APPLYING THE COUNT BACK LINE ENTRY By Daryl Guppy Several readers have asked for guidance on the application of the count back line (CBL). For traders who user the Guppy Traders Essential charting pack or tool packs with Metastock, or Ezy Charts, the construction details are unnecessary. These programs have a count back line tool which automatically calculates the placement of the count back lines when the cursor is placed over a price bar. Metastock and Supercharts users have to complete these calculations by hand. All users must know the correct starting point for the CBL calculation. The increasing incidence of double bottoms has led to some confusion about which low should be used in the calculation. These notes are designed to explain the construction process, and to show how the technique is integrated with other indicators. The CBL is not designed as a stand alone technique. It is the final step in planning a trade that has been signaled by other indicators. My preferred combination includes the use of straight edge trend lines and the Guppy Multiple Moving Average. The objective is to identify when a downtrend has turned into an up trend. The focus is on breakout trading and the objective is to plan an entry as close as possible to the pivot point low. This is the low that sets the ultimate low point of the downtrend. We cannot know which bar is this until after the event. But if we know as soon as possible then we have an advantage because we capture the early part of the trend change. The CBL is also used to manage entries into an established trend. Here it works as a stop loss function, and we will look at this in a later series of notes. When we select a stock we use methods which manage risk at one level. When we actually buy the stock we take on a different type of risk which is broadly execution risk. This risk is complicated by our actual ability or inability to get in or out at the price we would like to. It is a trend following tool which is designed to confirm the reversal of a short term trend. This is an important modifier. The count back line is not designed to identify and define a long term trend. We use the MMA for this. The count back line is used to select the better entry points once we have received trend change signals from other sources. It is a tool that is used within the context of a previous selection. The count back line is used to create a short term hurdle which must be overcome before we can have any confidence of a likelihood of a trend change. It consists of four applications. The first is as a trend change verification tool. The second is as an entry tool with a defined range of safe price levels. The third is as a stop loss tool. The fourth is related to the stop loss function when it is used as an exit tool. Our objective is not to predict the future, but to put the balance of probability in our favor. We start with the trend verification function. Assume for the moment that the MMA chart is already showing a strong potential for a trend reversal. We are looking for a trend change and we are prepared to follow the downtrend down until we get a definite signal that the change is taking place. The count back line is used initially as a resistance line. It is calculated from the most recent low in the current trend. Any action between the count back line and the existing low point is ignored. With each new low, we recalculate the position of the count back line. We wait until we get a close above the count back line before we act. Because we have already been alerted by the MMA relationship, we can take the count back line signal with confidence. It confirms what we already know. As the trend continues down we recalculate the count back line.
A close above the short term resistance level signals an entry. All of this is based on end of day downloads. We get the signal tonight, and we get to take action tomorrow. The count back line defines the safe zone of entry. We need to know how far we can safely chase price. The chart extract shows the simplest and easiest application of the count back line. Prices have been traveling in a downtrend, but there is some evidence from other indicators, such as the Guppy Multiple Moving Average, a straight edge trend line, a stochastic or RSI that a new up trend is emerging. We have already made the decision about the potential for a trend trade. Now we apply the count back line to determine the exact entry conditions and prices.
We start with the most recent lowest low. This is marked with an * and shown as bar A. This is the first SIGNIFICANT bar. We move to the top of the bar. Then move across to the left to locate the next highest bar in the current downtrend. This is the next SIGNIFICANT bar. It is significant because it has a higher high than the first bar. In this example this is shown as bar B. Then move to the top of bar B, and across to the left to the next bar with a higher high. This is the third SIGNIFICANT bar, shown as bar C. Move to the top of this bar and then plots a line extending to the right. This is the count back line entry bar. No action is taken until there is a close above this bar. We accept that the close is set by the smart money so we ignore temporary highs created by the bulls. In the chart the first higher bar 1 sets a high equal to the count back line. No action is taken. Bar 2 pushed above the count back line for the high of the day, but the close is on the same level as the count back line. No action is taken. Bar 3 also shows a close on the value of the count back line and this is ignored.
Bar 4 deliver the signal for action. The close is above the value of the count back line. Action is taken on the next day. This is an end of day indicator that sets up an order for execution in the following day’s market. This is shown as bar 5. We do not know at the time that bar A – marked with an * - will become the pivot point low of the downtrend. We can only know this retrospectively. Every time a new low is made that is lower than the low used in the CBL calculation the CBL calculation starts again. The previous CBL calculation is shown starting at the two ** and is marked in red. As the downtrend develops, new CBL calculations are made with each new low, and the CBL entry line is lowered.
There are several variations on placing the CBL which confuse some users even though they may be using the automatic tools. Selecting the correct starting point for the calculation is vital. Select the incorrect point and the calculation does not confirm the entry signal at the correct time. In each of these chart illustrations we retain the A, B, C notation for each of the SIGNIFICANT days used in the calculation. In the simplest application these significant days equal three calendar days. This is not always the case. The chart shows the first significant day, marked as bar A. The * marks the bar that is the start of the calculation point. It is preceded by an inside day. This day is shown as a thick red line. The high of the day is lower than the high of the first significant day. When moving back from bar A we do not find the next highest bar until the third calendar day in this series. Bars B and C are the significant bars because each has a higher high. The inside day is ignored in making the count back line calculation. The three significant bars occupy four calendar days.
There are no real limits on the number or combination of inside days which may be ignored in the search for three significant bars. In this example the three significant bars cover 7 calendar days. The cluster of thick red bars between bar B and C show different types of price action. Some dip considerably lowers than bar B. This is not important. What is significant is the way none of the highs on this cluster of bars is higher than bar B. It is only bar C that meets these conditions, so this becomes the final significant bar in this series. Although the construction rules specify to use the lowest bar some people are confused when there are several bars with equal lows. The chart shows the most complex of these dilemmas. Bar A is preceded by a day with an equal low, shown as the thick red bar. Two days previous there is another thick red bar that sets an equal low. Which one should be used as the calculation point for the CBL line? The construction rules specify that we start with the lowest low in the current trend, and that is bar A. The start point of the calculation is shown by the *. This spreads the CBL calculation over seven calendar days. A related area of confusion is created by equal highs appearing after one or more of the significant days. The same rules apply here as with inside days. The key feature of a significant bar is that it is higher than the preceding significant bar. When we start with the top of bar A we move to the left ignoring the first thick red bar with an equal high, Likewise we ignore the two preceding days with lower highs. We also ignore the next thick red bar which has an equal high. It is not until we hit bar B with its higher high then we can set the next significant day. In this example the three significant days are found over nine calendar days.
Traders who complete the CBL calculations by hand are most often confused by the problems of gaps. In Share Trading the rules specify that in the case of a gap, the calculation moves to the next highest bar in the CURRENT trend. I did not write this in capitals in the book, and perhaps I should have because this causes more confusion than any other feature of the count back line calculations. Several of the chart examples in Share Trading show how this is applied to stocks with gapping prices. The chart shows an extreme example which includes two gaps. We start with the lowest bar in the current trend, shown as bar A with the * under the initial calculation point. From the top of bar A we move to the left to the next higher bar in the current downtrend. This is shown as bar B. Again, move to the top of this bar, then to the left to the next highest bar in the current trend which is shown as bar C. From the top of this third significant bar the count back line is plotted.
The count back line is designed to capture activity in the current trend and it starts from the most recent lowest low. In the situation shown in the final chart, no new count back line calculation is made unless there is a new low that is lower than the calculation point shown by the *. The count back line is designed to trigger an entry as the trend changes from a down trend to a new up trend. A close above the count back line is the trigger. It is a clear cut signal and next week we look at this, and at how the count back line is then used as a stop loss and protect profit tool. INDICATOR REVISION COUNT BACK LINE (CBL) CONSTRUCTION Count Back Line construction - long side - buy low, sell high The CBL is a short term resistance or support line calculated in a falling trend, by counting back two higher highs, and then projecting a horizontal line to the right. A close above this resistance line suggests the intermediate down trend has changed. Closes above or below the line are used to fine tune entry and exit points. To reduce whipsaws the technique is used when a trend break has been signalled initially by a trendline break or assesses the trend change using a Guppy multiple moving average.
VOLUME 1 By Daryl Guppy SUBJECT SUMMARY VOLUME Volume is the fuel driving the market. It is usually shown as a histogram, with solid bars. Volume charts yield clues when volume is out of character. Unusually high, or unusually low. High volume on a lower close indicates selling pressure - people want to get out and nobody is eager to buy so the price falls. High volume on a higher close indicates buying pressure - people want to get in, but nobody will sell so they have to bid higher. Volume becomes erratic as the liquidity of the stock falls. Large blue chips have high liquidity - there are large scale trades every day. A small speculative stock has low liquidity - there are sometimes no trades for days on end. Volume significance depends on the normal liquidity of the stock.
collection of volume tools.
Volume is one of the most elusive concepts in technical analysis. In this series of articles we will show how volume is better understood and combined with other technical tools to provide a strategic analysis of trend movements, sustainability and change. We start with an overview of classic interpretations of volume and then move onto more modern combinations. It is important to understand the limitations of existing volume analysis before we can understand where new volume interpretations fit, and how they overcome some of the limitations imposed by existing volume analysis tools. The implementation of this analysis rests on new analysis tools. We explore new analysis tools because the old analysis tools fail to give us a reasonable way to understand the relationship between trend and volume. Although some are very good at establishing the relationship between price and volume, this is not the same as understanding trend behaviour. This limits volume to a trading tool rather than an investment or trending tool. We start with the existing
Volume has a vital role to play in immediate trading. This is the assessment of order lines and volume behaviour in relation to very specific trading situations. Momentum trades are the best example of this. Here the relationship between volume and price action is very clear. Although this combination identifies an immediate and short lived trading opportunity, it does not assist in understanding the broad trending behaviour of a stock. Volume in this sense is a trading solution.
The broader relationship between volume and price is captured in specialist charting displays, such as equivolume. Here the intention is to match changes in volume on a daily basis with changes in price. The display is ugly and confusing. It is difficult to extract any particularly meaningful relationship from this type of display. The intention is to identify trend change points. We suggest that this has limited application because a trend change point is rarely a single point in time. Trends develop and evolve. They do not suddenly emerge. There are times when large volume is associated with a significant change in price, and a significant change in trend. However, this trend change is difficult to separate from the short term momentum driven activity shown in the first chart.
The On Balance Volume (OBV) chart is the next attempt to explore the relationship between trending behaviour and volume activity. It compares the volume on up days with the volume on down days and produces an accumulative value. All the volume in up days is added to the accumulated total. On down days, all the volume is subtracted from the accumulated total. (This ignores the fact that buying volume always equals selling volume). The indicator
attempts to track the impact of volume changes as measured by bullish or bearish activity. This is a direct transition from the study of price activity where we are concerned with up days and down days. Although we can smooth, or average, the OBV values, the result remains much the same. We are measuring the activity of each day based on a buy or sell dichotomy. Buying and selling on individual days does not give us the required information about trending activity. Traders often combine OBV with other indicators to develop a better understanding of the potential for trend change. However, the relationships do not appear to offer consistent results or a significant edge. An OBV application suggests that when the trends are broken on the OBV indicator that this precedes a trend break in price because it captures the smart money flowing into our pout of a security. These trend breaks are shown by the pink lines on the chart extract. Note that the sharp rise in OBV captures the false breakout, and then signals an exit before the genuine trend breakout occurs. There are more advanced and complex applications of OBV, but this example highlights several of the limitations to OBV. The first is the assumption that the balance of buying or selling on individual days is significantly related to trending activity. Strong trends experience significant downtrends within the context of the established up trend. The OBV indicator does not provide a tool to distinguish between those OBV events which are an acceptable retreat within the context of a major trend, or those which are a threat to the trend. The second assumption is that there is a significant change in OBV relationships at the beginning and end of the trend. This is often the case, but OBV analysis is unable to distinguish between a genuine trend change and a pullback within the context of an existing trend. The volume relationships from which the OBV is constructed are not designed by themselves to identify genuine trend changes. The third factor is that OBV tracks only the activity of those who are active in the market. It is unable to distinguish between accumulation events and distribution events. Accumulation is where investors begin to accumulate shares in anticipation of a trend change. Careful accumulation will not always impact on the existing trend, or show a change in OBV as buyers are buying on down days within a falling market. The same applies to distribution where investors are selling stock because they believe the uptrend has ended. Distribution is inadequately tracked using OBV measures because the distribution sellers sell into a rising market to maximize profits. This bullish selling which is distribution activity, does not reflect in changes in OBV values. The OBV indicator is based on a largely untested assumption that volume increases at the points at which a trend changes. This is either in anticipation of a downtrend change – buying – or in anticipation of an uptrend change – selling. Forget for the moment that this assumption ignores one essential reality in the market. For every seller there must be a buyer. For every person who believes the stock is going down, there is a buyer who buys the stock because he believes it is going to go up, either now, or in the near future. In this very important sense, bullish buying and selling is always balanced. Over an extended period the trend in prices will tend to favor one outcome rather than another, so the balance is tipped in favour of the bulls or bears. We often extrapolate the momentum observation – high volume and significant price change – and apply it to a longer term chart extract. The chart extract shows the logical conclusion of this which suggests that trend changes can be confirmed by volume activity.
The volume chart above is taken from a chart that has five significant trend changes from up trend to down trend, and from down trend to up trend. Your task is to use the volume chart to identify the time points or areas at which you believe volume shows these changes in trend. Next week we will give you the solution and explain why this type of activity is a misleading distraction when we try to incorporate volume into better trend trading decisions. And no, this is not a party trick. One of the most frequent questions I am asked in trading seminars is “What about volume?” When we examine breakout trades identified using GMMA analysis or CBL techniques the inevitable question comes “What about volume?” These questions are all based on the assumption that volume is a useful way to confirm trend changes or trending activity in price. This chart gives you an opportunity to see how the assumed relationship between volume price and trending activity can be applied. To understand the way in which volume is related to trending activity we must develop a broader understanding of the information that volume give us. Volume is an indication of participation in the market by existing shareholders or owners. Understanding their behaviour provides a more useful tool in understanding the probability of trending behavior. We need to move beyond the concepts of accumulation and distribution. We look at this in the next article.
ACCUMULATION DISTRIBUTION VOLUME 2 By Daryl Guppy SUBJECT SUMMARY DISTRIBUTION AND ACCUMULATION At the top and bottom of market moves price activity slows and briefly shows a consolidation or broadening pattern. At market tops this is a distribution pattern. Canny traders sell stock at high prices to less skilled market participants. They distribute their holdings. At market bottoms these same canny traders accumulate stock from sellers who have given up in disgust. These patterns are not sudden. They develop slowly, keeping prices within a temporary trading band on steady volume. When these patterns coincide with GMMA crossover points in two time frames we get additional confirmation of a major trend change.
Last week we left you with a volume display. We asked you to use the volume chart to identify the time points at which you believe volume shows these changes in trend. The full chart display matching price with volume shows how difficult this task really is. The boxes match the time period of the trend change. There is no clear relationship between volume and trend turning points. In some cases there is a decline in volume as the trend makes a major change such as change B. Elsewhere major volume spikes occur in the middle of trends and do not have any impact on the trend. We assume there is a volume relationship, but we rarely test it rigorously. This idea has become an accepted convention and forms the foundation of several technical and fundamental analysis techniques. It is so commonly accepted that we no longer seriously put it to the test.
This assumed relationship did not develop and gain acceptance unless it was, at one time, significant. As with some aspects of market analysis, this volume work dates back to the first half of the last century. It was significant then because the total volume of trading in the market and the total number of people involved in the market was exceptionally small. Jesse Livermore was the last significant trader to make effective use of these relationships, even as they were changing in his time with the growth of market participation in the late 1920’s. The explosion of market participation in the 1990’s confirmed the change in these volume relationships but most traders still cling to the ideas developed more than 60 years ago.
Yes, we did select a chart where these relationships were not strong because we wanted to illustrate several points. First were those cumulative changes in volume behaviour do not necessarily identify points of trend change. The analysis of traded volume, without reference to other factors, does not provide a solution for understanding trend behavior, trend change or trend continuation. The second point was that volume analysis, as usually applied, cannot be applied to all stocks. There may be a coincidental relationship, but these coincidences are too infrequent to allow this assumption about volume and trend changes to be applied with any level of confidence. Despite this we will continue to hear commentators talk about these relationships as if they are a firm established fact. The third point, not shown on this chart, is that any volume and trend relationship must be broadly applicable to all stocks without regard to liquidity, velocity of trading, or quantity of turnover. Belief in this relationship is difficult to unseat so we include two more charts which illustrate the lack of volume and trend relationship. The first is ANZ. The vertical liens show key trend change points. They are not associated with any significant volume relationships.
The second chart is a lower priced and lower volume chart. Perhaps with less liquidity this trend and volume relationship may be clearer. The answer is still in the negative. After the trend break AGO develops a steady long term trend. Volume is lower than in the previous downtrend.
The analysis tools commonly used to analyse volume all rest on the assumption that the trading activity on a daily basis, or on an average daily basis, is a measure of trending activity in price. These indicators measure the changes in relationship between those who are active in the market and who have a bullish or bearish perspective. To better understand the role that volume plays in trend analysis we need to broaden our understanding of market behaviour and of the range of participants in the market. This brings together two separate concepts. The first is accumulation and distribution. The second is the way in which traded volume is related to available volume. ACCUMULATION Our understanding of volume comes from three sources: fundamental, intuitive and technical. Fundamental analysis uses volume as a measure of liquidity. Intuitively we believe volume is related to changes in price activity. Technically we apply several indicators to track changes in volume and its significance. On a broad basis we talk of accumulation and distribution phases in the market. It is interesting that although these phrases are part of our analysis vocabulary, they are not related to volume. They are most frequently described with reference to chart pattern behaviour.
These concepts are important because they provide a link between volume and trend analysis. The accumulation phase develops where existing shareholders believe the stock has no future. In disgust they sell the stock to smarter investors who have decided the down trend has, or is about to end. Classic theory suggests that these are investors who have made superior analysis based on fundamental analysis. These are the investors buying quality stock at lower than fair value. They are accumulating. On a technical basis, this accumulation activity may be identified with a number of chart patterns. These include consolidation bands, double bottoms, trend line breakouts, saucer patterns and the development of support areas. These patterns suggest that the selling pressure has been halted as buyers come into the market. This accumulation phase is not marked by rapid changes in price or a new trend. However, the accumulation precedes the development of a new trend as eventually others in the market are also alerted to the potential for a new up trend in the stock. The reverse applies to a distribution phase. This occurs when investors believe the stock is overvalued. It also occurs when some investors are aware of developing bad news. The assumption is that this is based on superior fundamental analysis. Prior to the trend change, smart investors begin to sell stock. This selling creates several chart patterns. These chart patterns include head and shoulder reversals, rounding tops, resistance levels, consolidation bands etc. These patterns are technical confirmation of the distribution activity. In classic theory accumulation precedes a trend change, and distribution precedes a trend change. This is illustrated on the diagram and is an important starting point for trend volume analysis. This theory fails to address some significant issues. It leaves no room for continuation pattern behaviour in mid trend. It does not provide us with a way to understand mid trend weakness and to distinguish this from end of trend behavior. Next week we show how this concept is applied when we include the ideas associated with available volume. AVAILABLE VOLUME The market is a mechanism driven by supply and demand. This is economics 101. Today’s price is decided by the balance of supply and demand – but only amongst those who are active in the market today. The order line today reflects the balance of supply and demand – buys and sellers – on this day only and only for a small proportion of those who own shares. It does not reflect the total supply of shares for the company. On any given day, the total number of shares on issue by the company are not available for trading. Only those shares held by those willing to sell are available for buying. The market for shares is made up of four groups. The first is those people who own shares in the company. The second is those people who own shares and who have decided to sell them. The third is the group of people who do not own shares (or enough shares) and wish to buy shares. The fourth group is those who do not own shares and who do not wish to buy shares at this time. We can ignore the last group because this latent demand cannot be measured effectively. What is particularly important is the interaction between those who want to buy shares and those who have shares and who choose to sell or not sell.
This interaction takes place within a defined context. That context is the total number of shares available for trading by the public. This is the starting point for trend volume analysis. The relationship was originally explored by Gann. The idea also forms a foundation of the Standard and Poor’s methodology in determining the construction of an index. More recent work, with a Gann analysis perspective has been done by Woods and Arp. This is free float analysis. How do we determine the free float analysis figures? Publications such as Huntley’s Shareholder are an important starting point. They list the substantial shareholders along with the total number of shares on issue. The entry for HHL in the 2006 edition shows there are 24 million ordinary shares on issue. The top shareholder holds 53.3% of the shares. Combined, the top 4 shareholders hold 72% of the shares on issue. This is a ‘tight’ share registry. By comparison, HHV has an ‘open’ share registry with 214 million shares on issue. The largest single shareholding holds 6.6% of shares on issue. This is a larger pool in which traders can play. There are several problems with this information. First Huntley’s Shareholder covers the top 500 stocks. Coverage of the remaining two thousand plus stocks listed on the exchange is much more limited. Locating this information is much more difficult. The second problem is that this information is accurate as of November 2005. Getting up to date information as changes develop is a more time consuming task. The third assumption is more significant. The Gann analysis and Standard and Poor’s assumption is that those shares held by the largest shareholders, or which are locked up for other reasons such as Government ownership, or in escrow, are non-tradable. These shares do not form part of the free float.
We believe that the free float analysis is crippled on several grounds. The diagram shows the way the publicly available shares, or circulating shares, may be divided up. This includes shares owned by the company directors or their nominees. These may be a significant proportion of the available shares. A significant number of shares may be held by fund managers and institutions. These may also be restricted in their availability for trading. Finally there are the public owned shares. The HHV example shows a company with many public circulating shares. The changes in the mix of company, fund and public shares have a
significant impact on the trading activity in a stock. This is not considered by free float analysis based on share registry analysis.
The first is the assumption that large shareholders lock up their shares and do not trade them so they are not included in the free float calculations. The assumption is that these shares are not available for trading by the general public, so the number of shares included in the free float is reduced. Standard and Poor’s use a variety of methods to determine an exact figure for the free float. This is used to decide which stocks are included, or excluded from the Stand and Poor's Indexes. In Australia, Telstra is not included in the ASX S&P 200 because the Government owns 51% and so the free float is reduced. The second is that free float analysis as used by Standard and Poor's essentially stops once it is applied to the selection of stocks suitable for inclusion in an index. This is very suitable for S&P business, but it fails to recognise the importance of free float style analysis. The third is that the market is ineffectively analysed using a free float figure calculated or based on company share register information and assumptions. The fourth is related to our discomfort with additional Gann style analysis as applied by Woods and Arp. We feel that forcing free float analysis into this Gann framework is not the most efficient application of the free float volume methodology.
Given these assumptions we make an important change to the application of free float analysis. There is a difference between the official number of shares that are available for trading by the public, and the actual number of shares that are traded. Rather than calculating a figure, we want to take this figure from the activity of the market. The free float is an important starting point for analysis. We want to take this a step further to develop this into Trend Volume analysis. Instead of telling the market what it is supposed to be doing by using a precalculated free float figure, we use market activity to provide a Trend Volume figure. This is used to identify accumulation, distribution and continuation volume behaviour. Next week we show how this is applied using the new Trend Volume analysis tools in the GTE Charting software upgrade.
TREND VOLUME ANALYSIS 3 By Daryl Guppy SUBJECT SUMMARY TREND VOLUME Trend volume analysis is based on the Free Float concept developed by Gann and applied in modern markets by Woods and Arp. Trend volume analysis differs in that it uses the actual cumulative volume traded between significant trend points as a means of verifying future trend turning points. Major trend turns or continuation points in market trends occur when all the old shareholders have been replaced with new shareholders. When the entire available share register has been turned over then buyers must bid higher to get stock because the new shareholders are reluctant to sell at a loss. It is a useful tool for trading Initial Public Offerings. The shares available for trading are different from the number of shares on issue. Of the shares on issue some may be locked up under escrow conditions. Others are held by major shareholders and are effectively not available for trading. If the top 10 shareholders own 60% of the shares on issue then effectively only 40% of shares are available for trading. This is the volume trend figure used for the analysis. This technique is most useful in identifying bottom reversals and continuation patterns in up trends. Trend volume analysis is used as a guide as we cannot be certain that the shares which have changed hands all belong to just one group of old shareholders. It is used to verify other trend change analysis.
observation based on historical trend behaviour.
We start with a brief summary for new readers. Existing volume analysis tools concentrate on detail. If we attempt to scale these upwards and apply them on a strategic basis, existing tools, such as OBV give results that are inconsistent and inclusive. The study of raw volume behaviour does not provide a reliable way to understand trending and trend change behaviour. An alternative away of understanding volume behaviour is the free float concept used by Standard and Poor’s in deciding which stocks to include in an index. This concept and methodology is drawn from work by Gann. This methodology is developed more, within a Gann context by Woods and Arp. On a broader context, trend behaviour is related to volume when we talk of accumulation and distribution behaviour. This is an accurate concept in the market, but it is rarely defined in terms of volume behaviour. It is more frequently defined by chart patterns such as consolidation bands and saucer or rounding top patterns. Accumulation and distribution does not provide a way to understand continuation volume behaviour. In this article we bring together these concepts and combine them with trend volume analysis. We start with an
The price chart shows the development of a clear uptrend from a sideways consolidation pattern. The consolidation patterns start at point 1 and ends at point 2. The circles identify points at which the new uptrend pauses, moves sideways, and then continue upwards. The final circle 7 shows a repeat of the pause pattern and includes two dips back to the trend line. The uptrend is easily defined using the straight edge trend line. The key question for traders is how to use this chart information to decide if the uptrend is about to end and if this is just a temporary pause in the trend prior to a trend continuation. This is the same chart that we used last week to illustrate the basic concepts of accumulation - circle 1 - and distribution – circle 7. When we combine this with basic chart analysis, we end up with a different question in circle 7. If this is not a distribution pattern, then we need to stay with the trend for a continuation
of the trend. In the next article, we will show how this decision is made easier by combining trend volume analysis with the GMMA. How can we effectively understand the nature of this trend behaviour? The classic tools are trend lines, moving averages, and our preferred tools, the Guppy Multiple Moving Average. We can understand this trend behaviour more effectively if we also incorporate trend volume. The key is the points circled between the start of the up trend and circle 7. At each of these points the market has paused, retreated, consolidated and then moved upwards. At each of these points a trader needs an answer to the question – end of trend, or trend continuation? The answer starts with the identification of the trend weakness points shown in the circles. Our objective is to establish if these are related to volume.
Our starting point is between circle 1 and 2. We calculate the volume in this consolidation area. We use the Find Trend Volume tool in GTE Charting. (Upgrade available shortly) This is the period in which we can assume that all the available shares held by the public and those company directors who wish to trade have been traded. In classic terms, this gives us a free float figure. In reality, this gives us a trend volume figure. The trend volume figure reflects the actual trading activity in the stock. It may be smaller or larger than the calculated free float figure as the commitment of existing shareholders and reluctance to sell is not restricted to company directors as assumed by the S&P methodology. The trend volume figure is derived from the significant changes in price activity. It is an inferred value related to the number of shares on issue and those which are currently in free circulation. This trend volume figure is derived from the activity of the market. It is not derived from the share register. This is an essential difference because this matches the volume with the behavioural characteristics of the market. The trend volume figure is derived from clearly defined changes in price behaviour. It does not have to be closely related to a free float share registry figure. The volume figure obtained in the calculation between point 1 and point 2 is then projected forward. The first projection is shown by the yellow bar B. We use the Plot Trend Volume tool in GTE Charting. If this trend volume figure is significant then it will match the time point at which there is another trend change. In this example, it matches point 3 on the original
chart. Project the trend volume value forward again, shown by yellow bar C, and we appear to have a problem. This trend volume does not conclude until point 5. This suggests that the trend retreat at point 4 was a mid trend price weakness. The same problem emerges when the trend volume is projected forward as yellow bar D. Point 6, a significant drop from the high, also falls within the value of the trend volume projection. More significantly, the trend volume calculation ends at point 7 on the chart. Is this the end of a trend, or a point at which the trend will continue? Additional analysis provides the answer and we look at this solution next week. However, we first need to understand what this trend volume is telling us.
We start with section A – the accumulation period. In this diagram it is based on a consolidation band. In this period we assume that most of the shareholders on the stock have become disillusioned with the company. This includes those who purchased near the top of the previous trend. It includes those who purchased as the stock fell. They believed the trend would recover. It includes those who purchased near the beginning of the consolidation period in anticipation of a rapid trend rebound. All of these existing shareholders no longer believe the stock has a future. This is classic economic interpretation and we take it a step further. Those people who buy in this period do so because they believe the stock has a future. For every seller there is a buyer with exactly opposite opinion. The balance of volume is always equal, and does not give us a significant advantage when deciding the nature of the trend. In such a classic accumulation pattern we can assume that all of the available shares have changed hands. This is the basis of trend volume. The number may be very different from the calculated free float number. This volume figure in this accumulation pattern gives us an idea of the number of shares that are actually really circulating and really traded. We verify the significance of this figure by projecting it forward on the historical trend. Once the new shareholders from the accumulation period have sold all their shares – giving into the lure of short term returns – the shareholder register is made up of new shareholders. They have based their profit and loss calculations on their new and higher share purchase price. Most of them will not sell unless they can get a higher price than their purchase price. On an individual level they may be unsuccessful in this objective. However, as a group of new additions to the share register, their objectives may be more achievable. Between area A and area B the old shareholders sell to a new group of shareholders. Once this trading volume figure is reached, there is an increased probability of a trend change. The new shareholders in area B sell to a new group of shareholders in area C. The diagram
shows how this trend volume figure reflects a lower level of daily volume so it takes a longer chronological period for the trend volume figure to be reached. When it is reached, it signals another trend change, or continuation. The area in circle 4 shows a price retreat which is a low probability retreat to the trend. We use several factors to decide this. The lack of complete change of trend volume makes it less likely that this price pullback will lead to a trend change. The same analysis is applied to point 6. The final trend volume projection, yellow box D, matches a consolidation pattern in this trend. The usual interpretation of this is to call it a distribution phase. In classic analysis we take the price dip at point 6 as an early warning sign of trend weakness. When matched with trend volume analysis, the interpretation may be significantly different. We combine this trend volume analysis with other indicator analysis to reach a better conclusion about the significance of the price retreat at point 7 which matches the completion of trend volume. Next week in the concluding article we show how this analysis is combined with other indicators to provide a better trading solution.
This diagram example has been constructed to clearly explain the development of the concept. The final chart extract shows how the Find Trend Volume tool in GTE Charting is applied to a real stock. We start by selecting the peak and valley of a trend. This volume value is then projected backwards. Each vertical bar is placed at the same volume quantity, as shown by the yellow boxes. The trend volume quantity is about correct, catching major turning points. We can apply the volume figure and project it forward from the last calculation on the chart. We use this to verify other trend change or continuation signals. The Trend Volume match with trend continuation and turning points gives us a significant new way to incorporate volume in trend analysis for trading. In the next article we show how trend volume analysis is combined with GMMA analysis to make better trading decisions.
TREND VOLUME TRADING ANALYSIS 4 By Daryl Guppy Trend volume gives traders a way to identify when trend turning points may develop. Trends need volume to continue. Volume is the fuel of the market, but it is not inexhaustible. The fuel is loaded in defined quantities. When one quantity is used, it must be replaced. When one group or groups of people have purchased all the available shares, then trading will stop unless they are prepared to sell those shares to others, preferably at higher prices. The Find Trend Volume tool in GTE charting identifies the level of volume associated with trend behaviour between major trend peaks or trend pause points. This trend volume figure helps with a better understanding of accumulation, distribution and continuation accumulation distribution points. Trend volume is not a stand alone tool. The analysis is enhanced when combined with other trend analysis tools. We combine it with the Guppy Multiple Moving Average and this gives a better understanding of potential behaviour at critical trend points. There are three points in the trend which traders are interested in. They are: The beginning and end of a trend. These are high risk points because the prevailing trend must be overcome. The problem of false breakouts or signals, makes trading difficult. Mid trend weakness where several end of trend signals are generated, but subsequently the trend rallies and continues. Analysis techniques which help traders to anticipate when a trend may be changing so they can position themselves to enter or exit. This establishes the most appropriate time to tighten stops. We start with the first problem – trend changes. Dramatic trend changes do not always come from „V‟ shaped trend breakouts. Stocks which have been locked in sideways consolidation patterns can rapidly breakout above resistance levels. The chart shows an example of this activity with an initial break above the resistance level that rapidly turns into a very fast moving trend. This is a characteristic behaviour of low priced speculative stocks, but it is also seen in mid cap stocks. SUBJECT SUMMARY TREND VOLUME Trend volume analysis is based on the Free Float concept developed by Gann and applied in modern markets by Woods and Arp. Trend volume analysis differs in that it uses the actual cumulative volume traded between significant trend points as a means of verifying future trend turning points. Major trend turns or continuation points in market trends occur when all the old shareholders have been replaced with new shareholders. When the entire available share register has been turned over then buyers must bid higher to get stock because the new shareholders are reluctant to sell at a loss. It is a useful tool for trading Initial Public Offerings. The shares available for trading are different from the number of shares on issue. Of the shares on issue some may be locked up under escrow conditions. Others are held by major shareholders and are effectively not available for trading. If the top 10 shareholders own 60% of the shares on issue then effectively only 40% of shares are available for trading. This is the volume trend figure used for the analysis. This technique is most useful in identifying bottom reversals and continuation patterns in up trends. Trend volume analysis is used as a guide as we cannot be certain that the shares which have changed hands all belong to just one group of old shareholders. It is used to verify other trend change analysis.
The resistance breakout is not enough to trigger an entry signal. The GMMA relationships are also uninspiring. The prolonged sideways movement means the GMMA groups also travel sideways. As the breakout develops in area A the GMMA quickly turns upwards, separates and begins to diverge into two clear groups. Although this is a strong GMMA signal we tend to ignore it because the previous GMMA activity has not been a useful way to understand the trending activity. As a result we miss out on this type of trading opportunity. When we include trend volume in the analysis we see a more complete picture of the developing trend change and its potential. The yellow box captures the appropriate trend volume value based on analysis of the historical chart. We use the Find Trend Volume tool in GTE Charting to establish this figure based on significant trend turning points. We use the Plot Trend Volume tool to apply this figure to the historical chart so we can validate its accuracy. Once the full value of trend volume is reached we can anticipate that any new buyers will have a different perspective on the stock. There is an increased probability of trend change, or continuation, at the points where the trend volume figure has been reached. When we combine these three trading signals – resistance break, GMMA separation and fulfilment of the trend volume figure – we have a greater potential for a trend change. This means we can act more quickly, and more confidently on trend change signals. This confluence of multiple signals is also found with dramatic trend changes that show the classic “V” shaped reversal. However the trend volume analysis gives an additional advantage. The GMMA relationships between the long term and short term group provide many trading opportunities. Aggressive traders who want to position themselves early in anticipation of a trend change have focused on the test and retest activity in downtrend. The long term group of averages begin to compress. The short term group of averages show rally and retreat behaviour with each rally penetrating further into the long term group. This signals an aggressive entry in anticipation of the trend break. Aggressive entries carry higher risk because the downtrend may reassert itself.
We improve the timing of the entry when we combine GMMA analysis with trend volume analysis. The trend volume figure is not an exact figure. We prefer to use it as a guide. As the full trend volume figure approaches, shown in the completed yellow box, we are more alert for other trend change signals, such as the test and retest activity shown in the GMMA. When this activity takes place towards the end of the trend volume fulfillment period then there is an increased probability of a trend change. Aggressive traders can make an early entry with greater confidence. Next week we examine how this analysis is used to verify mid trend weakness and identify safer entry points.
TREND VOLUME TRADING ANALYSIS 5 By Daryl Guppy SUBJECT SUMMARY TREND VOLUME Trend volume analysis is based on the Free Float concept developed by Gann and applied in modern markets by Woods and Arp. Trend volume analysis differs in that it uses the actual cumulative volume traded between significant trend points as a means of verifying future trend turning points. Major trend turns or continuation points in market trends occur when all the old shareholders have been replaced with new shareholders. When the entire available share register has been turned over then buyers must bid higher to get stock because the new shareholders are reluctant to sell at a loss. It is a useful tool for trading Initial Public Offerings. The shares available for trading are different from the number of shares on issue. Of the shares on issue some may be locked up under escrow conditions. Others are held by major shareholders and are effectively not available for trading. If the top 10 shareholders own 60% of the shares on issue then effectively only 40% of shares are available for trading. This is the volume trend figure used for the analysis. This technique is most useful in identifying bottom reversals and continuation patterns in up trends. Trend volume analysis is used as a guide as we cannot be certain that the shares which have changed hands all belong to just one group of old shareholders. It is used to verify other trend change analysis.
Trend volume is not a stand alone tool. The analysis is enhanced when combined with other trend analysis tools. We combine it with the Guppy Multiple Moving Average and this gives a better understanding of potential behaviour at critical trend points. There are three points in the trend which traders are interested in. They are: The beginning and end of a trend. These are high risk points because the prevailing trend must be overcomed. The problem of false breakouts or signals, makes trading difficult. Mid trend weakness where several end of trend signals are generated, but subsequently the trend rallies and continues. Analysis techniques which help traders to anticipate when a trend may be changing so they can position themselves to enter or exit. This establishes the most appropriate time to tighten stops. We continue with the second problem – mid trend weakness.
The modern bull market is characterized by long term trending stocks with trend volatlity. We see midtrend weakness where several end of trend signals are generated, but subsequently the trend rallies and continues. We use trend volume analysis to avoid these false exits. The analysis also provides the opportunity to add to existing positions at points of temporary weakness. The chart extract summarizes the problem at point B. Price has collapsed below the trend line. Is this a trend break, or just a temporary weakness? The usual solution is to look at the GMMA relationships. They show a penetration of the long term group of averages. This is the first time in this trend. Additionally the long term group of averages are showing initial signs of compression. The usual analysis tells us to tighten stops and prepare to take an exit at the next highest rally peak near point C. We prepare to abandon the trend. Traders who entered the trend more recently may take this is an exit signal to protect their trading capital. Applying trend volume analysis improves our analysis of this trend behavior. The yellow box shows the total of the trend volume figure for this stock. At point B we know that the total trend volume fulfillment figure has not been reached. For this example we assume that only 50% of the appropriate trend volume figure has been traded at point B. This suggests that there is a lower probability that this price retreat will be the beginning of a trend change. The trend volume analysis suggests that there is a higher probability of a trend change developing when the appropriate trend volume figure has been reached. At the midpoint of this activity there is a lower probability of a trend change.
Combine this with the GMMA relationships and it suggests that this is a temporary pause in the trend. For those who hold stock this means they do not need to tighten stops significantly. It may also mean that initial exit signal generated by the dip below the trend line can be ignored with safety. It means that the dip below the count back line stop loss can also be ignored because there is a lower probability that this price fall is the beginning of a new sustained downtrend.
This analysis method is enhanced with the Count Trend Volume tool in GTE Charting. Analysis techniques help traders to anticipate when a trend may be changing so they can position themselves to enter or exit. This establishes the most appropriate time to tighten stops. At point D we know there is a low probability of a trend change. At point E the trend volume figure has almost been reached so there is a higher potential of a trend change or continuation. In this environment traders tighten stops and they prepare to act on the stops quickly. Trend volume analysis tells traders when it is appropriate to be nervous. The Count Trend Volume tool is used to count the developing volume between the selected point – point 1 – and the last trading day on the chart – in this case point 2. Traders know in advance the cumulative trend volume and can compare this with the previously verified trend volume figure derived from the Find Trend Volume tool.
Equipped with this advance information we can make more effective use of other trend information from the GMMA, count back line, trend lines and other indicators. Using the Count Trend Volume tool we know that from point 2 only 5% of the trend volume figure has changed hands. This trend is most likely to remain stable and intact until the cumulative trend volume figures approaches 90% of its value. When that happens we prepare to tighten stops and pay more attention to developing distribution or accumulation patterns. The final chart brings together these analysis features combining trend volume and GMMA analysis. This combination enhances the application of the GMMA and improves our understanding of the trend. As with all indicators and indicator combinations, this analysis applies most effectively to compatible stocks. Not all stocks show clear trend volume reliability. However, where trend volume analysis provides a close match with historical trend change points then the combination with GMMA analysis improves trading success.
MODERN PRICE AND VOLUME By Daryl Guppy INDICATOR REVISION PRICE AND VOLUME RELATIONSHIPS Using Metastock Explorer screen to find securities where the price has increased 5% and the volume is 50% above the 50 day moving average. Formula is ColA CLOSE, ColB REF(CLOSE,-1), ColC ROC(CLOSE,1,PERCENT) ColD VOLUME, ColE MOV(VOLUME,50,EXPONENTIAL), ColF ((VOLUME-MOV (VOLUME, 50,EXPONENTIAL))/MOV(VOLUME,50,EXPO NENTIAL))*100, Filter WHEN (COLC>=5) AND WHEN(COLD> =COLE*1.5)
The classic concept of the relationship between price and volume suggests that price follows volume. When people search the market for opportunity many of them look for significant changes in daily volume. The classic volume analysis techniques are based on this observation. They all use changes in volume to tell the trader something about the potential to change price and the price trend. In modern Western markets, this is not very successful.
The observation that price follows volume was accurate 60 years ago when markets were dominated by a small group of large and well informed investors. The financial markets were reserved for the elite so participation was limited. The general public was not widely involved in the market. Even in the 1920s only a small proportion of the public was involved in the market. Legendary America trader Jesse Livermore used this observation as an important part of his trading method. We watched for volume accumulation as the big well informed investors began to buy stock. Then he simply joined the buying. Modern markets are very different. They have changed dramatically, but slowly. These changes have been gradual so many traders have been slow to recognise the important changes between volume and price. The most important differences between past financial markets and modern markets are these: The number of participants is much higher so the impact of the elite is smaller. The flow of information is much better. Advanced technical tools are available to all participants Advanced market analysis tools are available to all participants It is more difficult to conceal significant news The result of these changes is a change in the way we understand volume. Now volume more often follows price. This change has occurred because more people are participating in the market and they are using similar analysis tools. More people use the same information to make the same type of decision. When they see rising prices today, they become buyers tomorrow. Their buying increases the volume substantially. In modern markets volume often follows the lead set by price increases. There is often a small increase in volume associated with the rapid price move. This increase is volume is usually too small to appear in searches based on finding substantial increases in volume. Understanding the way price leads volume allows traders to make better use of market price scans. When they see high price increases without unusual volume increases they have the confidence to trade in anticipation of increased volume the next day. In some markets, investors are overwhelmed with news. It is available in the newspapers, on dedicated financial television channels, on the internet and on radio. In 1930 the Wall Street Journal was less than 30 pages. Now it is often over 300 pages. In the past the problem was getting information. Now the problem is how to reduce the amount of information we have so we can locate the most important information.
In the mid -1990’s it was a difficult and time consuming task to compete basic market analysis. Creating a list of all stocks with PE ratios higher than the industry sector averages required many hours of research. Finding stocks where the price had increased by more than 15% over the past 3 days and where volume has also increased by more than 15% was a task beyond the capacity of most investors. They relied on specialist brokerage reports. Now these tasks are completed in a few seconds on a web site, or using readily available software. Many of these results are free and they offer a quick way to understand what is happening in the market. The results identify stocks where there is an increased probability of a trend change or price continuation. Our favourite market search is to find all securities which have increased by more than 10% in one day. Many other traders use similar searches. We look for price changes preferably without supporting volume surges – and then we think about buying the stock.
The DMA chart shows the typical result we are interested in. The 16% daily price increase is not matched with a substantial increase in volume. Smart traders enter the next day in anticipation of increased volume and an increase in prices. Traders who moved quickly were able to get an entry around $0.14. Those who waited for volume confirmation delayed the entry until the following day and paid up to $0.20 to join the rising trend. This pattern of volume following price persisted as the uptrend continued. The volume of trading is much higher than the value of trading before the day when prices increased by 16%. The AMX and GDY charts show the same relationships. traders use price as a leading indicator of trend changes without waiting for volume confirmation. The change in volume on the day of the price increase is not large enough to feature in most volume based market searches discussed in the previous chapter. Modern analysis software available on the internet makes it very easy to compete these searches. Many people use this as an important search tool. They all receive the results at about the same time, so many people make a similar decision. The result is an increase in volume that follows an increase in price. Volume follows price and this is the reverse of the traditional way of understanding the relationship between price and volume.
Strong price movements followed by an increase in volume are an important leading guide to changes in trend behaviour. This is also applied to a fast decline in prices, followed by an increase in volume. This is an early warning of the end of an up trend.
TRADING WITH ATR By Daryl Guppy Volatility is the new challenge in modern markets. It has made identifying the end of downtrends and the start or new uptrends more difficult. We have made increased uses of the trader’s application of the Average True Range (ATR). The ATR calculation contains a number of variables and in these notes we show how they are selected and combined to give optimal outcomes for individual stocks. The ATR tool in the GTE charting package is exceptionally useful because it allows the trader to start the ATR calculation from a user selected point selected with the click of a mouse. This is not easily possible with MetaStock where the user must use separate dialog boxes to input the starting point. The calculation parameters for the ATR indicator tool in GTE are shown below.
We start with the basics of the combination use of traders ATR. A short side ATR calculation is applied to a falling trend. The trend reversal is signalled when prices close above the value of the short side ATR. Aggressive traders will use this as an entry point. Conservative traders wait until the value of the long side ATR is higher than the last value of the short side ATR.
Once the downtrend has ended, a new long sides ATR calculation is applied. When the long side ATR moves above the value of the short side ATR then a long side entry is confirmed. The value of the long side ATR is used as the trailing stop loss. A close below this level is taken as an exit signal. Under perfect conditions, this is what it looks like on a chart.
Although we may take an aggressive or a conservative entry, when it comes to the exit there is no such distinction. The exit is always taken on the day following the close below the long side ATR. Usually I am looking for a long side trade, so my assessment of the indicator and its signals start with the short sides ATR. I am looking for two features. 1) Compatibility with the short side ATR as a means of defining the trend. This means there are no false exit signals as the downtrend develops., The chart extract shows the short side ATR is compatible with defining the downtrend. It means that where there is a close above the value of the short side ATR that this has a high probability of signalling a genuine change in the trend. This is shown in the chart.
2) Compatibility with the long side ATR. This means that the trend breakout identified with the short side ATR can also be managed effectively with the long side ATR. The chart shows that this has failed. Prices dip below the value of the long side ATR signalling an exit from any long position. The long side ATR is not suitable for trading the new rising trend because of these exit signals. As the trend develops it may show that these are false exit signals. No matter, it still means the long side ATR is not a suitable trade management tool. We look for past compatibility with ATR management, and continuing compatibility in the emerging trend. This sets up the broad parameters for ATR trading. We fine tune ATR trading by adjusting the calculation value of the ATR to better match the volatility of the market. The initial chart extract shows ATR (2) for the short side ATR and ATR (1) for the long side ATR. Why do we select these values and what do they mean? The ATR calculation provides a value for the average true range over a selected period. Our preference is to use a 14 day moving average period. If this calculation is used then this is an ATR (1) calculation or 1*ATR. This is the most sensitive calculation. It can generate many false exit signals in a trend, but it provides a tighter stop loss. An ATR(2) calculation takes the ATR(1) calculation value and doubles it. This is also written as 2*ATR. Next week we look at how change in sensitivity impact on the ATR. INDICATOR REVISION TRADERS ATR The traders application of the Average True Range (ATR) captures price volatility, defines the emerging trend breakout and provides a method to manage the developing trade. Our purpose is to use the ATR calculation as a stop loss designed to protect capital and identify the end of one trend and the beginning of another. We use the ATR as a method to identify and confirm trend changes. Later we want to use the ATR as a protect profit stop designed to protect profits and identify the end of a trend. Traders ATR is a tool in Guppy Traders Essentials charting.
TRADING WITH ATR part 2 By Daryl Guppy Volatility is the new challenge in modern markets. It has made identifying the end of downtrends and the start or new uptrends more difficult. We have made increased uses of the trader’s application of the Average True Range (ATR). The ATR calculation contains a number of variables and in these notes we show how they are selected and combined to give optimal outcomes for individual stocks. The ATR tool in the GTE charting package is exceptionally useful because it allows the trader to start the ATR calculation from a user selected point selected with the click of a mouse. This is not easily possible with MetaStock where the user must use separate dialog boxes to input the starting point. Changes in ATR sensitivity have a large impact on the positioning of trading signals.
The changes in sensitivity can be seen on the chart. The 1*ATR delivers a trend change signal more quickly than the 2*ATR calculation. In volatile conditions we prefer to use the more
sensitive calculation so we can get an early signal. The key to deciding which to use is the compatibility. In this chart extract neither the 2*ATR nor the 1*ATR generate false exit signals in this falling trend. In this case, we would use the 1*ATR calculation. The same shift applies if we change the sensitivity of the long side ATR. We use the more sensitive short side 1*ATR as the reference point.
The objective is to adjust the sensitivity of the ATR calculation by adjusting the application of the ATR calculation from 1*ATR to 2*ATR. The sensitivity adjustment is designed to be compatible with the observed trend. In falling markets with high volatility we use a short side 2*ATR calculation to ensure the trend breakout is genuine. We then use a 1*ATR to ride the rising trend to keep the stop loss tight to protect profits. The combination you use is a judgement call. This is the methods we use. In a volatile falling market if the 1*ATR short sides calculation is compatible with the falling trend because it does not give false exit signals, then we apply the 1*ATR short side. This gives an earlier entry signal into the trend reversals. We use 1*ATR to trade the rising trend to keep the stops tight. We use a 14 day calculation period for the ATR. The chart shows the impact of changing the calculation length. We used the 14 day 1*ATR as the base calculation point.
We use a 3, 7, 14 and 21 moving average of the 1*ATR short side. There is no strongly significant difference in the entry points for these values. We find the default 14 day calculation gives robust results that work in most situations.
The final variable is the trigger point in the ATR calculation. The trigger point is the point where the ATR calculation ends. This is shown by a horizontal line that moves to the right of the chart. In GTE this line colour changes to black. For the short side ATR we use a trigger point abased on the low. The low must be higher than the value of the short side ATR before the ATR indicator signals a change in trend. For the long side ATR we prefer to use the closing price as the trigger.
The chart shows the difference. The calculation for the ATR does not change, The green ATR line exactly matched the red ATR line calculation. The difference is when the ATR calculation stops. If the trigger is based on the low then an exit is triggered near $5.12. It is a false exit. If the close is used as the trigger then the exit is triggered near $5.84. We find the application of traders ATR to be very successful in current market conditions. These notes explain in detail how we assess and apply this indicator. INDICATOR REVISION TRADERS ATR The traders application of the Average True Range (ATR) captures price volatility, defines the emerging trend breakout and provides a method to manage the developing trade. Our purpose is to use the ATR calculation as a stop loss designed to protect capital and identify the end of one trend and the beginning of another. We use the ATR as a method to identify and confirm trend changes. Later we want to use the ATR as a protect profit stop designed to protect profits and identify the end of a trend. Traders ATR is a tool in Guppy Traders Essentials charting.
TRADING AVERAGE TRUE RANGE part 1 By Daryl Guppy Managing volatility is the most significant challenge in changed market conditions. Long term trend volatility is effectively managed using the trend volatility line but this is less suited to the increasingly common shorter, sharper trend behaviours. These extended rallies require management based on price volatility, but these measures need to be more sensitive to volatility developments to ensure profits are kept and not diminished by stops that are placed too far below the current price action. The count back line with its self adjusting stop is one option for volatility. Another is the traders application of the Average True Range (ATR). This captures price volatility, defines the emerging trend breakout and provides a method to manage the developing trade. Our purpose is to use the ATR calculation as a stop loss designed to protect capital and identify the end of one trend and the beginning of another. We use the ATR as a method to identify and confirm trend changes. Later we want to use the ATR as a protect profit stop deigned to protect profits and identify the end of a trend. In extended rallies it can be combined with the CBL line to provide a series of alert and confirmation exit signals. INDICATOR REVISION AVERAGE TRUE RANGE The average true range (ATR) indicator was developed by Welles Wilder. It is a measure of the true ranging activity of a stock. Most times when we talk about range we mean the difference between the high and the low for the day. This gives us an idea of how volatile the stock is. This measurement does not tell us who is in charge of the price – bulls or bears. The ATR indicator measures only the range of prices set by the strongest players in the markets. It does this by comparing the distance from yesterdays close to today’s high, and the distance from yesterdays close to today’s low. This is combined with the distance from today’s high and low. These figures are averaged to give the Average True Range of price movements between the end of yesterdays trade and the close of today’s trading.
The ATR is an elegant mathematical solution developed by Welles Wilder. It highlights the difference between the mathematical analysis of market behaviour and the actual process of trading. Just having a good mathematical solution does not create a good trading solution. Hence we call this work the traders ATR. Our purpose is to use the ATR to enable entry at the best point in the trend to: 1. 2. 3. 4.
Follow the trend break Define average price volatility and price volatility limits To adjust price volatility calculations as average price volatility changes Set stop loss conditions related to price volatility
ATR CALCULATIONS The mathematics of the ATR calculations are less important than the use to which the results are put. The ATR calculations are done automatically in most charting software. Our interest is in the logic of the calculations rather than the details.
\The logic is summarised in Figure 22.1. The True Range is equal to Today’s high to low, or yesterdays close to today’s high, or yesterdays close to today’s low. The largest of these figures is selected and used in the ATR calculation. The largest of these calculations is selected as the starting point for the calculation of today’s ATR value. In the example in figure 22.2 the largest ATR calculation for today is 1.20. This figure is combined with the one day ATR calculations for the previous four days. This provides a total of 4.90 for the previous 5 days. The 5 day average of this calculation is 0.98. Today’s value of the 5 day average ATR is 0.98. It suggests that price can move 0.98 during the day and remain within the average 5 day volatility range.
The value of the ATR is the degree to which price can be expected to move on the next day and still remain consistent with the existing trend. The trader takes the next step and decides a move larger than this value is outside the current volatility range and may indicate a change in the trend. The 1*ATR is often considered too sensitive so the indicator sensitivity is reduced by calculating the 2*ATR value. Usually the ATR values is multiplied to create a 2*ATR value. In this example the 2*ATR value is 0.98*2= 1.96. This doubling is used to reduce the whipsaw, or false signals generated by the 1*ATR.
These ATR calculations provide great insights into volatility and its measurement. The changing value of the ATR calculation is usually plotted as a line as shown in Figure 22.3. Typically the result of these calculations are shown in a separate window below the main chart display. And they are not particularly useful for actual trading. The display does not quickly show the relationship between the ATR calculation and today’s price. It is difficult to use the ATR as a trend change indicator, a stop loss or a protect profit stop. Additionally the ATR value moves up and down and that breaks the first rule of a stop loss. In a rising market the stop loss should only move upwards because its purpose is to protect the profit and provide an early exit signal. A stop loss value that moves to lower values in a rising trend does not protect profit. The traders application of ATR overcomes this problem by taking the essential calculations of the ATR process and modifying their application to prevent the erosion of profit when a trend reverses. Next week we look at how this ATR calculation is modified to make a useful traders ATR.
TRADING AVERAGE TRUE RANGE part 2 By Daryl Guppy Managing volatility is the most significant challenge in changed market conditions. The increasingly common shorter, sharper trend behaviours and extended rallies require management based on price volatility, but these measures need to be more sensitive to volatility developments to ensure profits are kept and not diminished by stops that are placed too far below the current price action. The traders application of the Average True Range (ATR) captures price volatility, defines the emerging trend breakout and provides a method to manage the developing trade. Our purpose is to use the ATR calculation as a stop loss designed to protect capital and identify the end of one trend and the beginning of another. We use the ATR as a method to identify and confirm trend changes. Later we want to use the ATR as a protect profit stop deigned to protect profits and identify the end of a trend. In extended rallies it can be combined with the CBL line to provide a series of alert and confirmation exit signals. INDICATOR REVISION AVERAGE TRUE RANGE The average true range (ATR) indicator was developed by Welles Wilder. It is a measure of the true ranging activity of a stock. Most times when we talk about range we mean the difference between the high and the low for the day. This gives us an idea of how volatile the stock is. This measurement does not tell us who is in charge of the price – bulls or bears. The ATR indicator measures only the range of prices set by the strongest players in the markets. It does this by comparing the distance from yesterdays close to today’s high, and the distance from yesterdays close to today’s low. This is combined with the distance from today’s high and low. These figures are averaged to give the Average True Range of price movements between the end of yesterdays trade and the close of today’s trading.
TRADERS ATR The traders ATR takes the calculation results are displays them in a way that is useful for trading decisions. It has five elements. We start with the result of the ATR calculation and create a ratchet or stepped process. For example, we start with the first ATR calculation of 1.00. If tomorrows ATR calculation is 1.2 then the value of the ATR is plotted at a higher level. If the following days ATR calculation falls back t0 1.00 then the new lower ATR value is ignored. The ATR value is shown as the previous days ATR value of 1.02. Values lower than 1.02 are ignored until a new higher ATR value is calculated. This process is shown in figure 22.4. The dots show the value of the ATR calculation. The three dots below the horizontal ATR line show ATR values lower than the value of the horizontal ATR line.
When the next ATR value is 1.03 then the ATR plot moves higher. Using this first modification the ATR value follows the rising trend without taking any backward steps. This makes the ATR more useful as a stop loss method rather than just an interesting measure of all changes in price volatility. In a falling trend the same principle is applied, but in reverse. The ATR in a falling trend is designed to follow falling prices down. In this environment the ATR shows only lower ATR values and ignores any higher ATR values. The second element of the trader ATR is the relationship between the ATR calculation and the current price. How is the ATR value of 1.00 related to today’s price? Unless the trader establishes a relationship then the ATR calculation remains a curiosity rather than a trading tool. We start with a long side trade. Here the intention to enter an uptrend and use the ATR as a method of managing the trend. A fall that is greater than the value of the ATR suggests the price volatility has expanded. This is a potential end of trend signal. To use the ATR in this way the value of the ATR must be directly related to the current price so it establishes a barrier. If the price tomorrow moves below the value of today’s ATR then it creates a trading signal.
The value of the ATR can be subtracted from the value of today’s price. We have a choice of using the low price for the day, the close price for the day or perhaps the open, high or median price for the day. The selection of the subtraction point has a significant impact on the location of the ATR value as shown in figure 22.5. The ATR calculation for the indicator is the same, but the subtraction point is different so the location of the ATR line changes. The purpose in using the ATR is to create a stop loss line that follows a rising trend and gives an exit signal when there is increased probability the trend is changing. Our preference is to subtract the value of the ATR from the value of the close to establish the correct position of the ATR exit signal. This selection is a solution to the increased volatility in the market. If we use the low as the calculation point then the danger is that the ATR line is too far away from the current price because intraday day volatility ranges have increased. By using the close the position of the ATR becomes a tighter stop loss and it ignores the swings of intraday volatility. The ATR based on the close provides the better solution in conditions of high price volatility. There is a third element in the calculation of the ATR is the length of the average calculation. Depending on the software you use, the default is a 14 day or 10 day average
period for the calculation. In conditions of higher price volatility a 7 day average calculation is more suitable for catching rallies and extended fast moving short term trends. The fourth element in the ATR calculation is the multiplication factor. The multiplication factor is applied to the value of the ATR calculation. If the value of the 7 day ATR calculation is 1.00 then the 1*ATR value is also 1.00. The value of the 2*ATR would be 2.00. This can be extended to a 3*ATR equalling 3.00 but this is not useful for either investing or trading solutions. The selection of the ATR multiplication value has a significant impact on the management of the trade as shown in figure 22.6. The 2*ATR captures the long term underlying trend. The 1*ATR calculation is more sensitive, and triggers an earlier, and potentially, false exist. Prior to the global financial crisis many traders used the 2*ATR calculation and this was very suitable to long term rising trend. It remains well suited to these conditions, but with increased price volatility it often leaves the exit signal too far below the current price. Substantial profits are surrendered before the exit signal is triggered.
We prefer to use the 1*ATR. It’s a trade-off between more frequent exit signals and collecting better profits. In figure 22.6 the 1*ATR generates a false exit signal while the 2*ATR keeps the tared in the trade. However, if the 2*ATR exit signal had been triggered then the profit erosion for this tared is substantially larger than the profit erosion using the 1*ATR. Using the trend high at $15.80 as the calculation point, traders profits are eroded 13 % with the 2*ATR signal compared to a 9% profit erosion using the 1*ATR signal. The fifth element is the ATR display on the chart. It is this display that creates the full application of the traders ATR. In a rising trend the ATR values only move up. The value of the ATR is shown with a continuous stepped line, already introduced in figure 22.6. This display is available as a default indicator in the Guppy Traders Essentials charting package. When the price closes below the ATR line an exit signal is created. The ATR line is extended to the right clearly showing an end of trend signal. The stepped line display provides the trader with an instant evaluation of the current price in relation to the ATR stop loss conditions. This is the traders application of the ATR, and it opens the door to two other trading applications. We look at these next week.
TRADING AVERAGE TRUE RANGE part 3 By Daryl Guppy INDICATOR REVISION AVERAGE TRUE RANGE The average true range (ATR) indicator was developed by Welles Wilder. It is a measure of the true ranging activity of a stock. Most times when we talk about range we mean the difference between the high and the low for the day. This gives us an idea of how volatile the stock is. This measurement does not tell us who is in charge of the price – bulls or bears. The ATR indicator measures only the range of prices set by the strongest players in the markets. It does this by comparing the distance from yesterdays close to today’s high, and the distance from yesterdays close to today’s low. This is combined with the distance from today’s high and low. These figures are averaged to give the Average True Range of price movements between the end of yesterdays’ trade and the close of today’s trading.
Managing volatility is the most significant challenge in changed market conditions. The increasingly common shorter, sharper trend behaviours and extended rallies require management based on price volatility, but these measures need to be more sensitive to volatility developments to ensure profits are kept and not diminished by stops that are placed too far below the current price action. The traders’ application of the Average True Range (ATR) captures price volatility, defines the emerging trend breakout and provides a method to manage the developing trade. Our purpose is to use the ATR calculation as a stop loss designed to protect capital and identify the end of one trend and the beginning of another. We use the ATR as a method to identify and confirm trend changes. Later we want to use the ATR as a protect profit stop deigned to protect profits and identify the end of a trend. In extended rallies it can be combined with the CBL line to provide a series of alert and confirmation exit signals
SLIDING ATR When the traders ATR is displayed on a chart using the Guppy Traders Essentials charting package it provides a clear and elegant solution for managing the trend. However, the value of the ATR is often well below the current price activity. This creates a problem for trade entry planning. Ideally we prefer an entry close to the value of the ATR line. When we use CBL for entry method the price is often very near to the CBL value. With the ATR line use din this way it may take days or weeks for the price to move near to the ATR value.
The solution is a sliding ATR entry condition. This is applied to an established trend. It starts by identifying a compatible trend and evaluating the average distance of price above the ATR value. Price has a higher probability of moving into this area and a lower probability of falling below this area. The trade risk and reward calculations are based on an entry within the trading range. This may require a reduction in position size as the ATR stop loss may be some distance from the entry price. The illustration in figure 22.7 shows an example of this entry method where the entry range is always 0.80 cents and always calculated from 0.50 above the value of the ATR line. When the value of the ATR line changes the trade entry range is then adjusted. Traders wait for the price rebound behaviour to develop before the trade is entered. Aggressive traders may decide to pay a little bit higher price if the trend rebound is strong. COMBINED ATR ENTRY The count back line indicator follows the downtrend and gives an entry signal when price closes above the value of the CBL line in a down trend. This signals a change in the volatility of price in the existing downtrend and points the way to a higher probability of trend reversal. This same logic is applied with the ATR. The downtrend is followed using the short-side calculation for the ATR. The ATR line continues to fall until there is a closing price higher than the value of the short side ATR. This is a signal to close short positions and the closing value of the ATR provides a reverence point for a potential new uptrend. This is not an automatic stop and reverse process. A close above the short-side ATR is a signal the short trade is closed. It is not a signal to open a long side trade.
As shown in figure 22.8, traders start a long side ATR calculation. The entry signal is generated when the value of the long side ATR is higher than the closing value of the short side ATR. This is area A on the chart extract. The down trend is defined with the 1*ATR short side trading indicator. This is a 1*ATR calculation using a 7 day moving average period. It is used to define long term down trends. Traders wait for the price to move above the 1*ATR short side line. The entry signal is when the 1*ATR long side trading indicator value is very near to, or above the value of the 1*ATR short side indicator value. The objective is to enter the trade when the price rebound from near the value of the 1*ATR long side line. The price sometimes dips below the ATR line but closes above the ATR line and develops up momentum on the next day. This is a entry opportunity. Waiting for this condition increases the probability the trend change is genuine. Traders can apply a sliding ATR entry technique or join the trade at the best possible price in the days following the trend breakout confirmation. We look at these next week, in the final of these ATR notes.
TRADING AVERAGE TRUE RANGE Final By Daryl Guppy INDICATOR REVISION AVERAGE TRUE RANGE The average true range (ATR) indicator was developed by Welles Wilder. It is a measure of the true ranging activity of a stock. Most times when we talk about range we mean the difference between the high and the low for the day. This gives us an idea of how volatile the stock is. This measurement does not tell us who is in charge of the price – bulls or bears. The ATR indicator measures only the range of prices set by the strongest players in the markets. It does this by comparing the distance from yesterdays close to today’s high, and the distance from yesterdays close to today’s low. This is combined with the distance from today’s high and low. These figures are averaged to give the Average True Range of price movements between the end of yesterdays’ trade and the close of today’s trading.
Managing volatility is the most significant challenge in changed market conditions. The increasingly common shorter, sharper trend behaviours and extended rallies require management based on price volatility, but these measures need to be more sensitive to volatility developments to ensure profits are kept and not diminished by stops that are placed too far below the current price action. The traders’ application of the Average True Range (ATR) captures price volatility, defines the emerging trend breakout and provides a method to manage the developing trade. Our purpose is to use the ATR calculation as a stop loss designed to protect capital and identify the end of one trend and the beginning of another. We use the ATR as a method to identify and confirm trend changes. Later we want to use the ATR as a protect profit stop deigned to protect profits and identify the end of a trend. In extended rallies it can be combined with the CBL line to provide a series of alert and confirmation exit signals
ATR AND CBL VERIFICATION Both the CBL and the ATR indicators measure price volatility. We can use them as a combined alert and confirmation signal combination. This guards against false exit signals and improves the reliability of the exit while still maximising profits. However each indicator has a slightly different purpose. The purpose of the ATR is shown below and the key differences are in bold italics: 1. Follow the trend break 2. Define average price volatility and price volatility limits 3. To adjust price volatility calculations as average price volatility changes 4. Set stop loss conditions related to price volatility The count back line is similar, but different in some significant areas. The key differences are shown in bold italics. 1. Identify the trend break 2. Define significant price volatility and price volatility limits
3. To adjust price volatility calculations as significant price volatility changes 4. Set stop loss conditions directly related to price volatility Combining these two indicators to manage a developing trend change and to confirm the trade exit as shown in figure 22.9 provides a useful solution for the problem of false exits. Both indicators are displayed on the chart. A close below the highest value indicator is an exit signal. Confirmation of the exit comes with a close below the value of the lower indicator. The first signal on the left of the chart shows an ATR exit signal but not a CBL conformation signal so the trade remains open. The ATR calculation is commenced again from a new start point after the false ATR exit signal. On the right of the chart there is a combined ATR and CBL exit signal which confirms the end of the trend. The combination of methods which measure the same process – price volatility – in different ways develops a more reliable exit signal that eliminates many false exit signals. TRADERS ATR APPLICATION The expansion in price volatility is the defining feature of the post-GFC market. The management of extended short term rallies and declines provides the solution to consistent profits. The use of the traders’ application of the ATR provides an effective solution for end of day trading in stocks, indexes, commodities and currencies. The same method is also applied to intraday trading using 3, 5 and 15 minute charts. The traders’ ATR is defined as a trading solution. It is not applied as a long term investment or trend following solution, although higher values such as 2*ATR can be used in this way. TACTICS In long side trading buy while the price is above the ATR value. Sell when price drops below the ATR value In short side trading buy while price is below the ATR value Sell when price rises above the ATR value. Exits can be executed on either intraday alerts, or at the open on the following day. RULES The ATR value defines the acceptable limits of volatility. A move beyond these ATR limits signals an end to the current trend. Stop loss is based on the value of the ATR. This is updated whenever necessary ADVANTAGES A good measure of volatility. Good for short term trends Good for momentum driven trading as a stop loss and protect profit method Very useful for intra-day trading. Works well with derivatives.
