www.traderslibrary.com
Tren Tra ng In c ator s Copit © 2011 b Jon Peson Publise b Maetplace Boos
TABLE OF CONTENTS
All its esee.
Reproducon or translaon of any part of this work beyond that permied by secon 107 or 108 of the 1976 United States Copyright Act without the permission of the copyright owner is unlawful. Requests for permission or
Intoucon 3
further informaon should be addressed to the Permissions Department at Marketplace Books. This publicaon is designed to provide accurate and authoritave informaon in regard to the subject maer covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounng, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. From a Declaraon of Principles jointly adopted by a Commiee of the
Capte 1 : Seasonal Analysis 4 Capte 2 : Pivot Point Analysis 8 Capte 3 : Commitment of Traders Report 16 Capte 4 : ADX as a Trend Strength Indicator 23 Capte 5 : Stochascs & MACD 27
American Bar Associaon and a Commiee of Publishers. Charts created using TradeStaon ©TradeStaon ©TradeStaon Technologies, Inc., 20 01 2011. All rights reserved. No invesng or trading advice, recommendaon or opinion is being given or intended. TD Ameritrade, Inc. and John Person are separate and unaliated compa-
Capte 6 : 6 : Moving Averages 33 Capte 7 : Dow Theory 43 Capte 8 : Volume & Open Interest 48
nies and are not responsible for each others services or policies. This book, along with other books, is available at discounts that make it realisc to provide it as a gi to your customers, clients, and sta. For more informaon on these long lasng, cost eecve premiums, please call us at (800) 272-2855 or you may email us at
[email protected]. eISBN 978-1-59280-461-0 978-1-59280-461-0
Capte 9 : Trend Lines 52 Capte 10 : 10 : Ellio Wave 56 In Closin 62
Tren Tra ng In c ator s Copit © 2011 b Jon Peson Publise b Maetplace Boos
TABLE OF CONTENTS
All its esee.
Reproducon or translaon of any part of this work beyond that permied by secon 107 or 108 of the 1976 United States Copyright Act without the permission of the copyright owner is unlawful. Requests for permission or
Intoucon 3
further informaon should be addressed to the Permissions Department at Marketplace Books. This publicaon is designed to provide accurate and authoritave informaon in regard to the subject maer covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounng, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. From a Declaraon of Principles jointly adopted by a Commiee of the
Capte 1 : Seasonal Analysis 4 Capte 2 : Pivot Point Analysis 8 Capte 3 : Commitment of Traders Report 16 Capte 4 : ADX as a Trend Strength Indicator 23 Capte 5 : Stochascs & MACD 27
American Bar Associaon and a Commiee of Publishers. Charts created using TradeStaon ©TradeStaon ©TradeStaon Technologies, Inc., 20 01 2011. All rights reserved. No invesng or trading advice, recommendaon or opinion is being given or intended. TD Ameritrade, Inc. and John Person are separate and unaliated compa-
Capte 6 : 6 : Moving Averages 33 Capte 7 : Dow Theory 43 Capte 8 : Volume & Open Interest 48
nies and are not responsible for each others services or policies. This book, along with other books, is available at discounts that make it realisc to provide it as a gi to your customers, clients, and sta. For more informaon on these long lasng, cost eecve premiums, please call us at (800) 272-2855 or you may email us at
[email protected]. eISBN 978-1-59280-461-0 978-1-59280-461-0
Capte 9 : Trend Lines 52 Capte 10 : 10 : Ellio Wave 56 In Closin 62
Tren Tra ng In c ator s I
Introduction
the most important trend trading
In addion, I will share techniques
and booms. As a result, their
concepts that many traders seem
on how to correctly apply trend
trading careers end quickly. quickly.
to either not know or completely
line analysis and integrate mul-
forget to incorporate when execut-
ple meframe techniques. I will
ing investment decisions using real
also show you some of the more
money.
reliable technical indicators for
1. Seasonal and intermarket
Pon fom Ten Analsis “The trend is your friend” In simplest terms, trend is dened
analysis 2. Tradional trend line charng techniques 3. Technical indicators
helping to idenfy trend market condions.
It is a proven fact that more successful traders wait for a trend to be established and then try to prot by trading on the right side of the direcon of that price move for an extended period of me.
As the saying goes, “the trend is
The trick here is to stay disciplined
your friend”—unl the trend ceas-
and focused, but many trend fol-
es to exist. Many traders in the
lowers understand the signicance
course of their careers have tried
of seasonal analysis and they let
as the direcon of price over a
Many investors are familiar with
to idenfy when a trend ceases
historic data help them gauge how
period of me. There are many
the axioms, “sell in May and go
to exist and to capitalize capitalize on that
long they expect a trend to last.
techniques that can be used to
away,” or perhaps, “harvest lows
reversal. This is oen referred to
trade with the trend. Most prot-
are made in the fall,” but they fail
as ancipang a trend reversal, or
able longer-term longer-term traders choose to
to either adhere to their game
top or boom picking. While it can
trade in the direcon of the trend
plan or follow through with apply-
be extremely lucrave if you are
while intermediate-term traders
ing seasonal tendencies of sup-
right, unfortunately unfortunately very few trad-
will trade the longer-term trend
ply and demand funcons of the
ers are successful at picking tops
against pullbacks in the intermedi-
markets. I plan on sharing secrets
ate term me frame. Short-term
that I have also wrien about in
traders or daytraders will also
my second book Candlesck and
use pullbacks against longer-term
Pivot Point Trading Triggers, Triggers, as
trends but may also incorporate
well as in the Commodity Trader’s
countertrend techniques in their
Almanac,, which I co-authored with Almanac
trading decisions.
Je Hirsch, so please consult either
This guide is designed to introduce you to what I consider three of
of these tles if you wish to go further with your studies on trend.
Some of the most technically advanced studies are applied to trend trading. As I menoned, one of the simplest forms of analycal studies is understanding seasonal analysis. More complex analysis that I will introduce in this book
In simplest simplest terms, terms, trend is i s dened as the direction of price over a period of time.
Tren Tra ng In cators includes pivot analysis, Ellio wave studies, and then going back
1
to the turn of the 20th century,
Seasonal Analysis
the concepts of “trend phases” introduced by Charles Dow. All of this will help you in your decisionmaking process for not only entering trades but also holding onto your trades. I was taught early on, nearly thirty years ago, to cut your losses short and let your winners ride. Understanding and applying
T
he key to achieving wealth by trading the markets—other than being on the right side of the trend—is good risk management and being properly posioned in a trade. It is crucial that the individual trader fully comprehends the psychological impact trading has on one’s own psyche,
and more importantly, understanding how very lile predictability there is in the market. That is where
some of these principles in this
seasonal analysis can help prepare traders and investors for what lies ahead, and when shis in supply
book will not only shed light on
and demand funcons can reverse or help accelerate trending market condions. I believe this book will
how to do that, but we will also
help you to successfully formulate a solid plan of aack in market trends.
share with you where you can acquire further educaonal material in order to master the techniques that many have acquired through the last half century. All the best, John L. Person
If the trader is armed with the right knowledge and can implement the applicaon of good, sound technical analysis methodology to help me entries, exits, as well as to establish risk and prot objecves, the odds of success can be improved immensely. Seasonal analysis gives investors and traders an edge in capturing that elusive “predictability of the markets.” What many traders do not realize is that most markets demonstrate seasonal price paerns; meaning they tend to make highs or lows near the same me period year aer year. Stocks, commodies, and even foreign currencies have a strong tendency to demonstrate seasonal patterns. One of the greatest benets of incorporang seasonal analysis is being able determine when a market is in a weak or strong trend and me changes in the trend's direcon. The art of using history as a guide to predict future price moves is absolutely a mind-blowing experience, especially when you are able to prot from that knowledge. However, if it were that simple and reliable, everyone would be doing it, and every trader would be geng rich, and quickly. Unfortunately, this is not the case.
Tren Tra ng In cators Seasonal analysis cannot forecast
banks’ massive prinng of curren-
to break down the cumulave
tunity. If, for example, I see a
the outcome of each trade. Trend
cies. In addion, government de-
prots, which aids in the decision-
decent risk/reward opportunity
moves from a seasonal perspecve
cit spending was out of control.
making process.
of perhaps a three to one setup, I
can either be muted or magnied,
Therefore, gold was being bought
depending on economic turmoil,
by any and all avenues of invesng
polical events, monetary and s-
perspecves.
cal policy (smulus) changes, and weather concerns that will impact supply and demand parameters. There are always unique events
may diversify posion taccs.
sis helps me as a trader: I am
In the case of this bullish seasonal
constantly scanning for trading
trend in gold, instead of loading
In the Commodity Traders
opportunies. We all know we
up on a long futures posion, or
Almanac, 2010 Edion, I highlight-
can not take every trade, so there
just buying into a bullish opon
ed one of the top seasonal trades
must be a ltering process to
strategy, I usually look to diversify
in August for gold:
help us decide which trade has a
my posion in a bullish trend situ-
higher probability, and then we
aon such as spreading my trad-
that will aect certain markets or sectors. A specic company can inuence prices.
Here is where seasonal analy-
can look at the risk to reward lay-
ing capital around. I may look to
“Seasonally, this is a strong
out. I like to look for a good fun-
buy a highly correlated gold stock,
price period for gold unl late There are many mes when the
damental situaon and a market
and I will look at a near-the-money
September or early October. Look
macro economic environment will
that has a proven track record of
credit call spread in the exchange
to enter long posions on or
enhance a seasonal situaon. Let’s
somewhat high level of predict-
traded fund (GLD). At the same
about August 25 and holding unl
examine a case study using gold.
ability based on its past trading
me, I might expand my risk capi-
September 30. In the last 34 years
By August of 2010, the market was
history. I like to plan ahead, and
tal and look at a slightly out-of-
this trade has worked 20 mes for
using seasonal analysis helps me
the-money short term credit put
in turmoil over whether or not a
a success rate of 58.8%. The last
double dip recession was in the
in that process. I can start a shop-
spread opon posion. Finally, I
8 years have provided an amazing
making. Gold had been in a strong
ping list so-to-speak for which
might just take a reduced hold-
cumulave prot of $20,160 per
uptrend as it was acng on its own
sectors enter a period of strength
ing of a long futures posion. This
futures contract.”
or weakness, and based on my
way I am diversied in my actual
criteria, I can lter out which
trade, which can help me survive
areas to focus in on rather than
or take advantage of mulple out-
acng aer a market has already
come scenarios, whether the trend
moved. In addion, I can start
of gold connues sharply higher,
Seasonal analysis can not only
to lay out how much equity and
mildly higher, stays at, or drops
help dene when a trend move
which strategy I want to employ
rst and then takes o.
may take place, but can help one
to take advantage of the oppor-
merits, meaning there was global consumer demand and investment demand as many enes were looking at gold as a hedge against not only deaonary fears, but as a defense against longer term inaonary fears, due to central
USINg SEASONAL ANALySIS AS A FILTEr
Tren Tra ng In cators I think many traders get the mar-
the seasonal tendencies. The same
ket trend right at mes but fail in
technique enables traders to man-
their sense of ming and perhaps
age their risks more appropriately
over-posion themselves for a
rather than going “all in” in one
trade. Then, when a slight move
large overleveraged posion.
occurs against them or a draw-
Figure 1.1 is a seven-year average
down happens, as is oen the case
of gold’s price moves taken as of
in the real world of trading, they
the end of April 2009. Noce that
can’t aord to hang on. This oen
between the August low and the
results in a loss, or they miss the
September low, the average of
move enrely. An old saying of
those lows would come in around
mine that may resonate with you if
August 25.
you have had experience in trading markets: “The market will always
The seasonal analysis indicates
let you in the losers; the mar-
that this uptrend should connue
ket’s job is to keep as few winners
through the end of September
around as possible.” Diversifying
into early October. On average,
your trend trading strategy may
the market conducts a shor t-
help you overcome this issue.
term prot-taking correcon or a trend reversal in the third week
One has to remember that his-
of October to the rst week of
tory can and does repeat itself; the problem is the outcomes
rather sideways, sll adhering to
We have many scenarios that could
are not always the same. Let me
a seasonally strong period. Rather
unfold, so I believe a more pru-
explain. Perhaps the market is bull-
instead of moving up in value, it
dent, well-balanced trader can and
ish; it could move at lightning bolt
just remained the same. Now of
should diversify his or her posion
speed to the upside, not allowing
course there are the few mes
based on many dierent outcomes.
one to enter in a posion. Or the
when the market will not perform
By employing dierent strategies
market could move higher, but
according to its past historic sea-
with the same risk capital, one can
only by a small percentage. Or the
sonal tendency and moves down
sll prot handsomely if the mar-
market may not move higher but
against a long posion.
ket does indeed move according to
November. Aer that, gold prices have the best three month bullish trend period from November lasng into late February. Shor tterm traders can potenally experience a period of approximately ve weeks of stronger prices from August 25 through October 1.
Tren Tra ng In cators A quick review of recent history
traders uncover when the best
The graph shows the weekly
It was the next trading session
shows from the low made on
me of the year—on average—a
Person Pivots overlaid on the
where the move really started to
August 25, 2009 at 950.60, gold
market trend can occur, either up
charts, and you could see in the
accelerate.
peaked by October 14, 2009 at
or down.
Commodity Traders Almanac, it
1079.50. Two weeks later it corrected to a low of 1034. Back on August 25, 2008, gold traded as low as 835.6, but it did take heat and fell further, rst to a low of 754.3 by September 11. However by October 11, just four weeks later, gold made a sharp rally, posng a high of 889.5. A diversied trader may have ridden the storm out beer than a fully vested, long, futures-only posion trader. On a side note, that high
Take a look at Figure 1.2, which is a daily gold chart for 2010. As you can see, prior to August 24, the trend was up.
stated, “Look to enter long posions on or about August 25.” The market made a correcve pullback on August 24, trading right down to the predicted support targets.
If you did not act on the 24th, but rather waited unl the 25th of August to enter a long posion, you obviously would have had a beer advantage from a risk/ reward perspecve. This is where employing various bullish strategies would be instrumental, and help one become a more complete, well-balanced, diversied trader trying to capture a strong trending and strong bullish seasonal market condion.
made in October 2008 reversed
Buying on the close of business
hard in just 11 trading days, post-
and holding as of the date of this
ing from peak of 950.80 to a
wring, gold surged to a high of
trough of approximately 695.50,
1288 by September 21. As of the
over a 250.00 dollar correcon
close the market, gold was at
per ounce of gold.
1279.50. Seasonal analysis was
I menon this to support my previous statement that not all years are created equal from a seasonal perspecve in both the exact me of markets’ moves and in price swings. The key to focus in on is that seasonal analysis can help
instrumental in helping to dene a strong trend condion and therefore one may have enhanced trading performance. Even if you did not catch this trend, at the very least, seasonal analysis alerted you to a high probability situaon that
Tren Tra ng In c ator s may have kept you from trading on the wrong side of the market. Or as we say, ghng the trend. In addion to helping pick out a trend condion, seasonal analysis is absolutely instrumental in idenfying when a trend may cease to exist, and that is also a very valu-
QUICk QUIz 1. Wat is te e to aciein wealt b tain te maets? maets? a. Being on the right right side of the trend management b. Good risk management c. Proper trade posion . All of the above
able piece of market knowledge, because one needs to be able to take prots in this business. In the remainder of this ebook, we will delve into more techniques to aid traders in idenfying trends and how to tread on the right side of the market.
2. Wat tpes of secuies emonstate seasonal paens? paens? a. b. c. .
Stocks Commodies Foreign currencies All of the above
3. Seasonal pice paens sow tat most maets mae is o lows nea te same me peio ea ae ea. a. True b. False
2
Pivot Point Analysis
T
his chapter is devoted to my favorite technical tool, pivot points.. This is a tool that many traders either misuse or points do not understand enrely. I use pivot point analysis to
help conrm the market trend, or condion whether it is bullish or bearish. Then, I use the integrated formulas to project under those assumpons as to what the next me periods’ range might be. In addion, I use pivot analysis to conrm at what price level a potenal trend reversal level might be. As traders, we think about what more one wants than to stay with the trend, correct? Well, traders also need as much help in seng risk targets as they do prot targets. Pivot analysis helps me achieve both of these goals. This chapter will describe in full detail the principles behind the mathemacal calculaons as well as the raonale behind
4. Seasonal analsis can elp peict te outcome of eac tae. a. True b. False Fo te answes to tis qui, o to TaesLiba.com/TLEcone.. TaesLiba.com/TLEcone
the psychological impact that drives traders to make decisions around these levels. I will break it into separate secons to explain how it can be applied for idenfying support and resistance levels in trending market condions. This technical tool works for short and long term trend traders. It can be applied for stocks, futures, and in the foreign currency arena. Each investment vehicle has its own
Tren Tra ng In c ator s nuances, such as trading session
feel compelled not to learn about
all market parcipants’ collecve
a given session out of fear that
hours, me periods in which vol-
them because they seem compli-
percepon of value for that me
they would lose more by stay-
ume ows change, contract sizes,
cated. I will dispel that myth.
period. I want to quote the famous
ing in a long trade; they certainly
legendary trader Jesse Livermore, Livermore,
will respect that price point the
who stated nearly seventy years
next me the market trades back
ago this observaon: “The pat-
at that level. So the high and low
terns the traders and technicians
are important reference points.
observe are simply the reecons
With that said, pivot point analy-
of human emoonal behavior.” It
sis incorporates the three most
rings as true today as it did then.
important elements—the high, the
and decimal point placement so that you know how to correctly calculate the pivot point levels. First, you need to know the foundaon of the methodology of pivot point analysis; this will then allow you to apply it to the specic markets of interest that you are trading.
POWEr OF PIvOT POINT ANALySIS
In my rst book, A book, A Complete Complete Guide to Technical Trading Taccs, Taccs, I illustrated many trading methods that one can apply using pivot point analysis with candlescks paerns, including the power of mulple me frames, or what is know as conuence of various
The range, which is the high and
target levels. This chapter will
low of a given me period, accu-
highlight those techniques as well
rately reects all market parci-
low, and of course, the close of a given trading trading session. The most common formulas are:
as explain how to lter out and
pants’ exuberant bullishness and
Piot Point: the pivot point is the
The power in using pivot analy-
narrow the eld of the respecve
pessimisc bearishness for that
high, low, and close added togeth-
sis is that the strategy works in
support and resistance numbers
trading session, whether it is a day,
er and divided by three.
all markets that have established
and divulge various formulas that
a week, or a month. The high and
ranges, based on signicant vol-
are popular today.
low of a given period is certainly
ume or a large group of collecve parcipants. Aer all, the current market price equals the collecve acon of buyers and sellers. Pivot point analysis is a robust, me-tested, and best of all, tesable form of market analysis. This means that you can backtest to see the accuracy of this tool’s predicve analysis. The really unbelievable aspect of pivots is who uses them. In fact, many traders
P=(h+L+C)/3
important, as it mirrors human resistance 2: R2 is the pivot point
WhAT IS PIvOT POINT ANALySIS?
emoonal behavior.
Pivot point analysis is a mathemat-
a reference point for those who
ical formula designed to determine
bought out of greed thinking
the potenal range expansion
they are missing an opportunity.
based on a previous me period’s
They certainly won’t forget how
resistance 1: R1 is the pivot point
data, which includes the high,
much they lost and how the mar-
number mes two minus the low.
the low, and the close or sele-
ket reacted as it declined from
ment price. These variables from
that level. The opposite is true
a given me period’s range reect
for those who sold the low of
number plus the high and minus Think of it this way: the high is
the low. r2=P+h-L
r1=(P2)-L
Tren Tra ng In c ator s Suppot 1: S1 is the pivot point
number mes two minus the high. S1=(P2)-h Suppot 2: S2 is the Pivot Point
number minus the high plus the low. S2=P-h+L
resistance 3 = h + 2 (Piot – Low) Suppot 3 = L – 2 (hi – Piot) O r3 = (P-S1) + r2 S3 = P- (r2 - S1)
Some analysts add a third level to their pivot calculaons to help target extreme price swings on what has occurred on occasion, such as a price shock resulng from a news driven event. Currency mar-
resistance Leel 3
sively higher me period’s price
This is an extreme bullish market
support or resistance projecons.
condion generally created by
For example, from the daily num-
news-driven price shocks. This is
bers, I would look at the weekly
where a market is at an overbought
gures and then from the weekly
condion and may oer a day trad-
numbers, I would look at the
er a quick reversal scalp trade.
monthly numbers.
resistance Leel 2
There are other variaons which include adding the opening range.
ThE NExT LEvEL
I believe in looking at the progres-
In this case, that would involve simply taking the open, high, low, and close and dividing by four to derive the actual pivot point.
The longer the time frame, the more more important or signifs ignificant the data.
P = (O, h, L, C) /4
We see this level when there is a bullish market market price objecve or target high number for a trading session. It generally establishes the high of a given me period. The market oen sees signicant resistance at this price level and
It is rare that the daily numbers
kets tend to experience a double
PrICE ACTION rEACTION
dose of price shocks, as they are
Let’s see what these numbers
or S2 numbers and when the mar-
exposed to foreign economic
mean and how price acon reacts
ket does, it is generally in a strong
developments as well as U.S. eco-
with these projected target levels.
trending condion. In this case,
nomic developments that pertain
Here is how the numbers would
we have methods to follow the
to a specic country’s currency. currency.
break down by order, what typi-
market’s ow, and we will cover
This tends to make wide trading
cally occurs, and how the market
this in more detail in the next few
ranges. Therefore, a third level of
behaves. Keep in mind, this is a
secons. By focusing on just a few
projected support and resistance
general descripon and we will
select numbers and learning how
can be calculated. calculated.
learn what to look for at these price
to lter out excess informaon,
points to spot reversals in order to
I eliminate the analysis paralysis
make money and reduce risk.
from informaon overload.
will trade beyond the extreme R2
will provide an exit target for long posions.
resistance Leel 1 This is a mild bullish to bearish projected high target target number. number. In low volume or light volality sessions, or consolidang trading periods, this oen acts as the high of a given session. In a bearish market condion, prices will try to come close to this level, but most mes will fail.
Tren Tra ng In cators Piot Point
sees signicant support at or near
Here is how I ulize me frame in
sense. If the exchanges and the
This is the focal price level or the
this level in a bearish market con-
my research. There are approxi-
banking system use a specic me
mean, which is derived from the
dion and it is a likely target level
mately 22 business days, or about
to sele a market, then that is the
collecve market data from the
to cover shorts.
four weeks in any given month.
me period that should be consid-
Every month there will be an estab-
ered for a close. They should know
prior session’s high, low, and close. It is the strongest of the support
Suppot Leel 3
lished range—a high and a low.
those are the rules that make
and resistance numbers. Prices
In an extremely bearish market
There are typically ve trading days
money move. I want to follow the
normally trade above or below
condion, this level will act as the
in a week. Now consider that in
money ow.
this area before breaking in one
projected target low or support
one day of one week in one month,
direcon or the other. As a gen-
area. A price decline to this level
a high and a low will be made. It
eral guideline, if the market opens
is generally created by a news-
is likely that this high and low may
above the primary pivot, be a
driven price shock. This is where a
be made in a minute or within one
PrEdICTINg hIghS ANd LOWS USINg ThE CALCULATIONS
buyer on dips. If the market opens
market is at an oversold condion
hour of a given day, of a given week
I believe in keeping things simple,
and may oer a day trader a quick
of that month. That is why longer-
and that less is more. I use the
reversal scalp trade.
term me frames such as monthly
numbers and the ltering method
or weekly analysis should be includ-
to help me select either the high or the low of a given trading ses-
below this level, look to sell rallies.
Suppot Leel 1 This level consists of a mild bearish
vALUE OF TIME FrAME
ed in your market analysis.
to bullish projected low target num-
Daily, weekly, and monthly me
In the world of 24-hour trading,
sion, and somemes this works to
ber in light volume or low volality
frames can and should be ulized,
the most popular queson I get
project both the high and the low
sessions, or in consolidang trad-
as well. To understand how price
from those studying and using
with amazing accuracy. Therefore,
ing periods. Prices tend to reverse
moves within the pivots, begin by
pivot points is: “What are the
it is important not to be bur-
at or near this level in bullish mar-
breaking down the me frames
mes that you derive the high,
dened with informaon overload.
ket condions, but most mes fall
from longer term to shorter term.
low, and close informaon?”
Remember:
short of hing this number.
As traders, we should begin with a
There are many dierent people
•
monthly me frame, where there is
Suppot Leel 2
a price range or an established high
At this level, we nd a bearish
or low for a given period and this
market price objecve or targeted
range, including its price points.
low number. The market oen
Pivot point calculaons help
telling many dierent stories. Here
determine when to enter and
is what I do and what seems to
exit posions.
work the best for me. For starters, just keep things simple and apply some good old-fashioned common
•
They help as a leading price indicator for traders.
Tren Tra ng In cators •
Pivot points are used to proj-
not be applicable in most cases
This number represents the true
the preceding me frame. If they
ect support and resistance or
two, three, or four days later.
value of a prior session. In an
are, then to help lter out unnec-
uptrending market, if the market
essary informaon or excessive
gaps higher above the pivot point,
support and resistance numbers
then a retracement back to the
on my charts, I use the actual
pivot will aract buyers. Unl that
pivot point up to the R1 number
pivot point is broken by prices
for resistance, and then I target
actual highs and lows of trading sessions. •
•
The same principle goes for the weekly and monthly calculaons,
They help conrm other tech-
so at the end of that me period,
nical methods.
new data must be recalculated.
Daily, weekly, and monthly
If in a given trading day, the mar-
trading below that level, traders
the S2 for the potenal low for
me frames can and should be
ket goes through my daily target
will step in and buy the pullback.
that me period’s trading range.
used.
numbers, the importance of the
Have you ever heard of the phrase
weekly and even monthly numbers
“if bullish, buy breaks”? Well, using
is what gives me an indicator for
the pivot point as a price level to
the next major target levels of sup-
buy helps traders dene at what
port and resistance.
price a break might occur.
In every week, there are ve trading days. In every month, there will be an established range—in other words, a high and a low. In one day of one week in one month, a
As you can see in the Figure 2.1, if I determine the market is bearish, and if I understand the relaonship of the geometric distance of the resistance and support targets,
The opposite is true in an extreme-
I can eliminate the R2 number,
ly bearish market condion; the
since in a bearish environment we
high and a low will be made.
USINg ThE ACTUAL PIvOT POINT
It is likely that the high and the low
pivot point will act as the target
should see a lower high. If I am
I use the actual pivot point for
will be made in a minute or hour
high for the session. If a news-
looking for a lower low, then I can
many things. For example, it is
of a given day of a given week in
driven event causes the market to
eliminate the S1 support number
important to understand that
that month. That is why longer
gap lower, traders will then access
as well, and now I have reduced
the pivot point can be used as an
me frames such as a monthly or
the news. Once prices come back
the eld to just three numbers.
actual trading number in deter-
weekly analysis should be used.
up to test the pivot point, if the
mining the high or low of a given
market fails to break that level
me period, especially in strong
and trade higher, sellers will take
cic me frames for determin-
bull or bear market trend con-
acon and start pressing the mar-
ing support and resistance levels
dions. In an extremely bullish
ket lower again.
for that parcular ming element
trend condion, the pivot point
only, and infers that the analysis or
can become the target low for
Technically speaking, in a bearish
that trading session.
market, the highs should be lower
Pivot point analysis relies on spe-
calculaons for the prior day will
and the lows should be lower than
Once again, I am not using the numbers to place orders ahead of me (even though you could); I am using the numbers as a guide. These numbers work so well and oen act as a self-fullling prophecy because so many instuons and professional traders do use
Tren Tra ng In cators
them. Many hold dierently sized posions, and some traders may not wait for the exact number to hit. Instead, they may start scaling out of posions (as I do). With this method, you can use these numbers as exit areas on your trades. As Figure 2.2 depicts, in a bullish market environment, by denion, the highs should be higher and the lows should be higher than the preceding me period. When I have determined that we are in a bullish trend, I target the S1 up to the pivot point for the low of the session and the R2 for targeng the high. This will give me an idea of what the potenal trading range will be. Take a look at Figure 2.3. It is a 15-minute chart using all ve pivot calculaons. We have a mid-point number which is the pivot point, with two upside resistance levels, and two downside support targets. I have a week’s worth of data starng from Wednesday through the following Wednesday close. This chart is from thinkorswim by TD Ameritrade using the Person's Pivot indicator.
Tren Tra ng In cators
Using a ltering method as shown
LONgEr TIME FrAMES
in Figure 2.4, we eliminated the
When the market goes through the
excess support and resistance
projected daily target numbers,
lines, so now we have one resis-
I use the longer me periods to
tance and one support target
give me the next reliable price
level. Doesn’t this eliminaon pro-
objecve. That is where the
cess give a beer picture of what
signicance of the weekly and
may have happened as opposed
monthly numbers comes into play.
to what the real results were?
Take for example the weekly chart on the S&P 500 Exchange Traded Fund (SPY) in Figure 2.5 using the
monthly pivot levels. Noce when
the monthly pivots were projecng
the market was in a bearish trend
higher highs and higher lows? Not
in late 2008, the actual target
only can pivot point analysis help
levels were projecng out a lower
keep traders on the right side
high lower low scenario. Then, as
of a trending market condion,
the market reversed in a bullish
the support and resistance
trend throughout 2009, see how
target levels help navigate price
Tren Tra ng In cators Now here is where combining dierent me frames can be most useful. As you look at Figure 2.7, you will see the e-mini S&P 500 futures with the weekly and daily pivot levels. What I like to look for is what I call a conuence, or a synchronized setup of various me frames within a trend. For example, let’s say we are in a higher degree me frame bullish trend and the market pulls back to the weekly support. I also like to see a daily support level coincide with that weekly pivot support for a low-risk buy
extremes, allowing one to set entry and exit orders according to the market price direcon. For those interested in commodies, the graph in Figure 2.6 is a daily price chart of crude oil futures with a weekly pivot analysis displayed. As you can see, the pivot levels recalibrate and give not only a conrmaon reading that the market is bullish by displaying higher highs and higher lows, it does so with exact pricing.
Tren Tra ng In cators setup. Noce the price acon on September 23, 2010. The market pulled back to the weekly support level (pink) and that day’s daily pivot (green) coincided at the same level. As the day progressed, traders could not take the market any lower and by the end of the day, the longer-term trend stayed intact as prices connued higher. By idenfying the support targets in advance, one was keen to the idea to at least look to “buy the dip,” or at the very least, not sell at the low of a retracement.
CONCLUSION Pivot point analysis is a valuable trading tool. Of course, there is no holy grail of indicators, but combining correlated technical tools to help you plan your trades will certainly give you
QUICk QUIz 1. Wat is piot point analsis? a. A mathemacal formula designed to determine the potenal range expansion based on a previous me period’s data. b. A system for determining when to get into a trade. c. An exit-planning technique. . All of the above 2. Wat is te most impotant element to piot point analsis? a. b. c. .
The high The low The close All of these points are vital to pivot point analysis.
an edge in the markets, especially if you are looking to trade both with a trend and looking
3. Te basic fomula fo te piot point is:
for clues as to when or at what price level the
a. b. c. .
trend may end. If you are interested in furthering your educaon on the use of pivot point analysis, including how to construct a trading methodology using a pivot point moving average, take a look at my home study course from Traders’ Library, Candlescks and Pivot Point Strategies.
P +H - L (P x 2) – L (H + L + C)/3 (P x 2) – H
4. To unestan ow pice moes witin te piots, eamine me fames fom: a. Longer term to shorter term b. Shorter term to longer term Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
3
Commitment of Traders Report
T
here are many indicators and technical tools that can be used to help gain an edge in the market, espe-
cially in idenfying the strength of a trend, or more importantly, helping to me a trend reversal. You may be familiar with my “Person’s Pivots” and proprietary buy and sell signals, but believe me, I use other indicators and this chapter is focused on the “grand-daddy” of the consensus or contrarian indicators. I have been using this indicator since my start in the industry as a commodity trader back in the early 1980s. The tool I am talking about is none other than the C ommodity Futures Trading Commission (CFTC) Commitment of Traders report (COT). The data is like an insider informaon report, but it is legal. It acts like a true consensus of who literally “owns” the market. A trader can use this data to determine if market parcipants are too
Tren Tra ng In cators heavily posioned on one side of
gate of all long open interest is
ons are added to the trader’s long
ally represents 70 to 90 percent
the market in a long-term trend
equal to the aggregate of all short
and short futures posions to give
of the total open interest in any
run, especially when we are enter-
open interest.
‘combined-long’ and ‘combined-
given market. From me to me,
short’ posions. Open interest, as
the Commission will raise or lower
reported to the Commission and
the reporng levels in specic mar-
as used in the COT report, does
kets to strike a balance between
not include open futures contracts
collecng sucient informaon to
against which noces of deliver-
oversee the markets and minimiz-
ies have been stopped by a trader
ing the reporng burden on the
or issued by the clearing organi-
futures industry. “
ing a seasonally strong or weak me period from a supply and demand perspecve. This chapter will provide a quick synopsis of where to nd and how to use this
The terms and denion can be found at the CFTC’s website, but for ease of explanaon, I will quote it here:
report.
WhEN First, let’s discuss when this report is released and how you can use it. The COT reports provide a breakdown of each Tuesday’s open interest for markets, but they are not released unl Friday at 3:30 p.m. EST. Current and historical Commitments of Traders data is available as is historical COT data
“Open interest held or controlled by a trader is referred to as that trader’s posion. For the COT Futures-and-Opons-Combined report, opon open interest and traders’ opon posions are com puted on a futures-equivalent basis using delta factors supplied by the exchanges. Long-call and short put open interest are converted to long futures-equivalent open inter-
going back to 1986 for futures-
est. Likewise, short-call and long-
only reports, and to 1995 for com-
put open interest are converted
bined opons and futures reports.
to short futures-equivalent open
The informaon is based on the open interest gures. Open interest is the total of all futures and opon contracts entered into and not yet oset by a transacon, delivery, or exercise. The aggre-
interest. For example, a trader holding a long put posion of 500 contracts with a delta factor of 0.50 is considered to be holding a short futures-equivalent posion of 250 contracts. A trader’s long and short futures-equivalent posi-
zaon of an exchange. Clearing members, futures commission mer-
The data is collected as of the
chants, and foreign brokers (col-
close each Tuesday from each
lecvely called reporng rms) le
clearing rm by the corresponding
daily reports with the Commission.
exchange where a parcular com-
Those reports show the futures
modity is traded. It is then turned
and opon posions of traders
over to the Commodity Futures
that hold posions above spe-
Trading Commission (CFTC). They
cic reporng levels set by CFTC
release the data each Friday at
regulaons. If, at the daily mar-
3:30 p.m. EST.
ket close, a reporng rm has a trader with a posion at or above
I should point out that it is logical
the Commission’s reporng level in
to watch for any major direconal
any single futures month or opon
price changes in the market that
expiraon, it reports that trader’s
you are analyzing from the me
enre posion in all futures and
when the data was collected on
opons expiraon months in that
Tuesday to the close of business
commodity, regardless of size. The
on Friday to watch for any drasc
aggregate of all traders’ posions
prices changes that may alter the
reported to the Commission usu-
posion size of traders.
Tren Tra ng In cators kEy CATEgOrIES
to enter trades accordingly. Keep
INTErPrETATION
and the non-reportable posions
There are three categories to
in mind that the commercials are
Here are some general guidelines
category are net long, look at sell-
pay aenon to: non-commer-
not always right; they are not in
for interpreng the informaon
ing opportunies.
cials (professional traders, hedge
the market to me market turns.
presented in the Commitment of
Examine Figure 3.1 on the e- mini
funds), commercials (banks and
They are hedging their risk expo-
Traders report that I wrote about
sure in a cash posion.
S&P 500 index. See point “A,”
instuons, producers, or end
in my rst book, A Complete Guide
where the non-commercials are signicantly net long, and then
users), and non-reportable posi-
Since money moves the market,
to Technical Trading Taccs and in
ons holders (small speculators).
banks and large professional trad-
The Commodity Traders Almanac.
point “B,” which shows the small
Many people ask if the large
ers are a bit savvier when it comes
A. If non-commercials are net
speculators net short. This was
speculators and commercials have
to their business. Aer all, one
long, commercials are net long and
the reading that was released on
reportable posions, then how do
would think a bank has a good
the non-reportable posions cat-
March 6, 2009 from data collected
they gure out the small specu-
idea of what direcon interest
egory are net short, look at buying
on March 3, 2009. The actual bot-
lator’s posion? The answer is
rates are going to go once a cen-
opportunies. In other words, go
tom on the March e-mini S&P
simple; the long and short open
tral bank meeng occurs, right?
long with the pros.
contract was on March 6, 2009 at
interest calculated as “non-report-
This report reveals what the pro-
able posions” is derived by sub-
662.50. The market proceeded to
fessionals are doing in relaon-
B. If non-commercials are net
tracng total long and short open
ship to the small speculators. If
short, commercials are net short
interest from the total “reportable
80 percent of small speculators
posions” category. That is one
are accused of losing their money
more reason why there is no avail-
trading, then it would stand to rea-
able informaon for the number
son that you would not want to be
of traders that exist in the “non-
in the market on the side of the
reportable posions” category.
small speculator.
This report helps uncover pos-
Therefore, in the short term, the
sible imbalances in markets that
non-commercials, professional
have been in a trending market
speculators, or hedge funds are
condion for quite some me, and
considered the smart money.
therefore can help you develop a game plan to look for ming clues
rally at the close of business on March 31, 2009 at 827.25, which
Tren Tra ng In cators
was priced in the June futures con-
Examine the chart Figure 3.3,
professional trader category, the
cials or large professional traders
tract, up almost 25 percent from
which is also on the e-mini S&P.
black line represents the commer-
(blue) and the small speculator or
the lows. The small speculators
This shows my TradeStaon indi-
cials’ posions, and the gray bars
general public, as highlighted in
were net short into that rally.
cators with a zero line histo-
represents the small speculator
gray.
gram color coded to idenfy the
net posion.
Figure 3.2 using TradeStaon shows my Person COT indicator reecng that the small speculators were short as the professional traders were long since early February of 2009.
three classes of traders and their respecve net posions as measured against the open interest numbers. The blue bars represent the non-commercial posion or
The chart starts from January
Without going into exact details of
2008, and as you can tell, it was
this indicator or the exact gure
a very bearish market environ-
of each category’s net posion, I
ment. Noce that the gray his-
want to focus on the overall con-
togram lines are above the zero
sensus between the non-commer-
line, showing the small speculators
Tren Tra ng In cators were net long all the way down.
posted a low right at one of my
the CFTC Commitment of Traders
added to their net short posion.
The blue bars are below the zero
predicted pivot support levels and
Report, many small speculators did
Commercials were less short and
histogram line showing the large
set o a buy signal.
not follow that rule. In fact, noce
professional traders added to their
that they nally threw in the towel
net long posion.
professional traders were net short. In fact, you can even see that by late June of 2008, the commercials also commied to the short side.
The market did recover in what turned out to become an amazing rally. Professional traders held a net long posion (blue) right through early April. Commercials
and went net long darn close to both a seasonally weak me period and also near a predicted Person Pivot Point resistance target level (the red horizontal line on
At that point, we had a weekly buy signal intact, with the informaon that small speculators are building a new net short posion.
Now let’s focus on late February
(black) grazed a neutral posion,
of 2009, when the media and
bouncing between a small net long
headline news proclaimed the end
and net short the enre rally. It
This brings me to an interesng
ket back to test the June high near
of the stock market and that the
was the small speculators (gray)
point—the summer of 2010 was no
1130. In any event, the CFTC report
economy as we knew it was com-
that commied to the short side
doubt a choppy and volale mar-
is a strong contrarian indicator.
ing to an end. It was a very dicult
all the way up.
ket. Granted, we traded to these
me; housing prices plunged, jobs were lost, foreclosures skyrocketed, and the stock market plunged.
So let’s review. The small speculators were net long all the way down and net short all the way
On an interesng note, see how
up. Wow—not a prey picture,
professional traders (blue) were
especially if you were a small
mounng a net long posion and
speculator.
the commercials (black) were beginning to shed shorts? Now look at the gray histogram bars see how the small speculators threw in the towel, and aer a long losing bale being net long in a bear market nally went short, darn near the boom or “in the hole,” as we say. March of 2009
SUMMEr 2010 ExAMPLE
this chart).
This could be the ammunion the market needed to bring the mar-
levels quite well, which helped me
“JAPAN SELLS yEN FOr FIrST TIME IN SIx yEArS”
idenfy trading opportunies, but
Here is another example of how
look back at how the small specu-
this report can help me major
lators were net long on the sum-
market reversals: the front
mer break. A low was made in the
page business news showed the
last week of August at the 1037
Japanese government intervened
level, the small speculators made
on behalf of the Yen’s value, the
a net short posion, commercials
headlines stated.
predicted support and resistance
Here is where it gets interest-
were reducing shorts, and the
ing, though. Seasonally speaking,
professional traders were holding
One arcle as the story hit the
stocks tend to weaken in late April
a net long posion. In fact, dur-
newswires read as if the mar-
through the May me period. I am
ing the rst week of September,
ket price acon was a shock. The
sure you are familiar with the say-
before the monthly employment
only real shock was the fact that
ing, “sell in May and go away.” I
report was released and the Labor
the Japanese government actu-
can assure you that according to
Day holiday, small speculators
ally intervened. I would argue
Tren Tra ng In cators that their government most likely
situaon, it is exactly what hap-
trader should make? Aer all, sell-
ket temperature reading. If the
was aware that there were a large
pened; speculators who were net
ing Yen futures could be costly,
folks who trade their own as well
number of speculators holding
long needed to liquidate their long
especially with the increased vola-
as other people’s money need
long posions, and that is why
posions by selling, forcing the
lity; the leverage would kill you
to book a prot on a trade, it
they chose to intervene in the rst
price of the Yen versus the U.S.
if you were early on such a trade.
stands to reason if one is long,
place—in order to gain maximum
dollar lower.
Another consideraon would be
they would have to sell to get out,
the use of the CME’s electronic
and if they are short, they have
mini Yen futures contract, or put
to cover or buy back those short
opons on the Yen futures. A trad-
posions, right? Well, the non-
er could employ a combinaon of
commercial traders are considered
these products to take advantage
hedge funds or professional trad-
of a strong seasonal tendency.
ers, and if they manage money
results with minimal eort. In this situaon, the Yen was primed for a sharp correcon; all it needed was a push o a cli, so to speak.
Was this move predictable? Seasonally speaking, yes. The yen has a tendency to peak against
If you were a stock trader and did not have a futures account, you could take an opons posion on an exchange traded fund— the Japanese Yen Trust (FXY). But again, ming is every thing. If you sold too early, you risk the
If you were a speculator taking a percentage of prots, you would be forced to sell in order to act quickly before all prots eroded. That is what typically causes an avalanche of sell orders. In this
age of prots on a quarterly basis. As with the Yen setup, the reason I was excited about this trade and was selling futures and buying put opons was simple. The stars had all lined up.
chance of adverse risk on a futures
A. Seasonally, the Yen
contract, since opons premi-
peaks against the dollar in
ums could lose value as theta or
mid-September.
me decay impacts the opon the U.S. dollar in mid-September.
then they look to take a percent-
premium.
Armed with only that informaon,
B. Large speculators were holding a substanal net long posion in the market.
go long at a mul-year high. In fact
MArkET TEMPErATUrE rEAdINgS
one would most likely would want
Here is where the CFTC COT
uptrend for several months and
to look for a shorng opportunity.
report can help. I call it a mar-
was ripe for a correcon.
one would most likely not want to
So how to decide what choices a
C. The Yen had been in a dened
Tren Tra ng In cators D. The end of the quarter was
speculators started to build a long
within two weeks.
posion around the rst week of
Take a look at the chart in Figure 3.4 showing the Person Histogram
July and were fully commied to this uptrend.
COT report. As you can see, the
Now let’s examine the actual
commercials were net shor t and
report to see the complete break-
the speculators were net long. The
down of the CF TC’s numbers.
The non-commercials (profession-
you can start to explore selling
al speculators) were long 66,038
opportunies. Just remember, if
contracts versus short 13,995,
you are using opons, select strike
which was a whopping 40.9 per-
prices that are within the realm of
cent of the open interest of the
reality and select the expiraon
market. The commercials were
month that will give you me for
long 60,724 versus short 108,489.
the trade to mature.
The non-reportable posion traders (small speculators) were more or less neutral as they were long 29,390 versus short 33,669 posions. If a market is entering a seasonally weak period and is fully loaded on the long side, as conrmed with the COT report, then
You can nd this report at naonalfutures.com/cc-report.htm.
Tren Tra ng In cators QUICk QUIz 1. Te total of all futues an opons contacts entee into an not et oset b a t ansacon, elie, o eecise is efee to as: a. b. c. .
Consensus Open Interest Commitment of Traders Market Parcipaon
4
ADX as a Trend Strength Indicator
A
s previously discussed, a trend can be idened by using
2. Te Commitment of Taes epot: a. b. c. .
Acts as a true consensus of who literally owns the market. Is published by the New York Stock Exchange. Is an insider informaon report. All of the above
3. Wat is te e cateo to pa aenon to wen eaminin te COT epot? a. b. c. .
Non-reportable posion holders Non-commercials Commercials All of the above
4. how is te small speculato’s posion etemine? a. b. c. .
By subtracng total open interest from the total reportable posions It is derived from the short open interest. There is no available informaon for the small speculator’s posion. By subtracng the short open interest from the long open interest. Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
trend lines to idenfy either a series of higher highs and higher lows, or lower highs and lower lows. Moving
average ribbons and moving average channels can also help traders gauge the market’s direcon along with the strength of the trend. Because of the lag factor, it is oen more dicult for the trader to be prepared for a trend change or a period of non-trending acon. This can turn a protable trade into a losing one and frustrate beginning traders who may start quesoning their stop strategy. They may conclude that their stop was too ght and use a much wider stop next me, thereby increasing the risk. They might alternavely decide that their stop was too wide and therefore use too ght of a stop on their next trade and get chopped up.
ThE Adx INdICATOr Traders can use the ADX indicator to determine whether a market is trending or not, as well as the strength of a trend. The ADX indicator is part of the Direconal Movement Index developed by Welles Wilder and discussed in his 1978 book, New Concepts in Technical Trading Systems. Since the ADX is available
Tren Tra ng In cators in most charng plaorms, I will
Sugar prices remained in a trading
concentrate on the interpreta-
range for the next eight weeks.
on of the ADX, not the formula
In trading stocks and providing
by which it is calculated. Other
advice for clients through PA Stock
analysts like Chuck LeBeau, who
Alerts, the ADX analysis can be
won the coveted Traders’ Library
important. The strongest signals
Traders Hall of Fame award, pro-
from the ADX occur when it drops
vides in-depth detail on how to
down to low levels in the 10 to
eecvely, and most importantly,
15 range and then crosses back
correctly use this indicator in his
above the 20 level. This is because
DVD course.
the very low ADX readings indi-
It should rst be noted that the
cate that the market has reached
ADX is not a ming indicator as it
an extreme level of non-trending
does not idenfy whether a mar-
behavior.
ket is moving up or down but is instead is designed to determine whether a market is trending or not. When the ADX is rising, then the market is trending either up or down, and conversely a declining ADX suggests a non-trending market. Remember the direcon
the me frame, the more reli-
to turn higher. This coincided with
able the signals. Sugar was one of
the crossing of the 20-period MA
To the chart of Apple (AAPL) in
the strongest trending markets in
moving above the 50 period. By
Figure 4.2, I have added a 21-peri-
2009, as it more than doubled in a
the end of May, the ADX was clear-
od moving average of the ADX
single year.
ly rising, indicang that sugar was
as well as a doed line at the 20
now trending. It connued to rise
level. In both December 2008 and
during the summer and early fall,
February 2009, AAPL was unable
but in the middle of October 2009,
to move through resistance at
the ADX had turned lower (see
$103.75, but on March 23, 2009
arrow). This indicated that sugar
this resistance was overcome. The
was no longer trending, but this
ADX line dropped below the 20
should not have been taken as a
level in December and dropped
sign that sugar prices had peaked.
below 15 several mes in the next
of the ADX is more important than
In Figure 4.1, we have the weekly
its value.
chart of the connuous sugar
Like other methods discussed in this book, the ADX can be applied to weekly, daily, or intraday data. It is generally agreed upon by most technicians that the longer
USINg A 21PErIOd MOvINg AvErAgE
futures contract to which I have added the 20- and 50-period moving averages discussed earlier along with the 14-period ADX. The ADX was in a gradual downtrend into April of 2009 when it started
Tren Tra ng In cators average has proven to be useful. In
was sll below its 21-day weighted
a trending market, traders can use
moving average. Several days later,
a wider stop with more condence
the $52 level was overcome before
than is advised in a non-trending
MOS has a sharp pullback that
market. For my advisory service,
lasted several days.
PA Stock Alerts, my analysis suggested buying Mosaic (MOS) at $45.68 (see Figure 4.3) and this level was reached on July 21, 2010. Just over a week later on August 2, 2010, MOS closed above next resistance in the $47.65 area. The 20- and 50-day moving averages had turned posive, but the ADX
three months. As AAPL moved
that AAPL was starng to trend.
through resistance, the ADX
The 20- and 50-day moving aver-
moved above its moving average
ages were also posive and the
as well as the 20 level.
gap between the moving averages
As discussed before, if a resistance level is overcome, it then becomes support and several days aer the breakout, AAPL declined back to test support (former resis-
had begun to widen. For the next month, both AAPL and the ADX connued to move higher as AAPL rose from $103.75 to over $130 per share.
tance) as indicated by the dashed
Understanding whether the ADX
vercal line. On this pullback, the
is rising or falling is of key impor-
ADX line was rising and above the
tance and to help beer idenfy
20-day moving average, indicang
the trend, a 21-period moving
From a trading standpoint, this pullback could have made some traders consider closing out their long posions, but the movement of the ADX above its moving average indicated that MOS was in the trending mode, so a wider stop was a beer idea. A week later, MOS was trading close to $60.
Tren Tra ng In cators INTErPrETINg STrENgTh
The best way to determine whether the ADX can help your trading is to
As I have stressed earlier in this chapter, a rising ADX line does not give
study it, and run it on your exisng posions as well as those trades you
you any indicaon on what direcon a market is moving, but helps you
are considering. In this way, you should have a beer idea whether or
determine the strength of a rally or a decline. Figure 4.4 shows Brish
not the ADX can help you in your trading.
Petroleum (BP) when its price started to decline during the laer part of April as support at $51.90 was broken at the end of the month. Remember, this support now becomes resistance. BP stock tested this resistance and moved sideways (see box in Figure 4.4) for nine days before resuming its decline. Even though prices were locked in a trading range, the ADX was rising strongly. It had previously dropped below the 15 level and then moved strongly above 20. Towards the laer part
QUICk QUIz 1. Te Adx inicato ienes: a. b. c. .
Trade ming opportunies The direcon of a market’s movement If a market is trending or not The lag factor
of May, the rise in the ADX slowed as BP prices connued to plunge. The ADX did not drop below its moving average unl early July as BP started
2. Ten lines can be use to ienf a seies of:
to rally and eventually moved from a low near $27 to over $41 per share.
a. Higher highs and lower lows, or lower highs and higher lows b. Lower highs and lower lows, or higher highs and higher lows 3. Moin aeae ibbons an cannels elp to ienf: a. b. c. .
The presence of a trend The market’s direcon The strength of a trend Both b & c
4. Te stonest Adx sinals occu wen: a. b. c. .
The indicator drops to the 10 to 15 range. The indicator crosses the 20 level. There is no trend. Both a & b Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
Tren Tra ng In cators 5
Stochastics & MACD
make higher highs and the sele-
The second calculaon is the %D
ment price usually tends to be in
(3 period), and it is the moving
FAST vErSUS SLOW STOChASTICS
the upper end of that me peri-
average of %K.
There are other techniques asso-
It is calculated as follows:
ciated when using stochascs,
od’s trading range.
including fast stochascs and slow
When the momentum starts to %d=100(hn/Ln)
slow, the selement prices will
stochascs.
eorge C. Lane is credited
G
start to fade from the upper
with creang the formula
boundaries of the range and the
for stochascs, a range-
stochascs indicator will show
It is important to understand the
change in price. This is referred to
based momentum oscillator indica-
that the bullish momentum is
rules of how to interpret buy or
as a gauge in sensivity. A higher
tor. His indicator is a popular tech-
starng to change. The exact
sell signals. When the readings are
rate of sensivity will require the
nical tool used to help determine
opposite is true for bear or down-
above 80 percent, and %K crosses
number of periods in the calcula-
whether a market is overbought,
trending markets.
over the %D line and both lines are
on to be decreased. This is what
poinng down, a “hook” sell signal
“fast” stochascs does; it enables
is generated. A conrmed sell sig-
one to generate faster and higher-
nal is triggered once both %K and
frequency trading signals in a short
%D close back beneath the 80 per-
me period.
meaning prices have advanced too far, too soon, and are due for a downside correcon. Stochascs can also help to idenfy oversold
There are two lines that are referred to as %K and %D. These are ploed on a horizontal axis for a given me period and the ver-
markets, meaning prices have
cal axis is ploed on a scale from
declined too far, too soon, and are
zero to 100.
due for an upside correcon. The indicator itself is based on a math-
The formula to calculate the rst
emacal formula that is computed
component, %K (14 period) is as
to compare the selement price of
follows:
a specic me period to the price range of a specic number of past
Te alue of %k =c-Ln/hn-Ln*100
periods.
c=closin pice of cuent peio, Ln= lowest low uin n peio of me, hn=iest i uin n peio of me an n=numbe of peios.
The theory is based only on the assumpon that in a bull, or uptrending market, prices tend to
hn= te n peio sum of (c-Ln).
The dierence is how the parameters are set to measure the
cent line. Markets need volality in order The exact opposite is true to gen-
to move and we need markets to
erate a buy signal when %K cross-
move in order to trade. We also
es above %D. When the reading is
need to base our trading plans on
below 20 percent, and both lines
reliable signals. Not all mes do
are poinng up, a “hook” buy sig-
the setups that trigger an entry
nal is generated. A conrmed buy
work as perfectly as in Figure 5.1,
signal is triggered once both %K
which is why I use other conrm-
and % D close back above the 20
ing signals to corroborate trad-
percent line.
ing signals. I also like to see if the methodology works in a diverse group or non- correlated markets.
Tren Tra ng In cators
To test how robust, or how well a signal responds in dierent markets
low from a previous low, but the underlying stochasc paern makes a
helps validate the reliability of that signal.
higher low. This indicates that the low is a “false boom” and can resort
Figure 5.2 is a Spot FOREX Euro Currency chart that demonstrates the
to a turnaround for a price reversal.
same setup and trigger that would enter a long posion with the %K and
Market prices can and usually do vacillate around the actual pivot point
%D crossover above the 20 percent line with a conrming higher closing
number before making a decision on a direconal price move. It is at
high candle paern. The sell signal also works well as conrmed when
these points, or market condions, that you want to use a indicator to
%K and %D both cross over and close back below the 80 percent line.
help measure the true strength or weakness of the price acon. That is what the Stochascs indicator does. In Figure 5.3, we see how a second-
BULLISh CONvErgENCE
ary low is marked with a higher indicator low.
One other method to use the stochasc indicator is trading with a pat-
Once we draw the corresponding lines, it appears as if prices and the
tern called bullish convergence, seen in Figure 5.3. It is used in idenfy-
indicator are actually converging. This is hinng that the secondary low
ing market booms. This is where the market price itself makes a lower
is not as bearish as it seems, and that a market rally can occur.
Tren Tra ng In cators
In essence, this is exactly what happens, and as prices trade above both
The example in Figure 5.4 shows how the market makes a secondary
moving average values, we have a nice trigger to go long for a quick
high, but the corresponding high in the stochascs is at a lower level
protable scalp.
then the primary high point. This paern can alert you that if the market appears to be ready for a new bull trend, the stochascs readings
BEArISh dIvErgENCE
should be equal to or higher than the primary peak level.
Another signal is a trading paern called bearish divergence, seen in
Likewise, a higher high that is accompanied with a lower stochascs
Figure 5.4. It is used in idenfying market tops. This is where the mar-
reading indicates a potenal trend reversal, especially when prices are
ket price itself makes a higher high from a previous high, but the under-
near a pivot resistance level. Noce the lower closing low o the sec-
lying stochasc paern makes a lower high. This indicates that the sec-
ondary peak, and then as %K and %D both cross over and are beneath
ond high is a “weak” high and can resort to a turnaround for a lower
the 80 percent line. This helps conrm the sell signal, which was trig-
price reversal.
gered with the moving average crossovers and the lower closing lows.
Tren Tra ng In cators Bearish divergence signals warn
If the secondary stochascs
were the dierence between a
two exponenal moving aver-
you that there is an impend-
peak is less than or under the
12-day and a 26-day exponen-
ages, which then compares that to
ing downtrend of a substanal
80 percent level, this signals a
al smoothed average. The signal
the 9-period exponenal moving
amount. Therefore, it is impor-
stronger sell signal.
line used is a 9-day smoothing of
average. What we get is a moving
today’s MACD value, subtracted
average crossover feature and a
from today’s, or the last me
zero line oscillator, and that helps
count’s MACD value. Most chart-
us to idenfy overbought and
ing packages give the 12-period,
oversold market condions. The
26-period, and the smoothed
chart in Figure 5.5 shows how the
average of a 9-period for the sig-
MACD helps to conrm buy and
nal line.
sell signals.
There are many variaons and
I might add that since traders are
most charng soware packages
now more computer savvy than
allow you to change the parame-
ever before, many charng so-
rmaon of a lower closing low
MOvINg AvErAgE CONvErgENCE/dIvErgENCE
ters. Just remember, the less me
ware packages allow changing or
triggers the entry, which is on
MACD in its simplest terms is an
periods you input, the more sensi-
opmizing the sengs or param-
the close or the next open. Here
indicator that shows when a short-
ve the indicator will be to price
eters. In other words, it is easy to
are rules to guide you to trading
term moving average crosses over
changes. Therefore, with fewer
change or “tweak” the variables in
a stochascs bearish divergence
a longer-term moving average.
me periods, an indicator will gen-
Appel's original calculaons.
paern:
Gerald Appel developed this indi-
erate more signals. Longer me
•
The rst peak in prices should
cator as we know it today for the
periods help smooth out the false
correspond with a peak in the
purpose of stock trading. It is now
cross-over signals. Some varia-
%K and %D readings above the
widely used for short-term trad-
ons to consider are a 10-period,
80 percent level.
ing signals in stocks, futures, and
a 24-period, and for the smoothed
Forex markets, as well as for swing
average signal line, use an 8-peri-
and posion traders.
od input.
It is composed of three expo-
The concept behind this indica-
Just as is the case for most indica-
nenal moving averages. The
tor is to calculate a value, which
tors, the higher the me periods
inial inputs for the calculaons
is the dierence between the
tant to monitor for divergence paerns.
•
•
Prices should make a lower closing low to conrm a trigger
The bearish divergence paern
to enter a short posion. Enter
signals or forecasts that there is
on the close of the rst lower
an impending reversal in prices
closing low or the next open.
and that one is ready to occur. As
The protecve stop should ini-
I menoned previously, one can
ally be placed above the high
ancipate and get ready to place
of the secondary high.
an order to act on the signal, but you should not act unl the con-
•
The second peak must correspond to a signicant higher secondary price high point.
Traders can increase the me periods in the moving average calculaons to generate less trade signals and shorten the me periods to generate more trade signals. The 15-minute chart in Figure 5.6 shows many signals generated.
Tren Tra ng In cators
used, the less sensive the indicator will be to changes in price
MACD also has a zero base line component, called the histogram, which
movements.
is created by subtracng the slower signal line from the MACD line. If
MACD signals react quickly to changes in the market and that is why a lot of analysts including myself use it. It helps clear the picture when
the MACD line is above the zero line, prices are usually trending higher. The opposite is true if MACD is declining below the zero line.
moving average crossovers occur. It measures the relave strength
MACD is a lagging indicator since it is based o of moving averages. We
between current prices as compared to past me frames, giving a short
want to look for the zero line crossovers to idenfy market changes and
term perspecve relave to a longer term perspecve.
help conrm trade entries or to trigger acon to exit a posion.
To understand how to use this indicator, always remember that when
Watching for clues that idenfy shis in momentum as the market
the fast line crosses above the slow line, a buy signal is generated. The
moves from one extreme to another or overbought to oversold to trig-
opposite is true for sell signals.
ger a trading opportunity can be idened with the aid of MACD readings in both the moving average and the histogram component. While
Tren Tra ng In cators Currency, the MACD histogram
that the high close doji (HCD) trig-
helps idenfy both bearish and
gers a buy that is conrmed and is
bullish divergence paerns.
in sync with the stochascs signal.
You may have the impression I prefer the stochascs over the
Buy and sell signals with a bull-
absolute boom, that is a haphaz-
ish and bearish divergence as
ard guessing game to play. Trading
described in the last chapter
based on a set of rules and being
can also be found using MACD.
able to use a conrming indicator
However, with the MACD, we can
to idenfy a change in price direc-
see the convergence and diver-
on and then following that price
gence in the moving average lines,
movement is the essence of how
and it is more reliable when they
to make money in the markets.
appear in the histogram bars. In Figure 5.7 with the chart for Euro
whopping 237 pips dierence.
MACD study, and for the most
This frequently occurs where
part, I do. The fast stochascs indi-
MACD lags other indicators, how-
cator generally gives conrmaon
ever, it is most helpful as a trend
on my triggers earlier than the
momentum conrmaon tool.
MACD studies. In Figure 5.8, noce
it is more protable in buying the
The MACD triggers six days later a
Tren Tra ng In cators As you follow the ow of the market, you may noce where the MACD triggers a false sell signal, but the stochascs does not. However, once the stochascs %K and %D close below the 80 percent level, MACD helps to conrm the exit.
QUICk QUIz 1. Te stocascs inicato is use to etemine if: a. a market is overbought or oversold b. prices have moved too far, too soon c. a correcon is due . all of the above 2. A “false boom” is oen eeale b wat stocasc inicato paen? a. b. c. .
Bullish convergence Bearish convergence Bearish divergence Bullish divergence
3. A “wea i” is oen eeale b wat stocasc inicato paen? a. b. c. .
Bullish convergence Bearish convergence Bearish divergence Bullish divergence
4. Te moin aeae coneence/ieence inicato: a. Shows when a short-term moving average crosses over a longer-term moving average. b. Is composed of three exponenal moving averages. c. Idenes overbought and oversold market condions. . All of the above. Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
6
Moving Averages
A
simple way to determine the trend is to draw trend lines. In an uptrend, we should see a sequence of higher highs and higher lows. So we would draw a line against the
lows and extend it outward to forecast a support level someme in the future. In a downtrend, as the sequence of events shows lower highs and lower lows, we would draw a line against the top of the highs and extend it outward to help predict a resistance point in the future. Another method used in determining trend line support and resistance is through the use of moving averages. The moving average is generally calculated by taking the average of the closing price of a dened number of sessions. The moving average is one of the most widely ulized indicators in technical analysis. The reason that this is the case is that the moving average is easily idenable and easy to backtest. Many automated trend trading systems use moving averages or some derivaon of a moving average method to generate buy and sell signals. Moving averages are considered classic indicators and are very popular with traders today. Most technicians view the moving average as a way to signal a change in the direcon of the trend, and even for idenfying levels of support and resistance. They can also be used as a way to smooth out the volality of the market.
Tren Tra ng In cators Traders can use just one moving
indexes versus the futures stock
As we have discussed previously
given number of me periods and
average or combine a few dier-
index products. So when using
in this book, all traders, analysts,
dividing the sum by the number
ent ones and overlay these on
moving averages, it is important to
and technicians have equal access
of me periods. A 10-day simple
their charts. By using short-term,
understand that the variables and
to the most important common
moving average is the 10-day sum
intermediate-term and a longer-
parameter sengs of one instru-
denominators. Those are the open,
of closing prices, divided by 10.
term moving average overlaid
ment may be more or less sensi-
the high, the low, and the close.
As the name implies, a moving
on top of the chart, you can see
ve to another due to liquidity and
This chapter is dedicated to vari-
average moves or is considered
the trend direcon of market
trading hours.
ous moving average types, which
a rolling indicator because as a
includes examining these four vari-
new date emerges, you remove
ables. Most traders use the close
or drop the old date in your con-
as their price input for calculang a
nuously rolling new data as it
moving average. There are advan-
becomes available.
prices from a dierent perspecve. Dierent markets such as futures, stocks, exchange-traded funds, and foreign currencies all have their own parcular nuances such as trading hours and trading me frames. So it is important to understand that one set of parameters in the moving average may not work as eciently in one market versus another. For example, in the spot foreign currency markets, such as the euro currency, the trading hours are virtually around the clock ve days a week, compared to trading in the Euro Currency Exchange Traded Fund (FXE), where we have a limited trading session from 9:30 a.m. to 4:15 p.m. EST. This relaonship of me trading dierences even exists between the cash stock
WhAT ArE MOvINg AvErAgES? In its simplest terms, a moving average takes a measurement of past price acon to help smooth out price data. As the calculaon is formulated with each new date as the name implies, the sum moves as an older date is dropped. Since we are using past data to calculate the formula, moving averages are considered a trend following or
tages and disadvantages to only using a close variable input as your moving average. But rst let’s discuss the various types of moving averages, and then we will discuss the parameter inputs to use and the reasons and purposes for measuring these values.
conrmaon indicator. Since mov-
SIMPLE MOvINg AvErAgE
ing averages are based on past
There are two main types of mov-
price acon, they simply cannot be
ing averages. The rst is a simple
leading price indicators. When we
moving average (SMA), which is
discuss past price acon, remem-
dened as dividing the sum of
ber the shorter the me frame,
two or more gures by the num-
the more sensive the moving
ber of gures. When we apply
average will be to price changes.
this to market analysis, it means adding up the price inputs for a
By averaging the price data, a smoother line is produced and the trend is much easier to recognize. The disadvantages of the simple moving average is that it only takes into account the me period of the sessions covered in the calculaon and it gives equal weight to each day’s price.
ExPONENTIAL MOvINg AvErAgE The next calculaon is using what is known as an exponenal moving average (EMA). Exponenal moving averages are calculated from complex formulas and have
Tren Tra ng In cators become the most common aver-
the subject. One such arcle was
pare one me frame versus anoth-
by Frank Hochheimer who wrote
MULTIPLE MOvINg AvErAgES
ages used today by many quote vendors, analysts, and traders
an arcle way back in the 1978
The use of mulple moving aver-
a longer-term outlook. Figure 6.1
since they are weighted to give
Commodity Yearbook entled,
ages gives a trader read of the
shows a daily chart of the Russell
more importance to the newest
“Computers Can Help You Trade
market from dierent perspec-
2000. The white doed line is a 20
data from current market condi-
the Futures Markets.” He con-
ves. Generally speaking, when
day simple moving average based
ons as older data becomes less
ducted a study on 13 dierent
we use more than one moving
on the close, as compared to the
important as me passes and is
commodity markets to nd the
average, we are looking to com-
solid black line, which is a 50-day
eventually ltered out.
opmal moving averages between
Calculang all these numbers by hand or even with a calculator is tedious and me-consuming, but fortunately computers can now
simple, weighted, and exponenal in order to determine the best and most consistent cumulave net prots.
gure all this out for us. A simple
One of his ndings was that each
moving average is straighorward
individual market had its own
and has minimal mathemacal
opmal moving average sengs.
requirements.
Another of his ndings was that simple moving averages outper-
hISTOry OF MOvINg AvErAgES
formed both linear weighted and
We have the aerospace industry
the computer era emerged, more
to thank for the use of simple,
and more traders have developed
weighted, and exponenal mov-
their own backtest studies to op-
ing averages. The formula was
mize their sengs for individual
originally used as a way of calcu-
markets for their individual trad-
lang the trajectory of missiles.
ing needs. In this chapter, we will
As for applying moving averages
reveal various methods and combi-
to trading, many books and maga-
naons from parameter sengs to
zine arcles have been wrien on
the use of mulple simple moving
exponenal moving averages. As
average me frames.
er. Usually it is a short-term versus
Tren Tra ng In cators simple moving average based on
30-, 40-, 50-, 60-, 70-, and 80-peri-
the close. Buy signals are gener-
od moving average system over-
ated when the short-term moving
laid on your price chart. Ribbons
average is above the longer-term
can be used to determine a weak
moving average. An addional l-
or strong trend. With all the mov-
ter can be used to go along when
ing averages poinng in the same
the current price is trading above
direcon, the trend is said to be
both moving averages. You will
strong. Price reversals are con-
noce that by mid March of 2010,
rmed when all the moving aver-
a strong uptrend had developed
ages have crossed over each other
and the shorter-term 20-day mov-
and start to move in the oppo-
ing average acted as support unl
site direcon. Figure 6.2 uses the
mid-May, when prices broke below
e-mini S&P futures contract, illus-
both the 20- and then 50-day
trang an exponenal weighted
moving average. A reversal sell sig-
8-period moving average ribbon
nal would have occurred by early
combined with the 20- and 50-day
June. The short-term moving aver-
simple moving average.
age was below the longer-term
A good bullish setup to determine
moving average, and as an addi-
a high quality trade is not only
onal lter, current prices were
when the shorter-term moving
trading beneath both moving aver-
averages cross up over the inter-
age values.
mediate and longer-term sengs; in addion, we look for prices to
MOvINg AvErAgE rIBBONS
lengths. Since most computers and
by a specic me period, or by a
Moving beyond the use of two or
trading soware plaorms have
percentage. To create a simple
three dierent me period mov-
advanced graphics cards, the rib-
moving average ribbon for exam-
An addional lter would be if the
ing averages is the moving average
bons are mostly seen using gra-
ple, you start by using a 10-period
market closed at least two con-
ribbon. The ribbon as it is called is
dient colors. The ribbon moving
moving average, using 8 moving
secuve me periods above the
created by using a series of expo-
average method starts with one
averages increasing by 10 periods,
moving average sengs, as this
nenal moving averages of various
me frame and increases either
so that you will have a 10-, 20-,
would reduce the likelihood of a
close above all moving averages.
Tren Tra ng In cators reversal failure. Since most failed
high, and the low. For this secon,
market reversals or false breakouts
we want to focus on taking a mov-
occur almost immediately, waing
ing average of both the high and
for conrmaon by mulple closes
the low. In doing so, we will form
reduces the likelihood of a failed
a moving average channel. The
breakout. The downside to this l-
raonale here is that if we are in
tering method is that we increase
a strong uptrend, prices will con-
the risk factor because prices have
nue to close above past or prior
moved higher from the lows and
highs and will connue to move up
we reduce the potenal lion’s
unl the market or current prices
share of the prots since the trend
close below the average of past or
in this trade will have been su-
prior lows.
ciently intact.
In Figure 6.3, we have an e-mini
Another lter I use is if the real
S&P chart based on a ve-minute
body (open, close relaonship) is
me interval. We took a seven-
above the moving average sengs
period simple moving average of
for two or more periods. Others
the highs and a seven-period sim-
have used the enre range to help
ple moving average of the lows.
lter higher quality setups to enter
As you can see from this example,
posions when trend trading using
a strong uptrend developed once
moving averages.
the market closed above the upper channel or the seven-period mov-
MOvINg AvErAgE ChANNELS
ing averages of the highs. Noce
As we discussed previously, there
the lower band or the seven peri-
are four main variables that we
od moving averages of the lows,
all have equal access to and c an
the market entered a dened
use to input for moving averages.
downtrend. The moving average
BOLLINgEr BANdS
These are the open, the close, the
channel method helps traders stay
The moving average channel is a
on the right side of the market by
simple and less complicated meth-
that once the market closed below
idenfying posive or negave
od to calculate than using volality
momentum or strong trending
bands such as the more popular
market condions.
and famous technical tool known as Bollinger bands. Bollinger bands are made up of three moving average components in which the width of the bands expand or
Tren Tra ng In cators contract as price volality increas-
the lower Bollinger band, one may
CONFIrMINg INdICATOrS
is intact is not only when prices
es and decreases. The bands are
look to take a buying opportunity.
A word of warning when it comes
close outside of the bands, but
measured based o of the center
But when prices close below the
to using indicators for conrma-
also when the Bollinger bands
moving average component using
lower Bollinger band, traders can
on—make sure they are not
widen and point in the direcon
a 20-day simple moving average.
develop either an exit strategy
similar in nature or related in
of that trend. In addion, Bollinger
The upper band is calculated by
on long posions, or start to sell
parameter sengs. Remember;
bands can act as a gauge of vola-
mulplying the standard deviaon
short, ancipang that prices will
avoid collinearity when using
lity when the bands contract or
by two and the lower band is cal-
connue lower.
addional technical indicators for
come together; it shows when
On the other hand, as prices reach
conrmaon.
the market is in a period of low
culated by subtracng the 20-day moving average by two standard deviaons. •
•
gies from long posions or start
moving average
to implement short trades. It is
(20-day standard deviaon of price x 2) •
can start to look at exit strate-
Middle Band = 20-day simple
Upper Band = 20-day SMA +
important to note that in strong trending periods, prices will “walk the band,” meaning they will connue to move up or down when
Lower Band = 20-day SMA -
selement prices occur outside of
(20-day standard deviaon of
the bands averages. Just because
price x 2)
prices “tag” the Bollinger bands,
Simply put, two standard deviaons means that 87 percent of all prices will close inside the Bollinger bands. The Bollinger bands try to help us uncover whether prices are too high or too low in relave terms. A simple trading plan can be executed so that when price touches
volality or a consolidaon phase.
towards the upper band, traders
The benet to traders here is that
Make sure that indicators used for conrmation are not similar in nature or related in parameter settings.
meaning they are drawn either
once you understand that markets go through phases of volality or trend phases and then pause into consolidaon periods, it is the Bollinger bands that can help idenfy these dierent cycles or phases by examining the narrowing or widening of the bands. Figure 6.4 shows a daily candle chart on Google (GOOG) with a
to the upper or lower band, this
For example, avoid following
20-period simple moving average,
in itself is not a buy or sell signal.
any indicator that uses an 18- to
using the standard deviaon from
In order to improve the quality
22-day simple moving average set-
the formula menoned above. In
of the trade signal, one needs an
ng, because Bollinger bands use
early April 2010, prices broke out
addional indicator for a trade
the 20-day simple moving aver-
to the upside of the top band, but
conrmaon.
age for the middle band. A really
experienced a large gap lower in
good sequence of events to watch
price as the market trended lower.
for to conrm that a strong trend
Noce the direcon of the three moving average components all
Tren Tra ng In cators cators or trading techniques for conrmaon before entering trades, and Bollinger bands are no excepons.
CONFIrMINg PATTErNS Other means of conrming indicators can be the use of just simple patterns such as “M” top and “W” boom formaons. By denion, a “W” boom is a series of higher highs and higher lows, and an “M” top formaon is a series of lower highs and lower lows. In Figure 6.5, we see a
pointed down and prices hugged or “tagged’ the lower band. This illustrated a bearish market turn and downtrend. It wasn’t unl late July that prices traded back up above the middle band, which by early August acted as support. Besides idenfying support and resistance targets, Bollinger bands can also aid traders in uncovering direconal trend changes. As with most indicators, traders should incorporate other indi-
Tren Tra ng In cators daily chart on Wells Fargo (WFC).
ful to actually take the average
is that traders can focus on the
act as resistance. This is one idea
As you can see, right around July
of moving averages. Instead of
signal and the price to moving
that may help you start to devel-
5, we have a series of lows and
having excess informaon or mul-
average relaonship. If the market
op your own automated trading
closes beneath the lower Bollinger
ple moving averages overlaid on
truly is in a sell mode or bearish
system using moving averages to
band. Five days later, we suddenly
charts, you can more easily work
trend condion, then the average
idenfy trends.
nd the market piercing through
with one moving average overlaid
of both moving averages should
the middle band, almost closing in
on prices. The benet here is if
on the upper band. As the market
you have a charng program that
pulls back, noce it forms a sec-
can give indicaons of when mov-
ondary low on July 20, which is a
ing averages cross over, generang
higher low. This is what starts to
buy and sell signals, and you can
form the “W” paern.
use the moving average as a direc-
In addion, the secondary low is above or inside the lower Bollinger band. To take one step further,
onal moving trend line. It will not burden you with informaon overload and clog up your graphs.
you will also see that the July 20
In essence, with soware program
low is formed with a higher close
such as Genesis, TradeStaon,
than open sequence. Swing trad-
or Thinkorswim’s charts, trad-
ers can look to buy near the close
ers can have indicators built-in
of this bar at 25.91, placing stops
to give alerts or arrows when a
below the low formed on July 5 at
crossover of two moving averages
24.60. The prot objecve would
actually occurs. As you can see in
be near the top of the Bollinger
Figure 6.6, you only have to have
band at 28.55.
one moving average overlaid on prices, but as the arrow poinng
AvErAgINg MOvINg AvErAgES
down shows, you have a sell sig-
When you are using a series of
of intersecon of the crossover
moving averages, it can be help-
from the hidden moving average.
nal that develops from the point
Once again, the advantage here
Tren Tra ng In cators PIvOT POINT MOvINg AvErAgES
my favorite moving average con-
This informaon provides a clear
when markets are in a trending
cepts is using the typical price for
picture of the “average true price”
phase, and when applied correctly,
We have not discussed calculat-
a specic me period—otherwise
as a gauge of bullish or bearish
they allow the trader to let prots
ing a moving average using a
known as the pivot point—which is
market condions for that me
run and cut short their losses. That
combinaon of the four common
derived from taking the sum of the
period. In Figure 6.7, we have a
is, if one devises a specic trading
denominators (open, high, low,
high, low, and close and dividing
daily chart on the e-mini S&P.
plan with buy and sell signals that
and close) or averaging out one or
by three. The formula again is:
Noce that the pivot point mov-
have incorporated the use of mul-
ing average “hugs” prices closely
ple moving averages.
more of these components. One of
(h+L+C) / 3 = Piot Point
when we are in a trend mode. The moving average acts as a support in an uptrend phase and this moving average acts as a good resistance line in a downtrend phase. Always remember that the shorter the me frame, the more sensive the moving average will be to direconal price changes. The moving average used here is a simple moving average using a veperiod pivot point seng rather than the close.
MOvINg AvErAgE OSCILLATOrS ANd hISTOgrAMS If I have not stated it already, let
As the saying goes, “the trend is your friend,” but the age-old queson begs, so when does the trend end? To help answer this queson, savvy technicians and computer geeks who like to develop their own indicators can devise an oscillator to compare the dierence between two moving averages, as well as closing price to the distance of those moving averages. Based on moving average values, it is very relevant and possible to develop a histogram component by seng a standard deviaon of where a closing price is located to the last known value of the moving average.
me make sure we cover this sub ject now—because moving aver-
Based on a historical viewpoint,
ages are trend-following mecha-
an oscillator like this can be used
nisms, they obviously work best
to help determine the strength
Tren Tra ng In cators or weakness of a trend. In other
I created this histogram, I under-
words, this method can be used
stand and have more condence
to determine if prices have more
in what it’s trying to tell me, and
room to run, or if they have
therefore it helps me make a bet-
reached an overbought or over-
ter educated and informed trading
sold condion by looking at the
decision.
values of the current market price
MOvINg AvErAgES SUMMAry
and the moving averages. As prices depart too far from the means or the short-term moving
In summary, moving averages can
average starts to aggressively pull
be used in a variety of ways other
too far from the longer-term mov-
than just looking at a 200-day
ing average, one can construct a
moving average based on the close
histogram to help illustrate this
(which is the normal seng that
relaonship. It is even possible to
most stock pundits or the media
trade a convergence or divergence
will quote), as you can see from
based o of the paern in the
this chapter. You have now learned
histogram, similar to what is used
that there are a variety of param-
with MACD. Figure 6.8 shows a 15-minute intraday chart on the Euro Currency FX using my TradeStaon plaorm. I have a simple moving
age oscillator, which helps me
a higher low. We call this bullish
generate buy and sell signals, and
convergence. What this indica-
gives me clues to when the market
tor has idened is that the price
has reached an oversold or over-
has departed too far from the
bought condion.
means and that this downtrend
average overlaid on the chart to
Look at the low at the 7:30 a.m.
help me idenfy trending mar-
me frame; now look at the corre-
ket condions. As you can see,
sponding histogram reading. Then,
the boom secon of the chart
take a look at the low at approxi-
has what is labeled the Person
mately 9:45 a.m., and you should
Histogram. This is a moving aver-
see that the histogram reading has
that started approximately at 6:30 a.m. has likely exhausted itself. This is a very valuable tool in my trading because it helps me make the determinaon of entering and exing trades. Due to the fact that
eter sengs you can ulize in different ways in order to capture a reading of what these moving averages are telling us about the condion, and more importantly, the trend of the market.
Tren Tra ng In cators QUICk QUIz
7
1. Te simple moin aeae is calculate: a. From complex formulas b. By summing the price inputs for a given me period and dividing that sum by the number of me periods c. By dropping old price data as new price data emerges . From a series of weighted averages
Dow Theory
C
harles Dow was one of America’s most famous stock
2. Wen calculan te eponenal moin aeae, a. b. c. .
Past market condions must be taken into consideraon. More weight is given to newer data. Backtesng conrms accuracy. A calculator should be used.
3. To elp etemine te stent of a ten, use: a. b. c. .
Moving average channels Exponenal moving averages Moving average ribbons 50-day moving averages
market observers. His reputaon revolved around the fact that the market made connued gyraons. He
observed that the stock market moved in three phases. His observaons included that the market had short-term daily uctuaons, an intermediate-term trend called a secondary wave, and a longer-term trend called the primary wave. The primary uptrend was characterized by three upward swings. It was the work of Charles Dow that Ralph Ellio incorporated to create the Ellio wave theory. Back in 1897, the Wall Street Journal printed out two main indexes. One was the Industrial Average and the other one
4. Te Peson istoam elps a tae to: a. b. c. .
Make the determinaon of entering and exing trades. Generate buy and sell signals. Idenfy market condions as overbought or oversold. All of the above.
was the railroads, which is now what we call the Dow Jones Industrial Average, and the transportaon index. Back in the early 1900s, it was very easy to manipulate an individual stock. It was nearly impossible to manipulate a group of stocks, and that was what Charles Dow believed would be a beer way to gauge the strength of the economy, by looking at the overall
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trend of these indexes. That way, it gave him a beer idea of the bigger picture of the trend of the market. There was a third index added called the Dow Jones Ulity Index, and it helped to conrm a boom or bust cycle.
Tren Tra ng In cators Charles Dow had certain principles of conrmaon—if two of the three
dOW’S BULLISh PhASE ThEOry
sectors were rising, this would be good conrmaon that the economy
Dow believed an overall bull or bear market was created by three dis-
was in a bullish market trend condion, and therefore one could look
nct phases. A bullish buy signal was established once the market trad-
at buying stocks. If the industrial and the transportaon indexes were
ed above the high of a previous rally aer a denive downtrend (see
declining, that would signal an overall weakness in the economy and
Figure 7.1). Once prices trade above a previous high aer forming a dou-
that one may want to look to take prots in the markets. These were
ble boom, or what is known as a “W” paern, a buy signal is iniated.
known as simple but strong conrming index tools. Through me, we have seen many changes, including newer indexes, like the technology
If you examine the graph in Figure 7.2, you will see the disnct “W”
sector as represented by the NASDAQ. Now we also have exchange
paern or the double boom. Once the market trades back above the
traded funds (ETFs) on indexes like the S&P 500 called the SPDRs (SPY)
rst swing high, a buy signal was iniated. This is a weekly chart on
or the NASDAQ (QQQQs). To take maers further, we now have ETFs on the top sectors such as nancials (XLF), material stocks (XLB), the energy sector (XLE), and even consumer staples (XLP) just to name a few.
Tren Tra ng In cators the e-mini NASDAQ 100 futures.
comprise the market’s makeup
is the bull market. They just want
high, the feeling that one can’t
When combining this setup with
are in my opinion: precauonary
to get in something before missing
lose prompts the need to borrow
an understanding of Dow three
fear, lack of discipline, and greed.
the move. This is when we witness
money or become heavily lever-
wave phase theory, it is amazing
The beginnings of a bull phase are
a lack of discipline; investors buy
aged in the market. This was the
to see this acon as recently as
as markets are forming booms
just to get in, and they lose sight of
case in 2000 as the “tech wreck,”
the low in March of 2009. It’s been
known to be in accumulaon phas-
their trading plans.
as it was called, posted the top in
approximately 100 years since
es; this is known as Phase One.
Dow rst published his work, and
Investors who are cauous buy
Pase Tee
technology sector as represented
we sll see these setups working.
high-quality, beaten-down stocks
Phase Three is generally when
by the NASDAQ. My theory is that
Idenfying and trading a newly
and limit purchases. In other
the irraonal exuberance state or
due to the massive inicon of
discovered trend requires a bit of
words, they are just nibbling at
extreme speculaon takes place.
monetary loss on a large audience
knowledge in what to look for, as
this point. Typically, investors start
Investors will do anything to get
of speculators, it my take years if
well as paence and discipline. The
buying ulity stocks or high divi-
in on the acon, greed takes
not another decade or a terric
setups are there and they work,
dend yielding stocks. They want to
over, and this is where you nd
bull market to aract those who
if you know what to look for and
make money, but are afraid of los-
increases in margin trading. Many
lost money in that event to come
how to apply these principles.
ing, thus they are being cauous.
will borrow money to buy stocks
back into the market again.
As the fear of loss prevails, there is
to not only get in on the acon,
BEgINNINgS OF A BULL MArkET
lile in the way of courage.
In Figure 7.2, the price acon
but also with real hopes to “get
showed a steady stream of rising
rich quick.” Stock picking based on
Pase Two
prices aer the conrmaon buy
Once you have idened a bull-
value or posive earnings is usually
signal. Prices connued steadi-
ish setup, applying the concept
Then as the trend matures, we
not important at this stage of the
ly higher throughout 2009 and
of Dow’s theory can help you not
enter into what is known as Phase
game. People just get in believing
into early 2010. Certainly by mid
only potenally ride a trend a bit
Two. As the market starts to prove
stocks will keep going up.
February of 2010, phase one and
longer, but his theories can help
itself by displaying higher prices, volume starts to increase as more
This is the ulmate state of greed;
two were completed. As Figure
you correctly idenfy when a
and more investors buy as their
all levels of logic are abandoned,
7.2 shows, we had not yet expe-
trend may be exhausng itself.
emoons rule, and there is no lon-
rienced a typical phase three bull
ger that precauonary level of fear
market condion since prices did
that existed as it did in phase one.
not escalate to an irraonal exu-
The condence level is excessively
berance state. In fact, we had yet
condence level rises. Investors will
Pase One
start buying lower grade and small
The principles behind the emo-
cap stocks, just to get in the mar-
onal state of the masses who
ket before what they now believe
the stock market, in parcular the
Tren Tra ng In cators to experience any criteria for the beginnings of a bear market which I will explain now.
dOW’S BEArISh PhASE ThEOry A bear market or bullish reversal move is commonly idened once prices break below an important support level or old low. I like to sell against a failed double top as prices trade below the old low for conrmaon. In Figure 7.3 below, a sell signal occurs as prices trade below the low of what is also known as an “M” top paern. I just menoned the “tech wreck” that occurred in late 2000, and the graph in Figure 7.4 is a monthly chart on the e-mini NASDAQ 100 futures contract that shows a text book case of the “M” top paern that iniated not only a substanal sell signal but also the end of that bull mar-
ket’s trend. The three phases of the bullish side were very prominent in the rally preceding the bear market. As of this wring, we have sll not even come close to the highs made back then. In fact, many companies are either out of business or were acquired by others. Now, let’s look at Figure 7.5, a daily chart on the U.S. dollar index. Here is a classic double top or “M” top paern that iniated a signicant bear market move. Granted, this index was not around when Charles Dow stated his theories. However, when applying his theories on a bear mar-
Tren Tra ng In cators Pase One: distibuon Dow believed that like a bull market, there were three part s to a bear market, beginning with the distribuon phase. This is where there is a longer bale between bulls and bears, mainly when the general public is buying as professionals are selling to unload their long posion. Have you heard the phrase, “tops take longer to form than booms?” Noce in Figure 7.5 that the top lasted over one month before the sell signal was generated as the market entered a signicant bear trend.
Pase Two: Panic Phase two is what was termed the “panic” period. This is where prices accelerate rapidly to the downside, usually without any upside correcon. This could be a period where the media may be publicizing the fact that the bull market has ended and traders who were long might look to liquidate their longs to stop the bleeding.
Pase Tee: Capitulaon Phase Three is what I call the capitulaon period. We will see larger down days than before, and volality is ex tremely high as measured by wide price swings. But overall volume starts to dry up as extreme pessimism reigns supreme. ket condion combined with the failed double top paern, one would be able to ride this bear trend for a substanal prot. The similaries between these two markets are simply too strong to ignore. Both the NASDAQ 100 and the U.S. Dollar were highly visible in the media, but it is the “M” top paern that is consistent with creang a signicant bear market trend. Let’s review Dow’s bear market theories.
I believe it is due to the mass psychological aspect of human behavior that has proven the Dow Theory again and again. It has certainly not only stood the test of me, but it is applicable in markets that did not even exist in his own day. Apart from imbalances in supply and demand, it is the understanding of the three principles of precauonary fear, lack of discipline, and greed that will help you dene a trend. Truly successful trend traders plan out their trades, from when to enter to where
Tren Tra ng In cators to place their stops. They have faith in their methodology and act with courage when it is me to place an order. Greed does not dictate their trades, price acon does.
QUICk QUIz 1. dow’s teo on te maet’s aons inclue: a. b. c. .
Short-term, intermediate-term, and long-term trends Daily, secondary, and primary waves Ellio, Gann, and Dow uctuaons Both a & b
2. Accoin to dow, te tee pases of a beais maet ae:
8
Volume and Open Interest
T
rend analysis comes in many forms and indicators. Aer understanding and examining the direcon of price, which includes the close as well as the current close as
compared to past price acon (old highs, lows, opens, and closes), the next best conrming indicator for trend traders is vol-
a. b. c. .
Distribuon, panic, and capitulaon Precauonary fear, lack of discipline, and greed Irraonal exuberance, extreme speculaon, and accumulaon Lower high, lower low, double boom
3. duin a bull maet, ou ae most liel to n taes epecn to “et ic quic” in wic of dow’s pases? a. b. c. .
Phase One Phase Two Phase Three None of the above
ume. There is one more exclusive indicator for futures traders and that is open interest. These are important tools which will give clues to the strength or weakness of a trend, or as we technicians say, the health of the trend—so let’s review the basics.
vOLUME The denion of volume is the number of trades for all shares in stocks, or for commodies, the total amount of trades for all contract months of a given futures contract both long and short,
4. Accoin to dow, conmin an oeall ten amon aious inees enables one to aue te stent of te econom.
combined. For example, stock index futures like the e-mini S&P’s
a. True b. False
raons, which include March, June, September, and December
or the foreign currency contracts all trade on quarterly expicontract months. The volume will represent the total for all the trades in each contract month.
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Tren Tra ng In cators Most technical analysts believe that volume is an indicator of the
•
strength of a market trend. It is also a relave measure of the dominant behavior of the market. Volume is the measurement of the market’s acceptance or rejecon of price at a specic level and point in me.
and can be used to predict a reversal. •
ing in price and the volume is increasing, the market is said to be in a
Decreasing volume with a weaker price environment shows that fresh sellers are reluctant to enter the market and could be a sign of
There are several theories and so- called rules when using volume analysis on price charts. The rst rule to remember is: if a market is increas-
Decreasing volume while prices are climbing may indicate a plateau,
a future downtrend. •
Excessive volume while prices are high indicates that traders are selling into strength and oen creates a price ceiling.
bullish mode and can indicate further price appreciaon. •
Excessively low volume while prices are low indicates that traders are buying on weakness and oen creates a oor.
If a market is increasing in price and the volume is increasing, the market is said to be in a bullish mode and can indicate further price appreciation. The opposite is true for a declining market.
In Chapter Six, we discussed the use of moving averages. One technique that many traders use is taking a moving average of daily volume. This helps examine the overall trend of volume as well as lter and pinpoint abnormal decreases or increases in trading volume acvity. Let’s examine the graph below in Figure 8.1. This is a weekly chart on the stock Nelix, Inc. (NFLX), which as you can see experienced a stratospheric price increase starng in early 2010. The upper poron of the chart shows the candlesck price chart and the boom poron reects
The exact opposite is true for a declining market. However, if a substanal daily market price increase or decrease occurs aer a long steady
the bar histogram of weekly volume with a 20-week simple moving average overlaid on the volume graph.
uptrend or downtrend, especially on unusually daily high volume, it is
The low made in February of that year was marked by a bullish rever-
considered to be a “blow-o top or boom,” and can signal a market
sal on—at that me—the heaviest weekly volume. As the price trend
turning point or trend reversal. Here are some guidelines to use when
climbed higher, noce that the direcon of volume also increased, con-
using volume analysis:
rming the rally was real and sustainable. This shows there was an accu-
•
Increasing volume in a rising price environment signals excessive buying pressure and could lead to a substanal advance.
•
Increasing volume while prices are falling may signal a bear move.
mulaon of shares, or as we idened in the rst bullet point, increasing volume in a rising price environment. It signals excessive buying pressure and in this case it did lead to a substanal price advance.
Tren Tra ng In cators ket and more new money is ow-
IdENTIFyINg OPPOrTUNITy
ing into the market. This reects
This informaon can be used to
why the price increases.
idenfy an opportunity when
Of course, the exact opposite
there is a major top or boom in
is true on a declining market.
the futures markets. If you are a
Charsts combine both the price
stock trader, you may also want to
movement and the data from vol-
pay aenon to this data, espe-
ume and open interest to evalu-
cially if you are trading high beta,
ate the “condion” of the mar-
or stocks highly correlated to
ket. If there is a price increase on
underlying commodity markets.
strong volume and open interest
For example, in the graph in Figure
increases, then this is a signal that
8.2, we have a daily chart on corn
there could be a connued trend
futures. There are several compa-
advance. The opposite is true for a
nies that come to mind that have
bear market when prices decline.
a vested interest in what happens
If price increases, volume stays
to the trend in corn prices; one is
relavely at or is lile changed,
Archer Daniels Midland (ADM) and
and open interest declines, this
another is Bunge (BG).
reects a weakening market con-
A good queson to ask would be:
dion. This is considered to be a
can higher corn prices help or hurt
bearish situaon because if open
a company’s boom line? To a
OPEN INTErEST
short, and for every buyer there is
interest is declining and prices are
a seller. The open interest gure
stock trader, it would be important
On the other hand, open inter-
rising, then this shows that shorts
represents the longs or shorts, but
on a price advance to ascertain
est reveals the total amount of
are covering by buying back their
not the total of both. So the gener-
if the move was sustainable and
open posions that are outstand-
posions rather than new longs
al theory for open interest is that
accompanied by widespread accu-
ing in existence and not oset or
entering the market. That would
when prices rise and open interest
mulaon, rather than a short lived
delivered upon. Remember that in
give a trader a clue that there is a
increases, this reveals that more
price spike. Here is where volume
futures trading, this is a zero sum
potenal trend reversal coming.
and open interest would help one
game. For every long there is a
new longs have entered the mar-
gather further evidence.
Tren Tra ng In cators
Noce in Figure 8.3, we have three
price advance, accompanied with a
there could be a sustainable price
Hecla Mining (HL). Now whether
separate panes. The top secon
rise in open interest, revealing that
advance over me.
you are a futures trader or a stock
is a candlesck, the middle is the
traders are adding to longs with
open interest data, and the bot-
an increase in trading volume. This
tom secon is a volume histogram
indicates that traders are accu-
with a 20-day moving average
mulang posions and that the
study overlaid on the bar graph.
health of this trend is very strong.
From late June of 2010, we see the
This helps one to understand that
Let’s examine the graph in Figure 8.3 further. Gold can be traded as a futures contract, or stock traders can trade an exchange traded fund (GLD), or highly correlated stocks such as Newmont Mining (NEM) or
trader, here is where volume and open interest analysis can help traders understand the overall health of the trend. This informaon may help traders stay with the trend a bit longer. Like the
Tren Tra ng In cators old saying goes, “ride the winners and cut your losses,” using these technical tools may help you to see if the price advance or the trend is sustainable. As the chart shows, once again as prices start to boom in late July of 2010, the open interest gures shown in the middle secon start to increase. This is also accompanied by an increase in volume. Together, this signals that the start of the new bullish trend is healthy and sustainable.
CONCLUSION There are many indicators that rely and are
QUICk QUIz 1. volume is an inicato of te ealt of a maet ten. a. True b. False 2. If olume is inceasin in a isin pice enionment, ten: a. b. c. .
The market is in a bullish mode The market is in a bearish mode Further price appreciaon can be expected Both a & c
3. deceasin olume in a weae pice enionment:
built based upon prices, but very few are derived using volume studies, and as far as commodies are concerned, the open interest data. Both tools are instrumental for the traders who want to stay on the right side of the trend and are easy to access. Remember, these tools help conrm the overall health of the market trend.
a. b. c. .
Indicates a plateau. Can be used to predict a reversal. Could be a sign of a future downtrend. Indicates a bear market.
4. Wen pices ise an open inteest inceases:
9
Trend Lines TrENd LINE ANALySIS
I
was taught nearly 30 years ago, the most protable way to trade is with the trend. So naturally, it’s impor-
tant to idenfy what the trend is and in what market condion you are trading. Unfortunately, many people do not adhere to this advice, either by trying to outsmart the market or leng their intelligence or ego interfere with a simple raonale of idenfying the current market condion. In this chapter, I will disclose some of the more proper methods for idenfying the market condion, or what we call the trend, by simple line drawing techniques
a. b. c. .
New longs have entered the market. New shorts have entered the market. Money is owing out of the market. Traders are taking prots. Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
and ways to help idenfy when a market trend is potenally exhausng itself or running out of steam. I will also show some of the techniques that I learned early in my career on how to correctly use trend line analysis to help me implement trades. Most importantly, based on these techniques, I will cover how to look for
Tren Tra ng In cators inial entry points of interest, stop placement levels, spots to add on
FIrST ThINgS FIrST
posions once a trend is maturing, and places to move protecve stop
I was always taught if you are going to analyze the market, you need to
orders based on the use of drawing lines on my charts.
gure out where prices can go. To do that requires you to look at where
Throughout the history of the trading industry, many phrases and cli-
prices have been. Start with looking at the longer-term picture. Drop
chés have evolved due to past human errors and successes. From my
down to the intermediate term and then to the short-term me frame.
30-plus year career, I would like to share with you some of the tech-
For longer-term invesng requiring more than one month, I will start
niques and taccs for successful trend trading based on some of those
with the monthly chart. Drop down to a weekly chart and use my daily
phrases.
or end-of-day charts. For swing trading, I will sll look at the weekly and daily me frames, but include a 60-minute chart. For day traders, I like
ThE TOP FIvE SECrETS TO rEMEMBEr WhEN TrENd TrAdINg 1. The trend is your friend. 2. The trend is your friend unl it ends. 3. Never ancipate when a new trend will begin; markets have a habit of
moving further than traders expect. 4. When in a bullish trend, buy pullbacks. 5. When in a bearish trend, sell rallies.
to look at the weekly and daily market direcon and then take trades based o of the 5- and 15-minute me frame. As for drawing trend lines, the important thing here is to idenfy the pivotal swing points, both highs and lows, and then extend a line out to help idenfy the trend’s direcon. Let’s examine Figure 9.1. This is a chart on Potash (POT). I have purposefully made a black and white chart so that if you print this page out, it will be seen clearly. From the low marked point “A,” which was created by a “W” boom paern as the right side low was formed by a hammer candlesck, the market moved up to the rst pullback low, or swing low. This is where we would con-
In this chapter, we will go over the proper techniques for drawing trend
nect the trend line and extend out in the future. As the saying goes,
lines such as lines drawn from lows, from highs, and from range mid-
“the trend is your friend unl it ends.” Here is how correctly drawing
points. We will discuss the importance of the condion and locaon of
trend lines can help you idenfy a change in a trend’s direcon.
those trend lines specically, the angle, degree, and separaon from price to the trend line.
Once prices have traded beneath the longer term extension, say for two consecuve closes below the trend line, one can argue that the trend has changed direcon. Aer the peak at point “B,” the trend started to
If you are going to analyze the market, you need to gure out where prices can go.
reverse and change direcon. So does one look to buy the pullback as prices start to close back in on the line extension? If one did not enter at the beginning phase of this “W” boom paern, then one could look for
Tren Tra ng In cators
a low risk trade setup by buying
small loss. As you can see, prices
Let’s examine the next graph in
towards this support line, that
a test of the trend line extension.
connued lower. Once a reversal
Figure 9.2; this is a weekly chart
would be a targeted area to look
However, once prices fail to con-
occurs, traders wait for “bounces”
on McDonald’s (MCD). Another
to enter a long posion. As we
nue higher and close beneath the
or rallies to sell against. One such
double boom forms, creang
say, this denes buying pullbacks
uptrend line; in other words, fail
rally occurs in early May as the
the “W” paern from point “A” to
in a bullish environment. Point “C”
to hold the trend line support, the
chart shows. To determine future
point “B.” If one wanted to draw
intersects right at the trend line
trader should exit the long posi-
overhead resistance, one would
a textbook upward sloping trend
extension. Noce that the candle
on. This would result in a loss,
draw a line against the high at
line, it would exist at a nearly 45
formaon is a bullish engulng
but as the example here shows, a
point “B” and extend out.
degree angle. Once prices retrace
paern, which may help to con-
Tren Tra ng In cators However, once prices break out and above that level, if the market is to prove itself to be bullish, prices should not trade back under that line. The line of old resistance should prove to become the new line of support. Instead of buying the market on the rst breakout of old resistance, most conservave traders will wait unl the market pulls back to the horizontal line and then they will go long with close stops because the price acon should hold based on the theory that old resistance should act as new support. In this example, trend line “B” has acted under that old axiom.
QUICk QUIz 1. Pope ten line analsis can elp taes ienf: a. b. c. .
Inial entry points Stop placement levels Add-on posions All of the above
2. Wen in a bullis ten, bu pullbacs. a. True b. False 3. Wen in a beais ten, sell pullbacs. a. True b. False 4. A tae soul eit te lon posion:
rm the posive momentum as
support. Figure 9.3 helps to illus-
prices bounce o of the newly
trate this technique. In Figure 9.3,
constructed support trend line.
using the same weekly chart on
We have addressed how to properly idenfy bullish trend lines, one area that I believe is crical is idenfying what we say is “old resistance,” which turns into new
McDonalds (MCD), you can see the old highs during 2008. If you draw a horizontal line across your chart as prices boom in 2009 and start the new uptrend, that old high is creang a ceiling of resistance.
a. As prices connue higher b. When prices close beneath the uptrend line c. When prices hold the trend line support . All of the above Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
Tren Tra ng In cators 10
Elliott Wave Theory
N
o book on trends would be complete without some introducon on the
Ellio wave theory. I do not necessarily use Ellio wave theory consistently in my trading, but I do know the principles of the waves and the theory behind the psychological aspects that drive human beings are reected in market prices, namely fear and greed. As it is oen stated, human emoon oen interferes with human intelligence. I want to share with you my experience, feelings, and observaons on this theory, as well as quote a good acquaintance who is one of the premier technicians in the world on the eecveness of Ellio Wave, who says: “it works when it works.” This means that I do not use it all the me, and as
I disclose the principles here, you
and “M” top formaons, seasonal
thing that has been achieved and
will understand why. So I guess
analysis, pivot points, moving aver-
pracced even by Mr. Ellio him-
you are now asking yourself why
ages, trend lines, indicators like
self. His discoveries were simply a
bother sharing it in this book? The
ADX, MACD, and stochascs, and
compelling phenomenon into the
reason is because it reveals trends
volume and open interest studies.
art of forecasng price moves. I
and the trend paerns.
hISTOry ANd vALUE OF ELLIOTT WAvE
I believe it is important that traders have a complete understanding of trend analysis but also phases or waves as they are con-
will cover the basis for his discoveries and the overall strengths as well as weaknesses of his work. Keep in mind that Ellio wave is a fractal concept which works in
Ralph Nelson Ellio (1871-1948)
sidered. Ellio wave principles can
was a dedicated student of the
help you uncover just that, and
stock market. Back in the 1920s,
more specically, what phase or
he observed market moves, both
“wave” the market trend is in. As
bullish and bearish, occur in three
you may have already discovered,
disnct phases. He began to
all markets certainly do trade in
develop theories and views that
phases, from periods of consoli-
the overall prices in stock market
daons to trending modes. With
averages move in waves. This was
the knowledge of the Ellio wave
presumed to fall in line with the
principles, this informaon may
understanding of the work cred-
give you a beer understanding of
A completed Ellio wave cycle
ited by Charles Dow as dened in
which side of the market to be on,
from bullish to bearish or bearish
the Dow Theory.
and to capture protable moves
to bullish consists of eight waves.
The purpose of this chapter is to
with surgical precision. And hope-
There are two disnct wave deni-
give an introducon as to what
fully more mes than not, trading
ons. Impulse waves are the ones
Ellio wave is and how you can
from the winning side.
termed to be moving with the
apply this method in the markets
Since many of the concepts
combined with what we have
explained already are great tools
already covered, incorporang
in and of themselves, combining
Impulse waves have ve primary
Dow Theory with “W” booms
them with Ellio wave is some-
price movements and the cor-
mulple me frames so that it can truly benet all styles of trading from day to swing to posion traders. The fractal concept is simply dened as cycles or paerns repeang in shorter me frames and developing in longer-term me periods, meaning there are waves within waves.
main trend and correcve waves are against the main trend.
Tren Tra ng In cators recve waves are seen as having
posed of eight price moves, ve
For more experienced charsts,
wave one count for the weekly
three primary price moves, which
up and three down, as you can see
they would of course recognize
me period. We can also see a ve
are leered and run in the oppo-
in Figure 10.1. Incidentally, three,
that the end of a bullish move’s
wave count on a ve minute chart
site direcon of the main trend.
ve, and eight are contained in
h point could possibly be con-
that composes just wave one on
A healthy long-term trend follows
the Fibonacci series of numbers.
sidered the number one point of
a daily chart. Ellio wave theory
the indicaon of heavier volume
The fundamental concept behind
a one-two-three formaon, or the
combines the best of tradional
during the impulse waves (one,
Ellio’s theory is that bull markets
top of a head and shoulders for-
charng techniques and price pat-
three, and ve).
have a tendency to follow a basic
maon. The one thing Ellio most
tern formaons such as triangles
ve-wave advance, followed by
wanted charsts to recognize is
and wedges. These are simply con-
a three-wave decline. The exact
that his wave theory worked on
solidaon paerns within trends.
opposite is true for bear markets.
long-term charts as well as intra-
These trends’ phases are consid-
day charts.
ered waves.
It is assumed that Ellio used some of Fibonacci’s work because a complete wave cycle is com-
A WAvE IS A WAvE
Price objecves from predicting possible highs or lows can
It does not maer what me
be determined through the use
frame you trade in; a wave is a
of Fibonacci raos and the cor-
wave. The idea here is that each
responding rules associated with
wave is simply a subset of another
each wave descripon. I also have
wave just to a lesser degree. Each
had tremendous success iden-
wave is itself part of the higher
fying turning points as indicated
degree wave. We can dene
by the maturity of a price move.
this by saying waves of one me
For example, if it is the boom of
frame can be expanded to relate
wave two or four, I may look for
to a higher me period, and one
support targets using the Fibonacci
me frame can be subdivided
raos as well as the pivot point
into a shorter term me frame.
support targets. When I see a
For example, we might see a ve
conuence or mulple cluster of
wave count on a 60-minute chart
support targets from using both
that, when converted to a daily
techniques, it heightens my asser-
or weekly chart, counts as a full
on to go with a posion because
Tren Tra ng In cators I understand which direcon to
forms, Fibonacci correcon, and
The Ellio wave principle was
is referred to as a proporonate
trade from. I will admit there are
projecon raos and has a me
originally applied for the stock
and alternate relaonship with the
mes when an Ellio wave pat-
element as magnitudes of each
market, but the core foundaon
measurement of the waves.
tern is crystal clear and helps me
waves are concerned.
of its decipherable use was based on the premise of mass human
Wae One
psychology. Due to the exorbitant
The rst wave is the base or start-
extent of trading on a global scale
ing point derived from a con-
ysis can work with all markets
in foreign currency, I nd it works
solidaon trading phase aer a
well when the paerns jump out
prolonged price decline. It usually
on the charts. In a world of cha-
appears to be simply a small cor-
and time frames; whether it is stocks,
oc and turbulent volality, Ellio
recve bounce from a previous
wave aempts to give a trader
trend. It is the smallest in price
a beer chance of interpreng
moves as compared to the three
what phase a market is in, price
impulse waves. This stage or wave
objecves, and me duraons to
is what technicians have discov-
expect a move to last. It is highly
ered to be an accumulaon phase.
subjecve, and I strongly suggest
Using what we have learned with
scking to the rules I will outline
Fibonacci calculaons so far, we
Trading is not about being rigid
when applying these principles in
can apply the rao numbers to
and scking with just one sin-
your trading.
develop a technique to give price
trade on the winning side, and then there are mes when I do not have a clue and can not make out any clear or disnct paern. That is when I rely on other techniques such as trading in a short term me frame within the direcon of a higher degree me frame. For instance, if the 15-minute trend is up, classied by the market trading above a set of moving averages (namely pivot point aver-
Elliott wave anal-
ETFs, futures, or Forex.
ages), then I look for buy signals as dened by a series of higher highs, higher lows, and higher closing highs as prices trade above a set of moving averages on the ve-min-
gle method. Market condions
projecons for a typical ve wave
of tools to improve your market
rULES FOr TrAdINg WITh ELLIOTT WAvE
The key in understanding Ellio
forecasng abilies. Because it is
Each wave has its own set of char-
wave move, we can use several
wave is that it can work with all
a complete and comprehensive
acteriscs or personalies and
techniques.
markets and me frames, whether
analycal tool, I believe studying
rules. Besides wave counts and the
it is stocks, ETFs, futures, or Forex.
and using Ellio wave will improve
interacon with Fibonacci exten-
It is a valuable technical tool
your chances for success.
sion and correcon relaonships,
ute me period.
because it is comprised of wave
change, requiring an assortment
there is a me element and what
paern. In order to help determine the top or peak of a ve
Using soware that includes a Fibonacci correcon and expansion tool, we can easily determine a price objecve with fairly good
Tren Tra ng In cators
accuracy. If your charng soware
higher frequency of the 2.618 per-
The one drawback in using this
included examples of integrang
program does not have this fea-
cent rao work as well. See Figure
method is the consideraon of
longer-term pivot point analysis
ture, my website, NaonalFutures.
10.2 for illustraon.
how much me it takes for a swing
such as weekly and monthly me
measurement to reach its objec-
periods. These seem to be more
ve. Using Fibonacci extensions
eecve in predicng both me
just gives us an idea of a poten-
and price turning points.
com, provides a free pivot point and Fibonacci calculator.
Another method to predict the peak for wave ve is to take the
Once we determine the overall
measurement from the boom of
measurement or amplitude of
wave one to the top of wave three
wave one, extend that amount by
and mulply out by 1.618 percent.
3.236 and add that sum to the bot-
See Figure 10.3.
tom of wave one. I have seen a
al move; it does not give us a me frame in which the move
Wae Two
will occur. The move could take
As you can see in Figure 10.4, the
days, weeks, or months to meet
second wave usually retraces .618
the objecve. That is why I have
percent of the sum of wave one.
Tren Tra ng In cators Wae Tee
needs to be followed is to make
The third wave is one of the most
sure the third wave is a true wave;
important because this is where
it cannot be the shortest of the
you will see your trend conrma-
ve waves.
on occur. This wave is the largest
Wave two can at mes retrace
in the chapter on Dow Theory.
100 percent of the enre previous
These are commonly referred to
trend or wave one, but not beyond
as 1-2-3 paerns and resemble a
the beginning of that wave. This
head and shoulder chart paern.
means that if it is a bullish cycle,
Traders have also been able to use
wave two will not make a lower
the number two point to predict
low, and if it is a bearish cycle, it
the top of wave ve by taking the
will not make a higher high. This is
sum of the price move in wave
what technicians generally consid-
one, mulply that amount out by
er the makings of “W” paerns or
1.618 percent and then add that
double booms or “M” paerns
gure to the price point of the bot-
or double tops. This was discussed
tom of wave two.
of the three impulse waves. It is
Wae Fou
accustomed with heavy volume.
The fourth wave is the correcve
From a fundamental aspect, this is
wave. It usually gives back some of
where you will start to hear more
the advancement from the third
and more bullish news, which will
wave. One may see measuring
in turn support the move upward.
chart paerns like triangles, pen-
Generally speaking, the top of
nants, or ags during the fourth
wave three equals a measurement
wave. Triangles, pennants, and
of the length of wave one mul-
ags are connuaon paerns and
plied out by a factor of 1.618 per-
generally break out in the same
cent. Another way to determine
direcon as the overall trend. The
or predict the top of wave three
most important rule to remember
is to take the overall length of
about the fourth wave is that the
wave one, mulply that amount by
low of the fourth wave can never
2.168, and then take that sum and
overlap the top of the rst wave.
add it to the price point of the low
Here is where we will nd tremen-
of wave two. Technicians jump on
dous trading opportunies once
the trend and place market orders
you can idenfy the fourth wave.
to enter a posion from the break-
As the principle applies, old highs
out above the number one wave.
(resistance) once broken will later
You usually see a large increase
turn into a new low (support) on a
in volume and open interest at
re-test as we covered in our chap-
that point. This is where break-
ter on trend line analysis.
away gaps will occur. One rule that
Tren Tra ng In cators Wae Fie
the Extraordinary Value of the
beyond Wave A, then another
nal rather than chase the market
The h wave is usually the stron-
Ellio Wave Model , both of which
cycle begins in the opposite
as it declines and sell short right as
gest for some commodies, such
can be found at www.tradersli-
direcon.
it starts building an upside reversal
as coon, soybeans, gold, and cur-
brary.com.
rencies. This is where the longest
To summarize what we’ve learned
“leg” of the waves will be formed.
in this chapter, here are the main
It is also during this nal phase that the price advance begins to slow. From the rule of “mulple
that forms into wave ve. Beer
SUBJECTIvITy IN ELLIOTT WAvE
yet, with the knowledge of what
principles that you should focus
There are more observaons to
might look like you can:
on when working with Ellio Wave
understand which are quite sub-
•
project a prot objecve
Theory:
jecve rather than absolute rules •
lter a trading system to look
regarding Ellio wave theory.
techniques,” other indicators and Wave A is usually mistaken
Having the ability to look at a
for beer triggers to sell short
cs begin to show signs of being
as a regular pullback in the
chart and being capable of seeing
as the maturity of a long-term
overbought in a bullish trend, or
trend, but this is where you
the corresponding trends or waves
trend starts to dissipate.
oversold in a bearish trend. We
could possibly start seeing the
in the market will help you deter-
This will also help you not to sck
noce during this period that
makings of “W” or “M” pat-
mine which side of the market to
terns(1-2-3 paerns), double
around in a trade too long.
the market is beginning to lose
trade on.
momentum and that the trend
tops or booms, or a head and
may be exhausng itself.
shoulders chart paern.
oscillators like MACD and stochas-
•
the characteriscs of a h wave
One such setup is idenfying a higher right side double bot-
•
Wave B is a small retrace-
CONCLUSION
tom form as wave two forms.
ment back towards the high of
Remember, it will look like a dou-
Robert Prechter of Ellio Wave
wave ve, but it does not quite
ble boom or correct near the
Internaonal is one of the world’s
reach that point. This is where
.618 percent retracement level.
foremost leading experts on Ellio
traders will exit their posion
Wave two can also retrace 100
wave. If you see yourself wanng
or begin seng up their posi-
percent of wave one, so armed
to learn more into this subject, he
on for a move in the opposite
with this informaon, you will
has wrien several books on this
direcon.
have a beer idea of how much
Wave C conrms the end of
to risk on a trade. For example, as
subject, and I would recommend that you explore them, along with and his video courses Trading the Ellio Waves and Understanding
•
the uptrend and when conrmaon is made by going
you see a fourth wave develop, it will be beer to wait for a buy sig-
QUICk QUIz 1. Ellio wae analsis can wo in all maets an all me fames. a. True b. False 2. A complete Ellio wae ccle consists of ow man waes? a. b. c. .
5 3 8 13
Tren Tra ng In cators 3. Wat in of waes ae sai to moe wit te main ten? a. b. c. .
Correcve Fractal Dow Impulse
4. In wic wae will a tae see a ten conmaon occu? a. b. c. .
Wave one Wave two Wave three Wave four
Fo te answes to tis qui, o to TaesLiba.com/TLEcone.
C
In Closing
ABOUT ThE AUThOr
cal analysis, his trading style, and
John Person is a 32-year veteran
system development. John devel-
of the futures and opons trad-
oped the Person’s Pivots and the
ing industry. He started
PPS indicator, both of which
on the oor of the
are on TD Ameritrade’s
Chicago Mercanle
Thinkorswim trad-
Exchange back
ing plaorm. He
I hope you found this book use-
in 1979. This
also has devel-
ful in increasing your knowledge
was the premier
oped indicators
and understanding of trend and
exchange which
for TradeNavigator
its eect on the market. With
launched foreign
and TradeStaon
the tools and indicators we cov-
currency trading.
Securies. He has
ered, you’re well on your way to
He then had the privi-
being able to harness the power
lege of working with George
of a trend and using it to improve
Lane , the innovator of the sto-
bers of the largest exchanges. He
your trades.
chasc indicator.
is the author of three naonally
All the best in your connued
John has worked his way through-
ing books as well as three trad-
educaon and trading endeavors.
out the industry as an inde-
ing courses and a DVD seminar
pendent trader, broker, analyst
series. His latest book series, The
and branch manager for one
Commodity Trader's Almanac, is
of Chicago's largest discount
instrumental in trading the sea-
/ full service rms under the
sonal aspects of the commodity
direct supervision of a former
markets and the correlated ETFs
Chairman of the Chicago Board
and stocks of those markets.
taught thousands of traders, including mem-
and internaonally popular trad-
John Person
of Trade. John is the founder of NaonalFutures.com , an online
The naon’s most respected busi-
educaon website.
ness journalists call John Person for his market opinions. He is
John has shared his wealth of
widely quoted by CBS Market
knowledge in the eld of techni-
Watch, Reuters, Dow Jones
Tren Tra ng In cators Newswires, and appears regu-
rECOMMENdEd rEAdINg
larly on CNBC. He is a sought aer
Te Tee Secets to Tain Momentum Inicatos
speaker for many professional organizaons such as the Market
By David Penn
Technicians Associaon (MTA ) ,
You can't predict the future, but if you see a car going 100 miles an hour toward a
the Internaonal Federaon of
picket fence, you have a prey good idea. In trading, this concept is called momen-
Technical Analyst Society (IFTA)
tum and it is one of the most widely used factors in creang eecve, protable
and delivers keynote speeches and
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seminars at some of the country's
This eBook not only shows the three secrets that allow you to capitalize on the
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maon. Momentum indicators are excellent for geng on the right side of the
qualied to oer his clients a bal-
trend and spong the reversal before it happens. With a mastery of momentum,
anced perspecve of the trading
traders can put this predictability to work making them money.
industry. In addion, the personal
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contacts he has developed around the world and in the nancial industry have been instrumental in helping him gain an edge on informaon pertaining to the markets.
Te denie guie to Momentum Inicatos By Marn Pring Momentum, oen caused by fast-breaking news or big-money investors taking or dumping posions, is one of today's most valuable technical analysis tools for spong trends and catching turning points. Now, Marn Pring delivers the most comprehensive volume available on the subject. The Ulmate Guide to Momentum Indicators is a unique combinaon of text and audio-visual CD tutorial. It is an excellent teaching tool for in-depth research, instant reference, and interacve review. It provides technical traders with remarkably accurate methods—proven eecve in today's fast-moving markets—for ancipang and exploing trends. Item #6220328 - more info...
