S&c 01-2017.pdf

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Seasonal TRENDS A hybrid approach to optimize results

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Anatomy Of A BREXIT TRADE Analyze and profit from world events

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Be Your Own Hedge Fund

Approach the market like the pros do

Ichimoku Charts We take out the mystery

16 20

INTERVIEW

Denis Globa on trading system development

WEBSITE review n Barchart.com JANUARY 2017

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CONTENTS FEATURE ARTICLE

8 Use Seasonality To Optimize Algorithmic Strategies by Karl Montevirgen It’s not uncommon for markets to trend based on seasonal patterns. So when your system doesn’t seem to be giving you the returns you were hoping for, it may help to turn to seasonality analysis to try and optimize your trading system.

12 The Anatomy Of A Brexit Appointment

by Eva J. Tompkins and Jody Wong A trade occurs every day, hour, and minute. However, it’s not very often that you get to trade by appointment. Here, we look at the entry, management, and target of a Brexit trade.

16 Be Your Own Hedge Fund

by John Ehlers and Ric Way Think being your own hedge fund is out of reach? Maybe it’s time to rethink it. It could be a lot simpler than you expected.

20 Ichimoku Charts

by Rudy Teseo Some indicators may appear to be more complicated than they really are. Here, we dissect ichimoku charts and take the mystery out of them.

24 Earnings—Will Performance ‘Trump’ Fundamentals? by Bani Arora You often base your trades on opinions, and those opinions can be wrong. What’s the best way to hedge your positions for those times when you could be wrong? Here’s one way.

JANUARY 2017, Volume 35 Number 1

28 ETF Sector Investing

by Leslie N. Masonson Interested in learning more about using exchange traded funds in your trading? This month, we look at factor-based ETFs, as compared to the more traditional marketcapitalization weighting approach.

48 Mean-Reversion Daytrading

by Ken Calhoun TIPS Last month, we discussed swing trading mean-reversion pivot entries. This month, we continue on the same topic but this time for daytrading.

30 Futures For You

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

32 Explore Your Options

AT THE CLOSE

60 How Feelings Influence Your Trading

by Claudio Demb Trading is emotionally demanding. Our feelings dictate our actions and without our being aware of it, tend to make us trade irrationally. The first step in battling emotions is to be aware of them.

by Tom Gentile Got a question about options?

INTERVIEW

34 The Brains Behind A Trading System: Denis Globa by Jayanthi Gopalakrishnan Denis Globa, CEO of Multi­ Charts and TradingView, has over 15 years of experience in system development and trading various asset classes. He founded Multi­Charts trading platform and Trading­View online trading community with the intention of bringing trading system development to the hands of retail traders.

38 Q&A

by Rob Friesen This professional trader answers a few of your questions.

44 What Now For Banks?

by Koos van der Merwe As we search for investing opportunities in the new political environment, how attractive are the banking stocks? We’ll take a look at a few of them. This article is the basis for TIPS Traders’ Tips this month.

WEBSITES FOR TRADERS 40 • Barchart.com Market data platform

DEPARTMENTS 6 7 47 50 56 57 57 58 59 59

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n Cover: Roy Wiemann n Cover concept: Christine Morrison/Roy Wiemann

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4 • January 2017 • Technical Analysis of Stocks & Commodities

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18.65 18.79 Draw Indicators Indicators Events Events Compare Compare Technical Technical Analysis Settings Settings Draw Analysis 03/21/2015 3:44:06 PM O 236.02 H 236.20 L227.50 C 229.45 03/21/2015 3:44:06 PM O 236.02 H 236.20 L227.50 C 229.45 18.29

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Volume 6,228,654 Volume 6,228,654

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SaveExport Export Save B 17.45 x 515 Zoom: A 17.45 x 1,971 Zoom: V 45.819.056

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January 2017 • Volume 35, Number 1

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W

e’ve been through the debates, campaigns, pre-election coverage, and what did we end up with? An election result that was different from what was expected. That puts all the speculation and predictions in perspective nicely—at the end of the day, that’s all they are. You can never know with certainty what an outcome will be. As traders, the concept of uncertainty is nothing new. Look at how the markets reacted to the election results. The initial reaction in the overnight futures markets was in line with expectations, but the equity markets’ reactions after the election results was another surprise. And now that the elections are over, the big buzz is about where to invest going forward. We can’t ignore the US debt level, which always tends to take center stage. With debt levels as high as they are, a rise in interest rates will have some impact on the performance of the US economy. Bond yields rose right after the elections, which probably impacted the rise in stock prices. The US dollar also moved higher. When you look at these post-election reactions, it points toward a continued increase in yields. And an increase in yields could mean more federal spending, larger deficits, stronger growth, and inflation. But this is all, again, speculation.

W

hat should you really trade? As traders, it doesn’t matter, because as you know too well, expectations can end up being different from reality. If you are into setting New Year’s resolutions for yourself, one thing you could do is to make it a point to know what the markets are doing before they open each day. It’s not about whether you trade or not that day, whether you’re profitable or not, or how much you made. It’s more about being aware of the markets, because it’s that awareness that shows you are committed to learning about the markets. But don’t make the mistake of stopping there, because you still have to place trades to make money. There are many different ways to get somewhere, so with that awareness under your belt, you will be able to steer your trades in a direction that works for you. Be prepared to recognize market moves, expected or unexpected, and then take advantage of what is in front of you. What works for you may not work for someone else. Let’s hear what works for you and what you use to navigate the markets. Each year, we publish our Readers’ Choice Awards in our Bonus Issue. Please take a moment to visit our website, www.traders.com, and cast your votes for your favorite trading-related products and services. Wishing all our readers a healthy and prosperous 2017.

6 • January 2017 • Technical Analysis of Stocks & Commodities

Jayanthi Gopalakrishnan, Editor

Miami Downtown Richard Cavalleri/Shutterstock

EDITORIAL

[email protected]

2016 WINNER AI TRADING SOFTWARE The editors of S&C invite readers to submit their opinions and information on subjects relating to technical analysis and this magazine. This column is our means of communication with our readers. Is there something you would like to know more (or less) about? Tell us about it. Without a source of new ideas and subjects coming from our readers, this magazine would not exist. Email your correspondence to [email protected] or address your correspondence to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All letters become the property of Technical Analysis, Inc. Letter-writers must include their full name and address for verification. Letters may be edited for length or clarity. The opinions expressed in this column do not necessarily represent those of the magazine.—Editor

Vertical Runup Editor, I enjoyed readi ng Thomas Bulkowski’s article “Vertical Runup” in the November 2016 issue of Technical Analysis of Stocks & Commodities. I have a few questions if the author doesn’t mind. 1. In his chart in Figure 1, there appears to be a six-bar vertical runup that he did not use for this article. Was that because it met his criteria but wasn’t needed for this article, or did it fail his eye test/criteria? It looks to me that it does run up for the four-bar minimum before there is a considerable overlapping bar (similar to the one identified as EF with overlap at bar 5). It also has two smallish bars similar to the one identified as AB. Were either of those two aspects reasons for exclusion? 2. I noticed in a response from Bulkowski to a letter to the editor that also appeared in the November 2016 issue that he uses his own stock charting software. I was wondering if his charting software/database includes charts of stocks that are no longer listed or if it just includes the survivors/stocks currently listed with available quotes? That could possibly have an effect on the statistics of his chart study in terms of quantity of vertical runup candidates and/or bull market performance of those stocks that survived the entire 18-year study period.

When I studied my stock data provider’s available stocks from May 2008 to August 2011, it had delisted 1,846 stocks in just a little over three years. From 1995 to now, only a little more than 1,000 stocks have survived being listed for that entire 20+ years in my provider’s database, even though they routinely provide about 7,000+ stocks at any given date. Ed S. Author Tom Bulkowski replies: 1. I think you’re referring to the vertical run that begins on October 2, 2015. I wanted to show the two different types of outcome after a vertical run, so that’s why I only highlighted the two shown in the figure. The study ended in November 2013, so this figure was not included in the study. 2. I have two databases that I use for my research. One is for stocks that I follow daily. The other is an archive that contains stocks that have merged with other companies, that no longer trade (for whatever reason), or that I choose to no longer follow. I use both databases in my research. I understand your concern about survivorship bias. Thanks for writing, Ed. Editor: Thomas Bulkowski’s latest book is Chart Patterns: After The Buy (www. thepatternsite.com), which provides more information and statistics on the vertical runup pattern, including a frequency distribution that may help readers gauge when a vertical run will end and the behavior that followed. January 2017

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www.NeuroShell.com 301.662.7950 NOTE FROM A BOOK AUTHOR AND READER Editor, I am the author of six books related to trading system development. I have been a subscriber to Stocks & Commodities for many years and enjoy each and every issue. Howard Bandy We interviewed Howard Bandy, who is an expert in system development, statistics, math, computer science, and modeling, among other things, in the November 2015 issue of S&C (available to subscribers in the article archives at our website, www.traders. com). He published a new book in August 2016 titled Foundations Of Trading: Developing Profitable Trading Systems Using Scientific Techniques. (See our Books For Traders section in this issue for a description.)—Editor Continued on page 42 • Technical Analysis of Stocks & Commodities • 7

8 • January 2017 • Technical Analysis of Stocks & Commodities

TRADING SYSTEMS

Make The Most Of Your System

Use Seasonality To Optimize Algorithmic Strategies conjures up the image of an intelligently structured set of rules and parameters n Robo-investing elevates software-driven speculation to the level of a responsibly managed portfolio n Blackbox signifies a market approach that is arket seasonality and algorithmic strateproprietary, non-transparent, and non-modifigies are two distinct concepts that offer able. a potential “edge” to traders and invesTaken as a whole, an algorithmic strategy conjures tors who use them wisely. Seasonality up the notion that it is strictly a “hands-off” system, provides statistical transparency on recurring patterns that you are not privy to the details of its mechanism of market behavior. Algorithmic trading systems (it’s a black box), and that you should not intervene employ proprietary technologies and differentiated by turning it on or off. There is some truth to this, approaches to analyzing and engaging markets with and some systems have demonstrated robustness. speed, accuracy, and automation. Nevertheless, there is a possibility that seasonality Each approach envelops its own unique set of po- can be used to optimize or enhance certain strategies tential. In this article, I’ll explore the advantages that without interfering with their internal logics. might be created by combining them. I’ll begin by taking a look at the advantages that each approach The seasonality advantage has to offer. Traders who use seasonality to inform their trading decisions look for recurring buying and selling trends The algorithmic advantage within a calendar year. The notion of recurrent seaAn algorithmic strategy runs according to its own sonal patterns is fairly easy to grasp with regard to coded logic. Every person who subscribes to an certain commodity classes like agriculture (affected algorithmic system is motivated by the prospect of by weather, planting, and harvesting seasons), energies possessing a technology that can “outsmart” com- (supply/demand patterns correlate with summer and mon approaches to the market, analyzing assets from winter patterns), and precious metals—particularly a unique vantage point, and executing trades with gold, whose demand tends to peak during India’s superior calculating power and speed. wedding season (among other fundamental factors). The term “algorithm strategy” brings up a number of The strength of seasonal trends may be historisynonymous concepts like automated trading systems, cally consistent but it can’t be treated as an accurobo-investing, and blackboxes to name a few—all of rate predictor—not all years will show correlation which house implicit assumptions: between prices and seasonality patterns. But that historical consistencies exist is evidence enough that n Automated implies “hands-off” trading (that economically driven transactional activity may be is, it runs by itself) the driving force behind these price patterns. It’s It’s not uncommon for markets to trend based on seasonal patterns. So when your system doesn’t seem to be giving you the returns you were hoping for, it may help to turn to seasonality analysis to try and optimize your trading system.

n System

Roy Wiemann

M

by Karl Montevirgen January 2017

• Technical Analysis of Stocks & Commodities • 9

Average Gold Performance Since 1975 2.5%

Monthly average gain/loss in gold 1975–2013

2.0% 1.5% 1.0% 0.5% 0.0%

Step 2: Set rules for modifying the strategies. I allowed for only long positions during the months of August and September. The reason for this decision was pretty simple: Since August and September seasonality reflected high demand for gold, why not follow the historical trend?

Step 3: Select the strategies. It’s ideal to have a bunch of systems to choose from. For example, I can choose from nine algorithmic systems that -1.0% focus solely on gold futures. Among those nine, I chose four that represented the entire range of -1.5% performance—from most to least profitable. Each Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec system traded differently: Some were daytrading systems while others took swing or position trades, Figure 1: SEASONALITY IN GOLD. Gold has shown a consistent uptrend during the months of one traded long-only positions, and one was always August and September. in the market, while the rest took both long and short positions at different times (Figure 2). also interesting to note that seasonal buy/sell regularities in Note: Each system combines live and hypothetical results certain commodities have remained prevalent despite fun- depending on different points in its lifecycle. damental bull or bear market conditions. Step 4: Isolate August and September trades and compare A seasonality/algo hybrid longs and shorts. I focused on the August and September Using seasonality to optimize a strategy means emphasizing trades, differentiating performance results between comlongs when seasonal patterns trend upward and shorts when bined long/short trades versus long-only trades. The charts seasonal patterns trend down. In other words, you would use in Figures 3 & 4 show the results. seasonality to turn on or off buy/sell signals in months that seasonal patterns tend to be statistically strong. Comparing performance and efficiency Does the number of long versus short trades matter when a Testing the hybrid approach market is trending up? If seasonality can optimize a well-performing algorithmic I’ll start with system 1, which was the best-performing stratstrategy by emphasizing longs or shorts, then might it also be egy. Among the long trades, 85.4% were profitable. Among the capable of optimizing a poorly performing strategy as well? This short trades, 91.7% were profitable, but there were significantly is what I set out to explore, and here are the steps I followed. fewer short trades—in total, 48 trades were long positions while only 12 were short positions. Step 1: Identify a seasonal pattern. I decided to focus on It is true the short trades contributed to the overall profitability the gold market. Based on a 38-year seasonality chart of of this system. But it’s also hard to argue against the fact that gold, the months of August and September had consistently system 1’s profitability was attributable to the fact that it had shown a significant uptrend (Figure 1). As mentioned earlier, four times more long trades than short trades. I also noticed the following about systems 2 and 3: Strategy Year of Inception Type Annual ROI Profit Factor Worst Drawdown Total P/L Short trades had a good win rate and System 1 2008 Swing trading +98.8% 2.16 ($9,010) $230,304 were profitable, but there were between System 2 2007 Day trading +63.1% 1.68 ($5,774) $174,236 two to three times System 3 2006 Swing trading +59.8% 1.88 ($5,058) $127,699 more long trades than short trades. Position System 4 2007 +11.6% 1.16 ($44,273) $162,533 The takeaway: (always in market) Based on these obFigure 2: select the strategies. Here you see a summary of the performance of four trading systems that focus on trading gold servations, staying futures. -0.5%

CASEY RESEARCH

the rise of gold demand in this two-month period was partially attributable to the Indian wedding season among other fundamental factors.

10 • January 2017 • Technical Analysis of Stocks & Commodities

Long vs Short PL (in points)

Long vs Short % of Total PL

400 System 1

350 300

System 2

250 200

System 3

150 100

System 4

50 0

System 1

System 2 Long

System 3

System 4

0%

20%

Short

FIGURE 3: LONGS VS. SHORTS FOR AUGUST AND SEPTEMBER TRADES. Here you see the performance of long and short positions in points.

with the seasonality trend has shown to make a big difference, as all three systems with completely different trading rules and parameters corresponded with the seasonal long bias. System 5’s inefficiencies System 5’s performance, an always-in-the-market system, revealed the inefficiencies of taking short positions during a historically uptrending season. Its long positions contributed to 94.9% of the total positive P/L. That the short positions contributed a mere 5.1% to the total profits brings up a question: How necessary were the short trades? System 5 took 16 long and 15 short trades, an almost perfect 50/50 ratio. Yet the long trades made the bulk of the profit. This means that the short trades—half of the total trading for the months of August and September—not only contributed a mere 5% in profits, but they racked up a lot of unnecessary trading costs. Hence, the trades were highly inefficient.

How to manage a seasonality-driven

algo portfolio The possibilities for this hybrid approach open up a potentially promising area of research. We encourage you to further research this approach in different markets that show strong seasonal patterns. Sadly, many people who subscribe to or follow algorithmic strategies carelessly alternate between systems, or they turn systems on and off based on nothing other than equity drawdown. They do this even if drawdown falls within expected predetermined ranges specified by the developer. In other words, people agree to subscribe to an algorithmic product yet tamper with the product without any clear or objective basis. When people do this uncritically, it is usually because they don’t have an understanding of how a system works and are uncomfortable with losses (even if the losses fall within expected parameters), or they believe they can contribute to the system’s performance, or they don’t have sufficient risk capital to trade the strategy (which means they shouldn’t be trading it in the first place).

40% Short

60%

80%

100%

Long

FIGURE 4: Does the number of long vs. short trades matter when a market is trending up? Staying with the seasonality trend makes a big difference. All three systems with completely different trading rules and parameters correspond with the seasonal long bias.

You would use seasonality to turn on or off buy/sell signals in months that seasonal patterns tend to be statistically strong. Explore seasonality

Not all strategies will prove to be robust, and you should have a solid working knowledge as to when to keep or ditch a system. But if you are going to intervene with a system, it’s best to do so with objective criteria. Seasonality analysis is one possibility that you might want to explore to optimize your strategies. It provides historically based parameters and probabilities to help you better manage your decisions. Karl Montevirgen is a content designer/strategist at Halifax America LLC, a stocks/option, futures, and forex brokerage in Sherman Oaks, CA. In addition to creating and designing content, he has extensive knowledge of and experience with commodity futures and foreign exchange. He can be contacted through the Halifax America website at www.halifaxamerica. com or by email at [email protected].

Further reading

Montevirgen, Karl [2015]. “Calculating Pip Values,” Technical Analysis of Stocks & Commodities, Volume 33: April. [2014]. “Position Sizing In The Spot Forex Markets,” Technical Analysis of Stocks & Commodities, Volume 32: April. Katz, Jeffrey Owen, with Donna L. McCormick [1997]. “Seasonality And Trading,” Technical Analysis of Stocks & Commodities, Volume 15: April.

January 2017

• Technical Analysis of Stocks & Commodities • 11

Make A Date With Opportunity

A trade occurs every day, hour, and minute. However, it’s not very often that you get to trade by appointment. Here, we look at the entry, management, and target of a Brexit trade.

T

by Eva J. Tompkins and Jody Wong he referendum of the United Kingdom (UK) on June 23, 2016 that would decide whether the UK would exit the European Union (EU) was an opportunity to create a GBPUSD trade that could be planned in advance

12 • January 2017 • Technical Analysis of Stocks & Commodities

pursuant to a set of trading rules. Unlike the intervention of the Bank of Japan on March 18, 2011 or the Swiss National Bank’s removal of the peg of the Swiss currency to the euro on January 15, 2015, the Brexit (Britain exit) trade could be anticipated and planned using both fundamental and technical analysis. The appointment was set for June 23, 2016 at 5:00 pm EST. A completed trade is like a good story. There is a beginning (entry), a middle (trade management), and end (when you exit the trade and make your profit). Fundamental traders had

BREXIT: KASTASGR/SHUTTERSTOCK

The Anatomy Of A Brexit Appointment

TRADE ANALYSIS

information from both sides of the Brexit issue. The media had labeled this event as “Brexit” or British exit from the EU. The event could have just as easily been labeled “Bremain” or British remain with the EU, but it wasn’t, so already, a bias had been created by the media toward the exit of the UK from its 27 EU neighbors. Pro-exit supporters argued that with the passing of Brexit, food costs would go down, a health savings of £350,000 would occur, the immigrant onslaught would not occur, and the United Kingdom would be independent. The argument for remaining in the EU was that a UK recession would be avoided, the UK would not appear to be xenophobic, and the economic prosperity that the UK enjoyed since entering the EU in 1973 would continue. Upon conclusion, the fundamental traders would surmise that the GBP will go down if Brexit passed, and up if it did not pass. With the passage of Brexit, traders would flee to the JPY and CHF, causing these currencies to go up in value.

Figure 1: trading channels within a trend. Channel traders would look for price to rise into an entry at 1.4740.

Figure 2: trading with bollinger bands. When price breaks the upper Bollinger Band, you would consider the price high and look for an entry for a short/sell position. Here, price initially pierced the Bollinger Band at 1.4829.

The entry

A trade can only go up, down, or sideways. With Brexit, there were only two of the three choices available, up or down. There are differing lengths of time for staying in a trade, and that measure depends on the emotional personality of each individual trader. A position trader is willing to hold a position for a period longer than a few weeks. A swing trader will hold a trade for a few days to several weeks, and a daytrader will typically be out of the trade by the end of the trading day. There are numerous styles of trading and these, too, depend on the emotional personality of the trader. We will be analyzing the Brexit trade using different styles. The highest probability for a profitable trade entry is a confluence of styles that overlap approximately at the same entry price. Of the three main elements of a trade—entry, management, and target—the entry is the most important because the entry will determine the amount of risk in the trade. Without a high-probability entry, there will be no trade to manage or money to be made. For our trade analysis, we will be looking at the GBPUSD, since the USD is the reserve currency of the world. The polls in the UK closed at 5:00 pm EST and the first results reported were that the UK would be leaving the EU. The GBPUSD began to rise from 1.4520. Channels help locate optimal buying and selling points while trading within a trend. Channel traders would look for price

A completed trade is like a good story. There is a beginning (entry), a middle (trade management), and end (when you exit the trade and make your profit). to rise into an entry at 1.4740. In Figure 1, traders can see an entry of 1.4740 as price returns to the top of the channel. Bollinger Bands measure price volatility. It is an indicator that typically expresses bands as a 2% deviation for a 20-period moving average. The purpose of Bollinger Bands is to provide a relative definition of high and low. When price breaks the upper Bollinger Band, you would consider price as high and look for an entry for a short/sell position. In Figure 2, price initially pierced the Bollinger Band at 1.4829. Fibonacci or harmonic trading uses specific price pattern ratios to determine turning points in the market. These turning points are based on the idea that patterns are predictive since they repeat themselves. In Figure 3, price has hit a Fibonacci extension of 127.2 or a price point of 1.4934 for entry on the day of Brexit. January 2017

• Technical Analysis of Stocks & Commodities • 13

FIGURE 3: TRADING FIBS OR HARMONICS. Here, price has hit a Fibonacci extension of 127.2 or a price point of 1.4934 for entry on the day of Brexit.

FIGURE 4: TRADING BASED ON PRICE ACTION. Here you see that price rose into a previously untested level (1.4960–1.5100), represented by a bearish candle where unfilled sell orders were found.

which are major whole numbers and a possible Brexit entry. The levels at whole numbers are considered psychological levels or comforting for many traders and thus a higher degree of strength or probability is assigned to these more rounded levels. Major whole numbers are followed by major quarters, minor wholes, and minor quarters. In the context of the GBP, these numbers have double zeros except for the minor quarters. For example, looking at the chart in Figure 5, if you trade whole numbers, you’d concentrate on the selling level at 1.5000. In Figure 6, you can see the range of 1.4776 to 1.5100 as a legitimate, rule-based entry region. On a daily chart, the difference in this range was 324 pips. Here’s where it gets interesting. The best of the five possible entries—based on either channel, Bollinger Bands, Fibonacci, unfilled sell orders, or whole numbers— was the whole number of 1.5000. This level was also suggested by the trading media on television. Based on the move away from this 1.5000 level, a trader could see there was a great amount of imbalance at this level. The trader could tell this by the manner in which price exited this level—with a strong move out and displaying force.

Managing Brexit

The management of a trade is the yin and yang of all traders. Traders want to be conservative and give price enough room to breathe, or move, so that they do not get stopped out. Traders also have an aggressive FIGURE 5: PSYCHOLOGY OF WHOLE NUMBERS. If you trade whole numbers, you would concentrate on the mindset and want to get as much 1.5000 selling level. profit from the trade as possible, as soon as possible, while minimizing Price action trading tells you what is and has happened risk. While price is moving in a profitable direction, there are on a chart without relying on an indicator. The trader of this several styles of trade management that could be used to stay style looks for size, position, location, shape, and character in the trade and maximize profit. Some trade management of each candle that helps to identify the unfilled buy and sell styles include, but are not limited to, the use of a trendline, orders. In Figure 4, price rose into a previously untested level an average true range (ATR), a moving average, and moving (1.4960–1.5100) represented by a bearish candle where unfilled your stop while respecting lower highs. sell orders were found. A down trendline consists of a minimum of two, but ideally Whole number traders represent simplicity by placing their three, points: a high point in price, a lower high to define the entries, stops, and targets on double zeros such as 1.5000, downtrend, and a third lower point for confirmation of the 14 • January 2017 • Technical Analysis of Stocks & Commodities

strength of the trend. A trendline would not have been viable in this trade because the next lower high created a steep angle that would have an immediate trendline break. An ATR measures the average length of a candle on the trade timeframe. If you had used an ATR, you would have been stopped out on the first 30-minute candle when price reacted with a pullback of 250 pips. If you entered at 1.5000, price created a cushion of 40 pips after the first half hour. The art of this trade was to make the next 1,650 pips in profit before exiting the trade. A trader also had the option of adding onto this trade or taking profits as price moved to a projected target. In Figure 7, you see that if you used a nine-period simple moving average (SMA) you would have stayed in the Brexit trade and exited when price broke this moving average. A stop is the trader’s insurance policy. If you are wrong about the degree of price movement, then you will be stopped out for a profit or a small loss. As price moves, you could move your stop to respect lower highs. This method seems simple, but traders have a tendency to become emotional and follow price too closely with their stops such that price does not have the ability or distance to move. In Figure 8, you see that if you had moved your stop to respect lower highs, you would have stayed in the Brexit trade.

FIGURE 6: LOOKING AT THE WHOLE PICTURE. Here, it is clear that the range of 1.4776 to 1.5100 is a legitimate, rule-based entry region. On a daily chart, the difference in this range was 324 pips.

FIGURE 7: TRADE MANAGEMENT. If you had used a nine-period simple moving average for your trades, you would have stayed in the trade until price broke the moving average.

Taking profit and exiting Brexit

The satisfaction of having completed a profitable trade is achieved when FIGURE 8: using stops. Here you see that if you had moved your stop to respect lower highs, you would have the profits are taken. Unlike unreal- stayed in the Brexit trade. ized profit, realized profit can be used to pay bills and buy groceries. The turning points in the market that are seen by Fibonacci number of 1.3000, and the 1985 low. In Figure 10, the varitraders are used for entries and exits. Fibonacci or Harmonic ous styles of trading with anticipated targets for the Brexit trading uses specific price pattern ratios to determine turning trade include channel, Fib number, whole number, and the points in the market. These turning points are based on the 1985 low. idea that patterns are predictive since they repeat themselves. After the passing of Brexit, a ripple effect was generated In Figure 9, the target of 1.3351 was forecasted by Fibonacci in multiple markets. Gold soared past $1,300.00 dollars. The yields on German and Swiss bonds sank into subzero territory, traders at 261.8. Other possible exits, or predetermined target options for a trader, included the bottom of the daily channel, the whole Continued on page 31 January 2017

• Technical Analysis of Stocks & Commodities • 15

Go Solo

Be Your Own Hedge Fund

A

by John Ehlers and Ric Way hedge fund is an aggressively managed portfolio of investments that uses advanced investment strategies with the goal of generating high returns. Though that sounds daunting, you can do this on your own. What’s holding you back from trying? You are probably thinking:

• I don’t have the experience to be a successful trader. • I don’t know how to formulate a trading strategy. • I don’t have the technology for an advanced investment strategy. • I am worried about the risks of trading. • I don’t have time. Managing a fund is a full-time job. • I don’t have the capital to start a fund. • I don’t know the legality of running a hedge fund. 16 • January 2017 • Technical Analysis of Stocks & Commodities

In this article, we’ll address each of these concerns and show you that yes, you can in fact be your own hedge fund. That is to say, you can manage your own money using proven trading signals while reducing your exposure to risk.

You have experience

That you are reading this proves you are almost halfway to the goal of having enough experience. You must be thoughtful, able to consider alternatives, and be willing to learn from others. Everyone has to start someplace, and the advantage of learning is that you are exposed to the experience of others. Often, education is expensive. But it doesn’t have to be. You can assimilate the experience of others and learn from their mistakes. The problem with learning from others’ trading experience is that there is a wide diversity of opinion of what a successful trading style is. Your trading style is a selection that only you can make, depending on your preferences and comfort zone. The first biggest choice is whether you want to follow fundamental data or technical considerations. If you prefer fundamentals, your best approach to being your own hedge fund would be to find a combination of stocks and bonds that

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Think being your own hedge fund is out of reach? Maybe it’s time to rethink it. It could be a lot simpler than you expected.

TRADING SYSTEMS

Noisy indicators delay your analysis

place you on the “efficient frontier” using modern portfolio theory. Basically, this means you have a mix of instruments using random variables that gives you the best tradeoff between risk & reward. It does not necessarily mean the strategy has the goal of generating high returns. Since you are a reader of this magazine, you probably prefer the technical analysis approach. So let’s start with that.

Jurik algorithms deliver low lag, low noise analysis

Come up with a strategy

Within the umbrella of technical analysis, there is still a wide diversity—and often contradictory—opinion on what constitutes a successful trading strategy. But the arguments basically boil down to selecting the best combination of profit factor and percent winning trades. Profit factor is the ratio of gross winnings to gross losses and is analogous to the payout in gambling. If you prefer trend trading, you will necessarily have to be in successful positions for a longer period of time. In addition, you will have to estimate when the onset of a trend has taken place. This means you must take a tentative position and then exit quickly if your estimate of trend onset is not successful. Therefore, your trading will be characterized by a relatively high profit factor due to the big winners and a relatively low percentage of winners because of taking many explorative trades. We prefer short-term trading due to the cyclic content in the data. What’s behind some of this cyclic content? In a nutshell, companies have to “make their numbers” on a monthly basis. Our experience is that the monthly cycle is measurably present in the data, and is there with sufficient regularity to give you a decided edge in your trade entries & exits. In round numbers, a month cycle consists of a 10-day move up and a 10-day move down. If you are only taking long positions, you will have an average trade duration on the order of 10 days. This means your average risk exposure is less than it would be if you were expecting the trend to be your friend. This strategy is simple: Buy on a cyclic trough and 1 exit the trade on a cyclic peak.

The necessary technology

You say you don’t have the technology for an advanced investment strategy? Balderdash! The Internet is teeming with vendors vying for your attention. Even our own website, www.StockSpotter.com, fits this category of Internet-based services that provide trading signals or strategies to implement. It is your obligation to do due diligence and to assess the experience, credibility, and track record of any vendor attempting to license their trading signals to you.

Manage your risks

About the only way to evaluate basic potential risk is to examine a historical trading track record. It’s another example of expecting the

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past to be a prolog. A minimum requirement for the track record would be that it has been established long enough to cover several kinds of market conditions and should have a sufficient number of trades so the estimates of profit factor and percent winning trades are statistically significant. If there are a number of variables constituting the trading system, an old rule of thumb is that the track record should have at least 30 trades per variable. For example, a simple moving average

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 -$4,000 -$2,000

$0

$2,000

$4,000

$6,000

$8,000

$10,000 $12,000

FIGURE 1: NORMALIZED PROBABILITY DISTRIBUTION. Here you see a normalized example of the probability distribution resulting from the Monte Carlo simulator by being fully invested in one stock at a time for a year. It creates credible annual statistics from real historical trades where 100% investment is achieved by trading one stock at a time. January 2017

• Technical Analysis of Stocks & Commodities • 17

www.stockspotter.com/In/MonteCarloProfit. aspx. Figure 1 shows a normalized example of 0.9 the probability distribution resulting from the Monte Carlo simulator by being fully invested 0.8 in one stock at a time for a year. 0.7 From the central limit theorem, it is no 0.6 surprise that the Monte Carlo simulator produces a normal probability distribution. 0.5 From these statistics, you can easily estimate 0.4 your expectation (the average profit you can expect) as well as the one-sigma and two0.3 sigma points on the curve. In this case, the 0.2 probability of breakeven or better is outside 0.1 the lower one-sigma point, but the probability of having a loss is still uncomfortably high. 0 But we can fix that. -$4,000 -$2,000 $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 It is well-known in statistics that if you FIGURE 2: AN INCREASE IN THE NUMBER OF STOCKS. If you trade four different stocks in parallel using random selections, the variance of the probility distribution is halved. In other words, it reduces double the number of independent elements the annual probability of a loss. in your random sampling, you reduce the variance of the distribution by the square crossover system has the length of the two moving averages as root of two. So if you increase the number of stocks being variables, and thus a minimum of 60 trades using the system traded simultaneously by a factor of four, you will halve the should be used for the track record. This rule prevents curve- variance of the probability distribution. Figure 2 shows what happens when you trade four different stocks in parallel using fitting by “optimization.” Since we are dealing with random variables in the market, random selections. Figure 2 shows that your expectation will not increase bewe think the tests for risk should be far more stringent than using just a single equity curve. The variations in equity curves cause your total capitalization is spread across four stocks at from test to test can be substantial, even when the system has a a time instead of simply being continuously invested in one high profit factor and high percentage of winning trades. Risk stock at a time. You can reduce the variance still more by addis particularly important when you start trading because the ing more stocks. For example, if you traded eight stocks at a risk of ruin is higher than after you have had a chance to build time, you would halve the variance again. However, reducing equity based on your trading results. A better way to evaluate the variance quickly reaches a point of diminishing returns, and you are also taxing the amount of capitalization you can trading risk is through the use of a Monte Carlo simulator. Here’s how a Monte Carlo simulator works: First, take all afford. In general, trading four stocks at a time is adequate the trades in your history and create another list consisting of to reduce the probability of an annual loss in a well-designed the profits per day for each day. Then take all of these profits system. per day and drop them into the proverbial hat (of course, we will be doing this process on a computer). Randomly draw Strategy pas de deux the profit per day from the hat, record it, and place the profit Your hedge fund strategy needs a small revision to reduce risk. per day back in the hat. By repeating the drawing process 260 That is, you want to develop four “channels” in which to trade. times, you have simulated a year’s worth of trading using ran- The trade signals and timing are completely independent in the domly selected results. Now, repeat the annual process 5,000 four channels and the trade timing is unsynchronized. This is a or 10,000 times and you have just simulated 5,000 or 10,000 small but crucial modification of the original strategy, because years of trading using your real track record history. That’s these four channels halve the variance in your returns. enough random data upon which to create credible statistics on what you can expect from your trading system. Time is no obstacle You can find an example of a Monte Carlo simulator at http:// It is easier to manage your hedge fund than you may think. With over 5,000 stocks and ETFs in the US markets, there are plenty of trading opportunities every day (not counting penny stocks, OTC stocks, and the like). Just grab your trading In general, trading four stocks signals from the Internet every day and apply them to your at a time is adequate to reduce four trading channels. For example, at StockSpotter we give the probability of an annual explicit entry signals and exit signals on open positions, in 1

loss in a well-designed system.

Continued on page 49 18 • January 2017 • Technical Analysis of Stocks & Commodities

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CHARTING

One-stop chart

Separating the various components of the ichi seems to thwart the purpose of the ichimoku, which, in Japanese, means “at a glance.” In one indicator, we get insight into trend, buy/sell crossovers, support & resistance, stop-loss points, and the future potential of a stock under analysis. Still, studying the five plots individually will emphasize the part each plays in the analysis. Here’s a tip. Learning these Japanese terms is not easy, so I assigned an arbitrary A, B, C, D, and E to the five plots on a printout of the cloud and then studied the rules without regard to the names. Figure 1 shows the ichimoku cloud—a lot to swallow in one gulp—with the five plots. The five plots, in a nutshell, are: Tenkan-sen (conversion line: blue line) (H + L)/2 default period = 9 Kijun-sen (baseline: red line) (H + L)/2 default period = 26 Chikou span (lagging span: dark green line) The closing price shifted back 26 bars

Ichimoku Charts Some indicators may appear to be more complicated than they really are. Here, we dissect ichimoku charts and take the mystery out of them.

T

by Rudy Teseo

hese days, you have to be careful when you use the word “cloud.” You have to be sure your listener knows whether you’re referring to some server in the sky or an indicator used by stock chartists (technical analysts). I’m a latecomer when it comes to the ichi. Like many traders, I took one look at the indicator and said, “No, not for me; there are a lot simpler indicators that I still haven’t mastered.” And when I couldn’t find it in Steve Achelis’ Technical Analysis From A To Z, that was the death knell. But then I received an email offering a free ichi ebook, which I downloaded. Within 15 minutes I was starting to think differently about this indicator. I then watched a couple videos on the topic at TC2000.com and was hooked.

20 • January 2017 • Technical Analysis of Stocks & Commodities

Senkou A (leading span A: green line) (Tenkan-sen + Kijun-sen)/2 Senkou B (leading span B: red line) (52-period H + 52-period L)/2 Note that leading spans A&B are shifted forward 26 bars. Figure 2 shows the tenkan-sen (blue) and kijun-sen (red). When these are viewed without the surrounding distractions, we see our old friend, the moving average crossover, reveal itself. You could analyze the blue and red lines in relation to each other and also in relation to the cloud itself. Here’s where it is similar to moving average crossovers. When the shorter period line (blue) is above the longer period plot (red), the

CLOUD BEAR: PHLOXII/SHUTTERSTOCK

Above The Clouds

stockcharts.com

trend is positive. If both plots are also above the cloud, then the positive trend is further reinforced. A buy signal is generated when the tenkan sen crosses above the kijun sen, while the tenkan sen, kijun sen, and price are all above the cloud. The reverse of these signals indicates a negative trend. Figure 3 shows the cloud plot. When prices are above the cloud, the trend is up. When senkouA is rising and above senkouB, the uptrend is strengthening. When tenkan sen and kijun sen are above the cloud and price is in an uptrend, then tenkan sen, kijun sen, senkouA, and senkouB are all viewed as support. If you added tenkan sen and kijun sen to the chart and if both are below the cloud and price is in a downtrend, then tenkan sen, kijun sen, senkouA, and senkouB are all viewed as resistance. This will help in your entry and exit decisions. Figure 4 shows the chikou span in isolation. This plot is the closing price shifted back 26 bars. When it is above the price, the trend is bullish; when below the price, the trend is bearish.

FIGURE 1: THE FULL PLATE. On this chart of Dr. Pepper Snapple Group (DPS), you see a full ichimoku cloud with all five plots.

FIGURE 2: CONVERSION AND BASELINE PLOTS. When the tenkan sen (conversion line) and kijun sen (base line) plots are viewed without the surrounding distractions, they are similar to moving average crossovers. When the short (green) is above the long (magenta), the trend is positive. If both lines are above the cloud, the positive trend is further reinforced. A buy signal is generated when the tenkan sen crosses above the kijun sen, while the tenkan sen, kijun sen, and price are all above the cloud.

FIGURE 3: THE CLOUD PLOT. When senkou A is rising and above senkou B, the cloud is green, which indicates the uptrend is strengthening. When senkou A is below senkou B, the cloud will be red, which indicates a downtrend. January 2017

• Technical Analysis of Stocks & Commodities • 21

Bringing it

FIGURE 4: CHIKOU SPAN PLOT. When the chikou span plot is above price, the trend is bullish; when it’s below the price, the trend is bearish.

all together In Figure 5 you see a bullish configuration on the chart of Agilent Technologies (A). Chikou span is well above price, tenkan sen is above kijun sen, senkou A is above senkou B, and price is above the cloud. This makes for a good model for further analysis of this charting technique. Figure 6 shows a bearish configuration for American A i rl i nes (A A L). Chikou span is well below price, tenkan sen is below kijun sen, senkou A is below senkou B, and price is below the cloud. This is another good analysis model for bears.

Confidence

FIGURE 5: BULLISH CLOUD PATTERN. On this chart of Agilent Technologies (A), chikou span is above price, tenkan sen is above kijun sen, senkou A is above senkou B, and price is above the cloud.

booster Knowing all this is just the tip of the proverbial iceberg. It will take a lot of analysis of your own portfolio to become comfortable with ichi. What I found most distressing was that the consensus of analyst ratings was often in direct contrast to what I was sure was the correct ichi analysis. That, of course, made me monitor those stocks to see which analysis proved to be true. Try it. You’ll thank me later.

Figure 6: BEARISH CLOUD PATTERN. On this chart of American Airlines (AAL), chikou span is well below price, tenkan sen is below kijun sen, senkou A is below senkou B, and price is below the cloud.

Continued on page 58 22 • January 2017 • Technical Analysis of Stocks & Commodities

Keep An Eye On Volatility

You often base your trades on opinions, and those opinions can be wrong. What’s the best way to hedge your positions for those times when you could be wrong? Here’s one way.

C

by Bani Arora ompany XYZ, the largest holding in your portfolio, is due to release earnings tomorrow. You open up your favorite charting software and focus all intellectual efforts on interweaving your technical analysis insights with historical nuggets of earnings

24 • January 2017 • Technical Analysis of Stocks & Commodities

information. You analyze your favorite indicators on charts spanning various time periods, flouting its defects and deviations from perfect order, ignoring the visual mischief that creates misleading signals, and celebrate your efforts when a buy signal appears as a triumphant symbol of your studies. You are long the underlying stock and it is a tantalizing thought the company will meet, if not beat, Wall Street expectations and better still, spike up in price following the earnings release. But the impending unimagined adversities lead to unfavorable financials and the stock price takes a nosedive. You may think the correction is too steep, but remember,

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Earnings—Will Performance ‘Trump’ Fundamentals?

options

markets are never wrong, while opinions often are. Markets have a way of bridging the gap between the priestly technical ability of the professional chartist and the blind reaction of the intelligent layman who happens not to have acquired the finesse of the technical analysis vocabulary. After all, as Albert Einstein once said, “Insofar as the propositions of mathematics refer to reality, they are not certain, and insofar as they are certain, they do not refer to reality.”

Options prices can be a prominent leading indicator for predicting the effect of earnings announcements because they quantify uncertainty and jump effect via an increase in implied volatility.

Event-based options strategies

The important question is: How do you hedge yourself in cases like this wherein the future proves you more wrong the increase in implied volatility will still be embedded in the than right for a stock-specific event? My answer is this: Trade near-term option), and the next-available expiry as the second options-based strategies. strip for computing the one-day event implied volatility. I will Assuming you’ve already studied options basics with fanatic illustrate the computation with an example. intensity, let’s design some event-based strategies to hedge your bets and use your singular trading genius to minimize What is volatility? luck and create truly spectacular profits. Before moving ahead, remember you are dealing with volatility, The first step is to quantify the expected impact of an and as all you mathematical geniuses are aware, volatility is “earnings catalyst” on the stock price move. You need insight the square root of variance. Math 101 teaches us that variance that will reveal valuable information about the market’s ex- is additive, while volatility is not. Here’s a quick example. pectations. But where do you get that from? Yes, you guessed If volatility of one option (vol-1) = 23%, then its variance right—the options market. (var-1) = (.23*.23) = 5.29%, and if volatility of the second Before I get into the details of the strategies, I’d like to option (vol-2) = 28%, then its variance (var-2) = (.28*.28) = remind you that for best results, you should trade liquid op- 7.84%. Now, we are mathematically correct when we add vartions, both in terms of strike and maturity. As option pros, 1 and var-2 = 5.29% + 7.84% = 13.13%, but we are making we know that in terms of strikes, the at-the-money (ATM) a mistake if we add vol-1 and vol-2 directly (23% + 28% <> options (both calls and puts) carry maximum liquidity and 51%). Rather, to get vol-1+vol-2, we take the square root of tighter bid–ask spreads, and in terms of maturity, the near- var-1+var-2 = sqrt(13.13%) = 36.24%. term options are more liquid than the longer-term options. Now that we’ve that figured out, let’s begin the process of Given that most stocks now also have listed weekly options quantifying the earnings-related one-day volatility. (vs. only monthly/quarterly options), it has led to increased Say today is Friday, July 1, 2016. Company XYZ is set to price efficiency, so it’s a good idea to also add weekly options report earnings on Wednesday, July 6, 2016. Company XYZ to your options toolbox. also has weekly listed options, so the options with maturity The question lingers: Why options? The answer is that nearest to the event expire on Friday, July 8, 2016. These options options prices serve as a prominent leading indicator for will carry a significant bump up in their volatility to reflect the predicting the effect of earnings announcements by quanti- increased market uncertainty for the forthcoming earnings. fying uncertainty and jump effect via an increase in implied You use these options to compute the “elevated volatility.” The volatility, which is forward-looking. And since the event is next options’ expiration falls on Friday, July 15, 2016. You in the future, this serves as an excellent indicator to quantify use these options to deduce the “normal” volatility. For both maturities, use options with the same strike level. the market’s opinion. The next step involves stripping out the normal volatility But how do you determine the magnitude of the increase in options’ implied volatility attributable to the “earnings from the elevated volatility to compute the one-day event event”? The answer lies in deriving the one-day implied vola- implied volatility. Let’s work out the details with an example tility (attributable to the event) from options of two different (see Figure 1). Let’s say the implied volatility for the July 8, 2016 options maturities. To get started in the process, we need to pick the options maturities. Ideally, you pick one with maturity prior is 46% (vol_1) and that for the July 15, 2016 options is 28% to the event and the second with maturity after the event, and (vol_2). So, var_1 = (.46*.46) = 21.16%, and var_2 = (.28*.28) isolate the one-day volatility from the difference in their variance, that is, Time (T) to Expivolatility squared. The astute reader Instrument Implied Volatility Variance (var) Var * T/ T-1 ration (days) might quickly point out: But what if the Option 1 4 46% 21.16% 0.2821 nearest available listed maturity is only for an expiration date after the event? It Option 2 9 28% 7.84% 0.0882 doesn’t matter; we will use the nearest FIGURE 1: CALCULATING ONE-DAY EVENT IMPLIED VOLATILITY. Here you see the variables used to compute available expiry as our first strip (as the implied volatility for a one-day event such as an earnings announcement. January 2017

• Technical Analysis of Stocks & Commodities • 25

Instrument

Strike

Put 1

$141

Put 2

$150

Position

Stock Price at Expiration $140

$145

$150

$155

-2

($1)*2=($2)

$0

$0

$0

+1

$10

$5

$0

$0

Total Payoff

$8

$5

$0

$0

That’s a pretty significant move. How could you monetize this move? Let’s look at some possible strategies.

Selecting the ideal

Strategy payoff at expiration

strategies FIGURE 2: 1x2 PUT RATIO SPREAD PAYOFFS. In this case you buy one ATM put and pay $4.05, and sell two The easiest solution would be to buy OTM puts to collect $2.60, for a net premium of $1.45. That’s a 60%-plus reduction in premium paid than if you had a call and hedge your short position only bought one ATM put. in case the stock price spikes, or buy a put and hedge your long position in = 7.84%. The time to expiry for the July 8 option (T_1) = four case the stock price tanks. You can do this by trading the ATM trading days and for the July 15 option (T_2) = nine trading options for the July 8th maturity since it is only an earnings days. Now, we divide (var_2 * T_2) by (T_2 -1) = 0.7056/8 play and you don’t need to pay additional time premium for = 0.0882, and (var_1* T_1) by T_1 -1 = 0.8464/3 = 0.2821. the July 15th expiry. Of course, with the heightened implied Why? Remember, there is only one day of jump in implied volatility, option premiums are also high, so buying outright volatility due to the event. Subtracting 0.2821 from 0.0882, options will be an expensive hedge and will eat into the profits of our underlying position. So you take advantage of the high premiums by also selling options and trading a spread, thereby 1x2 Put Ratio Spread Payoff reducing the premiums paid. In other words, if you are long $8 the underlying and want to hedge against a downside (upside), you could buy ATM puts (calls) and sell OTM puts (calls). But as we know, the premium for OTM puts is smaller than that of the ATM puts, so we decide to trade ratio spreads, that is, $5 sell >1 OTM puts (calls) while buying 1 ATM put (call).

$0 $132

$140

$145

$150

Stock price at expiration

FIGURE 3: STOCK PRICE VS. STRATEGY PAYOUT FOR 1x2 PUT RATIO SPREADS. The maximum payoff is $8, which is when the stock price at expiration is at $140.

you get ‑0.1939. Now, multiply that with the product of (T_1 -1) and (T_2 – 1) and divide it by (T_1 – T_2), which gives you: (-0.1939 * 24 / -5) = 0.9308. Since this is the variance, you take its square root, which equals 0.9648. This is the annualized event volatility, so if you divide it by the square root of 256 you get our final answer, 0.9684/16 = 6.03%. Note that I use 256 instead of 252 as the number of trading days in a year to get a whole number for the square root. This gives you the one-day expected stock price move due to the forthcoming earnings event. So if the current stock price is $150, the market is expecting the stock to move up or down by about $9.04. Instrument

Strike

Put 1

$140

Put 2

$145

Put 3

$150

Ratio spread Let’s work out an example with a simple 1x2 put ratio spread, and the same logic can be applied to a call ratio spread as well (see Figure 2). At the time of evaluation, let’s say the stock price is $150.05. The ATM 150 put that expires four trading days from now at 46% volatility costs (using a simple BlackScholes calculator) $4.05. The 141 put at 51.5% volatility (remember volatility is not constant across all strikes) costs $1.30. So you buy one ATM put and pay $4.05 while selling two OTM puts and collecting $2.60, for a net premium cost of $1.45 ($4.05-2.60). That’s a 60%-plus reduction in premium paid than if you had only bought one ATM put. Why pick $141 as the strike for the OTM puts? Because the model indicated a move of about $9 (so $150-$9 = $141), and you assume that to be the worst-case scenario for a stock price plunge, in which case the OTM puts will expire worthless and you would have pocketed the premium. Let’s take a look at the graph in Figure 3 for the payout of this strategy.

Butterfly spread For those of you with a penchant for taking a higher risk and not indulging in buying/shorting the stock prior to earnings, you might Position Stock Price at Expiration consider trading a butterfly spread. $135 $140 $145 $150 You can do this by going long one +1 $5 $0 $0 $0 put at $140 strike, short two puts at -2 ($10)*2=($20) ($5)*2=($10) $0 $0 $145 strike, and long one put at $150 strike (see Figure 4). Without using +1 $15 $10 $5 $0 any formulas, try to intuitively guess Total Payoff $0 $0 $5 $0

FIGURE 4: BUTTERFLY PUT SPREAD PAYOFFS. In this case, you’re going long one put at $140 strike, short two puts at $145 strike, and long one put at $1150 strike.

26 • January 2017 • Technical Analysis of Stocks & Commodities

Continued on page 46

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WhY tRADE ETFS?

ETF Sector Investing Are you interested in learning more about using exchange traded funds (ETFs) in your trading? Leslie N. Masonson, an active ETF trader, is president of Cash Management Resources, a financial consulting firm that focuses on ETF strategies. He is the author of Buy—Don’t Hold: Investing With ETFs Using Relative Strength To Increase Returns With Less Risk; and All About Market Timing, as well as Day Trading On The Edge. His website is www.buydonthold.com, where he writes a weekly blog. To submit topics for future columns, reach him at [email protected].

O

by Leslie N. Masonson

ne of the more recent ETF innovations over the past decade has been the introduction of factors to enhance performance and minimize risk compared to the more traditional market-capitalization weighting approach. A factor is simply a characteristic of a security that has demonstrated an ability to provide an equal to or better than average return with lower risk. As a precursor to factor-based ETFs, Morningstar introduced its equity style in 2000 which consisted of nine boxes with large, medium, and small-cap stocks labeled on the vertical axis, and value, blend, and growth labeled on the horizontal axis. Stocks were placed in one of these nine boxes and their performance was compared.

Factor-based ETFs have shown

outperformance According to Morningstar, since 2010, factor-tilted ETFs have had inflows of over $250 billion. “Smart beta” (as factor-based ETFs are often referred to) ETF providers use one or more specific factors in their ETF offerings. Moreover, academic, quant, and institutional research has shown that using these factors individually or in combination can provide enhanced returns with less risk over long timeframes, such as a few decades at minimum. Among the backtested factors that have shown the characteristic to outperform standard benchmarks are quality, value, and momentum. Other factors that have outperformed at a lower level include low volatility, size (for example, smallcap), and dividend yield. In general, according to FactSet, over a 30-year period ending in 2015, small-cap stocks have outperformed large caps in 13 years, including 1991, 2001, 2003, and 2009, where they outperformed by more than 10 percentage points. They had an average excess return over large caps during this period of 0.7%. In comparison, value stocks have outperformed the market in 23 out of 30 years with an average 3.5% excess return, and momentum stocks accomplished the same objective in 18 years with a 1.53% excess performance. Vanguard analyzed common factors from 2005 through 28 • January 2017 • Technical Analysis of Stocks & Commodities

2014 in a research paper and found that over this period, momentum was top ranked in annual return in 2005, 2007, and 2013, value was top ranked in 2006 and 2012, size was top ranked in 2009 and 2010, and low volatility was top ranked in 2011 and 2014. Of course, over the short timeframes such as one-year periods, any factor can go in and out of favor and can underperform the general market averages and then bounce back as a strong performer years later. This was the case in Vanguard’s research. As with any investment approach, there is no way to know if any of these factors will actually perform better than their benchmarks in decades ahead, but it certainly appears possible based on an evaluation of these ETFs that have been available for a number of years. Factor ETFs continue to see new entrants to the market. For example, Fidelity Investments introduced a handful in October 2016 that include core dividends (FDVV), rising rates (FDRR), low volatility (FDLO), momentum (FDMO), quality (FQAL), and value (FVAL). Surprisingly, Fidelity was late to the market in delivering these ETFs, even though the company has been studying factors for over 30 years and has been using them in its active mutual fund strategies for years. Whether or not these ETFs will gather sufficient assets to sustain themselves should be interesting to watch, especially since other providers have had similar ETFs in the marketplace for years and have garnered significant assets. More and more factor-based, equal-weighted ETFs are being offered by providers, since they often perform better than market-weighted ETFs over many years.

Factor-based performance comparison

Let’s take a look at a handful of well-known factor ETFs to review their performance over the most recent three-year period ending October 21, 2016, since they all existed during this time period. The first four ETFs listed in Figure 1 are iShares ETFs for minimum volatility (USMV), momentum (MTUM), quality (QUAL), and value (VLUE), respectively. The last three ETF portfolios invested in large- and mid-cap securities. VLUE focused on three factors simultaneously that included return on equity, earnings variability, and debt equity. The fifth ETF listed is Guggenheim’s S&P 500 Equal Weight ETF (RSP), which came public in April 2003. The best-performing ETF of the five shown was MTUM with a 14.12% return compared to USMV’s 13.32% return, and it had the next-to-lowest beta at 0.79, but has very low daily volume at 28,292. VLUE offered the lowest performance at 8.72% while also having the highest standard deviation, which resulted from the out-of-favor years when performance suffered. However, it offers the highest current yield at 2.36%, but the lowest average daily volume of 19,852. RSP has been in existence for over 13 years and has accumulated $10 billion

Comparison of Factor ETFs (As of Sept. 30, 2016) Ticker Symbol

USMV

MTUM

QUAL

VLUE

RSP

Inception Date

10/18/2010

4/16/2013

7/16/2013

4/16/2013

4/24/2003

Net Expense Ratio

0.15%

0.15%

0.15%

0.15%

0.40%

30-Day SEC Yield

2.31%

1.68%

1.97%

2.36%

1.57%

176

121

124

148

506

No. of Holdings Net Assets

$13.38B

$1.84B

$3.11B

$952M

$10.0B

3 -Yr. Return

13.32%

14.12%

11.76%

8.72%

10.33%

Benchmark

13.50%

14.33%

11.92%

8.88%

10.77%

20-Day Avg. Vol.

723,362

28,292

61,771

19,852

820,787

Equity Beta Std. Deviation

0.59

0.79

0.95

1.13

1.00

8.84%

10.80%

10.60%

11.72%

10.95%

Sources: Ishares, Guggenheim, Fidelity FIGURE 1: COMPARING FACTOR-BASED ETFs. Here, five different ETFs are compared. Clearly, the low-volatility ETF and momentum ETF had the best returns at 13.32% and 14.12%, respectively, but the latter had very low average trading volume.

Further reading

Masonson, Leslie N. [2016]. “ETF Perspectives,” Technical Analysis of Stocks & Commodities, Volume 34: September. [2016]. “ETF Sector Investing,” Technical Analysis of Stocks & Commodities, Volume 34: November. Pappas, Scott N., CFA, and Dickson, Joel M., PhD [2015]. Factor-Based Investing, Vanguard Research: April. • www.etf.com • www.ishares.com • www.guggenheiminvestments.com • www.fidelity.com

FIGURE 2. HOW DO THESE SIX ETFS COMPARE? Viewing these ETFs over a three-year timeframe from July 18, 2013 through October 21, 2016 shows that the momentum, low-volatility, and quality ETF outperformed the S&P 500.

in assets, but it has the highest net expense ratio at 0.40%, and it has the highest average daily volume at 820,787. From the standpoint of traders, USMV and RSP offer the most liquid vehicles, while for long-term investors, MTUM, VLUE, and QUAL offer decent returns with acceptable yields. In Figure 2, looking at the performance since July 18, 2016 when all three ETFs had a common starting point, MTUM clearly led the pack for most of the period with a gain of 46.27%. VLUE started strong but faded at year-end 2015 through October 21, 2016, ending with only a 26.34% gain. Notice that RSP was ahead of the S&P 500 for over 90% of the time and ended with a 6.64 percentage point advantage. Just looking at the data from the February 11, 2016 low (not shown) through October 21, 2016, we find that VLUE reversed direction and led the pack with a gain of 22.29% compared to 22.01% for RSP and 17.06% for the S&P 500. The takeaway from viewing short-term time periods is that factors can move from a leadership to a laggard position and vice versa rather quickly, and that a long-term investment

horizon is required to gain the true benefit of a particular factor strategy. To replicate the data in Figure 2 or see a graph of the return figures just mentioned, you can go to StockCharts.com and key in those ticker symbols in the Perf­Chart section on the left side of the homepage, and press go. Then move the cursor over the left and right arrows at the bottom of the chart to obtain any starting and ending dates. Investors and traders looking to find a happy medium between the standard buy & hold approach and active investing can potentially add a rewarding investment strategy to their mix by considering factor-based investing with a portion of their money. However, this should only be done after performing the necessary due diligence. This means not only evaluating the possible benefits of the ETF being considered but also any downsides, such as higher-than-average net expense ratio, portfolio composition, sector weighting imbalances, liquidity, bid/ask spreads (for active traders), and rebalancing frequency resulting in short-term capital gains. In addition, traders and investors can use a few technical indicators with factor ETFs such as an MACD or a 100- or 200-day moving average to time their entry and exit points among the five different factor ETFs discussed here to remain in the best-performing one until a sell signal occurs, then reinvesting the proceeds in the strongest ETF in the mix.

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January 2017

• Technical Analysis of Stocks & Commodities • 29

FUTURES FOR YOU INSIDE THE FUTURES WORLD Want to find out how the futures markets really work? Carley Garner is the senior strategist for DeCarley Trading, a division of Zaner, where she also works as a commodity broker. She has written multiple books on futures and options trading, the latest is titled Higher Probability Commodity Trading. Garner also authors widely distributed e-newsletters; for your free subscription visit www. DeCarleyTrading.com. To submit a question, email her at [email protected] or via www.DeCarleyTrading.com. Selected questions will appear in a future issue of S&C.

commodity optionS BUYING When is the best time to buy commodity options? It is no secret that I tend to favor options selling over options buying, but that doesn’t mean there aren’t favorable times to buy options. That said, before delving into strategies to go long options, it’s imperative to understand that long options traders must be more accurate in regard to market direction and timing than options sellers must. Moreover, they must carry the heavy burden of time value erosion, which often causes traders to lose money despite being somewhat accurate in their price prediction. Nearly all books and courses that focus on options trading attempt to drill home the message of buying options when volatility is low. Yet, unfortunately, human nature lures options buyers to the markets during times of high volatility and leaves them uninterested in quiet markets. This is a habit traders must be willing to shake if they are going to have a chance at profiting from an optionsbuying strategy. It is not unlike paying extra money for a sporting event ticket while a team is hot, or paying additional money for a name-brand pair of jeans; in most aspects, the increased value is merely perceived. Thus, in the end, the buyer is likely to be disappointed. At times, however, options buying can be particularly attractive. For starters, low volatility is a necessary box to check, but it’s also a good idea to be aware of market seasonality or the technical setup of the particular market in which you are interested in buying options. Specifically, the best options-buying opportunities are countertrend speculations. For instance, a trader is generally better served by buy-

ing a put option written against a futures contract that is trading at a relatively elevated level, and buying underpriced call options in a market hovering near historical lows. It’s easy to determine which markets are trading near highs or lows, but not all futures and options trading platforms offer implied volatility (IV) readings. Even those that do aren’t necessarily easy to interpret or utilize. This is because implied volatility is highly relative. What seems like a high IV level today might seem low tomorrow, and vice versa. In case you are unfamiliar with implied volatility, it is the amount of options

Seek out those commodity markets trading at a relative low and stock indexes trading at a relative high to find optionbuying opportunities. premium priced into an options market to account for expectations of future volatility. It is an increase in implied volatility, and therefore in expectations of upcoming volatility, that causes option prices to inflate ahead of major economic announcements or political events even while the underlying futures market is stagnant. One affordable and easy source of implied volatility information is Moore Research Center, Inc. (MRCI). The firm specializes in seasonal studies, but it also offers charts of implied volatility in

30 • January 2017 • Technical Analysis of Stocks & Commodities

Carley Garner

each of the major commodity markets on a daily, weekly, and monthly basis. We particularly enjoy the opportunity to scroll through the weekly implied volatility chart of various commodity markets to identify sectors that might provide attractive opportunities to buy options if the IV is low, and sell them if IV is unusually high. Once the commodity markets with low implied volatility have been weeded out, it is a good idea to find those trading at, or near, significant highs or lows. With that said, it should be noted that commodity markets are opposite the stock market in that increases in volatility tend to impact call options in a more dramatic fashion than put options. As is common knowledge, when it comes to the S&P or any other stock index, it is possible to make money faster, and in larger amounts, by buying put options. In other words, call options in commodities tend to become overpriced similar to the way put options in the stock market can become overpriced. This is because the most explosive price risk is to the upside in commodities and to the downside in stock indexes. Armed with this knowledge, it makes sense to seek out those commodity markets trading at a relative low and stock indexes trading at a relative high to find options-buying opportunities. In a perfect world, the markets with low volatility trading at relative price extremes will also coincide with seasonal tendencies. For instance, if you are lucky enough to find a soybean market lurking near multimonth lows during the month of October—that is, a time when the annual low in soybean prices is frequently seen, referred to as the “harvest lows”—in a

FUTURES FOR YOU low-IV environment, it just might be the perfect storm required to put the odds of success in favor of options buyers. For those wondering why it takes so many things to fall into place for an options-buying strategy to make sense, it

is because most options expire worthless. This puts the probabilities overwhelmingly in favor of the options seller in the majority of circumstances. Remember, as an options buyer, it is necessary to be accurate on the direction of the underly-

ing futures price, the timeframe the price move occurs in, and the magnitude of the move itself. Without the stars aligning, it can be difficult to make money in the face of such obstacles.

TRADE ANALYSIS TRADE ANALYSIS risk results in volatility, which adds fuel to the fire of trading. Will a trading opportunity like the Brexit occur again? The simple answer is yes. Once Article 50 is signed by the prime minister of the United Kingdom, the two-year clock will begin and the United Kingdom will have a deadline to exit the EU. As a result of Brexit, a new prime minister was elected and she had previously announced that Article 50 will be signed before the end of the FiGURE 9: FindinG tURninG pointS. Here the target of 1.3351 was forecasted by Fibonacci traders at 261.8. year, but at the time of this writing, the timeline for this is undefined. The first minister of Scotland has stated that a second referendum for Scottish independence is “highly likely.” Consequently, Northern Ireland has also expressed interest in a new movement for independence. The result of all of these political issues will cause a ripple effect and create movement in the Great British pound and further opportunities for traders. The ripple effect of Brexit carried over into the US Presidential election FiGURE 10: diFFEREnt StyLES FoR diFFEREnt FoLKS. You could apply your entries and exits based on the on November 8, 2016. During the bottom of the daily channel, the whole number of 1.3000, and the 1985 low. Here, you see how you can use channels, night of the election, the emini S&P Fibonacci levels, whole numbers and the 1985 low for your entries and exits. 500 futures dropped more than 120 points into a limit-down move and trading was temporarily halted by the exchange. The price tompKinS & WonG / BREXit move and its effect on the futures and forex markets would Continued from page 15 make for an interesting topic for analyzing further. while the benchmark 10-year US Treasury bond dropped to its lowest level since 2012. Investors rushed into safe haven currencies and assets for protection from the Brexit storm. The US dollar, the Japanese yen, and the Swiss franc all went up in value. German 10-year bonds fell below zero for the first time ever. Amid the confusion, the US Federal Reserve backed away from raising interest rates during 2016. Uncertainty was created in the currency market. With uncertainty comes risk, and more

Eva J. Tompkins, JD, is a practicing attorney and an active trader. She can be reached for questions or comments at [email protected]. Jody Wong, JD/MBA, is a practicing attorney, an active trader, and has a master’s degree in business administration. He can be reached for questions or comments at JodyGWong@ aol.com.

January 2017

• Technical Analysis of Stocks & Commodities • 31

Explore Your Options Got a question about options? Tom Gentile started his trading career on the floor of the American Stock Exchange in 1994. He has appeared on many financial TV and radio shows, as well as hosting a weekly talk show himself, and has coauthored many books on the markets. He can be found at www.tomgentile.com. To submit a question for Tom Gentile, post it to our website at http://MessageBoards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Tom Gentile

New Year’s Resolutions for Options Traders Happy new year everyone! It’s a new year, a new presidency, and the first 100 days in the White House will include a new cabinet and agenda. Do you know what else it’s time for? Reviewing your performance as a trader for the last year as well as setting goals and planning for 2017. I find that the best time to do this is during the last week of the year, but if you miss that opportunity due to excessive partying or perhaps excessive in-laws at your house, now is as good a time as any to get started. Creating a trading plan involves answering questions around your plan, so let’s get started.

What am I going sacrifice in order to get to my trading goal? Trading doesn’t come without a price. There are two things I believe a person will sacrifice over time to be a great trader—time and money. But not necessarily in that order. You may have heard that if you think the cost of trading education is high, try the cost of ignorance.

Look at the big picture For a trader to be successful, he must start at the bottom and build a foundation. It’s just like a builder who wants to be successful: he has to start at the bottom and survey the land before any work begins. You must take stock of yourself as a trader and ask yourself the following questions:

The problem with money is that it has emotional value for just about everyone on this planet.

What do I want out of trading? Do I want to be right or do I want to be profitable? One thing to remember is that money is just the icing on the cake of trading. The problem with money is that it has emotional value for just about everyone on this planet. That’s because all our lives we have been trained to believe that money can buy different things at different times. It’s OK to want to be profitable but too much greed, like anything, can ruin a good trading plan. Your desire to be a great trader should always keep you pumped up. This is what keeps successful traders consistently profitable.

How much time should I commit to being the trader I want to be? Now that you have some basic knowledge under your belt, you need to figure out at some point what trading style you want to adopt—directional or nondirectional? Maybe you want to do both. I don’t know

too many people who can talk out of both sides of their mouth, and I look at trading the same way. Either you are directional or you’re nondirectional. This means either you are looking at patterns in the stock market or patterns in the options markets. What markets am I going to trade? I have seen and heard a lot of people say “I trade everything,” or “I trade whatever is profitable.” But take note: The words “everything” and “profitable” never exist in the same sentence. That’s like working at a big-box store and being the clerk, stock boy, butcher, bakery person, cashier, and manager all at the same time. You will run yourself ragged and not make a dime on anything. Don’t become a Jack of all markets. Instead,

32 • January 2017 • Technical Analysis of Stocks & Commodities

get really good at one or two strategies and be a master of them. How will I utilize options as part of my plan? Most options traders who have gained experience fall under one of two categories—they either trade for direction or for volatility. Trading for direction means leaning bullish or bearish and simply leveraging options to help create gains for less risk. Trading volatility means you’re looking for the options premium to rise or fall, regardless of market direction by taking advantage of more market-neutral trades. Whatever your choice, reread the last paragraph and become a master of one of these forms of options trading. Last question: Can I take responsibility for my own actions? Here’s one that 90% of novice traders fail to learn. When you accept total responsibility for your trades and your actions that result from trading, you close the door to excuses. That is one giant leap away from the crowd and one giant leap toward consistent success in the markets. Imagine for a moment Peter Lynch losing a few million dollars and then blaming his analysts for their bad advice. Its simply not going to happen because Peter Lynch takes responsibility for his own actions. When you take responsibility for your own actions, it also means a less likely chance of repeating the same mistake twice. Here’s your assignment, should you choose to accept it: Make a monumental decision to create a blueprint for success, determine how you are going to get there, and what you have to sacrifice. You also want to develop a trading plan and take responsibility to carry out that plan.

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The Brains Behind A Trading System: Denis Globa The thought of developing a trading system can overwhelm you with words like backtesting, optimization, curve fitting, and performance results whirling through your head. But anyone who has gone through the learning process and has successfully applied their own systems to their trading will tell you it’s a journey well worth the effort. Denis Globa, founder and CEO of MultiCharts and TradingView, fits this bill. With over 15 years’ experience trading various asset classes, he founded MultiCharts, a trading platform for charting, system development, and trade execution, and TradingView, an online trading community and visualization platform, with the intention of bringing trading system development to the hands of retail traders. Stocks & Commodities Editor Jayanthi Gopalakrishnan interviewed Denis Globa via email in early November 2016. Could you tell us how you got interested in trading systems? I learned about systematic trading as I was learning about trading. I started trading forex and then moved on to trading futures and stocks. While it has its advantages, trading forex is still extremely risky because of the high volatility and huge leverage. That’s why I recommend to all beginner traders that they strictly follow risk management practices. To this day, I remain a fan of systematic trading. System trading is the only approach that lets you evaluate your results using the scientific method, and it lets you make concrete conclusions about the quality of your decisions. Despite all the obvious advantages of discretionary trading, you can never truly know if a profitable trade was coincidence, pure luck, or the result of your approach. Do you have a mathematics background? My background in mathematics is not very deep, but I did have a university education in math, plus I met people along the way who helped me to develop a system-based approach to trading the markets. With my university education and being around people who are strongly connected to system trading, it was possible for me to develop fully automated

algorithmic trading systems, which made it even more attractive. Who or what was the biggest influence behind your interest in the markets? One of my greatest influences was the “Turtles experiment” conducted by commodity traders Richard Dennis and William Eckhardt in 1983, in which they taught students their trading method and had them trade it. Of course, the markets have changed since then and the markets now behave differently, which makes the approach obsolete. But it proved that even new traders can successfully trade for a long period of time if they use a systematic approach. If someone wants to create a trading system for the first time, what are some prerequisites for them? By this, I mean how necessary it is for someone to be familiar with money management, technical analysis, and so forth? The main prerequisite is to understand that it will take a lot of time and effort to create a system that works. It may take months or even years and you’ve got to be ready for that journey. You also need to thoroughly understand fundamental and technical analysis, and the basics of statistical methods to estimate the quality of trading systems.

34 • January 2017 • Technical Analysis of Stocks & Commodities

Creating a trading system is like flying on autopilot. It’s something you have to know and trust. These are more like basic requirements or principles that form the foundation of system analysis. This includes things such as the accuracy of input data, backtesting results that have statistical significance, and methods to accurately evaluate quantitative and qualitative trading results. If you don’t have accurate historical data, it becomes impossible to get the correct simulation. If you make conclusions and assessments on partial data, then you’ll have to do more checking—in other words, more work. When you make conclusions about the specifics of the system you are testing, those conclusions must be founded on a large number of mutually compensating factors and not just one single piece of data that looks impressive to you. In addition to knowing the basics of statistical methods, basic programming

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skills are also a must-have. If you don’t have some basic programming skills you won’t be able to create a trading system. What’s the best way for someone to start learning to code? Do they need to learn a specific coding language? Basic programming courses are widely available, either offline or online. There are a bunch of sites now that will teach you the basics, such as Codecademy, Coursera, and Udemy, for example. There are a lot of places that will teach you how to code at no charge. As for languages, C# is great for creating complex systems, or for some of the more basic tasks, I would just focus on the language that your platform uses. How important is it for a system trader to grasp the topic of trading psychology? Trading psychology is definitely super important for both system and discretionary traders. Creating a trading system is like flying on autopilot: It’s something you have to know and trust. In order to be comfortable, you’ve got to understand its characteristics and make informed decisions about when to change the algorithm, and when to just let it run. If you’re psychologically unprepared, you can end up reducing your trading system to a discretionary system, since you will have constant interruptions.

Multicharts

What’s the importance of writing out a plan or visualizing your trades before starting to create a system? Building a system is an iterative pro-

cess. You usually start with a simple idea, make a beta verOptimization is a vital sion and see what happens. You tool for finding obscure can make some improvements patterns, ones that are and changes, and try it again. invisible to the naked eye. You continue to repeat this process until it’s responding properly to different market conditions. A big mistake is to try to craft thousands of trades, it’s obvious where a huge system properly from the very the patterns are. It’s also important to beginning and spend a ton of time doing make sure all trading-related expenses it without testing it in the real market. are accounted for, such as spreads, commissions, or extra charges for replacing What do you think makes system and modifying orders. If you omit such trading superior to, say, discretionary expenses from your evaluation period, trading? they can come as a nasty surprise, or I would say the two main things are turn what you thought was a profitable speed and objectivity. The markets have system into a terrible one. become extremely volatile, and millisecIt’s the same with optimization. I’m onds can make all the difference between truly convinced that optimization is a a good trade and a bad one. In this sense, vital tool for finding obscure patterns, algorithmic trading has the advantage, ones that are invisible to the naked eye. and plus it has the objective data to help Brute force or genetic optimization lets evaluate its performance. you find optimal parameters, but you have to check how robust they are with What type of systems did you develop walk-forward analysis. when you started? We developed systems based on ar- How are they different from the systems bitrage, news, and price patterns. The you create now? first and the second are still used in I don’t create systems for my personal high-frequency trading (HFT), but they use any more. Working on our main aren’t entirely suitable for retail traders product at MultiCharts leaves no time due to high speed requirements for in- for trading. We do interact with a large teracting with exchanges. Price patterns number of individual and institutional are still relevant today, but they have traders on a regular basis, and the gentheir own set of challenges: Searching eral feeling is that systems evolved and for them requires complex systems with became much more complicated. There’s uncertain logic. a lot of focus on high speeds of order exIt’s too easy to fit your system to data ecution, depth of market, and order flow with a few dozen trades, resulting in analysis because that’s the direction in incorrect analysis. But with hundreds, or which technology has advanced.

Figure 1: drawdown profit/loss. Here you see there are more win drawdowns than loss drawdowns.

36 • January 2017 • Technical Analysis of Stocks & Commodities

How do these impact the way trading systems are designed? In a nutshell, they increase requirements for data accuracy and speed of order placement. What this does is significantly complicate system development and testing, because it requires the re-creation of detailed history of depthof-market price changes and working with huge data arrays. You also need to place trading robots in co-location zones with low latency and dependable communication channels. That complicates things. It sure does. I’m sure many traders don’t realize the complexities of building trading systems. What are some mistakes you see people make when they build trading systems? There are a few things I could note, but I would say some of the big ones are incorrect evaluation of backtesting results, incorrect optimization, and absence of simulated trading on a demo account. Some people get too excited when they finally craft a system that shows profit. So they rush ahead with it, thinking they’ve considered all possible factors. In reality, while simulated trading is a necessary step, even that doesn’t guarantee good results in real-market conditions. You need to remember that a broker’s demo-server is just a simulation, since your orders are not making it to the real market. This might appear inconsequential on liquid markets, but we’ve seen instances when systems performed well on sim accounts, but lost their advantage when launched in a real account. Sometimes people trade during drawdowns and that makes them think their system is broken. What would your advice be to them? To avoid psychologically difficult moments, we recommend that our customers build systems with a low expected drawdown. If you look at the drawdown chart in Figure 1, you see there are more win drawdowns than loss drawdowns. When you have a system with a low expected drawdown, it’s possible to pause your trading and take a look at why the drawdown is happening. I prefer systems that have a lot of transactions and a small

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works today and will likely work in the near future.

When do you know it’s time to abandon your trading system and create a new one? As soon as the system veers outside of its acceptable deviation range, or stops being profitable, then you know it’s time to reevaluate its market fit. I have never heard of systems that work well for years on end. That’s more what traders wish rather than reality. It’s important to always track market behavior and constantly improve something that

It never ends, does it? Thank you for sharing your knowledge of trading systems with us, Denis.

January 2017

Further reading

Gopalakrishnan, Jayanthi [2016]. “TradingView,” Quick-Scan, Technical Analysis of StockS & commoditieS, Volume 34: October. ‡MultiCharts, ‡TradingView ‡See Editorial Resource Index

• Technical Analysis of StockS & commoditieS • 37

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

NEW YEAR, NEW PRESIDENTIAL TERM, NEW APPROACHES To begin, I have two announcements: First, the year 2017 marks the 25-year anniversary of Bright Trading, LLC. Second, given that we are looking at four-plus years of anticipated volatility, it’s time for the return of the trader. Actually, things began to change on September 9, 2016, in contrast to the preceding quiet summer months. On that day, every stock in the Dow Jones Industrial Average was down, 98% of the S&P 500 stocks were down (only 11 were up on the day), and the S&P 500 slid 2.5% or 53 points. The catalyst for that decline was Fed-speak and politics. Since that day, we have had increased volatility, rolling up and down with the various news on Clinton versus Trump or whether the Federal Reserve was going to raise interest rates or not. Since politics is in the forefront at the moment, with January 20, 2017 as Inauguration Day, it is fitting to discuss some macro themes here. There are adjustments to be made for the present and future trading landscape. As a “cardcarrying member of Wall Street,” you don’t want to render yourself obsolete, so press on with the necessary adaptations. To quote Benjamin Franklin, “When you are finished changing, you’re finished.”

our 25 years of business, Bright Trading has seen a direct correlation between trader profits and volatility levels. Backand-forth movement, higher frequency of gaps and fills, larger directional moves, more overbought/oversold outlier conditions, and abrupt turns and retracements have all contributed to increased trading revenue through providing liquidity and correcting inefficiencies. This has been true with individual stocks or ETFs, pairs, baskets, trading the peers of a sector (piston trading), opening-only orders and closing imbalances. Daytraders, short-term swing traders, and hedged portfolio traders welcome volatility as an opportunity to provide a beneficial service to the market and play a small part in offsetting greed or fear.

Expect increased volatility Trump’s presidency is anticipated to be unpredictable, therefore increasing movement in the markets, whereas a win for Clinton would have meant an expectation of four more years of what we had been used to for the last eight years. Under the business-as-usual scenario if there had been a Clinton win, volatility might have declined from recent levels. But in

• Learn to hedge by trading pairs or long/short baskets. You can also pair a stock with its associated ETF. This allows you to do a swing trade and reduce market exposure risk at the same time. • Lower your position size so you can withstand greater moves for or against you. This will reduce emotions that cause freezing up or taking

Volatility is an opportunity to provide a beneficial service to the market and play a small part in offsetting greed or fear. How to approach it Let’s look at some ways to participate in a market with increased volatility.

38 • January 2017 • Technical Analysis of Stocks & Commodities

profits too soon. • Allow for the expansion of ATR beyond the 14-day average. • Live in the world of probabilities. Not every idea will work out correctly or immediately. • The length of time required to stay in a trade may be increased. • Have lists of stocks you’d like to participate in, but only if the price is right. Be more selective of your entry prices and timing. • Let the market go first and wait patiently for an attractive entry level. • You could allow stocks to reach outlier levels before entering them. Instead of entering a stock and waiting for a profit target or being stopped out, have a list of stocks that you would like to deploy if an outlier situation occurs. Trading from the extremes can provide opportunity or can present additional risk. If you are implementing mean reversion through pairs trading, then you want to be mindful of the premium or discount in the spread relationship. Accomplishing excellent spread prices when you place capital into a pair relationship is critical for profits. • Trade some. Hold some. Don’t be all out on a profitable trade, because symbols and spreads can often travel farther than you would expect. Holding onto some of your position can make a difference. These are times of change and we have to change with them. I believe in sudden events, I believe in surprises. The market is factoring in everything it knows or can anticipate, but it can’t factor in complete surprises.

Q&A Trump’s first 100 days Trump’s message during his campaign was that he would disrupt the current political and business environment. Given that his pledge was to shake things up, we should expect the unexpected. He may surprise everyone and start doing everything he said he would do. Or on the flip side, since he likes to be unpredictable, he might not do any of what he pledged. There are indications that he will work with China rather than slap protectionism tariffs on goods we import. Since we have a step-by-step guide of what Trump laid out in a commitment to the American people if he was elected president, we should look at his list of actions planned for his first 100 days in office. The macro themes surrounding his campaign promises have been driving markets since the day after election day, and they will be the litmus test for whether he is committed to these or whether it was only campaign rhetoric and empty political jargon. Perception of a Trump presidency What has Trump laid out for his presidency and what do we expect he will pursue? Here’s a summary: • Large increases in infrastructure spending • Support of American manufacturing and energy production • Repatriation of corporate profits held outside the US • Lower taxes on business • Less regulation • Restrictions on special interests and placing term limits on Congress • Repealing Obamacare • Reducing the size of the federal government beginning with a hiring freeze • Placing tariffs on imports • Tightening up the borders and restricting immigration • Increase in defense and military spending • Dim view of some of the tech giants. You can take each one of these bullet points and make a list of the conventional wisdoms that gets echoed and that lead

ultimately to a consensus outlook. Then write down your contrarian takeaways. This will help you look for the signposts that suggest you either “drive 65” or “slow down for the S curves.” Does the macro catalyst for each item in Trump’s agenda have wind in the sails? We may see some similarities to the Ronald Reagan presidential years and the market and the economy could be dislocated for a period of time. Given the GOP sweep that occurred with the election, there should be fewer obstacles to getting stuff done. It all depends on what the incoming president’s team wants to accomplish. There may be a lot of noise and the markets could stay in a trading range, but two main outlier scenarios are also possible:

Don’t be afraid to utilize macro thinking in your short-term trading. This can help you trade with the wind at your back. 1. This is the start of—either immediately or delayed—an incredible bull market 2. The trouble is only starting, and the worst case will play out and a serious recession will hit. What we have seen so far is the stocks and industries that did well under the previous administration are being sold in favor of buying stocks within industries that are anticipated to do well under the new leadership. Multiple scenarios. Multiple strategies. Multiple models or variations of those strategies. Multiple timeframes. Multiple methods and paths for executing trades. Run the scenarios Run scenarios of how the markets may play out in the near future and for the next four years. You can’t predict what will happen, but you can prepare multiple trading plans with multiple scenarios that could play out. Prepare for a bull January 2017

market, a recession, and a sideways market. By creating trading plans with list of stocks and rules for each scenario, you will be prepared for what the market gives you. Play relative performance when the macro forces are clear When there are clear and persistent macro forces in play, participate by trading best-in-breed stocks within their sector. Selecting the strongest stocks in the strongest groups and hedging with their corresponding ETF or the SPY is one way to trade it. The same holds true for shorting the weak stocks in the weak groups and hedging against the corresponding ETFs. Alternatively, buy best-in-breed stocks and pair them against worst-in-breed stocks. The theme is to start with a single idea and find a hedge for it. It is through hedging your trades that you may find the ability to participate in volatile markets without being shaken out. Let’s look at some examples of macro forces that could act on given sectors. • If we get an uptick in interest rates, then those stocks with a bond component, such as utilities or those with a larger dividend like REITS, would be sold. • If infrastructure spending is the focus, then the industrials can benefit. • If national security is a concern or the risk of war has increased, then defense contractors may see money flow into that group. • If there is any potential for decreased regulation in banking and some unwinding of the restrictions, then the financial sector may benefit. Don’t be afraid to utilize macro thinking in your short-term trading. This can help you trade with the wind at your back. You may also catch reversals from the overbought or oversold areas. Remember that technicals are great, but understanding the reason behind a trend or move may be even better. Your strategy can be as simple as Continued on page 47

• Technical Analysis of Stocks & Commodities • 39

www.barchart.com

Barchart.com got a facelift. It looks more modern, is more intuitive, and easier to navigate. It still has its rich feature set that its subscribers have known to appreciate. The contents of the site could help in your trading whether you’re a stock, options, forex, or futures trader. Here’s how. Say you’re ready to start your trading day, coffee in hand; you open up Barchart.com on a device of your choice, and start by reading the Barchart morning call. It doesn’t cost anything to register. The only time that payments come into the picture is if you opt to use any of the premium services. I’ll focus on the free content for this review.

A view from the top floor

Barchart.com could be your one-stop place to get a good overview of what to expect in the markets. You will see what happened in the overnight markets, you can catch up on world news, get a preview of US stocks before the markets open, find out about significant movements in the futures markets, and see if any events are going to impact your trading day. It’s a relatively quick read and a good starting point to plan your trading day. And if you start early enough, you have time to do your analysis before the markets open. There’s also an S&P sectors market map from which you can see which sectors are performing well and which ones aren’t. And with that overall view of the market, you’re ready to face what the market has in store for you, although you can never be 100% sure. At least you can create a roadmap so you can navigate through the markets and pick a clear direction. If it’s stocks you’re trading, go to the stocks tab and you’ll see a ton of choices divided into these categories: market pulse, performance leaders, most active, indices, trading signals, sectors. I decided to start with the most obvious—market overview under market pulse. What you’ll see first, not surprisingly, is an overview of the broader indexes and the market leaders by volume (Figure 1). Maybe you see something here that makes you curious. You click on the symbol and you’ll see enough informa-

barchart.com homepage

tion that could prove to be useful in your trading. You’ll get a quote overview, a three-month performance chart, and fundamental data. Below that is a section on price performance, which shows you how price is performing with respect to the high and low for a one-month, three-month, and one-year period. The data is easy to visualize and you get a

The overall view of the market you get from Barchart.com helps you create a roadmap to help you navigate through the markets with a clear direction. sense of the general trend of the specific stock’s price. Scroll lower and you’ll see the most recent news stories related to the stock. Along the right-hand side of the page you’ll see the Barchart.com technical opinion of the stock. That opinion could be similar to yours or it may be different. To find out how that opinion was derived,

40 • January 2017 • Technical Analysis of Stocks & Commodities

you can select the see more option to dig a little deeper and find out why the opinion was made. Other cool pieces of information you can see here are ETFs related to your selected stock, other stocks that may be impacted by movements in your selected stock, and support & resistance levels, which, to me, looked similar to pivot points. This feature caught my attention so I selected the see more option and came across a cheat sheet that could come in handy when selecting entry & exit points (Figure 2). On this page, you see the bid/ask prices—I should mention that prices are updated in real time on this site—and a table listing all key turning points and support & resistance levels based on several indicators. You can deselect indicators you don’t want to use. With all this information in hand, you could start strategizing your trades. And I’ve only touched on the market overview section under stocks. There’s a lot more to explore.

Stock screener

I was curious to find out more about the stock screener. It took a little getting used

FIGURE 1: STOCK MARKET OVERVIEW. Here you see the performance of the broader indexes, market leaders by price volume, and 52-week new highs and lows. If you scroll down you’ll see the most recent news, gainers and losers, top 100 stocks, performance leaders, and price surprises. All data is updated in real time.

to, since there is a limited number of criteria to choose from. You can set filters based on price quotes, fundamentals, technical, profile, and opinion. Within each of these are other criteria to select. After playing around with the different choices, I was able to come up with a scan that reduced the number of stocks to over 100. If you find a scan you like, you can save it so you can use it again. After running the scan, select the results tab and you’ll see a table listing all the stocks that met your criteria along with other details. If you set a filter based on the price quote and you want to see all the stocks with a new high price, you can sort columns by last price, weighted alpha, or price changes for different time periods (year, one month, three months). Once a scan is completed you can save the results as a watchlist, see all the results in flipcharts where you can scroll through all the charts, or download the results as a .csv file. You can, if you choose, go through each symbol on the list, analyze it more, and add an alert or add it to your watchlist or portfolio. Under the My Barchart tab, you can build custom portfolios, watchlists, alerts, screeners, data view tables, and chart templates. As you can see, there is enough information available on this site to make it your go-to stop before, during, and after market hours. And you’re not limited to US stocks. You can also view information from markets in Canada, UK, and Australia.

It’s worth exploring

FIGURE 2: SUPPORT & RESISTANCE LEVELS. Here you see the key turning points and support & resistance levels for the selected stock based on pivots, stochastics, Fibonacci, moving averages, highs/lows, RSI, and HLC. January 2017

Barchart.com may not be a substitute for your trading platform, although you could pay for premium services, one of which is BarchartTrader, which allows you to trade from your desktop, tablet, or phone. Other premium services include Barchart Premier, Trends In Futures, and Futures Trading Education. You have the opportunity to sign up for a 30-day trial for these services, some of which are offered by external companies. Even if you don’t sign up for the premium services, there’s enough on Barchart.com to keep you busy throughout the entire trading day.

• Technical Analysis of Stocks & Commodities • 41

Continued from page 7

Waves AND Profit-taking Editor, I am new to trading. I read the article “Waves And Profit-Taking” in the November 2016 issue of S&C, and I am interested in finding out more about this theory. I see that the author of the article, Howard Wang, has published a book about it called New Concepts In Trading: ProfitTaking Theory, but it’s in Chinese. Will the book become available in English? Does the author have any other references on this theory in English? Ron Turmel Author Howard Wang replies: Thank you for your interest. I do hope to publish the book at a later date in English. WHICH TREND INDICATOR WINS? Editor, I enjoyed the October 2016 article in Stocks & Commodities by Markos Katsanos, “Which Trend Indicator Wins?” Prior to reading his article, I had been curious about what trend indicator was best, and his article did an excellent job at reviewing four popular trend indicators. I have a few questions for the author: 1. I found the CI indicator mentioned in Katsanos’ book (Intermarket Trading Strategies) to be one of the best in my CMT (Chartered Market Technician) studies. I wondered whether the author has evaluated the CI indicator performance as compared to r-squared or any of the other three indicators discussed in his October 2016 article. 2. I noticed in his modified yen futures system code and modified emini intraday system code the addition of the r-squared indicator and the combined use of both CI and r-squared in the emini intraday system. Katsanos mentioned in his evaluation section that each of the indicators evaluated missed some strong trends. Based on his decision to use both CI and r‑squared in an emini system, has he found

that combining both CI and r-squared improves overall performance? 3. I did not notice a mention of the originator of the r-squared indicator—is Katsanos the originator? Thank you to the author for taking the time to share his knowledge with the many fellow analysts who read Stocks & Commodities! Ed Author Markos Katsanos replies: I didn’t include the CI in the comparison test because my intention was for the test to be as objective and impartial as possible. The CI, unlike the rest of the indicators, detects both direction and trend and it is not directly comparable, as it can be also used as an overbought/oversold indicator. In addition, I wanted to use exactly the same test conditions, and the CI required certain modifications. Since you are the second reader who asked me about the CI and how it compares with the other indicators, I decided to test it using the same system and procedure that I used in the article. There was a problem, however, with the parameter limits because, unlike the other indicators, the CI can have both positive and negative values, so I had to change the code to account for the negative values. As you can see in the OOS test results in the table in Figure 1, my first

impression was that the performance was average. Examining, however, more closely the last four rows of the results you can see that it detected almost all trend trades (missed only one) and with the least delay (only six days), capturing the most profits ($57,700). In addition, unlike with the other indicators, there was no problem in detecting V-bottom reversals. The main disadvantage and the reason for the rather poor overall test performance was that it didn’t filter out trades effectively, allowing more trades in nontrending market conditions. This is the main reason for adding the r-squared indicator in the emini system. My intention wasn’t to detect missed trend trades but to filter out false trends. On testing the modified system, this improved the performance considerably. And finally, concerning your third question: The r-squared indicator is not really a novel idea but rather a statistical method for calculating the correlation between price and its linear regression. I am not the originator of the r-squared indicator and I don’t know who first started using it to detect trends.

OOS-SA M P LE P ERFORM A N CE (2 0 1 1 -2 0 1 6 ) SY ST EM

N et Pro fit

To tal N u m b er o f Trad es An n u al rate o f retu rn Percen t Pro fitab le Pro fit F acto r

M ax lo sin g trad e

M ax In trad ay d raw d o w n Av g. d elay -Bars

M issed tren d trad es

To tal p ro fit in tren d trad es Av g. En try Efiicien cy M A PERIO D

TD I PERIO D

TD I SM O O TH IN G

MA

BUY & HOLD

$44,592 84

-$38,867 1

$30,429 14

$40,968 17

$21,257 18

$26,552 18

$36,600 27

1.86 $-2,830

$-38,867

3.99 $-2,596

4.18 $-2,274

1.93 $-3,800

2.25 $-3,227

2.44 $-3,981

13.87% 38.1%

$-16,775 0 0 $77,448

100.0% 50

-26.36% 0.0%

$-41,988

A DX

10.17% 57.1%

$-14,261 16 4 $36,628

56.0% TEST PARAMETERS 50

14

R2

12.96% 54.5%

VHF

7.48% 29.4%

$-10,715 7

$-19,048 11

72.6%

66.0%

3 $47,425 50

18

4 $43,480 50

36

3

ER

9.06% 27.8%

$-14,623 7

CI

11.84% 40.7%

$-12,800 6

3 $ 47,750

1 $ 57,730

50

50

63.8% 24

68.6% 24

3

4

30

0.42

0.38

0.36

58

TD I M AX

42

0.85

0.45

0.42

85

22

10

0.24

0.26

28

12

10

10

3

4

M U LT

1.8

1.5

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TD I TREN D

TD I/L RS C RIT L AG

FIGURE 1: OUT-OF-SAMPLE RESULTS. You can see in the last four rows of the results that the CI detected almost all trend trades and with the least delay, capturing the most profits ($57,700). However, it didn’t filter out trades effectively in nontrending markets, leading to poor overall performance.

42 • January 2017 • Technical Analysis of Stocks & Commodities

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A Sector Worth Watching

What Now For Banks? When Donald Trump won the US Presidential election, the Dow Jones Industrial Average immediately rose to a new high, against all predictions. As we search for investing opportunities in this new order, how attractive are the banking stocks? We’ll take a look at a few of them. by Koos van der Merwe

he United States has elected a president who promised to “make America great again.” With his history of unpredictability, from bankruptcy to making billions of dollars, President-elect Donald Trump throws a degree of uncertainty into the stock market. Predictions widely given before the election were that if he were elected, the stock market would crash. However, the opposite occurred. The Dow Jones Industrial Average (DJIA) rose to new highs, and meanwhile, the price of gold—usually a popular hedge against uncertainty—crashed. The question is, “What now for the future of the US stock markets?”

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Figure 1: Monthly chart of JP Morgan. The rise from the low of $15.03 in March 2009 to $76.69 could be a WAVE III in the Elliott wave count. Both the RSI and stochastic RSI indicators are almost at overbought levels. Volume has, however, dropped as the price rose. A WAVE IV correction is possible from here.

44 • January 2017 • Technical Analysis of Stocks & Commodities

AdvancedGET

T

With a Republican president in office together with a Republican Senate and Congress, the prospect of sweeping changes becomes a possibility. So where should you put your money? Rumor has it that President-elect Donald Trump, in his numerous businesses, has a close association with banks

July32015 58.80 5

in the same way every successful business person has. Are investing in banks the way to go? stocks The first bank that comes to mind is JP Morgan Chase & Co. (JPM). Note that in the 2008 bank crisis while financial services firm Lehman Brothers declared bankruptcy, JPM was one of the banks that survived, even though its share price fell from $53.25 to $15.03. Figure 1 is a monthly chart showing how the share price rose from the low of $15.03 in March 2009 to its present high of $76.69. An Elliott wave count suggests that this could be a WAVE III. Both the RSI and stochastic RSI indicators are almost at overbought levels. Volume has, however, dropped as the price rose. This share could be put on a watchlist, waiting for WAVE IV to complete a correction before buying. The second bank that comes to mind is Wells Fargo & Co. (WFC), which has recently corrected due to a scandal over bogus account creation within the bank. The scandal led to the departure of veteran chief executive John Stumpf. The chart in Figure 2 is a monthly chart of WFC showing how the price rose from a low of $7.63 in March 2009 to a high of $58.80 by July 2015. The Elliott wave count suggests that the share is completing a WAVE 4 with a major WAVE 5 still to follow. The stochastic RSI is at oversold levels and starting to suggest a buy at this point on the chart. Figure 3 is a daily OmniTrader chart of Goldman Sachs, showing how the share rose strongly from November 7, 2016, the day before the presidential vote. Volume rose strongly with the share price surging on November 9, when the results of the presidential election were announced. The RSI shown on the chart is at oversold levels, which suggests that a correction is likely. It may be a good idea to wait for a new buy signal before entering a long position in this stock. But certainly add it to your watchlist. Figure 4 is a daily OmniTrader chart of Bank of America (BAC). The share gave a buy signal on the vote line on November 7, 2016 based on the buy signals given by four strategies shown in green below the

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Figure 4: Daily chart of Bank of America. The share gave a buy signal on the vote line on November 7, 2016 based on the buy signals given by four strategies shown in green below the vote line. The RSI indicator is at overbought levels, suggesting a correction should occur. January 2017

• Technical Analysis of Stocks & Commodities • 45

ELLIOTT WAVE

With the prospect of sweeping changes, where should you put your money? vote line. The RSI indicator is at overbought levels, suggesting that a correction should occur in the near future.

And more

There are many more banking stocks to keep an eye on. If you look at this from a regulatory standpoint, having Trump as president with Republican control of Congress could bode well for banks. There is speculation that we could see higher interest rates and higher inflation rates. This could mean that banks will lend more and see an increase in their profit

margins. Overall, the prospects for the banking sector look positive, at least for the short term. Koos van der Merwe has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa. He can be reached at [email protected].

further reAding

van der Merwe, Koos [2016]. “Gann Fans & Kondratieff Waves,” Technical Analysis of StockS & commoditieS, Volume 34: Bonus Issue. ‡Advanced GET (eSignal); ‡OmniTrader (Nirvana Systems) ‡See Editorial Resource Index

OpTIONs

arora/FunDaMentals

Put Butterfly Payoff

the most probable price level that you are expecting with this butterfly spread. It will be the middle strike, or $145, a down move of only $5, that is, approximately 50% of the expected worst-case bearish scenario of $9+. And without using a Black-Scholes calculator, can you also tell what your maximum payout of this butterfly put spread would be? Of course! It will be $5 (the difference in put strikes, that is, $145-$140 or $150-$145) and indeed, that will be the case when the stock price = $145. Let’s verify that. Say at expiration the stock price is unchanged at $150 or rises to $155. In this case, all your puts will be OTM and will expire worthless. However, if the stock price drops to $145, the $150 put is in-the-money (ATM) by $5 ($150-$145) and that is your payout (excluding commissions). In case the stock price drops even further down to $140, you gain $10 ($150-$140) on the $150 strike, but you also lose $5 ($140-$145)*2 = $10 on the two $145 strike puts you are short, while you make nothing on the $140 strike put (since it expires worthless), for a net P/L of zero ($10-$10). So your maximum payout is $5 and it occurs when the stock price closes at $145, that is, the middle strike of the butterfly spread (see Figure 5). Sounds simple, doesn’t it?

Veneer of simPlicitY

Because it sounds simple, many stock traders think they’re good at trading options. But there’s more to it than just knowing the different options strategies. You also need to be able to design a trade structure for a specific scenario using correct volatility assumptions together with a thorough risk management, based on understanding the (a)synchronous relationship of different options-related risks, and you need to have prescient timing 46 • January 2017 • Technical Analysis of StockS & commoditieS

Strategy payoff at expiration

Continued from page 26

$5

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Stock price at expiration Figure 5: risk graPh oF ButterFly sPreaD Payout. From this graph you see that your maximum payout will be $5.00 if the stock price at expiration is $145 (the middle strike of the butterfly spread).

for your trade executions. This is what differentiates a successful options trader from others. After all, options trading is ultimately a volatility play. Bani Arora is a derivatives trader and can be reached at [email protected].

further reAding

Arora, Bani [2016]. “Revival Of The Gold Myth,” Technical Analysis of StockS & commoditieS, Volume 34: August. [2016]. “VIX: Managing Financial Armageddon!” Technical Analysis of StockS & commoditieS, Volume 34: May.

NinjaTrader 8 released NinjaTrader, LLC has launched Ninja­ Trader 8 trading software for futures, forex, and equities traders. With more than 500 user-driven enhancements to the trading software, the update adds func­ tionality and flexibility, with a focus on greater performance, optimized naviga­ tion, and expanded analysis capabilities, while laying the groundwork for future product development. Some of the enhancements include a new interface, new charting features, increased performance, expanded C# development support, improved backtesting, market data enhancements, expanded SuperDOM functionality, a new forex tool suite, and a new alert system. The new streamlined interface seeks to keep its familiarity while optimizing workflow. A new tabbed functionality simplifies navigation and minimizes the screen space used, while further personalization is available through the inclusion of four unique “skins” and regionalization options for Spanish, German, and Russian traders.

The charting enhancements are based on user feedback and include a drag & drop functionality to move indicators and chart bars between tabs or windows; a data series option to “center” the last traded price on the price scale; an extended interval selector for customization of any bar type and interval; and a new “no time scroll” crosshair mode with the ability to “lock” a crosshair at a specific time. The increased performance comes from a fully multithreaded core and user interface for faster workspace load times. All connection technologies are now supported in the 64-bit version of NinjaTrader 8 and data processing & storage methods have been configured to minimize response times. The expanded C# development support allows developers to build rich trading apps and integrate them directly into NinjaTrader 8, and are no longer limited to writing custom indicators and strategies. For improved backtesting, the Strategy Analyzer has been redesigned to improve workflow, provide greater fill accuracy, and allow for optimizations on multiple objectives simultaneously. The market data enhancements are achieved through a rewritten core data engine, delivering sub-second time stamps and historical bid/ask prices stored with each last trade tick. Improved session management enables users to ex­ clude certain calendar dates from charts and strategies and customize end-of-day markets for particular dates. Expanded support for forex traders

includes a new FX Board and the ability to configure various trading windows in pip increments. The redesigned alert functionality allows for execution of complex multi­ faceted conditions without programming experience. A detailed listing of the enhancements can be found at http://ninjatrader.com/ Whats-New-NinjaTrader-8. NinjaTrader 8 is free to use for chart­ ing, strategy backtesting, and trade simulation. Traders can use their broker or market data provider of choice with NinjaTrader 8. Among the supported brokers for new live trading accounts are NinjaTrader Brokerage, Interactive Brokers, and TD Ameritrade. Data ven­ dors include Kinetick, eSignal, IQFeed, and Google Finance. Founded in 2003, NinjaTrader Group and its subsidiaries provide trading software and brokerage services to ac­ tive traders.

trades here, here, but but rather rather showing showing you you how how trades you can create a methodology that can you can create a methodology that can incorporate the macro themes that are incorporate the macro themes that are present now. You could also buy some present now. You could also buy some favored fi financials nancials while while shorting shorting the the favored fi nancial ETF. This will reduce variance financial ETF. This will reduce variance and increase increase your your market­neutral market­neutral stance, stance, and and you would be looking for the outand you would be looking for the outperformance of the fi nancial stocks that performance of the financial stocks that you chose as compared to XLF. you chose as compared to XLF.

The trading trading opportunities opportunities are are abunabunThe dant. Think about how you can reduce dant. Think about how you can reduce the risk risk of of losses losses while while increasing increasing your your the staying power on the profi table trades. staying power on the profitable trades. Don’t neglect neglect the the power power of of research, research, Don’t planning, end­of­day review process, and planning, end­of­day review process, and journaling. In 2017, it is going to be the journaling. In 2017, it is going to be the year of the trader—so trade profi tably! year of the trader—so trade profitably!

http://ninjatrader.com

Q&A FrieseN FrieseN

Continued from from page page 39 39 Continued

entering ETF ETF trades trades at at the the open open of of the the entering market, such as going long XLF and market, such as going long XLF and short XLU, XLU, or or the the converse. converse. Another Another short idea is to go long XLY and short XLP, idea is to go long XLY and short XLP, which is discretionary versus consumer which is discretionary versus consumer staples. staples. am not not recommending recommending certain certain II am

January 2017

• Technical Analysis of Stocks & Commodities • 47

TRADING ON MOMENTUM

Mean-Reversion Daytrading Last month, this professional trader discussed swing trading mean-reversion pivot entries. This month, he continues on the same topic but this time for daytrading.

O

by Ken Calhoun

ne of the biggest challenges that daytraders face is rapidly scanning for breakouts during the opening 30 minutes of each day’s trading session. If you have ever overlooked a big opening breakout, you may find the technique I’ll discuss here especially useful. By waiting for a 50% retracement, also known as a mean reversion, you can use this as a second opportunity to enter a strong-trending stock following a pullback. This article will show you how to daytrade mean-reversion pivot entries. It is important to note that this strategy is best used with stocks priced $20–$70/share with opening moves of at least one point in a single direction, that then pull back to 50% before pivoting. It is usually unwise to daytrade penny stocks or other cheap, less-than-$20 stocks, because they exhibit choppier, haphazard price action compared to professional daytraders’ stocks with higher volume and sustainable volatility. The best charts to daytrade are those with wide and clean, well-defined technical momentum breakout patterns that are relatively easy to enter and exit, unlike choppy, lowpriced risky stocks that amateurs and undercapitalized traders unwisely seek to trade.

Daytrading strategy: Buying after a mean reversion

As with swing trading mean reversions, this strategy primarily works for pullbacks of nearly exactly 50%—no more and no less. Once you spot one of these mean-reversion patterns, you simply enter your trade when a breakout moves above the 50% price level. From a scanning standpoint, it is smart to look at several charts within the same sector once you spot a mean-reversion pattern, because intraday charts within the same industry group often exhibit similar price-action patterns that you can potentially capitalize on.

Step-by-step action plan

Here’s how you can put this strategy to work in your intraday trades: Step 1: Look for a chart that has moved up at least one point during the first 30 minutes of the trading day (9:30–10 am Eastern Time), as seen in the chart of Harley-Davidson, Inc. (HOG) in Figure 1 on the morning of October 18, 2016. Step 2: Next, calculate the mean of this trading range (in Figure 1, this is ($50 + $53)/2 = $51.50). This is your meanreversion pivot price. Wait for price to drop slightly below this value. Step 3: Enter a buy-stop order to enter your trade once price breaks above the 50% mean-reversion pivot price (in this example, it is $51.50).

esignal

Step 4: A second entry occurs once price action has broken above the current day’s high. Use this to add to your winning position ($53.40 in this chart).

FIGURE 1. MEAN-REVERSION DAYTRADING PIVOT. Here you see a trade entry for a daytrade after a 50% retracement.

48 • January 2017 • Technical Analysis of Stocks & Commodities

Tip: Although most daytrades are best done inside a 20-minute round-trip timeframe, you may find it useful to also test an intraday swing trading technique, in which you let the position ride until right before the closing bell, at which time you close the position (for example, at 3:50 pm Eastern Time).

Insights: Why this technique works

The mean-reversion daytrading strategy works because it waits until after the first major wave of short sellers are finished exiting their positions. Once sellers are done, a “short squeeze” as well as new buyers come in to start lifting price back up to retest prior highs. By waiting for a full 50% pullback before entering, you will find the likelihood of an upside reversal is better for initiating a new long position, since this 50% mean reversion is a favorite strategy of professional traders.

Trade management tips

From a risk management standpoint, you can use a tight $0.40 initial stop for risk management for stocks in the $40–$50/ share price range. Tighter stops of from $0.10–$0.20 are best for stocks in the $20–$30/share range for daytrading. Trading mean-reversion pivots like this can help simplify your approach for keeping tight stops, since the pivot low is an obvious technical price support level. For those who like to daytrade quickly, the initial exit target is simply the high of the current day’s initial breakout resistance level ($53.25 in Figure 1) or the nearest whole-number resistance level ($53 in Figure 1), whichever gets hit first for your daytrading exit. Ken Calhoun, a professional daytrader and educator, is a producer of trading courses, a live room, and video-based

EHLERS & WAY/BE YOUR OWN HEDGE FUND Continued from page 18

advance, for exercise at the market on the open of the next trading day. All you have to do is monitor your own open positions in each of the four channels, exit a trade when you get a signal, and replace it with another buy signal on that day. You can do this in the evening and place your market orders. The whole process can be completed in less than 15 minutes per day.

anD then there’s capital

Like any business, trading your hedge fund requires capital. Most brokerages require a minimum account balance of $2,000 or so. At this minimum level you would be dividing your hedge fund into four $500 channels. Frankly, that’s a pretty small amount, and it leaves you with no real initial margin of error for drawdown. Since you would only be trading a few shares of many stocks with this low level of funding, commission costs can become a factor in your trading. All in all, we would recommend a minimum $10,000 account for your “hedge fund.”

Bypass the legal stuff

This is the United States—you can do anything you want with your own money. You can trade any way you like. To be clear,

The best charts to daytrade are those with wide and clean well-defined technical momentum breakout patterns that are relatively easy to enter and exit. training systems for active traders. He is a UCLA alumnus and is the founder of TradeMastery.com, an educational resource site for active traders. In this “Trading on Momentum” monthly column, he covers the topic of breakout trading techniques.

Further reading

[2016]. “Mean-Reversion Swing Trading,” Technical Analysis of Stocks & Commodities, Volume 34: December.

See our Traders’ Tips section beginning on page 50 for implementation of Calhoun’s idea (with a focus on his December 2016 column) in various technical analysis programs. Accompanying program code can be found in the Traders’ Tips area at Traders.com.

what we mean when we say “be your own hedge fund” is the way you go about conducting your own trading, not accepting somebody else’s money to trade. That way, you don’t have to worry about the legal issues that come with managing other people’s money. What we’ve described here is using proven trading signals and employing diversity to reduce your risk exposure.

take oWnership

The concerns you may have about trading can be addressed by treating your own money as if it were in a hedge fund with you as the fund manager. This requires establishing your own trading style, acquiring trading signals (if necessary, by lease), and applying diversity to reduce risk. This is all very doable with the technology available today. S&C Contributing Editor John Ehlers is a pioneer in the use of cycles and DSP technical analysis. He is president of MESA Software. MESASoftware.com offers the MESA Phasor and MESA intraday futures strategies. He is also the chief scientist for StockSpotter.com, which offers stock trading signals based on indicators and statistical techniques. Ric Way is an independent software developer specializing in programming algorithmic trading signals in C#. He may be reached at [email protected]. ‡StockSpotter.com January 2017

• Technical Analysis of Stocks & Commodities • 49

For this month’s Traders’ Tips, the focus is Ken Calhoun’s article in the December 2016 issue of Stocks & Commodities, “MeanReversion Swing Trading.” Here, we present the January 2017 Traders’ Tips code with possible implementations in various software. The code for the following Traders’ Tips selections is posted here: • Traders.com  Home–S&C Magazine  Traders’ Tips The Traders’ Tips section is provided to help readers implement a selected technique from an article in this issue or another recent issue. The entries here are contributed by software developers or programmers for software that is capable of customization.

F TRADESTATION: JANUARY 2017 TRADERS’ TIPS CODE In “Mean-Reversion Swing Trading,” which appeared in the December 2016 issue of Stocks & Commodities, author Ken Calhoun describes a trading methodology where the trader attempts to enter an existing trend after there has been a pullback. He suggests looking for 50% pullbacks in strong trends and waiting for price to move back in the direction of the trend before entering the trade. Here, we are providing the TradeStation EasyLanguage code for a mean-revision strategy based on the author’s concepts. We have also included a companion indicator to help visualize the trade setups. Strategy: MeanReversion // TASC JAN 2017 // Mean-Reversion Swing Trading // Ken Calhoun inputs: ChanLength( 20 ), StopDollars( 1 ), MALength( 50 ) ; variables: UpperBand( 0 ), LowerBand( 0 ), MidBand( 0 ), LongOK( false ), ShortOK( false ), LowRef( 0 ), HighRef( 0 ), TriggerLine( 0 ), MAValue( 0 ) ; UpperBand = Highest( High, ChanLength ) ; LowerBand = Lowest( Low, ChanLength ) ; MAValue = Average( Close, MALength ) ; if Low = LowerBand then begin LowRef = Low ; LongOK = false ;

50 • January 2017 • Technical Analysis of Stocks & Commodities

Figure 1: TRADESTATION. Here’s an example of the MeanReversion strategy and indicator applied to a 60-minute chart of Alphabet (GOOG). ShortOK = true ; end ; if High = UpperBand then begin HighRef = High ; LongOK = true ; ShortOK = false ; end ; // 50% Pull Back Level TriggerLine = .5 * ( HighRef + LowRef ) ; if LongOK[1] and LongOK and Close crosses over TriggerLine and Close > MAValue and MarketPosition( 1 ) < 1 then begin Buy next bar at Market ; LongOK = false ; end else if ShortOK[1] and ShortOK and Close crosses under TriggerLine and Close < MAValue and MarketPosition( 1 ) > -1 then begin SellShort next bar at Market ; ShortOK = false ; end ; Sell next bar at Upperband Limit ; Sell next bar at Lowerband Stop ; Buy to Cover next bar at Lowerband Limit ; Buy to Cover next bar at UpperBand Stop ; SetStopShare ; SetStopLoss( StopDollars ) ; Indicator: MeanReversion // TASC JAN 2017 // Mean-Reversion Swing Trading

// Ken Calhoun inputs: ChanLength( 20 ), MALength( 50 ) ; variables: UpperBand( 0 ), LowerBand( 0 ), MidBand( 0 ), LongOK( false ), ShortOK( false ), LowRef( 0 ), HighRef( 0 ), TriggerLine( 0 ), MAValue( 0 ) ; UpperBand = Highest( High, ChanLength ) ; LowerBand = Lowest( Low, ChanLength ) ; MAValue = Average( Close, MALength ) ; if Low = LowerBand then begin LowRef = Low ; LongOK = false ; ShortOK = true ; end ; if High = UpperBand then begin HighRef = High ; LongOK = true ; ShortOK = false ; end ; TriggerLine = .5 * ( HighRef + LowRef ) ; Plot1( UpperBand, "UpperBand" ) ; Plot2( LowerBand, "LowerBand" ) ; Plot3( TriggerLine, "Trigger" ) ; Plot4( MAValue, "Mov Avg" ) ; if LongOK then begin SetPlotColor( 1, Green ) ; SetPlotColor( 2, Green ) ; end else begin SetPlotColor( 1, Red ) ; SetPlotColor( 2, Red ) ; end ;

F METASTOCK: JANUARY 2017 TRADERS’ TIPS CODE Ken Calhoun’s article in the December 2016 issue of Stocks & Commodities, “Mean-Reversion Swing Trading,” presented a visual trading system designed to take advantage of pullbacks in uptrends. The formula given here, used as a filter in the explorer, will find such trading opportunities. The first two lines of the formula allow the user to adjust the parameters of the scan:

• "Z" is the minimum percentage increase in the initial upswing • "Fudge" is the percentage difference allowed between the close on the pullback and the actual 50% mean reversion.

The formula is presented using values of 10% minimum move and a 0.1% allowance on the difference at the reversion level. Exploration filter: z:= 10; fudge:= 0.1; p1:= LastValue(TroughBars(1, C, z)); pv1:= Trough(1, C,z); p2:= LastValue( HHVBars( C, p1 )); pv2:= HHV( C, p1); meanrev:= (pv1 + pv2) / 2; pv3:= LLV(C, p2); p1 < PeakBars(1, C, z) AND pv2 >= pv1 * (1 + (z/100)) AND Ref(Abs(pv3 - meanrev) <= pv3 * (fudge/100), -1) AND C > Ref(C, -1) AND LLVBars(C, p2) = 1 AND pv1 >= 20 AND pv2 <= 70

—William Golson MetaStock Technical Support www.metastock.com

F eSIGNAL: JANUARY 2017 TRADERS’ TIPS CODE For this month’s Traders’ Tip, we’ve provided the study

To download the EasyLanguage code for the strategy in this article, please visit our TradeStation and EasyLanguage support forum. The code can be found at https://community. tradestation.com/Discussions/Topic.aspx?Topic_ID=147651. The ELD filename is “TASC_JAN2017.ELD.” For more information about EasyLanguage in general, please see http://www.tradestation.com/EL-FAQ. A sample chart is shown in Figure 1. This article is for informational purposes. No type of trading or investment recommendation, advice, or strategy is being made, given, or in any manner provided by TradeStation Securities or its affiliates. —Doug McCrary TradeStation Securities, Inc. www.TradeStation.com

Figure 2: eSIGNAL. Here is an example of the Mean_Reversion_Swing.efs study plotted on an intraday chart of APC. January 2017

• Technical Analysis of Stocks & Commodities • 51

Mean_Reversion_Swing.efs based on the formula described in Ken Calhoun’s article in the December 2016 issue of S&C, “Mean-Reversion Swing Trading.” In the article, Calhoun presents a strategy of trading pullbacks during a trending market. The study contains formula parameters that may be configured through the “edit chart” window (right-click on the chart and select edit chart). A sample chart is shown in Figure 2. To discuss this study or download a complete copy of the formula code, please visit the EFS Library Discussion Board forum under the forums link from the support menu at www. esignal.com or visit our EFS KnowledgeBase at http://www. esignal.com/support/kb/efs/. The eSignal formula script (EFS) is also available for copying & pasting from the Stocks & Commodities website in the Traders’ Tips area. —Eric Lippert eSignal, an Interactive Data company 800 779-6555, www.eSignal.com

Figure 3: WEALTH-LAB. This chart shows a potential trade in HeidelbergCement AG (ticker HEI.DE in Wealth-Data).

avoid trades when a stock is not really trending, as the 1-2-3 pattern seems to perform best in established trends. F WEALTH-LAB: JANUARY 2017 TRADERS’ TIPS CODE In his December 2016 article, “Mean-Reversion Swing Trading,” author Ken Calhoun shows clean and concise rules for entering in a trend continuation following a pullback after a breakout. This pattern (widely known as “1-2-3 pattern”) could be programmed to apply to intraday or daily charts alike. Our rendition targets daily charts. Since the rules didn’t put much emphasis on exits, leaving this to the trader, we added a simple profit target. Here, you can find the complete trading system’s rules: Entry: 1. Wait for a five-day close-to-close uptrend. 2. If the closing prices retrace 50% of the uptrend’s distance (±1 percentage point) over the next 10 bars, a valid pullback has formed. 3. Look for the prices to rebound and buy on a stop 50 cents above the retracement price. If this condition hasn’t been met within 10 days, the setup is invalidated. 4. A second entry is made if the first position has been established and the high price breaks through the 15-day highest high price. Exit: 1. Exit on a $1 stop-loss from the retracement price. 2. Exit with a profit target at two times the retracement distance. Motivated readers could make various improvements to the program’s logic. For instance, to help this technique work equally well on stocks outside the $20–70 price range, make the stop-loss and profit target adaptive by replacing the fixeddollar distance with a unit of ATR. Another suggestion is to 52 • January 2017 • Technical Analysis of Stocks & Commodities

Wealth-Lab strategy code: using System; using System.Collections.Generic; using System.Text; using System.Drawing; using WealthLab; using WealthLab.Indicators; namespace WealthLab.Strategies { public class MeanReversionSwingTrading : WealthScript { private StrategyParameter paramUptrendDays; private StrategyParameter paramReversionLasts; private StrategyParameter paramReversionExpiresAfter; private StrategyParameter paramSecondEntry; public MeanReversionSwingTrading() { paramUptrendDays = CreateParameter("Days in uptrend", 5, 2, 10, 1); paramReversionLasts = CreateParameter("Reversion lasts", 4, 2, 12, 2); paramReversionExpiresAfter = CreateParameter("Expires after", 10, 5, 20, 5); paramSecondEntry = CreateParameter("Second entry?", 1, 0, 1, 1); } protected override void Execute() { bool runup = false, reversion = false, pullback = false, secondEntry = paramSecondEntry.ValueInt == 1; int runupBar = -1, pBar = -1, reversionBar = -1, uptrendDays = paramUptrendDays.ValueInt; double runupStart = 0, runupHigh = 0, runupRange = 0, pivotPrice = 0, reversionThreshold = 1.0; Highest hi = Highest.Series(High,15); if( secondEntry ) PlotSeries(PricePane, hi, Color.Blue, LineStyle.Dashed, 1); for(int bar = GetTradingLoopStartBar(15); bar < Bars.Count; bar++) {

if( ActivePositions.Count > 0 ) { if(!SellAtStop(bar+1, Position.AllPositions, pivotPrice 1.0, "$1 stop")) SellAtLimit(bar + 1, Position.AllPositions, pivotPrice + 2.0, "Profit Target"); } if( ActivePositions.Count == 0 ) // First entry { if( !runup ) { if(CumUp.Series(Close,1)[bar] >= uptrendDays) { runup = true; runupBar = bar; runupStart = Low[bar-5]; runupHigh = High[runupBar]; runupRange = runupHigh - runupStart; pivotPrice = runupStart + (runupRange / 2d); DrawLine(PricePane,runupBar,runupHigh,bar5,runupStart,Color.Blue,LineStyle.Solid,2); } } if( !pullback ) { if( runup ) { if( bar >= runupBar + paramReversionExpiresAfter. ValueInt ) { runup = false; //AnnotateBar("Pullback timeout exceeded",bar,false,Color.Red); } else { double runupInPercent = runupRange / (double) runupStart * 100d; double closeToExact = (reversionThreshold / 100d); if( (Low[bar] <= (pivotPrice * 1.0+closeToExact)) && (Low[bar] >= (pivotPrice * 1.0-closeToExact)) ) { pullback = true; pBar = bar; DrawLine(PricePane,runupBar,runupHigh,pBar,pivot Price,Color.Red,LineStyle.Solid,2); } } } } // Buy at stop if price moves $0.50 the pivot price or above if( pullback ){ double entryStop = pivotPrice + 0.50; if( BuyAtStop( bar + 1, entryStop, "1st" ) != null ) { DrawLine(PricePane,bar,entryStop,pBar,entryStop,Col or.DarkGreen,LineStyle.Dotted,2); runup = false; pullback = false; LastPosition.Tag = pivotPrice; } else // Invalidate entry if too many bars have passed since pullback if( bar >= pBar + paramReversionExpiresAfter.ValueInt ){ pullback = false; AnnotateBar("Rebound timeout exceeded",bar,true,Color.Orange); } } } else //Second entry if( ActivePositions.Count == 1 && secondEntry ) BuyAtStop(bar+1, hi[bar], "2nd"); } } } }

A sample chart is shown in Figure 3.

—Eugene, Wealth-Lab team MS123, LLC www.wealth-lab.com

Figure 4: NEUROSHELL TRADER. This NeuroShell Trader chart shows the reversion trading system over the past 10 years for Anadarko Petroleum Corp (APC).

F NEUROSHELL TRADER: JANUARY 2017 TRADERS’ TIPS CODE An automated mean-reversion trading system as described by Ken Calhoun in his December 2016 article in Stocks & Commodities (“Mean-Reversion Swing Trading”) can be easily implemented using NeuroShell Trader’s Turning Points add-on indicators, which compute the relevant peak and valley statistics. Simply select new trading strategy from the insert menu and enter the following in the appropriate locations of the Trading Strategy Wizard: BUY LONG CONDITIONS: [All of which must be true] A>=B(Add2(TPbars(High,Low,Close,3,2,1),1),5) A>=B(TPslope(High,Low,Close,3,2,1),45) CrossBelow(Close,FibRetr(High,Low,3,1,3,0)) STOP PRICE: Add2(FibRetr(High,Low,3,1,3,0),0.5) LONG TRAILING STOP PRICES: TrailPricePnts(Trading Strategy,1)

If you have NeuroShell Trader Professional, you can also choose whether the parameters should be optimized, including optimizing the retracement level to different Fibonacci retracements besides just 50%. After backtesting the trading strategy, use the detailed analysis button to view the backtest and trade-by-trade statistics for the strategy. Users of NeuroShell Trader can go to the Stocks & Commodities section of the NeuroShell Trader free technical support website to download a copy of this or any previous Traders’ Tips. A sample chart is shown in Figure 4. —Marge Sherald, Ward Systems Group, Inc. 301 662-7950, [email protected] www.neuroshell.com

January 2017

• Technical Analysis of Stocks & Commodities • 53

Figure 5: NINJATRADER. The MRST strategy is displayed on the APC daily chart in NinjaTrader 8.

F NINJATRADER: JANUARY 2017 TRADERS’ TIPS CODE The concept discussed by Ken Calhoun in his December 2016 article in S&C, “Mean-Reversion Swing Trading,” is now available as a strategy named “MRST” for download at the following links for NinjaTrader 8 and for NinjaTrader 7: NinjaTrader 8: www.ninjatrader.com/SC/January2017SCNT8.zip NinjaTrader 7: www.ninjatrader.com/SC/January2017SCNT7.zip Once the file is downloaded, you can import the strategy in NinjaTader 8 from within the Control Center by selecting Tools → Import → NinjaScript Add-On and then selecting the downloaded file for NinjaTrader 8. To import in NinjaTrader 7 from within the Control Center window, select the menu File → Utilities → Import NinjaScript and select the downloaded file. A sample chart implementing the strategy is shown in Figure 5. You can review the strategy’s source code in NinjaTrader 8 by selecting the menu New → NinjaScript Editor → Strategies from within the Control Center window and selecting the MRST file. You can review the strategy’s source code in NinjaTrader 7 by selecting the menu Tools → Edit NinjaScript → Strategy from within the Control Center window and selecting the MRST file. —Raymond Deux & Paul Hunt NinjaTrader, LLC www.ninjatrader.com

F UPDATA: JANUARY 2017 TRADERS’ TIPS CODE Our Traders’ Tip for this month is based on the article by Ken Calhoun that appeared in the December 2016 issue of Stocks & Commodities, “Mean-Reversion Swing Trading.” In the article, the author loosely defined a swing trading technique for entering long positions into uptrending 54 • January 2017 • Technical Analysis of Stocks & Commodities

FIGURE 6: UPDATA. Here is a point & figure (1x3) approach to mean-reversion swing trading as applied to Anadarko Petroleum Corp (APC).

instruments that have a 50% retracement, but that swing to make new highs. This can be easily realized with a point & figure–based system, since all the key signals for entry are simplified within this methodology. The Updata code is in the Updata library and may be downloaded by clicking the custom menu and system library. Those who cannot access the library due to firewall issues may paste the code shown at the Stocks & Commodities website in the Traders’ Tips area into the Updata custom editor and save it.

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

F AMIBROKER: JANUARY 2017 TRADERS’ TIPS CODE The chart techniques based on after-the-fact determination of “waves” are highly subjective. In real-life trading, you don’t know that the wave has ended until the reversal is large enough. A mechanical approach close to the one described by Ken Calhoun in his December 2016 column and in this issue on a mean-reversion technique was presented in the November 2003 Stocks & Commodities article “The Zigzag Trend Indicator” by Spyros Raftopoulos. In that article, a zigzag indicator that is appropriately delayed (to ensure its stability) was used to enter pullbacks. Users can find the AmiBroker code I had provided based on that article at the Stocks & Commodities website at Traders.com in the Traders’ Tips section: http://traders.com/Documentation/FEEDbk_docs/2003/11/ TradersTips/TradersTips.html#amibroker

The code given there implements ideas similar to those described by Calhoun. The technique has the advantage of not relying on a strict “50%” pullback rule. —Tomasz Janeczko, AmiBroker.com www.amibroker.com

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FUTURES LIQUIDITY

T

rading liquidity is often overlooked as a key technical measurement in the analysis and selection of commodity futures. The following explains how to read the futures liquidity chart published by Technical Analysis of Stocks & Commodities every month.

very high volumes. The greatest number of dots indicates the greatest activity; futures with one or no dots show little activity and are therefore less desirable for speculators. Courtesy of CBOT

Commodity futures

The futures liquidity chart shown below is intended to rank publicly traded futures contracts in order of liquidity. Relative contract liquidity is indicated by the number of dots on the right-hand side of the chart. This liquidity ranking is produced by multiplying contract point value times the maximum conceivable price motion (based on the past three years’ historical data) times the contract’s open interest times a factor (usually 1 to 4) for low or

three-year period. Thus, all numbers in this column have an equal dollar value. Columns indicating percent margin and effective percent margin provide a helpful comparison for traders who wish to place their margin money efficiently. The effective percent margin is determined by dividing the margin value ($) by the three-year price range of contract dollar value, and then multiplying by one hundred.

Stocks

All futures listed are weighted equally under “contracts to trade for equal dollar profit.” This is done by multiplying contract value times the maximum possible change in price observed in the last

Trading liquidity has a significant effect on the change in price of a security. Theoretically, trading activity can serve as a proxy for trading liquidity and equals the total volume for a given period expressed as a percentage of the total number of shares outstanding. This value can be thought of as the turnover rate of a firm’s shares outstanding.

Trading Liquidity: Futures

Commodity Futures Exchange % Margin Effective Contracts to Relative Contract Liquidity % Margin Trade for Equal Dollar Profit S&P 500 E-Mini (Dec ’16) GBLX 4.8 23.3 3 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>> Crude Oil WTI (Jan ’17) NYMEX 6.9 5.2 1 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••> 10-Year T-Note (Dec ’16) CBOT 1.3 18.4 9 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••> Euro FX (Dec ’16) CME 2.8 8.7 2 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Ultra T-Bond (Dec ’16) CBOT 3.8 19.6 2 ••••••••••••••••••••••••••••••••••••••••••••••••••••••• 5-Year T-Note (Dec ’16) CBOT 0.8 22.2 18 •••••••••••••••••••••••••••••••••••••••••••••••••••••• T-Bond (Dec ’16) CBOT 2.9 17.3 3 ••••••••••••••••••••••••••••••••••••••••••••••••••••• Russell 2000 Mini (Dec ’16) ICEUS 4.9 17.1 2 ••••••••••••••••••••••••••••••••••• Natural Gas (Jan ’17) NYMEX 8.7 7.4 2 •••••••••••••••••••••••••• Nasdaq 100 E-Mini (Dec ’16) GBLX 4.6 15.7 3 •••••••••••••••••••••• British Pound (Dec ’16) CME 5.1 13.2 3 ••••••••••••••••••••• Gasoline RBOB (Jan ’17) NYMEX 8.2 6.1 1 •••••••••••••••••••• Soybeans (Jan ’17) CBOT 5.3 9.7 3 •••••••••••••••••••• ULSD NY Harbor (Jan ’17) NYMEX 6.7 5.6 1 •••••••••••••••• Gold (Dec ’16) COMEX 5.5 35.9 4 •••••••••••••• 2-Year T-Note (Dec ’16) CBOT 0.3 19 24 ••••••••••••• Corn (Mar ’17) CBOT 5.6 11.9 9 ••••••••••••• Sugar #11 (Mar ’17) ICEUS 8.2 16.5 7 ••••••••••• Eurodollar (Dec ’16) CME 0.1 18.2 41 •••••••••• S&P 500 VIX (Dec ’16) CFE 41.5 39.2 5 •••••••••• Wheat (Mar ’17) CBOT 5.2 7.1 5 •••••••• Japanese Yen (Dec ’16) CME 4.4 35.9 6 ••••••• Australian Dollar (Dec ’16) CME 3 10.4 4 •••••• Canadian Dollar (Dec ’16) CME 2.6 9.2 4 •••••• Dow Indu 30 E-Mini (Dec ’16) CBOTM 4.5 23.7 4 •••••• Silver (Dec ’16) COMEX 7.7 23 3 •••••• Coffee (Mar ’17) ICEUS 6 15.3 3 ••••• High Grade Copper (Dec ’16) COMEX 4.1 10.1 3 ••••• Cotton #2 (Mar ’17) ICEUS 5.5 15.8 6 •••• Hard Red Wheat (Mar ’17) KCBT 4.6 4.7 4 •••• Lean Hogs (Feb ’17) CME 6.1 4.1 2 •••• CBOT Chicago Board of Trade, Division of CME Live Cattle (Feb ’17) CME 4.5 7.9 3 •••• CFE CBOE Futures Exchange Mexican Peso (Dec ’16) CME 8 12.9 5 •••• CME Chicago Mercantile Exchange S&P Midcap E-Mini (Dec ’16) GBLX 4.6 18.7 2 •••• COMEX Commodity Exchange, Inc. CME Group Soybean Meal (Jan ’17) CBOT 6.3 10.1 4 •••• GBLX Chicago Mercantile Exchange - Globex U.S. Dollar Index (Dec ’16) ICEUS 2 8.9 3 •••• ICE-EU Intercontinental Exchange-Futures - Europe Platinum (Jan ’17) NYMEX 5.7 8.9 3 ••• ICE-US Intercontinental Exchange-Futures - US Swiss Franc (Dec ’16) CME 3.2 13.4 3 ••• KCBT Kansas City Board of Trade Cocoa (Mar ’17) ICEUS 7.5 18.2 8 •• MGEX Minneapolis Grain Exchange Crude Oil Brent (F) (Jan ’17) NYMEX 7 4.8 1 •• NYMEX New York Mercantile Exchange Feeder Cattle (Jan ’17) CME 5.9 6.2 1 •• New Zealand Dollar (Dec ’16) CME 3.7 14.5 4 •• S&P GSCI (Dec ’16) CME 8.6 9.9 1 •• Soybean Oil (Dec ’16) CBOT 3.8 12.3 12 •• 1701 30-Day Fed Funds (Jan ’17) CBOT 0.1 11.9 34 • Trading Liquidity: Futures is a reference chart for speculators. It compares markets “Relative Contract Liquidity” places commodities in descending order according to according to their per-contract potential for profit and how easily contracts can be bought how easily all of their contracts can be traded. Commodities at the top of the list are easior sold (i.e., trading liquidity). Each is a proportional measure and is meaningful only est to buy and sell; commodities at the bottom of the list are the most difficult. “Relative Contract Liquidity” is the number of contracts to trade times total open interest times a when compared to others in the same column. The number in the “Contracts to Trade for Equal Dollar Profit” column shows how volume factor, which is the greater of: many contracts of one commodity must be traded to obtain the same potential return In volume 1 or exp –2 as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price In 5000 Excursion).

56 • January 2017 • Technical Analysis of Stocks & Commodities

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Editorial Resource Index Casey Research . . . . . . . . . . . . . . . . 10 StockSpotter.com . . . . . . . . . . . . . . . 17 TC2000 (Worden Brothers) . . . . . . . . . . . 20 StockCharts.com . . . . . . . . . . . . . . 21 MultiCharts . . . . . . . . . . . . . . . . . . 37 TradingView . . . . . . . . . . . . . . . . . . 37 Barchart.com . . . . . . . . . . . . . . . . . 40 Advanced GET (Interactive Data) . . . . . . . 45 OmniTrader . . . . . . . . . . . . . . . . . . 45 eSignal (Interactive Data) . . . . . . . . . . . . 48 TradeStation . . . . . . . . . . . . . . . . . 50

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MetaStock . . . . . . . . . . . . . . . . . . . . 51 Wealth-Lab . . . . . . . . . . . . . . . . . . 52 Neuroshell Trader (Ward Systems Group) . . 53 NinjaTrader . . . . . . . . . . . . . . . . . . 54 Updata . . . . . . . . . . . . . . . . . . . . . 54 AmiBroker . . . . . . . . . . . . . . . . . . . 54

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January 2017

• Technical Analysis of Stocks & Commodities • 57

The following selection of book descriptions represents a sampling of recent book releases in the investing field. Books described here may be from some of the major book publishers as well as some independent book publishers. These are not critical reviews or editorial evaluations, but rather a brief look at the book marketplace to help keep readers up to date on new or recent book offerings.

Foundations Of Trading: Developing Profitable Trading Systems Using Scientific Techniques (165 pages, softcover $15.95, August 2016, ISBN 978-097918386-7) by Howard Bandy, published by Blue Owl Press. Bandy’s extensive qualifications and educational background give him no shortage of ability to write on the topic of trading system development. His deep education includes university degrees in mathematics, physics, engineering, and computer science, and he was a professor of mathematics and computer science, as well as a university dean. He began studying artificial intelligence, modeling, and simulation while in graduate school, and continued applications throughout his career. He was a senior research analyst for a commodity trading advisor, and the author of six books related to trading system development, of which Foundations Of Trading is the latest. Bandy writes that developing profitable systems is difficult for several reasons: First, the financial markets are very efficient. Second, the profitable patterns are a weak signal in a noisy background. And third, competition is stiff. He writes that, in a nutshell, the trader’s universal goal is to have confidence in the signals generated by the trading system. He states that the goal of his book is to outline a few basic and relatively simple, but not necessarily simplistic, ideas that will assist readers in their system trading. The focus is developing and managing systems that have a good tradeoff between reward & risk, and systems in which the trader will have confidence. In addition, he draws attention to some common misconceptions related to

trading system development and trading that could hurt performance. The book shows the reader how to assess key aspects such as the trader’s personal risk tolerance; data analysis; the profit potential of the financial issue being traded; adjusting the model to fit the data; validation to estimate future performance; comparing an alternative use of funds; determining whether the system is broken; and computing the proper position size to maximize account growth while holding drawdown within the trader’s tolerance. Bandy was interviewed for the November 2015 issue of Stocks & Commodities. www.wiley.com

The Volatility Smile (528 pages, $85 hardcover, September 2016, ISBN 9781-118-95916-9) by Emanuel Derman & Michael B. Miller, published by Wiley. The Black-Scholes-Merton option model played a significant role in 20th-century finance, and it remains the most widely applied theory in all of finance. Despite this success, these authors note, the model is fundamentally at odds with the observed behavior of options markets: a graph of implied volatilities against strike will typically display a curve or skew, which practitioners refer to as the “smile,” and which the model cannot explain. Option valuation is not a solved problem, and the past 40 years have witnessed many new models that try to reconcile theory with markets. This book presents a unified treatment of the Black-Scholes-Merton model and the more advanced models that have replaced it. It is also a book about the principles of financial valuation and how to apply them. Derman and Miller explain not just the mathematics, but the ideas behind the models. The book demonstrates how readers can evaluate and build their own financial models. The first half of the book serves as a course on option valuation and the Black-Scholes-Merton model, and the second half focuses on the behavior of the volatility smile. www.wiley.com

TRADING TECHNIQUES

TESEO/ICHIMOKU CHARTS Continued from page 22

Rudy Teseo is a private investor in stocks, options, and currencies, and has taught classes in technical analysis and option trading. He can be reached at [email protected].

When prices are above the cloud and all the other plots of the ichimoku charts are showing a bullish move, it further reinforces a possible bullish move.

FURTHER READING

Elliott, Nicole [2007]. “Ichimoku Kinko Hyo Charts,” Technical Analysis of StockS & commoditieS, Volume 25: September. Muranaka, Ken [2000]. “Ichimoku Charts,” Technical Analysis 58 • January 2017 • Technical Analysis of Stocks & Commodities

of StockS & commoditieS, Volume 18: October.

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9. Andromeda Trading System Petros Development Corp. 10. Options 40 In 4

Key-Volume Strategies, Inc.

These are the 10 trading systems clicked on most often on the Traders’ Resource website. Each entry is listed in order of clicks received. This is not an editorial rating or ranking. For more information on specific products and services, try checking store.Traders.com for archived S&C product reviews.

as brokerages, data services, courses and seminars, software, and more. We hope this will help you learn about products to help in your trading endeavors.

The information in Traders’ Resource is the most accurate at the time of posting and is subject to change. Because the vendors posting to Traders’ Resource are responsible for their own listing, Technical Analysis, Inc. declines any and all liability for any representations made by the businesses and individuals listed. Nor can Technical Analysis, Inc. endorse any business or individual listed on Traders’ Resource. Technical Analysis, Inc. makes no warranties, express or implied, as to the accuracy and reliability of claims herein. You agree to release Technical Analysis, Inc., together with its respective employees, agents, officers, directors and shareholders, from any and all liability and obligations whatsoever in connection with or arising from your use of Traders’ Resource. If at any time you are not happy with the information posted to Traders’ Resource or object to any material within Traders’ Resource, your sole remedy is to cease using it. This list is updated frequently. If you are aware of a business that should be listed, please email us at [email protected].

January 2017

• Technical Analysis of Stocks & Commodities • 59

How Feelings Influence Your Trading Trading is emotionally demanding. Our feelings dictate our actions and without our being aware of it, tend to make us trade irrationally. The first step in battling emotions is to be aware of them.

T

by Claudio Demb houghts, feelings, and actions—three distinct and separate entities, yet they have a circular relationship. You see this kind of relationship in everyday

60 • January 2017 • Technical Analysis of Stocks & Commodities

On to the real world

Let’s look at a real-world trading example to illustrate some of these concepts. But before that, I’ll give a brief explanation of my trading system. Of course, describing a trading system would be a chapter in itself, and that’s not the purpose of this article. What I’ll describe here regarding my trading system is an oversimplification. I have two main trading systems— one for the longer term and one for the shorter term. The longer one is based on the monthly and weekly timeframe

COMPUTER/LEFT AND RIGHT BRAIN: SHAL_HALUD/SHUTTESTOCK/COLLAGE CHRISTINE MORRISON

It All Comes ’Round Again

life. Think about it—you feel anxious, which then leads you to worry about all the possible bad outcomes. Or perhaps you detect some physical pain and feel something is wrong with your body, which then makes you think you may have a serious illness. So you see how sometimes when you think about something, it triggers a particular feeling. Trading is an emotionally demanding profession. Your feelings affect the way you trade. You may have a good system and iron-fist discipline, but if you are in a heightened emotional state, all hell can break loose and everything you have built over time may be lost instantly. Some people refer to it as “blowing out.” Of course, short of blowing out and washed away dead, you can have a very bad fall, heal over time, and get back in the game. A helpful image or metaphor, if you prefer, is the professional boxer who gets knocked down but gets up and fights another round. There is a limit to how many hits you can take, and there is a point at which you may have to stop for a while. Intellectually, you may know all this, but doing it is a different matter. I have been at the trading business for over two decades and have had my share of bad, bloody hits, and have even come close to blowing up. But here I am, doing better, more experienced, and part of a group of traders, no longer working in isolation; I have learned the hard way that isolation can be deadly. When I look back, I know I have not escaped attending the school of hard knocks.

Trading Psychology

On March 14, 2016, I entered long Cliffs Natural Resources Inc. (CLF) followed by another entry KGC 5.0K 12.5K 25.0K 50.0K 250.0K No info on April 1 and another one on May AUY 5.0K 12.5K 25.0K 50.0K 250.0K No info 6, 2016. The first two entries were HL 9.0K 22.7K 45.4K 90.9K 454.5K Y good, but the third one was not; in SSRI 2.8K 7.0K 14.2K 28.5K 142.8K No info fact, it was an impulsive entry. That TRQ 5.0K 12.5K 25.0K 50.0K 250.0K No info led me to feeling very uneasy and CLF 1.3K 3.3K 6.6K 13.3K 66.5K Y on May 9, 2016 I closed the entire AKS 2.0K 5.0K 10.0K 20.0K 100.0K Y position with a small profit (Figure CNX 2.0K 5.0K 10.0K 20.0K 100.0K Y 2). Needless to say, knowing that I RIG 1.2K 3.1K 6.2K 12.5K 62.5K Neutral had not traded well made me feel PBR 2.0K 5.0K 10.0K 20.0K 100.0K No info down and upset. A few days later, FIGURE 1: WHAT KIND OF POSITIONS DO I NEED? Here you see the list of stocks I considered trading and their hypothetical price target. You will also see the size of my positions in each of these stocks, which is dependent on the on May 19, 2016, a must-take setup came up (Figure 3) that I ended up size of my trading account. not taking. Let’s dig into this trade and see how many psychological and the shorter one on the weekly and daily charts. In both trading systems, I need to take into account the overall market pitfalls I was guilty of. stage; I need to have an entry trigger, a stop, a first target, and a second target. This second target is determined by using a Tricks of the mind trend-following method with a trailing stop. To begin with, I was thinking about In this example, I developed a trading plan based on the making money. And with that comes concept of reverse engineering. The concept sounds complia lot of excitement—something that cated, but in simple terms, it’s a plan to achieve the defined has always cost me dearly. However, outcome—in other words, what it is that we need to do in I tell myself that this time, I am cool, order to achieve a specific result. In this example, I calculated I know what I am doing. Even though what kind of positions I needed in order to make x amount there is some truth to my knowing what of money. In Figure 1 you can see the stocks with the hypoI am doing as a trader, the mind can thetical target based on historical prices. My plan was clear, play powerful tricks. I am referring to so I only needed to execute my trading system as flawlessly rationalization, which is when you use as possible. It may sound simple and easy, but let’s not get logical explanations to justify your acahead of ourselves. tions whether they are correct or not. Hypothetical Target $20 $20 $11 $35 $20 $75 $50 $50 $80 $50

$100,000

$250,000

$500,000 $1,000,000 $5,000,000

Insider

tradestation

Stocks

FIGURE 2: ALL PLANNED OUT. Here you see where I took the first, second, and third entries and where I exited the trade. January 2017

• Technical Analysis of Stocks & Commodities • 61

FIGURE 3: LOST OPPORTUNITY. Given that my judgment was clouded by emotions, I missed a great setup that came my way. It’s a lost opportunity, but life goes on. There’ll be many more of those to come.

Strong feelings dictate action, and in the grips of that powerful emotional state, you can be forced to enter or exit positions. Let’s take a deeper look and see what happens after taking the first and second entries. My entries were good, the trade was working well, and the position was growing larger. I wanted to have my full position as soon as I could. I was feeling confident even though my anxiety was rising. I used the next deep pullback to enter the third and final portion of my full-size position without respecting my entry trigger—it was an impulsive trade. The knowledge that entering that third portion was an impulsive trade led me to experience strong negative feelings. It is these strong feelings that dictate action, and in the grips of that powerful emotional state, I was forced to get out of the position. This is a textbook case of a fight-or-flight response. In that state of mind, you can no longer be rational. I ended up closing the entire position with a gain, but that doesn’t matter. The point is I failed to execute my plan. In other words, this unrealistic dream I had was crushed and I was brought down to reality.

62 • January 2017 • Technical Analysis of Stocks & Commodities

Life goes on, and just as the sun rises every day, the market opens up the following day. But clearly, in this situation, I am not in a good emotional place; my emotional capital is almost spent as a result of my last impulsive trade. Thus, when the next must-take setup shows up, I am not able to take it. I am still anchored to my last trade, and the painful memory of it makes me too fearful to take the new setup.

Think, feel, act

As is evident in the example I gave you, feelings dictate our actions. Feelings happen quickly and we often don’t notice them. Because we’re not aware of those feelings, we find ourselves thinking a particular way. In other words, our emotional states color our lenses. All of a sudden, we could be seeing a gloomy scenario that is not there, and if you are not aware of this sort of pitfall, you will end up trading your feelings instead of the setups that you are supposed to trade. Claudio Demb has been an independent trader and investor for over 20 years. He is a practicing psychiatrist and lives with his family in Brookline, MA. He may be reached via email at [email protected]. ‡TradeStation

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