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award-winning BESt

BESt

Feb. 2005-2011

Feb. 2005-2011

Trading System: Stocks

Trading System: Futures

BESt

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Feb. 2003-2011

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Real-Time Data

Based on Technical Analysis of Stocks & Commodities magazine Readers’ Choice Awards (2003-2011); in each award category, results are based on the company that receives the highest number of votes cast by the magazine’s subscribers over a fixed time period that ends shortly before announcements of the awards.

2011 Rating based on Barron’s magazine 2011, a hands-on review of each company’s online brokerage products and services by a Barron’s journalist, in several categories, after which numerical scores are assigned per category and aggregated to determine overall numerical score and star rating. Barron’s is a registered trademark of Dow Jones.

3/17/2011 5:01:49 PM

THE TRADERS’ MAGAZINE SINCE 1982

GAP FILL AND GO An everyday strategy

http://www.traders.com/

14

IN THE VOLUME ZONE For trending and nontrending markets

16

PUT A STOP TO IT

Focus on your exit strategy 30

INTERVIEW

Markus Heitkoetter of Rockwell Trading

46

MSCI INDEXES Find your trading opportunities here

82

REVIEWS

■ The Machine Lite ■ MESA9

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T A K E C O N T R O L O F Y O U R I N V E S T M E N T L I F E. ©2011 MarketSmith, Incorporated. All rights reserved. MarketSmith® is a registered trademark of MarketSmith, Incorporated. The O’Neil Database ® and all data contained herein is provided by William O’Neil + Co. Incorporated.

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800.264.7538 | TradeStation.com *Based on Technical Analysis of Stocks & Commodities magazine Readers’ Choice Awards (2003-2011); in each award category, results are based on the company that receives the highest number of votes cast by the magazine’s subscribers over a fixed time period that ends shortly before announcements of the awards. IMPORTANT INFORMATION: TradeStation Securities is a member of NYSE, FINRA, NFA and SIPC. No offer or solicitation to buy or sell securities, securities derivatives or futures products of any kind, or any type of trading or investment advice, recommendation or strategy, is made, given or in any manner endorsed by TradeStation Securities, Inc. or any of its affiliates. • Please visit our website www.tradestation.com for relevant risk disclosures. • Past performance, whether actual or indicated by historical tests of strategies, is no guarantee of future performance or success. • Active trading is generally not appropriate for someone of limited resources, limited investment or trading experience, or low risk tolerance. • There is a risk of loss in futures trading. Options and Security Futures trading is not suitable for all investors. • Trading foreign exchange carries a high level of risk and may not be suitable for all investors. There is a possibility that you may sustain a loss equal to or greater than your entire investment; therefore, you should not invest or risk money that you cannot afford to lose. • System access and trade placement and execution may be delayed or fail due to market volatility or volume, quote delays, system and software errors, Internet traffic, outages and other factors. • All proprietary technology in TradeStation is owned by TradeStation Technologies, Inc., an affiliate of TradeStation Securities, Inc. • © 2011 TradeStation Securities, Inc. All rights reserved.

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3/22/11 11:19:11 AM

CONTENTS

MAY 2011, Volume 29 Number 6

14 Gap Fill And Go

by Jamie Theiss Here’s a look at two trades using a strategy you can use almost every day.

FEATURE ARTICLE

INTERVIEW

46 Short Swings In Futures With Markus Heitkoetter by Jayanthi Gopalakrishnan and Bruce Faber As founder and Ceo of Rockwell Trading, Markus Heitkoetter has shared his trading methods and ideas with more than 300,000 traders in over 196 countries. An author and speaker, he has seen his work published in major publications and on thousands of websites around the world. What’s he got to say about the market right now?

TIPS

16 In The Volume Zone

by Walid Khalil and David Steckler The volume zone oscillator can be applied to trending and nontrending markets. Find out how it can be used to trade the Djia, Spy, and gold.

24 Investment Candles

by Thomas N. Bulkowski Which candlesticks work best as reversal or continuation patterns?

30 Putting A Stop To It

by David Garrard A greater focus on your exit strategy and less on your entry may make a big difference in your overall trading results.

38 Context Is Everything

by Gil Morales and Chris Kacher This is how you use stock and index charts to determine market context.

54 Futures For You

by Carley Garner Here’s how the futures market really works.

60 Explore Your Options

by Tom Gentile Got a question about options?

AT THE CLOSE

TCA

82 New Opportunities In MSCI Indexes

by Donald Pendergast Jr. Never before has the typical futures market participant had so many trading opportunities available — and all under one roof.

45 Q&A

quick-scan, review 34 • The Machine Lite Quick-Scan: Web-based portfolio management system for equities and exchange traded funds 56 • MESA 9 Review: Analysis software

DEPARTMENTS 6 8 59 61 70 72 74 74 76 77 79

Opening Position Letters to S&C †Traders’ Glossary Traders’ Tips Trade News & Products Traders’ Resource Advertisers’ Index Editorial Resource Index Books for Traders Futures Liquidity Classified Advertising

by Don Bright This professional trader answers a few of your questions.

TIPS

This article is the basis for Traders’ Tips this month.

TCA WM

These articles – and articles like them – can be found online at www.traders.com

n Cover art: Jose Cruz n Cover concept: Christine Morrison/Jose Cruz

Copyright © 2011 Technical Analysis, Inc. All rights reserved. Information in this publication must not be stored or reproduced in any form without written permission from the publisher. Technical Analysis of Stocks & Commodities™ (ISSN 0738-3355) is published monthly with a Bonus Issue in March for $64.95 per year by Technical Analysis, Inc., 4757 California Ave. S.W., Seattle, WA 98116-4499. Periodicals postage paid at Seattle, WA and at additional mailing offices. Postmaster: Send address changes to Technical Analysis of Stocks & Commodities™ 4757 California Ave. S.W., Seattle, WA 98116-4499 U.S.A.

Printed in the U.S.A.

4 • May 2011 • Technical Analysis of Stocks & Commodities

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Interactive Brokers LLC is a member of NYSE, FINRA, SIPC. Supporting documentation for any claims and statistical information will be provided upon request. * Rates were obtained on March 1, 2011 from each firm’s website. Some of the firms listed may have additional fees and some firms may reduce or waive commissions or fees, depending on account activity or total account value. [1] Interactive Brokers’ Margin rates are the lowest of the entire group surveyed according to Barron’s online broker review Making the Right Connection - March 14, 2011. [2] According to Barron’s online broker review Making the Right Connection - March 14, 2011, Barron’s ranked Interactive Brokers with a 4.5 star rating for cost. Criteria included Trade Experience, Trading Technology, Usability, Range of Offerings, Research Amenities, Portfolio Analysis & Reports, Customer Service & Education, and Costs. [3] For additional information, see our website at www.interactivebrokers.com/bestexecution. [4] IB calculates the interest charged on margin loans using the applicable rates for each interest rate tier listed on its website. For additional information on margin loan rates, see www.interactivebrokers.com/interest.

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May 2011 • Volume 29, Number 6 March 2006 • Volume 24, Number 3

The Traders’ MagazineTM The Traders’ Magazine TM EDITORIAL

EDITORIAL [email protected] [email protected] Editor in Chief Jack K. Hutson Editor in Chief Jack K. Hutson Editor Jayanthi Gopalakrishnan Editor Jayanthi Gopalakrishnan Managing Editor Elizabeth M.S. Flynn Managing Editor Elizabeth M.S. Flynn Production ProductionManager Manager Karen KarenE.E.Wasserman Wasserman Art Art Director Director Christine ChristineMorrison Morrison Graphic GraphicDesigner Designer Wayne SharonShaw Yamanaka

Staff Writers Dennis D. Peterson, Editorial Intern Emilie Rommel Bruce Faber Webmaster Han J.David Kim Penn Technical Writer

Contributing Ehlers, Bruce Faber Staff WritersEditors Dennis John D. Peterson, Anthony W. Warren, Ph.D. Webmaster Han J. Kim Contributing Bright, Thomas ContributingWriters EditorsDon John Ehlers, KevinBulkowski, Lund, Martin Pring, Barbara Ph.D. Star Anthony W. Warren, Contributing Writers Don Bright, Thomas Bulkowski, Martin Pring, Adrienne Toghraie

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O Position Opening PENING POSITION

S O

pring is the season typically associated nce renewal, again we agot a reminder of and just with time to refresh how sensitive the financial markets reenergize. Alas, the spring of 2011 hasn’t are.that Weway. saw We a major in the Japanese felt haveselloff had political unrest in markets, which — as expected — triggered Middle Eastern countries including Tunisia,a domino effect on markets throughout the Bahrain, Egypt, Yemen, escalating to the crisis world. Add disappointing earnings numbers in Libya, which has given rise to international from US corporations andthe you a situainvolvement. There was 9.0have magnitude tion that just got worse. So what started off as earthquake and tsunami in Japan that devasa strong year ended up correcting, and rather tated the northeastern portion of the island of rapidly. and I must admitathat although Honshu triggered nuclear crisis.corrections are healthy for any market, when you have a 2%think drop,about it getsit,you thinking.to We have been faced with a year of crises. If you in addition Prior to the Federal Reserve’s F OMC meeting, I usually take a look at yieldin the recent crises in the Middle East and Japan, about a year after the BP the oil spill curve. At present, it’s looking a little flat, and given that the general consensus the US Gulf Coast, we have seen quite a number of global events such as floods in is that the earthquakes Fed is goingintoNew tighten at their January 31stcoups meeting, I am Africa. concerned Australia, Zealand, and currently, in North With that the yield curve may be heading in the direction of being inverted. And if that all these events taking place within the past year, the arrival of spring has been were to happen, that would not be a good sign for the US economy. I’m not rather bleak. that we in areJapan goingshows to go through a recessionary period. Butweakness given thatof suggesting What happened us the power of nature and the almost anything can happen, it doesn’t hurt to expect the worst. If nothing else, mankind, no matter how powerful we believe we are. Earthquakes in Japan, and it helps to preserve your capital. California, for that matter, are common, given their proximity to fault lines. Japan has prepared itself for earthquakes, but no matter how prepared you are, nature has the power of throwing something at you so powerful it is beyond expectation. It’s that unexpected variable that will us akilter. Weimportant live in a world of unknowns, with that in mind, youknock can see why it’s to design a trading and from time to time we are reminded in a most jarring way that these unknowns system that gets you out of the market at the right time. When access to exist. Yet we is never expect them. of options available increases. This makes it the markets easy, the number

So

W

important to be thorough with the different types of orders, front-end software, and trading systems that are out there. Lee Leibfarth, in his article “The Automated hen the world is confronted with crisis, I prefer be actively Daytrader” starting on page 22, addresses thesuch various options thatnot aretoavailable and involved in the markets. I would rather not be in a position where I would how you can take advantage of them. be But taking advantage price of oilthat andtrade, gold,you or wide fluctuabefore gettingof to the the rising stage of placing need currency to understand the tions. But I didn’t see any major moves that indicated that the markets were going market you are trading. You should be able to do so after reading Paolo Pezzutti’s to take any majorMarket hits. There were theThe usual expected short-term reactions, butpatthe “Understanding Structure.” markets follow different behavior markets seemed to return to normal quickly. Could it be that there are others who, terns, and you need to determine if it is volatile, trending, in a trading range, moving like me, also would rather not be involved in the markets such times? That’s strongly in one direction, or moving but not with much during momentum. a comforting thought, and I will stick with that for now. Only when you know what the structure of the market is will you be able to apply theI am confident that the peopleBut of Japan tragedy and to rebuild correct trading technique. that’s will just recover the firstfrom step.the You still have have and regain their strength. Although the beginning of spring may not appear to beof a discipline, as you will find out after reading this month’s Technical Analysis time of renewal right now, there may be something unexpected that will give rise STOCKS & COMMODITIES interview with Ken Tower. Only then will you be able to to a brighter future. know when to exit. Here’s to smart trading! Jayanthi Gopalakrishnan, Editor Jayanthi Gopalakrishnan, Editor

6 • May 2011 • Technical Analysis of Stocks & Commodities 8 • March 2006 • Technical Analysis of STOCKS & COMMODITIES +1105 Opening_Position.indd 1 +0603 Opening Position

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The editors of S&C invite readers to submit their opinions and information on subjects relating to technical analysis and this magazine. This column is our means of communication with our readers. Is there something you would like to know more (or less) about? Tell us about it. Without a source of new ideas and subjects coming from our readers, this magazine would not exist. Email your correspondence to [email protected] or address your correspondence to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All letters become the property of Technical Analysis, Inc. Letter-writers must include their full name and address for verification. Letters may be edited for length or clarity. The opinions expressed in this column do not necessarily represent those of the magazine.—Editor

MATHEMATICAL EXPECTATION Editor, I have been a follower of your magazine for quite some time, and usually read it from cover to cover as soon as it arrives in the mail. For some time I have been using an evaluation methodology similar to what Stephen Massel describes in his article, “What Can You Expect, Mathematically?” in the March 2011 issue of S&C. I was pleasantly surprised to see the methodology I use in evaluating my trading systems described in such a good fashion, and can’t help but ask the author about the single discrepancy I have with the one described in the article. Massel describes the calculation for the reward/ risk ratio as the average profit per trade/ average loss per trade in dollars as an appropriate measure. I moved away from using such a measure some time ago, as it is very dependent on the price of the instrument being traded (and thus on the position size) — as the author properly states in his “Application To Your Own Trading” section. Instead, I prefer to use the payoff ratio, which is calculated as (average percentage profit per trade)/ (average percentage loss per trade). Conceptually, they should be equivalent, as both of them are dividing an average profit per trade by an average loss per trade (one expressed in dollars and the other one expressed as a percentage). However, in practice, I have found that there are slight differences in the result between each approach. In some cases, the percentage calculation for the expectancy is higher and in others the absolute amount calculation is higher, as can be seen in the attached spreadsheet [not shown—Ed.] with a set of tests runs.

Conceptually, I think there should be a preference for the expectancy calculated as a percentage, since it offers the advantage of independence to the price level of the traded instrument. Can the author offer any further insight on this? On a side note, the article mentions that the author works in Wealth-Lab. Does he have any performance visualizer for the Wealth-Lab platform that incorporates the measures he mentions in his article? Thanks and keep up the good work. Jorge Dardón P. Doral, FL Author Steve Massel replies: Thanks for your email. Yes, I agree, the R/R ratio in dollars is more applicable when trade size is an inherent part of the strategy, for example, when adjusting for risk. A purer method of evaluation, where risk is not adjusted, would be to use R/R as the average % gain / average % loss, as I do in such cases — and as you point out, I discuss this in the section on application to your own trading. I have played around with mathematical expectancies (MEs) in Wealth-Lab. I have added the ME to the PerfScript code so that it is calculated and displayed as part of the standard metrics in the performance tab. I have also written an indicator that shows a rolling ME calculation based on period-to-period price moves. I would be happy to share these with you, if you would like. Please also note that the following typo appeared in the article: The scalp system example, R/R, should have been 0.8 instead of 0.9 in order to yield an ME of 26. Unfortunately, I did not receive the spreadsheet attachment you mention.

FOLLOWUP ON Market Instrument Function Editor, The article “The Market Instrument Function” published in the December 2010 issue of S&C left me very enthusiastic about using this signals processing technique, but also perplexed as to how to do just that. I have a background in engineering, but not in signals processing. After reviewing the “mathematical discussion” section several times, I still do not understand how to compute the E(t-tau) device instrument function. Computing the output from the input plus device instrument function is simple, but how does one compute the device instrument function from the input and output? I am interested in an expression of the type “E(t-tau)=...” Could the authors provide an example calculation or further reading suggestions on computing the device instrument function from the input + output? Eric Lanoix Vancouver, BC, Canada Authors Aleksey Gersimov and Alexander Ershov reply: The main purpose of our article “The Market Instrument Function” was to introduce you to the instrument function method and to show a forecast for price movement that was built by this method for such assets as Dia and Spy. In the article we showed a five-year forecast. We do not know of any other method that can build such long-term forecasts. In the article’s sidebar titled “Mathematical discussion,” we showed that the presence of an input signal, device, and output signal is always equivalent to the Fredholm equation of the first type. This part of the article is related to the problem definition but not to its solution. It is a universal mathematical description of any problem, in which the device transforms an input signal into an output signal. For those who are interested in the solution to the problem, the following explanation is a method that makes it possible to determine the instrument function.

8 • May 2011 • Technical Analysis of Stocks & Commodities

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Consider the function ƒ(τ), the price history, as an input signal; and the ~ function ƒ(t), the future movement of prices, as an output signal. All the factors influence the pricing we describe with a market instrument function E(t–τ). According to our article, the detailed description is equivalent to the Fredholm equation of the first type:

~ f (t) =

b

∫ a

f (τ)E(t − τ)dt

(1)

It is clear that if we know the instrument function, we can always determine ~ the function ƒ(t) — the future movement of prices — from equation (1). To determine E(t–τ), we can divide the history of the price movement into two parts and consider one of them as the past ƒ(τ) and the second one as the future. In this case, in equation (1), only one unknown function is left: function E(t–τ). Our aim is thereby reduced to solving the Fredholm equation of the first type relative to the equation kernel E(t–τ). This equation is of a convolution type. That’s why we can apply the Fourier transform to equation (1), as follows:

~ g (u ) =

1 2π

∞

∫ g( x ) e

−iux

dx

−∞



(2)

However, according to the convolution theorem, Fourier transform of convolution is a multiplication of Fourier integrals–appropriate functions; thus, we get:

~ ~ 2π E (u)y~(u) = f (u)



(3)

where: ~ E(u) is a representation of function E(t–τ) ~ y (u) is a representation of function ƒ(τ) ~ ~ ƒ is a representation of function ƒ(t). Thus, by means of the Fourier transform, we managed to reduce the solution of the original integral equation (1) to the solution of the algebraic equation (3) for representing the desired solution.

The solution of the latter equation has the form:

~ E (u) =

( (( ( ~ f (u) ~ y (u)

1 2π

(4)

~ ƒ (u) where the function ~ y(u) must belong to the space L2(–∞,∞). By that, the representation of the original integral equation solution turned out to be expressed through representations of the given functions — input and output signals. The solution itself can be expressed by means of the inverse Fourier formula:

E ( t –τ) =

1 2π

1 = 2π

∞

~

∫ E (u ) e

− iu ( t − τ )

du

−∞ ∞

∫

−∞

~ f ( u ) − iu ( t − τ ) e du ~ y ( u)



Herewith, the limits of integration in equation (1) can be determined from the maximum of the correlation function of ~ the functions ƒ(t–τ) and ƒ(t). Please note that the dependence of the market instrument function E(t–τ) on the difference of t and τ means the presence of temporal shift between the functions ~ ƒ(τ) and ƒ(t). Finally, here is a list of further reading readers may find useful: Hackbusch, Wolfgang [1995]. Integral Equation: Theory And Numerical Treatment, Birkhäuser Verlag. Jerri, Abdul J. [1985]. Introduction To Integral Equations With Applications: Pure And Applied Mathematics, Marcel Dekker. Kanwal, Ram P. [1996]. Linear Integral Equations, 2d edition, Birkhäuser. Polyanin, Andrei D., and Alexander V. Manzhirov [2008]. Handbook Of Integral Equations, Crc Press. Porter, David, and David S.G. Stirling [1990]. Integral Equations: A Practical Treatment, From Spectral Theory To Applications, Cambridge University Press. Smithies, F. [2009]. Integral Equations, Cambridge University Press.

NEW FORMAT FOR TRADERS’ TIPS Editor, As a long-time subscriber and reader of your magazine, I enjoy your magazine and get a lot of good trading ideas from it. However, I dislike the new format for the Traders’ Tips column. I don’t like that you no longer print the code but instead direct readers to your website or to the contributor’s website for the code. When I tried going to your website for the code, I found it was down, so I wasn’t able to obtain the code when I wanted to use it. In addition, at some of the software developers’ websites, it can be very difficult to find the current code or it is not posted there. I liked your old format where the code was printed in the monthly magazine, so that I can be sure I’ll have a copy of the code available. Please go back to printing the code in each month’s hardcopy edition. Paul Thank you for writing. We discontinued printing all the code (for the most part) in the Traders’ Tips section because of the space it took and because printed code just isn’t very useful, given the difficulty (or impossibility) of accurately keying in long code lists. Since most readers want to copy and paste the code anyway from a web page, we opted to move the code online and started printing mainly the commentary from the Traders’ Tips contributors, producing a more condensed section in the printed magazine, with some exceptions. (In this issue, we’ve included some code because the code listings were short.) In any case, we regret any frustrations this change may cause some readers. We will continue to print code in articles and in the Letters section.—Editor METASTOCK CODE FOR Cup Formations Editor, In “Identifying Cup Formations Early” (S&C, April 2011), I believe there is an error in the first line of the Meta­Stock

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formula given in the article: {Basic Definitions} semicupperiod:=LastValue(Max(BarsSince(C >=LastValue(C*parameter)),1))+1;

I get the following alert at C*: “This is not a recognized name, constant, or operator.” I don’t know what to change it to or even what that means. Can you help? Bob Robertson Author Giorgos Siligardos replies: There is no error in the code. The basic code segment is just a part of the “S&CIsSemiCup” indicator. You are getting the error because you input only part of the indicator. The indicator is the “S&C – IsSemiCup” indicator, and the Basic code must be inserted in the line that reads . Please review the article and also find the entire code listing at the S&C website in the Subscriber Area at: http://technical.traders.com/sub/ Codes/2011/042011Siligardos.asp. [To navigate to the Subscriber Area, go to S&C’s homepage at www.Traders. com, click on “Stocks & Commodities,” and click on “Subscriber’s Area.” You will need to enter your last name and subscriber number, found on your magazine’s mailing label, to enter this area. Then scroll all the way down until you see the heading “S&C Article Code.” See also the S&C Traders’ Tips online at http://www.traders.com/

Documentation/FEEDbk_docs/2011/04/ TradersTips.html for additional code on cup formations for other software platforms.—Editor] For your convenience, below I show the entire code set for the “S&C – IsSemiCup”: MetaStock code -------------------------------------------S&C - IsSemiCup -------------------------------------------{Giorgos E. Siligardos, 2009} {Basic Semi-Cup Identification Algorithm} {parameter} parameter:=Input(“parameter”, 1, 100,2); FilC:=(Log(C)); eps:=0.0000000001; {Basic Definitions} semicupperiod:=LastValue(Max(BarsSinc e(C>=LastValue(C*parameter)),1))+1; Ptop:=LastValue(HHV(FilC,Semicuppe riod)); Pbot:=LastValue(LLV(FilC,Semicupperi od)); boxheight:=LastValue(Abs(Ptop-Pbot)/5); boxlength:=LastValue(Max(Int(semicupp eriod/5),1)); {Grid Nodes} b0:=LastValue(Cum(1)-semicupperiod+1); b5:=LastValue(Cum(1)); b1:=LastValue(Min(b0+boxlength,b5)); b2:=LastValue(Min(b1+boxlength,b5)); b3:=LastValue(Min(b2+boxlength,b5)); b4:=LastValue(Min(b3+boxlength,b5)); L2:=Pbot+2*boxheight; L3:=Pbot+3*boxheight; {Directional Strength} DSX1:=Abs(Sum(Max(FilC-Ref(FilC,-

1),0),2*boxlength)-Sum(Max(Ref(FilC,1)-FilC,0), 2*boxlength))/ (eps+Sum(Max(FilC-Ref(FilC,1),0),2*boxlength)+Sum(Max(Ref(FilC,-1) -FilC,0),2*boxlength))*100; DSX2:=Abs(Sum(Max(FilC-Ref(FilC,1),0),3*boxlength)-Sum(Max(Ref(FilC,1)-FilC,0), 3*boxlength))/ (eps+Sum(Max(FilC-Ref(FilC,1),0),3*boxlength)+Sum(Max(Ref(FilC,-1) -FilC,0),3*boxlength))*100; {Conditions} isSemicup:= {1}(semicupperiod>=20) AND {2} (Ref(DSX1,-(b5-b2))>25) AND {3} (DSX2=b2, FilC>L3,0))= 0) AND {5}(Cum(If(Cum(1)>=b4, FilC>L2,0))= 0) ; LastValue(isSemicup*semicupperiod); ----------------------------------------------------

CLARIFICATION: Trade News & Products A listing of an eSignal product update in the March 2011 Trade News & Products column should have included an image of eSignal’s website, not that of the parent company, Interactive Data. In addition, the website associated with the eSignal software is www.eSignal.com, not its parent company website, www. InteractiveData.com.

eSignal.com

S&C

“Yes, Freman, those people down there look tiny – and given our directives and business matrix, unfortunately, they are tiny.” 12 • May 2011 • Technical Analysis of Stocks & Commodities

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ETRADE.COM / 1-800-ETRADE-1 Customers who receive promotional offers from affiliates of E*TRADE Financial Corporation may be subject to IRS Form 1099-MISC reporting requirements should the total value of those items exceed $599 in a calendar year. Please consult a tax professional. 1. This offer applies only to new Power E*TRADE accounts opened with a minimum $2,000 deposit from an external bank or brokerage account. You will receive up to 500 trade commissions for each stock or options trade executed within 60 days of the deposited funds clearing in the new account. You will pay $9.99 for your first 149 stock or options trades and $7.99 thereafter up to 500 stock or options trades (plus 75¢ per options contract). Account must be funded within 60 days of account open. Credits for cash or securities will be made based on deposits of new funds or securities from external accounts made within 45 days of account open, as follows: $250,000 or more will receive $500; $100,000-$249,999 will receive $250; $50,000-$99,999 will receive $100; $25,000-$49,999 will receive $50. Your account will be credited for trades and deposits within eight weeks. You will not receive cash compensation for any unused free trade commissions. Excludes current E*TRADE Securities customers (except IRA accounts), E*TRADE Financial Corporation associates and non-U.S. residents. This offer is not valid for IRAs, other retirement, business, trust or E*TRADE Bank accounts. New funds or securities must remain in the account (minus any trading losses) for a minimum of 6 months or the credit may be surrendered. One promotion per customer and per linked account. E*TRADE Securities reserves the right to terminate this offer at any time. Accounts must be opened by December 31, 2011, the offer expiration date. 2. The Power E*TRADE Pro trading platform is available at no additional charge to Power E*TRADE active trader customers who execute at least 30 stock or options trades during a calendar quarter. To continue receiving access to this platform, you must execute at least 30 stock or options trades by the end of the following calendar quarter. 3. The projections or other information generated by Strategy Scanner regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Strategy Scanner is a product of Trade Ideas LLC, a third party not affiliated with E*TRADE Financial Corporation or any of its affiliates. Securities products and services are offered by E*TRADE Securities LLC, Member FINRA/SIPC. System response and account access times may vary due to a variety of factors, including trading volumes, market conditions, system performance and other factors. ©2011 E*TRADE Financial Corporation. All rights reserved.

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Using Candlesticks And Simple Moving Averages

Here’s a look at two trades using a strategy you can use almost every day. by Jamie Theiss

I’m

going to show you two trades using a bread & butter strategy you can use almost every day to capture profits from the stock market. As you can see from Figures 1 and 2, I use candlesticks and moving averages on a five-minute time frame. I use the eight- and 21-period simple moving averages (SMA), which are displayed in green and blue, respectively, along with the 200-period SMA (red). Of course, eight and 21 are Fibonacci numbers. In addition, the 200-day SMA is watched by so many that it has practically become self-fulfilling. I call the technique the “gap fill and go.”

THE SETUP

To set up these trades, please observe that the eight- and 21-period SMAs are in an uptrend on the five-minute chart. While not shown, the SMAs are also in an uptrend on the higher time frame charts, such as the 15-minute and 60-minute charts. Next, we have a bullish gap up on the opening bell. Now the hardest part of the trade is sitting on your hands for the first 30 minutes of trading. You want to just sit and observe. Then, you may begin to notice the gaps are starting to fill. This is just a version of the well-tested slogan, “Buy the dips and sell the rallies.” You are just waiting for the dip to occur in the predetermined uptrend.

JOSE CRUZ

Gap Fill And Go

THE FAS TRADE

In the Direxion Daily Financial Bull 3X Shares exchange traded fund (FAS) trade in Figure 1, you are waiting for the

14 • May 2011 • Technical Analysis of STOCKS & COMMODITIES

+1105 Theiss.indd 1

3/24/11 11:11:59 AM

first green bar to take out a red bar. This will usually happen during the 10:00 am reaction time. This could be anywhere from 9:50 am to 10:10 am. The fourth red bar’s highest price is just below $30.20, so you want to buy one cent over that red bar, or $30.21, and place your protective stop one cent below the entry bar, which is $29.98. I don’t wait for the bar to close and take the entry as Buy soon as the previous bar’s high is taken out. The current low of the not-yet-closed entry bar is what the stop would be. If that low is broken, then the reason for the trade is over. That gives you a 23-cent risk for this trade. It is critical you share-size correctly for the risk amount. For example, if your risk per trade is $100, using a risk of 23 cents gives you a share size of 435 [100/$0.23 = 435]. It is wise to average down to 400 shares to Figure 1: the fas trade. The eight- and 21-period SMAs are in an uptrend and there is a bullish gap up on the opening bell. Once you see a potential winning trade, you calculate your risk-reward ratio, position account for slippage and transaction costs, size, and place your protective stop. and to keep you from using odd lots. In addition, I hope you noticed how the flat 200-period Sma (red) acted as a floor of support for the price movement. It is almost as if by magic. To recap, we have a reversal bar off the Sell flat 200-period Sma with rising eight- and 21-period Smas, at the 10 am reaction time. We’ve identified a potential winning trade, calculated the risk, determined share size, and placed our protective stop. Now we sit on our hands again and let our edge play itself out, and wait for our profit-taking plan to activate. While there are many ways to trail the price and take profits, for this method I will use a five-minute bar-by-bar trail method. But first I have to be willing to let the trade breathe a bit and let my edge play out. I am going to wait until I have two consecutive bars of Buy profitability. Only then will I move my stop to breakeven and start the bar-by-bar break count. Looking at the Fas chart, you can see the first bar break is after the little doji bar. That Figure 2: the ntap trade. The setup is similar to the FAS trade, but in this case, the 200-period SMA narrow range bar is only high $30.55/low is overhead. This gives you a possible price target. An effective method to manage your positions would be $30.48, so I would exit the trade as soon as to take partial profits just below the SMA overhead resistance and trail your remaining positions. In the event $30.47 prints in the time & sales window. My there is a big run to the upside, you would be in a good position to take advantage of it. entry was at $30.21 and I am flat at $30.47, which leaves a profit of 26 cents on 400 shares, or $104. It is but pulled back with the rest of the market to fill the gap by not the most profitable trade at only a 1:1 risk-reward ratio, the 10:00 am reaction time. Again, I am looking for a green bar to take out a red bar. but it is a profit, nonetheless. The entry price triggered at $54.03, but the spread and slippage got my cost to $54.05. The low of that big red bar at the The NTAP trade In Figure 2, the setup is almost the same as with Fas. The Smas pivot on the 20-period Sma is $53.71, so my stop will be at are rising on the five-, 15-, and 60-minute charts. NetApp Inc. Continued on page 36 (Ntap) showed some strength on the first two five-minute bars May 2011

+1105 Theiss.indd 2

BLACKWOOD PRO

Sell

• Technical Analysis of Stocks & Commodities • 15

3/31/11 8:38:09 AM

+Khalil Steckler indd 1

3/24/11 10 14 32 AM

INDICATORS

Trending Or Nontrending?

In The Volume Zone Here’s a look at the volume zone oscillator, which can be applied to trending and nontrending markets. Find out how it can be used to trade the Djia, Spy, and gold. axiom of technical analysis states that with few exceptions, all technical indicators can be classified as either trending or oscillating (nontrending) in their design. This new indicator, the volume zone oscillator (Vzo), addresses both. In his book Technical Analysis Of The Financial Markets, John J. Murphy explains that using oscillators provides three benefits:

An

n Overbought and oversold conditions warn that price trend is overextended and vulnerable. n Divergence between oscillator and price action shows hidden strength or weakness in the market, which is not apparent in the price action.



AYA KAKEDA

n The crossing of the zero line can give an important trading signal.

The volume zone oscillator Volume is simply the number of shares or contracts that have been traded throughout the day, so the higher the volume, the more active the security. Volume is always treated as a secondary indicator, despite its importance in confirming trends and chart patterns. Volume analysis is a key component of analyzing and predicting the future direction of an asset. Joe Granville introduced the on-balance volume (Obv) indicator in his Granville’s New Key To Stock Market Profits. This was one of the first and most popular indicators to measure positive and negative volume flow. The concept behind Obv is that volume precedes price. Obv adds a period’s volume when the close is up and subtracts the period’s volume when the close is down. Unlike the Obv, which discards such criteria, Vzo takes into account both time and volume fluctuations from bearish to bullish and vice versa. Vzo takes volume actions one step forward by smoothing the volume and plotting such actions in the form of an oscillator, not as a trend-following indicator like the Obv. These modifications take the form of a leading indicator that provides buy/sell signals based on oversold/overbought behavior.

The formula depends on only one condition: If today’s closing price is higher than yesterday’s, then the volume will have a positive value VOLUME ZONE OSCILLATOR CODE (bullish). Otherwise, it will have a negative With appreciation to Aapta member Bob Fulks for assistance with the TradeStavalue (bearish). So: Volume zone oscillator = 100 x (VP/TV) where: VP (Volume position) = X-days Ema (± volume) and TV (Total volume) = X-days Ema (volume)

by Walid Khalil and David Steckler

tion coding.

TradeStation Volume zone oscillator: Input: Period(14); Vars: MV(0), R(0), VP(0), TV(0), VZO(0); MV = iff(DataCompression >= 2, AbsValue(Volume),Ticks); R = Sign(Close - Close[1]) * MV; VP = XAverage(R, Period); TV = Xaverage(MV, Period); if TV 0 then VZO = 100 * VP / TV;

May 2011

+Khalil Steckler.indd 2

Plot1(VZO, “VZO”); Plot2(+60, “+60”); Plot3(+40, “+40”); Plot4(+15, “+15”); Plot5(-5, “-5”); Plot6(-40, “-40”); Plot7(-60, “-60”); Plot99(0, “zero”); MetaStock Volume zone oscillator: Period := Input(“Y” ,2 ,200 ,14 ); R :=If(C>Ref(C,-1),V,-V); VP :=Mov(R,Period ,E); TV :=Mov(V,Period ,E); VZO :=100*(VP/TV); VZO

• Technical Analysis of Stocks & Commodities • 17

3/24/11 10:14:50 AM

^DJI Weekly 9/11/2009 Open 9440.13 Hi 9698.67 Lo 9402.8 Close 9605.41 (1.7%)

15,000 14,000 13,000 12,000 11,000

4 2 3

1

9,605.41

6

Uptrend

Turning point

^DJI - Volume Zone OSC (14) = 31.05

1

10,000

Downtrend 5

3

8,000 7,000

31.0627

7 5

AMIBROKER

^DJI - Volume()

7 Uptrend 6

4 2

9,000

Figure 1: the volume zone oscillator (vzo). On this weekly chart of the DJIA you see all the components of the VZO: the 60-period EMA, 14-period ADX, and the seven oscillator zones.

INDICATORS

and its money flow analysis also explain Dow theory’s trend phases of accumula‑ tion, public participation, and distribution. Figure 1 displays more than three years of Dow Jones Industrial Average (D jia ) weekly data, numbered at points discussed in detail, and the zones are colored, accord‑ ing to their trend. The chart shows only the four major zones (+60, +40, ‑40, ‑60) plus zero (horizontal black line):

 

The Vzo discerns bullish volume from bearish volume and is useful for identifying at which zone (bullish or bearish) volume is positioned. The oscillator is plotted on a vertical scale of& ‑100 to +100. Movements above +40 are considered Analysis of STOCKS COMMODITIES magazine overbought, while an oversold condition would be a move under ‑40. Movements above +60 mark extreme overbought th approval or changes: levels, while an extreme oversold condition is a move under ‑60. The zero line demonstrates equilibrium between buyers and sellers. The components of the Vzo system are: 06-938-1307 • email: [email protected] n 60-period exponential moving average (Ema)

PROOF #1

n 14-period average directional movement index (Adx) n Seven oscillator zones: +60, +40, +15, zero, ‑5, ‑40, and ‑60.

VZO clarifies money flow

Volume figures alone do not provide a clear money flow analysis or even explain changes in volume attitude during different trends; Vzo analysis can add important information about the trend as well as a clear money flow analysis. Vzo movements

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1 During the uptrend period starting from October 2005 until October 2007 (area 1), Vzo was moving with the trend, fluctuating between the zero line and the upper zone (public participation phase). 2 At area 2, price was rising normally while the Vzo was declining, forming a negative divergence (distribution phase). 3 At turning point zone 3, Vzo has made a new two-year low, giving a warning that more shares than usual have been distributed (distribution phase). 4 At point 4, for the first time in more than two years, Vzo has failed to reach the upper boundary, giving another warning that bears are taking control (distribu‑ tion phase). 5 At zone 5, Vzo clearly shows the heavy selling pressure confirming the downtrend (panic & public participation phase). 6 At point 6, and for the first time since April 2007, Vzo has reached +40, indicating new money flows (accumulation phase). 7 Finally, at point 7, Vzo has rebounded from the zero line without reaching ‑40, indicating an uptrend attitude (accumulation phase). The volume zone oscillator is useful in uptrending, down‑ trending, or sideways market conditions. The following ex‑ amples of the Vzo include the seven oscillator zones: +60 is marked with green crosses, the +40 with a green line, the +15

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iShares Gold Trust (“Trust”) has filed a registration statement (including a prospectus) with the SEC for the offering to which this communication relates. Before you invest, you should read the prospectus and other documents the Trust has filed with the SEC for more complete information about the issuer and this offering. You may get these documents for free by visiting www.iShares.com or EDGAR on the SEC website at www.sec.gov. Alternatively, the Trust will arrange to send you the prospectus if you request it by calling toll-free 1-800-474-2737. Investing involves risk, including possible loss of principal. The Trust is not an investment company registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Trust are not subject to the same regulatory requirements as mutual funds. Because shares of the Trust are created to reflect the price of the gold held by the Trust, less the Trust’s expenses and liabilities, the market price of the shares will be as unpredictable as the price of gold has historically been. Brokerage commissions will reduce returns. The price received upon the sale of the shares, which trade at market price, may be more or less than the value of the gold represented by them. There is no guarantee an active trading market will develop for the shares, which may result in losses on your investment at the time of disposition of your shares. For a more complete discussion of the risk factors relative to the Trust, carefully read the prospectus. The trustee’s arrangements with the custodian contemplate that at the end of each business day there can be in the trust account as such custodian no gold in an unallocated form. BlackRock Asset Management International Inc., an affiliate of BlackRock, Inc., is the sponsor of the Trust. ©2011 BlackRock Institutional Trust Company, N.A. All rights reserved. iShares® is a registered trademark of BlackRock Institutional Trust Company, N.A. iS-3531-0111

++Full pg Ad Template.indd 1

264433mea02_B.indd

DM

3/23/11 10:56:31 AM

T:10.75”

IAU

SPY

L=112.81 0.16 0.14% B=112.81 A=112.82 O=112.32 Hi=112.92 Lo=111.98 V=87,961,317 Mov Avg Exponential (Close,60,0) 109.72

INDICATORS

124.00 122.00 120.00 118.00 116.00 114.00 112.81 112.00

60-Day EMA

109.72 108.00

and +40, indicating more buying pressure than selling pressure.

Uptrend system

rules When the Adx is above 18, the action is considered to be Volume Zone Oscillator (14) 25.01 60.00 40.00 15.00 -5.00 -40.00 -60.00 0.00 80.00 trending. The price crossing the 60.00 40.00 60-day Ema determines whether 25.01 15.00 the trend is bullish (above the -5.00 -20.00 Ema) or bearish (below the -40.00 -60.00 E ma). When the Adx is below ADX w/Level (14, 18, Black) 18.63 18.00 18.00 45.00 18, the action is considered 40.00 35.00 to be sideways, regardless of 30.00 25.00 whether price is above or below 18.63 the Ema. 15.00 When price is above the 6011 • Technical Analysis of STOCKS & COMMODITIES magazine day Ema and Adx is greater than Figure 2: the seven oscillator zones. On the daily chart of the SPY, these zones are marked on the VZO subchart, with 18, buying signals are issued each horizontal line representing one zone. act Karen Moore with approval or changes: when: TRADESTATION

106.00

with a gray line, zero with a black line, ‑5 with a light blue

6) 938-0570 • fax: 206-938-1307 • email: [email protected] line, ‑40 with a red line, and ‑60 with red crosses. The zones are marked on the daily Spy with Vzo in Figure 2.

Uptrend psychology PROOF #1

During uptrends, volume rises with rising prices and falls during corrections. This is one of Dow theory’s basic tenets, as expressed by Robert Edwards and John Magee: “Volume goes with the trend.” Long-term investors tend to accumulate shares gradually, leading to a major shift in the demand/supply outcome toward the demand, which in turn leads to waves of higher lows followed by higher highs. Volume tends to increase upon reaching new price territo‑ ries and decrease during downward corrections. The Vzo will react to that behavior by staying in the upper zone between zero

n The Vzo crosses from below ‑40 to above ‑40 (over‑ sold reversal) n A retracement down from +40 that fails to reach ‑40 is common during an uptrend. Vzo will not reach the lower boundary and will rebound from a low above ‑40. Thus, crossing from below zero to above gener‑ ates a buy signal. To reduce whipsaws, you can wait for a crossing from below zero to above +15. Three selling conditions occur during a long position when: n The Vzo rises above +60 and starts to go down n A negative divergence appears at an extreme level and Vzo breaks below +40 n Price goes below the 60-day Ema and Vzo falls below zero.

Downtrend psychology Advanced algorithms deliver low lag, low noise analysis.

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During downtrends, volume rises with falling prices and falls during upward corrections. Long-term investors tend to lay off their shares gradually, leading to a major shift in the demand/ supply outcome toward the supply, which in turn leads to waves of lower highs followed by lower lows. The Vzo will react to that volume behavior by staying in the lower zone between ‑40 and zero, indicating more selling pressure than buying pressure.

Downtrend system rules

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When price is below the 60-day Ema and Adx is greater than 18, sell short signals are issued when: n The Vzo crosses from above +40 to below +40 (over‑ bought reversal)

20 • May 2011 • Technical Analysis of Stocks & Commodities

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SPY

124.00

L=112.73 0.08 0.07% B=112.73 A=112.74 O=112.32 Hi=112.92 Lo=111.98 C=112.73 V=88,987,876 Mov Avg Exponential (Close,60,0) 109.72

INDICATORS

122.00 120.00 118.00 116.00 114.00 112.73 112.00 60-Day EMA

109.72 108.00 106.00

Volume Zone Oscillator (14) 25.07 60.00 40.00 15.00 -5.00 -40.00 -60.00 0.00

Bearish divergence

Sell S

Buy

Sell short

80.00 60.00 40.00 25.07 15.00 -5.00 -20.00 -40.00 -60.00 45.00

n The Vzo falls below ‑60 and starts to go up n A positive divergence appears at extreme lev‑ els and V zo breaks above ‑40 n Price goes above the 60-day Ema and Vzo rises above zero.

With this information, now review the Spy with Vzo in ADX w/Level (14, 18, Black) 18.63 18.00 18.00 Figure 3, but annotated with 35.00 buy and sell information. 25.00 Back in mid-February 2010, 18.63 15.00 when the Adx was greater 18.63 FIGURE 3: TRENDING CONDITIONS. All conditions for the buy and sell signals are met in the areas marked buy and sell on the VZO. than 18, Spy rose back above Also note the sell short signal on June 11, 2010. Price was below its 60-day EMA and the VZO crossed up and down through zero. its 60-day Ema while the Vzo crossed up and down through the zero line. The price closing GLD above the Ema on February L=123.80 0.22 0.18% B=123.79 A=123.80 O=123.97 Hi=124.29 Lo=123.43 C=123.80 V=8,061,633 Mov Avg Exponential (Close,60,0) 119.45 17 (far left, blue ellipse) was 122.00 accompanied by the Vzo clos‑ 120.00 119.45 ing at 7.80 (blue rectangle, 118.00 labeled buy), its highest close 116.00 since January 19. This posi‑ 114.00 tion would have remained 112.00 long until March 18 when the 112.73 110.00 110 Vzo closed well above +60 108.00 60-Day EMA and then fell lower (second 106.00 blue ellipse and second blue 104.00 rectangle, labeled sell). Volume Zone Oscillator (14) 25.07 60.00 40.00 15.00 -5.00 -40.00 -60.00 0.00 The next buying opportu‑ 80.00 60.00 nity came on March 29. Spy 40.00 was trading above its 60-day 22.16 15.00 Ema (third blue ellipse) and -5.00 --20.00 the Vzo fell below and then -40.00 -60.00 rose back above zero (third ADX w/Level (14, 18, Black) 18.56 18.00 18.00 blue rectangle, labeled B). 26.00 This trade was also profitable, 18.56 14.00 exiting on April 16 when the Vzo clearly made a bearish FIGURE 4: NONTRENDING CONDITIONS. In such situations, the VZO fluctuates between ‑40 and +40, indicating a balance between divergence with price (note buyers and sellers. the rising price trendline and the falling Vzo trendline) and n A retracement up from ‑40 that fails to reach +40 is com‑ after rising above +40, closed below +40 (fourth blue ellipse mon during a downtrend. Vzo will not reach the upper and fourth blue rectangle, labeled S). boundary and will fall lower from a high below +40. Thus, crossing from above zero to below zero generates In nontrending a sell short signal. To reduce whipsaws, you can wait for a crossing from above zero to below ‑5 periods, the demand/ B

There are three covering/closing conditions during a short position when:

supply outcome is neutral.

22 • May 2011 • Technical Analysis of Stocks & Commodities

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GLD L=123.80 -0.22 -0.18% B=123.79 A=123.80 O=123.97 Hi=124.29 Lo=123.43 C=123.80 V=8,061,633 Mov Avg Exponential (Close,60,0) 119.45

122.00 120.00 119.45 118.00 116.00 114.00 112.00 112.73 110.00

60-Day EMA

108.00 106.00 104.00

Volume Zone Oscillator (14) 25.07 tt 15.00 -5.00 -40.00 -60.00 0.00

Buy

Sell

80.00 60.00 40.00 22.16 15.00

Buy

Sell

Multiple buy signals

ADX w/Level (14, 18, Black) 18.56 18.00 18.00

-5.00 --20.00 -40.00 -60.00 26.00 18.56 14.00

FIGURE 5: BUY AND SELL SIGNALS IN NONTRENDING CONDITIONS. Two buy and two sell signals were indicated by the VZO. There were also numerous buy signals on GLD after June 7, 2010, when the ADX fell below 18 and the VZO rose above 15.

A few days later came the flash crash on May 6 that sent Spy below its 60-day Ema. Time to watch the short side! The Vzo rose above ‑40 and chopped around for a week in late May to early June. The sell short signal came on June 11 and the following few days (yellow rectangle, labeled sell short), when with price still below its 60-day Ema (yellow ellipse), the Vzo start crossing up and down through zero. Figures 2 and 3 explained how Vzo is used in trending conditions, when the Adx is greater than 18. Figures 4 and 5 display the Vzo action in nontrending conditions when the Adx is less than 18. Take a look at Figure 4.

Nontrending (oscillating) psychology

In nontrending periods, the demand/supply outcome is neutral, with periods of buying followed by periods of selling. The Vzo usually reacts to this volume behavior by fluctuating between ‑40 and +40, indicating a balance between buyers and sellers. If Vzo reaches the zone between ‑40 and ‑60, it means that sellers are finishing offloading their shares, which increases the likelihood of buyers stepping in. If Vzo reaches the zone between +40 and +60, it means that buyers are finishing up accumulating their shares, which increases the likelihood of sellers stepping in.

Nontrending (oscillating) system rules

Nontrending conditions exist when the Adx is less than 18. When the Adx is below 18, it appears as black crosses. When that is the case, the relationship between price and the 60-day Ema is ignored. Vzo rarely reaches +60 or ‑60 when Adx is less than 18. When the Adx is less than 18, buying signals are issued when: n The Vzo crosses up from below ‑40 to above -40

Two selling conditions occur during a long position if: n The Vzo rises above +40, use the sell rules from when Adx is greater than 18 n The Vzo never rises to +40, sell when it closes below ‑5. If the Adx is less than 18, sell short signals are issued when: n The Vzo crosses up from above +40 to below +40

n The Vzo crosses from above ‑5 to below ‑5. Two covering/close conditions can be found during a short position if: n The Vzo falls below ‑40, use the close/cover rules from when Adx is greater than 18 n The Vzo never falls to ‑40, cover/close when it closes from below +15 to above +15. Now look at the Gld chart with annotations in Figure 5. On March 3, 2010, the Vzo rose above +15 when the Adx was well below 18. That was the first buy signal (first yellow rectangle, labeled buy). The Vzo fell below ‑5 on March 8 (blue rectangle) so the trade would have been sold for a loss of 1.56% before transaction costs. The Vzo issued another buy signal on March 29, 2010 (second yellow rectangle, labeled buy); ignore the relationship between price and the Ema when Adx is less than 18. Gld rallied, and by April 9, the Vzo was above +60. On April 12, the Vzo fell below +60 (green ellipse), so even though the Adx is below 18 (it was 17.46), follow the sell rules for when Adx is greater than 18 and sell on the close. This second trade would have been sold for a 3.9% gain before transaction costs. These trades assume entries and exits at the closing price and are hypothetical, so there’s no guarantee they would work this way in the future. Note the Vzo strategy does not incorporate a stop-loss methodology. Some technicians avoid using a stop-loss when swing trading, on the grounds that it hurts more than it helps. These technicians exit a long position when their strategy issues a sell signal, and they manage risk by adjusting their position Continued on page 28 May 2011

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n The Vzo crosses from below +15 to above +15.

• Technical Analysis of Stocks & Commodities • 23

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dard & Poor’s 500 from August 1996 to August 2006. I split the list and discarded the rare ones. That left just 13 candle types, which I describe here.

Candlesticks, Statistically

Investment Candles

Which candlesticks work best as reversal or continuation patterns? Find out here.

I

by Thomas N. Bulkowski nvestment-grade candlesticks work as reversal or continuation patterns at least two-thirds of the time (66%), and they are plentiful. By “plentiful,” I mean that I sorted a list of 103 candlestick patterns by how often they appeared in the Stan-

and definition Before I discuss the performers, let’s review the configuration. Figure 1 shows two candlesticks, one black and the other white. The price bar’s high is at the top of the candle, and the low is at the bottom. Between those two extremes are the opening and closing prices, the order of which determines the candle body’s shade. The thin bars at either end are the shadows or wicks, with a body sandwiched in between. A candle need not have a shadow, and the body can be a flat line as in a four-price doji. In those situations, all four prices are the same. If price closes lower than the open, the candle is shaded (shown as black in the figure). If price closes above the open, then the candle is clear (white in the figure). Candle color is not a representation of price closing higher or lower than the previous day. In the discussion that follows, the numbers pertain to results from a bull market only, not a bear market. A candle line is a single price bar. I chose to define a close above the top of the candle pattern as an upward breakout and below the bottom of the pattern as a downward breakout. The thinking behind this definition is that a reversal candlestick should reverse the prevailing price trend immediately. After the breakout, a continuation candle should see the price trend resume the trend direction leading to the candle pattern. Defining a reversal in this way is like having your mom tell you to pick up your socks from the floor. She doesn’t mean do it within the next three days or a week. She means Now! If a candle acts as a reversal, then signs of that behavior should occur promptly.

LISA HANEY

Configuration

24 • May 2011 • Technical Analysis of Stocks & Commodities

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You might think that having the closing price at the end of the candle pattern means an immediate breakout the next day. That’s wrong. A gravestone doji has the closing price at the bottom of the day’s range, and yet it takes an average of three days to close lower. A dragonfly doji is the opposite of a gravestone because the closing price is at the bar’s high. It takes an average of three days to break out upward. The point is this. During those three days, there is plenty of time for price to reverse if it is going to. A true reversal will pick up their socks when their mom says so, and not wait until Dad comes home.

High Upper shadow Open

Above the stomach

Close Body Open

Close

Bearish doji star

Lower shadow

“Above the stomach”

Figure 1 shows an example of the above the stomach candle pattern. The three thin vertical lines are my way of Low marking the price trend leading to the start of the candle pattern. In this case, it is downward, meaning that the candle must appear in a short-term downtrend. Figure 1: basic candlestick configuration, above the stomach and bearish Following the trendlines is the two-line above the doji. Here you see the configuration of a candlestick, a reversal pattern that appears in a short-term downtrend referred to as “above the stomach” and a bearish doji star, which is stomach pattern. It begins with a black candle on the first considered to be a bearish reversal but doesn’t act that way 69% of the time. day followed by a white candle that opens and closes at or above the midpoint of the black candle’s body. This pattern works as a bullish reversal 66% of the time in engulf (overlap) the shadows, only the body. Either the tops of a bull market. the bodies can be the same price or the bottoms, but not both. The bearish engulfing has one of the highest reversal rates: Bearish doji star 79% in a bull market. Figure 1 also shows an example of a bearish doji star, one of the lucky 13 performers. It forms in an uptrend, and the two-line Investment-grade candlesticks work candle begins with a tall white candle. “Tall” means a height above as reversal or continuation patterns at most other candles leading to the appearance of the doji star. Following the tall white candle is a doji, which is a price least two-thirds of the time (66%). bar in which the opening and closing prices are the same or nearly so. The body of the doji must be above the prior bar’s body, but the shadows can overlap. That’s the only Bearish Bullish Bearish tricky thing about this candle pattern. Avoid unusually belt hold belt hold engulfing long shadows on the doji. The bearish doji star is supposed to act as a bearish reversal, but it doesn’t to the tune of 69% of the time in a bull market. In other words, price continues moving higher in more than two out of three contests. You may roll your eyes, but remember that all price has to do is close above the top of the pattern to stage an upward breakout. Even so, tests on this candle show that it takes Last engulfing Deliberation Last engulfing three days to close above the top of the doji.

bottom

Bearish engulfing

Figure 2 shows a bearish engulfing candlestick that lives up to its name. It’s supposed to act as a bearish reversal and it does, but more about that later. The bearish engulfing candlestick is a two-line pattern that must form in an upward price trend. The first candle line is white and the second is black. The body of the black candle engulfs the body of the first, meaning the opening price is above the prior bar’s close and the closing price is below the white candle’s open. The body does not have to

Figure 2: bearish engulfing, bullish and bearish belt hold, deliberation and last engulfing top and bottom. The bearish engulfing and the belt hold act as strong reversal patterns. The deliberation acts as more of a continuation pattern as do the last engulfing patterns. May 2011

+Bulkowski.indd 2

top

• Technical Analysis of Stocks & Commodities • 25

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CANDLESTICK CORNER

Bullish and bearish belt hold

Figure 2 shows the bullish and bearish belt hold candles. The belt hold family is one of the few single-line candles that do not act randomly. For the bullish belt hold, look for the candle to appear in a downward price trend with a tall white candle. The opening price should be at the low (meaning no lower shadow) and price should close near the bar’s high. The bearish belt hold has the identification guidelines reversed. Price must trend upward, leading to the candlestick. Price opens at the high for the bar and closes near the low, leaving a tall black candle to print on the chart. The bullish belt hold acts as a bullish reversal 71% of the time, and the bearish belt hold reverses the short-term trend 68% of the time.

Deliberation

The deliberation is another candlestick that is supposed to act as a reversal but doesn’t. That’s probably due to its height. It’s far easier to break out upward from this three-line candle, since price closes near the top of the candle. Identification is trickier for this one than for the other candles discussed so far. An uptrend must precede formation of this candlestick pattern. The first two candles are tall white ones. The last candle in the pattern is a small-bodied candle that opens near the prior bar’s close. Each line’s open is above the prior open, and the close is above the prior close. The candle is supposed to act as a bearish reversal, but test-

Rising window

Falling window

Three outside up

ing found it is a bullish continuation 77% of the time. Look for price to close above the top of the pattern (a continuation of the uptrend) more often than it closes below the bottom (a trend reversal).

Last engulfing, top and bottom

Figure 2 shows the last engulfing top and bottom patterns. First up: bottoms. What’s the difference between a bearish engulfing pattern (top left inset in the figure) and the last engulfing bottom? Answer: The price trend leading to the candlestick. In the last engulfing bottom, the price trend leading to the candle is downward. The first bar is a white candle followed by a black candle whose body engulfs the prior candle’s body. The black candle need not engulf the shadows of the white candle. The last engulfing bottom is supposed to act as a bullish reversal, but it is really a bearish continuation 65% of the time. The last engulfing top is a two-line pattern, with the first candle being black followed by a white candle. The white candle’s body overlaps or engulfs the prior candle’s body, not including the shadows. As you might have guessed, this supposedly bearish reversal actually acts as a bullish continuation 68% of the time.

Rising and falling windows

A rising window is a bullish gap in an upward price trend, and an example appears in Figure 3. Candle color is not important, which is why I show half-shaded candles. Look for the high price on the first bar to be below the low on the second bar, leaving a gap or window on the chart. A rising window acts as a bullish continuation pattern 75% of the time, as measured using the candles surrounding the gap. A falling window is also a gap, but some call it a bearish gap. I show an example of this in Figure 3. The low price in the first candle of the pattern remains above the high of the next bar’s price. A falling window appears in a downward price trend and it acts as a bearish continuation pattern 67% of the time.

Three outside up and down

Three outside down

Two black gapping

FIGURE 3: RISING AND FALLING WINDOWS, THREE OUTSIDE UP AND DOWN, TWO BLACK GAPPING. The rising and falling windows act as continuation patterns, the three outside up and down patterns act as bullish and bearish reversals, respectively, most of the time, and the two black gapping patterns act as continuation patterns 68% of the time.

The three outside up and down candle patterns are bullish and bearish engulfing candlesticks, respectively, with price confirming the pattern by closing higher (three outside up) or lower (three outside down). The price trend leading to the candle pattern is as shown in Figure 3, along with the candle color. The last day of the three-line patterns can be any color. The three outside up candlestick acts as a bullish

The bullish belt hold acts as a bullish reversal 71% of time, and the bearish belt hold reverses the short-term trend 68% of the time.

26 • May 2011 • Technical Analysis of Stocks & Commodities

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THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. THE TESTIMONIAL MAY NOT BE REPRESENTATIVE OF THE EXPERIENCE OF OTHER CLIENTS AND THE TESTIMONIAL IS NO GUARANTEE OF FUTURE PERFORMANCE OR SUCCESS. TECHNICAL ANALYSIS OF STOCKS & COMMODITIES LOGO AND AWARD ARE TRADEMARKS OF TECHNICAL ANALYSIS, INC.

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CANDLESTICK CORNER

reversal of the short-term downtrend 75% of the time. The three outside down is a bearish reversal 69% of the time.

TWO BLACK GAPPING

The final performer in our candlestick circus is the two black gapping candle pattern, as shown in Figure 3. As the name suggests, it includes two black candles with a downward price trend leading to them. The high price of the first black candle remains below the low of the price bar, leaving a falling window on the chart. The next day shows another black candle, with the high of this bar being below the prior bar’s high. The two black gapping pattern acts as a bearish continuation 68% of the time.

S&C Contributing Writer Thomas Bulkowski is a private investor with 30 years of experience and considered by some to be a leading expert on chart patterns. He is the author of several books, the most recent of which is Encyclopedia Of Candlestick Charts. His free website and blog have more than 500 articles dedicated to price pattern research and can be found at www.thepatternsite.com. He may be reached at [email protected].

SUGGESTED READING

Bulkowski, Thomas N. [2011]. “What You Don’t Know About Candlesticks,” Technical Analysis of STOCKS & COMMODITIES, Volume 28: March. _____ [2008]. Encyclopedia Of Candlestick Charts, John Wiley & Sons. _____ [2005]. Encyclopedia Of Chart Patterns, 2d ed., John Wiley & Sons. _____ [2006]. Getting Started In Chart Patterns, John Wiley & Sons. _____ [2002]. Trading Classic Chart Patterns, John Wiley & Sons.

CLOSING POSITION

The candlestick patterns discussed here are the best-performing reversal or continuation patterns in a bull market. Each works as described at least 66% of the time and are as plentiful as fleas on an untreated dog housed outside. Before you rush to your nearest stock market and shop for these patterns, realize that high reversal or continuation rates are not the same as how well price performs after the breakout. To learn about the best candlesticks for price performance, read my next article, “Top 10 Candles That Work.”

S&C

INDICATORS IN THE VOLUME ZONE Continued from page 23

size. Other technicians will not enter any trade without a stoploss. There are pros and cons to both sides of the argument, so you have to make that decision yourself. There were numerous buy signals on GLD after June 7, when ADX once again fell below 18 and the VZO rose above 15. Sell signals (not shown) occurred when the VZO closed below -5.

SWINGING WITH THE VZO

Conservative swing traders might want to see the VZO fall to -40 or rise above +40 before buying or shorting when the ADX is below 18. The risk is that by the time the VZO rises or falls to those levels, the ADX will probably be above 18 so you would need to monitor the relationship between price and the EMA before taking a directional trade. Another possibility when the ADX is below 18 is to buy or write option straddles or strangles. A low ADX means volatility is low. These neutral option strategies are used when you believe the underlying security is stable and you don’t think it is going to make a large price move. An ADX move above 18 would be a signal to consider exiting the straddle or strangle. Next month we will introduce a similar, complementary indicator: the price zone oscillator (PZO).

Walid Khalil, CFTe, MFTA, is a member of the International Federation of Technical Analysts (IFTA) and chief technical strategist at Premiere Securities, Cairo, Egypt. He teaches technical analysis at the Egyptian Society of Technical Analysts (ESTA). He may be reached at [email protected]. David Steckler, JD, is an investment advisor with Global Investment Solutions, and is a past president of the American Association of Professional Technical Analysts (AAPTA). He is a member of IFTA. He may be reached at [email protected].

SUGGESTED READING

Edwards, Robert D., and John Magee [2007]. Technical Analysis Of Stock Trends, 9th ed., W.H.C. Bassetti, ed. AMACOM. Granville, Joseph E. [1969]. Granville’s New Key To Stock Market Profits, Prentice Hall/Simon & Schuster Professional Publishing. Murphy, John J. [1999]. Technical Analysis Of The Financial Markets, New York Institute of Finance. ‡TradeStation

See our Traders’ Tips section beginning on page 61 for implementation of Walid Khalil’s and David Steckler’s technique in various technical analysis programs. Accompanying program code can be found in the Traders’ Tips area at Traders.com. S&C

28 • May 2011 • Technical Analysis of STOCKS & COMMODITIES

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Why use stops?

When a loss is posted, we always measure it relative to our original holdings. A similar measure is calculated when a profit

is posted. It is important to understand the asymmetry built into a loss/win cycle. Figure 1 shows that if you post a loss of 10%, it will take a percentage gain of 11.1% to recover. Okay, you can live with that as a recovery target. So what happens if you post a loss of 30%? It requires a recovery of 43% above your present net holdings to get back to your original account value. What happens if you lose 80% of your holdings? Well, that will require a 400% price move to recover your losses — not much chance of that in today’s markets. The lesson here is to cut your losses early. That is where the proficient use of stop alerts comes in. Consistently deploying stops can be painful, but it will allow you to know the maximum limit of your loss in advance, moving you away from later stage fear–based decision-making that can occur when a trade goes against you. It’s already been decided in your trading plan; you exit with a controlled loss. In fact, if you develop good exit techniques based on trailing

GARY BERNARD

More Exit, Less Entry

30 • May 2011 • Technical Analysis of Stocks & Commodities

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The simplest stop type is normally referred to as a “stop-loss,” “protective stop,” or “hard stop.” It is usually implemented as a static stop level introduced upon entry into a position. These stops can be either percentage price offset based, or dollar loss amounts defined by an overall portfolio risk assessment. For simplicity, most traders use a percentage offset approach. Depending on your trading style, you might calculate a stop price based on an acceptable percentage loss. If you are a shortterm trader, you likely will use a tighter percentage, whereas longer-term investors will use a looser percentage stop. Very often, if the price moves in the desired direction sufficiently, the stop-loss level can then be set at the entry price (plus commission costs) and held there. This is a conservative approach to risk mitigation that ensures that you do not lose any money on the particular trade. Some traders may place protective stops based on support and resistance levels. This has the added advantage of forcing you to evaluate the relative position of these levels prior to trade entry. By reviewing these levels relative to the present price, and evaluating the potential reward and risk absorbed before the levels are reached, you have effectively performed a rudimentary risk/reward analysis. If the calculated potential reward is greater than the potential risk defined by the support and resistance levels, then you have further reason to execute the trade. For a simple and low-maintenance stop methodology, enter your stop just below the recent support (long positions) or just above the recent resistance level (short positions).

Volatility and

trailing stops If you feel you are ready for more complex stop methods, spend some time looking at the recent price volatility of the stock you are considering. Investigate the average true range (Atr) indicator as a tool for price volatility evaluation. Your goal is to specify a percentage offset that stays outside the noise/deviations that the daily stock price exhibits. More complex approaches use dynamic volatility and an evaluation of standard deviation of the price series to offer loose, medium, and tight stop recommendations (Figure 2). Volatility stops work best in trending environments. Use a trend indicator such as a moving average or trendline to determine the direction and extent of the price trend, then trail your open positions using volatility

1200 1000 800 600 400 200 0 0

40

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Figure 1: recovery from a drawdown. A loss of 10% will take a percentage gain of 11.1% to recover. A loss of 30% requires a recovery of 43%. A loss of 80% of your holdings requires a 400% price move to recover your losses.

CALCULATING ATR The true range (TR) is the greatest of either: • The difference between the current high and current low • The absolute value of the difference between the current high and yesterday’s close • The absolute value of the difference between current low and yesterday’s close. The average true range (ATR) is the average of the TR. The calculation of the 14-period ATR is: ATR = [(ATR of previous day x 13) + Current TR] / 14 stops. If you did your homework and set your stop outside the noise, this type of stop can minimize the occurrence of undesired exits due to whipsaws. Your personal trading goals also should be used when defining the proximity of the volatility stop. If you are a short-term trader, you might keep your

Dynamic volatility stops in action with tight, medium and loose offsets 9.00 8.50 8.00 7.50 25.01

7.00 Tight Medium Loose 2010

14

6.50

Jul

Aug

23

Figure 2: volatility and trailing stops. Here you see the application of a more complex approach to stops using dynamic volatility and an evaluation of standard deviations of the price series. Note that there are loose, medium, and tight stop levels. May 2011

+1105 Garrard.indd 2

20

25.01

Recognia, Inc

Static stop-losses

Recovery required from a drawdown Required recovery (percent)

stops, you can also control the greed that often sets in when trades go in your direction. You can often end up with more profit due to systematic usage of stops. There are all sorts of complicated mechanisms, but as is common in most investing situations, simple is best. We’ll review some of these.

• Technical Analysis of Stocks & Commodities • 31

3/31/11 9:30:35 AM

MONEY MANAGEMENT

stops, you may find that if the stock you are holding gets into a period of sideways movement, you may end up holding the This study introduces some of the position longer than normal unless you impose a time limit. basics that can lead to improved As a trader, you can elect to execute your stop exits based position exits via the use of stops. on manual or automatic methods. If you are planning to trade your exits manually, you must expect an additional slippage amount since there will be a delay between when you are stop closer to the noise. If you wish to stay in the position notified of your stop trigger and the execution of your exit longer and are willing to expose yourself to higher potential trade. In rapidly falling markets, this slippage can be very large. Under these conditions, slippage will also occur with drawdowns, then use a looser volatility stop. Highly volatile and directionless markets are the worst condi- preentered orders, but unless the liquidity is very limited, tions under which to trade using a volatility-based stop. Under traders who preenter stop exit trade levels should experience these conditions, stops are likely to get hit frequently. Use your less slippage than those who do not place and update their protective stop trades. discretion when under these conditions.magazine 2011 • Technical Analysis of deploying STOCKSstops & COMMODITIES Another trailing stop method involves maintaining a stop at the lowest low in the recent past. Depending on your planned Conclusion tact Karen Moore withhorizon, approval changes: trading youor might track the trailing stop at the level This is by no means a comprehensive study of stops but of the lowest low in the last 20 bars for a long position. You introduces some of the basics that can lead to improved posiwould use the highest•high in [email protected] last 20 bars for a short posi- tion exits via the use of stops. The key message is that as an 6) 938-0570 • fax: 206-938-1307 email: tion. Decreasing or increasing the number of bars effectively investor or trader, you are well advised to spend more time tightens or loosens the stop proximity. This approach has the improving your exit methods and following a more consisdual advantages of being both conservative and simple to tent approach to planning and executing your position exits. PROOF #2 Successful traders and investors know that the exit is equally calculate and track. Note that many trailing stops have no built-in time limita- as important as the entry when it comes to optimizing your tion. If you are a short-term trader and elect to use trailing odds of success. Brokerages are now adding new tools to their websites that empower account holders with educational material and easy-to-use trade idea generation and risk mitigation tools. These new tools, due to their objective, consistent and reliable Safe and Secure since 1992 nature, boost investor trust and confidence. Thus, educated and confident investors are better and more profitable investors.

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Suggested reading

Vervoort, Sylvain [2009]. “Using Initial And Trailing Stops,” Technical Analysis of Stocks & Commodities, Volume 27: May. _____ [2009]. “Average True Range Trailing Stops,” Technical Analysis of Stocks & Commodities, Volume 27: June. _____ [2009]. “Trailing Resistance And Support Stops,” Technical Analysis of Stocks & Commodities, Volume 27: July. ‡Recognia Inc.

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In addition to selecting an equity, select some filters such as maximum number of positions, scaling in strategies, the universe of stocks and ETFs, and the exchange traded fund (Etf), in- type of stop you want to implement. dex, option, currency pair, futures contract, and so on to trade at any given time, at times you may want Both The Machine and The Machine Lite are to select a portfolio of tradables that designed to eliminate the guesswork from creating give you the desired results. Markets a portfolio and reduce the learning curve. perform differently during different market conditions, which is why we are always told to diversify our holdings. But there is not much point in diversifying To help you accomplish this, The and reduce the learning curve. For this if everything you own goes up or down Connors Group has come up with The review I tested The Machine Lite. The together. Creating an optimal portfolio, Machine, and its less-powerful version major difference between the two: Lite one that lets you keep your losses to a is referred to as The Machine Lite. Both doesn’t give you access to all available minimum, can be challenging and time products are designed to eliminate the strategies. guesswork from creating a portfolio consuming. Features The selection of strategies is the focus of The Machine Lite. You create a portfolio by first selecting a group of strategies, which is different from the conventional portfolio builders. Most of you are probably familiar with the different strategies developed by Larry Connors. All strategies available in Lite are developed by the Connors Group. The strategies are easily accessible through their website. The only strategies not revealed are the trend-following strategies, which are not available in the Lite version. It is easy to see which ones are available by using a dropdown menu under the Strategies tab. You can go through each of the available strategies and analyze their historical performance “It’s heartbreaking to see Reynolds in trouble for fraud. to determine which ones are best for you. But I always look forward to his rooftop chases.” For example, I selected the Etf Rsi 10 34 • May 2011 • Technical Analysis of Stocks & Commodities

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• Technical Analysis of STOCKS & COMMODITIES • 35

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REAL WORLD GAP FILL AND GO Continued from page 15

I’m going to show you two trades using a strategy you can use almost every day to capture profits from the stock market. $53.70. That gives me a 33-cent risk, and using the $100 risk per trade example, a share size of 300. Wait for two consecutive bars of profitability before moving your stop to breakeven. One difference in this trade is that the 200-period SMA is overhead and giving you a price target. This price target is almost at $55.00, which, being a whole number, is another obvious target price. Because of this, I will need to manage the profit taking a little differently. I want to set a take-profit order on 200 shares just below $55, which is also a test of the overhead 200-period SMA resistance area. If it does not get there, I will still use the bar-by-bar break to get out. In addition, I will trail my remaining 100 shares on a bar-by-bar break if the take-profit order is hit. I want to leave some shares on, just in case there is a big run to the upside. Just like the previous trade, I have identified a potential winning trade. There is a reversal bar off the rising 20-period SMA, at the 10:00 am reaction time. I have identified my risk of 33 cents, share-sized correctly, and put my protective stop in place. Now I have to let my edge play out. It gets a little dicey when the rising 20-period SMA is retested on the very next bar, but it soon takes off and goes right to the 200-period SMA. It tested the resistance point of the overhead 200-period SMA and went as high as $55.02. My take-profit order at $54.98 is taken out and my remaining 100 shares are sold when the five-minute bar is broken at $54.74. With my cost being $54.05, I have a profit of 93 cents on 200 shares and 69 cents on the last 100 shares. That gives me a $255 profit on the NTAP trade. This is a much more respectable 2.5:1 riskreward ratio. Add the $104 from the FAS trade, and I have a

total of $359 for the first hour of the trading day. I’m probably done for the day unless I see something so extraordinary that I can’t stand not to take it. But even then I will probably cut my risk in half and share-size accordingly. What I’ve showed you here is something that happens almost every day. And in case you are wondering, it works just as well on the short side, maybe even better, since fear is more powerful than greed and the price usually drops faster than it goes up. For the short trades, all you have to do is the converse. The SMAs should be declining and you should get a bearish gap down. Some of the key points to remember are rising SMAs on the five-, 15-, and 60-minute charts for long positions. You are buying the dips on a confirmed uptrend. On the short side, you are selling the rallies on a confirmed downtrend. Wait for the green bar to take out a red bar at a moving average at the 10 am reversal time. You have a reversal bar, at the reversal time, on a moving average line. Identify your risk and share size correctly to your risk amount. Set your stop one cent below the entry bar or the pivot bar, whichever is lower, then sit back and let your edge play out. After two consecutive bars of profit, move your stop to breakeven. Take profits using the bar-by-bar break or other well-defined price target. Happy trading! Jamie Theiss is a full-time trader who daytrades stocks, swing trades forex, and from time to time position trades commodities. He may be reached at jamie_theiss@ yahoo.com. ‡Blackwood Pro

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Charts And Checkpoints

This is how you use stock and index charts to determine market context. by Gil Morales and Chris Kacher

Y

ou do not have to be a Chartered Market Technician to understand how market context can influence the price behavior of stocks. No stock is an island, and how a stock behaves is often a function of the market at large, which in turn is a function of underlying conditions — the context within which any particular market environment is developing. In the simplest of terms, we know that in a bull market, most

stocks go up, and in a bear market, most stocks go down, so this basic idea that market context can provide meaningful clues when studying stock charts is already something we are familiar with when we speak of bull and bear market environments.

JOSé CRUZ

Context Is Everything It’s the context

While the use of stock charts can be very complex, often the exercise of comparing the price behavior of a stock to a chart of the market as represented by, for example, a major market index such as the Nasdaq Composite Index or the Standard & Poor’s 500 can help you understand a stock’s potential strength. You are also able to better understand why certain price movements are evident in a stock’s overall price chart.

38 • May 2011 • Technical Analysis of Stocks & Commodities

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Price window

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2021 1974 1927 1880 1833 1786 1739 1692 1645 1598 1551 1504 1457 1410 1363

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When it comes to understanding the price/ volume behavior of stocks, context is everything.

NASDAQ Composite Index daily chart 1998

The patterns don’t

4

Volume window 50 DMA line have to be perfect 11200 9600 In autumn 1998 the stock market was 8000 experiencing a very sharp selloff in a very 6400 short period of time: a sort of “instant 5/99 6/98 7/98 8/98 9/98 10/98 Price window 13.0 bear market” that lasted not quite three 12.5 Schwab, Inc. (SCHW) dailyof chart 1998 BONUS 2011Charles • Technical Analysis StockS & commoditieS months but saw the Nasdaq fall 33% 12.0 11.5 from peak to trough in that time. In Figure 11.0 1 Please or changes: 10.5 1 we see the Nasdaq Composite Index contact Karen Moore with approval 3 10 daily chart from that period stacked on 9.5 phone: 206-938-0570 ext. 312 • fax: 206-938-1307 • email: [email protected] 2 9.0 top of a daily chart of Charles Schwab, 8.5 Inc. (Schw), one of the early leaders 8.0 7.5 that emerged from the market bottom 7.0 4 of October 1998. In this example, the 6.5 Cup-with-handle Volume window 50 DMA line 154385 Nasdaq came down in a series of three base formation 123508 very sharp waves, the first ending in early 92631 61754 August, the second in early September, x100 and the third in early October. 5/99 6/98 7/98 8/98 9/98 10/98 As the Nasdaq was approaching a top Figure 1: a cup with a jagged handle. The NASDAQ came down in a series of three very sharp waves. in July at point 1 on the chart, Schw was As the NASDAQ was approaching a top in July at point 1, SCHW was attempting to emerge from a sideways in fact attempting to emerge from a side- consolidation on brisk volume. Note the powerful countertrend move in SCHW when the NASDAQ bottoms at point 4. This could be the deciding factor in purchasing shares of SCHW. ways consolidation on brisk volume — an indication of strength. However, the market began to roll over, putting a lid on Schw’s attempted breakout. The stock wanted to break out and move higher, but the pressure of a topping market overwhelmed the breakout and Schw fell back into its base. As the market began an initial leg down from point 1 to point 2, Schw mimicked the action of the general market by pulling back down in similar fashion. As the second leg to the downside began at point 2, Schw ® also broke sharply to the downside, again mimicking the action of the market on the downside break as well as the reaction rally up to point 3. The market then broke down again to a lower low at point 4, but this time Schw did not mimic the action of the market as it made a higher low. In fact, the entire pattern became an O’Neil-style cup-with-handle formation where the cup is formed between points 1 and 3 and the jagThank you for voting ged handle is formed between points 3 and 4. 25.01 NeuroShell Trader #1 In most cases, this steep pullback in the handle would be improper, as a truly constructive handle area will generally Artificial Intelligence Software hold within a relatively tight price range of 11% or less. 9 yeArS In A row! However, the extremely volatile and sharp downside break in the Nasdaq Composite Index from point 3 to point 4 explains similar volatility in Schw’s handle within the overall cup-with-handle formation, and in fact Schw is displaying powerful countertrending behavior by the time the market bottoms and turns back to the upside at point 4. This was a critical factor in our decision to purchase Schw aggressively in October 1998 as the market confirmed a new rally phase. Often, technicians search for perfect chart patterns, but in some cases an imperfect one can be explained by the market environment.

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• Technical Analysis of Stocks & Commodities • 39

3/24/11 11:59:57 AM

Price window - Semi-log

3159 2925 2691

NASDAQ Composite Index weekly chart 2001-2002

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Finds support along the 10-week moving average

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Note series of tight closes along the lows of this consolidation

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Figure 2: institutional buying. What is important to note here is the series of tight weekly price ranges and closes along the low of LMT’s base from point 2 to point 3. This is a subtle sign of steady institutional buying. An even starker clue was LMT’s breakout to new highs as the market began to move to the downside. 1

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NASDAQ Composite Index weekly chart 2010

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FIGURE 3: THE POTENTIAL LEADERS. On this weekly chart of Rovi Corp. (ROVI), you see a base-on-base formation that continues in a sustained uptrend. During this time, the NASDAQ was correcting. Once the market started rallying higher, ROVI was able to continue higher at a more consistent pace.

Where is the

money moving? Note that in August 2001, major defense stock Lockheed-Martin (Lmt), shown on a weekly chart on the bottom half of Figure 2, was moving higher in a shallow uptrend leading up to the tragic events of September 11, 2001. What did Lmt know? At that point, the market, shown on a weekly chart, had been in a serious bear market that began in March 2000, and when the market reopened a week after 9/11 on September 17, it split wide open as it sold off for five straight days. During that week, Lmt staged a newhigh gap-breakout as we saw in the stacked weekly charts of the Nasdaq Composite index, our proxy for the market, and Lmt. After selling off for five days, the market then turned around and began a short rally that carried for 15 weeks from point 1 to point 3. Lmt continued to move higher from point 1 to point 2, then pulled back and began consolidating its prior gains from point 2 to point 3. Lmt pulled back during the first three weeks of the consolidation at point 2 before leveling out and drifting upward over the next eight weeks in a series of tight weekly price ranges and closes. At point 3 the market topped out and began a new leg in a continuing bear market, but Lmt began to move up off the lows of its consolidation, or base. The series of tight weekly price ranges and closes along the lows of Lmt’s base from point 2 to point 3 is a subtle sign of steady institutional buying. With money coming out of other sectors in the market, institutions were looking to redeploy in tradables that would benefit from the fact that a significant underlying condition was coming into play: that the US was about to move to a war footing. The clue that institutions were moving money in that direction is partly explained by Lmt’s tight price action along the lows of the base, but its breakout to new highs as the market began to roll over to the downside was an even starker clue. Lmt continued to move higher for the next several months, finally topping out in June 2002. In this case, market context in the form of changing underlying conditions as the US began preparations

40 • May 2011 • Technical Analysis of Stocks & Commodities

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Price window

NASDAQ Composite Index daily chart 1

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for war, combined with logical clues in the weekly chart of Lmt, were the pointers telling you where the money was moving.

Identify potential

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36126 leaders 30105 The next two examples 24084 x100 show why we view market 4/10 5/10 6/10 7/10 8/10 9/10 Price window 180 corrections and even bear 174 Chipotle Mexican Grill (CMG) daily chart markets as constructive 168 162 4 5 market periods, in that 3 156 2 1 150 nascent leadership will often make itself 144 known amid the more obvious negative 138 132 tone of a market correction or outright A pocket 126 pivot buy 120 bear market. point 114 In the first example, we compare 108 102 the 2010 weekly charts of the Nasdaq 96 Volume window 50 DMA line Composite Index (top) and Rovi Corp. 29940 23952 (Rovi) in Figure 3. Rovi was a relatively 17964 11976 unknown name as it wended its way higher x100 going into April 2010 as it moved in phase 4/10 5/10 6/10 7/10 8/10 9/10 with the market’s uptrend. At point 1, FIGURE 4: THE TIDAL PULL. Although CMG gapped up at point 1, it did tend to pull back because of the weight of however, things began to change as the the market. But for the most part, it still held the lows of the gap-up move to point 1. At point 4 it follows the market market broke off of its peak and began but holds its ground after the pocket pivot buy point. Once the market correction came to an end, CMG quickly to correct. Rovi acted in lockstep with moved to new price highs. the market for exactly one week as it too broke off its peak at point 1, but it quickly leveled off as it April to August 2010 was very bullish for Rovi, and once the weight of the market lifted, the stock was able to continue moved sideways for several weeks. Meanwhile, the market continued lower into point 2, but higher at a more consistent pace. Rovi broke out of its tight sideways consolidation or base and Another example from 2010 can be seen in the chart of made a new price high. The market bounced up into point 3 Chipotle Mexican Grill (Cmg) in Figure 4. It shows some as Rovi continued to move higher after its breakout. At point different dynamics during the same market correction from 3, however, the market pulled back once more, but Rovi held April to August that we examined in conjunction with Rovi in up as it built a second consolidation on top of the first one Figure 3. The key juncture occurs right at the end of April as from which it broke out at point 2. This is an O’Neil-style Cmg is trending higher with the market and when the market “base-on-base” formation, and if a stock were to form such a begins a steep downside break that culminated in the flash pattern during a strong bull market rally, we might consider that it was lagging. However, market context is everything, and when a stock like Rovi builds a base-on-base formation as it moves up slowly while the market is simultaneously going through an intermediate-term correction, then that is showing significant relative strength that identifies the stock as a strong potential cartoon leader when the market recovers and begins a new uptrend as it does at point 4. Rovi then broke out of the second base in the base-on-base formation at point 4 and continued in a sustained uptrend. Throughout the market’s correction, Rovi wanted to move higher, but the action of the market acted as a weight upon the stock, effectively putting a lid on its attempts at new price highs. Instead of correcting with the market, however, Rovi showed its strength by holding each breakout and consolidating the move to new highs each time as it built its formation. In this “Charlie, it’s your broker. He wants to know when you’re getting back into the market.” case, such action in the context of a market correction from

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crash of May 6. At point 1, Cmg was in fact gapping 1692 up and breaking out to new all-time price highs, but the weight of the general market 1504 was felt by the stock as it too pulled back, 1316 but for the most part held the lows of the 163150 gap-up move at point 1. The stock then 130520 97890 proceeded through points 2–4 as it made x100 a higher high each time. 12/06 2/07 4/07 6/07 8/07 10/07 1/08 3/08 5/08 7/08 9/08 11/08 1/09 3/09 5/09 2 221 Each of these moves to a new high co3 Potash Saskatchewan, Inc. (POT) 195 incided with points 2–4 on the Nasdaq weekly chart, 2007-2009 169 143 chart, which are all peaks of bouncing 1 117 rallies within a broader downtrend. In fact, at this stage Cmg was telling investors 91 78 that it really wanted to move higher, but 65 the weight of the market downtrend was 52 keeping a lid on the stock. After point 4 the market broke sharply to new lows, and the 39 tidal pull was more than Cmg could resist, 130348 so it too began to move lower. 97761 65174 Eventually, the market bottomed and x100 began to rally, but Cmg rolled over and 12/06 2/07 4/07 6/07 8/07 10/07 1/08 3/08 5/08 7/08 9/08 11/08 1/09 3/09 5/09 shook out once more to lower lows before FIGURE 5: SHORT-SELLING OPPORTUNITIES. It is only at point 3 where POT is in sync with the NASDAQ that you should consider shorting POT. This is critical in understanding why you shouldn’t short a stock at the formation turning back to the upside. of the head in a head & shoulder formation, instead waiting for right shoulders to form first. A pocket pivot buy point marked the turnaround in Cmg. As we moved into point 5, the market, as indicated by the Nasdaq’s chart, began to roll over again, but Cmg stood its ground, moving roughly sideways from the pocket pivot buy point. At point 5 the market made a final low and Cmg was free to do what it wanted to do all along — go higher. In this case, the action of Cmg during the market correction offered numerous clues that helped to distinguish it as a strong name during a market correction, which then took a major leadership role in the ensuing market bottom and new rally phase that began in early September. Within the market context of a sharp correction, Cmg displayed strong relative strength that would have helped alert investors identify it as a strong leader once the market correction came to an end. From this point, Cmg ran some 65% higher over the next three months. NASDAQ Composite Index weekly chart 2007-2009

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opportunities Nowhere is market context more important than in short-selling operations. In a bull market, most stocks, even the “dogs,” will tend to go higher. Hence, trying to sell stocks short within the market context of a bull rally is not advisable, as it will tend to offer far lower probabilities of success relative to selling stocks short within the proper market context, namely, a bear market. In Figure 5 we see the Nasdaq stacked on top of Potash Saskatchewan (Pot), both of which are in strong uptrends at point 1 in each of the charts. At point 1 on the Nasdaq chart, the market tops, but Pot continues higher. At this point, the 42 • May 2011 • Technical Analysis of Stocks & Commodities

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trading techniques

Investors can make use of stock charts in many ways, from the highly complex to the extremely simple. only thing investors know for sure is that the market is beginning what could turn out to be a short-term pullback, and often, leading stocks will continue higher even as the market tops or is in the process of topping. In this case, the market corrects from point 1 to point 2 with a leg down and then a reaction rally, but Pot maintains its uptrend right into point 2. From points 1 to 2, Pot is essentially marching to its own tune as it begins to countertrend the market, but from points 2 to 3 it begins to get back into sync with the market. By the time we get to point 3, note that Pot has formed a head & shoulders top with one left shoulder, a head at point 2, and two short right shoulders right around point 3. These two right shoulders also mimic the market action at the same point, as we’ve outlined with dotted lines on the Nasdaq chart. In this case, it only makes sense to short Pot once it has formed an identifiable breakdown and topping formation, in this case a head & shoulders. In addition, note that the proper time to short Pot is nearly four months from its absolute peak at point 2 and only when it begins to act in synchrony with the market action. When the market breaks down after point 3 in a major bear market down leg, Pot follows right along as it too blows to pieces. In this case, market context was critical in understanding when it was not correct to short a leading stock like Pot, and only once Pot began to get in sync with the market did it confirm the potential for further weakness by finishing off its head & shoulders formation with two right shoulders that led to the final break that occurred in synchrony with the market.

Charts as visual checkpoints

Investors can make use of stock charts in many ways, from the highly complex to the extremely simple. Often, valuable information can be gleaned by understanding how to use charts without having to understand statistics or mathematical formulas. Often, charts are most useful when implemented as visual checkpoints, as we have done here. Gil Morales is the managing director and chief portfolio manager for MoKa Investors and the cofounder of VirtueOfSelfishInvesting.com; coauthor of GilmoReport.com; and formerly a senior proprietary portfolio manager for William O’Neil + Co. He is also the coauthor of the book Trade Like An O’Neil Disciple: How We Made 18,000% In The Stock Market. Chris Kacher is the managing director and chief investment strategist of MoKa Investors, and the cofounder of VirtueOfSelfishInvesting.com. He is a former research analyst and senior proprietary internal portfolio manager for William O’Neil + Co. and coauthored Trade Like An O’Neil Disciple: How We Made 18,000% In The Stock Market.

Further reading

Morales, Gil, and Chris Kacher [2010]. Trade Like An O’Neil Disciple: How We Made 18,000% In The Stock Market, John Wiley & Sons. O’Neil, William J. [2009]. How To Make Money In Stocks, 4th ed., McGraw-Hill. _____ [2003]. The Successful Investor, McGraw-Hill. ‡TradeStation

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Q&A SINCE YOU ASKED Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question, post your question to our website at http:// Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Don Bright of Bright Trading

MARK TO MARKET ACCOUNTING You have written about the tax advantages of being a professional trader versus a retail trader. You also mentioned something about mark to market accounting. Could you expand on these points? —JBelliott Sure, glad to shed some light on this. If you were to buy 1,000 shares of GE at $20, yet it is now trading at $21, you have a mark to market profit of $1,000, even though you haven’t sold the shares yet. In my mind, this gives a better and truer reflection of where you really stand. On the other end, if you bought 1,000 shares of Google [Goog] a few months back at $640, and it’s now trading at $575, you have a mark to market loss, but not a capital gain loss. Some retail traders tend to almost kid themselves by saying, “I haven’t really lost any money because I haven’t sold the stock yet.” Well, as cute as that sounds, you really have lost money, no doubt about it. We don’t have to match up trades, which is a total nightmare. We simply buy and sell as needed, and whatever our net gain is, we pay K-1 type taxes on it (distribution of partnership income). We are also exempt from Fica (self-employment tax). We see on a daily and even minuteby-minute basis exactly where we stand in real time. Another big benefit is if we do suffer a loss, it can offset other income rather than being carried forward at only about $3,000 per year. DEFINING NEWS STOCKS I have wondered about what your traders do when some major global event happens — for example, hurricane Katrina, the BP oil spill, and now this massive earthquake and tsunami in Japan. I sometimes think it might be safer to just

daytrade instead of doing longer-term trading. You have mentioned that you like to avoid “news stocks” — and that makes sense, but I’m not sure how you define a news stock. Can you give me some insight, please? —Yelpmaster Really good questions. Let me try to explain our thought process. First off, let me address “news stocks.” Remember, our traders tend to trade the same stocks (our “children”), much like a surrogate specialist or market maker and/or build up a portfolio of correlated pairs. All of these stocks are researched heavily, and we have excellent software to update our information daily. I mention this because there are many traders who like the idea of filtering for the latest big-mover com-

A fundamentally solid stock in a good trading range can be moved by rumors or actual news. pany on a daily basis. We’ve found that if one of our “children” is constantly in the spotlight, it takes away from our overall comfort level in the fundamentals and technicals. A fundamentally solid stock in a good trading range can be moved by rumors or actual news. There is a difference, of course. Rumors tend to have some truth to them, but more important, rumors bring in overzealous speculators. They might start buying options or even the actual stock, simply based on one thing or another. For most rumor-type news items, we usually prosper because we are up to date with what is going on in the company. We have generally done our homework, and anticipate such news items. May 2011

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Second, we have a plan in place for specific stock price movements. If we see a gap up, premarket, we have a plan for it, the same thing at the end of the day when we see major market on close (Moc) imbalances published. So basically, keep up to date, prepare a plan for price movements, and keep your share size appropriate for your account size. Now to global events that we simply have no way of anticipating. A lot boils down to simple common sense. After the horrific BP spill in the Gulf of Mexico, we had dozens of traders with positions. Some closed out immediately (good move), some cut their overall exposure to oil stocks (another good move), and yes, some just sat there like deer in headlights (not a good move). “When in doubt, get out” is a good motto. But let’s take this a step further. Many of our traders have dozens of pairs of stocks in many sectors, and some of these traders are really smart. The BP spill would have an effect on many sectors for months after the initial report was made — fishing and canneries, hotels on beaches, restaurants (tourism in general), and so on. So naturally, many of our people made some major changes to their portfolios — a good thing. Remember, we are in a global financial marketplace, so plan for an exchange rate impact within various sectors as well. You’ll be able to see the effect of the quake on the Japanese currency, for example. So keep share sizes appropriate to account size. Have a contingency plan for adjustments. Use common sense to follow the trail of secondary sector impact. Prepare for currency effects. Hope this helps. S&C

• Technical Analysis of Stocks & Commodities • 45

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INTERVIEW

Don’t Make It Overly Complicated

Short Swings In Futures With Markus Heitkoetter As founder and CEO of Rockwell Trading, Markus Heitkoetter has shared his trading methods and ideas with more than 300,000 traders in over 196 countries. Heitkoetter started trading stocks 19 years ago, using point & figure charts from numbers published in the morning newspaper. In 1996, he began developing a number of trading systems, and in 2002, he decided to leave his job as a director at IBM to become a professional trader. Throughout his career, Heitkoetter has traded virtually everything from stocks, options, futures, commodities, and spreads, all the way to forex and interest rates. In addition, he is the author of the bestselling book The Complete Guide To Day Trading and is a regular speaker at Trading Expo and CME Group–sponsored events. His articles and videos are published on MoneyShow.com, in major publications, and on thousands of websites around the world. Heitkoetter lives with his family in Austin, TX. STOCKS & COMMODITIES Editor Jayanthi Gopalakrishnan and Staff Writer Bruce Faber interviewed Markus Heitkoetter via telephone on March 7, 2011. arkus, can you tell us about yourself and how you got started in trading? I am originally from Germany, but I live in Texas right now. I did my first trade when I was in high school. I was 18, which is when I was legally allowed to trade in Germany. At that point I bought one share of VW, which is a share in the German DAX. I bought it for around 50 Deutschemarks. I was so excited. I could only afford one share. Talk about disposable income in money you can afford to lose! After I bought that share I would, twice a day, go to a pay phone in my school and call my broker. I would ask him things like, “How are we doing? How much money did I make?” This went on until the third day when my broker said, “You know, Markus, how much money would you like to make on this trade?” I said to myself, “If I could make 10 Deutschmarks, that would be awesome.” So I told him, “Ten Deutschmarks. That is the profit I want to make.” He said, “Done. Stop by my office tomorrow morning. I will give you the 10 Deutschmarks, but stop calling me every single day.” This was my first trade, and it turned out to be a profitable one, which of

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course encouraged me. But I noted that with the little money I had at that time I could not really be a trader. So I saved some more and then started trading options. I did some straddles and strangles, and I had the quotes from the morning newspapers, and some hand-drawn point & figure charts. This is how I identified stocks in the DAX 30 that were poised for a breakout. That is how I started building my account. From then I started trading stocks. I tried everything that everyone knows these days. I tried fundamental analysis. I tried the CANSLIM method. I did all of this until finally in 1995, when computers became more powerful, I went into chart analysis. I was fascinated by it. I bought my first software, which was SuperCharts by Omega Research, now TradeStation. This is where I first started reading about indicators. I have a German book about 600 pages long, The Big Book Of Indicators, with 167 indicators. I think I plotted 163 of them on my screen. I just thought that the more indicators I used, the better. Little did I realize that half of the indicators were screaming “Buy!” and the other half were screaming “Sell!” I was sitting there with analysis paralysis, not knowing what to do.

I wasted two years trying to automate a trading system until it finally dawned on me: I needed to simplify my trading. So what did you do? Like every trader, I went through the phase of automating trading systems, so I thought, “I am smarter than everybody else.” Having a programming background, I thought I could develop the perfect trading system. I read a lot of books about it. At that time I had not discovered the Internet yet, so all of my quotes came from dial-up. I wasted two years of my life trying to automate a trading system when it finally dawned on me: I needed to simplify my trading. I had to keep it easy so I could know, at any given time, when to enter and when to exit. I discovered daytrading, so in 1998–99 I started discovering the emini S&P, and the currency market. I started daytrading these markets in 2000, and then finally in 2002 I felt confident enough to leave my job at IBM, and moved to Austin with the

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goal of becoming a professional trader. And here I am. Expanding on your idea of simplifying your trading system, I noticed that you had your trading plan available for people to view on your website. It is actually a very simple plan. The other thing I noticed was that you have conditions for different markets. You have time frames for each of those markets, and then you have different strategies. Can you tell us why all of those things are so important to a trader? Yes. First of all, as a trader you need to follow multiple markets and you must have multiple trading strategies. Let’s talk about the trading strategies first. Early in my career I noticed there was no hybrid strategy. By this I meant that I noticed there were either trend-following strategies or trend fading strategies. Obviously, trend-following strategies work great in trending markets, but you frequently get stopped out if the market

is going sideways. On the other hand, trend fading strategies work perfectly in a sideways market, but as soon as the market starts trending, you get hurt. It dawned on me it might make sense to actually have at least two strategies — a trend-following strategy for a market that is trending, and a trend fading strategy for when the market is going sideways. This has helped me tremendously in my trading. It is not the idea of, “Okay, I can fix everything with a hammer.” You know what they say: “To him who only has a hammer, everything looks like a nail.” It’s good to have a toolbox. Trend-following strategies are great to trade. They have a high reward–risk ratio. It is said that the markets are only trending 20% of the time. I don’t know if that is true, because I have never measured it, but looking at the market it sure feels this way. So I wanted to make sure I had a strategy for any market condition. Well, today I trade four different strategies. Two are trend following. One is trend

fading and one is a scalping strategy. The market is either trending or going sideways. In my own trading, I noticed there is also a transitional phase where I am not quite sure if the market is still trending or if it is already going sideways. This is often happening in the opening. I love using my scalping strategy at the open when the market is looking for direction because at this point, it is not really going sideways. It wants to start trending, but it is not trending yet. So I love trading the market with a scalping strategy during the first five to 10 minutes. I try to put some money in the bank to finance my stop-loss for the trendfollowing strategy, which I expect to be a more rewarding strategy. That is my take on having multiple trading strategies. What about multiple markets? We know that markets change all the time. I am a futures daytrader. I love trading futures. I love looking at the emini S&P as an index, and there was a

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INTERVIEW

time when the emini S&P was fantastic to trade. But the emini S&P has changed. Now it just has small trends and turns around on a dime. Right now, crude oil and gold are the hot markets to trade. I like to watch five different markets and since these are futures markets I am very well diversified. I love watching the emini S&P as a stock index. I like watching the euro as a currency. I like watching the 30-year bond as an interest rate product, and then I like watching crude oil and gold as the metal and energy market. If I am watching these five markets with my four trading strategies, there is always something to trade. I am an extremely lazy trader. I only like to trade the first two hours of the morning. If I had just one market and one strategy, I might not see an opportunity during this time. The more opportunities, the easier it becomes for me to choose which ones are the best. Do I have a nice trend in gold, or is it an ugly trend in the emini S&P, for example? By being diversified and looking at just these five markets I can focus on the best trades. If you look at the S&P on a daily basis, it has been trending up since November 2010. But if you look at a day where the range has been wide and trending down, do you as an intraday trader look at the day’s trend or do you make your decisions based on the market trend? In situations like this, I would just like to use my indicators to tell me which direction the market is going. To answer your question, no, I do not look at the bigger picture. I do not care if the markets are trending up on a daily basis. If I see shorting opportunities like today, in a market that is crashing down, I’ll take those. For example, today the emini S&P dropped 25 points and represented a terrific opportunity to go short. Yes, I will trade against the long-term trend, because today I think the emini S&P dropped like 25 points. There are plenty of opportunities and plenty of money to be made. I am not really looking at the overall picture. As a daytrader, I am happy if I can predict where the market is going in the next 10 minutes. This is why I never look at daily

charts and try to make sense of them. I like to simplify my trading. I like to keep it easy so that at any given time when I look at a chart I know exactly whether I should go long, go short, or stay out of the market. What are some of the indicators you like to use? I have narrowed it down to three indicators. The main indicator I like to use is the Bollinger bands, which are a fascinating concept. I use them in a slightly different way. Many traders like to use Bollinger bands as a trend fading opportunity, saying that if price is touching the upper band, you should sell, and if they are touching the lower band, you should buy. That is not what I do. Instead, I like to use the Bollinger bands to confirm my trend. If you look at a chart in a downtrend, you’ll see that the lower Bollinger band is nicely pointing down in a 45-degree angle or more, and prices are constantly touching the lower Bollinger band. It is like a trendline that is attracting prices. It is like a trendline underneath the prices in a downtrend. You can also see that this downtrend is over as soon as the lower Bollinger band starts to flatten or turn around. The same is true for an uptrend. In an uptrend, you will see that the upper Bollinger band is pointing up at a 45-degree angle or more, and prices are constantly touching the upper Bollinger band. This up move is over when the upper Bollinger band starts to flatten or turn around. So I like to use Bollinger bands to identify trends in the market. As a daytrader I have to modify the settings of the Bollinger bands. The standard settings for the Bollinger bands are usually around 18, 20, or 21 for the moving average, and two for the standard deviation. According to John Bollinger himself, he suggests that if you are looking at a time frame that is smaller than a daily chart — that is, if you are looking at an intraday chart — you should shorten the number of bars used in the moving

average from nine to 12. I have had the best experience with a setting of 12 for the standard moving average, and two for the standard deviation for the Bollinger bands. These give you the really nice signals for the trend. I like to support what I see using the Bollinger bands with two other indicators, the moving average convergence/divergence (Macd) and the relative strength index (Rsi). The relative strength index by J. Welles Wilder was originally developed as an oscillator. The idea was, if the Rsi moved above the reading of 70, the market is overbought and should turn around. However, in my daytrading, I have noticed that as soon as the Rsi moves above 70, we get the really strong trends. As long as the Rsi stays above 70, the trend is perfectly fine. However, when the Rsi dips below 70, that is another warning signal that the uptrend might be over. What about in a downtrend? The same is true for the downtrend. I use an Rsi with a setting of seven. I am looking seven bars back, and as soon as I see that the Rsi is dipping below 30, it is usually indicating a very strong trend. Once I see the Rsi getting above 30 again, it means this trend is losing steam and might be over soon. That is how I use the Rsi in conjunction with what I see on the Bollinger bands. With the last indicator, the Macd, I use the standard settings of 12, 26, and 9. But I also like to use the Macd with a twist. First, there’s the traditional way many traders use the Macd. It is a simple Macd crossover. We have the Macd, and we have a signal line. Many traders use this as a signal as soon as the Macd crosses the signal line as a buy or sell entry. In order to avoid whipsawing, I add one more twist. In order to go long, I want to see that the Macd has crossed its signal line from below and it is above the zero line. This is when I usually see the really nice uptrends. I look at it the same way during downtrends. I want to see that the Macd is below its signal line and below the zero line. By adding this one criterion, I avoid a lot of whipsawing that occurs when you are using the Macd. If you

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combine all three indicators together — the Bollinger bands, the Macd, and the Rsi — you get clear-cut signals on the charts. You know exactly when a trend is starting and when a trend is over. What else do you look at? I like to use some major support and resistance lines. Most traders are familiar with the concept of pivot points and know the pivot point study where you have a pivot point, a resistance area 1 and a resistance area 2, and support areas 1 and 2. Many traders use the pivot points. I like to consider the pivot point itself as major support and resistance for the day. I also like to take a look at the resistance 2 line and the support 2 line. But instead of support 1 and resistance 1, I like to use the previous day’s high and the previous day’s low. Those who are trading on the daily charts often use these two values to determine their entry points. There are many traders who like to buy the breakout of yesterday’s high, and so it often acts as resistance. The same applies to the previous day’s low that acts as support. The five major support and resistance lines I am looking at are the pivot point itself, resistance 2 of the pivot point study, support 2, and then the previous day’s high and the previous day’s low. I will not enter a trade into support and resistance if there is not enough room to take profits before I hit support or resistance. If I am getting a signal close to support or resistance, I wait until prices are breaking through before I consider taking the trade. You also use range bars as opposed to time-based charts. Why? Range bars are fascinating. When you are looking at charts we have three ways to look at them: First, constructing bars or candles based on time. This is what many traders use, like a one-minute chart, a five-minute chart, or a 10-minute chart. Recently, it has become more popular to look at volume-based charts, which are also known as tick charts. The term is a bit misleading because what we are looking at is a trade. This is where traders might use a 300-trade chart, or tick chart, and after a certain number of

trades take place, a new bar or candle is plotted. These traders take the time element out of charts and basically just look at volume. If there is a lot of activity you get more bars, and in times of low activity you get fewer bars. With range bars you are looking at volatility. With range bars you define the range. For example, in the emini S&P, I like to use two points. As long as prices

LEGAL NOTICE

NOTICE OF CLASS ACTION SETTLEMENT

If You Purchased a June 2005 Ten Year Treasury Note Futures Contract (“June Contract”) Between May 9, 2005 and June 30, 2005, Inclusive, In Order to Liquidate A Short Position In the June Contract, Then Your Rights May Be Affected and You May Be Entitled To A Benefit The purpose of this notice is to inform you of a Settlement with defendants Pacific Investment Management Company, LLC and PIMCO Funds (“Defendants”) in the certified class action Hershey, et al., v. Pacific Investment Management Company, LLC, et al., Docket No. 05-cv-04681 (RAG) (“Action”) pending in the U.S. District Court for the Northern District of Illinois. The Court has scheduled a public Final Approval Hearing on April 7, 2011, 2:00 p.m. at the Everett McKinley Dirksen United States Courthouse, 219 South Dearborn Street, Chicago, Illinois, Courtroom 1219. In order to resolve the claims against them, Defendants have agreed to wire transfer $59,375,000 into the Escrow Account within ten days of the Court’s Order requiring that notice be sent to the Class and an additional $59,375,000 into the Escrow account at least seven days before the Final Approval Hearing. Together, the foregoing payments, plus all interest earned thereon, constitute the Settlement Fund. A copy of the Settlement Agreement, the formal Settlement Notice, Proof of Claim and other important documents are available on the settlement website at www.pimcocommoditieslitigation.com. For additional information, you may also contact the Settlement Administrator (Rust Consulting, Inc.) at 1 866-216-0282. If you are a member of the Class, you may seek to participate in the Settlement by filing a Proof of Claim on or before June 7, 2011. You may obtain a Proof of Claim on the settlement website referenced above. If you are a member of the Class but do not file a Proof of Claim, you will still be bound by the releases set forth in the Settlement Agreement if the Court enters an order approving the Settlement Agreement. All objections must be made in accordance with the instructions set forth in the formal Settlement Notice and filed with the Court and served on the Parties’ counsel by March 15, 2011.

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stay within this two-point range, you will not get a new bar or candle. If prices break out of this two-point range — that is, they are moving more than two points from the low or are moving away more than two points from the high — then we will get a new bar. Again, we are taking the time element out of charts and we are just looking at volatility. So if the market is moving quickly, we get

• Technical Analysis of Stocks & Commodities • 49

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INTERVIEW

Time-based charts are erratic. Traders who switch to range bars say that they get a much clearer picture. It is all about simplicity, at least for me. more bars on the chart. When we get low volatility, like in the overnight sessions, we get fewer bars on the chart. We are contracting and expanding the chart based on volatility. Here is why I like these bars, or candles — it doesn’t matter what you use. A candle or a bar is constructed based on four variables: the open, high, low, and close. When using range bars, you know where the high of the bar will be because based on the criteria, the high of the bar will be two points away from the low. It cannot be any other way. Therefore, range bars all have exactly the same length. By the same token we know where the low of the bar will be because it will be two

points away from the high. By definition a range bar can only close at the high or the low. It cannot close anywhere in between because if the market breaks out of this range, it will move an additional tick and we get a new bar. Based on the close of bar we also know where the next bar will open. If a range bar closed at the high, the next bar must open one tick above the high. The same is true for the low. If we close at the low, using range bars, the next bar must open one tick below the low of the bar. If you think about it, you have the same four variables — the open, high, low, and close. When using range bars we know where the high will be and where

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the low will be. We know that the bar will either close at the high or the low. Based on this, we know where the next bar will open. This gives me an edge in the market. I look at charts differently. Knowing where the bar closes and opens helps me in my trading. If you have never used range bars, I encourage all readers to check them out. It smoothes out the chart. You might see beautiful signals if you just use range bars and your favorite indicators. Time-based charts are erratic. Traders who switch to range bars say that they get a much clearer picture. It is all about simplicity, at least for me. Are range bars readily available? I would say so. Most charting software packages include them. They might be called something else in your charting software. They are called range bars, or momentum bars, or breakout bars, depending on the charting software you use, but it’s all the same. Since very few traders are using them, often they are hidden deep in the charting software and you might have to contact the support team to find where you can apply the settings for range bars. I would say that more than 90% of the charting software packages have them. Basically, it is the good old point & figure concept. Point & figure charts are also breakout charts. The only difference is that here we are using bars or candles instead of point & figure charts, but it is the same concept. Are range bars primarily for finding or following trends, as opposed to finding other things price is going to do? I also use the range bars to time my entry, especially when using the scalping strategy, or my trend fading strategy. I noticed that the two-point range of the emini S&P gives me fantastic opportunities to enter at the opening of the next bar. If you are a technical trader who uses any sort of indicators, you will know that most indicators are based on the closing price of the bar. And that’s why using range bars with any sort of indicator, you will get a much clearer picture. They help identify trends, but also determining exactly when to enter

50 • May 2011 • Technical Analysis of Stocks & Commodities

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Rockwell Navigator

For more information circle No. 21

smoother the trend is in the range bar.

Figure 1: 15-minute chart of the euro

Figure 2: 16-tick range bar of the euro. Note how the trend is much more refined in the range bar than the 15-minute bar chart.

and when to exit. You see the sideways moves in the market and then just one long beautiful trend because we are expanding the amount of bars. Instead of having one bar that is 10 points long, say on the emini S&P, you will have five bars each being two points long. If you have one bar that is five points long, by the time your indicators are telling you to enter or exit, the move is already over. However, if I break it down into five bars, I have an opportunity to basically

fine-tune when I want to enter into this trend. I can enter much earlier than many traders who are using time-based charts. For comparison purposes, look at the 15-minute chart of the euro in Figure 1 versus the 16-tick range bar on September 22, 2009, in Figure 2. Note how much

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What kind of money management strategies do you use? I just love the idea of Ryan Jones’s fixed ratio money management approach. The idea here is to look to make a fixed amount of money each week, and over time, earn the right to increase your contract size in proportion to your account balance. So, if you start trading with a single contract and your goal is $100 per week, you might establish that after eight weeks and $800 in profits, you will start to trade two contracts. Now your goal is $1,600 (two contracts x $800) and when you have grown your account an additional $1,600, you may now trade three contracts. Conversely, if your account starts to dip, you need to reduce the number of contracts you are trading until you build back your account. Now your goal is to make $1,600. You are still trying to make $800 per contract, but since you are now trading two contracts, you are shooting for $1,600. If you make that, then you can trade three contracts. You are always increasing by one. You are not suddenly jumping up from one to two to four to eight, like some other management techniques suggest. And yet this technique will allow you to double your trading account, in less than a year, making only $100 per week, per contract traded. This takes a lot of pressure off of traders. Many traders think they have to make five points on the emini S&P every day. I tell them no. It is about consistency. Try to make small but consistent

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INTERVIEW

profits, because then you can use money management to leverage responsibly and turbo-boost your trading results. I tell traders to try to make $100 per week per contract. Then, using proper management techniques, you will still be able to double your trading account in less than a year. That is a revelation for many traders. They say, “Yeah, this sounds like a goal I can actually achieve: $100 per week per contract? I should be able to do that.” And you don’t have to stop there. You can just keep adding one contract until you reach a comfortable point. How long do you stay in a trade on average? On average, I would say maybe around 10 or 12 minutes, especially on the scalping trades. I want to see the scalping trades happen quickly. The scalping trades should work out within 30 seconds to two minutes. However, if I have a trend-following trade, it might go on for 10 to 30 minutes. I work with fixed profit targets and stop-losses, and here’s why. I found that it is much easier if I know exactly where to exit a trade before I enter it. By doing this I can let my trading platform manage my trades for me. This has helped me tremendously because, like many other traders, there are many emotions going on once you are in a trade. These days the enemy of a trader is that you currently see the open profit and loss. This lets your emotions fly high. So I like to put my trades on autopilot once I am in. I am a discretionary trader. I decide what trading signals I take. I have a rule-based trading system, so based on my trading strategies I have a rule for when I should enter and exit trades. But then I am making the decision whether I take a trade. However, once I am in a trade, I like to remove discretion from my trading and really have my trading platform manage the trade for me by automatically applying a profit target and a stop-loss. In between I will manage the trade, but just a basic trade management, because I like to keep it simple. If I see that a trade has already moved two-thirds toward my profit target, I move my stop

to breakeven. There is no need to let a winning trade turn into a losing trade just by not properly managing it. But I don’t use trailing stops, so I just use the basic trade management here. As a daytrader, I might have several trades on at any given time. I might be in three, four, or five trades at a time. If I were to use some complicated exit strategy, I don’t think I would be able to manage this. I like to keep it simple, which is why I like to work with predefined profit targets and stop-losses. What are some common mistakes that you see traders making? If I had to pick only three, I would say the first is making it too complicated. I see traders who have trading plans that are so complex that they are difficult to follow. These traders have so many indicators on their screens that they don’t know when to enter and when to exit. My screen is extremely organized. It is clean, and at any given time I know whether I should go long, short, or stay out of the market. When I am in a trade I also know exactly when to exit a trade. I have simplified my trading, and this has helped me tremendously. Second, I believe traders are overambitious. This is the second common mistake: setting unrealistic or overambitious goals. We talked about the power of small but consistent profits, and then applying proper money management techniques. Many traders start with unrealistic goals. They start with maybe a $5,000 or $10,000 account and expect to make a living by trading. Then they are surprised when they are not making $250 a day on a $5,000 account. Start small and set small goals. Once you achieve that goal, then you can start raising the bar. The third is not having a systematic approach. I am not talking about a trading system. I am talking about a systematic approach to achieving goals. I tell traders, if they are new to trading, that their first goal should be to make $100 with

trading. To achieve such a small goal, you just need a simple strategy. You don’t need complex trading strategies. For a simple goal you don’t even need money management. Just start somewhere. Make your first $100. Once you have achieved this, focus on your next $1,000. In order to make $1,000, you might need multiple trading strategies. You have to learn how to read a chart because you have to be able to identify whether the market is trending or going sideways, because, based on this, you will apply the appropriate trading strategy: a trendfollowing strategy in a trending market, and a trend fading strategy in a sideways market. So move from your first $100 to your first $1,000. From there you move on to your first $10,000. That is when you need to understand how to use money management. You may even apply some more trading strategies. You are trying to achieve these goals in a systematic way. It is not that you immediately say, “I have a $5,000 account. I need to make $10,000.” No. Start with making a profit of $100, and only then acquire the information you need for each stage. For the first $100, there is no need to know everything about 45 different money management techniques. You don’t need 113 indicators to make your first $100. You can even achieve it with a very simple scalping strategy. You don’t need complex trading strategies or algorithms here. Then just build it up from there. So you would say “Keep it simple”? I don’t even remember what I said at the very beginning of this interview. This is why I need to keep my trading simple. Two minutes into my trading, and I don’t remember why I entered there or what my plan was. So keeping everything simple helps me in my trading. I don’t make it overly complicated. Thank you for your time, Markus.

Related reading

Heitkoetter, Markus [2008]. The Complete Guide To Day Trading, Outskirts Press. ‡Rockwell Navigator

S&C

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DISTINCTIVELY DIFFERENT DELIVERY Why are there dramatic differences in the way the yen is quoted in the futures market relative to the foreign exchange market? There are distinct differences between the futures and the forex markets that create dramatically different pricing for the yen, yet in both markets the currency’s inherent value will always be similar. For starters, yen futures and the dollar/yen currency pair in forex are each quoted in different terms; second, forex contracts represent immediate delivery and futures represent “future” delivery, which causes some variation in pricing. Although speculators are essentially betting on the same underlying assets when trading currencies in either the forex or futures market, very different standards are set in each trading arena. For instance (ignoring the relatively new currency pair futures introduced by the Cme Group and Ice), the traditional Cme Group currency futures are all paired against the US dollar. Specifically, all are quoted and traded in terms in which the dollar is the quote currency. The price you are buying or selling a currency futures contract at is quoted in terms of the US dollar. For instance, if the euro is trading at 1.3345, it takes exactly $1.3345 to purchase a single euro. The yen is an exception in the currency world. The value of a single yen is nearly worthless and can be thought of as being similar to a penny in US currency. That is, if the US dollar didn’t exist and all of our transactions took place in pennies, the US currency would trade like the yen. You might see the yen futures contract quoted at a rate of 1.22400. Unlike the euro, this does not mean it would cost $1.224 to buy a single yen. Instead, it can be looked at in two ways; the price

of a yen is 1.224 cents, or the cost of 100 yen is $1.224. However, currencies in forex aren’t always traded in the same manner. In forex, traders are executing buys and sells on a pair, rather than a single currency that is automatically paired against the dollar. Yen speculators have the freedom to place wagers on the value of the yen relative to the euro, the Canadian dollar, and many others. In pairs trading, buying one currency means selling the currency it is paired with. To illustrate, if you are buying the Eur/Usd it is the equivalent of simultaneously purchasing the euro and selling the US dollar. It isn’t any

The value of a single yen is nearly worthless and can be thought of as similar to a penny in US currency. different from buying the euro against the dollar in the futures markets, but the reality isn’t displayed in nearly as obvious of terms. Forex pairs are standard regardless of the brokerage firm you choose. In essence, you can trade the Eur/Usd pair, but you couldn’t trade the Usd/Eur pair. If you wanted to be long the US dollar, you would simply sell the pair (that is, sell the euro and buy the dollar). In the case of the yen, it is traded against the greenback in the standard Usd/Jpy pair, which is the opposite of the yen futures contract traded on the Cme Group. Therefore, the price quoted for the yen futures and the Usd/Jpy are the inverse of each other. Accordingly, the Usd/Jpy in the forex market will be trading in the 80s while the yen futures contract (essentially the Jpy/Usd, if

there were such a thing) will be trading in the 1.20s. For instance, assume a yen futures value of 1.22400 is the equivalent to one yen/1.22400 (Jpy/Usd) or one yen is equal to 1.22400 cents. The inverse of this can be found by dividing one by 1.22400 (1/1.2240), or 0.8169. In forex, however, you will see the yen quoted with two digits on the right of the decimal such as 81.96. By moving the decimal, the price is now quoted in the cost per one US dollar. In other words, 81.96 yen are required to purchase one US dollar. Adding to the complexity, unlike the Usd/Jpy currency pair in forex, yen futures are priced for future delivery (as the title of the contract implies). The forex market is known as the spot market because delivery of the underlying asset is set to occur immediately should a trader fail to “roll” their contracts to a distant delivery date (usually the next day). Currency futures, on the other hand, represent quarterly delivery of the underlying. There are four delivery months: March, June, September, and December. Futures speculators not interested in taking delivery of a currency will only need to roll their positions four times per year, as opposed to daily. Because delivery takes place at a specific date in the future, the market tends to have expectations as to what the value of any particular currency will be at that date. Just because the Usd/Jpy is trading near 81.69 today doesn’t mean the futures contract set for delivery three months (or more) from now will be trading at or near 1.2240. Variations in the value might stem from expectations of interest rates, or other fundamental factors. S&C

54 • May 2011 • Technical Analysis of Stocks & Commodities

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M

by Dennis D. Peterson esa9

is a set of studies for TradeStation, MultiCharts, and NeuroShell Trader that employs the latest evolution of John Ehlers’s analysis techniques. The indicators are a set of tools, and without a doubt, one of the most powerful approaches that try to predict price behavior. The premise of Ehlers’s approach is unassailable. A price series is nothing more than a time series and therefore subject to signal analysis techniques. The overall approach is to find what Ehlers refers to as the dominant cycle. If price were to move up and down following a perfect sine wave, prediction would be a snap, and of course, the dominant cycle would be that sine wave. But alas, the real world is more complicated. In a perfect world, it’s not difficult to imagine taking the normal up and down price movements and converting them to a sine wave. Borrowing a picture from Ehlers’s user manual, a sine wave superimposed on a straight line (see Figure 1) begins to look like price in a trend. If only it were so easy. A trend following a straight line is, especially if it’s daily data, a highly unlikely event, if not impossible.

and physicist Joseph Fourier (1768–1830), employs the linear B sum of sine and cosine D waves. Amazingly, you can replicate a repeating square waveform with a series of sine and cosine waves in the E limiting case. But the A C answer you get is not one that is tradable, and Figure 1: SINUSOIDAL PRICE MOVEMENT. If a price series could be characterized Ehlers makes that point as a sine wave superimposed on a straight line, it would look like the blue oscillating line on top, as opposed to the cyclic price series in red at the bottom. Point A marks the zero in his user manual. value line. Points B and C mark the endpoints of trend amplitude, while points D and E He employs filtering mark the endpoints of cyclic amplitude. If the amplitude of the trend (B to C) is twice that techniques using a of the cyclic component (D to E), then MESA9 declares that prices are in a trend. feedforward design to measure the dominant cycle, as opposed to way. In the real world, the cycle period the feedback design he had with Mesa8. is constantly changing, especially if you When Ehlers talks about a spectrum of are using relatively few datapoints, where frequencies, he is really talking about a set the influence of the latest datapoint will of cycles for which he has calculated their matter more, as opposed to, say, adding amplitude, and the cycle with the greatest an extra day to the last five years of daily data. You can see a graphic representaamplitude is the dominant cycle. One thing to keep in mind as you tion of a dominant cycle by inserting the look at the oscillating red and blue lines Mesa9 bandpass indicator. I will discuss in Figure 1 is that while the real world the bandpass indicator later. can be cyclic, it almost never continues to have the same periodicity. Figure 1 Trend vigor is an idealized view in more than one Trend vigor is the ratio of trend ampli-

Dominant cycle

The temptation here is to use a Fourier series. Or at least explain what the analysis is doing in terms of a Fourier series. A Fourier series, invented by the French mathematician

Figure 2: DAILY QQQQ WITH MESA9 HEAT MAP. The vivid colors indicate trend: green is an uptrend, red is a downtrend, and blue is no trend (sideways). The scale at the right of the color map indicates the number of bars in a peak-to-peak cycle. The range is 12 to 60, so that the peak-to-valley values are 6 to 30, which are values you would use in a typical indicator such as RSI.

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tude (Figure 1: distance between points B and C) and cycle amplitude (Figure 1: distance between points D and E). Trend vigor greater than 1 suggests an uptrend, while vigor less than ‑1 suggests a downtrend, and if between +1 and ‑1, then price is in a cyclic mode. While there is a separate indicator for vigor, you can get an idea of how a price series FIGURE 3: DATA RANGES AT TWO DIFFERENT SIGNAL TO NOISE RATIOS (SNR). Profit is just lucky when noise equals (left-hand chart: 0 dB SNR), but when the signal is twice as strong as noise (right-hand chart: 6 dB SNR), the results are goes from upward to downward to signal worthwhile profit. neutral by inserting the heat map indicator (Figure 2). Since Ehlers likes to start his analysis with the heat map, let’s discuss it for a moment. The way you use the heat map is simply to pick a point in time and, using the color, find candidates for the number of cycles. For example, starting with the lower left portion, you see where the red (downtrend or a short posi‑ tion) first turns to blue (no trend) at the beginning of June or so. At this point in time — transitioning from red to blue — the last of the shortterm short trades disappears (at least for the time being), and suggests you hold the trade for six days (half times lower range of 12). But also at the beginning of June, note that the red extends all the way FIGURE 4: DAILY QQQ WITH MESA9 INDICATORS. Overlaid on the price are two lines that come from inserting the trendline indicator. The subcharts below the price chart are (starting from the top): bandpass showing the dominant cycle (oscillating to the top of the heat map range, red line), trend vigor showing the ratio of trend to cycle strength (oscillating blue line between white +1 and ‑1 thresholds), and which says a short position held for detrend showing the result of subtracting the instantaneous trendline from prices and then scaled for display with + and ‑1 30 days (half of maximum range of sigma lines (green bars oscillating between parallel white lines). 60) should make a profit. We have the benefit of history, and the result is that on crest, but at the low of that daily bar, you of that, you now have the signal. Simply June 4, 2010, Qqqq closed at 45.09, and have used the cycle correctly, but making put, it is the root mean square (Rms) of on July 1, 2010, Qqqq closed at 42.59, a zero profit due to the noise. On the other the dominant cycle. Ehlers would say profit from a short sale. hand, if you use the “signal is twice as you have an acceptable Snr if the ratio strong as noise (6 dB Snr)” bars, you of the signal to the noise is two or more, Signal to noise ratio see some worthwhile profit, regardless or in digital processing terms, the signal “Digital signal processing” also uses the of your noisy entrance and exit points. is 6 dB above the noise. term signal to noise ratio (Snr). Noise So how does Ehlers calculate the signal is the random up and downs that reflect to noise ratio? He calculates noise as Indicators neither a cycle nor a trend. If you are the average daily range. The signal is There are 10 indicators that come with going to use cyclic data, you would like taken from the dominant cycle, which he Mesa9. Having gotten this far with the to know that it is more than just a shot finds using his feedforward techniques. explanations given here, the names should in the dark — that you won’t be trading Using Figure 1 again, note the bottom not be a surprise, with names like “Mesa9 noise. Ehlers gives a nice example of red wave. If you take the values from the Snr” or “Mesa9 trend vigor.” data that is in an environment where the curve starting at zero on the left (point Let’s talk about one more with an noise equals the signal (Figure 3: 0 dB A), to point where they cross zero again, example, namely Mesa9 detrend. The Snr) and where the signal is twice that and are rising (point C), form the sum explanation in the user manual should of the noise (Figure 3: 6dB Snr). of squares (since in Figure 1 half of the now read easily: “This Mesa9 indica‑ If you enter a long position at the values of the oscillating red line are tor detrends the price by subtracting the cyclic valley, but at the high of the daily below zero), divide by the number of instantaneous trend line from the price. bar, and exit the long trade at the cyclic samples and take the square root of all The display is scaled to show the price May 2011

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These are top-notch analytics. A few products attempt to be adaptive, and this is one that succeeds.

FIGURE 5: DAILY QQQQ WITH MESA9 INDICATORS. Overlaying the price bars, shown in red and cyan, are the trendline indicators. The subcharts below starting at the top are the following: SNR (signal to noise ratio), sinewave with leading and lagging waves, and trend vigor. The fuzzy look to SNR is indicative of a weak signal. The crossover of the red and cyan lines of the sinewave indicator shows potential entry points.

relative to plus one sigma and minus sigma values.” The results are in Figure 4. When the detrend indicator touches one of the threshold sigma lines, price is in a cyclic mode and is likely to be a reversion to mean, such as the case seen at the beginning of July (Figure 4: bottom subchart).

Analysis plan example

Now that you have an idea of the pieces, let us look at an example of how to use the indicators to analyze a price series. We’ll use daily Qqqqs, but any stock or commodity would work. The emphasis in this plan is to buy the trend, because the reality is that most of the money is made in that fashion. Start by looking at

the heat map (Figure 2). What you are looking for is solid green or red swaths of color. What you don’t want is the mix of colors that you see in August 2010. Ehlers would describe the heat map as the view from 30,000 feet. Next, you need to focus more. Cre‑ ate the chart you see in Figure 4. Check vigor (Figure 4: middle subchart with sinusoidal blue line) to assure that the trend is not falling off. For focus, use the bandpass and detrend indicators. Use the bandpass indicator (Figure 4: top subchart with sinusoidal red line), and when you see a valley, you should buy because price should be in a dip. This occurs in the second week in Oc‑ tober. Use detrend (Figure 4) to assure

yourself that there is no countermove. In mid-October, detrend is flat, which is the condition you want for confirmation. Mid-October (October 15, 2010) shows where you would take a long position in Qqqq, since the heat map is showing a large amount of green, vigor is above one and not falling off, bandpass has formed a valley, and detrend is flat. But suppose vigor says that you are in a cyclic mode — that is, vigor is between +1 and ‑1. This occurs, roughly speak‑ ing, in the July, August, and September (2010) time frame. Just prior to this time frame, you see that the signal to noise ratio is showing a low Snr (Figure 5). What you are looking for is a crossover of the two lines of the sinewave indicator, while vigor is at least roughly between +1 and ‑1, and Snr is not indicating a weak signal (Figure 5: top subchart fuzzy area). Note it is not a lot of time to get some decent trades. The sinewave indicator is a pure sine wave based on the phase of the dominant cycle. The phase is advanced 45 degrees to create the lead wave (cyan).

Other

FIGURE 6: DAILY S&P MIDCAP. Here’s a NeuroShell Trader screen with sinewave (top subchart) and trend vigor (bottom two subcharts) indicators.

Ehlers has included several Easy‑ Language code examples in the user manual. Looking at the first example, adaptive Rsi code, what you should conclude is that any indicator that uses a fixed number of periods is only a guess at the real number of periods. If the indicator is an oscil‑ lator, you can be misled. From the

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product review

heat map, you can see that the number of periods to use is changing, but even more prominent are the changes in periods you see manifested in the dominant cycle (Figure 4: top subchart — red line) and the sinewave indicator (Figure 5: middle subchart). As mentioned at the beginning, Mesa9 is also available on a number of platforms. MultiCharts supports EasyLanguage files, and as a result, you see the same type of screens you get with TradeStation. The first five figures were all created using TradeStation. The implementation in NeuroShell Trader is a bit different, however. The heat map isn’t available, but the rest of the Mesa9 indicators are. For example, when you insert the sinewave indicator, the two sine waves are in separate subcharts. But you can get the same appearance and functionality that you see in Figure 5 by merging the two subcharts by clicking and dragging one of the sine wave subcharts onto the other sine wave subchart (Figure 6: top subchart). Trend vigor has a histogram-like look (Figure 6: bottom two subcharts), so up- and downtrends stand out better. Use version 5.6 (or later) of NeuroShell Trader, and similarly, version 6.0 of MultiCharts and version 8.6 for TradeStation.

Summary

These are top-notch analytics. A number of traders might be surprised at what is seen here, namely, that the number of periods in a cycle is constantly changing, perhaps not every day, but certainly every few days or a couple of weeks. If you are using oscillators and you are not changing the number of periods to fit what Ehlers calls the dominant cycle, then this is likely to be one of the reasons you are losing money. A few products attempt to be adaptive, and this is one that succeeds. This is exactly the type of product that is worth your investment in time and money. Dennis Peterson is a Staff Writer for Stocks & Commodities. ‡Mesa9

S&C

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 to measure market trend intensity. Average True Range — A moving average of the true range. Bid and Ask — Highest price and lowest price that an investor will pay for a tradable. Bollinger Bands — Bands widen during increased volatility and contract in decreased volatility, and when broken, are an indication that the trend may continue in that direction. Call Option — A contract that gives the buyer of the option the right but not the obligation to take delivery of the underlying security at a specific price within a certain time. Candlestick Charts — A charting method, originally from Japan, in which the high and low are plotted as a single line and are referred to S&C as shadows. Covered Call — Selling a call option while holding an equivalent in the underlying tradable. Doji — A session in which the open and close are the same (or almost the same). Elliott Wave Theory — A pattern-recognition technique published by Ralph Nelson Elliott in 1939. Euro — European unit of currency, of the European Union. Exchange-Traded Funds (ETFs) — Collections of stocks that are bought and sold as a package on an exchange. Exponential Moving Average — A variation of the moving average, the EMA places more weight on the most recent closing price. Fade — Selling a rising price or buying a falling price. Fibonacci Ratio — The ratio between any two successive numbers in the Fibonacci sequence. Gap — A day in which the daily range is completely above or below the previous day’s daily range. In-the-Money (ITM) — A call option whose strike price is lower than the stock or future’s price, or a put option May 2011

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whose strike price is higher than the underlying stock or future’s price. Long — Establishing ownership of the responsibilities of a buyer of a tradable; holding securities in anticipation of a price increase in that security. Money Flow — A number of technical indicators that incorporate volume and price action to measure buying or selling pressure. Calculated by multiplying the day’s volume by its average price. Moving Average — A mathematical procedure to smooth or eliminate the fluctuations in data and to assist in determining when to buy and sell. Moving Average Crossovers — The point where the various moving average lines intersect each other or the price line on a moving average price bar chart. Moving Average Convergence/ Divergence (MACD) — ­The crossing of two exponentially smoothed moving averages that are plotted above and below a zero line. Near-the-Money — An option with a strike price close to the current price of the underlying tradable. Out-of-the-Money (OTM) — A call option whose exercise (strike) price is above the current market price of the underlying tradable. Put Option — A contract to sell a specified amount of a stock or commodity at an agreed time and price. R/R Ratio—Reward/risk ratio. The ratio of profit target or trade gain and risk or trade loss. Relative Strength Index (RSI) — An indicator invented by J. Welles Wilder and used to ascertain overbought/oversold and divergent situations. S&P Emini — Electronically traded, smaller-sized ($50 times the S&P 500) contracts of the Standard & Poor’s 500 index. Stochastics Oscillator — An overbought/ oversold indicator that compares today’s price to a preset window of high and low prices. Volatility Index — A widely used measure of market risk. Sometimes referred to as the “investor fear gauge.” S&C

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Explore Your Options Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, 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 of Optionetics

A Stronger Call Position I’ve noticed many stocks see their strongest or weakest price levels in afterhours or premarket trade immediately following an earnings release. With the stock’s listed options not open during those sessions, it seems an investor with a long call, if the move is up, could be missing out on exiting at more opportune levels. Why is this and do you see any changes in the future? Whether listed equity options will trade in the afterhours or premarket sessions and afford option strategists the same type of access as stock traders have to their shares is, in the end, a political thing. I haven’t heard of any pending reform to do so. One real deterrent to extending trading hours for options is liquidity. Remember, calls and puts are derivatives of the underlying, which we can assume will have less liquidity during these trading sessions. Thus, even if you are holding a typically well-traded front month option, closing or adjusting into an attractive spread would likely prove challenging at best. An argument to extend trading hours for a security’s options might be following an earnings announcement. For the most highly capitalized companies that also sport strong institutional liquidity during the regular trading session, this could make sense. For companies such as Apple (Aapl), Google (Goog), Bank of America (Bac), and the like, we might expect there to be sufficient interest to make a special session worthwhile. Currently, traders who are long a call (or a put) who find themselves with a quick profit on paper can still take some action in the afterhours or premarket. For instance, with an existing long call, if shares rally to attractive levels and where you might look to sell out the position, the trader can short the stock up to the number of contracts held in order to take partial or lock in profits.

This type of action converts the position from a long call into a synthetic long straddle or a full-fledged long put if 100 shares are shorted for every call held. A couple caveats to using short stock as a hedge against a long call are the trader’s account being approved and being financially capable of holding short stock. In addition, if the stock in question is hard to borrow, this type of hedge wouldn’t be allowed, as your broker won’t be able to locate shares to be shorted. One way around this possible road block would be to use a synthetic long call made up of long stock and a long put, in lieu of the regular call. Again, the capital requirement for non–risk based accounts will be greater than it would for an equivalent amount of regular long calls because of the cost of the stock. However, if your concern is not being able to trade in the extended hours and when stocks do hit extremes not seen in the regular session, the flexibility to hedge is more readily available. “Your Assignment is Complete” I thought the process of automatic exercise guaranteed assignment at expiration if the stock crossed a certain price threshold. Recently, I was alarmed to learn that’s not necessarily the case. Is this true? Under what circumstances would I have to be concerned as a trader who focuses on verticals? Automatic exercise will occur without the contract buyer needing to take any action on expiration if the call (or put) is in-the-money by a penny or more. However, remember that the owner of a contract is not obligated to convert the call or put, regardless of price. If the trader decides not to take on the obligation of long or short stock via the exercise process, even though the contract has been determined to have expired in-

the-money, he or she can put in a “do not exercise” notice with their broker. Similarly, an option that appears to have expired worthless based on the closing price of shares at expiration can always be subject to assignment if a holder of that contract decides to exercise it. While neither instance is common, news after the official close that affects shares in the afterhours could prompt this kind of surprise. The “surprise” of being assigned may also be the result of the contract holder needing to reduce risk. As a trader who focuses on verticals, you’re covered to guard against unlimited risk regarding any surprises with your short contract. Since you own an offsetting long call or put, you could opt to exercise or request your own “do not exercise” action. Under circumstances where you become aware after expiration of a change in the underlying shares that could affect the obligation with your short contract, you can take the same action as the counterparty of your short option. This may wipe out your profits, but at least your open-ended risk would be eliminated. The good news is scenarios like these aren’t commonplace. However, with the automatic threshold for exercising down to a penny, the surprise of finding oneself with an unwanted long or short stock position that won’t be covered until the next trading session does seem to pose a greater risk. In fact, according to the Options Clearing Corp. (Occ), 20.50% of in-the-money options (which can mean a penny, mind you) went unexercised in 2010. For what typically amounts to a few less pennies profit to close out this type of position prior to expiration, that makes good “sense” to us. Contributing analysis by senior Optionetics strategist Chris Tyler

S&C

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For this month’s Traders’ Tips, the focus is Walid Khalil and David Steckler’s article in this issue, “In The Volume Zone.” One additional Traders’ Tip is contributed for Koos van der Merwe’s article in the December 2010 issue of S&C, “Less Stress With The JM Internal Band.” Code for the volume zone oscillator for MetaStock and TradeStation is already provided in Khalil and Steckler’s article. Subscribers will also find the same code at the Subscriber Area of our website, www.Traders.com. Presented here is an overview of possible implementations for other software. Traders’ Tips are provided to help the reader implement a selected technique from an article in this issue. The entries are contributed by various software developers or programmers for software that is capable of customization. Readers will find all the code listings that accompany the following Traders’ Tips at our website, Traders.com. Provided here is some discussion of the technique's implementation by the Traders’ Tips contributors as well as some example charts. To locate Traders’ Tips at our website, use our site’s search engine, or click on the Traders’ Tips link from our home page. For past Traders’ Tips, click on the “Stocks & Commodities” link from our home page in the red box on the left, then click on the “Article Abstracts” link in the red box on the left, then click on the issue of interest, then on “Traders' Tips.”

F TRADESTATION: volume zone oscillator In the article “In The Volume Zone” in this issue, authors Walid Khalil and David Steckler present a volume zone oscillator (Vzo) that can be used to incorporate both trending and oscillating price action. They also suggest some methods by which the Vzo can be used with other indicators and rules for trading. We have prepared code for this indicator (_Vzo_Ind) and a strategy (_Vzo_Strategy). The strategy utilizes the 60-bar Ema of the close, the volume zone oscillator, and the 14-bar Adx. An Adx above 18 is considered trending, while below 18 is considered nontrending, according to the authors. Alerts were coded in the indicator to alert when the Vzo crosses the overbought and oversold values as set by the inputs. To download the EasyLanguage code for the indicator, go to the TradeStation and EasyLanguage Support Forum (https:// www.tradestation.com/Discussions/forum.aspx?Forum_ ID=213) and search for the file “Vzo.Eld.” A sample chart is shown in Figure 1. This article is for informational purposes. No type of trading or investment recommendation, advice, or strategy is being made, given, or in any manner provided by TradeStation Securities or its affiliates. —Chris Imhof, TradeStation Securities, Inc. A subsidiary of TradeStation Group, Inc. www.TradeStation.com

Figure 1: TRADESTATION, volume zone oscillator. This shows a daily chart of SPY with several indicators and the “_VZO_Strategy” applied.The indicators include the _VZO_Ind (cyan plot in subgraph 2), 60-bar EMA of the close (red plot with the price data), and the custom two-lines indicator (subgraph 3) plotting the 14-bar ADX (yellow) and the value of 18 (cyan line). The value of 18 for the ADX is the breakpoint for trending versus nontrending, according to the authors.

F eSIGNAL: volume zone oscillator For this month’s Traders’ Tip, we’ve provided the formula VolumeZoneOsc.efs based on the formula code from Walid Khalil and David Steckler’s article in this issue, “In The Volume Zone.” The study contains one formula parameter to set the number of periods, which may be configured through the Edit Chart window. To discuss these studies or download complete copies of the formula code, please visit the Efs Library Discussion Board forum under the Forums link from the Support menu at www.

Figure 2: eSIGNAL, volume zone oscillator May 2011

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esignal.com or visit our Efs KnowledgeBase at http://www. esignal.com/support/kb/efs/. The eSignal formula scripts (Efs) are also available for copying and pasting from the Stocks & Commodities website at Traders.com. A sample chart is shown in Figure 2.

—Jason Keck Interactive Data Desktop Solutions 800 815-8256, www.eSignal.com/support/

F BLOOMBERG: volume zone oscillator The Bloomberg chart in Figure 3 shows the volume zone oscillator described in the article by Walid Khalil and David Steckler in this issue, “In The Volume Zone.” Based on the uptrend rules given in the article, a bullish signal is present during December 2010 (defined by a rectangle) that coincides with the early stage of the rally that peaked in mid-February 2011. The oscillator crosses above the zero line on December 6, the final day on the chart where the entire bar is below the 60-day Ema. At that point, the Adx line hovers just around the 18 level, as evidenced by the orange line that cuts through the Adx histogram. Three days later, on December 9, the Vzo crossed back above +15, the market gapped above the 60-day Ema, and the Adx is close to 20, showing the strengthening of the up move. In their article, the authors also note that the Vzo will react to that volume behavior by staying in the lower zone between -40 and zero, indicating more selling pressure than buying pressure. Conversely, on this chart, one can observe the Vzo oscillating in a range between zero and +40 as the market is in the first wave of the up move during the second half of December. Using the CS.Net framework within the Stdy function on the Bloomberg Terminal, C# code or Visual Basic code can be written to display the volume zone oscillator. The C# code for this indicator is shown at Traders.com. All Bloomberg code written for Traders’ Tips can also be found

Figure 4: WEALTH-LAB, volume zone oscillator. Here is a Wealth-Lab Developer 6.1 chart showing the volume zone oscillator strategy applied to a natural gas continuous futures contract (NG20_I0B, daily).

in the sample files provided with regular Sdk updates, and the studies will be included in the Bloomberg global study list.

—Bill Sindel Bloomberg, LP [email protected]

F wEALTH-LAB: volume zone oscillator The volume zone oscillator system presented in Walid Khalil and David Steckler’s article in this issue, “In the Volume Zone,” is now available as a free download to Wealth-Lab users, as well as many other ready-made trading strategies. To start using this strategy and exploring its potential to help you switch gears to trade in both trending and range-bound markets, simply click the “Download” button in Wealth-Lab’s Open Strategy dialog. Although the new oscillator implementation is fairly straightforward, the accompanying system rules have to function in different market regimes and cover such events as positive and negative price/oscillator divergences. The complexity of their implementation is hidden in an additional library, “Community Components,” available for download to Wealth-Lab customers from our site, www.wealth-lab.com (see the “Extensions” section). Users can see the divergence lines drawn on a chart, both in the traditional way and as a “binary wave” to be used in mechanical trading systems. A sample chart is shown in Figure 4. —Eugene www.wealth-lab.com

Figure 3: BLOOMBERG, volume zone oscillator. Here is a one-year daily chart of Goodyear Tire & Rubber (GT), with the volume zone oscillator and ADX shown in separate panels below the price chart.

F aMIBROKER: volume zone oscillator In their article in this issue, “In The Volume Zone,” authors Walid Khalil and David Steckler present a new volume zone oscillator that can be easily implemented using AmiBroker Formula Language. A ready-to-use formula for the indicator can be found at Traders.com and is also shown below. To use the code, enter the formula in the Afl Editor, then press “Insert indicator.” To modify the averaging period of the volume zone oscillator, click on the chart with the right mouse

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Figure 5: AMIBROKER, volume zone oscillator. Here is a weekly price chart of the DJIA (upper pane) with a 14-period volume zone oscillator (middle pane).

button and select “Parameters” from the context menu. A sample chart is shown in Figure 5. function VZO( Period ) { R = sign( Close - Ref( Close, -1 ) ) * Volume; VP = EMA( R, Period ); TV = EMA( Volume, Period ); return Nz( 100 * VP / TV ); } Period = Param(“Period”, 14, 1, 100 ); Plot( VZO( Period ), “Volume Zone Osc” + _PARAM_VALUES(), colorBlack, styleThick ); Plot( 60, “”, colorLightOrange, styleNoLabel ); Plot( 40, “”, colorLightOrange, styleNoLabel ); Plot( 0, “”, colorBlack, styleNoLabel ); Plot( -40, “”, colorLime, styleNoLabel ); Plot( -60, “”, colorLime, styleNoLabel );

—Tomasz Janeczko, AmiBroker.com www.amibroker.com

F WORDEN BROTHERS TC2000: volume zone oscillator The volume zone oscillator (Vzo) in Walid Khalil and David Steckler’s article in this issue is now available in the TC2000 indicator library. To add the indicator to your chart, just click the “Add indicator” button and select it from the list. In Figure 6, we’ve plotted a 60-period exponential moving average of price and the Adx with the period and smoothing set to 14. These additional indicators are used to evaluate the system rules explained in the article. The oscillator zones on the Vzo are marked using plot guides on the Vzo indicator. To add/edit the plot guides on an indicator, click on the name of the indicator and select “Edit plot guides.” You can add and customize plot guides on any indicator in the system to mark significant levels. And once

Figure 6: TC2000, volume zone oscillator. Here is a weekly chart of SPY with the 60-period exponential moving average of price, VZO with oscillator zones, and ADX. The watchlist also shows columns for price above the 60-day EMA, ADX above 18, and VZO crossing up through -40.

you’ve set up the plot guides the way you want them, click on the indicator and select Save. You now have your own customized version of the indicator available to you in the indicator library. Using the “QuickSort/Add Column” feature, you can find stocks meeting the various Vzo system rules. As seen in Figure 6, we’ve added columns to find stocks passing the uptrend buy rules. Symbols Wfr and Qep are trading above their 60day exponential average, Adx is above 18, and Vzo has just crossed up through -40. This all happens in real time. For more information on TC2000 or to start a free trial, visit www.TC2000.com. You can also access your watchlists, scans, and chart template while away from your computer using the new TC2000 Mobile app for Android 2.0 and higher (www. TC2000.com/Mobile). —Patrick Argo, Worden Brothers, Inc. www.TC2000.com

F NEUROSHELL TRADER: volume zone oscillator The volume zone oscillator (Vzo) described by Walid Khalil and David Steckler in their article in this issue can be easily implemented with a few of NeuroShell Trader’s 800+ indicators. Simply select “New Indicator…” from the Insert menu and use the Indicator Wizard to set up the following indicator: Multiply2( 100, Divide( ExpAvg( Multiply2( NumPosNegMom(Close,1,1), Volume), 14), ExpAvg(Volume, 14) ) )

To create a volume zone oscillator trading system, select “New Trading Strategy …” from the Insert menu and enter the following in the appropriate locations of the Trading Strategy Wizard: Generate a buy long market order if ALL of the following are true: A>B(Close, ExpAvg(Close, 60) ) May 2011

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Figure 7: NEUROSHELL TRADER, volume zone oscillator. This NeuroShell Trader chart demonstrates the volume zone oscillator and corresponding trading system. A>B(ADX(High, Low, Close, 14, 14), 18 ) OR2( CrossAbove(VZO, -40), CrossAbove(VZO,0) ) Generate a sell long market order if ONE of the following is true: AND2( A>B(VZO, 60), ARef(C, -1), V, -V); VP:=Mov(R, Period, E); TV:=Mov(V, Period, E); VZO:=100 * (VP / TV); return VZO;

To import this strategy into Tradecision, visit the area “Traders’Tips from Tasc Magazine” at www.tradecision.com/ support/tasc_tips/tasc_traders_tips.htm or copy the code from the Stocks & Commodities website at www.Traders.com. A sample chart is shown in Figure 11.

—Yana Timofeeva, Alyuda Research 510 931-7808, [email protected] www.tradecision.com

F NINJATRADER: : volume zone oscillator The volume zone oscillator (Vzo), as presented by Walid Khalil and David Steckler in their article “In The Volume Zone” in this issue, has now been implemented as an indicator for NinjaTrader. The indicator is available for download at www.ninjatrader.com/SC/May2011SC.zip.

F UPDATA: volume zone oscillator This tip is based on “In The Volume Zone” by Walid Khalil and David Steckler in this issue. In their article, the authors present an indicator that takes into account both time and volume fluctuations for predicting future price direction, of equal application to trending or oscillating market phases. We have added the Updata code for this indicator to the Updata Indicator Library. It may be downloaded by clicking the Custom menu and then “Indicator library.” Those who cannot access the library due to a firewall may paste the following code into the Updata Custom editor and save it. PARAMETER “Exp. Averaging Period” #ExpAvgPeriod=14 NAME “VZO (“ #ExpAvgPeriod “)” “” DISPLAYSTYLE Line PLOTSTYLE Thick2 RGB(0,0,0) INDICATORTYPE Chart @R=0 @VolumePosition=0 @TotalVolume=0 @VolumeZoneOsc=0

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FIGURE 14: CHARTSY, volume zone oscillator. Here is a sample chart of the volume zone oscillator (VZO). FIGURE 13: UPDATA, volume zone oscillator. This chart shows the 14-period VZO applied to the S&P 500 index. If the VZO breaks below zero while price falls below its 60-period EMA, it signals closing out long positions established during this uptrend.

FOR #CURDATE=#ExpAvgPeriod TO #LASTDATE @R=Sign(Close-Close(1))*Vol @VolumePosition=Sgnl(@R,#ExpAvgPeriod,E) @TotalVolume=Sgnl(Vol,#ExpAvgPeriod,E) @VolumeZoneOsc=100*(@VolumePosition/@TotalVolume) @PLOT=@VolumeZoneOsc ‘Draw Oscillator Zones DRAWLEVEL LINE,0,RGB(100,100,100) DRAWLEVEL LINE,15,RGB(255,0,0) DRAWLEVEL LINE,-5,RGB(255,0,0) DRAWLEVEL LINE,40,RGB(0,0,255) DRAWLEVEL LINE,-40,RGB(0,0,255) DRAWLEVEL LINE,60,RGB(0,255,0) DRAWLEVEL LINE,-60,RGB(0,255,0)

FIGURE 15: CHARTSY, PROPERTIES WINDOW. Here, the indicator properties window is shown for the volume zone oscillator.

A sample chart is shown in Figure 14. The properties window for the Vzo is shown in Figure 15. To download Chartsy, discuss these tools, and help us develop other tools, please visit our forum at www.chartsy.org. Our development staff will be happy to assist and you can become a Chartsy contributor yourself. —Larry Swing (281) 968-2718, [email protected] www.mrswing.com

NEXT

A sample chart is shown in Figure 13.

—Updata support team [email protected] www.updata.co.uk

F Chartsy: volume zone oscillator For Windows, Mac, and Linux

The indicator presented in “In The Volume Zone” by Walid Khalil and David Steckler in this issue is available for Chartsy version 1.4 or higher as the “volume zone oscillator” plugin. To install this plugin, go to Tools→Plugins→Available Plugins. You can find the Java source code for the volume zone oscillator (Vzo) here: http://chartsy.svn.sourceforge.net/viewvc/chartsy/trunk/Chartsy/ Volume%20Zero%20Oscillator/src/org/chartsy/vzo/VolumeZoneOscillator.java?revision=423&view=markup

F SHARESCOPE: volume zone oscillator Here is a ShareScope script to implement the volume zone oscillator (Vzo) based on Walid Khalil and David Steckler’s article in this issue, “In The Volume Zone.” //@Name:VZO //@Description:Volume Zone Oscillator. As described in Stocks & Commodities magazine, May 2011 issue. var period = 14; function init() { setSeriesColour(0, Colour.Red); setTitle(period+” VZO”); setHorizontalLine(60); setHorizontalLine(40); setHorizontalLine(0); setHorizontalLine(-40); setHorizontalLine(-60); } function getGraph(share, data) May 2011

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Figure 16: SHARESCOPE, volume zone oscillator { var VZO = []; var ma1 = new MA(period, MA.Exponential); var ma2 = new MA(period, MA.Exponential); for (var i=1; idata[i-1].close?1:1)*data[i].volume); var ema2 = ma2.getNext(data[i].volume); VZO[i] = ema2!=0?(100*ema1/ema2):0; } return VZO; }

—Tim Clarke www.sharescope.co.uk

F TRADE NAVIGATOR: volume zone oscillator Trade Navigator offers everything needed for recreating the indicators and highlights discussed in Walid Khalil and David Steckler’s article in this issue, “In The Volume Zone.” Detailed instructions and code to recreate the custom indicator and add it to any chart in Trade Navigator are shown here and at Traders.com. We also show you how to use the custom indicator alongside existing indicators in Trade Navigator to set up a template that can be easily applied to any chart. Here is the TradeSense code to create the custom indicator. Input this code by opening the Trader’s Toolbox, then click on the Functions tab, and click the New button. Volume zone oscillator &R := IFF (Close > Close.1 , Volume , Volume * -1) &VP := MovingAvgX (&R , 14 , False) &TV := MovingAvgX (Volume , 14 , False) &VZO := 100 * (&VP / &TV) &VZO

To create a chart template, go to the “Add to chart” window on a daily chart by clicking on the chart and typing “A” on the keyboard. Click on the Indicators tab, find the volume zone oscillator in the list, and either double-click on it or highlight the name and click the Add button. Repeat these steps to add the Adx and the MovingAvgX indicator. (These are just two of the many indicators provided

in Trade Navigator.) On the chart, click on the MovingAvgX label and drag it into the price pane. Hold down the Crtl key and click in the pane with the volume zone oscillator to make seven horizontal lines. Click once for each line at the -60, -40, -5, 0, 15, 40, & 60 values in that pane. They do not have to be exact because you can either drag the line to the correct position later or set it in the Chart Settings window. Click on the chart and type the letter E to bring up the chart settings window. Click on the MovingAvgX in the list under price. Change the values as follows: Expression: close, Bars used in average: 60, and Show initial bars: false. Click on the pane 3: Adx line to highlight it. Then click the Add button at the bottom. Select Add Indicator → Add Indicator to Selected Pane. With “custom indicator” highlighted, click the Add button. Type “18” and click the OK button. Click in the Function name box and change it from custom indicator to 18 line. Next, click on the Adx to highlight it in the list on the left. Set “Bars used in calculation” to 14. Click the Add button and select “Add HighlightBars to selected indicator.” With “Custom HighlightBars” highlighted, click the Add button. Click the No button when prompted to use indicators from the active chart. Type Adx (14, False)>18 and click the OK button.

Setting up the template

Click on 18 line to highlight it in the list on the left. Click the Add button and select “Add HighlightBars to selected indicator.” With “Custom HighlightBars” highlighted, click the Add button. Click the No button when prompted to use indicators from the active chart. Type Adx (14, False)