. In the downward runs, the tail is not as extreme
but still much longer than any random data would show. These charts show that the one- and two-day moves are fewer than random,
both markets. For SPY and that the VIX has a bias in the opposite direction from SPY.
(left chart), there is a
larger occurrence of
one- and two-day changes of direction to the downside than Mean Reversion
to the upside; that is, downside sequences tend to be shorter 1410

in duration than do upside moves. For the VIX (right chart), 1400
it’s the opposite, with downside sequences longer most of the Exit on close Exit on close
1390
time. Also note there are a few very long sequences of runups of 2nd day of 2nd day
for SPY and rundowns for VIX. 1380
Let’s look at it another way. Figure 3 compares the upward
1370
runs for SPY and VIX with a random movement. The longer
bar (the rightmost of 3) is the random sequence. For both SPY 1360

and VIX there are fewer one- and two-sequence moves than 1350
Buy the close Buy the close
expected with random data. These runs have been shifted to
1340 of the 3rd of the 3rd
create the fat tail. Upward runs have a very long tail to the day down day down
right, with one sequence as long as 14 days. For downward 1330
2/1 017

7
2/1 017
2/1 017
2/8 17
2/9 17
2/1 017
2/5 17
2/6 17
2/7 17
2/3 17
2/4 17
2/1 17
2/2 17
1/3 017
1/3 017
1/2 017
1/2 017
1/2 017
1/2 017

runs the tail is not as extreme, but still much longer than any
01
/20
/20
/20
/20
/20
0
/20
/20
/20

1/2
2/2
3/2
/2
0/2
1/2
9/2
0/2
8/2
7/2
6/2
5/2
1/2

random data would show.

FIGURE 4: EXAMPLE OF MEAN-REVERSION RULES. In each of these examples,
These charts show that the one- and two-day moves are the trade is closed out on the second day after entry, although profit-taking will
fewer than random, and that the VIX has a bias in the op- occur for many trades.
posite direction from the SPY. For me, that justifies using
opposite strategies.
away from random in one- and two-day reversals, the index
MEAN REVERSION markets favor reversing after day 3 or day 4. I’m going to
I’ll start with the SPY strategy, based on one of my favorite alter the rules somewhat to favor the long side, for obvious
approaches, the three-day pattern, which works well for equity reasons, lengthening the holding period for long positions and
index markets because they have a history of being noisy. lengthening the entry thresholds for short sales. The complete
I’m going to rename this technique short cycle because it set of rules are:
will no longer be just three days. Because prices have shifted
July 2017 • Technical Analysis of STOCKS & COMMODITIES • 25
 1. Enter long on the third close down, exit on the third
close after the entry.
Index markets are notoriously
the noisiest of all markets, 2. Enter short sales on the fourth close up, exit on the
second close after the entry.
that is, they have the greatest
3. Take profits based on a five-day ATR times a factor of 0.60,
occurrence of erratic behavior. added to the entry for longs, and subtracted for shorts.
4. Filter with a 120-day moving average, that is, enter long
only when the trend is up, and enter shorts only when
the trend is down.
SPY
8000

7000 Figure 4 shows two examples of mean-reverting buy signals.

6000
Each is closed out on the second day after entry, although
5000
profit-taking will occur for many trades.
The results of these rules, applied to SPY from 1998 through
4000
February 2017, are shown in Figure 5. The cumulative profits
3000
from longs and shorts are shown separately and are based on a
2000 $10,000 investment and commissions of $8 per trade. There are
1000 many more long trades than shorts. While a return of $6,500
0 does not seem like a lot, the program is in the market less
-1000 than 10% of the time; therefore, it avoids a great deal of risk.
Futures or options traders could leverage these results.
6

7
4

5
1

3
0
7

9
5

6
3

4
2
0

1
9

01

01
01
01

01
01

01
00

01
00

00
00

00
00

00
00

00

00
99

5/2

5/2
5/2

5/2
5/2

5/2

5/2
5/2

5/2
5/2

5/2
5/2
5/2

5/2

5/2
5/2
5/2

5/2
5/1

1/2

1/2
1/2

1/2
1/2

1/2
1/2
1/2

1/2
1/2

1/2
1/2

1/2
1/2

1/2
1/2

1/2

1/2
1/2

cumL cumS netPL

FIGURE 5: PROFITS FROM TRADING SPY USING A MEAN-REVERSION HIGH MOMENTUM
STRATEGY. There are many more long trades than shorts. A return of $6,500 For the high-momentum strategy, you could use the same
may not seem like a lot, but the program is in the market less than 10% of the time;
therefore, it avoids a great deal of risk. Futures or options traders could leverage
basic setup but with a more symmetric threshold for longs
these results. and shorts. I’ll use the ETF UVXY to trade both long and
short. For futures, there is VX, which gives a similar pattern
Two UVXY Trades for High-Momentum Strategy of results but with higher returns and higher risk.
85

80
Sell a lower open after 1. After two lower closes, enter a short sale on a lower
75
the second day down open or on a lower close (whichever comes first), exit
70
Exit on the on profit-taking or the day after the entry.
65
following close 2. After two higher closes, enter a long position on a higher
60

55
open or higher close (whichever comes first), exit on
Sell again profit-taking or the day after the entry.
50
on the open Exit
45 3. Take profits based on a 10-day ATR times a factor of
0.90, added to the entry for longs, and subtracted for
16
16
16
16

16
16

16

16
16
16

16
16
16
16
16
16

/20
/20
/20
/20

/20
/20
/20

/20
/20

/20

/20
/20
/20
/20
20
20
/9/
/8/

/23
/22
/21
/19

/20
/18
/16

/17
/15
/13

/14
/12
/11
/10
11
11

shorts.
11
11
11
11

11
11
11

11
11

11

11
11
11
11

FIGURE 6: TWO SHORT SALES USING THE HIGH-MOMENTUM STRATEGY

APPLIED TO THE ETF UVXY. Most of the trades are likely to be short sales, which 4. Filter with a 40-day moving average, that is, enter long
is not surprising given the high volatility. Profit-taking will also be frequent. only when the trend is up, and enter shorts only when
the trend is down.
UVXY 80000 VX
25000 70000 Besides going in the
20000 60000
50000 direction of the cur-
15000
40000 rent price move, these
10000 30000 parameters are faster
5000 20000
10000 than those used for the
0
0 SPY mean-reversion
-5000 -10000 approach. It won’t be
16
15
14
13
12
11

5/2 15

6
5/2 14
5/2 12

5/2 13
5/2 11
5/2 09

5/2 10
5/2 08
5/2 07
5/2 06
5/2 5
4

01
00
00
/20
/20
/20
/20
/20
/20

surprising that most

0
0
0

0
0
0

0
0
0
0

4/2

4/2
4/2
4/2

4/2
4/2
4/2

4/2
4/2
4/2
4/2
4/2
4/2
/29
/29
/29
/29
/29
/29

5/2
5/2
12
12
12
12
12
12

cumL cumS netPL cumL cumS netPL of the trades are short
FIGURE 7: RETURNS OF HIGH MOMENTUM FOR THE ETF UVXY (LEFT) AND FUTURES VX (RIGHT). The long trades using
sales, which is similar to
futures have a drawdown of about $5,000 in 2008, but the shorts, which account for most of the trades, show steady gains. The returns
of about $70,000 for futures over 13 years are still significantly higher than $20,000 for UVXY over five years. Continued on page 46
26 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
 BarsBack simulation shows a visible peak of the reward/risk
around 12 weeks. This makes sense since 12 weeks is exactly
a full quarter.
Now that the model passed the statistical tests, it’s time to
build a reporting system to monitor on a weekly basis.
In Figure 9 you see a TradeStation Radarscreen example
applied to the 30 stocks in the Dow Jones Industrial Average.
It can easily track up to 1,000 stocks and ETFs. You can rank
them and focus on stocks with higher ratings in order to find
entry points.
IT CAN BE DONE
Can you build your own technical stock rating process start-
ing from the indicators you are familiar with? Is it possible to
get rid of analysts? Is it possible to transform the information
provided by a technical indicator into a clear-cut recommen-
dation? In this article, I created a model and tested it from
different perspectives to validate it from a statistical point of
view. Almost any technical indicator could be put through a
similar process.
In spite of all the mathematical calculations that can be done
and the sophisticated trading platforms available to the trader
KAUFMAN / THE RETURN OF HIGH MOMENTUM
Continued from page 26
the way many professional traders sell high volatility. Figure
6 shows two trades using UVXY, although profit-taking is
also frequent.
The results for this strategy are shown in Figure 7. Profits
for UVXY are on the left, but only start at the beginning of
2012. Futures, VX, are on the right and begin in 2004. The
long trades using futures have a drawdown of about $5,000
in 2008, but the shorts, which account for most of the trades,
show steady gains. The returns of about $70,000 for futures
over 13 years are still significantly higher than $20,000 for
UVXY over five years.
IT ALL MAKES SENSE
For the pragmatists, that these two approach-
es have good returns and show consistency
should be convincing. For those needing a
fundamental explanation of why the index
market reacts in the opposite way to its own
volatility index, the statistics of up and down
price runs should help. Plus, there is a shift from short-term
random price movement to create the fat tail.
My own conviction is based on measuring noise. Index
markets are notoriously the noisiest of all markets, that is,
they have the greatest occurrence of erratic behavior. The
10-day average noise of S&P futures (ES) is 0.31 and VX
is 0.35, where a higher value means less noise, more trend.
In addition, VX is highly biased to the downside, while ES
46 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
to make everything easier, traders still need psychological
support to pull the trigger. Such support can come only from
something the trader trusts and is familiar with.
So forget about stereotypes and don’t be stopped by others
telling you that your way is not correct. The reality is, nobody
knows. I encourage you to build your own lens to look at the
markets with, and improve upon it, day by day.
Domenico D’Errico is an independent research & develop-
ment partner for investment management companies and
professional traders. He also runs his own research firm
and software house (www.Trading-Algo.com). D’Errico is
a TradeStation Open Platform Developer and a two-time
winner of the TradeStation developer contest. He is avail-
able for advisory and coaching through his website, www.
Trading-Algo.com.
‡TradeStation
‡See Editorial Resource Index
‡See Editorial Resource Index†See Traders’ Glossary for definition
is biased to the upside. Together, they make a good trading
combination.
Perry Kaufman is a trader and financial engineer. He is the
author of many books on trading and market analysis, in-
cluding Trading Systems And Methods, 5th ed. (with the first
edition published in 1978 as a seminal book in the field of
technical analysis), and most recently, A Guide To Develop-
ing A Successful Algorithmic Trading Strategy (2016). For
questions or for more information, visit his website at www.
KaufmanSignals.com.
FURTHER READING
Kaufman, Perry J. [2013]. Trading Systems And Methods,
5th ed., Wiley.
[2015]. A Guide To Creating A Successful Algorithmic
Trading System, Wiley.
[2003]. A Short Course In Technical Trading, Wiley.
[2017]. “VIX Or Historical Volatility?” Technical Anal-
ysis of STOCKS & COMMODITIES, Volume 35: March.
[2014]. “Timing The Market With Pairs Logic,”
Technical Analysis of STOCKS & COMMODITIES, Volume
32: March.
[2014]. “A Better Trend,” Technical Analysis of STOCKS
& COMMODITIES, Volume 32: April.
[2014]. “Slope Divergence: Capitalizing On Uncer-
tainty,” Technical Analysis of STOCKS & COMMODITIES,
Volume 32: June.
†See Traders’ Glossary for defi nition
 INDICATORS
Lean & Mean
The Reverse EMA Indicator
The exponential moving average is a popular indicator
among technical analysts. But it has its shortcomings.
Here’s a look at how the indicator can be used so it results
in minimum lag and provides crisper trading signals.
T
he exponential moving average (EMA) is
one of the cornerstones of technical analy-
sis. It is easy to implement and has excellent
smoothing qualities over a wide range of
applications. The disadvantage of the EMA
is that it has different group delay, or lag,
across the spectrum of frequencies present in market
data. This different lag causes a nonlinear relationship
between frequency and phase, leading to waveform
distortions. The moving average is computed from left
to right across the chart, and some traders have tried
to also perform the EMA from right to left, thereby
canceling the nonlinear phase response and getting
twice the smoothing in the process.
The problem with forward and backward EMA is
that it is noncausal. In other words, you cannot actu-
ally use such a filter in real time. Trading is always
performed at the right-hand edge of the chart, and
waiting for data to happen so you can perform a
reverse EMA is a way of cheating on real results. In
short, it doesn’t work for real trading.
In this article I will describe a causal forward and
backward EMA indicator that can be used in real
trading. This indicator provides a clean and crisp
output that can be adapted to cycle, momentum, and
trend activity. It has the primary attributes I think
are necessary for a technical indicator. That is, it has
double smoothing at the high end of the frequency
INGA POSLITUR
spectrum to reduce aliased components, and it has a
difference that mitigates the impact of spectral dilation
at the low-frequency end of the spectrum.
by John F. Ehlers
THE EMA
An EMA is computed by multiplying the input data by
a number (less than 1) and adding to it the complement
of that number, multiplying the previously computed
value of the EMA. In EasyLanguage code, this is
written as:
EMA = α*Price + (1 – α)*EMA[1];
The two coefficients of this filter sum to unity, so
the gain of the filter is 1. That is, if a constant input
is applied to the filter, the quiescent filter output will
have the same value. If a spike amplitude of 1/α (an
impulse) is applied to an EMA, its immediate output
is a value of 1. In the next sample period there is no
input, so the output value is just (1 – α). In the next
sample period there is still no input, so the output
value is (1 – α)2. The process continues, so the general
expression for the EMA response to an impulse at
the Nth sample period is (1 – α)N. This is one reason
why it is called an exponential moving average—the
amplitude response falls off as the exponent of the
time sample from the impulse event.
With apologies to the mathematical purists, we can
frame the EMA equation in terms of Z-transforms,
where Z–1 signifies one unit of delay. Doing this, the
EMA equation becomes:
Output = α *Input + (1 – α)*Output*Z–1
Rearranging the terms, we get:
Output*(1 – (1 – α)*Z-1) = α *Input
The Z-transform of a filter is the ratio of the output
to the input, so algebra further gives us:
September 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 TRADESTATION
FIGURE 1: EXAMPLE OF FILTER RESPONSE. On this daily chart of the SPY, the reverse EMA accurately reflects turning points with little lag.

can further factor the previous equation for an FIR filter as:
Output α
= H(Z ) = H(Z) = (1 + cZ –1) (1 + c2 Z –2) (1 + c4Z –4) (1 + c8Z –8) …
Input 1 − (1 − α) Z –1

THE REVERSE EMA ALGORITHM
I came across this algorithm in Martin Vicanek’s article “A
New Reverse IIR Filtering Algorithm.” To understand the
reverse EMA algorithm, it is best to simplify the Z-transform
equation by forgetting about the α gain term and letting c =
(1 – α). Doing this, the Z-transform becomes:
1 small for trading by using only eight modules.
H(Z) =
1 − cZ
If we carry out the long division of this rational equation for
the Z-transform of the EMA, we get the infinitely long series:
Time reversal of the FIR filter is easy. All that need be done
is to reverse the order of the impulse response and add a total
delay to make the time-reversed filter causal.
The equation for such a filter is:
H(Z) = (c + Z –1) (c2 + Z –2) (c4 + Z –4) (c8 + Z –8) …
This filter can be realized by successive filtering where each
module filters the preceding module. Errors are sufficiently
THE REVERSE EMA INDICATOR
A practical indicator can be created by subtracting a forward-
and-reverse EMA response from a standard EMA. The basic

H(Z) = 1 + cZ –1 + c2 Z –2 + c3Z –3 + c4Z –4 + …

This is an exponential decay of the filter response to an input.

In addition, since c has a value less than unity, the coefficients
become vanishingly small after a sufficient number of terms. This indicator provides a clean
Therefore, we can truncate the infinite series to a finite number
of terms with a quantifiable amount of error. If we truncate the
and crisp output that can be
series, the Z-transform now becomes the expression for a finite adapted to cycle, momentum,
impulse response (FIR) filter. A simple moving average (SMA) and trend activity.
is a special case of an FIR filter where all the coefficients are
the same.
Having the Z-transform of the filter represented as a FIR, we
10 • September 2017 • Technical Analysis of STOCKS & COMMODITIES
idea is that the forward-and-reverse EMA does not contain the
EASYLANGUAGE CODE FOR REVERSE EMA INDICATOR
frequency-phase distortions, so subtracting it from a standard
EMA highlights those distortions. One perspective is that it is
{
just those distortions that comprise the indicator output. Reverse EMA Indicator
A typical example of the filter response is shown in Figure 1. (C) 2017 John F. Ehlers
The single input parameter to the filter is the typical alpha for }
an EMA filter. By changing the alpha to be 0.05, the indicator
will show more of the trend response. By changing the alpha Inputs:
to 0.3, the indicator will show more of the cycle response. The AA(.1);
reverse EMA indicator output is similar to that of the roofing
filter (discussed in my book Cycle Analytics For Traders) except Vars:
that the roofing filter has independent control of the upper and CC(0),
EMA(0),
lower band edges.
RE1(0),
The EasyLanguage code to compute the reverse EMA indica-
RE2(0),
tor is given in the sidebar “EasyLanguage Code For Reverse RE3(0),
EMA Indicator.” RE4(0),
RE5(0),
THE REALITY OF IT RE6(0),
The reverse EMA indicator is causal RE7(0),
and can be used for real trading. It RE8(0),
is virtually universal. It has a single Wave(0);
input parameter that lets it highlight
cycle, momentum, and trend com- //Classic EMA
CC = 1 - AA;
ponents. It has minimum lag. It has
EMA = AA*Close + CC*EMA[1];
high-frequency filtering that reduces
the impact of aliased components of //Compute Reverse EMA
the sampled data. It has low-frequency RE1 = CC*EMA + EMA[1];
filtering that rolls off at the rate of 6 dB per octave, thereby RE2 = Power(CC, 2)*RE1 + RE1[1];
mitigating the effects of spectral dilation. All around, it is a RE3 = Power(CC, 4)*RE2 + RE2[1];
crisp new indicator that should be in everyone’s toolbox. RE4 = Power(CC, 8)*RE3 + RE3[1];
RE5 = Power(CC, 16)*RE4 + RE4[1];
S&C Contributing Editor John Ehlers is a pioneer in the use RE6 = Power(CC, 32)*RE5 + RE5[1];
of cycles and DSP technical analysis. He is president of MESA RE7 = Power(CC, 64)*RE6 + RE6[1];
Software. MESASoftware.com offers the MESA Phasor and RE8 = Power(CC, 128)*RE7 + RE7[1];
MESA intraday futures strategies.
//Indicator as difference
He will hold a three-day workshop in October in San Sim-
Wave = EMA - AA*RE8;
eon, CA to offer an intimate and intense learning experience
in cycles and DSP including fully disclosed trading strategies; Plot1(Wave);
for more information, see MESASoftware.com/#workshop. Plot2(0);

The code given in this article is available in the Article Code section
of our website, www.Traders.com. _____ [2014]. “The Quotient Transform,” Technical Analysis
of STOCKS & COMMODITIES, Volume 32: August.
See our Traders’ Tips section beginning on page 50 for commentary _____ [2013]. Cycle Analytics For Traders: Advanced Techni-
and implementation of John Ehlers’ technique in various technical
cal Trading Concepts, Wiley.
analysis programs. Accompanying program code can be found in the
Traders’ Tips area at Traders.com.
Vicanek, Martin [2015]. “A New Reverse IIR Filtering Algo-
rithm,” http://vicanek.de/articles/ReverseIIR.pdf.
‡TradeStation
FURTHER READING ‡See Editorial Resource Index
Ehlers, John F. [2015]. “Decyclers,” Technical Analysis of †See Traders’ Glossary for definition
STOCKS & COMMODITIES, Volume 33: September.
_____ [2014]. “Predictive And Successful Indicators,” Tech-
nical Analysis of STOCKS & COMMODITIES, Volume 32:
January.
_____ [2016]. “Measuring Market Cycles ,” Technical Analysis
of STOCKS & COMMODITIES, Volume 34: September.
12 • September 2017 • Technical Analysis of STOCKS & COMMODITIES
 TRADING EXAMPLES
Last month in part 8 of this series, I
looked at the V-Trade trading rules.
In this ninth part of the series, I
encourage you to carefully study
the V-Trade buy/sell examples so
you get an idea of how it works in
the real world.

USDJPY SHORT TRADES

In the first example, I use a 100-tick
(10 pips) forex USDJPY modified
renko chart (Figure 1). The USD-
JPY is most likely completing an
impulse wave with a top at (5). Note
that after wave (3), there is an ABC
zigzag correction, which completes
wave C-(4). This starts an impulse
wave up with a positive divergence
between the lower price bottom of
Wave C-(4) compared to wave A,
but a higher indicator bottom at the
level of C-(4).
At this point, you could project Fi-
bonacci targets from wave (4). Wave
1 comes close to the 161.8% target.
Note the positive convergence with a
higher top both in price and indicator
between the tops (3) and 1. You can
expect a wave 2 pullback followed by
a continuation of the uptrend.
The USDJPY retraces to the sup-
port of the wave (3) top and the active
middle line of the volatility band to
complete correction wave 2.
The USDJPY continues the move
up to the next double red renko
brick (top of wave 3). The negative
Practice Makes You Better divergence between the higher top in
price and lower top in the indicator

The V-Trade pushes price down for correction

wave 4 to the 161.8% Fibonacci
support and the middle line of the
Part 9: Trading Examples
SILVER DOLLAR: ROMAN SIGAEV / SILVER YEN:KAVALENKAVA / WAVE ART:

volatility band.
RODINA OLENA /SHUTTERSTOCK / COLLAGE: CHRISTINE MORRISON

Finally, the USDJPY moves up to

In this ninth part of a multipart series, we look at some example trades using the complete wave 5-(5) when it reaches
V-Trade trading rules. the 261.8% Fibonacci target. This
creates a double downward brick and
by Sylvain Vervoort a negative divergence—higher top in
price vs. lower top in the indicator.
objective of the V-Trade article series is to explain the techniques If you consider this the possible

My I apply to make manual and automatic buy & sell decisions, or a

combination of both. But before I move on to the V-Trade tools avail-
able in the expert system, I want you to use what you have learned
in the technical analysis part of this series and practice the V-Trade
by applying the V-Trade buy/sell rules.
end of an up-moving impulse wave,
does it comply with the uptrend-to-
downtrend reversal rules?
• We expect a downward first

14 • November 2018 • Technical Analysis of STOCKS & COMMODITIES

 TRADING SYSTEMS

correction wave A or 1.
• Price is at the top of the volatility band.
• The last move up is a completed impulse wave.
• The SRSI indicator is coming down from the top with
a negative divergence.
• Price is at resistance of the 261.8% Fibonacci tar-
get.
• Price shows an upper wick at the double reversing
red renko brick.

Complying with the V-Trade rules, you decide to open a

short trade. Say you have basic capital available of $10,000.
You sell short one lot USDJPY at ¥111.10. One lot represents
$100,000. In other words, a price change of one pip (0.01)
represents a value of ¥1,000, or around $9 at ¥110 per $1.
In the first instance, we may expect a common 50%
retracement over wave (5) and possibly a 50% retracement
over the complete (1) to (5) impulse wave.

METATRADER4
Closing the short trade at the end of
correction wave A FIGURE 1: 10-PIP MODIFIED RENKO CHART OF USDJPY. All signs point to the
Figure 2 shows the correction for the A-wave down. At the completion of impulse wave (5).
red dotted vertical line marked 1, we opened the short trade
at the close or the open of the next bar, after the double red
bar down at a price of ¥111.10. Soon after, double green
bars show up at the vertical dotted gray lines 2 and 3. Does
that mean a possible reversal already?
At these points, we are not complying with the retrace-
ment and continuation rules. For a reaction, it is too small.
This looks like a short-term reaction to the support at 2,
resistance at 3, and volatility channel middle line. Also,
there is no reversing signal visible in the indicator; it con-
tinues its move down. The next reversing signal comes a
couple of days later (marked “4” with the vertical green
dotted line). Are we reaching the end of correction wave
A? Is this a reversing point?
You expect a pullback wave B. The USDJPY moved
beyond the 50% retracement of the full previous impulse
wave up. There is also price support, and price reaches the
61.8% Fibonacci retracement level. Price is at the bottom
of the volatility band with a positive hidden divergence
between price and indicator. Complying with the V-Trade
rules, we close the short trade at ¥109.80. That is a profit
of 130 pips or a value of ¥130,000. FIGURE 2: END OF CORRECTION WAVE A. Once the end of wave A looks very likely,
the short trade is closed.

Waiting for the end of correction wave B

If we are at the bottom of wave A, the next wave is a correction
wave B in relation to wave A. Usually, this is a limited Fibo-
nacci pullback between 38.2% and 61.8% of wave A. Making
money in this rather small move isn’t easy. Because of this,
we do not open a long trade but we wait for the downtrend to
resume after the top of wave B.
Figure 3 shows a retracement between 38.2% and 50% of
wave A with a double red brick. Is this the top of wave B?
Does it comply with the downtrend continuation rules?
• You expect a continuation of the downtrend with cor-
rection wave C after reaching a retrace target. Price
retraced between 38.2% and 50% of wave A and 38.2%
of the full previous impulse wave.
• The USDJPY is near previous price resistance and close
to the top of the volatility channel.

November 2018 • Technical Analysis of STOCKS & COMMODITIES • 15

 • The stochastic RSI indicator has a nega-
tive hidden divergence between price
with a lower top and the index with a
higher top.

Most likely, this is the top of wave B. We

open a new short position at 110.10 with a stop-
loss a few pips above the B-top. A Fibonacci
projection over wave B gives a 161.8% target
at 109.07. We put an auto-closing order at that
level following up the move down. Look at the
first double down brick in wave B, the gray FIGURE 3: WAITING FOR END OF WAVE B TO CONTINUE THE MOVE DOWN WITH WAVE C. Here
dotted line. We don’t consider this the end of you see a retracement between 38.2% and 50% of wave A with a double red brick. Is this the top of
wave B. The retracement is too small and passes wave B?
previous price resistance. Furthermore, there is
support from the 100-brick average and the SRSI is still
moving up at that point.

A profitable wave C
Figure 4 shows the wave C down. On the way down, a first
double green brick appears (marked as wave a). Could this
be the end of the ABC correction move?
Looking at the downtrend-to-uptrend reversal rules, this
might be the case except that price is not reaching passive
or active support. Another point is that wave A and C usu-
ally are of the same size, which is not the case here. You
will have to decide to either take profit or risk some of the
profit staying in the trade, expecting a smaller abc zigzag
correction within wave C. There is resistance at the end of
wave A level and the middle line of the volatility band. I
continue to stay in the trade but if price moves beyond the
middle line resistance I will close the trade.
After another single green bar up for correction wave
b, price turns back down against the volatility channel FIGURE 4: AUTO-CLOSING THE WAVE C SHORT TRADE. The short position is closed
middle line resistance. Before the next double green bar when price reaches the 161.8% Fibonacci target over wave B.
is completed at the vertical dotted green line,
the short position is closed when price reaches
the 161.8% Fibonacci target over wave B. The
profit is 103 pips, which is the equivalent of
¥103,000. Total profit is now ¥233,000. This is
likely the end of wave C and wave (A) correc-
tion of a higher degree. The last up move of 680
pips (wave 5-(5)) helps to infer the completion
of wave (A). If this is a wave (A), you can now
expect correction wave (B).
The expected up correction (B)-wave is ini-
tially a correction for wave C and if larger, it’ll
be a correction for the complete ABC downward
zigzag wave. Resistance for this move up is
given by the top of wave b, the upper side of the
volatility band, and the 200-bar average (green).
Most likely, this will be a V-wave correction with
a smaller abc correction. Is it worth opening a
long trade? In general, it is good practice not to FIGURE 5: WAITING FOR THE END OF CORRECTION WAVE (B). The 161.8% Fibonacci projection
trade against the trend unless you are awaiting over wave (B) gives a price target of 108.43. At the same time the magenta 161.8% Fibonacci projection
a larger move. So you wait for the end of this over the first wave A gives the same price target.
16 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
 correction and go back in for a short position
once the correction completes.

Waiting for the end of correction wave (B)

The start of the temporary reversal of the trend
is confirmed by the positive divergence with a
lower bottom in price but higher bottom in the
indicator (green up arrow in the indicator panel
in Figure 5). The top of the first correction wave
“a” has a convergent move with lower tops in
price and indicator (brown arrow), which con-
firms that wave a is a correction wave for the
previous wave C.
The bottom of wave b has a convergent FIGURE 6: AUTO-CLOSING THE SHORT POSITION. The short position is closed at 108.50, which is
move with higher bottoms (blue arrow), which the first wave A of the second zigzag correction.
confirms that this is a correction wave for the
previous wave a. Finally, the c-wave completes
the correction for the C or ABC downtrend
move, resulting in a negative divergence with
a higher price top and lower indicator top (red
down arrow).
Is this the end of the correction? I expect a
wave (C) for a continuation of the downtrend.
Price is near the top of the volatility band, the
100-bar average and, with the negative diver-
gence, I open a new short trade at 109.60 with
a stop-loss a few pips above the last top c-(B).
The red Fibonacci projection over wave (B)
shows a price target of 108.43 at the 161.8%
level. At the same time, the magenta Fibonacci
projection over the first wave A down gives the
same price target at the 161.8% level. We place
an auto-closing order a fraction higher at 108.5
for the new short position. FIGURE 7: WAITING FOR THE END OF CORRECTION WAVE B. The convergent move with a lower
bottom between price and the indicator is enough reason to expect a correction.
Auto-closing the short order with wave A of
the second zigzag
From Figure 6 you see that the USDJPY moves
down to the level of the auto-closing price. I
close my short position with a profit of 110
pips. That’s ¥110,000. The total profit goes up
to ¥343,000.
USDJPY is at the bottom of the volatility band
and there is a convergent move between the last
wave b and A. You expect a B-correction wave,
which is a retracement in the downtrend.
Again, because this is just a correction in
the down move, I won’t open a long trade, but
will wait for the end of this correction to go for
another short trade when starting wave C.

Waiting for the end of correction wave B

The first double red renko brick in the up correc-
tion in Figure 7 is most probably the end of the FIGURE 8: AUTO-CLOSING THE SHORT TRADE. A series of red downward bricks brings price down
B-correction wave. The A-wave showed a con- but a double green candle suggests a possible reversal. The short position is closed after reaching
vergent move with a lower bottom between price the Fibonacci price target.

18 • November 2018 • Technical Analysis of STOCKS & COMMODITIES

and the indicator. This is reason to expect a correction. move with another abc zigzag. This is probably the end of the
With the double red brick now, there is a negative hidden ABC double zigzag correction wave. With the convergent move
divergence with a lower top in price but a higher top in the between waves a and c-C, you expect an up correction with
indicator. Price is near previous passive price support. A a 50% retracement of the last wave c. The US2000 moves up
continuation of the previous downtrend is imminent. I open to the 50% pullback, coming close to the 200-brick average
a new short position at 108.90. and price resistance from the bottom of the previous wave
A Fibonacci projection over wave B (green) gives the first A. You can call this a wave 1 or wave A. The hidden nega-
161.8% target. This target is confirmed with the 161.8% light tive divergence between wave b and wave 1 suggests a wave
blue Fibonacci projection over the first B-wave in the chart 2 or B, smaller than wave 1. Price retraces almost 100% of
and the (A) wave. Reason enough to set an auto-closing order wave 1 and makes a turn with a double green up brick. This
a fraction above the 161.8% light blue target at 108.15. It is is most probably the bottom of a correction wave 2. There is
likely this will be the end of correction wave C and (C). a convergent move between waves c-C and 2, which means
you can expect a continuation of the previous uptrend of wave
Auto-closing the short trade
A number of red downward bricks (Figure 8)
brings price down. Then, price turns up with a
double green candle after reaching the Fibonacci
price target. The auto-closing level is reached
and the short position closes with a profit of:
108.90 - 108.15 = 0.75 or 75 pips. The total profit
now amounts to 343+75 = 418 pips or ¥418,000.
An equivalent of 418,000/110 = $3,800, a profit
of 38% in just six trading days. This ends the
first trading example based on V-Trade rules
and techniques.
Look at the USDJPY daily chart in Figure 9.
The last eight days show the down correction
that started when the USDJPY reached a top and
touched the light blue 261.8% Fibonacci target.
At this last top in price, note the negative diver-
gence between price and indicator (higher top in
price but lower top in the indicator). Watch the FIGURE 9: HERE’S WHAT HAPPENED ON THE DAILY CHART. On the daily chart of USDJPY, the
last eight bars show the down correction that started when the USDJPY reached a top and touched
50% retracement over the last up move on the the light blue 261.8% Fibonacci target. At this last top in price, note the negative divergence between
daily chart. This is the correction that I traded price and indicator (higher top in price but lower top in the indicator). Watch the 50% retracement over
in my first V-Trade example. the last up move on the daily chart. This is the correction that was traded in Figure 8.

US2000 (RUSSELL 2000)

LONG TRADES
In the second example I use the Russell 2000
Index (US2000) to look for long trades. In
Figure 10 is a 600-tick (60 pips or six points)
modified renko chart. Again, I assume a basic
starting capital of $10,000 to allow trading at
some $15 per point.
Starting from the beginning of the chart,
from the top, there is first an abc zigzag wave
down, which ends just below the active support
of the 200-brick average and the low side of
the volatility channel. Waves a and c clearly
have a lower-degree impulse wave down (i
to v). Next, there is an in-between correction
wave B up to the 100-brick average, the upper
side of the volatility band, and resistance from
the previous wave v-a bottom, which has now FIGURE 10: LONG TRADES ON THE RUSSELL 2000 (US2000) INDEX. On this six-point modified
become a resistance level. renko chart, it is likely an uptrend will begin with the creation of wave 3. You could open a long trade
After the wave B top, price continues its down at 1494 with a stop a few pips below the bottom of wave c-C.

November 2018 • Technical Analysis of STOCKS & COMMODITIES • 19

 1 for the creation of wave 3. It’s time to open
a long trade at 1494. I use a hidden stop a few
pips below the bottom of wave c-C.

THAT FIRST PROFIT

Price moves up to a 50%
retracement of the previ-
ous double ABC zigzag
down correction (Figure
11). This resistance and
the passive resistance of
the previous price levels
of the first wave a and the B-wave together with
the active resistance of the 100-brick average
FIGURE 11: COLLECTING THAT FIRST PROFIT. Is it time to close the first long trade? With the resis-
and of the upper side of the volatility channel
tance and convergent moves between price and the SRSI, you could expect a correction wave 4.
stopped the up move, creating a double negative
renko brick.
With all the resistance and convergent moves
between price and SRSI, you could expect a
correction wave 4.
It’s a good time to take profit on the open
long position. You close it at 1530, a profit of
1530-1494 = 36 points. At $15 per point, you
get a profit of $540.
Since you are trading long and expect the
wave 4 price reaction to be limited, you don’t
open a short position. You wait for the end of the
correction to enter another long trade.

Waiting for the start of wave 5?

In Figure 12, price moves down into wave (2)
territory, which means there is no valid wave 3
anymore. You have to renumber from the start
of the up wave. Either you are looking at a cor- FIGURE 12: WAITING FOR THE START OF WAVE 5? Price moved down into wave (2) territory, which
rection wave up or an impulse wave up. means there’s no valid wave 3 anymore. It is likely that price completed correction wave 2 and you can
expect the wave 3 within the wave (3) extension. Is there a continuation pattern for wave 3?
For now, go for an impulse wave with an exten-
sion in wave (3). It is likely that price completed
correction wave 2 and you can expect the wave
3 within the wave (3) extension.
Do we have a continuation pattern for wave
3?
You expect a wave 3 or C. Price retraced
more than Fibonacci 61.8% retracement, which
is normal for a wave 2. Price is close to the
low of the volatility band. Between price and
the SRSI indicator, there is a positive hidden
divergence.
Wave 2 seems to be complete. All OK for the
start of wave 3.
You open a new long position at 1518 to
capture some profit in this wave 3 extension,
using a stop-loss a few pips below the bottom
of wave 2.
FIGURE 13: TAKING WAVE 3 PROFIT. The Fibonacci projection over wave 1 gives a target price
Taking wave 3 profit at 161.8% that falls within the double reversal brick. At the same time you see a negative divergence
Figure 13 shows the wave 3 up move in some between wave tops 1 and 3. This may be the end of wave 3. The long trade is closed at 1578.

20 • November 2018 • Technical Analysis of STOCKS & COMMODITIES

 You close the long trade at 1578. That makes
a profit of 1578-1518= 60 points or $900. The
profit amounts to 540+900=$1,440.
You expect a wave 4 correction but you stay out
of the trade until the end of correction wave 4.

Waiting for the end of wave 4?

The first reaction in the down move finds sup-
port at the level of the last resistance in the up
move for wave 3 (Figure 14). The SRSI is still
moving down, so you ignore this double green
up candle.
Price goes further down to support of the
200 MA and the low side of the volatility band.
Here you already can see that the expected wave
4 moves in the territory of wave 2. Wave 3 is
FIGURE 14: WAITING FOR THE END OF WAVE 4. The way things unfolded resulted in a renumbering no longer valid. It looks like there is another
of the waves. Instead of looking for a wave 4 correction, you’re now looking for a wave 2 correction. extension, meaning we are now looking for
an impulse wave [1] to [5], with an extension
impulse wave (1) to (5) and this one with one
more extension 1 to 5.
With this new numbering you are no longer
looking for a correction wave 4 but for a cor-
rection wave 2. Because the last wave 1 is rather
large, you can expect a zigzag correction for
wave 2. This means you are probably at the
end of the first wave “a” of the zigzag. With the
positive hidden divergence between bottom (2)
and the current wave a, you expect an up retrace
for the wave b. The turning point for wave b is
announced with a convergent move between
wave 1 and b. This indicates that a continuation
of the downtrend is imminent.
The next double green reversing brick on
the way down finds support at the 100-brick
FIGURE 15: MORE PROFIT. What happened after the long entry? Price continued moving up until it average and the low side of the volatility band.
reached the 261.8% Fibonacci target and the top for wave [5]. The long trade is closed at 1698, the Furthermore, there is a positive divergence
last double red brick on the chart.
between bottoms a and c-2. You may expect a
continuation of the extended up impulse wave
smaller steps. The first resistance is given by the active 200 with the start of wave 3. Let’s open a new long trade at 1542
(red) and 100 (green) average. Price temporarily goes down with a stop a few pips below wave c-2.
but finds support around the passive price level of the previous
top (1). The stochastic RSI at this point is moving up. Did we make a profit?
Price continues the up move until finding the next resistance Have a look at Figure 15 to see what happened after the long
at the level of the passive price resistance of top 1. Another entry. At the bottom of wave 2, there is a positive divergence
small reaction follows but is stopped by the top of the first (green arrow). You expect a wave 3, possibly with an exten-
reaction and support of three averages, the 20- 100- and 200. sion. Price moves up to the static resistance of the previous
Price moves up further, reaching the upper side of the volatil- top at the middle of the wave 2 down move. Between these
ity band. Here, there is one more reaction with a double-sized two tops, there is a convergent move. Meaning we expect a
red bar. Price falls back to the previous top in the up move retrace, not a reversal.
and the wave 1 top. The retracement stops at the support of the 100-brick aver-
The US2000 continues the up move until there is another age. This larger reaction is normal for a wave 2. Expecting
double red reversal brick. A Fibonacci projection over wave a wave 3 extension, we annotate the waves “i” and “ii” and
1 gives a target price at 161.8% that falls within the double expect wave iii. The convergent move between bottoms 2
reversal brick. At the same time you see a negative divergence and ii announces the end of correction wave ii and the start
between wave tops 1 and 3. This may be the end of wave 3. of wave iii.
22 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
 You should now have all
the required knowledge to
successfully trade using the
many V-Trade rules.

A Fibonacci projection over correction wave 2 gives future

price targets at 100%, 161.8%, and 261.8%. Price moves up
until a first resistance creates a double red brick at the level of
the top of wave 1, the 100% Fibonacci target. The convergent
move up to that point announces a reaction. This results in only
a small pullback and price continues moving higher.
Another reaction is started with a negative divergence. This
is most probably the expected wave iii top. Reaction wave iv
finds support at the 100% Fibonacci target and middle line of
the volatility channel. The convergent move between bottoms
ii and iv is part of the uptrend continuation rules. Price moves
higher to the 161.8% Fibonacci target, completing waves v and 3.
We are now expecting an uptrend retracement for wave 4, price
is at Fibonacci resistance and at the upper side of the volatility
band while SRSI makes a negative divergent move.
Wave 4 ends and wave 5 starts with a positive hidden
divergence—higher lows in price and lower lows in the SRSI.
The up move resumes, looking for the top of wave 5. Price
goes up to the upper side of the volatility channel just above
the wave 3 top marked “iii.” The convergent move at this point
indicates to expect some pullback (iv).
The next impulse brings price again to the upper side of the
volatility channel. This is most probably the top of wave 5 and
wave (3). You can number the extension impulse wave in wave
5 as “i to v.” Now you expect some correction for wave (4).
You decide to stay in the trade as long as the Fibonacci
261.8% target isn’t reached or you close the trade if the middle
line of the volatility channel is broken by a closing price.
The up move continues and price reaches a top for waves
(5) and [3]. You react the same way, staying in the trade. We
now have a top for waves (5) and [3].
After the correction wave [4], price finally reaches the 261.8%
Fibonacci target and the top of a wave [5]. You close the long
trade at 1698, the last double red brick on the chart.
This results in a profit of 156 points or $2,340 at $15 profit
per point. The total profit is now 1,440 + 2,340 = $3,780 or
37% on your $10,000 capital in about 10 weeks.
You now expect an uptrend-to-downtrend reversal that
complies with the following rules: Expect a correction wave
A after a double downward renko brick, price is at the top
of the volatility band, the up move is a completed (extended)
impulse wave, there is a negative divergence between price
and indicator, price reached a target, and has a wick above
the double-sized reversing renko brick.
You could risk going for a short trade now!

Continued on page 36
November 2018 • Technical Analysis of STOCKS & COMMODITIES • 23
 VERVOORT/THE V-TRADE
Continued from page 23
TRADE WITH CONFIDENCE
You should now have all the required knowledge to success-
fully trade using the many V-Trade rules. But you would
need to be in front of your computer at all times to manually
execute trades.
A trader needs to be flexible and I will show you a number
of tools I use to trade manually, automatically, or using a
mixture of both. These tools are built into an expert system
and I can give you a number of ideas that will be useful for
your own personal kind of trading.
You can expect the first article on the expert system in an
upcoming issue. At that point, I will start with an overview
of the current completed expert system and explain why dif-
ferent kinds of trading possibilities are integrated into this
system. Stay tuned!
Sylvain Vervoort is a retired electronics engineer who has
been studying and using technical analysis for more than
40 years. Currently, he experiments with trading forex and
CFDs with rule-based systems. His book Capturing Profit With
Technical Analysis received a bronze medal from the 2010
Axiom Business Book Awards in the category of investing.
His Band Break System Expert is available on DVD. More
information about the V-Trade System will become available
on his blog under construction at at http://blog.stocata.org.
Vervoort may be reached at sve.vervoort@scarlet.be or via
his website at http://stocata.org.
FURTHER READING
Frost, A.J., and Robert Prechter [2001]. Elliott Wave Principle,
John Wiley & Sons (first published in 1985).
Vervoort, Sylvain [2018]. “The V-Trade, Part 1: Five Basic
Trading Rules,” Technical Analysis of STOCKS & COM-
MODITIES, Volume 36: March.
TOSHCHAKOV/DIAMONDS
Continued from page 31
diamond pattern, you can overcome the pitfalls. The bottom
line is that diamond patterns are common, have a distinctive
and identifiable shape, and have a relatively low failure rate.
These characteristics make the diamond the king of all the
known technical patterns. They can be extremely profitable
and fun to trade.
Igor R. Toshchakov (a.k.a. L.A. Igrok) is a professional
trader of forex and other financial markets, analyst, and fund
manager since 1993. He is also the author of Beat The Odds
In Forex Trading: How To Identify And Profit From High
Percentage Market Patterns (Wiley, 2006).
36 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
[2018]. “The V-Trade, Part 2: Technical Analysis,”
Technical Analysis of STOCKS & COMMODITIES, Volume
36: April.
[2018]. “The V-Trade, Part 3: Technical Analysis—Fi-
bonacci Projections And Daily Pivots,” Technical Analysis
of STOCKS & COMMODITIES, Volume 36: May.
[2018]. “The V-Trade, Part 4: Technical Analysis—
Trends & Reversals,” Technical Analysis of STOCKS &
COMMODITIES, Volume 36: June.
[2018]. “The V-Trade, Part 5: Technical Analysis—
Moving Average Support & Resistance And Volatility
Bands,” Technical Analysis of STOCKS & COMMODITIES,
Volume 36: July.
[2018]. “The V-Trade, Part 6: Technical Analysis—
Divergence Indicators,” Technical Analysis of STOCKS &
COMMODITIES, Volume 36: August.
[2018]. “The V-Trade, Part 7: Technical Analysis—V-
Wave Count,” Technical Analysis of STOCKS & COMMODI-
TIES, Volume 36: September.
[2018]. “The V-Trade, Part 8: The Basic Trading Rules,”
Technical Analysis of STOCKS & COMMODITIES, Volume
36: October.
[2009]. Capturing Profit With Technical Analysis:
Hands-On Rules For Exploiting Candlestick, Indica-
tor, And Money Management Techniques, MarketPlace
Books, Inc.
[2012]. Ground-Breaking Band Indicators: Newly
Discovered Tactics for Timing Profit, DVD, http://stocata.
org. Includes an autotrading expert system.
‡MetaTrader4 (MetaQuotes Software Corp.)
‡See Editorial Resource Index
When you see a broadening
triangle on any of your charts,
there is always a chance it can
eventually turn into a diamond.
‡TradingView.com, ‡eSignal, ‡FutureSource
‡See Editorial Resource Index
 ow that we’ve had our fill

N of holiday fun and times

are slowing back down (as
slow as normal is, I sup-
pose), it’s back to looking at charts
to find those big trading wins for
the new year. I’ve personally been
setting up my charts to continue
the momentum of last year’s trades
and, most important, checking my
indicators yet again to make sure
I have the perfect combination. As
you set up your charts, there are
three main indicators I think traders
should pay close attention to in 2016
and beyond. I’ll describe the three
indicators here and how I use them,
but for more details as well as how
they’re calculated, see sidebar “The
Three Indicators.” The indicators are
useful in forex trading but also for
stock trading.

Indicator 1: T3 moving average

The first indicator is the T3, devel-
oped by Tim Tillson, which he wrote
about in this magazine in 1998. I use
the T3 like clockwork to help find
major trends in the market. Some
people use the Perry Kaufman in-
dicator. Whatever you use is fine,
but the first indicator I would lock
down is one focused on identifying
the overall trend on the time frame
in question. Check out the red line
on the chart in Figure 1; anything
above that red line is considered to
be in the buy zone. As I’m sure you
can guess, anything below that line is
a potential sell zone. I primarily use
Coin flipping: mj007/waves: tukkki/Tilt dice: bilciu/Shutterstock/Collage: Joan Barrett
Attention, FX Traders this indicator to find the buy versus
sell zones in the market. This is

Top Three Indicators extremely important for one reason:

Unless you choose to sit out, you can
only buy or sell in the market. If you
For Your 2016 Trades were to enter the market on a guess,
you’d have a 50/50 chance of being

(And Beyond) right in your decision to either buy or

sell. For most traders, that’s not worth
the chance of failure and I completely
agree. My goal with this indicator is
You’ll have more confidence in the trades you place if you use the right combination
to tilt the odds in my favor of trading
of confirming indicators. Need a good set to get started with? Here are three you can
in the right direction. But, as you
use to help get your trading geared up for the new year.
know, this is just the beginning of
planning and executing your trade.
by Joshua Martinez
This is why I combine this indicator
10 • February 2016 • Technical Analysis of STOCKS & COMMODITIES
 FOREX FOCUS

with the stochastic relative

strength index (stochRSI).

Indicator 2: Stochastic RSI

(StochRSI) indicator
This is one of the more
common indicators and for Buy zone
good reason. This indicator
counts the endless waves in
the market to identify over-
bought and oversold zones.
In Figure 2, you can see
that this indicator breaks up
the market into three zones
made from the two red lines Sell zone
on the chart. When the Sto-
chRSI breaks above the top
red line into the overbought

MARKET TRADERS INSTITUTE

zone, you might expect the
market to U-turn. The op-
posite is also true; when
the StochRSI is below the
lower red line, the market’s
considered oversold, and
a market correction is ex- FIGURE 1: T3 MOVING AVERAGE. This indicator helps to identify the overall trend. Anything that is above the red line is
pected. U-turns are critical considered to be in the buy zone and anything below the red line is in the sell zone.
to your trading plans since
these reversal points could
either help you turn a great
profit or make your trading
account take a hit.
What I like most about this
indicator is that it’s nothing
new. It’s been around a while,
people have worked hard to
perfect it, and it works. As
always, in trusting any indi-
cator, you have to see its past
performance. Looking back
at Figure 2, in the time span
of this chart, if you were to
have traded using just this
indicator alone, you could
have made three successful
trades just by trading market
U-turns that the indicator
identified.

Indicator 3: Flipit
Last, the one that doesn’t
get enough attention in my
opinion is the flipit indicator.
Finding the trend and where
FIGURE 2: STOCHASTIC RSI. When the StochRSI breaks above the top red line into the overbought zone, you might expect
the market’s going next sim- the market to U-turn. The opposite is also true; when the StochRSI is below the lower red line, the market’s considered over-
ply isn’t enough. Pinpointing sold, and a market correction is expected. These reversal points could either help you turn a great profit or make your trading
your trade means planning account take a hit.

February 2016 • Technical Analysis of STOCKS & COMMODITIES • 11

 your position down to the en-
try, which this indicator helps
you do. The gist is that this
indicator acts as an aggressive
inner trendline that makes
the charts pop more visually,
leading you to find potential
entries more easily. Visually
(Figure 3), when the market
is above the green line, the
market is expected to extend
its bullish move when in an
upward trend. If the market
is showing candles below the
red line, consider the market
to be in the buy zone during a
short-term pullback. Overall,
this indicator helps you not
only spot directional shifts but
you can also see the overall FIGURE 3: FLIPIT INDICATOR. When the market is above the green line, the market is expected to extend its bullish move
direction of the trend versus when in an upward trend. If the market is showing candles below the red line, consider the market to be in the buy zone during
a short-term pullback.
a short-term pullback.

TRADE WITH CONFIDENCE

I want to leave you with this: convergence is key in 2016. If Utilize multiple indicators and
you were burned at all by the market in 2015, you know that trading tools so that you are more
placing confident trades is an important factor in whether or
not your trading account is profitable by the end of the year. If confident about your expectation
you can’t trust what you’re seeing in the market or you’re not for what the market will do next.
sure about your trading plan, chances are, that’s not the trade
for you. Convergence is when you utilize multiple indicators
and trading tools so that you have multiple points of proof kettraders.com or via Facebook at https://www.facebook.
about your expectation for what the market will do next. When com/fxpathfinder/.
multiple signs point to the same trading conclusion, you’ll be
more confident in your trading decisions, right? With that FURTHER READING
said, combining multiple indicators like the three discussed Tillson, Tim [1998]. “Smoothing Techniques For More Ac-
in this article could boost your confidence and returns, start- curate Signals,” Technical Analysis of STOCKS & COM-
ing this year. MODITIES, Volume 16: January.
‡The Ultimate Charting Software (Market Traders Institute, Inc.)
Joshua Martinez is a forex analyst at Market Traders In- ‡See Editorial Resource Index
stitute, Inc. He may be reached via email at JoshM@mar-

THE THREE INDICATORS

1. The T3 moving average is an adaptive moving average. StochRSI = (RSI – Lowest low RSI) /
It is a smoothed moving average with a value that falls (Highest high RSI – Lowest low RSI)
between a double exponential moving average (DEMA) and
an exponential moving average (EMA). Trading signals are 3. The flipit indicator is a stop-and-reverse indicator and
generated similar to how moving averages are applied. is helpful for generating entry & exit signals. The indica-
tor plots in step-like fashion. Here’s the formula for the
2. The stochastic RSI (StochRSI) is an oscillator developed flipit indicator:
by Tushar Chande and Stanley Kroll. It applies the stochas-
tic formula to RSI values. The oscillator moves between Top = Sum(high, period)/period
the values of zero and 1. Here’s how it is calculated: Bottom = Sum(low, period)/period
—J. Martinez

12 • February 2016 • Technical Analysis of STOCKS & COMMODITIES

 USING THE FIBONACCI TOOL
Fibonacci tools—I call them Fib
tools—work well when a market is
trending. But before making your
entry & exit decisions using these
tools, you need to find the retrace-
ment levels.
The first step is to find out the
recent swing high and swing low. If
a market is trending downward, you
need to click your mouse on the swing
high and drag the cursor to the recent
swing low. For an uptrend, you click
the swing low and drag the cursor
to the recent swing high. The Fib
retracement levels traders typically
use as their support & resistance areas
include 0.236, 0.382, 0.500, 0.618, and
0.764. In an uptrend you can buy at
these levels and in a downtrend you
can sell at these levels.

APPLYING FIBONACCI TOOLS

TO PRICE ACTION
You can use Fib tools on their own
but you can also combine them
with other indicators or patterns. I
will show you how to combine Fib
tools with candlestick patterns. Last
month in part 1 of this article series,
I discussed how reversal candlesticks
can help you determine when buy-
ing or selling pressure is exhausted.
Since this strategy is based on when
the market is trending, you can look
out for exhaustive candlesticks that
give you a clue as to when the trend
is ending.
Swing Low, Swing High Take a look at the one-hour chart of
GBP/NZD in Figure 1. It’s clearly in

Price Action an uptrend. In an uptrend, the general

thinking is that if the currency pair
retraces from the recent high, it will

With Fibonacci find support at one of the Fib levels,

where traders would want to place buy
orders as the price pulls back. I set the
Part 2 swing low at 1.9859 on November 28,
2014 and the swing high at 2.0270 on
SAIBARAKOVA IIONA/SHUTTERSTOCK

Combining price action with Fibonacci levels is simple but powerful. Here’s how to December 3, 2014 and overlaid the Fib
unleash the potential of these levels. tool based on these points. You have
to wait for the uptrend to retrace from
by Solomon Chuama the recent high before you initiate any
buy orders or make any analysis on

M
any traders, especially forex traders, keep an eye on support & resistance levels the Fib levels.
to place their buy & sell orders. But let’s see how to best use the Fibonacci In Figure 2, you see that GBP/NZD
retracement levels as potential support & resistance levels. commenced its upward movement
18 • August 2016 • Technical Analysis of STOCKS & COMMODITIES
 FOREX FOCUS

on November 28, 2014, retraced on December Swing High 0.0

2.0305
2.0275
4, 2014, and converged at the 38.2 Fib level. 2.0245
The 38.2 Fib level held for two days before it 2.0215
23.6 2.0185
continued its upward movement. It is best to
2.0155
take a long position after the appearance of a 38.2 2.0125
price rejection candlestick at the 38.2 Fib level. 50.0
2.0095

As the market oscillates over time, you have 2.0065

61.8 2.0035
to look out for exhaustive bearish candlesticks 2.0005
peculiar to uptrending markets; that would 1.9975

determine how long the market would last. As 1.9945

1.9915
you can see, the market has traveled above the

IFX TRADER
1.9885
Swing Low 100.0
recent high, which resulted in the formation 1.9855
26 Nov 2014 27 Nov 2014 28 Nov 2014 1 Dec 2014 2 Dec 2014 3 Dec 2014 4 Dec 2014
of a shooting star price rejection candlestick. 22:00 06:00 14:00 22:00 06:00 14:00 22:00 06:00 14:00 22:00 06:00 14:00 22:00 06:00 14:00 22:00 06:00 14:00
FIGURE 1: CURRENCY PAIR IN AN UPTREND. Here the swing low is set at 1.9859 on November
You can close your order after the appearance
28, 2014 and the swing high at 2.0270 on December 3, 2014 and overlaid the Fib tool based on
of price rejection candlesticks, which will give these points.
you about 355 pips profits. 2.0565
Let’s examine a similar situation in a down- Shooting star price rejection candles 2.0525

trend. In Figure 3, you will find a one-hour chart 2.0485

2.0445
of EUR/USD in a downtrend. I set the swing 2.0422
2.0405

high at 1.2529 on November 26, 2014 and the 2.0365

2.0325
swing low at 1.2300 on December 3, 2014 and Swing High 0.0 2.0285

overlaid the Fib tool on the chart. In a down- 2.0245

23.6 2.0205
trend, it is expected that if prices retrace from 2.0165
38.2 2.0125
the low, it will encounter resistance at one of the Price rejection candlestick 50.0 2.0085
Fib retracement levels, which will give traders 61.8 2.0045
the opportunity to short. Since the EUR/USD 38.2 Fib level is held
2.0005
1.9965
currency pair was stalling at 1.2310 along the 1.9925

low, it was time to put the Fib tool in action. I 1 Dec 2014 2 Dec 2014 3 Dec 2014 4 Dec 2014 5 Dec 2014 8 Dec 2014
1.9885
9 Dec 2014
21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00
will wait for price to push upward and retrace FIGURE 2: THE END OF THE UPTREND. It’s best to wait for the uptrend to retrace from the
to enable me to take a short position. recent high before you initiate any buy orders. Then as the market moves up you have to look for
However, in Figure 4, you see that on December signs of price rejection which will signal you to exit your position.
4, 2014 the price pushes up to about 1.2445 from 1.2550
1.2310 resulting in the formation of an exhaus- Swing High 100.0 1.2535
1.2520
tive candlestick pattern called a shooting star. 1.2505

The principle behind price action is that if an 1.2490

1.2475
exhaustive candlestick forms above or below a 1.2460

Fib retracement level, it gives you a confirmation 61.8 1.2445

1.2430
that the level will hold for some time. 50.0 1.2415

The exhaustive candlestick pattern did form at 38.2

1.2400
1.2385
the 61.8 Fib retracement level. This means you 1.2370
The EUR/USD currency pair has since paused at 1.2310 23.6 1.2355
have to go short after the shooting star formed. in a downtrend. The Fib retracement tool has to be put to 1.2340
How long will you keep the short trades open? work. We have to wait to see whether the price will push up 1.2325

You have to look out for exhaustive candlestick to enable us to complete our analysis. 0.0
1.2310
Swing Low 1.2295
patterns. On this chart, you will see that there 26 Nov 2014 27 Nov 2014 28 Nov 2014 1 Dec 2014 2 Dec 2014 3 Dec 2014 4 Dec
13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00
is another exhaustive candlestick pattern called FIGURE 3: PRICE ACTION IN A DOWNTREND. On this one-hour chart of EUR/USD, price action
a bullish engulfing pattern that appears at the is in a clear downtrend. The Fib tool is overlaid on this chart based on the swing high at 1.2529
end of the downtrend. You can exit the short on November 26, 2014 and swing low at 1.2300 on December 3, 2014. You want to wait for price
to push upward and retrace before taking a short position.
trade that you opened when that price rejection
candlestick pattern appears. If you covered
your short position here, you would have made The principle behind price action is
a profit of 200 pips.
that if an exhaustive candlestick forms
USING FIB TOOLS TO MANAGE above or below a Fib retracement level,
YOUR TRADES it gives you a confirmation that the
Basically, there are two ways to set your stop-loss level will hold for some time.
with Fib tools. But it is better to combine the
August 2016 • Technical Analysis of STOCKS & COMMODITIES • 19
 The price later pushes upwards which led to the formation of a 100.0 1.2505 your analysis with price rejection candlesticks.
Shooting Star. It is time to go short. 1.2485 In the chart in Figure 5 you see a shooting star
Shooting Star
61.8 Fib level is held
1.2465
price rejection candlestick. When an exhaus-
61.8 1.2445
tive candlestick forms above or below the Fib
50.0 1.2425
1.2405
retracement level, it means that that level could
38.2
1.2385 hold. Managing stop-losses this way is suitable
23.6
1.2365 for short-term intraday traders.
1.2345
The second method of setting your stop-loss
1.2325

0.0 1.2305
is to place it past the swing high or swing low.
Swing Low 1.2285 In Figure 6 you see that if you had shorted the
Bullish engulfing pattern 1.2265 EURUSD at the 50.00 Fib level, you could place
1.2245 your stop-loss above the swing high as high-
28 Nov 2014 1 Dec 2014 2 Dec 2014 3 Dec 2014 4 Dec 2014 5 Dec 2014 8 Dec 2014
13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 lighted on the chart. Adopting this method does
FIGURE 4: THE RETRACEMENT. Price pushes up to about 1.2445 from 1.2310 resulting in the forma-
tion of an exhaustive candlestick called a shooting star. Since the shooting star formed at the 61.8 Fib
have consequences that you need to be aware
level, it suggests that you can go short after the shooting star formed. You could hold on to the short of. It’ll result in having a wider stop-loss, which
position until the bullish engulfing pattern appeared at the end of the downtrend. could be unsuitable for long-term, swing, and
position traders. If you adopt this method, you
100.0 need to adjust your position size accordingly
1.2525
Here, past the 61.8 Fib level is the stop loss 1.2505
because of the cost implication. You may have
if you shorted at 50.0 level. 1.2490 an unfavorable reward-to-risk ratio as a result
Shooting Star
1.2470
of the wide stop-loss if it is not proportional to
61.8 1.2450 your potential reward. The advantage of this
1.2430
50.0
1.2410
method is that it gives your trades more room
38.2 1.2390 to remain in the market until the market moves
1.2370 in your favor.
23.6 1.2355

1.2335

1.2315
CANDLES AND FIBS
0.0
1.2295
Combining Fib tools with candle-
Swing Low
1.2275 stick patterns can be useful in
27 Nov 2014 28 Nov 2014 1 Dec 2014 2 Dec 2014 3 Dec 2014 4 Dec 2014 5 Dec 2014
16:00 00:00 08:00 16:00 00:00 08:00 16:00 00:00 08:00 16:00 00:00 08:00 16:00 00:00 08:00 16:00 00:00 08:00 making your trading decisions.
FIGURE 5: MANAGING YOUR RISKS WITH FIB TOOLS IN A DOWNTREND. One method is to set An exhaustive candlestick pattern
your stop loss past the next Fib level. If you shorted at the 50.0 Fib level, you would place your stop
signals whether a Fib retracement
loss at the next Fib level of 61.8.
level is likely to hold. The Fib tool
used in isolation does not have a high success
100.0
1.2525 rate but works well when combined with
1.2500
This is the Stop Loss Shooting Star
1.2475
other technical tools like price action. You
above the Swing High
61.8 1.2450 use the Fib tool to spot potential support
50.0 1.2425 & resistance levels, then look back to see
38.2 1.2400
1.2375
whether these levels are in line with other
23.6
1.2350 previous price areas. If they are, there is
1.2325
0.0 1.2300
a likelihood that prices will bounce from
Swing Low 1.2275
these levels.
27 Nov 2014 28 Nov 2014 1 Dec 2014 2 Dec 2014 3 Dec 2014 4 Dec 2014 5 Dec 2014
13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00 13:00 21:00 05:00

FIGURE 6: PLACE THE STOP PAST THE SWING HIGH OR LOW. If you had shorted the EURUSD at the 50.00 Solomon Chuama has been working in
Fib level, you could place your stop loss above the swing high as highlighted on the chart. However, be mindful the financial industry or 15 years. He is a
that your stop loss will be wide which could be unsuitable for long term, swing and position traders.
trading seminar organizer and instructor
who tries to pass on to students his passion
and knowledge of forex trading.
Fib tool with your knowledge of price rejection (exhaustive)
candlesticks to set your stop-loss. FURTHER READING
The first step of the first method is to set your stop-loss Chuama, Solomon [2016]. “Trade Using Pure Price Action,”
past the next Fib level. In the one-hour chart of EURUSD in Technical Analysis of STOCKS & COMMODITIES, Volume
Figure 5, if you shorted at the 50.0 Fib level, you place your 34: July.
stop-loss at the next Fib level of 61.8. You do this based on the ‡IFX Trader (MetaQuotes Software Corp.)
understanding that the 50.00 Fib level will hold. Another way
to guide against placing a premature stop-loss is to combine
20 • August 2016 • Technical Analysis of STOCKS & COMMODITIES
 There’s Good And There’s Better
Trendline Algorithm
It’s likely that in the decades to come, we’ll be ruled by big
data and artificial intelligence. And at the heart of it are al-
gorithms. Here’s an algorithm that’ll help calculate trendlines
and the indicators behind them.
by Dirk Vandycke
An algorithm is created to solve a problem and its real
leverage is that a computer can run it. So once a
solution surfaces, a computer can apply it rigor-
ously and tirelessly over and over again.
This article isn’t a discussion on how to use
trendlines or about how valuable they are. Many
traders use trendlines and it’s well understood
that they are valuable tools. If we hand over the
task of detecting trendlines and the patterns and
setups that depend on them to machines in the
28 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
form of screeners or something else, it could be time saving
and rewarding. The hard part is coming up with a useful
algorithm.
THE BAD
Creating an algorithm for detecting trendlines can be difficult,
mainly because they don’t have a hard mathematical defini-
tion. Even if you did come up with one, there’ll still be some
amount of fuzziness there. There’s a chance you’ll have a lot
of false positives and negatives show up. Dealing with these
PURE SOLUTION/SHUTTERSTOCK
can lead to curve fitting.
Each person has their own way of analyzing trends and if
you were to ask a handful of people to analyze the trend of
one particular stock, don’t be surprised if you end up with dif-
ferent trendlines. This brings up another challenge: How can
you define a trendline independent of specific chart properties
and at the same time get an objective outcome (as much as
 INDICATORS

possible) of the algorithm? You want good MSFT

trendlines while feeding the algorithm as 65

few parameters as possible. 63

Keep in mind that trendlines are not 61

the only way to analyze trends. You can 59
use moving averages, regression analy-
57
sis, or time series analysis, among other
55
techniques. Some approaches may be
easier to turn into algorithms because of 53

their mathematical character. The biggest 51

disadvantage of mathematical indicators 49
is their time lag but I won’t go into that in
47
this article. Here, I’ll focus on how to let

CHARTMILL
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/02

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computers detect trendlines and not on

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11

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11
their analytic or predictive power. FIGURE 1: FINDING HORIZONTAL TRENDLINES. On the vertical axis of this chart of Microsoft Corp. (MSFT),
a frequency spectrum of price action is added. The $57 range seems to be closing in on an important horizontal
THE UGLY support/resistance level. You could zoom in the histogram to narrow down the price level to a cent. In this
When originally tackling the problem, example, the frequency spectrum was taken to $0.50. Other high-frequency buckets, like the $51 one, are not
anywhere near a good example of a horizontal support/resistance line.
I played around with several ideas. One
was to use a point & figure chart, since
all trendlines have 45-degree angles on them. The problem I
encountered is that because the time axis has no importance,
it was difficult to return to the bar or candlestick chart.
A first step was solving support & resistance lines (horizon-
tal trendlines). By projecting all data points in the chart onto
the y-axis (price axis), you get a histogram like the one you
see in Figure 1. The highest bars in the horizontal histogram
point to the highest action prices, which indicate support &
resistance areas on the price axis. I wanted to extend this
concept to nonhorizontal trendlines as well, but that involves
Left ChartMill Right ChartMill
more than just rotating the concept. I tried different methods
Support Number Support Number
but all ended up futile. A good algorithm isn’t going to look 6 5
at the chart. It needs to dig into data.
FIGURE 2: CHARTMILL SUPPORT NUMBERS. Here you see the left and right
support numbers illustrated. The red candle has a left support number of 6,
THE GOOD because seven candles ago, a lower price was seen. If you go to the right, you’ll
The problems I encountered led to the realization that trend- see that you’d have to wait six days for a lower price. Hence, the right support
lines do not have to be horizontal and that good trendlines will number is 5.
intersect with price at less important tops and bottoms.
I’ll look at why a top or bottom is important, or why one be calculated in two runs over all bars. A first run goes from
may be less important than another. To figure that out you’ll left to right to calculate all left support numbers. The first bar
have to define the strength of support & resistance. From here gets a zero left support number, since it has no candles to its
onward, I’ll focus on support lines (connecting bottoms) but left. Each subsequent bar gets zero as its left support number,
the same applies to resistance lines (connecting tops). unless it shows lower prices, in which case it inherits the left
The left support number at any point (current point) is support number from its left neighbor and adds one. That’s
defined as the maximum horizontal range from that point to all there is to it. For the right support numbers you repeat the
its left where prices are above the current price. On a daily process from right to left.
chart that space would be measured in days. Likewise, the
right support number counts how many “days” to its right a WRAPUP
price hasn’t seen lower prices. Where does all this take us in our search for trendlines? Simply
Take a look at Figure 2. Counting to the left and right from put, good trendlines will be the ones connecting bottoms with
the red candle, there were seven and six days, respectively, large-enough support numbers. The bigger a support number
where price wasn’t lower or as low as the red candle. In this is, the more important the bottom will be. The logic is that if
case, the red candle has a left support number of six bars and you connect bars with a support number larger than a certain
a right support number of five bars. threshold, the lines created will be good ones for a certain
I’ll define a bar’s support number as the minimum of either timeframe. I also played around with a maximum threshold
the left or right support number. Support numbers can easily and weighting more recent bars, but that didn’t make much
July 2017 • Technical Analysis of STOCKS & COMMODITIES • 29
 iPath S&P GSCI Crude Oil TR Index ETN iPath S&P GSCI Crude Oil TR Index ETN
-0.02(-0.32%) +0.09(+1.5%)
---R1 6.29 ---R1 6.19
---S1 5.45 ---R2 6.18 ---S1 6.07
20 ---S2 6.07 6.8
19
18 6.6
17 6.4
16
15 6.2
14 6
Weekly

13
5.8

Daily
12
11 5.6
10
9 5.4
8
7 5.2
6 5
5
60M 8M 4.8
50M 7M
40M 6M
5M
30M 4M
20M 3M
2M
10M 1M
0 0
Nov Dec 2015 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2016 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2017 Feb Apr May Jun Jul Aug Sep Oct Nov Dec 2017 Feb

FIGURE 3: CHARTMILL TREND LINES. Here you see two charts of different timeframes showing appropriate (but different) trendlines with the algorithm. Only the
most recent/relevant trendlines are shown.

of an overall impact on trendline quality.

In Figure 3 you can see the algorithm at work that I created.
Trendlines do not have to
I called it the ChartMill Trend Line Algorithm (CTLA). It be horizontal and good
selects relevant trendlines starting from the right of the chart trendlines will intersect
and with a threshold based on the timeframe. As you can see, with price at less important
different timeframes make for different trendlines. I encour-
age you to experiment with them and share your feedback
tops and bottoms.
and ideas to come up with (even) better ones.

Dirk Vandycke has been actively and independently studying

the markets since 1994 with a focus on technical analysis, of anything he can get his hands on. He may be reached at
market dynamics, and behavioral finance. He writes articles dirk@monest.net.
on a regular basis and develops software partly available
at his co-owned website, www.chartmill.com. With master’s ‡Chartmill.com
degrees in both electronics engineering and computer sci- ‡See Editorial Resource Index
ence, he teaches software development and statistics at www. †See Traders’ Glossary for definition
howest.be, a Belgian university. He’s also an avid reader

KATSANOS / TRADING THE NIKKEI various technical analysis programs. Accompanying program
Continued from page 15 code can be found in the Traders’ Tips area at Traders.com.

the basis for a successful trading system. FURTHER READING

Keep in mind that intermarket correlations can change over Katsanos, Markos [2009]. Intermarket Trading Strategies, John
time and the trader must periodically update the system or change Wiley &Sons.
the intermarket securities to profitably mimic these changes. _____ [2015]. “Trading The Loonie,” Technical Analysis of
STOCKS & COMMODITIES, Volume 33: December.
Markos Katsanos is the author of Intermarket Trading Strate- Wang, Cassandra [2017]. “Using Correlation To Trade The
gies and is a Contributing Writer to this magazine. He can S&P 500,” Technical Analysis of STOCKS & COMMODITIES,
be reached at markos.katsanos@gmail.com or through his Volume 35: February.
website, http://mkatsanos.com. ‡TradeStation
‡See Editorial Resource Index
The code given in this article is available in the Article Code †See Traders’ Glossary for definition
section of our website, www.Traders.com.

See our Traders’ Tips section beginning on page 48 for com-

mentary and implementation of Markos Katsanos’ technique in
30 • July 2017 • Technical Analysis of STOCKS & COMMODITIES
 The Steep Climb
Vertical Runup
Sometimes you see a price move that just goes vertical. What
happens after that move ends? The answer may be obvious
to you, but there may be ways to find trading opportunities
after the run is exhausted.
by Thomas Bulkowski
any times I have watched a stock go vertical and won-
M dered how long it would take before the stock starved
of oxygen and the run died. Perhaps you have wondered
the same thing about a move in a stock you owned.
After the vertical move ends, what happens?
The obvious answer is that price drops. Of course it does!
However, price actually continues rising 21% of the time, but
at a slower pace. The other 79% of the time sees price give
back just over half the rise. Those are some of the results I
found when studying the vertical runup pattern for my new
book, Chart Patterns: After The Buy.
The chart in Figure 1 highlights two examples of the vertical
runup (and yes, there is a vertical rundown, too) on the daily
chart. The first one appears when price starts to push out of a
congestion region at A. Over the coming days, price makes a
smart move higher, with each price bar showing little overlap
with the prior one. The upward run ends after B when price stops
its vertical run and collapses. The retrace drops the stock from
8 • November 2016 • Technical Analysis of STOCKS & COMMODITIES
B to C before it attempts (and fails) to set a new high at D.
Vertical run EF behaves differently. The stock climbs
quickly during the run from E to F, but then continues climb-
ing at a slower pace following red line G before making its
way to peak H.
IDENTIFICATION
What does vertical runup mean? To answer that, I cataloged
1,726 vertical moves in bull markets from July 1995 to Novem-
ber 2013. I quickly decided that the minimum number of price
bars in the pattern should be four. That determination is based
on experience. I know that after three bars in a strong uptrend,
I can use a trailing stop a penny below the prior bar’s low to
follow price higher and exit quickly when the trend ends.
A vertical run begins when price exits a consolidation re-
gion and goes vertical. It ends when price stops going vertical.
That definition may sound stupid, but it works. Figure 1 shows
the vertical move starting at A and E, and ending after B and
F, respectively. The vertical run ends when price transitions
into a shallower move upward or a retrace with lots of overlap
SERGEY NIVENS/SHUTTERSTOCK
from bar to bar.
Sometimes, you will see a flag form along the run. I define
a flag (for the vertical runup only, not as a flag or pennant
chart pattern) as a minor retrace where price fails to make a
new high for at least three consecutive bars. Figure 1 shows
 CHARTING

 

a flag at I. Price fails to set a high above bar J for four bars.  


After that, the upward move resumes with the stock making 


new highs and price having less overlap than that shown in
 
      
the circle. $ % 
 # 
    
&    
 
For identification, I also considered how steep the run was.    

'(

This was like looking at pornography: you know it when you "  #
)   
 
see it. In this case, I looked for little overlap from price bar *(+
 
   ! "#
to bar. The stock looked as if it went vertical. Use the figures ,-(. 
  
/ 0%1 
  
   !"" #$%
in this article as a guide and then go search for vertical runs. " # # "&'(&)
  
If you find some, tell your neighbors. "$2
3
4%%
5 
STATISTICS  
 


Once you have identified a vertical run, how does the stock
behave after the run ends? Figures 2 to 4 describe the behavior,
beginning with Figure 2.
I measured how often price retraced a portion of the ver- vertical runup. A full retrace occurred 25% of the time dur-
tical run versus how often price continued to rise (but at a ing a bull market.
slower pace than in the vertical run). The figure shows that a
substantial portion of the stocks, 79%, will retrace a portion Continued on page 46
of the vertical move. The median
retrace was large, 53% (average Rockwell Collins (Aerospace/Defense, COL)
B H
of 58%). 95 D
94
Figure 3 shows the median time 93
to make an upward breakout, which 92 91
F
I define as a close above the price of 90
89
B. The median height (A to B) of the 88 C G
vertical runs I looked at was eight 87 86 A
price bars (or an average of nine). 85
84
Switching to calendar days, it took 83 J
a median of 18 days (average of 32) 82 81
I
for price to drop from the high at 80
79
B and then to recover to breakout 78
at C. This measure only included 77 E

THOMAS BULKOWSKI
76
stocks that retraced, not those that 75
74
continued rising after the vertical 73
72
run ended. Sep ’15 Oct Nov Dec Jan ’16 Feb Mar Apr May Jun Jul
Figure 4 shows how often price FIGURE 1: VERTICAL RUNUP AND RUNDOWN. Two vertical runs appear in Rockwell Collins with different out-
retraced the entire height of the comes.

21% continue Median 8 bars B 18 days C Breakout 75%: Partial

up to here here retrace
A
B B
79% drop

A
25%: Full
Start retrace
FIGURE 2: AFTER THE RUN ENDS. This figure FIGURE 3: UPWARD BREAKOUT MAGNITUDE. Here you see the median FIGURE 4: FULL RETRACEMENT. A
shows how often price slides higher versus time it takes a stock to make a new high after the vertical run ends. quarter of the vertical rises see price retrace
retracing a portion of the rise. the entire move.

November 2016 • Technical Analysis of STOCKS & COMMODITIES • 9

 BULKOWSKI / VERTICAL RUNUP Criteria 1990s 2000s 2010s
Continued from page 9
Retrace amount 60% 51% 45%
Time to break out (days) 21 19 14
After three bars in a strong Run length (price bars) 8 8 7
uptrend, I can use a trailing stop Samples 525 753 448
a penny below the prior bar’s low FIGURE 5: TRENDS OF THE DECADES. The vertical runs are sorted by three
to follow price higher and exit decades for bull runs only. In the 1990s, the median retrace was 60% compared to
just 45% for those vertical runs with retraces that occurred in the 2010s.
quickly when the trend ends.
from bull markets only. My hope was that I could use these
findings to help predict the end of the run and the behavior
VOLUME that followed.
Many of you think volume is important to stock behavior, Volume did not offer a clue to the depth of the retrace that
so I’ll discuss it. I used linear regression on volume from the followed the end of some vertical runs. However, the figures
start of the vertical run to its end and found that regardless that accompany this article show the typical behavior of a
of whether volume sloped upward or downward, it did not stock after a vertical run ends.
affect the depth of the retrace (that followed the end of the For those of you wishing more information on this chart
vertical run). pattern or to see the statistics of the length of the vertical runs,
Comparing the one-month average volume before the start the retrace amount, and time to breakout, see Table 26.2 of
of the vertical run to that shown during the run did not offer my book, Chart Patterns: After The Buy. It shows a frequency
a clue to the retracement amount, either. distribution that may help you determine when the vertical
The time from the end of the pattern to the breakout (that run will end and the behavior that followed.
is, from B to C in Figure 3) changed depending on volume.
Time for a quiz: If volume is trending higher (or above the STOCKS & COMMODITIES Contributing Writer Thomas
prior one-month average) during the vertical run, does that Bulkowski (who may be reached via email at tbul@hotmail.
mean a shorter time for the stock to break out? com) is a private investor and trader with more than 30 years
I compared the time from the end of the vertical run to the of market experience and considered by some to be a leading
day of breakout and found it took slightly longer to break out expert on chart patterns. He is the author of several books
if volume was either trending upward or had higher-than- including Chart Patterns: After the Buy, Getting Started in
average volume in the vertical run. So the answer to the Chart Patterns, Second Edition and the Evolution of a Trader
question is “no.” trilogy. His website and blog, www.thepatternsite.com, have
more than 700 articles of free information dedicated to price
THE DECADES pattern research.
The table in Figure 5 shows some interesting trends over the
years. I sorted the results of the vertical runs into the three FURTHER READING
decades for bull markets only. Recall that the data I used Bulkowski, Thomas [2016]. Chart Patterns: After The Buy,
measured from 1995 to 2013, but the sample sizes are high, John Wiley & Sons.
as shown in the last line of the table. [2005]. Encyclopedia Of Chart Patterns, 2d ed., John
In the 1990s, the median retrace was 60% compared to Wiley & Sons.
just 45% for those vertical runs with retraces that occurred [2014]. Getting Started In Chart Patterns, 2d ed., John
in the 2010s. Wiley & Sons.
The duration from the end of the vertical run to the day
price closed above the top of the vertical run (time to breakout) ‡TOM BULKOWSKI
shortened from three weeks to two weeks, respectively, from ‡See Editorial Resource Index
the 1990s to the 2010s.
The length of the vertical run did not change much at all
over the years. In fact, the average run length remained at nine
price bars (the table shows the median length only).

CLOSING POSITION
This article described what I call a vertical runup, a chart
pattern where price starts a near-vertical climb of at least four
price bars. The 1,726 patterns I found used daily price data
46 • November 2016 • Technical Analysis of STOCKS & COMMODITIES
 INDICATORS
How Wide Is Your Band?
Volatility Oscillator
It’s versatile—you can use it to identify overbought/
oversold levels, divergences, and trends. Here are
some ways you can use it.
T
he volatility oscillator is an indicator that
measures the percentage of standard devia-
tion. The volatility oscillator (VolatOsc) is
based on the idea of trading bands, which
is something that was developed by John
Bollinger. VolatOsc decreases as standard deviation
narrows and increases as standard deviation widens.
VolatOsc fluctuates above and below the zero line.
The indicator also has volatility bands placed above
and below the zero line. Even though the VolatOsc is
unbounded, you can use it to identify overbought and
oversold levels. Divergences between price and the
indicator can also generate trading signals. And you
can use VoltOsc to identify the general trend.
CALCULATING IT
You can calculate the VoltOsc with the following
steps:
1. Calculate standard deviation, which is usually
set at 20 periods.
2. Divide standard deviation by the 20-day simple
moving average (SMA), which normalizes the
value. The lookback period for the standard
deviation is the same as for the SMA. Normal-
ized standard deviation is multiplied by 100 to
move the decimal point two places.
3. Volatility bands are placed above and below
the zero line and equal the highest normalized
standard deviation for 20 periods.
4. Volatility oscillator values are positive when
BRIAN TAYLOR
the three-day SMA is higher than the 20-day
SMA. VolatOsc values are negative when the
by Vitali Apirine
three-day SMA is lower than the 20-day SMA.
VolatOsc values equal zero when the three-day
SMA equals the 20-day SMA.
The values 20, 3, and 20 are the typical default settings
used with the VolatOsc, but other values can be substi-
tuted depending on your trading style and goals.
If the second parameter equals zero, it means that the
closing price is used instead of the three-day SMA.
An example of calculating VolatOsc (20,3,20) in
Excel can be found in the Excel spreadsheet avail-
able at the STOCKS & COMMODITIES website at www.
Traders.com in the Article Code section. I used the
function STDEVP in Excel to calculate the 20-day
standard deviation. There are various ways to apply
VolatOsc. Here’s a look at some examples.
OVERBOUGHT OR OVERSOLD
VolatOsc is overbought when it touches the upper
band. Conversely, VolatOsc is oversold when it
touches the lower band. On the chart of the S&P 500
index in Figure 1 with VolatOsc(20,3,20), notice the
indicator became oversold at the end of October to
S&P 500 INDEX
Breakout
Breakout
Several overbought readings during strong uptrend
METASTOCK
Pullbacks and
Oversold oversold reading
FIGURE 1: S&P 500 INDEX WITH VOLATOSC (20,3,20). It’s typical for momentum oscil-
lators to become overbought (oversold) and remain so during a strong up (down) trend.
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 FTSE 100 IDX DOW JONES INDU AVERAGE NDX

0.0%
Breakout
Bullish Divergence 23.6%

50.0%
61.8%

Lower low 100.0%

Oversold
Higher low

FIGURE 2: FTSE 100, AUGUST 2013–APRIL 2014. Signals work better when VolatOsc FIGURE 3: DAILY CHART OF DJIA WITH VOLATOSC (15,3,15) FROM AUGUST
(20,3,10) starts to diverge from the band after its touch. It generated a bad signal when 2011–FEBRUARY 2012. VolatOsc became oversold (blue ellipse) after the pullback in
index continued to move higher in January 2014 (dotted red vertical line). November 2011. It coincided with the Fibonacci retracement 50%–60% level after the
DJIA surged in October. This provided an entry point to participate in uptrend.

November 2012. The S&P 500 trendline breakout was
confirmed when VolatOsc touched the upper band in the middle
of January of 2013. It signaled the end of a consolidation. De-
spite this overbought reading, the index did not decline. Instead,
the S&P 500 Index continued higher. Two more overbought
readings occurred before the index declined in June 2013. The
VolatOsc then moved from overbought to oversold territory.
After the trendline breakout and the VolatOsc touch of upper
band in July, the uptrend resumed. It’s typical for momentum
oscillators to become overbought (oversold) and remain so
during a strong up (down) trend.
Overbought and oversold readings for VolatOsc may be use-
ful in a sideways move within a range. In Figure 2 you see that
the London Financial Times Index (FTSE 100) traded between
6,316.91 and 6,865.86 from August 2013 to April 2014. Signals
work better when VolatOsc starts to diverge from the band after
its touch. It generated a bad signal when index continued to move
higher in January 2014 (see dotted red vertical line).
DIVERGENCES
Divergences form when a new high or low in
price is not confirmed by the VolatOsc. In other
words, a bullish divergence forms when price
records a lower low but the VolatOsc forms
a higher low. It could foreshadow a bullish
reversal. A bearish divergence forms when
price records a higher high and the VolatOsc forms a lower
high. It could foreshadow a bearish reversal.
Once a divergence takes hold, chartists should look for a
confirmation to signal a reversal. A bearish divergence can be
confirmed when prices break a support level or if the VolatOsc
touches the lower band. A bullish divergence can be confirmed

S&P 500 INDEX Russell 2000 INDEX

Higher high

Higher highs Breakout

Breakout
Market crash

Breakout
Higher highs
Volatility
oscillator
band
squeeze

Bearish Divergence Bearish Divergences

Lower high Lower high Lower high

Relatively low
Bollinger
BandWidth

FIGURE 4: WEEKLY CHART OF S&P 500 INDEX WITH VOLATOSC (20,3,10) FROM FIGURE 5: RUSSELL 2000 INDEX WITH VOLATOSC (20,3,20) AND BOLLINGER
SEPTEMBER 1984–JANUARY 1988. There were three bearish divergences over a BANDWIDTH (20,2). After the VolatOsc band squeeze and a relatively low Bollinger
40-month period. The third from March–August 1987 foreshadowed the market crash BandWidth (red ellipse), the Russell 2000 Index broke its trendline and triggered a bearish
of 1987. signal in early September 2001.

10 • August 2017 • Technical Analysis of STOCKS & COMMODITIES

 DOW JONES INDU AVERAGE NDX DOW JONES INDU AVERAGE NDX

Bear Market

Bull Market

Contraction

Band Squeeze
Contraction

Contraction
Expansion

Contraction Expansion

FIGURE 6: DJIA WITH VOLATOSC (20,2,1) DURING THE BULL MARKET FROM FIGURE 7: WEEKLY CHART OF DJIA. VolatOsc (20,3,10) contracted during the 1994
2003–2008. VolatOsc expanded and contracted periodically before and after the band bear market.
squeeze.

if price breaks above a resistance level on the price chart or if start with a narrowness and a subsequent VolatOsc touch of
VolatOsc touches the upper band. the lower band.
On the daily chart of the Dow Jones Industrial Average (DJIA)
with VolatOsc (15,3,15) from August 2011 to February 2012 COMPARE WITH BOLLINGER
in Figure 3, you’ll see that VolatOsc formed a higher low as BANDWIDTHS
the index formed a lower low in August to early October 2011. The chart in Figure 5 shows the Russell 2000
DJIA confirmed the bullish divergence when prices broke out Index with VolatOsc (20,3,20) and Bollinger
above the resistance level in the same month. Also note Volat- BandWidth (20,2). Let’s compare the two.
Osc became oversold (see blue ellipse) after the pullback in After VolatOsc band squeeze and a relatively
November 2011. It coincided with Fibonacci retracement 50% low Bollinger BandWidth value (see red el-
to 60% level after the DJIA surged in October. This provided lipse), the Russell 2000 Index broke its trendline and triggered
an entry point to participate in uptrend. a bearish signal in early September 2001. Keep in mind that
The weekly chart of the S&P 500 index in Figure 4 shows you can apply the squeeze concept to weekly charts.
the VolatOsc (20,3,10) from September 1984 to January 1988.
There were three bearish divergences over a 40-month period. CONTRACTION/EXPANSION DURING TRENDS
There were bearish divergences from March to July 1985 and The monthly chart in Figure 6 shows DJIA with VolatOsc(20,2,1)
May to August 1986 as the index moved to a higher high. How- during the bull market from 2003 to 2008. VolatOsc expanded
ever, the VolatOsc formed a lower high both those times. After and contracted periodically before and after the band squeeze.
small pullbacks in July to November 1985 and September 1986 The weekly chart of DJIA in Figure 7 shows how VolatOsc
to January 1987, the uptrend continued. A bearish divergence (20,3,10) contracted during the 1994 bear market.
formed from March to August 1987, which foreshadowed the
market crash of 1987.

VOLATILITY OSCILLATOR SQUEEZE

The width of the band tells a lot. A narrow VolatOsc band is
relative. You should estimate VolatOsc bandwidth values rela- A bull market can start
tive to prior VolatOsc bandwidth values over a period of time when price breaks above a
(five to 12 months, for example). VolatOsc bandwidth readings
are considered narrow as they approach the lows of this range.
resistance level and VolatOsc
VolatOsc bandwidth readings narrow when price flattens or touches the upper band. A
moves within a relatively narrow range. break below a support level
Relatively narrow VolatOsc bandwidth values can foreshad- and VolatOsc touching the
ow a significant advance or decline. After a narrow bandwidth
period, a price surge and subsequently the VolatOsc touching
lower band could signal the
the band signals the start of a new move. A new advance could beginning of a bear market.
start with a narrow bandwidth and a subsequent VolatOsc
touch of the upper band. Conversely, a new decline could
August 2017 • Technical Analysis of STOCKS & COMMODITIES • 11
 DOW JONES INDU AVERAGE NDX
Top
Bottom
Bull Market
FIGURE 8: WEEKLY CHART OF DJIA WITH VOLATOSC (20,3,20) DURING THE BULL
MARKET FROM 2003–2007. The index broke above a resistance level (red horizontal
line) and VolatOsc touched the upper band in June 2003 (vertical green line), signaling
the start of a bull market. In January 2008, DJIA broke below a support level (green
horizontal line) and VolatOsc touched the lower band. signaling the start of the January
2008 bear market.
How do you identify a trend? A bull market can start when
price breaks above a resistance level and VolatOsc touches
the upper band. Conversely, a break below a support level and
VolatOsc touching the lower band could trigger the beginning
of a bear market.
In Figure 8 you see the weekly chart of the DJIA with Volat-
Osc (20,3,20) during the bull market from 2003 to 2007. The
index broke above a resistance level (red horizontal line) and
VolatOsc touched the upper band in June 2003 (vertical green
line). This signaled the start of a bull market. Then in January
2008, DJIA broke below a support level (green horizontal line)
and VolatOsc touched the lower band. This alerted you to the
beginning of the January 2008 bear market.
DOW JONES INDU AVERAGE NDX
Breakout
Breakout
Breakout Breakout
Breakout
Breakout
Breakout
FIGURE 9: DAILY CHART OF DJIA WITH VOLATOSC (20,3,20) DURING THE BULL
MARKET FROM 2004–2007. Even though VolatOsc touched the lower band in March
2005, DJIA broke support (horizontal green line) in mid April 2005. Using VolatOsc signals
in conjunction with price analysis can help you avoid bad signals.
12 • August 2017 • Technical Analysis of STOCKS & COMMODITIES
In Figure 9 you see the daily chart of DJIA with VolatOsc
(20,3,20) during the bull market from 2004 to 2007. When
VolatOsc touches of lower band (vertical green dotted lines) it
could suggest entry points for participating in the uptrend. But
if you take a look at March 2005, even though VolatOsc touched
the lower band in March 2005, DJIA broke support (horizontal
green line) in mid April 2005. VolatOsc was oversold in May
and July 2006 before index broke resistance (horizontal red line)
in the middle of August 2006. This gives you an example of
how using VolatOsc signals in conjunction with price analysis
helps to avoid bad signals.
The daily chart in Figure 10 shows the S&P 500 index with
VolatOsc (20,3,20) during the bear market from 2000 to 2003.
When VolatOsc touches the upper band (vertical red dotted lines)
it provides entry points to participate in a downtrend. Even though
the indicator touched the higher band at the end of April 2001,
the index moved higher. Three signals were generated when the
index made three highs from November 2001 to March 2002
and met resistance (horizontal red line). These are identified by
the vertical red dotted lines. The downtrend continued after a
break of the support level at the end of April 2002. The other
three signals were from October 2002 to January 2003, which
were confirmed with the break of the support level at the end of
January 2003 during the bottoming process. It generated false
signals at the end of March and at the beginning of May 2003,
which was toward the end of the bear market.
TO SUM IT UP
VolatOsc is a versatile momentum oscilla-
tor that can be used to identify overbought/
oversold levels, divergences, or trends. The
indicator becomes overbought or oversold
when it touches an upper or lower band.
Continued on page 38
S&P 500 INDEX
Bear Market
Top
Uptrend
Breakout Bottom
Breakout
FIGURE 10: DAILY CHART OF S&P 500 INDEX WITH VOLATOSC (20,3,20) DURING
THE BEAR MARKET FROM 2000–2003. Three signals were generated when the index
made three highs from November 2001 to March 2002 (vertical red dotted lines) and met
resistance (horizontal red line). The downtrend continued after a break of the support
level at the end of April 2002.

Beyond risk management,
I would like to see traders
move toward systematic
trading.
more mini market portfolios into the mix.
We continually strive to add more and
more markets into the portfolio all in an
effort to minimize portfolio risk.
That’s exactly how I did it when I co-
managed a Commodity Trading Advisor
(CTA) fund. Small investors can do it
the very same way. Perhaps they won’t
add 100 systems into an individual mini
market portfolio. They may also choose
to trade less than 40 markets inside their
portfolio, but the process is exactly the
same. More than likely, a trader will only
trade three systems in a mini market
portfolio and combine two markets in
their portfolio. But the fact is, following
this process, we are still looking at a
portfolio with reduced risk when com-
pared with the “one trick pony” trader
I mentioned earlier. The objective is to
continually build a portfolio to have as
many markets, trading styles, and time-
frames as possible given
capital limitations.
Do you use other kinds of
strategies to hedge your
futures positions such as
trading spreads?
You can use the tra-
ditional spread trading,
where you trade similar types of markets,
whether it’s corn against hogs or S&P
against T-notes, gold against T-notes
or the CRB against 10-year notes. You
could minimize your exposure that way.
I’m a traditional position trader, and my
“risk management” falls within those
categories that we talked about. I don’t
personally hedge my positions across
time or across markets in the traditional
sense. I simply build what I’ll term as
strong, diversified, intelligent portfolios
that puts my capital in the best position
to minimize risk.
Too straightforward for you. If you
were to give one piece of advice on risk
management, what would it be?
Beyond seeing traders properly man-
age trade, environmental, leverage, and
portfolio risk, I would like to see traders
move toward systematic trading. I like
to tell people, “Trade without ego. No
emotion. No greed. No opinion.” By
applying a systematic approach, you get
rid of the largest part of the risk equa-
tion, which is the human interaction.
Following systems, applying leverage
formulas, and constructing balanced
portfolios makes trading much easier
in the long run. It takes a long time to
implement, but it’s well worth the ef-
fort. I strongly recommend that traders
embrace the full advantages associated
with systematic trading.
Thank you so much for speaking with
us about risk management, David.
FURTHER READING
Sweeney, John [1997]. Maximum Ad-
verse Excursion: Analyzing Price
Fluctuations For Trading Manage-
ment, John Wiley & Sons.

APIRINE/VOLATILITY OSCILLATOR strength index to trading. He may be reached at vitapirine@

Continued from page 12 mediacombb.net.

The spreadsheet mentioned in this article is available in the Article

VolatOsc does not catch the exact top or bottom, but it can
help filter out insignificant moves and focus on the larger trend.
A bearish divergence can be confirmed when prices break a
support level or when VolatOsc touches the lower band. It
could be the start of a downtrend. A bullish divergence can be
confirmed when price breaks above a resistance level on the
price chart or when VolatOsc touches the upper band. It could
be the beginning of a bull market.
It’s necessary to use weekly or monthly charts for long-term
signals. VolatOsc should be used in conjunction with other
indicators or price analysis.
Vitali Apirine is a programmer engineer with an interest
in technical analysis, especially the application of relative
Code section of our website, www.Traders.com.
FURTHER READING
Apirine, Vitali [2017]. “Moving Average Stochastic,” Technical
Analysis of STOCKS & COMMODITIES, Volume 35: May.
[2017]. “Exponential Standard Deviation Bands,”
Technical Analysis of STOCKS & COMMODITIES, Volume
35: February.
[2016]. “Higher Highs & Lower Lows,” Technical Analy-
sis of STOCKS & COMMODITIES, Volume 35: February.
‡MetaStock
‡See Editorial Resource Index

38 • August 2017 • Technical Analysis of STOCKS & COMMODITIES

 Peeling The Layers

Volume & Open Interest

They may be the most overlooked metrics in a trader’s tool-
box, but understanding them can give you an insight into the
psychological makeup of the market. Here’s how.
by Paul Kogut
TOOLBOX: MONKIK/GAS FLAME: TIGERGALLERY/SHUTTERSTOCK.COM/COLLAGE: CHRISTINE MORRISON
of the urgency that market players feel. Often, when a trader
DVNVZK\DPDUNHWZHQWXSKHRUVKHJHWVWKHÁLSSDQWUHSO\
that there were more buyers than sellers. While this seems to
make sense, it is not accurate, since there has to be a buyer for
every seller. The correct response should be that the buyers
were more motivated than the sellers.

T
here’s more to volume and open interest than the val- You can directly correlate volume to this urgency. High
ues you see displayed on a chart. If you add one more volume tends to occur at market tops and bottoms and usu-
component to the mix, you can bring some subjectiv- ally occurs when market participants are in a panic to get in
ity into your interpretation that’ll give you a unique or out. Once these overanxious traders have bought or sold,
perspective into the mentality of buyers and sellers in there is no one overly motivated to do anything, and thus a
the futures market. market extreme is made.
The weekly chart of silver in Figure 1 shows a giant volume
WHO’S MORE MOTIVATED? spike in late April 2011 (A) that marked a blowoff top after a
7KHVLJQLÀFDQFHRIYROXPHLVSUREDEO\HDVLHUWRXQGHUVWDQG KXJHGROODUUDOO\/RZYROXPHWHQGVWRUHÁHFWWKHRSSRVLWH
WKDQWKDWRIRSHQLQWHUHVWVLQFHYROXPHLVDGLUHFWUHÁHFWLRQ emotion, that is, one of disinterest. It implies price action is not
16 • June 2016 • Technical Analysis of STOCKS & COMMODITIES
 SI - Silver - Weekly Continuation OHLC Chart NGZ15 - Natural Gas- Daily Continuation OHLC Chart
50.000 3.400
A 3.300
45.000
3.200
40.000 3.100
3.000
35.000 2.900
2.800
30.000 A
2.700
25.000 2.600
2.500
20.000
2.400
2.327
15.535
2.200
300K 10.000 2.100
600K
200K a 1.1M
200K a 400K
250K 1.05M
BARCHART.COM

100K 1M
100K 200K 0.95M
50K 0.9M
0K 0K 0.85M
2011 2012 2013 2014 2015 May 15 Jun Jul Aug Sep Oct

FIGURE 1: VOLUME SPIKES. In late April 2011 there was a giant volume spike FIGURE 2: PRICE BOUNCES. After a resumption of the downtrend, price bounced
(A) that marked a blowoff top after a huge $24 rally. at point A. But that happened on very low volume, which suggested that the renewal
of the downtrend could continue. Note the small drop in open interest (purple line
overlaid on volume) supporting that idea.
creating any sense of urgency. This usually occurs when the
market is just resting after a move and could soon continue GC - Gold - Daily Continuation OHLC Chart
1,240.0
in its original direction. 1,230.0
1,220.0
The daily chart of natural gas in Figure 2 shows that after 1,210.0
C 1,200.0
a resumption of the downtrend, price bounced at point A. But 1,190.0
that happened on very low volume, which suggested that the 1,180.0
B 1,170.0
renewal of the downtrend could continue (note also the small 1,160.0
drop in open interest supporting that idea). 1,150.0
1,141.0
1,130.0
A D
WHAT ABOUT CONTRACT EXPIRATIONS? 1,120.0
1,110.0
One caveat to both volume and open interest is the cyclicality 1,100.0
1,090.0
involved with futures contract expiration. As expiration nears, 1,080.0
volume tends to rise. One reason for this is obvious in that 1,070.0
a 480K
traders have to exit or roll forward their positions rather than b 460K
400K d
get involved in delivery. Another factor that causes a similar 300K 440K
c
scenario is option expiration. As time decay shrinks option 200K 420K
100K 400K
price and interest carrying costs, arbitrage opportunities 0K 380K
expand markedly between options, underlying futures, and May 15 Jun Jul Aug Sep Oct

the cash market. This is also why volume and open interest FIGURE 3: RISING OPEN INTEREST. When price moves on rising open interest,
surges in the runup to expiration. it represents new speculators entering the market, which means you can expect a
continuation of the trend. You can see this in October at point D. The volume spikes
that can be seen at A, B, and C identified short-term highs and lows.
OPEN INTEREST
Open interest can be an even better metric than volume when ZW - Wheat- Weekly Continuation OHLC Chart
analyzing the market, but deciphering its meaning at times 780 –0
760 –0
can be tricky. In theory, a price move on rising open interest 740 –0
represents new speculators entering the market, which means 720 –0
700 –0
you can expect a continuation of the trend. 680 –0
660 –0
The daily chart of gold in Figure 3 is an excellent example 640 –0
of how this phenomenon manifested itself in October (D). 620 –0
600 –0
$OVRQRWHWKHYROXPHVSLNHVWKDWLGHQWLÀHGVKRUWWHUPKLJKV 580 –0
and lows at A, B, and C. A
560 –0
540 –0
If price moves on falling open interest, it suggests specula- 522 –0
tors are liquidating their positions, and once they are done, 500 –0
480 –0
the move in price will have exhausted itself. Consequently, 460 –0
250K
the market should reverse after the liquidation is over. In the 200K a 500K
150K 400K
weekly chart of wheat in Figure 4, you can see how open in- 100K 300K
terest fell precipitously (A) as the market pushed to new lows. 50K 200K
0K 100K
This should have been a warning of an impending reversal. Nov 13 Jan 14 Mar May Jul Sep Nov Jan 15 Mar May Jul Sep

Open interest has the same type of distortion as volume FIGURE 4: A FALL IN OPEN INTEREST. On this weekly chart of wheat you can see
how open interest fell precipitously at point A as the market pushed to new lows.
Continued on page 44 This should have been a warning of an impending reversal.

June 2016 • Technical Analysis of STOCKS & COMMODITIES • 17

 TRADING ON MOMENTUM

Scanning for Swing Trades

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GD\SULFHUDQJH7KLVSURIHVVLRQDOWUDGHUH[SODLQVZKDW
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by Ken Calhoun
especially those under $10 a share, because of the potential
for overly volatile price action and weak, choppy, unsustained
trends. Similarly, high-priced stocks over $70 a share don’t
offer good leverage. The $20–$70 per share range is the
“sweet spot” for volatility, price action, and trend strength
when swing trading.

hen you visually scan through swing trading breakout STEP-BY-STEP ACTION PLAN

W FKDUWVLWLVLPSRUWDQWWRIRFXVRQÀQGLQJWKRVHZLWK
strong technical uptrends, increasing volume, and
ZLGHWUDGLQJUDQJHV<RX·OOEHDEOHWRXVHWKHVSHFLÀF
Here’s how you can put this strategy to work in your trades.

Step 1: Scan through 15-day 15-minute stock charts priced

criteria I will outline here to help you narrow your trading between $20 and $70 per share with a minimum high–low price
DSSURDFKWRÀQGWKHEHVWFKDUWVWRHQWHUZKHQVZLQJWUDGLQJ range of at least 10% (for example, $3 or more for a $30 per
(that is, round-trip trades lasting several days to several weeks share instrument) and minimum daily volume of at least one
in duration). million shares per day, similar to the chart of Silicon Motion
Technology Corp. (SIMO) illustrated in Figure 1.
TRADING STRATEGY: 15-DAY 10% RANGE WITH 45-DEGREE
MOVING AVERAGE UPTREND CONFIRMATION Step 2: Check that the 50-period simple moving average (SMA)
Increasing volume, volatility, and trend strength will provide OLQHLVLQDGHJUHHDQJOHXSWUHQGGXULQJWKHPRVWUHFHQWÀYH
the strongest combination of entry signals when used together. to seven days of chart history. You are looking to enter 15-day
In testing this strategy with several thousand real-money high breakouts, so the most recent day’s price action must be
trades over many years, I have found that this breakout entry a 15-day high (as in Figure 1 on March 23, 2016).
strategy works best with stocks and ETFs priced between
$20 to $70 per share with at least one million shares per day Step 3: Set a buy-stop order to enter your trade on any day
of volume. following this combination of signals, once price has moved
It is wise to avoid swing trading low-priced small-cap stocks, at least $0.50 above the most recent 15-day high. In Figure
1, this signal occurred
on March 18, 2016 and
again on March 23, 2016.
On this chart, a new
entry price is ($37.40
+ 0.50) = $37.90. I use
$0.50 above current
KLJKVDVDÀOWHUWRKHOS
avoid false breakouts.
Minimum 10%
high-low range Step 4: You can use a
on 15–day chart maximum $2 initial and
trailing stop value on all
stock swing trades.
50SMA in 45–degree
angle uptrend INSIGHTS: WHY
THIS TECHNIQUE
WORKS
The key to trading break-
RXWV LV ÀQGLQJ VWURQJ
enough uptrends that
continue up after you
eSIGNAL

enter your trade. By

FIGURE 1: WIDE-RANGE UPTREND CONTINUATION. Here’s an example of using a 45-degree uptrend with >10% high–low price combining a sustained
range to enter a breakout. uptrending chart with a
June 2016 • Technical Analysis of STOCKS & COMMODITIES • 45
 TRADING ON MOMENTUM
2016 WINNER
AI TRADING SOFTWARE

Volume-Weighted Winner

Moving Average 14 years

in a row!
Breakouts Build powerful
trading systems in
Here’s a moving average crossover technique to help you spot these strong MINUTES
technique to help spot strong breakout breakout trading patterns.
trading patterns in volatile markets.
without coding
TRADING STRATEGY:
by Ken Calhoun SWING TRADING THE VWMA & MA
CROSSOVER TECHNIQUE
hen you look for swing trading The biggest benefit to using VWMA is

W
®

entries and exits in volatile that it factors in volume as well as price

markets, it is important to use
volume in addition to price to
confirm your trading decisions. Using
the volume-weighted moving average
(VWMA) can provide an ideal technical
trading tool to help you combine price
and volume. This month, I will show
you how to combine the VWMA with a
simple moving average (MA) crossover
eSIGNAL
to plot the signal line. This can help you
avoid false breakouts, because higher-
than-average trading volume combined
with price often leads to exceptional
uptrend continuations. Visually, the
www.NeuroShell.com
VWMA will appear further away from 301.662.7950
the trendline when volume is high and
price is strongest (during strong break-
outs) and will get closer when volume Continued on page 45

FIGURE 1: 50 VWMA & 70 MA CROSSOVER SIGNALS (FAS). Here you see an example of entering and exiting a swing trade using VWMA trading
signals.

February 2017 • Technical Analysis of STOCKS & COMMODITIES • 7

8 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
 TRADING SYSTEMS

Finding The Edges Of Trend

Exponential Standard
Deviation Bands
Traders hunt for volatility, but how can you find it? ing ESD Bands.” You’ll find that ESD bands look
Here’s one technique you can apply that’ll help you similar to Bollinger Bands in that they consist of a
see volatility while a stock is trending. middle band with two outer bands. The middle band
is an exponential moving average (EMA) that is set
ometimes you see it right in front of your at 20 periods. An EMA is used because the ESD

S
eyes. Other times you may have to look formula also uses an EMA. The lookback period
hard to find it. Either way, volatility needs for the ESD is the same as for the EMA. The outer
to exist if you want to make successful bands are usually set two ESDs above and below
trades. Lucky for you, there are many ways the middle band. You may adjust the settings to suit
to measure volatility. One way is the exponential the characteristics of particular securities or trading
standard deviation bands (ESD bands), which are styles. Changing the number of periods for the mov-
volatility bands placed above and below an expo- ing average also affects the number of periods used
nential moving average. The bands are based on to calculate the ESD.
the exponential standard deviation, which changes
as volatility increases and decreases. The bands INTERPRETING THEM
automatically widen when volatility increases and In Figure 1 you see a chart of the S&P 500 index from
narrow when volatility decreases. This means they May 2016 to October 2016 with the ESD bands (20,2)
can be used on different securities with standard overlaid on the price chart. The ESD bands indicator
settings.
ESDB(20,2), S&P 500 INDEX
2260
2250

CALCULATING THEM 2240

2230

Here is how the bands are formulated: Upper band 2220

2210
2200
2190
2180

Middle band = 20-day exponential 2170

2160

moving average (EMA) 20–day EMA

2150
2140
2130
2120
2110

Upper band = 20-day EMA + (20- 2100

2090

day exponential standard deviation 2080

2070

of price × 2) Lower band

2060
2050
2040
2030
2020

Lower band = 20-day SMA - (20- 2010

2000

day exponential standard deviation 1990

METASTOCK

1980

of price × 2) June July August September October

For more details on calculating ESD
bands, please see the sidebar “Calculat-
PATRICK KELLEY
FIGURE 1: WHERE DOES IT BEGIN AND WHERE DOES IT END? Trends often start with strong
moves in one specific direction. A surge above the upper band shows extraordinary strength while a
plunge below the lower band shows extraordinary weakness. Such strong moves can signal the end
of one trend and beginning of another.

by Vitali Apirine
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 9
 CALCULATING ESD BANDS
Exponential standard deviation measures the amount of
variability or dispersion relative to the exponential moving
average (EMA). Generally speaking, ESD is the difference
between the actual value and EMA value. The larger this
dispersion or variability, the greater the exponential standard
deviation is. The smaller this dispersion or variability is,
the lesser the exponential standard deviation.
How to calculate exponential standard deviation
(ESD)
1. Calculate the exponential average price for the num-
ber of periods
2. Determine each period’s deviation (close minus
exponential average price)
3. Square each period’s deviation
4. Sum the squared deviations
5. Divide this sum by the number of periods
6. The standard exponential deviation is equal to the
square root of the number derived in 5.
(SMA), its true value will not be realized until 20 or so
periods later.
In Sidebar Figure 1 you see a spreadsheet example of
a 10-day standard deviation and a 10-day exponential
standard deviation for the S&P 500 large-cap index. The
spreadsheet also shows the 10-day standard deviation us-
ing the STDEVP function in Excel for comparison. The
values of the exponential standard deviation derived from
the spreadsheet are charted in Sidebar Figure 2.
Exponential standard deviation vs. standard deviation
Exponential standard deviation and standard deviation are
similar. Standard deviation measures dispersion around an
average. The chart in Sidebar Figure 3 of the Russell 2000
small-cap index shows the ExpStdDev(10) and StdDev(10)
in the subchart for comparison.
S&P 500 INDEX
1240
1230
1220
1210
1200
1190
1180
1170
1160

The lookback period for the exponential standard deviation 1150

1140
1130
1120
is the same as for the exponential moving average (EMA). 1110
1100
1090
The EMA starts with the simple moving average value 1080
1070
1060
1050
(1140.67) in the first calculation (see Sidebar Figure 1). 1040
1030
1020
After the first calculation, the normal formula takes over. 1010
1000
990
Because an EMA begins with a simple moving average ExpStdDev(10)
980

35
ExpStdDev values shown
in spreadsheet example 30

25

20

15

10

September October November December 2010 February March April May

SIDEBAR FIGURE 2: EXPONENTIAL STANDARD DEVIATION, CHARTED

RUSSELL 2000 INDEX

180

175

170

165

160

155

ExpStdDev(10), StdDev(10)
10.5
10.0
ExpStdDev(10) Standard Deviation and Exponential Standard Deviation 9.5
are similar 9.0
StdDev(10) 8.5
8.0
7.5
7.0
6.5
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
July August September October November December 1990 February March April May

SIDEBAR FIGURE 1: CALCULATION OF EXPONENTIAL STANDARD DEVIA- SIDEBAR FIGURE 3: EXPONENTIAL STANDARD DEVIATION AND STANDARD
TION BANDS USING A SPREADSHEET DEVIATION COMPARED

10 • February 2017 • Technical Analysis of STOCKS & COMMODITIES

 Noisy indicators
delay your analysis

A surge above the upper band

shows extraordinary strength
while a plunge below the lower
band shows extraordinary Jurik algorithms
weakness. Such strong moves deliver low lag,
can signal the end of one trend low noise analysis
and beginning of another.
Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
NeoTicker, Tradecision, TradingSolutions, MATLAB, Ninja Trader, Sierra Charts,
Genesis TradeNavigator, Market Delta, Extreme charts, DLLs for custom software

is designed to encompass most price action, which means that

Jurik Tools on live charts, on the web !
moves above or below the upper or lower exponential bands tinyurl.com/jurik-online
are relatively rare. Trends often start with strong moves in
one direction or another. A surge above the upper band shows
extraordinary strength while a plunge below the lower band
Jurik Research
shows extraordinary weakness. Such strong moves can signal
the end of one trend and the beginning of another.
ESD bands are a trend-following indicator and lag price 2010 -- 2011 -- 2012 -- 2013
action because they are based on the EMA. The direction of Add-In software

the EMA dictates the direction of the ESD bands. In general,

a downtrend is present when the bands move lower, while an jurikres.com • 800-810-3646 • 719-686-0074
uptrend exists when the bands move higher. The trend is flat
when the bands move sideways.
An upturn and break above the upper band can signal the Stock index (FTSE 100) started a downtrend with a decline
start of an uptrend. A downturn and break below the lower below the lower band in October 2000. After this initial break,
band can signal the start of a downtrend. Sometimes a strong the index met resistance near the upper band.
trend does not take hold after an upper or lower band break-
out, and prices will oscillate between the bands. Such trading Flat trend
ranges are marked by a relatively flat moving average. The A trading range can be identified with a flat moving average
band boundaries can then be used to identify overbought and and the average directional index (ADX). In Figure 5 you see
oversold levels for trading purposes. the S&P 500 index with ESD bands (20,2) and ADX(10). The
20-day EMA flattened out from February to early August.
Compare with Bollinger Bands
ESD bands use an EMA, which is more sensitive RUSSELL 2000 INDEX, ESDB(20,2)
than the simple moving average used in Bollinger 1255
1250
1245
BB(20,2)
Bands. In Figure 2 you see the Russell 2000 index ESDB(20,2)
1240
1235
1230
1225
with ESD bands (blue) and Bollinger Bands (red) 1220
1215
1210
1205
for comparison. 1200
1195
1190
1185
1180
1175
1170
Uptrend 1165
1160
1155
1150
The chart in Figure 3 is a display of the Dow Jones 1145
1140
1135

Industrial Average (DJIA) starting an uptrend 1130

1125
1120
1115
as the ESD bands turn up and the index surges 1110
1105
1100
1095
above the upper band. See how the DJIA was in a 1090
1085
1080
downtrend as prices continued to pierce the lower 1075
1070
1065
1060
band. With a strong thrust up, prices exceeded the 1055
1050
1045

upper band at the end of April and the bands turned 1040
1035
1030
1025
up to start a new uptrend. Prices held above the 1020
1015
1010
1005
lower band on dips in July and October. 1000
995
990
985
980
Sep Oct Nov Dec 2014 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Downtrend FIGURE 2: ESD BANDS VS. BOLLINGER BANDS. The Bollinger Bands are in red and the ESD
In Figure 4 you see the London Financial Times bands are in blue. There is a little bit of a difference between the two.

February 2017 • Technical Analysis of STOCKS & COMMODITIES • 11

 ESDB(20,2), DOW JONES INDU AVERAGE
10400
10300
ESDB(20,2) 10200
10100
10000
9900
9800
9700
9600
9500
9400
9300
9200
9100

The indicator window shows ADX (black line) uptrend starts holds above 9000
8900
8800
lower band 8700
confirming a weak trend. Low and falling ADX 8600
8500
8400
suggests the trend is weak. High and rising ADX 8300
8200
8100
indicates a strong trend. ADX was below 40 the 8000
7900
7800
entire time. In fact, it was often below 30. This holds above 7700
7600
lower band 7500
reflects the absence of trend. As you can see, the downtrend 7400
7300
7200
ADX peaked in January and fell until late May. 7100
7000
6900
6800
6700
AND THE VERDICT IS … 6600
6500

ESD bands are considered to be trend-following, 6400

6300
6200
so they can help identify the underlying trend. A 6100
6000

trend can be up, down, or flat. It is well-known 2009 February March April May June July August September Octob
that bullish trades are favored in an uptrend and FIGURE 3: IT’S AN UPTREND. The Dow Jones Industrial Average was in a downtrend as prices
bearish trades are favored in a downtrend. But continued to pierce the lower band. With a strong thrust up, prices exceeded the upper band at the
what about during a flat trend? This is when ESD end of April and the bands turned up to start a new uptrend. Prices held above the lower band on
dips in July and October.
bands can come into play. Prices often peak at the
upper band and trough at the lower band in a flat FTSE 100 IDX, ESDB(20,2)

trend. And if you use them together with other ESDB(20,2) 7000
6900
indicators or analytics, they can act as a strong uptrend holds below
upper band
6800
6700

confirming indicator. 6600

6500
6400
6300
holds below
Vitali Apirine is a programmer engineer with upper band
6200
6100

an interest in technical analysis, especially the downtrend

6000
5900
application of relative strength index to trading. starts 5800
5700
He may be reached at vitapirine@mediacombb. 5600
5500
net. 5400
5300
5200
See our Traders’ Tips section beginning on page 48 5100

for commentary and implementation of Apirine’s 5000

4900
technique in various technical analysis programs. 4800
Accompanying program code can be found in the 4700

Traders’ Tips area at Traders.com. 4600

4500

Jun Jul Aug Sept Oct Nov Dec 2001 Feb Mar Apr May Jun Jul Aug Sep

FURTHER READING
Apirine, Vitali [2016]. “The Middle-High-Low
Moving Average,” Technical Analysis of
STOCKS & COMMODITIES, Volume 34: Au-
FIGURE 4: WHEN THE TREND IS DOWN. Here you see the London Financial Times Stock index
(FTSE 100) started a downtrend with a decline below the lower band in October 2000. After this
initial break, the index met resistance near the upper band.
S&P 500 INDEX, ESDB(20,2)

ESDB(20,2)
gust. 1400

[2016]. “Higher Highs & Lower Lows,” 1350

Technical Analysis of STOCKS & COMMODI- 1300

TIES, Volume 34: February. 1250

breakout
[2015]. “Average Percentage True Range,” 1200
Technical Analysis of STOCKS & COMMODI-
TIES, Volume 33: November. 1150

1100

‡MetaStock
†See Traders’ Glossary for definition ADX(10)
‡See Editorial Resource Index 55
50
45
breakout 40
35
30
25
20

15

February March April May June July August

FIGURE 5: AND WHEN IT’S FLAT. Here you see the S&P 500 index with ESD bands (20,2) and
ADX(10). The 20-day EMA flattened out from February to early August. ADX was below 40 the
entire time. In fact, it was often below 30. This reflects the absence of trend. As you can see, the
ADX peaked in January and fell until late May.

12 • February 2017 • Technical Analysis of STOCKS & COMMODITIES

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 A Tad Bit Of Logic
Using Correlation To Trade
The S&P 500
Do you want to trade assets that are positively correlated
or are you better off trading assets that move in different
ways? Here’s a look at how a correlation strategy compares
with a moving average crossover strategy and a buy & hold
strategy.
by Cassandra Wang
W
hen you think of the term correlation, you think of
it as a relationship between two distinct variables. A
strong positive correlation means two variables move
together; a strong negative correlation means the two
variables move in opposite directions. So if you know
how well two assets are correlated, you could infer the patterns
of a variable. In the financial markets, when the movement of
one asset corresponds to the movements of other assets, this
results in inter-asset correlation.
14 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
HOW CORRELATED ARE YOU?
Inter-asset correlation is not a new idea. John Murphy, for
example, studied this correlation in his book Intermarket Tech-
nical Analysis. He described the relationships between asset
classes and proposed that traders and investors be mindful of
potential changes in these correlations due to different market
states. Various other studies have been done on the subject.
PULSE CHART: CREATIVE-TOUCH/HANDS: DGCAMPILLO/
So what is the implication of inter-asset correlation on the
movement of the S&P 500’s future price? Can this correlation
guide investors and traders? Can quantitative strategies based
SHUTTERSTOCK/COLLAGE: JOAN BARRETT
on correlation be developed and help people effectively trade
the S&P 500? Let’s take a look.
ETF SELECTION AND CORRELATION
CALCULATION
The table in Figure 1 lists 29 exchange trade funds (ETFs)
that were used to calculate inter-asset correlation. These ETFs
 TRADE ANALYTICS SYMBOL Description
AGG iShares Core US Aggregate Bond
LQD iShares iBoxx $ Invst Grade Crp Bond
TLT iShares 20+ Year Treasury Bond
include equities, bonds, REITs, and currencies. They were FXA CurrencyShares Australian Dollar ETF
selected based on availability of historical data and trading FXB CurrencyShares British Pound Ster ETF
volumes. Note that these correlation results could change if FXC CurrencyShares Canadian Dollar ETF
FXE CurrencyShares Euro ETF
you select a different set of ETFs.
FXF CurrencyShares Swiss Franc ETF
Inter-asset correlation is defined as the average of all unique
FXY CurrencyShares Japanese Yen ETF
pairwise correlations among the ETFs for a given week. The
EFA iShares MSCI EAFE
calculations include 13-week, 26-week and 52-week interval
EPP iShares MSCI Pacific ex Japan
periods that correspond to quarterly, semi-annual, and annual
EWC iShares MSCI Canada
timeframes. Adjusted weekly close price data was obtained EWJ iShares MSCI Japan
from Yahoo Finance. EWL iShares MSCI Switzerland Capped
EWU iShares MSCI United Kingdom
INTER-ASSET CORRELATION WITH S&P 500 EWZ iShares MSCI Brazil Capped
Figure 2 shows various inter-asset correlation interval periods IWN iShares Russell 2000 Value
plotted against the weekly close price of the SPY (S&P 500 OIH VanEck Vectors Oil Services ETF
total return ETF) from January 2002 to August 2016. With QQQ PowerShares QQQ ETF
the 26-week interval period, correlation changes with time, SMH VanEck Vectors Semiconductor ETF
ranging from 0.88 in the week of November 11, 2002 to 0.11 SPY SPDR S&P 500 ETF
in the week of March 6, 2015. During the bull market between XLE Energy Select Sector SPDR ETF
October 2002 and October 2007, inter-asset correlation ex- XLF Financial Select Sector SPDR ETF
perienced seven up/down cycles with its lowest value at 0.25 XLI Industrial Select Sector SPDR ETF
and highest value at 0.88. With reference to the correlation, XLP Consumer Staples Select Sector SPDR ETF
the financial crisis of 2007–2009 began with a local minimum XLU Utilities Select Sector SPDR ETF
in the week of September 14, 2007 and ended near a local XLV Health Care Select Sector SPDR ETF
minimum in the week of April 3, 2009. You can see from XLY Consumer Discret Sel Sect SPDR ETF
Figure 2 that the correlation patterns of the financial crisis VNQ Vanguard REIT ETF
differ from those observed between 2002 and 2007. On the FIGURE 1: EXCHANGE TRADED FUNDS USED IN THE
INTER-ASSET CORRELATION STUDY. This list includes
other hand, the correlation pattern corresponding to the bull ETFs, equities, bonds, REITs, and currencies.
market from March 2009 until August 2016
parallels those during the bull market between
2002 and 2007.
13wk_AvgCorr

Although the major peaks and troughs of 0.8

inter-asset correlation measured over 13-week 0.6
and 26-week interval periods are in similar 0.4

locations, the short 13-week period has more 0.2

total peaks and troughs than the 26-week

Inter-Asset Correlation

interval period. Similar trends are observed

26wk_AvgCorr

0.8
between the correlation plots of the 26-week 0.6
and 52-week interval periods. It seems that 0.4
larger interval periods yield fewer peaks and 0.2
troughs than a smaller interval period over the
same amount of time.
52wk_AvgCorr

0.8
0.6
LET’S APPLY INTER-ASSET 0.4
CORRELATION 0.2
I explored quantitative trading models to inves-
S&P500 (SPY)

tigate the usefulness of inter-asset correlation in

SPY_weeklyprice

200
trading. One that I tested is a relatively simple 150
trading strategy with the following rules:
100

• When inter-asset correlation, AVGcorr,

04/19/2002
08/09/2002
11/29/2002
03/21/2003
07/11/2003
10/31/2003
02/20/2004
06/10/2004
10/12/2004
01/21/2005
05/13/2005
09/02/2005
12/23/2005
04/13/2006
08/04/2006
11/24/2006
03/16/2007
07/06/2007
10/26/2007
02/15/2008
06/06/2008
09/26/2008
01/16/2009
05/08/2009
08/28/2009
12/18/2009
04/09/2010
07/30/2010
11/19/2010
03/11/2011
07/01/2011
10/21/2011
02/10/2012
06/01/2012
09/21/2012
01/11/2013
05/03/2013
08/23/2013
12/13/2013
04/04/2014
07/25/2014
11/14/2014
03/06/2015
06/26/2015
10/16/2015
02/05/2016
05/27/2016

is moving upward (that is, AVGcorr in

the close of the week is higher than the
previous week) a long SPY position is
initiated.
• The long position is held until AVGcorr is
lower than the previous week’s AVGcorr.
Date
FIGURE 2: INTER-ASSET CORRELATION RELATIVE TO S&P 500. Although the major peaks
and troughs of inter-asset correlation measured over 13-week and 26-week interval periods are
in similar locations, the short 13-week period has more total peaks and troughs than the 26-week
interval period.

February 2017 • Technical Analysis of STOCKS & COMMODITIES • 15

 Portfolio Equity = 4.6418e+006 Correlation Moving average Buy and hold
4.5M
strategy cross strategy strategy
Initial capital 1,000,000.0 1,000,000.0 1,000,000.0
4M Ending capital 4,641,797.1 2,266,191.3 3,125,520.8
Net Profit % 364.2% 126.6% 212.6%
3.5M
Exposure % 55.1% 72.6% 99.7%
3M Annual Return % 11.9% 6.2% 8.7%

2.5M All trades 42 37 1

Avg. Profit/Loss % 3.83% 2.54% 212.56%
2M
Avg. Bars Held 10.38 15.03 714
1.5M
Winners 34 (80.95 %) 18 (48.65 %) 1 (100.00 %)
1M
2004 2009 2011 2016 Avg. Profit % 5.21% 8.19% 212.56%
Equity curves of correlation strategy Avg. Bars Held 11.18 26.06 714
Portfolio Equity = 2.26619e+006 Max. Consecutive 7 5 1
2.4M Largest win 421987.7 360568.3 2125520.8
# bars in largest win 15 44 714
2.2M

2M Losers 8 (19.05 %) 19 (51.35 %) 0 (0.00 %)

Avg. Loss % -0.0204 -0.0281 N/A
1.8M
Avg. Bars Held 7 4.58 N/A
1.6M Max. Consecutive 2 4 0
Largest loss -124358.4 -152486.6 0
1.4M
# bars in largest loss 7 3 0
1.2M
Max. system % drawdown -18.9% -15.7% -54.6%
1M Recovery Factor 9.32 4.09 2.09
2004 2009 2011 2016 CAR/MaxDD 0.63 0.39 0.16
Equity curves of moving average strategy RAR/MaxDD 1.14 0.54 0.16
Profit Factor 11.96 2.52 N/A
Portfolio Equity = 3.12552e+006
Payoff Ratio 2.81 2.66 N/A
3M
Standard Error 274842.8 134769.4 312054.3
Risk-Reward Ratio 0.84 0.78 0.41
2.5M Ulcer Index 4.53 6.73 14.27
Ulcer Performance Index 1.43 0.11 0.23
Sharpe Ratio of trades 1.4 0.25 N/A
2M K-Ratio 0.1245 0.115 0.0608
FIGURE 4: BACKTEST RESULTS OF THE THREE STRATEGIES BASED ON
WEEKLY SPY DATA. The correlation strategy had the highest net profit and the
1.5M
least exposure to the market. The market exposures are 55.10% for the correla-
tion strategy, 72.58% for the moving average crossover, and 100% for the buy &
hold strategy.
1M

2004 2009 2011 2016

Equity curves of buy and hold strategy
FIGURE 3: EQUITY CURVES OF THE THREE STRATEGIES BASED ON WEEKLY
SPY DATA
Then cash is held in the account.
• The SPY long position is initiated again when the AVGcorr
increases again.
I’ll refer to this strategy as the correlation strategy. The
backtesting process showed that using an eight-unit simple
moving average (SMA) of the correlation calculated with a
13-week interval period produced good results, so the discus-
sion that follows is based on that set of parameters.
16 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
I compared the correlation strategy to two other reference
strategies. The first reference is the buy & hold SPY strategy
for the period between January 2, 2003 and August 26, 2016.
The second strategy I compared it to is a moving average
crossover system using an 18-week lookback period. The
18-week lookback period was selected based on optimization
results over the period using AmiBroker software. Using this
strategy, a long SPY position is initiated when the weekly close
price of the SPY crosses above its SMA. The long position
is held until price crosses below the SMA. Taxes, trading
spreads, trading commissions, and fees were not included
in the backtest calculations.
Figure 3 illustrates equity curves generated by the three
strategies between January 2, 2003 and August 26, 2016. The
 Correlation Moving average Buy and hold
Year
strategy cross strategy strategy
Can quantitative strategies
2003 22.9% 16.7% 28.4%
based on correlation be 2004 13.1% 0.6% 10.7%
developed to effectively trade 2005 11.1% 7.6% 4.8%
the S&P 500? 2006 6.6% 7.1% 15.6%
2007 5.7% -5.2% 5.5%
2008 -2.7% -4.5% -36.6%
table in Figure 4 details the trading results for each strategy 2009 26.8% 38.1% 25.9%
over a period of 13 years. If $1 million were invested into the 2010 6.2% 0.8% 14.8%
2011 6.5% -2.8% 2.1%
SPY at the beginning of 2003, 13 years later, the correlation
2012 23.3% 6.7% 15.9%
strategy would have yielded $4.6 million, a 364% net return.
2013 11.4% 25.6% 32.2%
The buy & hold and moving average strategies produced net
2014 10.9% 8.2% 13.5%
profits of 212.55% and 126.62%, respectively. Compounded
2015 11.8% 11.4% 1.4%
annualized returns (CAR) were 11.9%, 6.2%, and 8.7% for the
Aug-2016 12.3% 6.6% 7.8%
correlation, moving average cross, and buy & hold strategies
FIGURE 5: ANNUALIZED RETURN OF THE THREE STRATEGIES BASED ON
respectively. Not only did the correlation strategy have the WEEKLY SPY DATA. The correlation strategy reigns supreme. It produced more
highest net profit, it also had the least exposure to the market. profitable results than the optimized moving average crossover and buy & hold
The market exposures are 55.10% for the correlation strategy, strategies.
72.58% for the moving average crossover, and 100% for the
buy & hold strategy. The low exposure with the correlation The maximum percentage system drawdown, which is the
strategy indicates its relatively low risk potential. largest percentage drop from a peak to a trough in portfolio
Looking at the trading details over the 13-year period, the equity, is -15.68% with the moving average strategy, -18.93%
correlation strategy completed 42 trades, the moving average for the correlation strategy, and -54.61% for the buy & hold
crossover had 37 trades, and the buy & hold unsurprisingly strategy. The recovery factor for each system, which is net
only had one trade. The trader who bought and held the SPY profit divided by maximum system drawdown, was 2.09, 4.09,
had the highest average profit/loss percentage because he only and 9.32 for the buy & hold, moving average crossover, and
completed one trade. The correlation strategy had an average correlation strategies, respectively.
profit/loss of 3.83%, higher than the 2.54% of the moving The CAR/MaxDD row in the table is the compounded
average strategy. The 11-week average holding period of annualized return (CAR) divided by the maximum system
the correlation strategy is shorter than the 26-week average percentage drawdown (MaxDD). The correlation strategy has
holding period of the moving average cross strategy. the highest value of 0.63, whereas the moving average crossover
As shown in the table in Figure 5, the correlation strategy and buy & hold strategies have 0.54 and 0.16, respectively.
had 34 wins out of the total 42 trades, an 80.95% winning The profit factor—profits divided by losses—was higher with
ratio; on the other hand, the moving average crossover strategy the correlation model (11.96) than with the moving average
only had 18 wins out of 37 trades, a 48.65% winning odds, cross (2.52). The same for the payoff ratio, which is the ratio
lower than those in the correlation strategy. The maximum between the average win and average loss.
consecutive wins for the correlation strategy was seven trades The risk–reward ratio is best with the correlation method
as opposed to five consecutive wins in the moving average (0.84) and is trailed by the moving average crossover (0.78)
strategy. Also, the correlation strategy’s largest win was and buy & hold methods (0.41). The ulcer index measures
$421,987.70 after holding the SPY for 15 weeks, which is volatility in the downward direction and is lowest with the
sizably greater than the moving average cross’ $360,568.26 correlation model (4.53), meaning this model is the least
even though it was held for 44 weeks. volatile. The moving average crossover strategy has a higher
As for the losses, the correlation strategy had eight losses, ulcer index (6.73) than the correlation method, and the buy
which comprised 19.05% of its transactions over the 13-year & hold method has the highest ulcer index of 14.27, imply-
period. This is less than half of the moving average cross ing that this method is very volatile. The correlation model
strategy’s 19 losers, which comprised 51.35% of its transac- has a good Sharpe ratio of 1.4, whereas the moving average
tions. The total loss was smaller with the correlation strategy crossover model has a subpar Sharpe ratio of 0.25.
than with the moving average cross strategy. The average bars
held for the losses was seven for the correlation strategy and WHICH STRATEGY REIGNS SUPREME?
4.6 bars for the moving average cross. There were only two The correlation strategy does. It produced more profitable
consecutive losses with the correlation strategy as compared results than the optimized moving average crossover or buy &
to four consecutive losses with the moving average cross hold strategy. If you follow the inter-asset correlation trends,
strategy. The correlation strategy’s largest loss was held for you can buy and sell shares of the S&P 500 accordingly. When
seven bars while the moving average cross’ largest loss was
held for three bars. Continued on page 27
18 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
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 Options Sellers Rejoice
Seasonal Play In Crude
Brings Cheer
While OPEC deals are all the talk, the real fundamentals
moving crude prices are often predictably cyclical. Here is
how to capitalize as we start 2017.
by James Cordier and Michael Gross
easonal tendencies in commodities can be one of
S
the most powerful forces you can harness to if you
wish to master the art of commodities trading.
And of all the commodities, there is none with
more pronounced seasonal tendencies than the
energy markets. This is because demand for energy
changes with the weather, and thus, with the seasons. You have
higher demand for heating fuel in winter and higher demand
for travel and air conditioning fuel in the summer. And of all
the energy markets, none are more sensitive to these demand
cycles than crude oil, which is why we chose to focus on this
specific market.
20 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
DEMAND CYCLE FOR CRUDE OIL
It is demand at the wholesale level that has the most effect
on commodities futures prices. And if you sell options on
futures contracts, it is wholesale demand you should most
concern yourself with.
The period between summer driving season and winter
heating season is known as “shoulder” season here in the
US. This period is often characterized by weak demand for
crude oil.
By late October, heating oil storage levels have often reached
points deemed adequate to meet winter demand needs. At
the same time, gasoline production has been cut as demand
OIL REFINERY:PICHITO/SHUTTERSTOCK
wanes into the winter months. Gasoline stockpiles often hit
lows during this time of year.
But in December, two things happen:
1. Refineries, quite aware of the upcoming peak demand
period (known as “driving season”), begin the long
process of rebuilding depleted gasoline inventories.
 COMMODITIES

2. Because some of the biggest refining

states are subject to end-of-year taxes June Crude Oil (NYM) 15 Year Seasonal (2-16)
on crude inventories, many will put 100
off forward purchases of crude until
the new year.

HOW DOES THIS AFFECT CRUDE 75

OIL’S PRICE?
When refineries ramp up production of gaso-
line, they use more crude oil. But because
50
of inventory taxes, it can benefit refineries
to use up their current supply on hand to
get this process underway, drawing down

MOORE RESEARCH CENTER, INC. (MRCI)

their current crude supplies for year’s end. 25
This means they hold off on forward pur-
chases, often resulting in slacking wholesale
crude demand and crude oil stock numbers
building. 0
This slack demand will often bring Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May
crude prices to their seasonal lows in the FIGURE 1: 15-YEAR SEASONAL AVERAGE PRICE TENDENCY FOR JUNE CRUDE OIL. There’s a clear
November–December time period. However, tendency for crude oil prices to rise as winter gasoline production ramps up. Keep in mind that past perfor-
once the new year begins, refineries tend mance is not indicative of future results.
to begin aggressively buying crude oil to
meet gasoline production needs into spring.
This is why you will often see crude prices EIA Weekly Total Gasoline Stocks
climb during the first half of the year. This Current Year vs. Last Year vs. Average
tendency is illustrated in the chart in Figure 270
1. As you can see, there’s a tendency for
260
crude oil prices to rise as winter gasoline
production ramps up. 250
Barrels in millions

240
WILL IT HAPPEN IN 2017?
There is no guarantee that crude prices move 230
higher from January into spring. However, 220
current conditions would seem to favor
normal cyclical occurrences taking place 210
at their traditional time of year. 200

THE HIGHTOWER REPORT

Gasoline stocks have fallen predictably
into November. True, both gasoline and
crude oil stocks have been higher in 2016
than in past years. However, these moves
led by seasonal demand have tended to
occur in past years regardless of net stock
levels (Figure 2). If history is any guide, we
can expect refineries to begin ramping up
gasoline production in early 2017.
190
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2016 Last 15-yr avg.
FIGURE 2: GASOLINE PRICE TRENDS. Gasoline stocks tend to fall during summer months and reach lows
near year’s end. By December, refineries are already ramping up production in anticipation of next year’s
summer driving season. Thus, demand for crude oil by refineries tends to rise into the new year. Supply
patterns in 2016, while higher on a net level, appear to be adhering to seasonal norms.

PLAN YOUR STRATEGY
Gasoline production is expected to begin cranking up toward
the end of 2016, and forward purchases of crude oil are likely
to accelerate into the January–February timeframe.
Of course, speculating on what will happen can be a fool’s
errand when trading markets. Betting on what won’t happen
can offer better odds, which is what traders are after. That
means you shouldn’t necessarily position for higher oil prices
(although if it does move higher, all the better). You should
only look to position yourself to profit if oil does not move
substantially lower.
Despite talk of OPEC deals in late 2016, sentiment in crude
oil was bearish. Such a scenario could present opportune
times to sell puts if you’re looking for the highest premiums.
Nonetheless, if you want options to expire worthless, you want
to sell puts at strikes below your lowest projected price level,
Continued on page 31
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 21
 N
early a decade ago, a
headline in a promi-
nent financial pub-
lication named Dan
Harvey “the super
trader of index condors.” I
know—I wrote the piece. Re-
cently, coming across some old
notes, I wondered what became
of him, and with a little digging,
I was able to renew contact.
Turns out, some 10 years
later, working with partner
and options veteran Tom Nu-
namaker, Harvey had moved on
from condors to a new options
trade model that he calls the
road trip trade (RTT). The
partners believe it is more
consistently profitable while
req
requiring less hands-on man-
agement (in the lingua of the
options trade, “adjustment”)
and th
thus affords more time for
road trips, hence the name.
T pair trades the SPX,
The
th index that follows the S&P
the
500, as well as ES futures
options and the Russel 2000
index (RUT), using the bro-
ken wing butterfly (BWB) as
the vehicle of choice. To this,
they add a sometimes coun-
terintuitive adjustment that
has been dubbed (not by him)
the reverse Harvey. That is the
“secret sauce” and a primary
and reliable means by which
profits are earned.
Goals are straightforward:
preserve capital, reduce screen
time to one or two looks a
The Secret Lives Of Butterflies
erflies day, and earn 7% to 15% per
trade.

A Road Trip With A LONGER TIMEFRAME

ROADSCAPE: MICHAEL URMANN/BUTTERFLY WING: ECHO/

Nunamaker and Harvey use

Options Supertraders weekly options in the SPX

or ES futures. They choose
SHUTTERSTOCK/COLLAGE: NIKKI MORR

expirations 70 to 85 days out.

The trades must pass a series of
Here’s a way to trade options that allows you to spend less time managing the trade and filters, or “entry guidelines,” to
more time to go on road trips. be launched. They plan ahead
to exit 15 to 20 days before
by John A. Sarkett expiration.
They add a new RTT posi-
22 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
 OPTIONS

tion every two weeks and typically Profit/Loss by Change in SPX Index Price
$
have four or five on at a time. This 30000 +240%
is time diversification—another way 27500 487/12,732 = 3.8% T+80 +220%
T+65
of spreading risk and this in turn 25000 T+0
+200%

helps create a smooth and highly 22500 Debit is under 5% of margin +180%
20000 +160%
desirable cumulative equity curve. +140%
17500
Another benefit of this approach: 15000 +120%
low drawdowns and the ability to 12500 +99%
sleep well at night no matter what’s 10000 +79%
7500 +59%
taking place in the market.
5000 +39%
That’s the theory and perspective. 2500 +20%
Mechanically, here’s how it works: 0 0%
The traders start the trade with a -2500 -487 -20%
-39%
broken wing butterfly (BWB) with -5000
-7500 -59%
the highest strike placed behind the -79%
-10000
market (Figure 1). For example, if the -12500 -99%
-12,732
SPX was at 2000, the BWB might -15000 -120%
1894.50 1909.50 1924.50 1939.50 1954.50 1969.50 1984.50 1999.50 2014.50 2029.50 2044.50 2059.50 2074.50 2089.50 2104.50 2119.50 2134.50
be placed at 1975/1930/1875. That -8.9% -8.2% -7.5% -6.8% -5.0% -5.3% -4.6% -3.9% -3.2% -2.4% -1.7% -1.0% -0.3% +0.4% +1.2% +1.9% +2.6%

is: long a 1975 put, short two 1930

FIGURE 1: BROKEN WING BUTTERFLY (BWB). When placing the BWB the highest strike is placed behind the
puts, and long an 1875 put. market. There’s more risk on the left side of the graph (lower wing) and less to the right (higher wing).
Notice that the distance between
the 1975 and 1930 is 45 and the
distance between the 1930 and 1875 Profit/Loss by Change in SPX Index Price
is 55. Thus, there is more risk to the 36000 $
downside of the short strikes than 33000 T+37
T+19
to the upside. This is what gives 30000 T+0
the trade model its “broken wing” 27000 Before adjusting
characteristic: more risk on the left 24000
21000 After adjusting
side of the graph (lower wing), less 18000
to the right (higher wing). 15000
A typical butterfly that is sym- 12000
metrical and balanced would have 9000
6000
the outer long strikes equidistant +654
3000
from the short strikes in the middle, 0
for example, 1950/2000/2050. The -3000
amount of maximum risk, then, -6000

would be the same if the SPX went -9000

-12000
to zero or 10,000. -15000
Note here that they are start- -18000 Margin nearly the same
1856.50 1876.50 1896.50 1916.50 1936.50 1956.50 1976.50 1996.50 2016.50 2036.50 2056.50 2076.50 2096.50 2116.50 2136.50 2156.50 2176.50
ing behind the market with the -10.8% -9.9% -8.9% -7.9% -7.0% -6.0% -5.1% -4.1% -3.1% -2.2% -1.2% -0.3% +0.7% +1.7% +2.6% +3.6% +4.5%
butterfly. Most options mentors
FIGURE 2: BWB AFTER CONCERTED UP MOVE. The reverse Harvey adjustment rolls in the long strikes to create
or authors teach placing the short a credit and generate a $654 profit. Simple, but counterintuitive.
strikes right at the market, and
then adjusting from there. There
are distinct advantages to the road trip trade placement, as achieve profitability to the upside by adding adjustments that
you will soon find out. lift the T+0 line down the road. (T+0 means time plus zero,
The timing of the entry is not critical, but the pair prefers or today’s real-time profit or loss. T+7 is the expected profit/
a down day when volatility is up because volatility tends to loss in seven days, for example.)
be mean-reverting over time and because the butterfly will Size is typically 5x10x5 or 6x12x6 contracts, but the strategy
usually be cheaper with a spike in volatility. is easily scalable to larger sizes. Trading a two or three lot,
such as 2x4x2, is also possible, and adjustments tend to be
PRICE MATTERS even less frequent.
Price is important, too. The entry debit must be less than 5% Once the initial trade is on, the SPX is closely monitored.
of the initial margin. For example, if there is $10,000 risk Harvey says, “We measure price movement relative to the
to the downside, the cost of the broken wing butterfly must launch price of SPX or ES and do an ongoing analysis of the
be $500 or less. If it is higher, it will become too difficult to volatility smile curve, specifically with regard to steepening
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 23
 slope or curve irregularities. Also,
$ Profit/Loss by Change in SPX Index Price
35000
we monitor other market data in-
32500 T+72 cluding the CBOE Volatility Index
T+36
30000
T+0
(VIX), CBOE VIX of VIX (VVIX),
27500 CBOE SKEW Index, historical and
25000
implied volatility levels, and VIX
22500
20000 Before adjusting futures.”
17500 After adjusting With a more or less sideways
15000 market, the traders are purposely
12500 slow to adjust. Typically, this is the
10000
“normal” state of affairs. Sans big
7500
5000 up or down moves (some market
2500 analysts maintain the market tends
0 to move sideways 80% of the time)
-2500
in the first 21 to 30 days, they will
-5000
-7500 Margin reduced strive to “leave it alone and let theta
-10000 (options decay) do its job and start
1868.70 1883.70 1898.70 1913.70 1928.70 1943.70 1958.70 1973.70 1988.70 2003.70 2018.70 2033.70 2048.70 2063.70 2078.70 2093.70 2108.70
-6.0% -5.3% -4.5% -3.8% -3.0% -2.3% -1.5% -0.8% 0.0% +0.8% +1.5% +2.3% +3.0% +3.8% +4.5% +5.3% +6.0% accumulating profits.” That is the
FIGURE 3: MARKET MOVES DOWN. A reverse Harvey put debit spread is added to flatten the T+0 line and “buy
optimal period for going on a road
time,” hoping the market can recover and stay “under the tent.” trip.
In addition, to boost premiums and
profits, they layer other, “smaller”
trades on top of the basic road trip trade if SPX or ES
moves up sharply after the trade is launched (Figure 2).
These are generally:
It’s better to trade on a down
day when volatility is up because • small butterflies just outside the expiration tent
volatility tends to be mean- • put credit spreads (usually with a 10 delta short
strike), or
reverting over time and the • an iron condor.
butterfly will usually be cheaper
with a spike in volatility. It takes a large market move to catalyze further ad-
justment on the large butterfly. A large down move will
typically cause the pair to add a long put debit spread,
which is more resilient to whipsaw
than a straight long put (Figure 3).
Profit/Loss by Change in SPX Index Price Removing emotion from the mix,
$
32500 +210% they don’t decide to do this in real
T+71
30000
T+36
+190% time, by the way. The protective order
27500 +170%
T+0 to add a put debit spread is entered
25000 +160%
22500 +140%
in advance as a good-till-canceled
20000 +130% (GTC) conditional or “trigger” order
17500 +110% at the SPX price point near the short
15000 +95% strike where the risk curve starts to
12500 +79%
turn back down from its high point
10000 +63%
7500 +43% in the middle of the profit zone. A
5000 +32% further move to the downside might
2500 +16% prompt the addition of one more
0%
0 debit spread hedge prior to exiting
-2500 -16%
-32%
or repositioning the trade.
-5000
-7500 -48% What if the market makes a whip-
-10000 -63% saw move back up—and tends to stay
-12500 -79%
1842.20 1857.20 1872.20 1887.20 1902.20 1917.20 1932.20 1947.20 1962.20 1977.20 1992.20 2007.20 2022.20 2037.20 2052.20 2067.20 2082.20
up? They manage this by taking off
-6.1% -5.4% -4.6% -3.8% -3.1% -2.3% -1.5% -0.8% 0.0% +0.8% +1.5% +2.3% +3.1% +3.8% +4.6% +5.4% +6.1% a put debit spread if the price falls
FIGURE 4: SOMETIMES YOU JUST HAVE TO TAKE A LOSS. The trade is exited as it is “behind the tent” for a $200 to 50% to 75% of the debit paid,
loss, against a string of $1,000 winners, and so the mathematical expectancy of the model is maintained. from either time elapsed or a market
24 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
 OPTIONS

move higher. For example, if a put Profit/Loss by Change in RUT Index Price
debit spread costs $2 they would $
30000 +240%
consider selling it when it declines 27500
T+70
+220%
T+60
$1.50 to $1.00. 25000 T+0 +200%
The current P/L is monitored 22500 +180%
20000 +160%
constantly. The traders will exit a
17500 +140%
position if the loss exceeds 4% to 15000 +120%
5% of utilized capital (Figure 4). 12500 +99%
They consider a situation like this 10000 +79%
7500 +59%
“one of the best trades” even though
5000 +39%
a loss. Consistent gains combined 2500 +20%
with very small and infrequent 0 0%
losses increase the mathematical -2500 -20%

expectancy, the point being to stay -5000 -39%

-7500 -59%
in the process, week after week, and -79%
-10000
not get obliterated. This is a key to -12500 -99%
their relative longevity and success- -15000 -120%
1109.30 1121.30 1133.30 1145.30 1157.30 1169.30 1181.30 1193.30 1205.30 1217.30 1229.30 1241.30 1253.30 1265.30 1277.30 1289.30 1301.30
ful track record. -9.0% -8.0% -7.0% -6.1% -5.1% -4.1% -3.1% -2.1% -1.1% -0.2% +0.8% +1.8% +2.8% +3.8% +4.8% +5.8% +6.7%

THE REVERSE HARVEY
What if the market makes a large up
move after the 21–30 days? Harvey
will use a move that was named in his honor (by options trader
Mark Sebastian)—the reverse Harvey, a nifty and counterin-
tuitive piece of market jiu-jitsu. Here’s how it works.
The long wings are rolled in toward the short strike in order
FIGURE 5: BABY BUTTERFLY. As the market moves higher, you add a “baby butterfly” to the right of the initial broken
wing butterfly. Over time, it raises the T+0 line and position profitability.
to generate a credit, and “lift” the T+0 curve to the right of
the “tent” (the profitability zone in the risk curve). The reverse
Harvey (RH) process is continued gradually, if necessary,
until the right side of the expiration curve is lifted above zero

 




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February 2017 • Technical Analysis of STOCKS & COMMODITIES • 25

 Profit/Loss by Change in SPX Index Price of completely repositioning trades
$
6300 +81%
during these markets.
5850 T+18 +75% “We are not really making money
T+9
5400
T+0
+70% on the spot when we are doing a
4950 +64% reverse Harvey, even though we are
4500 +59%
4050 +52%
receiving a credit,” Harvey notes.
3600 +45% “We want to ‘let the butterfly be
3150 +41% the butterfly’ for as long as possible,
2700 +35% but if the market is going to grind
2250 +29%
higher, we can extract profits along
1800 +23%
1350 +17%
the way, and even achieve a state
900 +12% where there is no longer any risk
450 +6% to the upside. That is the impetus
0 0% behind the reverse Harvey.”
-450 -6%
-900 -12%
What if the market continues to
-1350 -17% grind higher, as has often been the
-1800 -23% case since 2008? Harvey will layer
2060.40 2075.40 2090.40 2105.40 2120.40 2135.40 2150.40 2165.40 2180.40 2195.40 2210.40 2225.40 2240.40 2255.40 2270.40 2285.40 2300.40
-5.5% -4.5% -4.1% -3.4% -2.8% -2.1% -1.4% -0.7% 0.0% +0.7% +1.4% +2.1% +2.8% +3.4% +4.1% +4.8% +5.5% in smaller trades at a higher level.
FIGURE 6: IRON CONDOR. A long iron condor can also be layered in to increase profitability. For example, he will add a so-called
“baby butter,” a smaller-size butter-
fly to the right of the main position
as in Figure 2. This technique serves to generate at least a on the risk curve (Figure 5). For example, if the main posi-
small profit even in the event of a sustained and unrelenting tion is 6-12-6 contracts, the “baby butter” would be perhaps
rally. Many other butterfly strategies lose money in sustained a 1-2-1, a total of four contracts. Over time, this can boost
rallies, but the RH process seeks to preserve positive expec- returns with a very little increase in margin.
tancy by generating a profit even in strong upside markets. In Harvey notes the reverse Harvey can be employed to
addition, it avoids the labor-intensive and expensive process cut risk and margin requirement not just with butterflies,

RISK/REWARD DEFINITIONS by dividing gross profit by gross loss.

Calmar ratio—The Calmar ratio is a comparison of the av-
erage annual compounded rate of return and the maximum
drawdown risk of commodity trading advisors and hedge
funds. The lower the Calmar ratio, the worse the investment
performed on a risk-adjusted basis over the specified time
period; the higher the Calmar ratio, the better it performed.
Generally speaking, the time period used is three years,
but this can be higher or lower based on the investment in
question.
Sortino ratio—The Sortino ratio is a variation of the Sharpe
ratio that differentiates harmful volatility from total overall
volatility by using the asset’s standard deviation of negative
asset returns, called downside deviation. The Sortino ratio
takes the asset’s return and subtracts the risk-free rate, and
then divides that amount by the asset’s downside deviation.
The ratio was named after Frank A. Sortino.
Probability or risk of ruin—The probability of an individual
losing sufficient trading or gambling money (known as
capital base) to the point at which continuing on is no longer
considered an option to recover losses.
The risk of ruin is calculated by taking into account
the probability of winning (or making money on a trade),
the probability of incurring losses, and the portion of an
individual’s capital base that is in play or at risk. It’s also
known as the “probability of ruin.”
Mathematical expectancy—The return on an investment as
estimated by an asset pricing model. It is calculated by tak-
ing the average of the probability distribution of all possible
returns. For example, a model might state that an investment
has a 10% chance of a 100% return and a 90% chance of a
50% return. The expected return is calculated as:

Profit factor—The profit factor is defined as the gross profit
divided by the gross loss (including commissions) for the
entire trading period. This performance metric relates the
amount of profit per unit of risk, with values greater than 1
indicating a profitable system. As an example, the strategy
performance report shown in Figure 1 indicates the tested
trading system has a profit factor of 1.98. This is calculated
Expected return = 0.1(1) + 0.9(0.5) = 0.55 = 55%.
It is important to note that there is no guarantee that the
expected rate of return and the actual return will be the
same.
—John Sarkett

26 • February 2017 • Technical Analysis of STOCKS & COMMODITIES

but also with other options spreads such as iron condors
(Figure 6).
Interestingly, especially when the trader is long in the trade,
the reverse Harvey can often be achieved for a relative few
dollars. For example, a lower long put price might have col-
lapsed to 0.10–0.20, say, and the trader can roll up to higher
strikes for not much more, thus cutting the risk and margin
on the trade substantially, often as much as 50%. Again, this
does dampen maximum profit potential (the high point of the
butterfly triangle), but only slightly.
To summarize, the up market reverse Harvey rolls in the
wings toward the short strike and generates a credit. The down
market reverse Harvey adds a put debit spread. Both flatten
the T+0 line. They are done as partials of the main position
as the market moves.
LOW RISK, HIGH REWARDS
Complexity increases, too, in the sense that you wind up with
more strikes than the original three, and each of those with
a varying number of contracts. This is by design, remember,
and Harvey calls it “inventory.” As such, it is imperative that
you not do it too quickly, or too big vis-à-vis the original
position.
Next time, I’ll discuss a method that trader and educator
Jim Riggio, who currently specializes in options butterflies,
uses for covered calls.
WANG/USING CORRELATION
Continued from page 18
inter-asset correlation moves up, buy the S&P 500; when the
correlation moves down, sell the S&P 500. The correlation
strategy produced an 11.9% compounded annualized return
with relatively low market exposure and a small maximum
percentage system drawdown based on backtests completed
over the past 13 years. The system is relatively stable with a
Sharpe ratio greater than 1. What’s not to like about it?
Cassandra Wang studies patterns in the stock market. She
may be reached via email at wang_cassie@yahoo.com.
The reverse Harvey can be
employed to cut risk and margin
requirement not just with
butterflies, but also with other
options spreads such as iron
condors.
John A. Sarkett is the author of Option Wizards: Real Life
Success Stories From The Financial Markets And Market
Mentors (http://option-wizard.com). More on Tom Nunamaker
and Dan Harvey can be found at capitaldiscussions.com and
roadtriptrade.com.
FURTHER READING
Sarkett, John [2012]. “The Queen Of The Iron Condors,”
Technical Analysis of STOCKS & COMMODITIES, Volume
30: July.
[2009]. “Adjusting Option Trades With Bill Ladd,”
interview, Technical Analysis of STOCKS & COMMODITIES,
Volume 27: Bonus Issue.
[2009]. “Sizing Up For Success,” Technical Analysis
of STOCKS & COMMODITIES, Volume 27: December.
FURTHER READING
Katsanos, Markos [2008]. Intermarket Trading Strategies,
John Wiley & Sons.
Murphy, John [1991]. Intermarket Technical Analysis: Trading
Strategies For The Global Stock, Bond, Commodity, And
Currency Markets, Wiley.
Philips, Christopher, et al. [2012]. “Dynamic Correlations:
The Implications For Portfolio Construction,” Vanguard
Research, April.
Williams, Stacy, et al. [2010]. “Risk On–Risk Off: The Full
Story,” Currency Quant Special, FX Quantitative Strategy,
HSBC, November.
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 27
 A Tale Of Two Indicators
Beyond The Hull
With Leavitt Projections
They’re predictive and have no lag. What are these indicators
and where can you find them?
by Jay A. Leavitt, PhD
llow me to introduce you to two indicators that
A could make a difference. One of the indicators is
comparatively faster than the Hull moving average.
The second indicator is even faster than the first;
it indicates when a trend is weakening and is also
predictive. And to top it off, I’ll describe a probability func-
tion that can sharply identify turns in the market, which will
increase your odds of making successful trades.
28 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
LINEAR REGRESSION AND THE
HULL MOVING AVERAGE
The Hull moving average (HMA) was introduced in 2005
by Alan Hull. According to Hull, “The Hull moving average
solves the age-old dilemma of making a moving average more
responsive to current price activity whilst maintaining curve
smoothness. In fact, the HMA almost eliminates lag altogether
and manages to improve smoothing at the same time.”
Since its introduction, the HMA has found popularity with
NEX999/SHUTTERSTOCK
stock, options, and currency traders. Effectively, the HMA is
faster than all other moving averages and is smoother. Because
of this, many accept that a bull trend is determined when only
two consecutive points on the HMA indicate a rising market
 INDICATORS

and conversely, a bear trend when falling. The speed of SPY Weekly Inputs
the HMA is the square root of its length. Meanwhile,
the speed of a simple moving average is much larger Indicator Operation Source Length
at half its length. WMA Price 25
The HMA employs a weighted moving average in WMA Price 13
its construction. But for the development of the new
Hull Interpolation 2*WMA[13] - WMA[25]
indicators, linear regression replaces that role. It is a
smoothing process where data is rendered as a straight Hull Moving Average WMA Interpolation 5
line. Its leading edge is used to represent the current Leavitt Projection Linear Regression Price 25
price. This rendering has zero lag. Its intercept, b, in
Leavitt Convolution Linear Regression Leavitt Projection 5
the line equation y = mx + b, will be central in what
follows. FIGURE 1: CONSTRUCTING THE HULL MOVING AVERAGE
The linear regression line, LRN, is constructed from
N consecutive data points, (y[0],1), (y[1],2), …, where
LRN[1] corresponds to the price, y[0]. The plot of LRN[1] Typically, the relative position of a moving average to the
acts and looks like a moving average. However, there are underlying is an indication of whether it is bullish or bearish.
differences between it and moving averages. For example, a Being below the underlying is bullish. But this analogy does
moving average plots below a rising curve; often, the plot of not apply to linear regression; the sign of its slope of its suc-
LRN[1] does not. Simple crossover studies with it have not been cessive points is all that matters. A positive slope indicates
productive. In spite of these reservations, linear regression is a bullish trend. For example, in the enlargement in Figure 2,
central to the two new tools. the dotted line is the linear regression of the red curve. From
Constructing the HMA is a three-step process. First, two November 1, 2015, the dashed curve is above the rising red.
weighted moving averages (WMA) of the data are calculat- The Leavitt convolution is the intercept of the linear regres-
ed—one of length N and one of length
N/2. Next, an interpolation of the data
149 SPY Daily
is formed, 2*WMAN/2 – WMAN. This
formulation of the data is smoother than 147 Linear Regression vs Hull
the original. Finally, the weighted moving Length = 9 bars
145
average of length √N is calculated from
the interpolation. This is the HMA. See 143
the table in Figure 1 for an example of
141
its construction. SPY
Hull
Figure 2 is a snapshot of SPY and the 139 Interpolation
Linear Regression LRg[1]
derived curves. The dashed line is the
Hull interpolation of the data source, 137
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 31
SPY, which is shown in black. Clearly, the FIGURE 2: SPY AND ITS DERIVED CURVES. Here you see 31 bars of daily SPY data, its moving linear
interpolation is smoother than SPY. regression, Hull interpolation, and Hull moving average.
The Hull moving average is plotted
in red. The yellow curve, labeled linear SPY Weekly
regression, is the plot of LRN[1]. The 250
HMA and linear regression are smoother
than the Hull interpolation. So far, neither SPY Hull
200
of the two displays an advantage of one
over the other. Projection Convolution
150

THE LEAVITT PROJECTION AND

CONVOLUTION 100
You can use the Excel function LINEST
to calculate the linear regression line. 50
LINEST returns the line’s slope and inter-
cept, LRN[0], a one-bar projection of the 0
7/08

7/09

7/09

7/10

7/10

7/11

7/11

7/12

price. This sequence of intercepts is the

7/12

7/13

7/13

7/14

7/14

7/15

7/15
11/0

05/0

11/0

05/0

11/0

05/0

11/0

05/0

11/0

05/0

11/0

Leavitt projection. Similar linear regres-

05/0

11/0

05/0

11/0

sion functions are available in LibreOf- FIGURE 3: LEAVITT PROJECTION, LEAVITT CONVOLUTION, AND HULL MOVING AVERAGE. Here you
fice Calc, TradeStation’s EasyLanguage, see the plot of SPY weekly data from 11/7/2008 to 12/24/2015. The Leavitt projection and Hull moving average
thinkorswim, and Matlab. is of length 25; the Leavitt convolution is of length 5.

February 2017 • Technical Analysis of STOCKS & COMMODITIES • 29

 Dividing the Market on October 9, 2015; projection on October
16, 2015, and the HMA two weeks later on
Idealized Market Waves Convolution with Index October 30, 2015. This speed relationship
Forms 4 Areas is maintained throughout the study.
The relationship between the projec-
Bull Bear tion and convolution provides additional
information. Their crossovers are signs of
Convolution < Index Convolution < Index a weakening trend prior to a convolution
Index
Convolution Greatest Likelihood Least Likelihood reversal. The convolution crosses over
Winning Trade Winning Trade SPY on November 6, 2015; both indica-
Market Wave Detail Least Likelihood Greatest Likelihood tors keep rising. However, the trend of the
Reversal Reversal underlying SPY begins breaking down.
Weekly data provides a stable, unbiased,
Convolution Gray area Convolution > Index Convolution > Index and unemotional basis for determining
Bull
Least Likelihood Greatest Likelihood market direction. Applying the Leavitt
Gray area
Winning Trade Winning Trade convolution to it shows promise as a
Convolution
Bear Greatest Likelihood Least Likelihood
market timer.
Reversal Reversal
Index Convolution
DIVIDING THE MARKET
The behavior of the convolution allows
FIGURE 4: DIVIDING THE MARKET. Here you see a representation of ideal market waves, details of the four
component parts of the market, and an analysis of each of the four areas. you to refine your analysis of the market
into four regions. Think of the image
Convolution Linear Convolution Below Strategy of the idealized market waves seen in Figure 4 as
# an idealization of Figure 3. The market is, overall,
Trend Regression Trend Linear Regression Signals
gradually rising. Each wave rises slowly, followed by
1 Bull Bull True Aggressive Bull
a sharp decline. In the real world, the index is noisier
2 Bull Bull False Conservative Bull along with the relative lengths. The magnitude of the
3 Bull Bear True Threat rises and falls in the wave are not uniform. However,
this model serves its purpose.
4 Bull Bear False Caution
On the market wave detail chart you see how each
5 Bear Bull True Caution wave has four component parts: bull, convolution
6 Bear Bull False Threat rising in green, or bear, convolution declining in red;
convolution above or below the index, gray.
7 Bear Bear True Conservative Bear
The right side of Figure 4 provides an analysis
8 Bear Bear False Aggressive Bear of each of the four areas. If you know these areas,
FIGURE 5: PARTITIONING THE MARKET WAVES. Here you see the various strategies derived you’ll be able to develop different trading strategies
from partitions created by the projections. for each. When the market is clearly rising or falling
(red and green areas), the strategies you use during
sion, length, of the Leavitt projection. It is shown as the dotted those times can be more aggressive, that is, you take higher
line in Figure 3. The Leavitt projection, plotted in red, and risk. When the market is in the gray areas, your strategies
the HMA, plotted in green, use the length parameter 25. The would be conservative.
length parameter of the Leavitt convolution is 5. The speed of the representation is important. With slower
The plot of the convolution in Figure 3 is similar to the other speeds, the gray areas reduce to whipsaws or are nonexistent.
two derived curves. It’s difficult to see any significant distin- This applies to moving averages and even linear regression,
guishing characteristic. They all appear smooth. However, the where the representation corresponds to the current price.
detail in the enlargement in Figure 3 reveals differences in The areas can be divided again by taking the trend of the
their relative speeds. The convolution signals a trend reversal linear regression into consideration. The linear regression
is used as a proxy for the index. This yields eight areas as
shown in the table in Figure 5. Lines 1 & 2 and 7 & 8 of the
table correspond to the strategies described in the market
When the market is clearly rising wave detail. The left side of the market wave detail chart
or falling, the strategies you use exhibits the reasoning behind the exits. When the trend turns
during those times can be more bearish, it’s a warning signal that the market direction might
reverse. This is the justification for the assignment of caution
risky or more conservative. in Line 4. Line 3 has even more compelling evidence that
the market will turn.
30 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
TRADING WITH PROBABILITY 1850 1
At each bar, i, the linear regression routine 0.9
finds the two parameters for the straight Conv
1750
0.8
line: Prob
0.7
1650
y = mix + bi 0.6
1550 0.5
Standard deviations can be calculated from 0.4
the sequence of slopes, {mi}, and intercepts, 1450
0.3
{bi}. Each standard deviation has a cor-
responding probability. Figure 6 shows 0.2
1350
an example of the convolution probability 0.1
function derived from the Leavitt convolu- 1250 0
tion. A large rise in the probability often 0 10 20 30 40 50 60 70 80 90 100
precedes a market fall, with the reverse FIGURE 6: A SMALL PIECE OF THE PIE. A large rise in the probability often precedes a market fall, with
forecasting a bullish move. the reverse forecasting a bullish move.

WRAPUP
The Leavitt convolution is a unique forecasting tool. One
of its strengths is that it determines the trend faster than the
Hull moving average. Beyond its speed, its greatest asset may
be its potential in the development of new trading strategies.
The ability to forecast implies the signals shown in Figure 5
will be flagged earlier than with contemporary entry & exit
strategies. New errors may be introduced as a consequence
of false projections, and it remains to be seen if the Leavitt
convolution features will outweigh them.
The 2013 Nobel Prize in Economics was awarded to three
Americans who, working independently of each other, came
to the same conclusion. In the short run, no matter your
source of information, the odds of having a winning trade
are only 50/50. Adding the convolution probability function
to your decision-making can increase the odds of having a
winning trade.
Jay Leavitt has a master’s and PhD in applied mathematics
from the Courant Institute of Mathematical Sciences, and
attended the University of Italy at Pisa on a Fulbright Scholar-
ship. He has been active as an advocate for the disabled and
served on multiple commissions. He taught mathematics and
computer science at the University of Minnesota and has since
retired from SUNY at Buffalo as director of academic comput-
ing. He now develops computerized trading systems.
FURTHER READING
Gardner, Max [2010]. “Trading Indexes With The Hull Moving
Average,” Technical Analysis of STOCKS & COMMODITIES,
Volume 28: December.
Hull, Alan. “How to reduce lag in a moving average,” http://
alanhull.com/hull-moving-average.

CORDIER & GROSS/CRUDE OIL
Continued from page 21
which could be as low as $35 per barrel.
As options sellers, you are looking to collect premium. Can
you collect enough premium by selling June crude oil $30
puts? If not, you can consider selling strike prices at $35 or
below for June or July contracts. Any price weakness could
provide opportunities for entry.
While seasonal tendencies are not perfect, they can be
a powerful tool in your trading arsenal, especially when it
comes to physical commodities. Combining them with a
high-percentage strategy such as option writing can bring
both consistency and high yields to your portfolio. The 2017
winter crude oil market is a good place to start.
James Cordier and Michael Gross are coauthors of The
Complete Guide To Option Selling, currently in its third edi-
tion. They are also portfolio managers with OptionSellers.
com, a wealth management firm specializing exclusively in
option-selling portfolios. More information on their strategy
and portfolios can be found at www.OptionSellers.com.
FURTHER READING
Cordier, James [2016]. “Option Writing And Seasonal Ten-
dencies In Nat(ural) Gas,” Technical Analysis of STOCKS
& COMMODITIES, Volume 34: October.
Cordier, James, and Michael Gross [2015]. The Complete
Guide To Option Selling, 3d edition, McGraw-Hill.
Gopalakrishnan, Jayanthi [2015]. “The Sell Side With James
Cordier,” interview, Technical Analysis of STOCKS & COM-
MODITIES, Volume 33: February.
‡Moore Research Center, Inc. (MRCI); ‡The Hightower Report
‡See Editorial Resource Index
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 31
 INTERVIEW

It’s A Marathon, Not A Sprint

Former futures broker, book publisher, and author Ed Dobson always had a
calling for the markets. He never lost that interest or stopped trading, despite
becoming busy with his brokerage career and publishing business, knowing
that one day he’d get back to trading more actively. Through the years, he con-
tinued to study charts, research spreads, write and publish books on trading,
and assist his clientele of active traders. He served as a broker at H.S. Kipnis,
Harris Upham, Smith Barney, and PaineWebber. He launched Trader’s Press
in 1975 to connect with traders and to publish educational books and materials
on trading and investing. He gave that up in 2009 to return to the path that he
first embarked on when he was just 12 years old and turned his full attention
to trading the markets.
Dobson has written or cowritten nine books on trading. His trading centers
on options strategies but he trades all markets. He leads a local traders’ group
in South Carolina. He can be reached at charttrader@charter.net.
STOCKS & COMMODITIES Editor Jayanthi Gopalakrishnan spoke with Ed
Dobson on December 12, 2016 about how many years of looking at charts
gives him a feel for the markets, what he doesn’t pay attention to, and about
the spread and options strategies he uses, including overlapping condors, “Trade what you see, not
Christmas tree spreads, and short-term calendar spreads.
what you think.” That’s an
old saying and it may sound
Ed, what got you interested in and sold them for $2,000. That experi- corny, but that’s my motto.
the financial markets? ence was probably what really got me
I was always a saver. By hooked on the idea of trading.
the time I was 12 years old I had some Through high school, I traded stocks
savings. My dad was a businessman and and worked up to 30 to 50 shares at a put that aside to pursue other oppor-
he introduced me to stocks. Since I had time. By the time I was in college, I was tunities?
some money saved up, he thought he’d trading 100-share lots. By the time I Yeah, I have always traded. While I
tell me about stocks. He recommended was a senior in college, I got started on was in college, I traded fairly actively. I
a Jacksonville grocery store and a futures, and I went on from there. went to Davidson College, 20 miles west
building supply company. So I bought of Charlotte, and majored in economics
20 shares of each and made a profit on So it sounds like your dad got you and business. When I was a senior and
them. That was enough to whet my ap- interested in stocks when you were got interested in futures, I would cut
petite. So that’s how I got interested in 12 years old, which led to peripheral classes on Friday afternoon and drive
the stock market. hobbies like collecting coins, collecting into Charlotte and go to the Bache of-
Trading stocks led to collecting stamps stamps, and so forth. fice, and I’d sit there and watch the tape.
and coins. When I was in high school, Yes, I can say my dad got me started. I was trading pork bellies, sugar, potatoes
besides trading stocks I also traded rolls But what really got me going was when and other futures markets. I had a broker
of BU coins. I was buying proof sets from I got interested in the proof sets, and there whom I thought was really cool.
the US mint every year for $2.10 before trading coins back and forth with others He was only 24 years old and he recom-
they were minted. 1964 was the last who had similar interests. I joined a local mended a few trades to me that worked.
year that the coins contained silver. The coin club, attended all their meetings, So I was already charting commodities
1964 proof sets were already trading for and started making money buying and in my senior year in college and driving
$20 before my sets were even delivered selling coins while still in junior high into Charlotte to trade.
to me. As soon as I got my proof sets school. After college I was in the US Army
delivered—I had ordered 100 of them, and couldn’t do much trading then. I was
for which I paid $210—I turned around Have you always traded, or did you in Vietnam for a year. But even when I
32 • February 2017 • Technical Analysis of STOCKS & COMMODITIES

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I consider trading the
perfect business, and
it’s best if you work in
the perfect location to
minimize your distractions.
was in Vietnam, I would receive charts in
the mail from a charting service. While I
was there I paper traded. I couldn’t place
any real trades, but I did the best trading
I’d ever done up to that point in my life
because I was trading on paper, which
didn’t involve any emotions. I did quite
well trading strictly from charts without
any noise such as news, reports, or any
other fundamental data.
I had decided, while in college, that
I wanted to be a broker. While I was in
Vietnam, I sent out over 150 resumes
to every broker in the New York City
area. That’s because my wife was work-
ing on her master’s degree and living
with her parents just across the bridge
from New York City in New Jersey. I
tried to get interviews lined up while I
was in Vietnam. I ended up getting an
interview with a company named Kipnis
Commodities. I started working there
with a guy named Gerald Gold, who, in
1959, had written one of the first books
on futures trading.
That was my first career job. The
company was based in Chicago but also
had offices in New York, San Francisco,
and Washington DC. I worked
in their New York office for four
years as a futures-only broker.
After that I came to my
senses and moved back to my
home state, South Carolina,
and lived near my hometown.
I joined Harris Upham in 1973.
I stayed with them (and Smith
Barney, into which they merged)
until 1980 then went to work
with PaineWebber. I was with
PaineWebber until 1992. In the
meantime, I launched Trader’s
Press in 1975 and started writing
books based on my own research
on spreads. While I was in New
York, I did research by hand on
commodity spreads going back
34 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
into the 1950s and 1960s. You
may remember my first book
was on spread charts (Commod-
ity Spreads: A Historical Chart
Perspective) and I published
that book in 1975. That was the
beginning of my book publishing
career and Trader’s Press.
What led you to the book publishing
business?
My initial goal was to put me in touch
with other traders who might become
prospective clients. For years, I published
books with the idea of generating leads
for myself as a broker. It helped me
develop an extensive clientele of active
traders. But I couldn’t trade effectively
for myself because as a broker, I would
receive hundreds of phone calls a day.
And even though I diversified into other
areas like financial planning, annuities,
and insurance, I couldn’t trade very
actively—I was so busy being a broker
and running my publishing business
at the same time that it “handicapped”
my trading. My publishing business
grew to the point that I was able to
leave PaineWebber in 1992 and pursue
it full time.
So while I’d always had an ambition
to become an active, independent trader,
I was stymied by being so busy, first as
a broker and then as a publisher, which
meant I had to travel and also stay fo-
cused on running the business. So I didn’t
become an independent, active trader
until just a few years ago, but I’ve had a
lifelong love for trading and the ambition
to be an independent trader.
What led you to make that life-chang-
ing decision to become an independent
trader?
I think I had already decided much
earlier on. It was just a matter of getting
to a point where I wasn’t bogged down
running the business. You need to have
the time to devote to the market and to
watch it. I sold the publishing business
in 2009 and since then I have been trad-
ing much more actively. Mind you, I had
traded for over 50 years up to that point.
I’ve traded all the futures markets. I even
started trading options when I was in
New York, before the CBOE was formed
in 1973. I traded a few over-the-counter
options for my own account when I was
a broker in New York back in the early
1970s. I’ve always had a special interest
in futures and options. Although I have
traded individual stocks, I now primarily
trade indexes and options positions.
The one major aspect of trading that
draws me to it is the challenge associ-
ated with trading. It’s well-known that
most people who try to trade for a living
end up failing, which is why I’ve always
considered it a great challenge and one
that I wanted to accept.
I have always held myself out to my
book customers and brokerage customers
as being one of them—that is, a fellow
trader. It was just that I didn’t have the
time to be a full-time trader. So I
felt like I always wanted to make
good on what I told people, and
that is that I am a trader. I wanted
to be able to do it seriously.
One other thing—and this may
be the main thing that helped me
decide to become a trader—is
that I consider trading to be the
best business in the world. It’s
been said before, but it’s true:
You can be your own boss, you
can trade from anywhere in the
world, you can enter and exit at
will, you have no employees, you
can acquire or dispose of your
inventory with a mouse click.
It’s the perfect business and it’s
best if you work in a location to
minimize your distractions.
My wife Donna and I live on a beautiful
13-acre lake right in the middle of town
but in a quiet, secluded neighborhood.
I’ve always had a dream of having a
place with solitude and quiet because I
like to trade in a vacuum. Under all cir-
cumstances, I want to avoid hearing any
opinion from anybody else or anything
that distracts me. I built a little 16x16 of-
fice 10 feet off of this lake and I sit here
with 4x8 picture windows counting ducks
and watching the geese. I built myself Newly Redesigned Software for
this 260 square foot trading office just
for the purpose of trading away from my Futures, Forex & Stock Traders
house. I don’t think I could trade effec-
tively with all the distractions of home.
This was another way that I prepared
for trading.
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sure the trading business still comes
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and how have you overcome them? Modern user interface with simplified navigation
Well, let me put it this way: When I Major charting enhancements
first started trading futures, it took me
about six months to lose all my savings. Up to 10X speed improvement in backtesting
I lost all of it, which in 1966 was about Add custom columns & indicators to SuperDOM
$10,000. That was everything I had. My Historical bid/ask data
attitude was that I was at a poker game,
and I was the patsy. I didn’t know what Expanded C# development support
I was doing. So I told myself that I was
going to learn the rules and come back
and learn to play poker better.
I actually spent many years in the
red, but I don’t give up easily. I always NinjaTrader 8 is always FREE to use for advanced
had this passion for trading, but I lost
charting, strategy backtesting and trade simulation.
money consistently for years. It may not
have been a lot, typically something like
$5,000 a year. I would save up money
and then lose it. I would save up again at trading? don’t put any effort into learning their
and lose it. But it was my passion and I would say it’s primarily because own emotions, how to control them, and
I wanted to succeed in it. It was a long of emotions. I think most people who how to deal with fear and greed.
time before I became profitable. study trading spend most of their time
studying a method or system. There That’s a good point because those emo-
It sounds to me like the money you are three elements to trading: There’s tions are always going to be there. You
lost was more like an investment in the system or the method, there’s the can’t get rid of them.
learning. element of money management or risk Yes, they are. When I was in the bro-
Yeah, someone interviewed me about control, and there’s the emotional aspect. kerage business, which was a period of
30 years ago and I termed the money I I think most people spend 80% of their about 23 years, I had clients who traded
had lost as something along the lines time studying the method or system, or futures and options. I met some really
of “my payments to the school of hard how to choose what to trade and how smart people. I had clients from all over
knocks.” to time it, and completely neglect the the country, many of whom were very
emotional aspect. And I think the reason intelligent. They had done their home-
Why do you think so many people fail most people lose money is because they work, they did their research, they had
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 35
 their own system. I would say 98% of of the day I spend at the gym or walking you would like all the losers and take all
the people I ever dealt with, despite all or doing yard work, and I monitor my those trades and avoid all the winners
the work they did and despite their high positions on my phone. because you didn’t like them!
IQs, still lost money. And when you look
at their P/L figures, you’re likely to think Let’s talk a little bit about how you Earlier, you mentioned that you trade
it may be people who haven’t studied trade. Are you a systems trader or are options on the indexes. Do you look at
or haven’t done their homework, or that you a discretionary trader? charts and identify specific patterns to
they don’t have a method to their mad- On a scale of zero to 100, with zero make your trading decisions?
ness. But the reality, in my experience, being fully systematic and 100 being No, I have a different approach. There
is that it has more to do with managing fully discretionary, I would say I’m about are some trades that I do almost every
emotions. Anyone can fall prey to fear 95% discretionary. week, continuously, regardless of what
and greed. the markets are doing. And one of them
As a discretionary trader, what do is a strategy I call a Christmas tree. It
What’s your typical day like as a you look at when making trading involves something that I call “overlap-
trader? decisions? ping condors.” I basically trade condors
When I started, I used to sit and watch As you know, my email handle is where I don’t pay anything for them. It’s
the screen all day, but I don’t do that “charttrader.” So I primarily choose difficult to explain, but I’ll try. Let’s say
anymore. I keep an eye on the futures trades based on chart patterns and vol- the S&P is at 2200 and I think there’s
ume analysis. I’m primarily a chance it might sell off in the next
discretionary, but I do have a week—I place my options trades with
I’m not a system trader but few mental guidelines, such as no more than seven days to expiration.
I know what the rules are, mental stops. But I don’t have And as an example, I’ll buy a 2090 put
any hard-and-fast rules. In fact, on the SPX. You know, that’s a $100
and I follow the rules. I would find it very difficult to multiplier, and it’s like trading 10 options
sit down and write about how on the SPY. I’ll buy a 10-point vertical
I trade. I guess you could say I spread, like a 2190/2180. There’ll be a
at night since I primarily trade the stock trade based on my many years of sitting certain cost for that vertical spread. And
indexes. I trade options strategies on the there watching charts and getting a feel then I’ll go lower. Say the cost for that
stock indexes, primarily the S&P and the for markets and chart patterns. 10-point spread is two points because
Russell. So I watch the futures pretty You know the term déjà vu? When I it’s 10 points out-of-the-money (OTM).
closely, and I watch gold and oil—all the see a pattern or a reversal day on high I will go down to a lower strike price
things that are constantly in front of you. volume, I recognize them. I don’t like and sell a naked option to pay for that
I’m usually at my desk for the first 30 using systems because they force you to vertical spread, and still leave some
to 60 minutes of trading so I can watch take arbitrary rules and you have to take credit. So it may cost two points for the
it on my desktop with multiple screens. trades that you really don’t feel confident 10-point spread 2190/2180. Then I’ll go
I’m trying to wean myself away from about. I won’t say I don’t have discipline. down and maybe sell a 2150 put. Because
spending all day in front of the screens. I do have discipline in getting out of of the vertical skew on the put options,
I’ve set goals for myself and am on a mis- losing trades. But I don’t think I would the 2150 sale might be enough to pay
sion. I’d say I spend two to three hours a have the discipline to follow a system for the 2190/2180 vertical and still leave
day watching the screens, watching the where you take every trade the system a credit. So I will do that, and then go
charts, and looking for trades. The rest tells you to take. Murphy’s Law says that down and buy a fourth option and buy
something for a nickel, something that
is way deep OTM. So there’s the first
CALCULATING BREAKEVEN POINT ON The tree involves a put vertical 1605- (put) condor.
THE “TREE” AT EXPIRATION 1595-1585. The downside breakeven I may have $0.40 or $0.50, which is $40
The original three-legged position is $1575.35. If SPX goes below 1595, or $50 per spread left over. Then I will
involves buying a “debit” vertical (two you’ve already made a profit of $1,000, go down and buy a 2155/2145/2135/2125
legs) plus the sale of a further out-of- which is the distance between 1605 put condor. So there’s a 10-point condor
the-money (OTM) same-side option and 1595. The short put at 1585 starts way deep, two standard deviations OTM
to pay for the vertical. If the position to lose when SPX is below 1585. But for a seven-day time period. But that
moves in the profitable direction past the the first 10 points are “covered” by the protects your naked option (the short
extreme end of the purchased vertical, profit already made on the 1605-1595 2150 put). You’re basically naked on one
the breakeven point is the width of the vertical. 1585 – 10 points = 1575. Add option, even though technically, you’re
vertical strikes added to the extra sold the $35 paid for the vertical and you not. So I can do this in my IRA as well
option plus any debit paid for the tree. get $1575.35. as in my personal account. Basically,
Here’s an example. Say SPX is at 1616. I’ll go down and buy a second condor
36 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
to protect the naked option in the first
one. Essentially, I’ve set myself up so
that if the market sells off, I’ve got a
good chance of making some significant
money, maybe $1,000 per spread, but I’ve
got no money out of pocket. I call that
“overlapping condors.”
That’s one of the strategies I do almost
every week. And it works better if volatil-
ity is high. When you’re trading the S&P,
volatility is measured by the VIX.
I also trade broken-wing butterflies,
which I trade a little further out. I trade
them very short-term and if volatility
is under 15. If volatility is over 15, I’ll
do them a little further away in time,
maybe two to three weeks or a month
even. That’s because when volatility is
higher, you can get a wider butterfly. If
the volatility (the VIX) is under 15, I just
keep everything under 10 days.
I also trade short-term calendar
spreads in the indexes, typically with
nine days on the short side and 23 days
on the long. I don’t do these trades every
week; I prefer to do them when volatility
is low. A lot of my trade decisions are
based on volatility levels. I’ll do some
strategies when volatility is high, and
other strategies when volatility is low.
I’m always watching the markets.
I scan through the new highs and the
new lows on Barchart.com every day. I
like to do that on stocks under $10. I’m
always looking for something that’s had
a flat-base breakout on high volume, up
or down, and then I go with it on the
second day if it looks like it’s going to
hold the breakout.
So you do these in addition to trading
the indexes.
Yes, I trade a lot of different markets
and strategies. I may have on 20 trades
but I primarily trade those complex op-
tions strategies that I just talked about
on the Russell and SPX. I love trading
these complex options strategies because
of the multiple metrics, and I consider
that a challenge. When you buy or sell
stocks, it’s a matter of “heads, you win;
tails, you lose.” But with options, it’s
more of a challenge, and part of the
reason I love to trade is because of the
challenge. When you’ve got five metrics
(the greeks—delta, theta, gamma, vega,
and rho) you’ve got to worry not just that I watch is price because that’s all
about price direction, but you’ve also that really counts. Most indicators are
got to worry about volatility, delta, and price derivative. I believe in the KISS
all the other metrics. principle (keep it simple).
Another criterion is I look for high
liquidity. I don’t trade anything unless it’s Once you enter your trades, how do you
got good liquidity because I don’t want a manage your open positions?
situation that I can’t get out of quickly and Well, I do have a few rules. For ex-
easily. And I love the diversification of ample, if I get into a calendar spread, I
indexes, because you don’t have to worry take a maximum 15% loss. That’s a debit
about surprise events or earnings. trade, so if I have a 15% loss, I’m out.
I’m typically in many of those calendar
You said you like to use charts. Do you trades no more than two to three days.
use any technical indicators to make What you don’t want to happen is to get
your trading decisions? into one of those trades and then have a
My primary entry and exit decisions sudden sharp move. For example, I got
are based on chart analysis and trends. into one a couple of days ago when the
When I consider a trade, I monitor and S&P was at 2213. I paid $8.65 for the
look at four timeframes. I look
at the five-minute, 30-minute,
daily, and weekly charts. On Trade only with pure risk
each of those, I look at Bollinger
Bands, and I’m interested in
capital. Use a trading
the direction of the center line, platform you know well.
which is the 20-period simple Learn it thoroughly. Don’t
moving average. If it’s up on the watch too many inputs.
daily and weekly chart, then my
bias will be to go long and if it’s
down, I’ll look to go short. spreads, and the next morning we had
I don’t use a lot of indicators. Another that huge move up. I was out to lunch
indicator I find to be very helpful is the with a friend, and as soon as I saw that,
stochastic momentum indicator, and I I got out right away. I think I lost 8% on
look at it on all timeframes. Occasionally that one. Usually I’ll wait for 15%, but
I will glance at ADX, and at volume, but if there’s a big sudden move that’s 30
that’s about it. points away one way or the other, I’m
You’ve heard the term “analysis out. It’s sort of like a stop-loss.
paralysis”? One thing I caution people Since you can’t put a stop-loss on
not to do is watch too many things a calendar, I just have to monitor it. I
because that’ll just get them confused don’t really have any hard-and-fast rules
and induce analysis paralysis. That’s on how to manage my positions; I just
because one thing will not necessarily play it by the “seat of my pants,” you
confirm another, so you can never come could call it.
to a conclusion. The primary indicator Every trader has their strengths and
weaknesses. I think my strength is in
reading charts and having the ability to
know when to get out of a trade just by gut
feel. I would say that one of my biggest
shortcomings as a trader is that I have
trouble sitting with winning trades and
letting them become big winners. I have
no trouble taking losses because I have
a very healthy respect for risk. But I’m
also scared of losing a profit (there’s that
“fear” emotion), so I tend to take profits
too soon. That’s a big issue for me.
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 37
 But that forces you to be right on a
high percentage of your trades. What
are some words of advice to those who
want to make that leap into becoming
an independent trader?
The first piece of advice would be
to read and study a lot of good books.
I won’t name any specific ones. I did
that for 35 years. My primary goal and
ambition with Traders Press was to
help other people become self-directed,
independent traders as opposed to rely-
ing on brokers’ advice or on advisory
services. I feel like I spent many years
trying to help people become indepen-
dent traders.
The next advice would be to paper
trade before trading with real money.
But be aware that when you paper trade,
there are no emotions involved. It’s is a
totally different ball game when you get
emotions involved. It will not be nearly
as easy. I would advise them to, at all
costs, avoid the influence of outside
opinions. I trade in a vacuum—I don’t
want to hear anyone else’s opinions.
I consider that dangerous because it
tends to give me a bias toward the
market. “Trade what you see, not what
you think.” That’s an old saying and it
may sound corny, but to me, that’s my
motto. If you see something that you
didn’t expect, then you’ve got to respect
it because the market, not you, knows
CHRISTMAS TREES WITH INSURANCE
When playing the Christmas tree strat-
egy, there are a few things you have to
take into consideration. Playing trees is
an art, not a science. There is no slick
spreadsheet analysis available, and you
have to keep in mind that portfolio
margin can have an effect on the extra
sold option.
Doing a tree at the current price often
yields a credit (which can be spent on
insurance) but also brings the breakeven
point closer to its current level and incurs
larger risk.
The tradeoff is that if the expected
move is relatively small, profit starts to
accrue almost immediately.
Because of positive volatility skew on
puts, trees using puts are usually cheaper
and have a breakeven point farther away
38 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
what it wants to do.
Most of the other things I The primary indicator I
would recommend involve
the standard advice: Trade
watch is price, because
only with pure risk capital, that’s all that really counts.
I’d say at absolute maximum
20% of your liquid assets. Use
a trading platform you know well. Learn believe it or not. I’m not a system trader
it thoroughly. I use thinkorswim and but I know what the rules are, and I fol-
consider it a fantastic tool. Don’t watch low the rules. I trade as a discretionary
too many indicators or inputs; as I said trader, which may be unusual. I’ve had
earlier, avoid “analysis paralysis.” my share of trades that had an instant,
And one last thing is if you’re going large loss, but I am able to absorb it
through a major stress period in your and move on to the next trade. It’s part
life, such as a divorce or death of a loved of the game.
one, a lawsuit or anything that’s on your
mind and is bugging you, don’t trade. That’s quite an accomplishment. The
Learn to step away from it and realize patience and persistence paid off.
that it can have disastrous results on Well, it took me years to get there. I
your trading. Only trade when you’re in think the correct word is “stubborn.” I
a position to be stress-free. I know that had many years of red ink. I kept records
is almost a contradiction in terms. of all my trades year after year, and the
Personally, I don’t consider trading ink was red for a long time. But I was
stressful. In fact, I consider it almost determined to do whatever it took to
soothing, which may be different than change that.
how most people think of it. In my
early days as a trader, when I was in Thank you very much for sharing your
New York, I would get into trades, and trading experiences and your journey
would run up a few hundred dollars’ to become an independent trader, Ed.
loss. I remember coming home and my
ears would be burning. I would worry FURTHER READING
about it over the weekend. But over the Dobson, Ed [1975]. Commodity Spreads:
years I just learned to get away from A Historical Chart Perspective, Trad-
that and now I trade without emotion, ers’ Press.
[1979]. The Trading Rule That
from the current price. Can Make You Rich*, Traders’
High-priced stocks and indexes with Press.
liquid weekly options are the best can- [2008]. The Shocking Truth About
didates for trading. Fibonacci Numbers, Traders’ Press.
‡thinkorswim (TD Ameritrade),
Trees can be used to play earnings,
‡Barchart.com
but the sudden huge price moves make
them riskier. It’s better to trade them
during weeks with no pending an-
nouncements.
The more time remaining to expi-
ration, the better the prices. This is
because there’s more time for the stock
to move.
A couple of days before expiration,
you can often salvage some time value
from your remaining positions that are
close to the current market level. This
can sometimes recover a substantial por-
tion of the initial debit incurred to set up
multiple positions and insurance.
 FUTURES FOR YOU
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner is the se-
nior strategist for DeCarley Trading, a division of Zaner, where she also works
as a commodity broker. She has written multiple books on futures and options
trading, the latest is titled Higher Probability Commodity Trading. Garner also
authors widely distributed e-newsletters; for your free subscription visit www.
DeCarleyTrading.com. To submit a question, email her at info@carleygarner-
trading.com or via www.DeCarleyTrading.com. Selected questions will appear
Carley Garner
in a future issue of S&C.

SERIAL OPTIONS
What are serial options and where have
they gone?
Those trading options on financial
futures such as the emini S&P, Trea-
suries, and currencies have probably
come across the term serial options.
Nevertheless, most traders likely didn’t
recognize the difference between them
and traditional options until they pulled
up their quote board one morning last fall
to discover they were gone. In its quest
to move away from monthly expiring op-
tions toward weekly options, the Chicago
Mercantile Exchange (CME) eliminated
the traditional monthly serial options
from the emini S&P and are following
suit in other products.
A serial option is one that is not a
quarterly option. Specifically, quarterly
options are those that are written against
futures contracts that expire in one of the
quarterly months (March, June, Septem-
ber, or December) and expire in those
particular months. Thus, serial options
are those monthly options written against
the quarterly futures contracts but expir-
ing in non-quarterly months (January,
February, April, May, etc.). In short, if
it’s a monthly option on a financial fu-
tures contract that expires in any month
other than March, June, September, or
December, it’s a serial option.
In the past, the CME listed monthly
serial options in addition to weekly expir-
ing options (options with expiration dates
on each Friday of the month). However,
this led to some confusion because the
traditional monthly options expired on
the third Friday of every month, leaving
their weekly options series with week
1, week 2, and week 4 versions. The
lack of a week 3 option confused some
traders who didn’t know to look at the
serial monthly options for the week
3 expiration (the third Friday of the
month). Now that serial monthly options
have been delisted and replaced with a
week 3 option, the weekly options suite
is complete. Unfortunately, of course,
simplifying things for weekly options
traders has complicated things for se-
rial monthly options traders, but in the
end, the change is more of a technicality
than a game changer. For instance, the
week 3 options that have replaced the
serial monthly options are seeing similar
trading volume and pricing tendencies.
Simply, they are essentially the same
options; they are just traded with a dif-
ferent symbol.
Exercising options
slows down and
complicates the exit
process. It also results
in less profit.
That said, there is one difference be-
tween the two instruments that should
be noted. The original monthly options
were American style, but the new weekly
options are European style. Academi-
cally, these two options types are worlds
apart but in practice, they behave in
relatively identical ways. American style
options are those that can be exercised
by the option buyer at any time before
expiration. A European-style option, on
the other hand, can only be exercised at
expiration.
I have been a commodity broker since
early 2004. In that time, I have only
February 2017
witnessed an option buyer exercising his
American-style options before expiration
on a handful of occasions (literally less
than one for each of my five fingers). This
is because an option buyer can usually
sell his long option in the open market
at a higher price than he would achieve
by exercising the option and then offset-
ting the futures contract. This is possible
because at any time before expiration
the price of an option represents its
intrinsic value (how far in-the-money
the option is) in addition to its extrinsic
value (the time value built into the option
to account for potential price changes
and volatility prior to expiration). To
illustrate, an emini S&P trader holding
a long 2150 call option expiring in two
weeks at a time the S&P 500 futures are
trading at 2200 could lock in his profit
by either selling the call option at the
current market price, or by exercising
the call option into a long futures con-
tract from 2150 and then offsetting that
futures contract. If he chooses the first
course of action, he could sell the option
for a total of 60.00 points ($3,000); the
option is 50.00 points in-the-money so
this represents the intrinsic value and
the market is assigning 10.00 points
in premium to account for the remain-
ing two weeks to expiration. However,
the trader choosing plan B would only
yield 50.00 points ($2,500) because the
exercise would result in a long futures
position from 2150 that could then be
sold at 2200 to lock in 50.00 points in
profit. In short, the trader exercising the
option has left 10.00 points, or $500, on
the table.
In addition, an option can be sold in-
Continued on page 44
• Technical Analysis of STOCKS & COMMODITIES • 39

NinjaTrader 8
NINJATRADER, LLC
1422 Delgany Street, Suite 400
Denver, CO 80202
Phone: 312 262-1289
Fax: 312 329-9888
Internet: www.ninjatrader.com
Requirements: Minimum requirements
are Windows Vista (SP2) w/platform
update, Windows 7, 8, or 10, Windows
Server 2008 w/platform update, Win-
dows Server 2008 R2 or later; 1 gigahertz
(GHz) or faster 32-bit or 64-bit processor;
2 GB RAM; Microsoft. NET Framework
4.5; screen resolution of 1024x768;
DirectX10 compatible graphics card.
Product: Trading platform for active
equity, futures, and forex traders.
Price: Always free use for advanced
charting, strategy backtesting, and strat-
egy simulation. For live trading in your
brokerage account, purchase it for $999
(or four monthly payments of $299);
lease it for $600 annually, $330 semi-
annually, or $180 quarterly; free through
a NinjaTrader brokerage account.
by Jayanthi Gopalakrishnan
injaTrader has a dedicated follow-
N ing and for good reason. It is broker
independent, the price is attractive,
it supports a lot of datafeeds, and
it’s easy to use. For the benefit of its
dedicated followers, NinjaTrader’s new
release NinjaTrader 8 (NT8) is an evolu-
tion of the previous generation. It looks
similar to the previous version, which
means you don’t have to invest a lot of
time to learn about its new features, but
the technology used to develop it is more
powerful than in the previous version,
and this is something you’ll notice once
you start using the product.
The most obvious difference is the
user interface has a cleaner look and as
you explore the new version you discover
there are several improvements that make
the trader’s experience much richer. And
with all the new improvements you still
40 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
PRODUCT REVIEW
Part 1
are able to program and trade in as many
ways as you want. It still follows the
“open development” model that makes
NT unique. You still have the sophisti-
cated trade submission and management
tools but with some improvements that
make these otherwise tedious tasks even
easier. Let’s take a look at some of these
new features.
INSTALLATION AND DATA
Installation is straightforward. You can
download it directly from the Ninja-
Trader website. Once you download it
you get your login credentials and you’re
ready to start your trial. The first thing
you’ll notice about NT8 is that it has free-
floating windows so you can arrange
them however you want and use as many
as you need. It’s not a static workspace
as you may find in some products. You
have the flexibility to customize your
workspace with only what is necessary
for you to trade.
CONTROL CENTER
One aspect of NT8 that stands out is its
simple design, and this is evident from
the control center window, which is
basically your starting point to access
the various features. This is where you
connect with a datafeed, monitor your
orders, your positions, and various ac-
count details.
You have different options when
it comes to the datafeed you want to
connect with. I used the NinjaTrader
FIGURE 1: CONTROL CENTER WINDOW. Think of this as the heart and lung of NinjaTrader 8. From here you
select your datafeed, open windows, place orders, and so on.
Continuum (Demo) option for
this review. You’ll notice on
the control center window in
Figure 1 that there are several
tabs along the bottom. In NT 8
you have the flexibility to add
tabs, remove tabs, and change
the location of tabs. In fact, this
tabbed interface is something
you’ll see in most windows in
NT8. Just looking at the control
center gives you an idea that
a lot more flexibility has been
added to the new version.

CHARTS
You can bring up charts from FIGURE 2: CHART TRADER. You can access Chart Trader from the button on the tool bar. You can place your orders
the control center, select the through the quick buttons and once an order is placed you can monitor them all from this window.
instrument you want to view
the chart of, and enjoy the
several charting features avail-
able to you. You have a couple
of different options for how
you want to place your charts
in your workspace. You can
have them in your workspace
as separate windows or you can
create different charts using the
tab format feature along the
bottom of the chart window.
The tab feature helps reduce
the amount of space you take
up on your desktop.
NinjaTrader allows you to
view and place orders directly
from the charts. Although this
is not a new feature, some en- FIGURE 3: ATTACHING ORDERS TO INDICATORS. Some traders like to place orders using indicators. Here you see an
example of how that is done by attaching an exit order on a 15-minute intraday chart of the emini S&P 500 to a 20-period
hancements have been made exponential moving average (EMA).
that make placing orders much
easier than in the previous ver-
sion. There are a couple different ways via the charts is by right-clicking on the ment to a higher level.
to place orders. One is through the chart chart and selecting one of four orders, A review of the charting feature in
trader button you see along the top of that is, buy limit, buy market if touched NT8 wouldn’t be complete without
the chart. If you click on that button, it (MIT), sell-stop market, and sell-stop mentioning the ability to attach your
brings up an order window next to your limit. There are some interesting ways orders to indicators that can be overlaid
chart (Figure 2). Here you can add an to manage your positions. You can place on a chart. Technical analysts often
unlimited number of exit points, set auto breakeven and auto trailing stops. base their entry and exit decisions on
your price targets based on trade size, These exit points all appear on your specific indicators. Having the ability to
stop-loss, profit, stop strategy, or any chart. For example, if you wish to place attach your orders to indicators directly
number of trade management strategies a limit order, it’ll display as a horizontal on the chart can prove to be helpful
you use. It’s also easy to monitor your line on your chart. In addition to that, for technical analysis enthusiasts. One
open positions. Once you place an order you can place an MIT order, which is that it’s easy to visualize and the
you’ll see a display of the number of will show up below the limit order to other is that you can see it in multiple
positions, average entry price, and P/L give you some added protection. Being timeframes. Say you enter a trade and
of the open position. able to visualize these trades directly want to exit when price hits a 20-period
Another way to place orders directly on your charts takes your risk manage- exponential moving average (EMA).
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 41

FIGURE 4: SUPER DOM. Visualize the depth of market
(DOM) from this window. You can customize it any
way you’d like. Here, the PnL and volume columns
were added. The 20-period EMA was attached to
the Super DOM, which is identified by the horizontal
orange line.
You have the ability to attach that exit to
the 20-period EMA (Figure 3). If price
hits a moving average, you could enter
a trade then. When attaching the order
to an indicator you have the option of
offsetting the order above or below the
indicator, which is helpful for placing
trailing orders. There is also an option
of enabling modify toward last price,
which will help to prevent the order
from moving too far away from the
market price. The nice thing about this
is that you gain more control over risk
management.
With NT8 you can place a series of
charts on a screen and place trades on all
charts. For example, on one chart win-
dow you could have several instruments
or the same instruments with different
timeframes on separate tabs.
And let’s not forget about the drawing
tools. In NT8 you can now attach draw-
ing tools to all charts on the screen—a
feature traders will find useful. Since
you can link charts, you can add a sup-
42 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
Technical analysts often base their entry and
exit decisions on specific indicators, so having
the ability to attach your orders to indicators
directly on the chart makes it visually easy to
see when a certain price hits an indicator.
port or resistance level to, say, a daily
chart of emini S&P futures and attach
it to all charts. So if you’re looking at
a one-minute chart of ES futures, the
same support or resistance levels from
the daily chart will show up on the
one-minute chart.
The charts also have a playback
feature, which is a useful tool when
it comes to testing strategies. In NT8,
you can download the playback data
from the control center for whichever
instrument you want and go as far back
in time as you’d like. You also have the
option to download the current day’s
data up to the current time. You have
two options to choose from—market
replay or historical. So if you’re sitting
there wondering why you may not have
achieved expected results on a particular
trade, take advantage of the playback
feature using historical data and try to
figure out why it didn’t work.
SUPER DOM
The Super DOM, or depth of market, is
one of the most-loved features among
NT users. It displays a price ladder with
the number of buy and sell orders (Fig-
ure 4). Again, you have the flexibility to
change the size of the window, move it
to wherever you wish, and add as many
Super DOMs using the tabbed feature
along the bottom of the window.
You can also add as many columns
as you’d like and even create your own
custom columns using NinjaScript. In
Figure 4 the PnL and volume columns
were added. The PnL column displays
your unrealized profits or losses for each
row based on your average entry price.
The volume column shows the number
of trades at the corresponding price. In
NT8, when you resize the DOM, the
number of rows on the ladder increases
or decreases dynamically. There’s no
need to go through a menu system as
you did in the previous version.
You can place orders from the Super
DOM window and one new feature that
has been added to the Super DOM is the
ability to attach orders to an indicator.
All you have to do is click the order you
want to attach to your indicator and hold
‘CTRL’ to allow attaching to the indica-
tor. If a price level touches the indicator,
a horizontal colored line will appear in
the DOM window (Figure 4).
THERE’S LOTS MORE
If you’re familiar with NinjaTrader,
you’ll recognize most of these fea-
tures. In NT8, they’ve now become
much more efficient and user-friendly
than in previous versions. Most of the
enhancements are behind-the-scenes
technology. Other notable features in
NT8 include strategy development and
advanced order handling. I will discuss
those and other features in part 2 of my
review of NT8. Stay tuned.
Jayanthi Gopalakrishnan is Editor of
STOCKS & COMMODITIES.
FURTHER READING
Gopalakrishnan, Jayanthi [2011]. “Ninja-
Trader 7,” product review, Technical
Analysis of STOCKS & COMMODITIES,
Volume 29: April.
S&C staff [2013]. “NinjaTrader,” product
review, Technical Analysis of STOCKS
& COMMODITIES, Volume 31: May.
‡NinjaTrader
‡See Editorial Resource Index
 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

TRADING THE SPRING AND SUMMER
ENERGY PATTERN
If you know anything about me, then you
know I love trading patterns. One of the
simplest patterns to follow is seasonal
patterns. I follow the work of friend and
fellow trader Jeffrey Hirsh, coauthor
of the annual Stock Trader’s Almanac.
This is one of the places where I learned
long ago about patterns that repeat over
a calendar year. One of the patterns I
have grown fond of over the years is the
pattern on crude oil that is described in
the Almanac.
Crude oil makes price gains in the
spring and summer months, mid-Feb-
ruary through mid-July. The slightly
less than 15% bullish move during this
been hit so hard, a big bounce was due? objectives, the chance for a bounce
Perhaps it was a bit of both. higher is more probable. If the buying
Over time, this seasonal pattern aver- and covering of short positions gets
ages about a 15% move. I believe that exacerbated a bit more, expecting a
with the new administration’s business 20–30% move like we experienced last
CL-SpotV - Weekly Bar Chart
Bullish pattern in Cash Crude Oil between mid-Feb and mid-July.
Since 2006, this 5-month pattern has been bullish 90% of the time.
140
130
120
110
100
90
80
70

PROFITSOURCE (HUBB.COM)
timeframe has occurred more than 90% 60
of the time over the last 10 years. The 50
mid-July through mid-February months
40
tend to be bearish, but in my mind, it’s
not a predictable amount worth trading. 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

The chart you see in Figure 1 is a 10- FIGURE 1: CRUDE OIL PRICE PATTERN. In the last 10 years, crude oil has dropped only once during that
year pattern in crude oil. Note the green timeframe.
and red blocks. In the last 10 years, only
33
once have we seen crude oil drop during Stock: OIH (MARKET VECTORS OIL SERVICES ET) O=29.30 H=29.62 L=29.03 C=29.62
32
that timeframe.
Now I want to show you what happened 31

last year between mid-February and mid- 30

July. Remember that crude was trading 29

in the mid-$20s and nearly every money 28
manager I know of who had clients in 27
Stock

energy stocks was pulling his hair out 26

trying to figure out why it hadn’t moved 25
higher before then. 24
WWW.TOMSOPTIONTOOLS.COM

One way of investing in this pattern 23

is by trading an exchange traded fund
22
(ETF), such as the Market Vectors
21
Oil ETF (OIH). In 2016 between mid-
20
February and mid-July, OIH traded from -27 -18 -10 -01 -22 -13 -06 -27
-01 -02 -03 -04 -04 -05 -06 -06
$22 a share to $30, representing a 35% 20
16
20
16
20
16
20
16
20
16
20
16
20
16
20
16
increase in this ETF during the crude FIGURE 2: IS THE PATTERN SEEN IN THE MARKET VECTORS OIL ETF (OIH)? In 2016 between mid-
oil pattern in 2016 (Figure 2). Was it February and mid-July, OIH traded from $22 a share to $30, representing a 35% increase in this ETF during
the pattern that worked, or that oil had last year’s crude oil pattern.

February 2017 • Technical Analysis of STOCKS & COMMODITIES • 43

 Explore Your Options
year isn’t impossible.

My target on oil: 20% higher by mid-

July 42 42
So now we have projected prices over the
coming year and a suggested timeframe
39 39
for this to happen. All we need is a way
to control risk during this timeframe.

OIH Stock Price

Here are three different ways to control

Stock Price
36 36
risk in oil:

1. Trade ETFs such as OIH as op- 33 33

posed to stocks, as ETFs are more

diversified and have over time
proven to be less risky because of
the diversification.
2.Trade shorter-term timeframes:
Buying and holding oil over the
last year proved to be profitable,
but it takes more capital than op-
tions do to hold the asset such as a
group of stocks, and the commod-
ity itself has much higher margins
than in the past.
3. Options are the one way to control
the price risk of the trade. Creat-
ing lower-risk and higher-reward
strategies gives you the ability to
trade the volatile oil markets with
the “big boys.”
With these points in mind, let’s look at
a call option on OIH.
A call option gives the buyer the right
to purchase an asset at a specified price
for a specified period of time. Most op-
tions traders are happy to sell the option
to someone else if it rises in value. As
you can see from the chart in Figure 3,
this case study involves buying the July
30 30
27 27
Aug-04 Aug-25 Sep-16 Oct-07 Oct-28 Nov-18 -300 -200 -100 0 100 200 300 400 500
Time (Days) Profit ($)
FIGURE 3: RISK CURVE FOR BUYING JULY 2017 OIH 35 CALLS. The most this position can lose in value is
if oil drops and OIH drops along with it. But if OIH moves up, say, 20% in value, the buyer of the July 2017 OIH
35 calls would see their options more than double in value.
2017 OIH 35 calls for 2.89 or $289 plus up 20% in value? Anyone who bought
commissions. That’s the cost and total shares on OIH would realize an options
risk of this trade. position gain of 20%. However, the buyer
If oil drops and OIH drops along with of the July 2017 OIH 35 calls would see
it, that’s the most this position can lose their options more than double in value.
in value. But what if OIH does move That’s because if OIH did get to $42,
the 35 calls would have a real value of
This seasonal pattern $7.00. If you paid $2.89 for them, and
they are priced at $7.00, that’s a profit
averages about a of $4.11 less commissions. A tidy profit,
15% move and if the I would say.
buying and covering There’s no guarantee that a pattern
of short positions gets like this, no matter how good it is, will
continue. But when you see the same
exacerbated a bit more, thing happening over and over again, it
expecting a 20–30% makes it hard to go the other way.
isn’t impossible.

FUTURES FOR YOU

GARNER
Continued from page 39
stantly with the click of a mouse, whereas
the process of contacting a broker to
exercise an option and then the broker
contacting the exchange to initiate the
exercise will take some time; meanwhile,
the S&P 500 futures could be trading
unfavorably relative to the price it was
trading at the time you decided to exit
44 • February 2017 • Technical Analysis of STOCKS & COMMODITIES
the position via an exercise. Given this
example, it should be clear that exercising
options is generally not a good idea. Not
only does it slow down and complicate
the exit process, but it also results in
less profit.
On a side note, not long before I began
writing this column, the CME began
listing weekly options that expire on
Wednesdays. In short, there will be
options expiring on each Wednesday
and each Friday in the emini S&P 500.
It has yet to be determined whether
spreading options trades between so
many expiration days will detract from
market liquidity or not, but the changes
are providing traders with a substantial
number of speculative “options.”
CALHOUN / MOVING AVERAGE BREAKOUTS
Continued from page 7
declines and price consolidates. This will help you determine
when to enter and exit your trades, when combined with an
MA crossover.
STEP-BY-STEP ACTION PLAN
Here’s how you can start using this strategy with your swing
trades.
Step 1: Look for a 15-day 15-minute candlestick chart in
which a 70-period MA line is above a 50-period VWMA
line, as seen from November 1, 2016 to November 4, 2016
in the chart of Direxion Daily Financial Bull 3x ETF (FAS)
in Figure 1.
Step 2: Wait until the 50 VWMA line crosses up over the 70
MA line, as seen on November 7, 2016. This provides you
with your crossover entry signal. You may enter your trade
anytime after this crossover signal is seen.
Step 3: Even if you miss the initial crossover day, you may
still enter a buy stop order to enter your trade once price
breaks out to new highs on a subsequent trading session (for
example, on November 8, 2016)
Step 4: As long as both MA lines remain uncrossed in an
uptrend, you keep your position open. Close your position
once the VWMA line crosses back down under the MA line,
as seen on November 16, 2016.
Tip: you may wish to test different simple moving average
periods other than the 70 MA I use, especially if you are not
using a 15-day chart. I have found that 70 MA produces the
most consistent crossover entry and exit signals for multiday
swing trades. The primary goal in setting correct MA pa-
At-the-Money (ATM)—An option whose strike price is nearest the
current price of the underlying deliverable.
Average Directional Movement Index (ADX)—Indicator developed
by J. Welles Wilder to measure market trend intensity.
Average True Range—A moving average of the true range.
Butterfly Spread—A sideways market strategy using all calls or puts,
designed to profit from a stock trading in a specific range.
Calendar Spread—Also known as a time spread or horizontal
spread, calendar spreads exploit differences in time value be-
tween options.
Chaikin Oscillator—An oscillator created by subtracting a 10-day
EMA from a 3-day EMA of the accumulation/distribution line.
Christmas Tree Spread—The simultaneous purchase and writing
of options with either a different strike price or expiration date
or combination of the two.
Collar—An option strategy implemented after a long position.
Higher-than-average trading volume
combined with price often leads to
exceptional uptrend continuations.
rameters is to have your signal line keep you in during strong
trends, and out once the trade consolidates or pivots, in order
to extract maximum potential profit from your trade.
INSIGHTS: WHY THIS TECHNIQUE WORKS
The VWMA crossover swing trading strategy is effective
because it waits until after price and volume confirm a new
breakout in progress. Combining a simple MA with the VWMA
crossover helps filter out low-volume price action moves while
entering on higher-volume strong breakout signals.
TRADE MANAGEMENT TIPS
When using visual lagging indicators like moving averages, it
is important to exit your trades as soon as price action stops
moving in your favor. A favorite trend reversal exit strategy
I use in my swing trades is to close out the trade if it loses
an aggregate two days’ worth of support, or two dollars, or
a moving average crossover (as observed on November 16,
2016), whichever occurs first. Exiting your trades at the first
sign of trouble is also usually a smart idea because you want
to minimize your stop-loss costs while maximizing profit. You
can always reenter your trade if the trend continues to break
out to new highs on a subsequent trading day.
Ken Calhoun is a producer of trading courses, a live trading
room, and video-based training systems for active traders.
He is a UCLA alumnus and is the founder of TradeMastery.
com, an educational resource site for active traders. In this
“Trading on Momentum” monthly column, he covers the
topic of breakout trading techniques.
Scalp—In commodities, purchasing and selling in equal amounts so
there is no net position at the end of the trading day; a speculative
attempt to make a quick profit by buying at the initial offering
price in the hope the issue will increase and can be sold.
Secular Trend—Pertaining to a long, indefinite period of time.
Sharpe Ratio Method—A classic return/risk measure. Both the Sharpe
and the Sterling ratio methods compare returns with variability
of returns, as opposed to risk of loss of original investment. Also,
a measure of risk-adjusted profitability calculated as average P/L
(minus some risk-free rate), divided by P/L standard deviation.
Ulcer Index—An indicator to measure downward risk or downward
variation. Originally designed for mutual funds. The UI looks only
at downside risk, not overall volatility like standard deviation.
Vertical Spread — A stock option spread based on simultaneous
purchase and sale of options on the same underlying stock with
the same expiration months but different strike prices.
February 2017 • Technical Analysis of STOCKS & COMMODITIES • 45
 has nothing to do with math,
and neither does it form the
basis of wave theory.

WHAT’S WITH
THE WAVES?
The underlying reason behind
the wave-like pattern of price
movements is the trader’s be-
havior. Price movement tracks
the collective behavior of all
traders, so the profit-taking
mindset of the trader may be
the key to unlock price move-
ment in stocks and their wave
patterns.
From a mathematical point
of view, wave theory is perfect.
But stock prices don’t move
up and down according to
any mathematical theory. The
strength of a wave is based
on the buy and sell actions.
In other words, it’s the profit-
taking behavior that causes
the stock’s up and down price
movement. If nobody sold
their positions, there would
be no waves.
How could you use wave
theory to determine stock
price movements? Here’s an
They Come In Waves example. In Figure 1, in the
areas marked A, B, C, and D
Waves And can you identify where the
stock price will likely be after

Profit-Taking the sell signal? You really don’t

know where the stock price
will move to, but you know
where the profit-taking will
Stock prices move in wave patterns. But what determines that price movement? Let’s take take place. And when profit-
a look at wave theory to see if it can shed some light … or is there something better? taking happens, the stock
price will most likely retreat
by Howard Wang back into the buyer’s entry
WAVES: KOVALE/HANDS, DOLLARS: BYEMO/SHUTTERSTOCK/COLLAGE: NIKKI MORR

zone. Applying this theory of

E ven if you’re not familiar with wave theory or subscribe to it, you have probably
realized that stock prices move in patterns that resemble waves. Given that prices
move in waves, it might seem logical that the movement of stock prices could be
determined by wave theory. But can it?
profit-taking helps you identify
the stock pullback area.
In Figure 2 you see that
because of profit-taking, the
If you think about why waves form, then it makes some sense to use wave theory to analyze stock price pulls back, form-
the stock market. So why not look at this more closely. I’ll start by considering two essential ing a correction wave. This is
points of wave theory. The first is that human behavior can be predicted, and the second is similar to what you would have
that stock market waves are based on human behavior. learned from wave theory. As
Let’s look at human behavior. The trader’s primary purpose of participating in the financial a result of profit-taking, four
markets is to make profits. A trader buys and sells securities in the hopes of making a positive waves form (A, B, C, and D).
return. So you could consider the act of buying and selling to be the trader’s behavior, which Though profit-taking is not the
30 • November 2016 • Technical Analysis of STOCKS & COMMODITIES
 CHARTING

result of wave theory, it Sell signal

is a direct cause of price
movement. Don’t use waves concept
165
C
HOW IS PROFIT- Sell signal
TAKING THEORY
Sell signal D 160
DIFFERENT?
Traders create price B 155
movement; it is their
A
actions that create stock 150
patterns. So where does
wave theory fit into all Where will profit-taking be?
this? It gives us the abil- 2013 Feb Mar Apr May Jun Jul
ity to use mathemati-
cal methods to analyze FIGURE 1: AFTER THE SELL SIGNAL. The profit-taking occurs in the areas marked A, B, C, and D. You may not know where price
the phenomenon of the will move but you do know that when profit-taking occurs, prices will retreat back to buyer’s entry zone.
waves, but it does not
tell us what causes the
wave formations. That’s When profit-taking happens, the stock price
where profit-taking theo- will retreat back into buyer’s entry zone
ry comes in; it analyzes 165
the cause of wave for- C
mations with a different 160
perspective than wave Buyer entry zone D
theory does. Profit-taking 155
theory gives a reason B
behind the waves, it tells Buyer entry zone
A 150
you where the buyers are, Buyer entry zone
where the profit-taking Buyer entry zone
will be, and where the 2013 Feb Mar Apr May Jun Jul
bottom will be. Profit-
taking theory defines the FIGURE 2: IT’S ABOUT PROFIT-TAKING. Because of profit-taking, the stock price pulls back, forming a correction wave. As a result
movement of waves not of profit-taking, the waves form. Though profit-taking is not the result of wave theory, it is a direct cause of price movement.
as mathematical analysis
but as the direct result of
profit-taking. Wave theory is a mathematical method of
analyzing stock waves, whereas profit-taking theory unlocks
the true cause of the formation of stock waves.

Howard Wang has a master’s degree in mathematics and It’s the profit-taking behavior
economic statistics, and has over 20 years of investment that causes the stock’s up and
experience. He is particularly interested in analyzing tech- down price movement.
nical indicators, candlestick construction, and designing
breakout trading software and automated trading systems.
He may be reached at applecapitalusa@yahoo.com.

FURTHER READING Technical Analysis of STOCKS & COMMODITIES, Volume

Wang, Howard [2016]. New Concepts In Trading: Profit Tak- 33: September.
ing Theory (published in Chinese).
[2015]. “The Breakout Relative Strength Index,”

November 2016 • Technical Analysis of STOCKS & COMMODITIES • 31

 INDICATORS
Hey Trend, How Strong Are You?
Weekly & Daily MACD
The moving average convergence/divergence oscil-
lator (MACD), developed by Gerald Appel, is one of
the more popular technical analysis indicators. The
MACD is typically used on a single timeframe, but
what if we looked at two timeframes on one chart?
T
he indicator I’ll discuss in this article, the
weekly & daily MACD (W&D MACD),
combines (as you may have guessed) weekly
and daily MACD oscillators on a daily chart. Each
oscillator turns two moving averages into a momentum
oscillator by subtracting the longer moving average
from the shorter moving average. Traders can look
for relative daily MACD line crossovers, weekly
and daily centerline crossovers, and divergences to
generate trading signals. Because the W&D MACD
is not bounded, it is not particularly useful for iden-
tifying overbought and oversold levels. Here’s how
you calculate it.
Calculation
1. Multiply daily exponential moving aver-
age (EMA) lengths by 5 (five days per
week) to get weekly EMAs.
12-day EMA * 5 = 60-day EMA = 12-week
EMA
26-day EMA * 5 = 130-day EMA = 26-week
EMA
2. Weekly MACD line:
(60-day EMA - 130-day EMA)
3. Calculate daily MACD line:
(12-day EMA - 26-day EMA)
PATRICK KELLEY
4. Relative daily MACD line:
Weekly MACD line + Daily MACD line
by Vitali Apirine
The values of 60, 130, 12, and 26 are the typical set-
tings used with the W&D MACD. However, other
values can be substituted depending on your trading
style and goals. The MetaStock code for the W&D
MACD can be found in the sidebar “MetaStock Code
For W&D MACD.”
In Figure 1 you see an example of a chart with the
weekly & daily MACD indicators in the upper panel.
Notice the W&D MACD consists of two oscillators.
The weekly MACD oscillates above and below the
zero line (centerline). These crossovers signal the
60-day EMA crossing the 130-day EMA. The direc-
tion depends on the direction of the moving average
cross. Positive weekly MACD indicates the 60-day
EMA is above the 130-day EMA. Positive values
increase as the shorter EMA diverges further from
the longer EMA.
Negative weekly MACD values indicate the 60-day
EMA is below the 130-day EMA. Negative values
increase as the shorter EMA diverges further below
the longer EMA.
The relative daily MACD fluctuates above
Relative
Daily MACD
Weekly
MACD
METASTOCK
FIGURE 1: WEEKLY & DAILY MACD INDICATORS. The weekly & daily MACD
indicators are displayed in the upper panel. Notice the W&D MACD consists of two
oscillators. The weekly MACD oscillates above and below the zero line (centerline)
and the relative daily MACD fluctuates above and below the weekly MACD line.
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 11
FIGURE 2: A STRONG UPTREND. On this chart, you see a bullish relative daily MACD
line crossover in early September 2010 and a bearish relative daily MACD line crossover
in mid-March 2011. This bullish signal lasted seven months. Notice the weekly MACD
line rose most of the time.
and below the weekly MACD line. The relative daily
MACD crossover signals the 12-day EMA has crossed the 26-
day EMA. The direction depends on the direction of the moving
average’s cross. The relative daily MACD is positive when it is
above the zero line. The relative daily MACD is negative when
it is below the zero line.
When the relative daily MACD is below the weekly MACD
but above the zero line, it means daily downside momentum
outpaces daily upside momentum, but there is less weekly upside
momentum. So, positive difference between 60-day and 130-
day EMA is greater than negative difference between 12-day
EMA and 26-day EMA. If the relative daily MACD is below
the zero line (negative) and weekly MACD is above the zero
line (positive), it indicates a whipsaw in the daily MACD or a
signal of a future change of weekly momentum. If the weekly
MACD is above the zero line and relative daily MACD is above
the weekly MACD, it indicates weekly upside momentum and
daily upside momentum outpacing weekly downside momentum
and daily downside momentum, respectively. The most profit-
able long trade occurs when the weekly MACD and relative
daily MACD rise together.
When the relative daily MACD is above the weekly MACD
but below the zero line, it means daily upside momentum out-
paces daily downside momentum, but it is less weekly downside
momentum. In other words, a negative difference between 60-
day EMA and 130-day EMA is greater than positive difference
between 12-day EMA and 26-day EMA. If the relative daily
MACD is above the zero line (positive) and the weekly MACD is
below the zero line (negative), it is possible that the daily MACD
did whipsaw or signaled future change of weekly momentum. If
the weekly MACD is below the zero line and the relative daily
MACD is below the weekly MACD, it indicates both weekly
downside momentum and daily downside momentum outpace
weekly upside momentum and daily upside momentum, respec-
tively. The most profitable short trade occurs when the weekly
MACD and relative daily MACD drop together.
12 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
FIGURE 3: A STRONG DOWNTREND. Here you see four relative daily MACD line cross-
overs in seven months. The weekly MACD line was negative and dropped, except from
second half of August to the first half of September.
The relative daily MACD is faster. The weekly MACD line
is slower and less reactive to price changes in the underlying
security.
RELATIVE DAILY MACD LINE CROSSOVERS
A bullish crossover occurs when the relative daily MACD line
turns up and crosses above the weekly MACD line. This hap-
pens when the 12-day EMA of the underlying security moves
above the 26-day EMA. A bearish crossover occurs when the
relative daily MACD line turns down and crosses below the
weekly MACD line. This happens when the 12-day EMA moves
below the 26-day EMA. Crossovers can last a few days or a few
weeks. It depends on the strength of the move.
The chart in Figure 2 shows NYSE Composite index (NYA)
with a bullish relative daily MACD line crossover in early Sep-
tember 2010 and a bearish relative daily MACD line crossover
in mid-March 2011. This bullish signal lasted seven months.
It indicates that the 12-day EMA was above the 26-day EMA.
Weekly MACD line became positive at the end of September
2010 (60-day EMA crossed above 130-day EMA). Notice the
weekly MACD line rose most of the time. This was one strong
uptrend.
In Figure 3 is a chart of London Financial Times index (FTSE
100) with four relative daily MACD line crossovers in seven
months. The weekly MACD line was negative and dropped,
The most profitable long
trade occurs when the weekly
MACD and relative daily MACD
rise together.
 except from the second half of August to the first half of Sep-
Compare Daily MACD Centerline Crossovers with Relative Daily MACD Line Crossovers
tember. The bearish crossovers worked well because this was
resistance break one strong downtrend.

DAILY MACD LINE CROSSOVERS

VS. CENTERLINE CROSSOVERS
In Figure 4 is a chart of the S&P 500 index (SPX) with daily
Eight daily centerline crossovers
(red and green dotted lines) in eight months MACD (12, 26, 1) and W&D MACD (60, 130, 12, 26). Eight
crossovers in eight months would have resulted in numerous
whipsaws. A break in the resistance level in early November 2004
signaled the correction’s end and the uptrend’s continuation.
Weekly centerline crossovers Notice the weekly MACD line declined from March to
(red and green ellipses)
August, briefly crossed the weekly centerline from August to
September (see red and green ellipses), and started to rise again.
This shows that weekly MACD signals are more important than
FIGURE 4: DAILY MACD LINE CROSSOVERS VS. CENTERLINE CROSSOVERS. There daily MACD signals.
was a lot of whipsaw movement going on here until the index broke above the resistance
level. This break signaled the continuation of the uptrend.
W&D MACD CENTERLINE
CROSSOVERS
Centerline crossovers are common W&D
MACD signals. A weekly bullish centerline
crossover occurs when the weekly MACD
line moves above the zero line to turn posi-
tive. This happens when the 60-day EMA
of the underlying security moves above the 130-day EMA. A
resistance break weekly bearish centerline crossover occurs when the weekly
MACD line moves below the zero line to turn negative. This
happens when the 60-day EMA moves below the 130-day
EMA.
A daily bullish centerline crossover occurs when the relative
daily MACD line moves above the zero line to turn positive. A
daily bearish centerline crossover occurs when the daily MACD
line moves below the zero line to turn negative. A continuation
FIGURE 5: W&D MACD CENTERLINE CROSSOVERS. Strong trading signals are hard
of centerline crossovers depends on the trend’s strength.
to come by during a choppy market. During such times, you can combine W&D MACD In Figure 5 you see a chart of the S&P 500 index (SPX) with
centerline crossovers with relative daily MACD line crossovers. Here you see a resistance W&D MACD (60, 130, 12, 26). The relative daily MACD line
break in early July 2016 that confirmed the daily MACD line bullish centerline crossover crosses the centerline faster than the weekly MACD line. There
in mid-March 2016 (green ellipse) and weekly MACD bullish centerline crossover in early
April 2016 (black ellipse).
were some good and some bad signals during the consolidation
from August 2015 to July 2016. In a choppy market, you can
combine W&D MACD centerline crossovers with relative daily
MACD line crossovers. A resistance break in early July 2016
05/03/2005
07/14/2006 08/20/2007 confirmed the daily MACD line bullish centerline crossover in
08/05/2004 mid-March 2016 (see green ellipse) and weekly MACD bullish
centerline crossover in early April 2016 (see black ellipse). It
signaled the end of the consolidation and continuation of the
uptrend. Notice the weekly MACD line rose after the April
05/12/2003 09/28/2004 06/06/2005 09/21/2006
centerline crossover.

WEEKLY W&D CENTERLINE CROSSOVERS VS.

FIGURE 6: DAILY CHART OF RUSSELL 2000 INDEX WITH W&D MACD(130,60,
1, 1)
14 • December 2017 • Technical Analysis of STOCKS & COMMODITIES
WEEKLY CENTERLINE CROSSOVERS
The daily chart in Figure 6 shows the Russell 2000 in-
dex with W&D MACD (130, 60, 1, 1). The weekly chart
(Figure 7) shows the same index with MACD (12, 26, 1).
Both charts are of the same time period (March 2003 to August
2007). The centerline crossover dates can be seen in the table in
Figure 8. The biggest difference was in June 2005 (four business
 days) and September 2006
W&D MACD Weekly MACD
07/14/2006 08/17/2007 (six business days).
04/29/2005 05/12/2003 05/09/2003
08/06/2004
WEEKLY W&D
08/05/2004 08/06/2004 MACD DIVERGENCE
Weekly divergences form
09/28/2004 10/01/2004
05/09/2003 10/01/2004 06/10/2005 09/29/2006
when the weekly W&D
05/03/2005 04/29/2005 MACD line diverges from
the price action of the un-
06/06/2005 06/10/2005 derlying security. A bullish
07/14/2006 07/14/2006 divergence forms when a
security records a lower
09/21/2006 09/29/2006 low and the weekly W&D
MACD line forms a higher
08/20/2007 08/17/2007
low. The lower low in the
FIGURE 7: WEEKLY CHART OF RUSSELL 2000 INDEX WITH MACD(12,26,1) FIGURE 8: CENTERLINE CROSSOVER security affirms the current
DATES. The centerline crossover dates downtrend, but the higher
from the charts in Figures 6 & 7 are
listed. low in the weekly W&D
lower Weekly
high centerline MACD line shows less
crossover weekly downside momen-
tum. A bearish divergence forms when a security records a
higher high and the weekly W&D MACD line forms a lower
Weekly Bearish Divergence
high. The higher high in the security affirms the current uptrend,
but the lower high in the weekly W&D MACD line shows less
higher high weekly upside momentum.
In Figure 9 you see a chart of the S&P 500 index (SPX) with
a weekly bearish divergence from July to October 2007. Weekly
W&D MACD formed a lower high as the index formed a higher
support break high in October. The weekly W&D MACD turned down with a
weekly centerline crossover at the end of December. SPX con-
firmed a reversal with support breakout in early January 2008.
The chart in Figure 10 shows a bullish divergence from
FIGURE 9: WEEKLY BEARISH DIVERGENCE. Weekly W&D MACD formed a lower high
November 2008 to March 2009 in the Dow Jones Industrial
as the index formed a higher high in October. The weekly W&D MACD turned down with Average (DJIA) during a bear market. The index forged a lower
a weekly centerline crossover at the end of December. SPX confirmed a reversal with low but the weekly W&D MACD formed a higher low. The
support breakout in early January 2008. subsequent weekly W&D MACD centerline crossover and DJIA
resistance break were bullish in late July 2009.

DAILY MACD AND RELATIVE DAILY

W&D MACD DIVERGENCE(S)
Daily MACD bearish divergences are normal during strong
higher high
uptrends while daily bullish divergences often occur in strong
Weekly Bearish Divergence
downtrends. Bearish divergence means decrease of upside
momentum. Despite less upside momentum, upside momentum
Bear Market is still outpacing downside momentum as long as the daily
MACD remains in positive territory. Relative daily MACD
upside momentum is outpacing daily downside momentum
resistance break when relative daily MACD is above the weekly MACD. The
opposite occurs at the beginning of a strong downtrend.
The chart in Figure 11 shows the S&P 500 index (SPX)
with daily MACD(12, 26, 1) and W&D MACD (160, 130, 12,
lower low
26) for comparison. The daily MACD formed four bearish
divergences from August to November 2009. The relative
FIGURE 10: BULLISH DIVERGENCE. The index forged a lower low but the weekly W&D
MACD formed a higher low. The subsequent weekly W&D MACD centerline crossover
daily MACD made only one bearish divergence from October
and DJIA resistance break were bullish in late July 2009.
Continued on page 41
December 2017 • Technical Analysis of STOCKS & COMMODITIES • 15
 APIRINE/WEEKLY & DAILY MACD Markets he points METASTOCK CODE FOR W&D MACD
Continued from page 15 out that signals on
Length1:=60;
weekly charts are Length2:=130;
more important Length3:=12;
than those on daily Length4:=26;
Four bearish divergences charts.
Weekly MACD WM:=Mov(C,Length1,E)-Mov(C,Length2,E);
centerline cross- DM:=Mov(C,Length3,E)-Mov(C,Length4,E);
overs and weekly
One bearish divergence WM;
divergences are
WM+DM;
more important
than relative daily
MACD centerline
crossovers, relative daily MACD crossovers, and daily MACD
divergences. The relative daily MACD generates fewer di-
vergences than the daily MACD during strong trends. W&D
MACD does not have any upper or lower limits and its values
are dependent on the underlying security’s price. It is not pos-
sible to compare W&D MACD values for a group of securities
FIGURE 11: DAILY MACD AND RELATIVE DAILY W&D MACD DIVERGENCE. The
with varying prices. There’s another indicator for that called
daily MACD formed four bearish divergences from August to November 2009. The relative the W&D percentage price oscillator (W&D PPO), which I will
daily MACD made only one bearish divergence from October to November. The index discuss in a future article.
continued higher since the uptrend was strong.
Vitali Apirine is a programmer engineer with an interest
to November. Notice the relative daily MACD was well above in technical analysis, especially the application of relative
the centerline and weekly MACD line was almost flat during strength index to trading. He may be reached at vitapirine@
this daily divergence. The index continued higher since the mediacombb.net.
uptrend was strong.
The code given in this article is available in the Article Code section
PUTTING IT ALL of our website, www.Traders.com.
TOGETHER
W&D MACD combines weekly See our Traders’ Tips section beginning on page 50 for commentary
and daily MACD signals. The and implementation of Apirine’s technique in various technical
standard settings for W&D MACD analysis programs. Accompanying program code can be found in
are the differences between the the Traders’ Tips area at Traders.com.
60- and 130-day EMAs and be-
tween the 12- and 26-day EMAs. FURTHER READING
The daily MACD oscillates Apirine, Vitali [2017]. “Moving Average Stochastic,” Technical
above/below the weekly W&D Analysis of STOCKS & COMMODITIES, Volume 35: May.
MACD. The weekly W&D MACD [2016]. “Higher Highs & Lower Lows,” Technical Analy-
fluctuates above/below the zero line. Weekly center- sis of STOCKS & COMMODITIES, Volume 35: February.
line crossovers are less frequent than relative daily Murphy, John J. [1999]. Technical Analysis Of The Financial
MACD crossovers and daily MACD centerline crossovers. Markets, Prentice Hall Press.
Weekly W&D MACD centerline crossovers on daily charts ‡MetaStock
are close to MACD centerline crossovers on weekly charts. ‡See Editorial Resource Index
In John J. Murphy’s book Technical Analysis Of The Financial

December 2017 • Technical Analysis of STOCKS & COMMODITIES • 41

 TRADING ON MOMENTUM
2018 WINNER
From Volatility Comes Momentum AI TRADING SOFTWARE

Wide-Range Winner
16 years
Chart Breakouts in a row!

Skip the narrow, choppy trading ranges
and look for a chart with enough range
to have some momentum behind it.
by Ken Calhoun
low range to qualify. So the low of the Build powerful
chart might be $16 with the high of the
chart at $20.
trading systems in
But here’s the challenge. Traders and MINUTES
technical analysts get into trouble when
they overthink trading signals on charts
without coding

O
ne of the most important
considerations you should
take into account when it
comes to stock selection is
that have narrow, relatively choppy, small
ranges. These are exceptionally difficult
to trade with any consistency. I urge
everyone to spend more time looking ®

volatility, as measured by the at the right side of the chart to assess

range of the chart you are trading. There
are many reasons to give preference to
trading charts with wide ranges, includ-
ing profit potential, reduced risk of false
breakouts, and the opportunity to scale
in to winning trades more easily.
Many technical analysis approaches
neglect the critical impact of trading
range on potential profitability. You
should focus your energy on charts that
have clearly defined technical entry
signals (such as gaps, cup breakouts,
ascending triangles, and moving average
crossovers) and sufficient
volatility to make your
trade worthwhile.
the number of points in the range of the
instrument you are considering, in ad-
dition to the main chart pattern. I think
of it like screening job applicants—the
more years of experience, the better.
www.NeuroShell.com
Similarly, when it comes to trading, the 301.662.7950
biggest-range charts are the best.
A key component to this approach “pop and drop” price action that results
is to also make sure you are trading in being stopped out of a trade. Volatility
stocks with consistent, well-developed without consistency equals gambling,
uptrends. This rules out most stocks which is not successful.
under $10, because much of the volatility
observed in those charts is hazardous Continued on page 56

TRADING WIDE-RANGE
CHARTS
You can define a wide-
range chart in differ-
ent ways, depending on
the time interval. This
month, I’ll feature a
15-day chart of Renew-
able Energy Group Inc.
(REGI) (Figure 1), that
has a nine-point range on
a $26 stock, roughly 30%.
I would consider 20% the
minimum trading range
you should scan for on a
15-day chart using this
technique. For example,
eSIGNAL

a $20 per share stock

would need a minimum FIGURE 1: WIDE-RANGE CHART BREAKOUT. Here you see a wide-range chart that has a lot of profit potential due to its strong
of ($20 × 20%) = $4 high/ uptrend and nine-point trading range.

November 2018 • Technical Analysis of STOCKS & COMMODITIES • 7

 lates to just under four years as opposed to the 10 years used
for backtesting in the article.
Once you have the spreadsheet downloaded, if your Excel
skills are up to it, you certainly can extend the Computa-
tionsAndCharts tab row formulas beyond the initial 1,000.
Making such an extension may not require any changes to
the Transaction Summary tab (Figure 12), which is built to
handle upwards of 270 transactions, but may also benefit
from having the number of rows extended if you decide to
extend the ComputationsAndCharts tab to accommodate 10
years.
The spreadsheet file for this Traders’ Tip can be down-
loaded from Traders.com in the Traders’ Tips area. To suc-
cessfully download it, follow these steps:

FIGURE 12: EXCEL, TRANSACTION SUMMARY TAB. The transaction summary • Right-click on the Excel file link, then
tab is built to accommodate at least 270 transactions but could be extended. • Select “save target as” or “save as” to place a copy of the
spreadsheet file on your hard drive.
bust system. He offers a couple of ideas that we might use to
replace or augment the stiffness exit criteria. —Ron McAllister
Excel and VBA programmer
To keep this spreadsheet to a manageable download size
rpmac_xltt@sprynet.com
(it’s already over 4 MB), I reduced the capacity to 1,000 bars
on the ComputationsAndCharts tab. A thousand bars trans-

CALHOUN range is narrow, then you will likely get

Continued from page 7
STEP-BY-STEP ACTION PLAN
Here’s how you can start using the wide-
range breakout strategy:
Step 1: Find charts with at least a
20% high-low trading range on a
15-day chart, in an uptrend, as seen
in Figure 1.
Step 2: Use an entry price of $0.50
above the current high ($26 plus $0.50
equals $26.50 in this example).
Step 3: Use an initial stop of the $2
($26.50 minus $2 equals $24.50).
Step 4: Add to winning trades every
$2.00 ($26.50 plus $2 equals $28.50
in this example).
INSIGHTS: WHY THIS
TECHNIQUE WORKS
Trading classic breakout patterns with
large ranges tends to work out much
better because of the momentum of
underlying price action. If the trading
56 • November 2018 • Technical Analysis of STOCKS & COMMODITIES
many more false breakouts. For example,
if you saw the same chart pattern as seen
in Figure 1 but with a range of only $17
to $19 (versus $17 to $26), it would be a
much poorer trading candidate. I used
to get into false breakouts all the time
because I was only looking for textbook
technical chart patterns. It was only
after many years of real-world trading
experience that I started to understand
that the math behind the chart (such as
the size of the trading range) is a lot
more important than the visual chart
pattern alone.
TRADE MANAGEMENT TIPS
The first tip to remember is to scan for
charts that have consistent uptrends in
the $20–$70 per share range. Charts that
are under $20, especially the cheap un-
der-$10 stocks, seldom exhibit multiweek
uptrends that can be easily capitalized on.
Conversely, stocks over $70 a share don’t
have the same leverage potential as charts
similar to the one shown in Figure 1.
A second tip is to combine what you
learned here in this month’s column
with approaches described in some of
my past columns, for example, trading
Trading classic breakout
patterns with large
ranges tends to work out
much better because
of the momentum of
underlying price action.
gap continuations, as seen on August 7
in Figure 1.
The final tip is that volatility cuts both
ways, so be sure to use tight initial and
trailing stops to intelligently manage
your trades. Good trades usually work
out well from the start; if a trade pulls
back or consolidates once you get in,
it is usually smart to exit sooner rather
than later.
Ken Calhoun is a producer of trading
courses, a live trading room, and video-
based training systems for active traders.
He is the founder of TradeMastery.com,
an educational resource site for active
traders and is a UCLA alumnus.