S&c 04-2017

THE TRADERS’ MAGAZINE SINCE 1982

Discounting Sentiment In the euro

Chart Patterns

What gives you the edge?

8 12

Triangle Breakouts Spot buying pressure as it builds

17

Playing With Numbers

Three strategies compared 18

EXploiting Guts, Risk, And Decay A high-risk play

26

INTERVIEW

J ustin Bennett, independent forex trader APRIL 2017

32

www.traders.com

APRIL 2017

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CONTENTS FEATURE ARTICLE

8 Discounting Sentiment In The Euro

by Philipe Saroyan Excess returns from trading sentiment are only seen in the short run … or are they? Here’s a look at a sentiment trading tactic using a contrarian, indirect sentiment indicator applied to the euro ETF that shows how over the long term, you can use a sentiment trading strategy.

12 The Edge In Chart Patterns, Part 1 by Giorgos E. Siligardos, PhD When you see a chart pattern forming, most likely, others will see it too. What gives you an edge when you trade a chart pattern? This two-part article will help answer that question.

17 Ascending Triangle Breakouts

by Ken Calhoun This month in our Trading On Momentum column, this professional trader introduces you to the ascending triangle pattern that you can use to help spot buying pressure as it builds.

18 Playing With Numbers

by Domenico D’Errico Which strategy will give you a better return on account? Here we compare the performance of three strategies to see which comes out ahead.

22 Taming The New Zealand Dollar

by Azeez Mustapha The New Zealand dollar (NZD) often moves in a predictable

April 2017, Volume 35 Number 5

manner when in a strong trend, and brings opportunities when it undergoes short-term corrections. Here’s a trading method that allows you to recognize those corrections.

40 Game Theory

by John Devcic When you think of trading, the farthest thing from your mind is to compare it to playing a game. But studies of game theory may help us know how to approach the markets.

25 Futures For You

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

43 Q&A

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

26 Exploiting Guts, Risk, And Decay

by Karl Montevirgen Risk is a necessary part of the trading game. Here’s one strategy that could work for you if you have the experience, the capital, and the willingness to take on higher risk.

AT THE CLOSE

60 Building Self-Confidence

by Stella Osoba, CMT There are certain traits a trader needs to succeed, and self-confidence is one of them. But how do you develop it so that it benefits your trading skills? Let’s find out.

28 Recognizing Price Action by Matt Blackman Here’s a look at the anatomy of one trader’s winning trade.

INTERVIEW

32 Justin Bennett’s Trading Path

by Jayanthi Gopalakrishnan Justin Bennett made his very first trade at the age of 14 and quickly found out the challenges that the trading world can pose. But those challenges only encouraged him to keep learning and trading. We spoke with Bennett on February 14, 2017 to find out more about what kept him going in his trading career in spite of running into roadblocks.

DEPARTMENTS 6 7 46 47 48 57 57 58 59 59

Opening Position Letters To S&C Books For Traders Trade News & Products Traders’ Tips Advertisers’ Index Editorial Resource Index Futures Liquidity Classified Advertising Traders’ Resource

38 Explore Your Options

by Tom Gentile Got a question about options?

n Cover: Jose Cruz n Cover concept: Christine Morrison

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April 2017 • Volume 35, Number 5

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T

he US economy has been fueled by easy money that has led to a long expansion, which was even more pumped after the US elections in November 2016. A lot of this has to do with a “business-friendly” administration and the anticipation of a favorable tax plan. But how much longer can this expansion continue? The reality is that markets are cyclical in nature and at some point, the markets will mean-revert. They always do, and the further away the markets are from the mean, the larger the impact. Unfortunately, that could end up being painful for the average household, not just in the US, but globally. Remember what happened during the housing crisis in 2007–2008. This is not a time to get too caught up in the euphoria that is surrounding the markets. There’s too much optimism and it’s become extremely speculative. Instead, think of approaching the markets each day with an unbiased look. After all, you’re responsible for your own actions. You can’t blame someone else or the market. You could but what good will it do? If there was one thing I would say to traders, it’d be “proceed with caution.” You don’t want to miss out on anything but at the same time it pays to be observant. Take a step back and look at the entire picture. Start with the global economy, narrow down to individual economies, look at the currency markets, the bond markets, the commodities, and equities. Then look at your indicators, whether that be macroeconomic data, or general market indicators such as volatility and market breadth, or something else, and then narrow your focus to individual trades. Get into the habit of looking at various timeframes. Get a feel for the market and think about what will start indicating when the markets will run out of steam. Is it a slowing down of momentum, an increase in volatility, more lows than highs, or something else?

Be

aware and know what the markets are doing instead of focusing on what you are trading. It’s easy to get sucked into the desire to chase something that everyone is talking about. Nobody knows when the markets will mean-revert. It’s a matter of how well you understand the markets and how well you manage your risks. So when I say to proceed with caution, make sure that every trade you put on has in place a strategy that will protect it from losses. Don’t just jump into a trade based on a hunch. Do your homework and trade smart.

6 • April 2017 • Technical Analysis of Stocks & Commodities

Jayanthi Gopalakrishnan, Editor

Miami Downtown Richard Cavalleri/Shutterstock

EDITORIAL

[email protected]

2017 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

EXPONENTIAL STANDARD DEVIATION BANDS Editor, I enjoyed the article in the February 2017 issue by Vitali Apirine, “Exponential Standard Deviation Bands,” and am sorry to be the bearer of sad tidings but he has reinvented the wheel. Exponential Bollinger Bands, as we call this work, are more than 20 years old and are included in our Bollinger Band Tool Kits for TradeStation, NinjaTrader and other platforms. We have done similar work with various other weighted average methods, always using the weighted average as the middle Bollinger Band and in the calculation of standard deviation used to set the width of the bands. We agree with Apirine about the utility of the approach he discusses and other alternative Bollinger Band formulations and strongly encourage traders to explore the pros and cons of the various trend and volatility calculations that can be used for Bollinger Bands. We made Bollinger Bands open source from the beginning precisely to encourage research. Over the years we have had many inquiries about alternative calculation methods and various derivatives such as Bollinger Envelopes. We have always tried to answer these in a timely manner and stand by to answer any questions researchers may have. If anyone has questions about Bollinger Bands and the related tools, techniques, and indicators, please feel free to drop us a line at [email protected]. Good trading. John Bollinger

Volume-Weighted Moving Average Breakouts Editor, I have a question about the article by Ken Calhoun on volume breakouts in the February 2017 issue of Technical Analysis of S tocks & Commodities, “Volume-Weighted Moving Average Breakouts.” My question is, can you tell me in what charting platforms the indicator discussed in the article, the VWMA (volume-weighted moving average), is available, or do you have a script to use in the thinkorswim platform? Thank you and best regards. Torsten If you use thinkorswim, you can add your own custom indicator using thinkscript. Here is a formula in thinkscript you could use to plot the volume-weighted moving average: input Length = 12; plot fastAvg = sum(volume * close, Length) / sum(volume, Length);

Hope this helps.—Editor INTERVIEW WITH ED DOBSON Editor, Reading your interview with Ed Dobson in the February 2017 issue of Technical Analysis of Stocks & Commodities (“Ed Dobson On Transitioning To Independent Trader”) was like reading a golden book. It was very well written, clear, enjoyable, and April 2017

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www.NeuroShell.com 301.662.7950 most importantly, a great teaching lesson in itself. For an independent trader like me, it was like looking at an open roadmap that one has to follow in order to become a successful trader. Thank you for publishing this interview. Claudio Demb EXCEL SPREADSHEET Editor, Thank you for all of Vitali Apirine’s informative and educational contributions to Technical Analysis of Stocks & Commodities magazine. After reading his November 2015 article on the average percentage true range (“Average Percentage True Range”), I’ve been able to better think about possible stocks for positions based on an “apples to apples” comparison now. In the February 2017 issue, I really enjoyed his “Exponential Standard Deviation Bands” article. I can see how it will greatly help my trading. Continued on page 45 • Technical Analysis of Stocks & Commodities • 7

8 • April 2017 • Technical Analysis of Stocks & Commodities

TRADING FOREX

Think Tactically

Discounting Sentiment In The Euro

JOSE CRUZ

Contrarian vs. coinciding There is a major difference between my approach in this article versus the approach discussed in my November 2016 article. The benchmark indicator in this article, the closed-end-fund discount, serves as a contrarian indicator, whereas the OSI trading indicator is a coinciding indicator. With that said, this approach can be seen as more of a trading tactic to your overall sentiment trading strategy, unless you are a contrarian. In academia and in practice, it’s generally understood that investors have a greater expectation for investment returns by discounting such factors as the price-earnings ratio, price-book ratio, and, in this case, a sentiment factor. I will calculate a daily closed-end-fund discount (CEFD) to serve as a proxy for sentiment.

Daily Returns vs. CEFD for Euro ETF

0.010

0.005

0.000

-0.005

-0.010

-0.015 -0.02

-0.01

0.00

0.01

0.02

FIGURE 1: DAILY RETURNS. Here you see a scatter plot of daily returns and previous day’s closed-end-fund-discount.

by Philipe Saroyan April 2017

• Technical Analysis of Stocks & Commodities • 9

R Core Team

S

entiment can have an impact on the markets, directly and indirectly. This is the reason why sentiment indicators are differentiated between two categories, direct and indirect. In this article, I will look at the closed-end-fund discount indicator, which is an indirect sentiment indicator similar to the traditional put-call ratio and other modified put-call ratios such as the options sentiment indicator (OSI), which I described in an article in this magazine in the November 2016 issue.

In Figure 1 you see a graph from the last 10 years plotting daily returns of the euro ETF (FXE) versus its closed-end-fund discount, which is my sentiment proxy. Notice a slightly negative linear relationship. The regression results (see Figure 2) show a convincingly negative slope for this linear relationship at the 95% confidence level. This negative linear relationship falls in line with my previous research, which says markets will discount the sentiment factor in the long run. Following this logic, I was able to fairly easily backtest the daily mid-price and closed-end-fund discount (CEFD) with a few data points. By discounting sentiment in this way, you would simply buy the euro ETF when the previous day’s mid-price (average of open and close) was trading at a discount to the net asset value; and sell the ETF when it was trading at

CEFD (t-1)

Excess returns from trading sentiment are only seen in the short run … or are they? Here’s a look at a sentiment trading tactic using a contrarian, indirect sentiment indicator applied to the euro ETF that shows how over the long term, you can use a sentiment trading strategy.

Regression Results SUMMARY OUTPUT

Traders and investors should discount sentiment when it is at its peak, especially when it is “noisy.”

Regression statistics Multiple R R-squared Adjusted R-squared Std. error Observations

0.036 0.001 0.001 0.003 2518

ANOVA df

SS

MS

F

Significance F

1.000 2516.000 2517.000

0.000 0.016 0.016

0.000 0.000

3.180

0.075

Coefficients

Std. error

T-stat

P-value

Regression Residual Total

Intercept Daily returns

0.000 -0.023

0.000 0.013

1.430 -1.783

0.153 0.075

Lower 95% 0.000 -0.049

Upper 95% 0.000 0.002

Lower 95% 0.000 -0.049

Upper 95% 0.000 0.002

CEFD(%) = LN

FIGURE 2: REGRESSION RESULTS. There’s a negative slope for this linear relationship at the 95% confidence level.

Calculating the indicator

2016-11-02

2016-06-27

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2015-01-22

2014-09-12

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2013-12-24

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0% 2007-07-20

)

The reason I use daily returns to predict sentiment is that prevailing research does not substantiate sentiment being able to predict prices when testing for these two variables. Although stock returns and sentiment have a covariant relationship, especially in the case of consumer sentiment, the research only shows evidence of prices being able to predict sentiment and not the other way around. Results suggest that there is a feedback loop from the stock market to general confidence/sentiment levels but that relationship doesn’t necessarily go in reverse. 50% Increased sentiment levels don’t necessarily affect price levels. 40% Based on this logic, I can stay sound in my sentiment trading strategy over the long term by initiating this tactic of discounting sentiment. 30% The backtest results show the strategy boasts an impressive hit rate of 52.17%. Although it is pos20% sible to easily transpose the y-variable—the daily CEFD(%)—making it the predictor variable, it would be invalid based on this premise. 10%

Discounting Sentiment

2007-03-13

NAVt–1

Prices predict sentiment

To calculate the indicator, first you’ll need the previous day’s mid-price, which is simply the average of the open and close prices. Then you would need the previous day’s net asset value (NAV), which is calculated and published by the ETF company each day. Both data points are fairly easy to compile. Finally, you would take the natural log of the two to compute a daily CEFD percentage, as in this equation:

-10%

Daily ETF return

FIGURE 3: DISCOUNTING SENTIMENT. Here, the euro ETF (FXE) is shown with and without the sentiment indicator.

10 • April 2017 • Technical Analysis of Stocks & Commodities

Midpoint price t–1

The CEFD indicator gives clear buy or sell signals each day to discount the prevailing sentiment when the ETF is trading at a premium, and to buy when it is trading at a discount. Figure 3 shows the backtested results from the last 10 years when trading this strategy on the euro ETF.

a premium. In this way, the strategy is contrarian, and falls in line with the tenets of prevailing research, supporting positive long-term results.

With CEFD indicator

(

To follow sentiment or not

The strategic trader should be aware that everincreasing prices should not make sentiment investors more bullish. This merely suggests a crowding-in effect will eventually be discounted. Continued on page 20

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Know What You Should Expect

The Edge In Chart Patterns Part 1

It

by Giorgos E. Siligardos, PhD

is true that most technical methods involving chart patterns are based on simple observation and are not rigidly tested from a statistical point of view. What you read on the Internet, in books, or in magazines about chart patterns mostly discuss observations by the authors who notice something they believe to be valuable and share it with the public. Tom Bulkowski (a Contributing Writer to this magazine) is one of the few authors who provides success/failure statistics for chart patterns. Before putting money in any pattern, you should first ask

12 • April 2017 • Technical Analysis of Stocks & Commodities

yourself if trading this pattern produced an edge historically, what the arithmetic value of this edge is, what overall edge could you infer from the pattern’s historical performance, and what the difference is between the theoretical edge and the real edge you get when you trade the pattern in real time. This two-part article will help you answer these questions.

First, the basics

When do you call a game of luck “fair”? The short answer is “when all the opponents have an average expected gain of zero for each play.” When the average expected gain from each play is not zero for one of the players, you can consider that he has an edge (positive or negative) over the other players. To put it simply, what you expect from a game is that on the one hand, it is not fair and on the other hand, you are allowed to play it from the side of the positive edge. For simple games of luck where the probabilities of outcomes

HAND/COINS: DENPHUMI/DICE: COPRID/CUP: DENZ/ SHUTTERSTOCK/COLLAGE: JOAN BARRETT

When you see a chart pattern forming, most likely, others will see it too. What gives you an edge when you trade a chart pattern? This two-part article will help answer that question.

CHART PATTERNS

are known, it is easy to calculate whether a player has an edge and the exact value of the edge. For example, in double-zero roulette it can be calculated that a player has a negative edge of -5.26% (and of course the casino has a positive edge of 5.26%). This means that on average, for every $x bet at the roulette wheel, the casino expects to get 5.26% of that $x as pure profit. I will present two examples without using rigid mathematical formulation to help the uninitiated grasp the main idea, which I will later expand to the chart patterns case. Example 1: The coin game You are offered a game where a coin is flipped and you place notional bets before the flip. A notional bet (NB) is the base upon which the profit or loss will be calculated. If the coin lands tails then you lose 1.2 times the NB (or $1.2 for an NB of $1) and if it lands heads then you get 2.3 times the NB (or $2.3 for an NB of $1). Assume further that the coin has a 50% probability of landing heads (and of course a 50% probability of landing tails). This means the coin itself is fair as it doesn’t show any preference for heads or tails. But is this coin-flipping gambling game fair for you? If you always bet $1 then after every two flips you expect to get on average one heads and one tails. From the tails you will lose $1.2 and from the heads you will gain $2.5. So after two flips and a sum of $2 NBs, you will end up having a net profit of $0.30. This means that the game is not fair since, on average, for every two flips you expect to get $0.30 as profit. Now, if you divide the profit $0.30 by the sum of NBs of $2 you get 0.15 or 15%. This 15% is the edge this games offers you as a player. From a practical standpoint, when your notional bet is $x in each flip, then you expect to get on average 15% of x (or $0.15x) as profit from each flip. Example 2: The dice game In this game, you place your NB and throw a dice. If the dice shows a 1 or 2 then you lose money equal to the NB. But if it produces 3 or higher you get 55% of the NB. Does this game offer you an edge? Assume you always place an NB of $1. Then, on average, after six throws of the dice you expect all different faces of the dice to come up and you will have lost a total of $2 ($1 for each of the outcomes 1 and 2) but you will also have gained a total of $2.20 ($0.55 for each of the outcomes 3, 4, 5, 6). So, on average, for every six throws you would have placed a total of $6 as NBs ($1 NB for each bet) and have an overall net profit of $0.20 ($2.20 - $2.00). This means that again this game is not fair, and it offers you an edge. To calculate the edge you divide the net profit of $0.20 by the sum of NBs of $6, which produces approximately 0.0333 or 3.33%. In the examples I discussed, you knew the exact probabilities of outcomes for the coin and the dice (the probability of getting 2 for a dice throw was 1/6) and also knew the payoff for each outcome. In such cases the calculation of the edge is simple. For cases where there is neither knowledge of the probabilities of outcomes nor the payoff for NBs you must perform a

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Monte Carlo simulation of the game assuming constant NBs to calculate the total net profit and then divide it by the sum of NBs to arrive at the edge of the game. In the case of chart patterns, there are many historical cases of patterns that can be used to estimate its historical edge and derive estimations about its overall edge.

The case of chart patterns

To calculate the edge of a pattern you must keep in mind the following: • Steer away from a vague definition of the pattern. With a vague definition, you run the risk of making vague

The results of this system suggest that for every $1 you bet in the bullish implications of the cup pattern, you would receive on average $0.16 back as profit. Only 39% of the trades were profitable meaning that losses were plenty but small and winnings were less but big enough. April 2017

• Technical Analysis of Stocks & Commodities • 13

conclusions about the pattern. Patterns that can be algorithmically defined by a computer are the best way to go since they give an objective method to quickly collect several cases for your research.

Cup after a downtrend

Cup after an uptrend

Cup after a sideways market

Figure 1: textbook examples of cups or rounding bottoms. Here you see diagrams of cups after a downtrend, after an uptrend, and after a sideways market.

Big Lots Inc (Daily)

30 bars

95 bars Apr

May Jun

Jul

Aug Sep Oct

Nov

2009 Feb Mar Apr May Jun

Jul

Aug Sep Oct

Nov

Figure 2: Cups in big lots inc. (BIG). The algorithm identified two cups in the daily chart of Big Lots for the year 2009.

Number of Cups Identified 200

103 106 108

100

0

176 177

191

28

36 39

53

65

122

134

124 120 114

114 118

191

184

170

150 153

150

50

186

173

173 153

150 115 93

81

54 37

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Number of Cups

250

Year

Figure 3: duration of cups identified per year. Here you see how many cups were identified each year from 1982–2014.

% Frequency

% Frequencies of Durations of Cups 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%

Mean duration: 52 bars Median duration: 32 bars Min. duration: 20 bars Max. duration: 1162 bars 10%

20–30

31–40

41–50

7%

51–60

5% 61–70

• You must have a rigid definition of what the pattern is supposed to produce (the hit of a target price, for example). If you believe a pattern is expected to produce a price move but it has no specific price target, then you must specifically declare what this move is about and how it is defined. This will ensure a clear method to calculate profit consistently. As an example, an easy way to define directional moves is through the magnitude of retracements. Any retracement larger than a specific threshold automatically signifies the end of the directional move. This basically puts the pattern in the context of a trading system and is how you should view the pattern if you want to calculate whether it provides an edge for you in your trading. You assume entering the market when specific conditions are met, and assume exiting the market when, again, specific conditions are met. You also know beforehand the money you are about to lose when the pattern fails. Once you have defined the entry price, stop-loss level, and how the profit from trading the pattern is calculated, you can backtest as many historical manifestations of the pattern as possible. Let P be the profit (either positive or negative) from a pattern defined as: • P = (Exit price - Entry price) for long trades on patterns that are considered bullish • P = (Entry price - Exit price) for short trades on patterns that are considered bearish.

46%

17%

• You must have a definite price threshold level that will signal when the pattern has failed to do what it was supposed to do. An example would be a “stoploss” level. This is important for determining the loss when the pattern fails. (For a head & shoulders top, for example, the passing of price above the level of the head is traditionally considered the end of the bearish implications of the pattern). Considering how technical analysis views chart patterns, and to avoid favoring specific manifestations of one pattern over others, the stop should take into account the dimensions of the pattern to facilitate general conclusions and provide a uniform way to judge it.

8% 2%

2%

2%

1%

1%

71–80

81–90

91–100

101–110

111–120

121–130

Duration Figure 4: %frequencY distribution chart of cups per duration. Almost half (46%) of the cups identified lasted from 20 to 30 daily bars.

14 • April 2017 • Technical Analysis of Stocks & Commodities

Let S be the distance of the stop-loss level from the entry price: S = | Entry price - Stop-loss level | (where | ⋅ | stands for the absolute value).

The fraction:

Cumulative % Frequency of Durations

P PF = S

100%

The edge of a cup pattern

This is an example I presented at the International Federation of Technical Analysis (IFTA) conference in 2014 in the context of a broader theme to point out the merits of algorithmic identification of chart patterns. You can tweak the ideas in this example to match your preference for the patterns you want to examine. The pattern I dealt with was the cup, which is a rounding base or rounding bottom that shows up after a downtrend (Figure 1). The cup is generally believed to have bullish implications for price movement. Although the behavior of volume during the cup is considered important and variations of the cup (like the “cup with handle” pattern) are also popular, for simplicity, I chose to eliminate volume and variation issues from the study and concentrate on the implications of the price formation. In my IFTA presentation I used a slight modification of the identification algorithm for cups that I had initially described in my February 2006 article for this magazine, “Identifying The Cup” (see further reading at end). I used daily charts of S&P 500 stocks from 1982 to 2014 and captured a total of 3,991 distinct cups of various durations (“distinct” means there was no time overlap of more than 70% between any two cups in the same chart). Figure 2 shows examples of cups identified by the algorithm in the daily chart of Big Lots Inc. In Figure 3 you see the number of cups identified per year and in Figure 4 you see the %frequency of cups per duration, respectively. The minimum duration was 20 bars and the maximum was 1,162 bars. The median duration was 32 bars and 80% of all cups identified lasted no more than 75 bars (see Figure 5).

80%

Cumulative % Frequency

40%

80% of all cups identified were less than 3 months long (75 trading days)

20%

Mean duration: 52 bars Median duration: 32 bars

60%

0%

20 75 13 0 18 5 24 0 29 5 35 0 40 5 46 0 51 5 57 0 62 5 68 0 73 5 79 0 84 5 90 0 95 10 5 1 10 0 65 11 20

is then exactly the profit (in dollar terms) for the pattern if you were to trade it by using notional bets of $1 for each trade. This offers the same normalization as the constant $1 notional bet in the examples of the coin and dice I presented earlier in the article. Note that if the stop-loss is hit and you exit the trade at exactly the stop level, then PF will always be greater or equal to -1. However, when your exit based on the stop-loss value is not predetermined (for example, taking into account gaps past the stop to simulate real-world conditions, or you require the closing price to penetrate the stop for the pattern failure to be considered valid) then the S and the PFs can be lower than -1. Note also that the PF practically plays the role of a profit factor (hence the name PF) because if your notional bet is $A when the stop-loss is hit, then the profit will be PF times that $A. The simple arithmetic average (mean) of the PFs over all historical patterns provides the implied historical edge for the pattern based on the backtest.

Duration (Bars)

Figure 5: cumulative %frequencY distribution chart of cups per duration. 80% of all cups identified lasted less than 75 daily bars.

H

Entry price

200 -21% 158

Initial stop

-30%

140 L

Figure 6: setting the initial stop-loss. The initial stop-loss starts at a value defined by 0.7 times the percentage height of the cup. If the percentage height is 30% then the initial value for the stop is set at 0.7 times 30% (or 21%) below the entry price. Once set, the initial stop-loss then becomes a trailing stop as price advances.

Here is how I identified the stop-loss for the cup. Let H be the high of the identification bar (the high of the bar when the cup was identified) and L the lowest low during the cup. The percentage height from H to L is therefore: (H - L) 100%. H The stop-loss value is then set by taking 0.7 times that percentage height below the entry price. So, for example (see Figure 6), if H is 200 and L is 140, the percentage height from H to L is 30%. Taking 0.7 times 30% gives you 21%. The stop-loss level therefore is 21% below the entry price of 200, or 158. Since the cup pattern is generally believed to produce upward price moves and there is no standard price target associated with it, I assumed a buy-only trading system that goes long at the high of the identification bar with the initial stop-loss April 2017

• Technical Analysis of Stocks & Commodities • 15

Frequency Duration of PF for Cups 1200

Frequency

1000 800 600 400 200

(-5 .5, (-5 5) ,4. (-4 5) .5, (-4 4) ,3.5 (-3 ) .5, (-3 3) ,2.5 (-2 ) .5, (-2 2) ,1.5 (-1 ) .5, (-1 1) ,0.5 (-0 ) .5, 0) (0 ,0 .5) (0 .5, 1) (1 ,1 .5) (1 .5, 2) (2 ,2 .5) (2 .5, 3) (3 ,3 .5) (3 .5, 4) (4 ,4 .5) (4 .5, 5) Mo re

0

Figure 7: Frequency distribution chart of the pfs of the cups from 1982–2014. The distribution of PFs for the cups is somehow positively skewed. It has a mean value of 0.166 which means the historical edge of the cups when used as bullish formations (at least as seen from the eyes of the trading system used in the study) is 16.6%. Bars that correspond to negative or zero PFs are colored red whereas bars that correspond to positive PFs are colored blue.

being trailed. The trade is exited only when the trailing stop is hit. Note that the trailing stop is naturally related to the percentage height of the cup to assume a uniform way of judging the cups. Why did I use the 0.7 value as a factor for the initial stop and not 0.5 or 0.8 or 1? There’s no mandatory reason. This is just an example. Since the initial stop-loss becomes a trailing stop, using different values for the factor will examine the bullish implications of the pattern from different points of view. More precisely, the value of the factor defines the retracements you allow the bullish move to produce. For example, by setting it to 0.2 you will examine if the cups produce immediate and strong trends (small retracements in relation to the percentage height of the cups). The 0.7 value seemed okay for providing a general idea, since it allowed room for retracements without being too pliable. Nobody is stopping you from examining various factor values to see which of them produce important and nice results. To determine profit/ loss, I took into account gaps that formed past the trailing stop. I also placed a requirement that the trailing stop had to go through the closing price to signal exits. The exit value I used was the low of the exit bar (to account for slippage) so the PFs could take values lower than -1. The distribution chart for the PFs for all the cups is shown in Figure 7. The mean value is 0.166 or 16.6% and this is therefore the historical edge of the cup pattern for the period 1982–2014. Mind you, this is from the point of view of the system used to estimate its bullish implications. The results are interesting in that they suggest that for every $1 you would bet in the bullish implications of the cup pattern, you would receive on average $0.16 back as profit. What is also interesting is that only 39% of the trades with this system were profitable. This means that the losses were plenty but small, and the winnings were less than the losses but big enough, as can be seen in Figure 7. This was to be expected, since applying an initial stop-loss prevented huge losses from occurring while the trailing stop let the profits run. If the number of historical PFs is quite large and the dis16 • April 2017 • Technical Analysis of Stocks & Commodities

tribution of PFs is not extremely different from the normal distribution, a statistical test called a “student’s t-test” (practically the same as the statistical z-test for large samples) can be applied to derive what is called a “confidence range” for the mean PF (that is, a confident range for the edge of all cups). For example, assuming that the 3,991 historical cups used in this study is a nonbiased sample of the population of all cups (since the time period from 1982 to 2014 is long enough and covers many market conditions), the t-test showed that a confident range for the overall edge of the cup pattern is from 9.1% to 24% with 99% confidence. In other words, the historical PFs calculated suggest that there is a 99% confidence that the true edge of the cup as a bullish pattern is between 9.1% and 24%.

Moving on

These findings are impressive and encouraging, but don’t rush to celebrate yet, as there are many issues that still need to be considered to get the whole picture, especially from a practical standpoint. I will tackle these issues in part 2. Stay tuned. Giorgos Siligardos holds a PhD in mathematics and a Market Maker certificate from the Athens Exchange. He is a financial software developer, a frequent contributor to Technical Analysis of Stocks & Commodities magazine, and for many years a scientific contributor in the Department of Finance and Insurance at the Technological Institute of Crete. His academic website is http://www.tem.uoc.gr/~siligard and he may be reached at [email protected].

Further reading

Bulkowski, Thomas N. [2005]. Encyclopedia Of Chart Patterns, 2d ed., John Wiley & Sons. Kuhn, Gregory [1995]. “The Cup-WithHandle Pattern,” Technical Analysis of Stocks & Commodities, Volume 13: March. Murphy, John J. [1986]. Technical Analysis Of The Futures Markets, New York Institute of Finance. O’Neil, William [1999]. 24 Essential Lessons For Investment Success, McGraw-Hill. [2002]. How To Make Money In Stocks, 3d ed, McGraw-Hill. Siligardos, Giorgos [2006]. “Identifying The Cup (With Or Without The Handle),” Technical Analysis of Stocks & Commodities, Volume 24: February. [2011]. “Identifying Cup Formations Early,” Technical Analysis of Stocks & Commodities, Volume 29: April.

†See Traders’ Glossary for definition

TRADING ON MOMENTUM

Ascending Triangle Breakouts This month in our Trading On Momentum column, this professional trader introduces you to the ascending triangle pattern that you can use to help spot buying pressure as it builds.

F

by Ken Calhoun

inding potential breakouts before they happen is a helpful visual scanning skill to develop. You can use ascending triangles to help you identify these new trading opportunities, because they reveal increasing buying pressure just in time to help you enter your position. You will see how to trade this useful bullish breakout trading pattern in this month’s column.

Swing Trading Ascending Triangles An ascending triangle is formed when there is a horizontal resistance level of three days or longer forming the top of a consolidation pattern, accompanied by an uptrending, lower trading line. You can think of this as a visual battle between buyers and sellers, with buyers slowly winning during a multiday timeframe. The uptrending lower line indicates that buyers are gradually winning. Once you see price action break out above the upper resistance line, it indicates a long trade entry. It is important to note that you should also wait until price moves at least $0.50 above resistance (or you see a large green candle form at the upper right area of the ascending triangle) to help avoid false breakouts.

Step-by-step action plan

Here’s how you can start using this strategy with your swing trades: Step 1: Look for a 15-day 15-minute candlestick chart in which price is in an uptrend, as seen in Figure 1, Shopify, Inc. (SHOP) from January 3, 2017 to January 5, 2017. Step 2: An ascending triangle occurs from January 5–9, 2017 in this chart. You may enter your trade once price action has broken out above the upper resistance line. Step 3: To potentially avoid false breakouts, waiting until $0.50 above resistance before entering (in this case that is $47.50/share + 0.50 = $48 entry) as seen on January 10. Step 4: Place an initial and trailing stop value of $2.00 per share to manage the trade.

Insights: Why this technique works

The ascending triangle is a useful bullish entry pattern because it visually shows the forces of demand overpowering supply, which leads to an increase in price. It is important for you to carefully observe what price does as soon as it breaks out to new highs. Much like you would anticipate a handle at the right side of a bullish cup pattern breakout, you can also anticipate occasional false breakout choppy price action following ascending triangle patterns. That’s why I have found it useful to wait until price has moved up at least $0.50 above resistance, preferably with additional bullish confirmations like a tall green candle and high volume, prior to entering the trade.

Trade manage-

esignal

ment tips You can visually see the forces of buyers and sellers at work with the help of the ascending triangles. Managing your trade entries is often simply a matter of buying strength and using careful risk management in context of strong chart enFigure 1: Ascending Triangle (SHOP). You enter a swing trade $0.50 above the upper resistance line after an ascending triangle breakout entry signal. April 2017

Continued on page 31

• Technical Analysis of Stocks & Commodities • 17

It’s Crunch Time!

Playing With Numbers

Is

by Domenico D’Errico it possible to “beat the market” by applying some type of trading rules to equities? Or is it better to use a simple buy & hold approach? Is there a way to test and compare some simple trading logic against buy & hold? In this article I’ll try to answer these questions and propose some ideas on how to analyze markets using a numericalbased approach. Are you ready to crunch some numbers?

18 • April 2017 • Technical Analysis of Stocks & Commodities

First, measure it

What does “beat the market” mean? Does it mean making greater profits or maintaining lower risk? Most trading platforms provide return on account (ROA) figures for the user, which is a useful performance indicator. ROA is the ratio between the strategy net profit and the strategy maximum drawdown. This indicator gives a snapshot of the risk/reward profile of the strategy. For example, an ROA of 1 means the profit of the strategy equals the risk—the higher the reading, the better the model. For the purpose of this article, I will assume that a trading strategy beats the market if its ROA is higher than the buy & hold ROA.

Buy & hold SPY ETF

Say you invested $100,000 in SPY at the beginning of 2000.

CHESSBOARD: VIVI–O/SHUTTERSTOCK

Which strategy will give you a better return on account? Here we compare the performance of three strategies to see which comes out ahead.

MONEY MANAGEMENT

Buy & Hold SPY

200000 180000

In Figure 1 you see how the equity curve moves through the years. At the end of 2016 the initial $100,000 increased to $153,000, giving you a total profit of $53,000 (53%). But in 2008 the equity line dropped to $48,000 for a maximum drawdown of $62,000 (62%). The buy & hold ROA is 0.86 (53% divided by 62%). Long-term investors need to analyze the risk/reward ratio for any instrument they are willing to buy and hold before investing. A helpful exercise is to imagine that the $100,000 starting capital is your own money. Pay careful attention to market bottoms and tops. What if at the end of 2002 you had only $60,000 in your account and in 2007 it was $100,000? What if in February 2008 your account value dropped to $48,000? What would you think in such situations? What would people around you say? Would you care about what they say? This exercise may raise some questions in your mind about your investment temperament, your tolerance for risk, your willingness to accept your losses, and your willingness to go against the crowd. Believe me, this exercise is better than any backtesting and can be helpful in making you a more objective, opportunity-minded investor.

There are other ways

I’m now going to analyze three other approaches to trade the SPY:

2. Trend-follower: Buy when a trend is supposed to start and sell after 12 weeks 3. Red candle: Buy a weekly red bar (a close below the open), sell after 12 weeks. Why is there a need for random trading strategies? A random strategy is an important benchmark to compare the results of other strategies with. But if a strategy’s ROA is similar to that of a random strategy, why spend time on it? Wouldn’t it be easier to just flip a coin? In Figure 2 are the backtest results to compare the four trading approaches.

140000 120000

Starting capital = $100,000

100000 80000

Max drawdown = -$62,028 (-62%)

60000 40000 20000 0

2000

2001

2003

2005

2007

2009

2011

2013

2015

Equity Figure 1: buy & hold equity curve. Here you see how a buy & hold strategy performed on the SPY from 2000–2016. At the end of 2016 the initial $100,000 increased to $153,000, giving you a total profit of $53,000 (53%). But in 2008 the equity line dropped to $48,000 for a maximum drawdown of $62,000 (62%). The buy & hold ROA is 0.86 (53% divided by 62%).

SPY ETF: Strategies Comparison €200,000 €180,000 €160,000 €140,000 €120,000 €100,000 €80,000 €60,000 €40,000

2000

2001

2003

Buy & Hold Buy & Hold Net profit $53,357 Max drawdown -$62,028 ROA 0.86 No. of trades 1

2005

2007

Random

2011

2013

Trend-Follower

Random

53% $73,518 -62% -$59,891 1.23 64

2009

Trend-Follower

74% $49,527 -60% -$35,514 1.39 54

2015

Red Candle Red Candle

50% $102,644 -36% -$52,982 1.94 64

103% -53%

No commission/slippage/dividend Figure 2: backtest results. Random ROA 1.23 is higher than buy & hold ROA at 0.86. Trend-follower ROA at 1.39 is better than buy & hold ROA. The red candle’s logic, with an ROA 1.94, is the best of the four.

tradestation

1. Random trading (random buy, sell after 12 weeks)

Net profit = $53,357 (53%)

160000

FIGURE 3: EASYLANGuaGE CODE. Here is some EasyLanguage code that can be used for testing the logic of different systems. April 2017

• Technical Analysis of Stocks & Commodities • 19

A trading strategy beats the market if its ROA is higher than the buy & hold ROA. And looking at the results, beating the market seems to not be a difficult task. Random ROA 1.23 is higher than buy & hold ROA at 0.86. How can this be explained? Buying randomly and selling after 12 weeks reduces the risk of having an open position during sharp down movements. In addition, exiting after 12 weeks acts as a “take profit” and you may eventually randomly reenter at a lower price. Trend-follower ROA at 1.39 is better than buy & hold ROA. This result is very close to the random ROA, which makes you think the trend-follower approach on SPY gives poor results. The logic of the red candle approach, with an ROA 1.94, is the best of the four. Breakout traders know very well that their techniques work mainly on volatile markets.

Is it possible?

Looking at the buy & hold results on SPY, it seems that beating the market would not be a difficult task—a 62% drawdown and a 0.86 ROA is not an ambitious target. Even flipping a coin could bring better results. If

saroyaN/discouNtiNg seNtiMeNt iN the euro Continued from page 10

Philipe Saroyan is a financial writer with current works in specialized research, digital content, and web development. He can be reached at [email protected].

Further reading

Allis, P., and J. McCallig [2007]. “Do Stock Market Returns Affect Consumer Sentiment? An Irish Study,” Irish Accounting Review, Vol. 14, No. 1, retrieved from ProQuest Databases. Coleman, M. [2013]. “Essays In Investor Sentiment” (a dissertation). Cohen-Charash, Y., et al. [2013]. “Mood And The Market: Can Press Reports Of Investors’ Mood Predict Stock Prices?” PLoS One, http://journals.plos.org. Liew, J., S. Guo, and T. Zhang [2014]. “Tweet Sentiments And Crowd-Sourced Earnings Estimates As Valuable Sources 20 • April 2017 • Technical Analysis of Stocks & Commodities

you buy and hold the S&P 500, it means your money may go up and down for years. If you wish to use the buy & hold approach, passive ETFs may not be the best choice. On the other hand, if you are an active trader, you may realize that SPY may not seem suitable for a trend approach as well—the SPY tends to mean-revert too often and this is the reason a simple “buy red candle and wait 12 weeks” strategy works better. Most trading platforms offer backtesting tools so it is possible to approach trading from a numerical base. If you are interested in “crunching your own numbers,” take a look at the lines of EasyLanguage code shown in Figure 3 that I used to test several different sets of logic.

Which one reigns above all?

You’ve seen how four strategies compare relative to each other. Different markets may be suitable for different trading approaches so it’s a good idea to analyze instruments with different volatility using different logic. Domenico D’Errico has a statistics background, is an app developer, and works as an advisor for asset managers and professional traders from different countries. He may be reached via his website Trading-Algo.com.

Further reading

D’Errico, Domenico [2016]. “Pair Trading With A Twist,” Technical Analysis of Stocks & Commodities, Volume 34: December.

Of Information Around Earnings Releases,” SSRN Electronic Journal. R Core Team [2016]. “R: A language and environment for statistical computing,” R Foundation for Statistical Computing, Vienna, Austria, https://www.R-project.org/. Saroyan, Philipe [2016]. “A Sentiment Indicator For Trading The Euro,” Technical Analysis of StockS & commoditieS, Volume 34: November. ‡R Core Team

‡See Editorial Resource Index ‡See Traders’ Glossary

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In this article I will describe a trading method designed to make quick profits following the release of some fundamental figures that affect the NZD.

It’s an interesting

currency NZD is an interesting currency, mainly because it moves in a fairly predictable way. Figure 1 shows the NZDUSD moving in a downward trend in the months of May, June, and July 2015. When the NZD is weak, you may see it losing stamina versus other pairs. And when NZD is strong, it may rally versus other pairs. This behavior of the NZD makes it attractive to traders who are aware of its speculative advantage. When the NZD reaches an equilibrium phase, you are likely to see GBPNZD, EURNZD, NZDJPY, NZDUSD, AUDNZD, NZDCHF, and NZDCAD in a trendless phase, similar to what happened from May 16–20, 2016 (Figure 2). Keep in mind that this strategy only considers NZD pairs or crosses. Traders can appreciate the predictability of an NZD pair when it trends strongly and when it stays in an equilibrium zone.

Kiwi Cooling Or Heating?

Taming The New Zealand Dollar The New Zealand dollar (NZD) often moves in a predictable manner when in a strong trend, and it brings opportunities when it undergoes short-term corrections. Here’s a trading method that allows you to recognize those corrections.

If

by Azeez Mustapha you know the market you’re trading, you’re likely to find great trading opportunities at some point. The New Zealand dollar (NZD) is no exception.

22 • April 2017 • Technical Analysis of Stocks & Commodities

The intention of the trading strategy described in this article is to act when there are strong movements in the NZD as a result of strong fundamental news. The actions will be taken according to the rules, since in most cases, you would gain some pips. This is expected based on past trades. It is only natural to want to trade based on strong reactions to the release of bullish or bearish news. Conversely, when the reaction to a news item is weak or nonexistent, traders will often not want to take any actions. But if you follow your trading rules, you’ll have a more balanced approach to the markets.

Taming the NZD

The idea behind the strategy is rational: When there is a strong trend movement after the release of fundamental data that affects the NZD, the price could continue in the direction the data

NZ BILLS: JAMIE FARRANT/LION: CHRISTOS GEORGHIOU/SHUTTERSTOCK/COLLAGE CHRISTINE MORRISON

Profit from it

www.metaquotes.net

FOREX

FIGURE 1: The NZDUSD in a Predictable Downtrend. During May, June, and July 2015, the NZDUSD pair traded downward. This helps us to appreciate the predictability of an NZD pair when it trends strongly and when it stays in an equilibrium zone.

pushes it and could reverse later. If price continues moving in the expected direction after the news release and then reverses, there is likely to be a pause in movement (mean reversion) before the next phase in price movement. It is this next phase that you want to benefit from. Crowds tend to overreact to news. Whether that news is bullish or bearish is not an issue. What is important is that traders want to take some gains after the reversals that occur when the effect of the news has eased. You can think of the overreactions by the crowds as possible trading opportunities. When frightened bears push price downward, we want to buy in the short term. When overjoyous bulls push price upward, you want to sell in the short term.

Strategy snapshot Strategy name: NZD Tamer Strategy type: Short-term Markets: Good for forex, better for binary options Suitability: Good for part-time traders Time horizon: 30-minute charts Trading periods: News releases with expected high impact Instruments: NZD pairs/crosses Setup: Enter an NZD pair 10 minutes after news is released. Look to go short when the pair/cross rallies, following the news. Reverse the logic when the currency pair/cross declines after the news release. Maximum positions: Only two trades per news release

FIGURE 2: Some NZD Pairs in Equilibrium Phase. When the NZD reaches an equilibrium phase, most NZD pairs or crosses (GBPNZD, EURNZD, NZDJPY, NZDUSD, AUDNZD, NZDCHF, and NZDCAD) end up moving sideways, become choppy, and start consolidating. This happened from May 16–20, 2016. You see four examples in this chart. April 2017

• Technical Analysis of Stocks & Commodities • 23

Duration: Each trade should be closed within 30 minutes to 1 hour Risk per trade: 1% Stop level: 100 pips Take profit: None Filter: No trades placed if news release has little or no impact on the market Hit rate: 75% on average, over the time.

A game of patience

You’re not going to get news releases that impact the NZD often, which means you need to exercise some patience when trading this strategy. Sometimes you may expect a news release to have an impact, but when it

is released, there may not be much movement. You want to stay in a trade for as long as you can make profits from it. You shouldn’t hold on to the position longer than is recommended. Here are a couple of examples. On May 26, 2016, the Annual Budget of New Zealand was released around 3:00 am GMT (black oval shape in Figure 3). In Figure 3, you also see that the figure for Private Capital Expenditure Q/Q, which affects the AUD, was made available at 2:30 am GMT. In each of the markets on the chart in Figure 4, the red vertical line shows where a trade was entered based on a signal candle, which is the candle that gives you a buy or sell signal. The candle that followed the signal reveals what hapContinued on page 45

FIGURE 4: Short-term Trades on AUDNZD and NZDUSD. In each of the markets, the red vertical line shows where a trade was entered based on a signal candle (the candle that indicates whether to buy or sell). The candle that followed the signal shows what happens to the position.

24 • April 2017 • Technical Analysis of Stocks & Commodities

www.forexfactory.com

FIGURE 3: Fundamentals that Affect the NZD: Annual Budget Release. On May 26, 2016, the Annual Budget of New Zealand was released around 3:00 am GMT. Here you see the figure for Private Capital Expenditure Q/Q, which was available at 2:30 am. This number affects movements in the Australian dollar.

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.

STOCKS VS. COMMODITIES Is commodity trading riskier than stock trading? Despite common assumptions, the answer to that question is no. If strictly speaking about speculation in prices, as opposed to long-term buy & hold investing strategies, the commodity markets are not any riskier than the stock market. It is true that most commodity market speculators lose money, but I would venture to say that aggressive stock speculation yields the same frustratingly dismal results. So why is there such a dark cloud hanging over the futures and options markets? It’s because of the nature of the futures exchanges and because the commodity industry allows speculators to conveniently trade substantially beyond their means with surprisingly low barriers to entry. In short, traders themselves and their behavior are what make the commodity markets appear to be riskier than the stock market. Let’s look at a few comparative points to illustrate this idea. Free leverage in commodities The allure of futures and options trading is easy access to leverage. Unlike stock traders who must first qualify for a leveraged account, which generally requires a substantial deposit in the six figures, all futures traders are granted leverage regardless of account size. Further, unlike stock traders who must pay interest to their brokers for borrowing shares for leveraged trading, commodity traders enjoy leverage without any cost burden. Unfortunately, human nature lures most traders into abusing the advantage

of accessible leverage in the commodity markets. In reality, it is the trader’s failure to properly manage risk and the over-use of leverage that creates the perception of commodity markets being riskier than stocks. To illustrate, a trader could buy or sell a WTI crude oil futures contract on the Chicago Mercantile Exchange’s NYMEX division for as little as $3,500 in a margin account. With that $3,500 a trader is making or losing money based on 1,000 barrels of oil with a market value of roughly $50,000 (depending

It isn’t the commodity market that is riskier than the stock market. It is the manner in which participants approach the commodity market that creates the perceived increase in risk. on the price of oil). At $1,000 in profit or loss per $1.00 change in the price of crude oil, it is easy to see how a trader could lose most, or all, of his money in the blink of an eye. Trading with a mere 7% of the contract value as collateral is an accident waiting to happen. Although the exchange makes it easy for traders of all size and experience levels to utilize such leverage, it is ultimately the trader’s choice. Traders can reduce leverage and increase their odds of success by simply increasing their account size. For instance, a trader with $50,000 on April 2017

Carley Garner

deposit trading a single crude oil futures contract has essentially eliminated all of the leverage and substantially shifted the probability of profitable trading. Thus, it isn’t the commodity market that is riskier than the stock market. It is the manner in which participants approach the commodity market that creates the perceived increase in risk. Unfortunately, most traders treat the futures market the same way they treat a Las Vegas buffet: They indulge in the present tense without consideration of future consequences. Commodity prices cannot go to zero It is possible for stock prices to go to zero. Even magnificent companies with seemingly indestructible business plans can cease to exist as economies and consumers change. Do you remember Blockbuster Video, Staples, or MCI Worldcom? These were all considered to be “blue chip” stocks and, in their heyday, it was difficult to imagine the landscape without them. Yet, we’ve all moved on and anybody holding those companies’ stocks to the end would have been painfully disappointed. While it is true that commodities can get much cheaper than most would deem reasonable, we’ve yet to see a commodity go to zero. Around-the-clock market access Stock traders might not always acknowledge that asset prices are moving around the clock but they are, regardless of which hours the New York Stock Exchange is open for business. It is naïve to assume that your portfolio is sleeping while you are; investors around the world are bidding and offering on assets in various Continued on page 39

• Technical Analysis of Stocks & Commodities • 25

ingly embedded within the very fabric of enterprise, most people do their best to mitigate it. Speculation, on the other hand, takes on a different perspective toward risk. Risk is not something to be avoided. It is a condition to be directly engaged and managed; a “material” to be shaped. It represents the flip side of opportunity. For the speculative trader, risk itself becomes the enterprise, with profit being the object. The question facing every trader, then, concerns how much he or she is willing to risk and what amount of profit might be worth a certain degree of negative outcome. Some strategies seek limited and immediate profits (in the form of “credits”) in exchange for unlimited risk and the potential for deep losses. As unsavory as this may seem, such strategies, when handled carefully and appropriately, can be an effective component in a trader’s arsenal. One such strategy—the short guts—exemplifies such an approach.

Aim Higher

Exploiting Guts, Risk, And Decay

Risk is a necessary part of the trading game. Here’s one strategy that could work for you if you have the experience, the capital, and the willingness to take on higher risk.

W

by Karl Montevirgen e all understand the basic notion that enterprise contains varying degrees of risk. Every undertaking, from a simple business project to the founding of a startup company, carries with it a probability of failure. As risk is seem-

26 • April 2017 • Technical Analysis of Stocks & Commodities

short guts Short guts is a rarely used option credit spread that is something of a variant to the short strangle. Instead of selling (short) one out-of-the-money (OTM) call and one OTM put, which creates a short strangle, you would sell one in-themoney (ITM) call and ITM put. From the start, this places you in a position from which both legs can be exercised by the buyer should you fail to close both positions before expiration. Now, why would a trader risk writing options that are relatively deep ITM? To capture a higher premium. The aim of this spread is to receive net credit by selling a call and put at a high premium price, allowing time decay to erode the premiums, and then buying back both contracts prior to expiration at a significantly lower price. ITM premiums are typically higher than atthe-money (ATM) or OTM premiums (particularly if the underlying stock has experienced high volatility). As complicated as it may seem, this spread follows the basic principle of buying low and selling high.

MAZE: NAEBLYS/SHUTTERSTOCK

Making sense of

optionS

Why many will not trade

short guts Aside from its unlimited risk profile (which is not uncommon in the wider field of option spread strategies), the counterintuitive nature of short guts and its grossly uneven risk/ reward ratio makes it highly unpalatable for most traders. This strategy also has a high margin requirement, preventing most traders from implementing it. But for those professionals or expert traders who have the capital resources and time to manage riskier trade opportunities, short guts is a marginal strategy that might be worth considering.

Implementing a short guts trade

What makes short guts a difficult spread to trade is not its structure but rather the prep work (which I’ll discuss later on in the article) and trade management that it requires. To put on a short guts trade, there are just two simple steps: 1. Sell an ITM call—at a strike lower than the current underlying price 2. Sell an ITM put—at a strike higher than the current underlying price. By selling an ITM call and put, you receive maximum credit, marking the highest profit potential for that trade. Ideally, time decay will rapidly erode the premiums. Before both contracts expire, close each leg by buying back the contracts.

Profit objective

Short guts is a delta-neutral income strategy. Ideally, you want to see the price of the underlying stock stay very close to the strike price around which you have structured your spread. Your goal is to take advantage of rapid premium decay so that you can receive maximum credit before buying back each leg prior to expiration. Remember that your maximum profit is limited to the net credit received when you wrote each position. Example: Stock XYZ is trading at $60. You sell an ITM call with a $55 strike price for a net credit of $6 and an ITM put with a $65 strike for a credit of $6 (see Figure 1). Net credit: Call premium + put premium sold = $12 or total of $1,200 (before commissions and fees). Maximum profit: Net credit ($12) - difference in strikes ($10) = $2 or gross profit of $200. • If XYZ stock remains at $60 by expiration, the calls and puts might have a value of around $5 each (a total liability of $1,000) upon which you close out each leg for a gross profit of $200. • If XYZ trades to $62 by expiration, the premium of your

Short Guts

Profit or loss $200

Stock price at expiration

$0 50

55

60

65

70

FIGURE 1: PAYOFF OF A SHORT GUTS TRADE. Here you see the breakeven points, max profit, and unlimited losses that could result in a short guts trade.

call might be priced at $7 while the put premium might decrease to $3. Closing each leg would also cost $1,000, leaving you with a $200 gross profit. • Let’s suppose that XYZ traded downward to $57 by expiration. The call premium would be at $2 while the put premium would cost $8. Closing each position would still result in a $200 gross profit. Breakeven levels Breakeven up: Higher strike + net credit - difference in strikes ($65 + $12) - $10 = $67 Breakeven down: Lower strike - net credit + difference in strikes ($55 - $12) + $10 = $53

Identifying a short guts trade

The prep work for such a delicate trade involves a number of discriminating factors. Here are the basic conditions to look out for: • A highly volatile stock whose volatility is starting to rapidly wane • A range-bound stock with clear areas of support & resistance, and with no scheduled news or earnings releases • Adequate liquidity (with an average daily volume of 500,000 or more) in the underlying stock despite its volatility decrease Continued on page 62

Your goal is to take advantage of rapid premium decay so that you can receive maximum credit before buying back each leg prior to expiration. April 2017

• Technical Analysis of Stocks & Commodities • 27

It’s All About Chart Patterns

Recognizing Price Action

I

by Matt Blackman

n the first of two interviews I conducted with stock trader Dan Zanger for this magazine in 2003, I asked him what indicators he used to amass $18 million trading stocks in less than two years. His answer was surprisingly simple. “I use absolutely no indicators whatsoever. I simply rely on chart patterns, price, and volume. Who has the time to look at so many indicators when you scroll through 400 stocks a night?” But the obvious question is, if it’s so simple, why don’t more people do it this way? Clearly, there’s more to Zanger’s success. To use a baseball analogy, while hitting the ball hard and in the right direction may seem simple enough, it certainly isn’t easy. But unlike raw physical prowess, trading technique can be taught to anyone dedicated enough to learn the ropes. Much has changed in the markets since that first interview

28 • April 2017 • Technical Analysis of Stocks & Commodities

with Zanger, but over the years he has remained true to his trading style. He continues to seek out those stocks with the best potential to explode higher when markets are in the right mood, ever on the hunt for the telltale signs that the big move is afoot. This was never more evident than in his calls on Acacia Communications (ACIA) in 2016. So what was it about Acacia that attracted his attention?

Anatomy of a winner

In 2016, while there were a few stocks that made big moves, the ACIA initial public offering (IPO) particularly intrigued Zanger. “Had I gone on vacation in May prior to the IPO, I would have never picked it up for $32,” he explains. So what was it that caused him to start advising his subscribers to watch it in mid-May? As far as IPOs were concerned, 2015 had been a dud, with no high-profile deals hitting the market, due in large part to the strength of the venture capital market. With lots of private money available, companies had little reason to go public. As a result, 2016 was the slowest

ZSOLT–UVEGESa/SHUTTERSTOCK

Here’s a look at the anatomy of one trader’s winning trade.

www.chartpattern.com

Real World

FIGURE 1: IT’S A BUY. Following a successful IPO launch for Acacia Communications (ACIA) on May 13, the May 23rd Zanger Report gave Dan Zanger’s technical buy area (TBA) of $32.

Figure 2: AFTER A RISE. By June 1, ACIA closed near $40. Zanger’s comment at that point notes the stock could be stalling after a gain, but traders who bought around $32 were already well in the green.

start for IPOs since 2008. “Prior to the ACIA launch, there had been almost no IPOs. It was no surprise that the ACIA IPO was cheap. It was only the second tech IPO of the year and most investors avoided it altogether.” He had a point. The only other technology IPO in 2016 had been Secure Works, a Dell spinoff that was priced below its target but then dropped immediately after it hit the market. But Zanger was confident that ACIA was different. Two days after it hit the market on Friday, May 13, 2016, the Zanger Report newsletter included a chart showing the first day’s action. Initially priced at $23, ACIA opened the day at $29 and had traded as high as $31.94 before closing at $30.95. A total of 4.2 million shares traded hands. His chart included the comment, “A move above $32 would be a good speculative TBA (technical buy area) for this IPO.” (A TBA is when price is above a bullish chart pattern or resistance area where breakouts can occur.) And on Monday, May 15, Zanger discussed the stock in greater detail with the members of his live chatroom. Little more than a week later on May 23, ACIA hit Zanger’s TBA as it moved above $32 on good volume with 1.2 million shares trading hands. The stock closed the day at $32.70 (Figure 1).

mean the up move may have stalled and it would be a good idea to reduce position size. By August 1, ACIA was trading above $62. Then on August 11, earnings exceeded expectations, causing the stock price to jump $28 in one day and volume spiked up. You can see this on the chart in Figure 3 (from Zanger’s August 14th newsletter). Following its monster move, ACIA paused for a day before continuing to march higher. The pullback that Zanger and his subscribers had been waiting for finally started to unfold on August 22. But in the subsequent rally, the stock never hit Zanger’s next TBA of $129. After peaking at $128.73 on September 7, it rolled over and began its long slide lower. Zanger issued the following proviso to his readers in the Sunday, August 21st newsletter (see Figure 4): “Thursday’s spike to $124.90 was a good reason to reduce into strength.”

Let’s look at how it moved

On June 1, ACIA closed just below $40 after hitting an intraday high of $43.10 per share (Figure 2). After an $11 gain from the TBA, the stock reversed down on heavy volume. This could

Recognizing the chart patterns, volume profiles, and momentum action that make them standouts are just the tip of the Zanger method iceberg. April 2017

• Technical Analysis of Stocks & Commodities • 29

Figure 3: POST-EARNINGS. On August 11, earnings exceeded expectations in ACIA, causing the stock to rocket. This chart from Zanger’s August 14th newsletter shows the move.

Figure 4: A PAUSE IN THE ACTION. The next good setup approaches as ACIA takes a break from its rally.

Finding stocks in the winner’s circle

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

Trading what works

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

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

30 • April 2017 • Technical Analysis of Stocks & Commodities

Trading technique can be taught to anyone dedicated enough to learn the ropes.

What isn’t readily visible in media soundbites is that it took Zanger years to develop his technique to search and find stocks like ACIA that have the key components, both technically and fundametally, to make them explosive stockmarket outperformers. But his is no get-rich-quick scheme. Once you have found potential winners, you need to have developed the patience to wait for the move; the laser-like focus to recognize that the move has begun; the timing to know when to strike; and the emotional control to manage the trade. And finally, you need to have nurtured the well-honed discipline not only to wait for the move to unfold, but also to know when to take profits. The only question that remains for would-be successful momentum traders is, do they have what it takes to meet the challenge? Matt Blackman, is a technical trader, author, reviewer, keynote speaker and regular contributor to a number of trading publications and investment/trading websites in North America and Europe. He also writes client newsletters and assists clients in building their professional profiles through various financial and mainstream media outlets as well as client resource management. He earned the Chartered Market Technician (CMT) designation from the Market Technicians Association (MTA). Follow Blackman on Twitter @RatioTrade or email him at indextradermb@ gmail.com.

Further reading

Blackman, Matt [2003]. “Chart Patterns, Trading, And Dan Zanger,” interview, Technical Analysis of Stocks & Com-

CALHOUN / ASCENDING TRIANGLE BREAKOUTS Continued from page 17

tries. Remember, the reason for your entry is because buyers are winning control of price action once it breaks above new highs. If price drops $2.00 or more beneath your initial entry, then it is smart to take a small stop, since the reason for your initial entry is no longer valid. If price continues to move up, it is often helpful to add shares to a winning position to scale in every two points or so, with a two point trailing stop. As with all of our professional swing and intraday charts, it is best to use this strategy with stocks and ETFs priced in the $20-$70/share range, because these charts tend to have stronger, more sustainable breakout trends than cheap, choppy stocks priced under $10/share. As with other bullish patterns such as cups, gap continuations, and 45-degree angle uptrends,

modities,

Volume 21: August. [2014]. “Seeing The Patterns With Dan Zanger,” interview, Technical Analysis of Stocks & Commodities, Volume 32: Bonus Issue. Bulkowski, Thomas N. [2005]. Encyclopedia Of Chart Patterns, 2d. ed., Wiley Trading. Zanger, Dan, and Matt Blackman [2010]. “Is Trading That Simple?” Technical Analysis of Stocks & Commodities, Volume 28: August.

‡ChartPattern.com

The ascending triangle visually shows the forces of demand overpowering supply, which leads to an increase in price. you will find that ascending triangles can help you spot strong breakout trading opportunities as they occur. Ken Calhoun is a producer of trading courses, live trading room and video-based training systems for active traders. He is a UCLA alumnus and is the founder of TradeMastery. com, an educational resource site for active traders.

April 2017

• Technical Analysis of Stocks & Commodities • 31

INTERVIEW

From Pennies to Currencies

Justin Bennett’s Trading Path Justin Bennett made his very first trade at the age of 14 and quickly found out the challenges that the trading world can pose. But those challenges only encouraged him to keep learning and trading. Driven by the passion of the markets, he started trading equities and then moved on to trading the currency markets. His persistence paid off. Along the way, he found a method that works for him and brings him consistent profits. At his blog, DailyPriceAction.com, he offers courses on trading and shares his thoughts. Stocks & Commodities Editor Jayanthi Gopalakrishnan spoke with Justin Bennett on February 14, 2017 to find out more about what kept him going in his trading career in spite of running into roadblocks. Justin, tell us a little bit about yourself. From your blog I understand that you started learning about the financial markets from a very young age. How did that come about? I guess technically I started trading when I was about 14 or so. I don’t honestly know where the interest in stocks came from. One thing that’s interesting is that I remember my dad used to subscribe to this magazine, Technical Analysis of Stocks & Commodities. So, clearly you guys have been around for a long time because as soon as I saw the magazine cover, it brought back some childhood memories. I remember my dad having stacks of S&C magazine issues in his reading corner. So maybe that’s where I picked up my interest. I don’t remember my dad doing a lot of trading but he always had an interest in the markets. Going back to when I started, when I was 14, I worked some odd jobs around the neighborhood and I would give my mom money to invest in various penny stocks that I found. Of course, nothing worked out. We all know too well about how 99% or so of the penny stocks work out. But that’s where my interest in stocks began and when I was 18, I started dabbling in the stock market. It was around 2007 when I started trading currencies. I made the switch from stocks to curren-

cies because I liked the idea that you can go long and short. You don’t have to worry about borrowing, so that was nice. And I also liked the fact that it was 24/7, so I could trade around the clock as well. I’ve been running my website now for about three years. You started young and realized that penny stocks don’t work out so well but yet you still wanted to continue learning. You realized that proper risk management was important. What changes did you make after trading in penny stocks? Yeah, with the penny stocks, obviously I had no idea what I was doing. My mom was against the idea of my trading penny stocks but my parents have always been the type who would let me fail instead of telling me not to do something. They would go along with it and let me fail because they felt that was the way to learn lessons in life. What I came to realize is that first of all, when it comes to penny stocks, as we know, there are a lot of scams out there and second, they’re just too volatile. When I was older, maybe around 18 or 19 years old, I started to work on my craft a little more in that I would do more research on stocks. I started trading more of the blue-chip stocks as opposed to penny stocks, so I was getting away from the pink sheets

32 • April 2017 • Technical Analysis of Stocks & Commodities

I always tell people that the only thing that separates someone who succeeds in this business and someone who doesn’t is persistence. That is really the only thing. and over-the-counter markets. And then from there, my trading just developed and evolved. The passion grew and over the next few years I continued to study and invest. There would be something that worked here and there, but overall, my success was limited. Between 2002 and 2007 is when I was trading or investing in stocks. And then in 2007 I transitioned to trading forex full time. I thought that was quite interesting when I read at your blog that you started using chart patterns. You used to use indicators but then they didn’t work out so well and you switched to basing your trading on chart patterns. Can you tell us about that transition? I think it had more to do with exhaus-

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You have to have the passion—not the passion for making money, but a passion for the game. You have to have the passion for trading. tion! I tried out as many indicators as I could and came to the realization that it’s difficult to have them work the way you want them to work. I don’t mean to say they don’t work or that a combination of them doesn’t work well. As Jack Schwager—trader and author of the Market Wizards series—said, there are a million ways to make money in the market but they’re not easy to find. So everyone has got to find what works for them and what fits their personality. For me, I had this realization, after two to three years of trying just about every possible indicator combination, when I finally removed all the indicators from my chart. I signed onto my trading platform one day and cleared off my chart of all the indicators. And that’s when I had this “aha moment.” I was looking at a naked chart and could see all these levels on the chart because without all the indicators I could now see the candlestick bars. You couldn’t do that before? What I had on my charts were maybe three or four indicators displayed in subcharts below the price chart. That made the chart so small and narrow that I couldn’t clearly see what was happening with the price action. When I removed those indicators, I was looking at a chart that was twice as big and I could see some critical levels in the price action. It was interesting in that they just started popping out for me. And that’s when I said, “Oh my gosh, there it is. What have I been doing all this time?” So I think that when you get back to basics, you see the market for what it is.

Yes, exactly. I came to realize the importance of price action trading and that’s all I discuss on my blog.

When you look at patterns such as head & shoulders, ascending and descending channels, or the pin bar (see sidebar, “What’s A Pin Bar?”), you’re just focusing on price action. What charts did you perform this type of analysis on? I only started this when I was trading forex. Prior to that I was using anything I could get my hands on. I also tried fundamental analysis. I was determined to make this work but everything I tried wasn’t working. That’s why I went for something quite drastic, and that was to remove everything from the charts. What I find interesting about your trading journey is your perseverance. For you it was the determination to find consistency through a technique that works for you. What kept you going? I always tell people that the only thing that separates someone who succeeds in this business and someone who doesn’t

is persistence. I mean, that is the only thing. But in order to do that, you have to have the passion. And it’s not a passion for making money, it’s a passion for the game. It’s a passion for trading. You have to get excited about it. When you look at the markets and you don’t get excited from watching the markets and seeing how they react to news, then your chances of succeeding are slim to none because you’ve got to have that passion for the game. That passion is the only thing that’s going to get you through the tough times. A passion for the money isn’t going do it. That’s a different outlook than most people have. You teach people how to trade forex. Do you find there’re a lot of people who come in with the drive to make money or do they really want to learn? Oh yes, it’s quite pervasive. I would say that 80% to 90% of the people who come to me, whether it’s somebody who wants to join my community or an email that I receive, do so based on the desire to make money. Everyone wants to know how they can make more money. They

What’s A Pin Bar? The pin bar, a candlestick pattern well known to forex traders, was originally given the name Pinocchio bar by technician Martin Pring. Yes, it has a long “nose,” or long wick, so the open and close are at either the top or bottom of the candle’s range. The nose or wick has to be at least two-thirds of the range of the entire bar, and a longer nose means the signal is more powerful. In some ways, it’s identical to what’s known as a hammer, or the bearish version of it, which is a shooting star. And there’s a reason why Pring called it a Pinocchio bar. It deceives you into believing that price is breaking out and moving in a specific direction. Alas, that’s not what it might end up doing. So when you see a pin bar forming, chances are price will reverse.

Bullish Pin Bar

Bearish Pin Bar Bearish pin bar

Bearish candle

That’s interesting. Was it this discovery that led you to calling your blog “Daily Price Action”? 34 • April 2017 • Technical Analysis of Stocks & Commodities

Bullish candle

Bullish pin bar

Bullish candle

Bearish candle

want to know how to make $2,000 a month through trading. Or they have some figure in their head of what they need to achieve in order to quit their job. That’s what everybody wants to do. I tell everyone the same thing and that is, “Just stop focusing on the money. Don’t try to make $2,000 a month. Don’t try to make $100 today. Focus on the process. Perfect the process and the money will follow.” That’s really what it’s all about and by process, I mean everything— using price action, identifying trends, risk management, the mental game … all of it. That’s the entire process. And if you focus on those things and you do it every single day, then the money will eventually follow. It could take a year, it could take eight years. You just don’t know but that’s what you should be focused on. When you say “risk management,” do you have a specific strategy you apply to all your trades or does it vary? I would say it varies, depending on the setup. But one thing that I do a little differently is I don’t apply the fixedpercentage rule. You always hear that you should risk two percent or one percent of your account. And I do that, in a sense, but I have what I call a hybrid approach where I’m more interested in the amount of money that’s being risked. So I’ll take a percentage of the account but it has more to do with how much money I can risk to the point where I’m not going to be emotionally compromised. The loss of money is what causes the emotional response, not the loss of a percentage. The percentage really doesn’t have any meaning until you apply a dollar amount to it. And how do you overcome the mental game besides using the hybrid approach of risk management you just talked about? That risk management approach is one way I overcome the mental game. The other way is that I trade the higher timeframes, which I think has a lot to do with the managing of emotions. In talking to traders and having been in that position myself, I have found that if you’re trading the five-minute chart

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NinjaTrader 8 is always FREE to use for advanced charting, strategy backtesting and trade simulation. or the 15-minute chart, moving from site is true. It’s quality over quantity. that to trading the daily chart takes a huge weight off your back. You trade Since you trade forex, how much at a much slower pace, which helps to attention do you pay to the news? reduce the stress levels. That’s because you’re not constantly watching the market all day There’s a misconception waiting for something to hapthat the more you trade, pen and then trading 5, 10, or the more you make. I 15 times a day. Instead, you might trade five believe the opposite is or 10 times a month. Everybody true. It’s quality over has this misconception that the quantity. more you trade, the more you make. And I believe the oppoApril 2017

• Technical Analysis of Stocks & Commodities • 35

announcements. In the forex market, there’re tons of different I consider myself a 100% ways that a news event, whether technical trader. I never it’s scheduled or unscheduled or a natural disaster, you name it, base a trading decision could affect currencies. I think on the outcome of a news the main difference is that with event. trading forex it’s more the combination of it being a 24-hour market and having a plethora I consider myself a 100% technical of different things that could affect the trader. I never base a trading decision currency that you’re trading. on the outcome of a news event. With the news, all I’m focused on is when Are the currencies much more volatile the news is coming out and what impact or less volatile than equities? that could have on my position. I don’t I would say they’re more volatile, not base trades on anything fundamental, in terms of percentage, of course. But per se. I’m more concerned about how I think the leverage in forex makes it the market reacts to the news. We’ve all a more volatile and dangerous market seen it happen—a number is released and to trade. The forex market is called the everybody thinks it’s positive, yet the Wild West for a reason. It’s not nearly as market doesn’t seem to think the same regulated and the leverage that you can way. Then everybody’s left scratching have in forex, even here in the US, is 50 their head. That’s why I focus on the to 1, and that is much greater than the market’s reaction. leverage you have with equities. And you just look at charts. When you look for patterns on your charts, do you look at multiple timeframes or do you just look at the daily charts? I trade the daily chart and four-hour timeframe. Sometimes I do take trades on the one-hour chart. But I would say 90% of what I do is on the four-hour chart and the daily chart. It seems that forex traders like that four-hour chart, for some reason. Why is that? Yeah, the four-hour chart is popular. It’s a good timeframe to use when trading around the clock and globally. It’s a good representation of various geographic sessions—US, London, and Asia. Earlier you mentioned you like trading forex because you didn’t have to borrow to trade and that it is a 24-hour market. What do you find to be the big difference between trading equities versus forex? Good question. I would say the biggest difference is that you’re talking about a global scale versus something that is company-centric. In equities, most of the movement comes from company

In terms of your students and your work with new traders, what do you see as some of the most common misconceptions that people have before they start trading? One of the biggest misconceptions or mistakes that new traders make is they overtrade. Say they’re looking at the daily charts. Instead of taking five or 10 trades a month, they end up taking 10 or more trades a week. I try to get their head around the concept that less is more and also get their head around the concept that—and I always emphasize this—all you really need is one or two good trades a month. One or two good trades a month could make a lot of money in this business, especially if you get good with pyramiding into a position. There’s no reason you can’t be making 5%, 10%, or 15% on a single trade. And all the while, you’re risking 1% to 2%

36 • April 2017 • Technical Analysis of Stocks & Commodities

of your account balance. So new traders need to learn that “less is more.” They need to realize they don’t need to take 50 trades a month to make a lot of money. The second misconception would be thinking that the markets can only go up and down, which means you’ve got a 50% chance of making money on every trade. They go in thinking that it may not be easy but it can’t be that difficult, either. I think people underestimate just how difficult it can be, especially the mental game. It’s not about looking at a chart and thinking you just have to buy down here and sell up there. I think you nailed it. And then do they realize when they start trading with real money that it’s a whole different game? I would think so, especially when the market starts to mess with you. The mental side of it is severely underestimated, I think, by most people who come into the markets. Do you think the rise of social media has got something to do with people wanting to trade more often versus the quality of their trades? Perhaps, but in the forex markets it’s difficult to say because for the last few years, the forex markets have contracted in terms of retail traders. But yes, social media may be impacting equity traders. Thanks for speaking with us, Justin.

Further reading

Pring, Martin [2004]. Pring On Price Patterns: The Definitive Guide To Price Pattern Analysis And Intrepretation, McGraw-Hill. • DailyPriceAction.com blog

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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

Risk Reversals and Robbing Peter to Pay Paul I often use options to speculate or to generate income. I anticipate future price movements and in what timeframe they will make those price moves. Then, instead of purchasing or selling short the stock, I take a position in either a call or put option based on my sense of price direction for that underlying security.

The sale of the put spread can reduce the cost of just doing a credit spread and it can sometimes set you up with an initial credit or infusion of a small amount of cash in your account. for example. Say you want to own 100 shares of PCLN, because you believe the price of the stock will continue to climb higher like the chart seems to

suggest. Say the price of a single share of PCLN is $1,646. To take ownership of 100 shares would cost you $164,600. Compare that to owning a call option. One contract controls 100 shares of stock. A call option with an expiration of March 17, 2017 at a strike price (the price at which you agree to have someone be able to call the stock away from you) of $1,645 is priced at $53.60. One contract is 100 shares, so 100 times $53.60 would cost $5,360. That’s significantly lower than the cost of owning the stock, but it still carries a lot of risk nonetheless. How can you utilize options where you can pay for the other without having unlimited risk? Robbing Peter to Pay Paul Risk reversals are the ability to buy a call and simultaneously sell a put that pays for the call. The problem here is that when it comes to risk, this is no different than buying the stock. There

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Minimizing risk Options were originally brought about to be a way to hedge your risk. Options can be used like a car or home insurance policy. You can use options to protect against a downturn in a stock you’ve owned for a while that has run up significantly enough for you. Holding onto the stock for more upside seems appealing, but you don’t necessarily want to give up too much of those gains, if hardly any at all. One

strategy could to be to buy put options commensurate to the number of shares you own. I like that I can own a call option vs. paying for the stock outright. Take The Priceline Group, Inc. (PCLN),

FIGURE 1: ROBBING PETER TO PAY PAUL. The put spread pays for the call spread. This is executed by simultaneously opening up/purchasing a call spread at a cost of -$187 and opening a sale of a put spread for $193. The result of the sale of one spread vs. the cost of the other results in a credit to your account.

38 • April 2017 • Technical Analysis of Stocks & Commodities

Explore Your Options is a better way to create a risk reversal using offsetting spreads. You buy a call spread and offset the risk/cost by selling a put spread. The sale of the put spread can reduce the cost of just doing a credit spread and it can sometimes set you up with an initial credit or infusion of a small amount of cash. I like to call this strategy robbing Peter to pay Paul. As an example, I am going to utilize options on the VanEck Vectors Oil Services ETF (OIH). This ETF tracks the price and yield performance of the MVIS US Listed Oil Services 25 Index (MVOIHTR). Basically, it tracks stocks in the oil services sector/industry. Say OIH is trading at $33. I will use options with an expiration date of July 21. A July 21, 2017 $30 call option contract will cost you $440 (premium of $4.40 times the 100 that one contract controls). A bull call (debit) spread would cost you $187 per contract. If you own 100 shares of OIH, it would cost or have you risking $3,300 (100 shares at $33 = $3,300). The call option reduces risk to $440 and the bull call spread has your risk reduced to $187. The option scenario for the rob Peter to pay Paul strategy is shown in Figure 1. What I am trying to accomplish here

FIGURE 2: RISK GRAPH FOR THE STRATEGY. There is an area where there’s no loss or risk at expiration. A big move in the underlying can bring significant profits.

is have the put spread (robbing Peter) pay for the call spread (paying Paul). This is executed by simultaneously opening up/purchasing a call spread at a cost of -$187 and opening a sale of a put spread for $193. The result of the sale of one spread vs. the cost of the other results in a credit to your account (held in the account until either the spread(s) are closed or till expiration) of $6 per contract ($193 -$187 = $6). This strategy may not always be set up to start as a credit to the account, but often, it even further reduces your

risk or hedges an already hedged position. As you can see in the risk graph in Figure 2, it is similar to a call spread, with the exception of the middle. This is what makes this strategy different— it hugs an area of no loss and risk at expiration. Basically, you are looking for a big move in the underlying. In this example, you are looking to profit over $34.

FUTURES FOR YOU gaRneR

Continued from page 25

countries that will impact the open of trade on the US stock market. Futures traders, on the other hand, are well aware of changes in market value throughout a 23-hour trading session because they can clearly see their account value fluctuate at nearly all times of the day. Although the overnight risks to stock traders aren’t always visible in the same way that it is by futures traders, it is still a real risk. No dividends for commodity traders Stock speculators holding positions long enough to qualify for dividends have

a distinct advantage over commodity traders—income. The cash flow provided by dividends gives traders a downside cushion against stock declines. Of course, commodity traders do not enjoy this luxury. Easy option market access The good news for commodity traders is that despite the lack of dividends, they will have easy and cheap access to the commodity option market. This allows traders to sell calls against long futures positions or sell puts against short futures positions. In either scenario, it provides the ability for commodity traders to create income while they wait for their trade to pay off. Stock traders are afforded April 2017

similar option market access, but it generally requires a rather large account to do so whereas futures traders can implement such a strategy with a small account (a few thousand dollars). Stocks vs. commodities The commodity markets get a bad rap for being “risky” but the truth is they aren’t any riskier than stocks. The elevated risk in commodity trading comes from the way traders approach speculation rather than from the market itself. The reality is, commodity markets can be as risky or as conservative as the trader chooses for them to be.

• Technical Analysis of Stocks & Commodities • 39

Call Bluff

Game Theory

T

by John Devcic

here are two main branches of game theory— cooperative and noncooperative. Noncooperative game theory deals largely with how individuals interact with one another while trying to achieve their own goals. In this article I will focus on noncooperative games. Game theory has been successfully used in biology, engineering, political science, and economics. Though many principles of game theory have been around a long time, the true start to the study of games was begun by John von Neumann and Oskar Morgenstern in their book Theory Of Games And Economic Behavior that was published in 1944. Initially, game theory was set up to study zero-sum games. Studying zero-sum games allows game theorists to understand a player’s behavior during a game, since players’ success or failure depends on how one player reacts to the other’s strategies and choices. Here, I’ll go over the major concepts of game theory and then explain how some of these concepts can be used by traders and investors.

40 • April 2017 • Technical Analysis of Stocks & Commodities

Forms & equilibrium

Game theory attempts to spotlight equilibria in the games it studies. Equilibria is a fancy word for sets of strategies where players will not change their behavior. The most famous of the equilibrium concepts was developed by John Nash and called Nash equilibrium. Nash equilibrium is a simple yet powerful idea. It states that no player in a game will have any reason to change his current strategy unless the other player has changed his strategy. I want to point out that this statement assumes that all of the players are aware of each others’ strategies. Knowing your opponent’s strategy will help when you formulate your own strategy. The concept of forms plays heavily in the understanding of game theory. Forms are a way of describing a game. There are two major forms. One is normal form and the other is extensive form. The normal form way of describing a game includes all conceivable strategies and their payoff to the player. Meanwhile, extensive form represents the game in a different way. An extensive form will look at a game as a tree. Along the way, there are points called nodes. You begin at an initial node and the game will flow along the tree determined by the player. Every time the player reaches a point where a decision has to be made it’s called a decision node. Each decision node belongs to a player. Each node presents the player with possible choices to make, and each move that player makes is called an edge that will lead to another node. The game

GAME THEORY WORDCLOUD: ibreakstock/SHUTTERSTOCK

When you think of trading, the farthest thing from your mind is to compare it to playing a game. But studies have shown that the behavior of players in a game is not unlike the behavior of participants in the most complex game setting of all—the markets. We can take a cue from these studies.

TRADING PSYCHOLOGY

will continue until that player reaches a terminal node. The terminal node is obviously the end of the game.

Types of games

Game theorists study games and how players behave during a game. There are many types of games they study. I will detail a few of the most important types. Zero-sum games and non-zero-sum games. I mentioned zerosum games earlier. A zero-sum game is one where there is a clear winner. The winner’s payoff comes via a direct loss by the loser or losers. An example of a zero-sum game is poker. The losers at the table will have lost their chips to the winner. As you can see, it’s a simple concept. There has been a running debate about whether or not the market can be considered a zero-sum game. Let’s take a look at a situation that may clear up this debate. Take the collapse of Enron as a perfect example of a zero-sum game. While Enron’s stock was plummeting, there were short sellers who rode the stock all the way down. Those were the winners. On the other hand, you had investors and other traders not only holding but also buying the stock as it continued to go down. The transfer of profits was obvious. The harsh reality is that the market through its very nature is a zero-sum game. The wealth shifts from one investor to another. The winners in a poker or chess game are far easier to identify than the winners in the market. While their identities are hard to come by, it still remains that the market is a zero-sum game. Obviously, a non-zero-sum game is the opposite of a zerosum game. Most of the games studied by game theorists are non-zero-sum games. Games in which all the players can lose or gain in tandem is an example of non-zero-sum games. But you can easily turn a non-zero-sum game into a zero-sum game by adding another player, one who acts as a false player of sorts. This new player is only there to lose and his loss will equal the net win for the winning player. Other non-zero-sum gains are games in which the total gains and losses by the players can turn out to be either more or less than what those players began with. Simultaneous and sequential games. Sequential games are turn-based games. One player will make a move only after another has made his move. The player who made the second move is responding to the first player’s move. There is a time advantage, which ends up giving the second player an edge over the player who made the first move. Simultaneous games are those where all of the players move at the same time. There are no moves based on another player’s move. Time advantage does not exist. A strategy is developed and used by each player based on what he believes to be the best strategy instead of one that reacts to moves or strategies made by other players. Continuous games. Most games studied by game theorists are those with a set number of moves that can be made. The number of moves that can be made will vary depending on

The market can be said to be a noncooperative, continuous, and simultaneous zero-sum game played with perfect information.

the move of the players. Continuous games, however, can go on forever, theoretically speaking. Players participating in a continuous game can choose their strategy from a continuous strategy set. Continuous games have no set number of players, moves, outcomes, or solutions.

Types of information

I want to briefly talk about information when it comes to game theory. There are two types—perfect information and imperfect information. Perfect information is when everything that can be known is known by all of the players in the game. An example of this is chess. The move made by one player is all that matters. The information is perfect because it is seen by the players and anyone watching. Imperfect information is the exact opposite of perfect information. The information is not known by all of the players right away. Decisions become more difficult to make with imperfect information.

Types of analysis

There are two types of analysis in game theory. First is descriptive analysis, which is the belief that a person’s behaviors can be predicted when that person is placed in a situation that is like the game being studied. The other form of analysis is prescriptive analysis. Some scholars believe that game theory is not a tool to make predictions but instead can be used as a suggestion for how people ought to behave in certain situations.

Putting it all together

The concepts explained in this article can be used by investors to make them better players, so to speak. The market can be said to be a noncooperative, continuous, and simultaneous zero-sum game played with perfect information. Knowing this, what is the best way to go about investing? Here are a few steps that are based on the concepts of game theory. First you want to identify the game you are playing. When it comes to investing, you have many choices to make and each of those choices or investment styles have strategies. You may choose to be a daytrader, or maybe you are trying to generate income, or perhaps you are a value investor. Regardless of what type of investor you are, you have different strategies you could apply. While these types of trading styles are only a couple of examples, the concept is clear. A daytrader will not go about investing the same way as a long-term investor. April 2017

• Technical Analysis of Stocks & Commodities • 41

Choose the strategy that is right for you and that will help you meet your goal. Second, you want to look at and attempt to identify the other players in the game. This can often prove difficult when it comes to investing. But you can make certain assumptions of the other players. There will of course be large investment banks, brokerage firms, daytraders, and other individual investors, some wealthy and others not so wealthy. When looking at the other players, it’s a good idea to try and get a sense of their strategy and then take on the market. The best way to combat the unknown players and their motivation is to formulate a strategy that best suits your investment goals. Third, is not to assume that all the participants in the market are in it to win. You may be there to make a fortune but some traders are gambling and can be erratic. While on the surface this seems illogical, you should not assume all investors in the market are rational and make well-executed decisions based on their strategy. Their strategy and reason for investing are not the same as yours so that’s something to keep in mind when formulating your strategy. While I will not get into the psychology of why certain investors do what they do, all you need to know is that not all investors are trying to win.

Lean toward analytical

The more complex a game is, the more difficult it can be to analyze. There aren’t any games more complex than the market. If you’re an analytical player, you’re not going to be overrun with emotion that could cloud your judgment, which is why I encourage everyone to try to be as analytical as they can be. Only then will you not allow simple whims to help you make your trading decisions. And this applies to long- and short-term traders or investors. The first step in becoming an analytical investor is to create a strategy. Game theory has an interesting definition for the word strategy. A strategy is a complete description of how you will behave under every possible circumstance. Following that definition, your strategy needs to plan for any scenario you can think of and also your response to them. While it may sound difficult to set up a strategy based upon scenarios that

One should not assume all investors in the market are rational and make well-executed decisions based on their strategy. may not have happened or will not ever happen, it does not have to be so. You can easily set up a strategy based on the one metric that is seen by all investors and traders: price. The price reflects what can be known about a security by all the players in the game at any one time. This matches the definition of perfect information nicely. If you base your strategy on what the price is and what your reaction to a price change is, you will become a more analytical investor.

Analyze that

The study of how players will behave in a game is an interesting and valuable piece of information. While game theory is complex and has been simplified for the benefit of this article, the theories presented by game theorists can be helpful to traders of any experience level. Looking at the market as a game is not in any way cheapening it. When we hear the word game, our initial instinct may be to think of something simple that isn’t going to occupy much of our time. But game theorists have shown that any game, complex or simple, can give us valuable information about how to play it and how to formulate a successful strategy to win the game. John Devcic is a market historian and freelance writer. He may be reached at [email protected].

Further reading

Neumann, John von, and Oskar Morgenstern [2007]. Theory Of Games And Economic Behavior, Princeton University Press.

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42 • April 2017 • Technical Analysis of Stocks & Commodities

The Edge In Chart Patterns (Part 2)

by Giorgos Siligardos

The first part of this article series showed how you can define the edge of a chart pattern through a trading system. The second part will elaborate on three practical issues of the subject. Coming soon!

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

A Losing Trader Finds His Way Oliver is so intent on following a blowing autumn leaf that he doesn’t even notice that he’s lost his way. All alone at the edge of the woods, he starts to cry. He cries and cries—but he is still lost. And so he rubs his nose and tries to think … —Oliver Finds His Way by Phyllis Root

This is a children’s book and within its pages, it describes a pattern I often observe with traders. Being focused is usually a good thing, but it isn’t always. Oliver, the little brown bear in the story, was intent, but that led him to a place he regretted. Traders can intently work at the widgets, strategies, or research all they want and still get lost in the woods. I have seen emotional responses where there should be rational thought and reactionary outcomes rather than reflective thinking. Even in this age of automation and computerassisted trading, the mental game still needs to be won. Owen (name changed so he doesn’t get thronged with fan mail) is a trader who has had a few challenges, the largest being that he hasn’t turned a profitable month in two years, until recently. What changed? Here is Owen’s story in his own words: “Trading with low capital has its unique set of challenges and requires a different mindset than when flush with funds. I learned from some educational webinars that I needed to reduce my risk. This is an area of the business that I hadn’t fully understood. “Lowering your variance will increase your returns over the long sample” was drilled into me until I began to implement the change.

As I have had a trading account on the leaner side, I have had fewer chances to be wrong, similar to being the short stack in a poker game. I learned I had to be selective as well as reduce as much risk as possible with each successive trade. This won’t be a solution for everyone nor is it a recommendation, but it is how I systematically reduced risks to each trade and to my overall trading account: • I decided to eliminate overnight risk altogether by trading intraday only. Note, this was not a permanent decision, but an “until further notice, based on progress” step. • I decided to add additional research to filter out story stocks (those with recent news or with ongoing stories about which I may not be able to stay

Small accounts require tight management, controlled bet ratios, respect to account and edge position sizing, and some form of stop-losses. up with the changing dynamics). • I decided to eliminate stocks that I identified as having specific risks. • I decided to trade hedged where possible and where necessary (this means finding a long or short stock that will protect me against market moves). • I decided to use ETFs for the short side of a pair trade where possible. April 2017

• I decided that for my account size, personality, lack of experience, and poor track record that trading intraday hedged portfolio style or pair combos would be best. • I decided to allow myself time to do the slow grind and build my account rather than shoot from the hip, cowboy style. Bet size. This was a tough area to get my head around as it seemed I had to trade larger per idea in order to make any money. It took a lot of “clubs to the head” by the losses to get my attention. I wanted to remain in this career and succeed by being consistently profitable. I would accept nothing less, so had to put rules in place and be disciplined about those rules. To keep things simple, I chose a structured approach that I can use every day for every trade: • I identify the stocks I want to trade and I ATR balance them against each other. • I then adjust the size to accomplish $35,000 average-per-pair trade. These can be: {{ Long stock vs. short stock (a specific reason for long, specific reason for short) {{ Long ETF vs. short ETF {{ Long stock vs. short ETF As I rolled this out, I chose to further reduce the risk by only using ETFs such as sector ETFs and pair them against a stock associated with that ETF, until further notice. I have learned that by reducing my bet size per idea and utilizing a consistent methodology for sizing each bet, I have

• Technical Analysis of Stocks & Commodities • 43

Q&A reduced my risk of ruin. I don’t come from the trading industry, nor do I have a quantitative background, and neither do I run things by formulas. All of this has been a stretch for me to understand and to put into place, but I see it more clearly now, and by doing it, I have proven to myself its validity. Here are a couple more guiding principles I use: I see the results. Keeping up a trading diary and an accounting sheet gives me more and more confidence. This provides me with a granular way to see what is going on and be able to tweak things. Adding to the methodology, I used a return on capital percentage (ROC) to calculate my profit targets and stoplosses. This keeps stop-loss uniform among all my trades and keeps my risk per trade in check. In the past, I took profits on many small trades, then would size up and have a few large losses, wiping out my profits. I didn’t understand that I could go broke taking small profits over and over again if I didn’t have rules to govern the other areas of my trading business. No home run attempts. With my smaller account size, there was the temptation to attempt home run trades. The problem was that when they wouldn’t work, I was caught with a large losing trade. I believe the reason I have chased after home run trades is confirmation bias. I saw all the ducks lined up and it just appeared like I couldn’t go wrong, that I was guaranteed to win. All in ... “I’m going to be rich,” I said! Since then I have learned to be okay

with playing it tight, that slow grind, with the ratio of transaction costs to gross profit being a bit higher for the short term. I needed to have the expectation that the economies of scale will kick in once I survive the learning curve, stabilize, and then slowly increase the amount of strategies and quantity of trades. Even though trading is a liquid business with great potential, I had to

It’s about low variance and average return on capital. allow it to grow more in-line with how a traditional business would develop. I have been taught that I need a positive expectation for every trade and to respect each trade as if it were the only trade I would get that day, and I had a family that depended on the outcome. I cannot be complacent and take a shot or a gamble to see what happens. There is a big difference between a trade done for information and one done out of boredom, desperation, or greed. When I have done the latter, it has usually ended in large losses relative to my account size. My advice to others: Don’t despise the small money. If you can identify with where I came from, small accounts require tight management, controlled bet ratios, respect to position sizing for the account size and edge, and some form of stop-losses. Any profits over your cost basis will grow your account so don’t short-change yourself, ending your career early, but rather, trade with discipline.”—Owen B.

Thank you to Owen for sharing his story. We can see that like Oliver, he has thought about how to find his way out of the woods—or “how do I do this business better.” To verify Owen’s integrity and see how he is actually doing in his trading, I audited the last 33 trades that Owen made: Trades: 33 Winners: 30 Losers: 3 Win/loss %: 90.91% Max loss ROC: -0.39% Max gain ROC: +0.73% Avg capital per pair trade: $34,990.47 Avg ROC: 0.17% Avg pair PL: $55.72 Total closed P/L: $1,838.75

From my perch, I can confirm a real turn has taken place in Owen’s trading career. I see the solid gains in his account, witnessing the consistency. It’s not about the win-loss ratio, although that is impressive right now. It’s about that low variance and average return on capital. I like to see numbers of 0.1% or above, accounting for all the wins and all the losses. From here, Owen should be able to scale up his business. He will have to track each strategy besides his sector pairs in this same fashion (it’s best not to lump it all together, but do separate recordkeeping on each strategy).

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44 • April 2017 • Technical Analysis of Stocks & Commodities

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MUSTAPHA / Taming The New Zealand Dollar Continued from page 24

pens to the position. There was lack of momentum on most of the currency markets when the news was released, and thus NZ pairs/crosses did not move significantly. Yet they moved vividly enough to justify taking temporary positions. AUDNZD moved downward and after 10 minutes, I opened a long position. The next candle that formed was bullish, bringing in more than 30 pips in the process. A similar scenario took place on the NZDUSD. I opened a long trade because the news had a bullish effect on the NZD and I was able to gain from the bullish candle that appeared later.

Take advantage of reversals

This strategy demonstrates that if you feel you missed out on a strong move after a fundamental number was released, there’s no need to mope. There are times when, after the release of fundamental data, short-term reversals provide trading opportunities. As a trader, your goal is to profit from the behavior of NZD, and this currency could continue going in the direction the news pushes it, follow with a correction, or reverse temporarily after the effect of high-impact news has eased. Watch it and get to know it

leTTerS

Continued from page 7

Being a self-employed trader who only trades my own account, I am interested in exploring his ideas from this article to see how they would have benefited my trades last year and going forward. I mostly use Excel for calculations and so was very interested to see the sidebar on page 10 of the February 2017 issue that showed an Excel spreadsheet to help calculate the figures. As I’m not a programmer and unfortunately only know the basics for creating formulas in Excel, I was hoping to get a copy of this Excel spreadsheet. Thank you again for the articles. I

The New Zealand dollar is an interesting currency, mainly because it moves in a fairly predictable way. This behavior makes it an attractive currency for traders who are aware of its speculative advantage.

and you may just be able to better find those opportunities that come your way. Azeez Mustapha is an analyst at Instaforex Companies Group and a blogger at Advfn.com and www.ituglobalforex.blogspot. com. He is a trading signals provider at some websites. He can be reached at [email protected]. ‡MetaQuotes

†See Traders’ Glossary for definition ‡See Editorial Resource Index

am looking forward to more articles in the future. ViNceNt YAcAViNo Readers will find this spreadsheet at http://technical.traders.com/sub/ codes/2017/042017Apirine.asp at our website, Traders.com, in our Article Code section from the home menu.— Editor SToCK FUNdAMeNTAlS worKSHeeT Editor, I read Koos van der Merwe’s article “Analyzing A Stock With Fundamentals” in your online publication Working Money at http://premium.working-money.com/ wm/display.asp?art=825. April 2017

I was wondering if the author could provide his Excel spreadsheet used in the article? Thanks. moHAmed Author Koos van der Merwe replies: I have emailed you a copy of my Excel spreadsheet file. Editor’s note: Readers will find this spreadsheet at http://technical.traders. com/sub/codes/2017/042017Merwe. asp at our website, Traders.com, in our Article Code section from the home menu. The spreadsheet contains fields for information the user can fill in to help analyze an equity using fundamentals.

• Technical Analysis of Stocks & Commodities • 45

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.

A Complete Guide To The Futures Market: Technical Analysis, Trading Systems, Fundamental Analysis, Options, Spreads, And Trading Principles, second edition (720 pages, $125 softcover, $81.99 ebook, January 2017, ISBN 978-1-11885375-7) by Jack D. Schwager with Mark Etzkorn, published by Wiley. Originally published in 1984 as one of the definitive works in the field, this guide has been updated for the first time in 32 years. The revised and updated second edition provides a foundation in futures market basics, details analysis and forecasting techniques, explores advanced trading concepts, and illustrates the practical application of these ideas with hundreds of market examples. The book covers technical analysis, trading systems, and fundamental analysis. It details different trading and analytical approaches, including chart analysis, technical indicators and trading systems, regression analysis, and fundamental market models. It seeks to separate misleading market myths from reality, and delves into the nuances of the futures market. It gives step-by-step instruction for developing and testing original trading ideas and systems. It illustrates a wide range of option strategies and explains the trading implications of each. In all, the book is a hefty guidebook of practical trading information and market insights from a recognized trading authority. www.wiley.com

Wiley 11th-Hour Guide For 2017 Level I CFA Exam (480 pages, $95, February 2017, ISBN 978-1-119-33113-1) published by Wiley. This review guide for taking Level I of the CFA exam compacts the 60 readings tested on the 2017 CFA exam into one portable volume. Organized in order from readings 1 to 60, the guide seeks to boil down the most important concepts to the crucial principles, formulas, and rules. It tries to ensure candidates are familiar with the most important testable information. The 11th Hour Review Guide is designed to be a tool to reach for in the last few weeks leading up to the exam, condensing each reading down to two to five pages. It tries to help reinforce the candidate’s existing knowledge and preparation that would have been 46 • April 2017 • Technical Analysis of Stocks & Commodities

gained through previous study. This guide complements Wiley’s CFA Study Guides, sold separately, but it could be used with any review course. Sample topics of the readings include ethical and professional standards, quantitative methods, microeconomics and macroeconomics, monetary and fiscal policy, international trade, financial reporting and analysis, corporate finance, portfolio management, and investment types. www.wiley.com

The 10-Minute Millionaire: The One Secret Anyone Can Use To Turn $2,500 Into $1 Million Or More (256 pages, $29.95 hardcover, $14.99 ebook, February 2017, ISBN 978-1-118-85670-3) by D.R. Barton Jr., published by Wiley. This book seeks to provide actionable steps toward shoring up retirement funds for the future. The book covers a range of instruments from fixed income and equities to private equity and covered calls in order to use as many opportunities as possible and to combine income and capital appreciation methods. With traditional income investments like CDs, money market funds, and investment-grade bonds generating historically low returns below the rate of inflation, some investors need to build a portfolio of income-producing investments that will grow over time, and this books seeks to demonstrate where and how to invest for cash flow. With catchy chapter titles, the book covers tenets of wealth creation, systematic trading, investing biases (loss aversion, streak bias), finding extreme stocks and fast movers, volatility, and loss protection. www.wiley.com

Reminiscences Of A Stock Operator (408 pages, February 2017, ISBN 9780857195944, 9780857190567) by Edwin Lefèvre, published by Harriman-House. This is a reissue of a well-known classic of the financial world from Harriman Definitive Editions. Originally published in 1923, journalist Lefèvre bases his novel on the life of legendary stock market speculator Jesse Livermore, who has inspired generations of investors and traders. The author, Lefèvre, pursued a career as a journalist at 19, then went on to become a stockbroker and an independent investor as well as a novelist and writer of short stories. In 1909 Lefèvre became the Panamanian ambassador to Spain and Italy. Other financial fiction by him includes Wall Street Stories (1901), Sampson Rock Of Wall Street (1907) and the nonfiction Making Of A Stockbroker (1925). His most famous book is Reminiscences, which first appeared as a series of articles in The Saturday Evening Post. www.harriman-house.com

STOCK ADVISORY APP VectorVest has released a redesigned VectorVest Stock Advisory App for i­Phones and iPads, providing stock analysis and market guidance. The redesign focuses on ease of use instead of just more data. Expanded free features include streaming intraday data, seven stock analyses per week, a user watchlist, enhanced stock graphs, and a market overview. A Trending WatchLists feature of interest to stock pickers includes the biggest price gainers among stocks and ETFs, and biggest volume movers. A Market Direction Signal offers intraday insight to help users determine if it’s a good time to buy stocks. Market analysis and guidance are offered via a daily video. Enhanced graphs include candlestick pricing and VectorVest’s proprietary momentum indicator, Relative Timing. The VectorVest Buy-Sell-Hold feature provides ratings on over 19,000 stocks. An initial two-week “open house” free trial includes unlimited stock analyses, 10 premium watchlists ranked by proprietary indicators, market guidance, and a daily market video. Flexible subscription options include a $9.99/month Essentials plan and a $19.99/month Premium plan. VectorVest platform subscribers can access the app’s full capabilities free of charge.

and trading. FinTech Exchange 2017 will feature presentations and roundtables from over 20 innovative firms during an all-day event. Presentation topics will include machine learning, exchange technology, data analytics and visualization, tick data management, big data and artificial intelligence, cloud security, market data, and trading software. While many fintech events focus largely on consumer-facing applications and services, the BarChart FinTech event is geared toward the financial markets and trading, which has special appeal to institutional and professional investors. FinTech Exchange 2017 will include 10 lightning rounds sponsored by CBOE. FinTech Exchange features firms representing software, market data, APIs, exchange technology, mobile, infrastructure, and emerging financial ideas and technologies like cloud computing, binary options, bitcoin, and blockchain. The event focuses less on seminars and panels and more on on-stage presentations. www.fintechchicago.com

www.vectorvest.com/StockAdvisory

FinTech Exchange Conference Barchart, a provider of market data and financial technology, will host the FinTech Exchange 2017 on April 27 in Chicago, its third annual event focusing on technology within financial markets

Fundamental Data Research and Screening IN THINKORSWIM TD Ameritrade now offers new features in its thinkorswim trading platform to facilitate fundamental data search and screening. The new capabilities enable thinkorswim users to search and sort fundamental data on the entire universe of equity symbols from their watchlists, and choose to collaborate and share their screeners with other users. All of the fundamental data available in thinkorswim’s stocks fundamentals tab have migrated into all of the watchlists. The watchlist interface now has more than 40 additional new data points, including growth rates, valuations, and profitability metrics, all backed with April 2017

full historical data. Many of these are customizable by timeframe and display aggregation, for example, yearly, quarterly or five-year trend data. Separately, thinkorswim’s paperMoney function has been upgraded based on client feedback to give the user an even more realistic experience. Expiring securities such as options, futures, and futures options now end automatically in these demo accounts to better simulate a real-time trading experience. www.amtd.com, www.thinkorswim.com

MTA ANNUAL symposium on technical analysis The Market Technicians Association (MTA) will hold its 44th annual symposium in New York on April 6–7, 2017. Presenters will discuss how technical analysis is incorporated into market analysis, portfolio management, and trading processes. The 2017 conference will explore the discipline of technical analysis across asset classes to examine the theory, methods, data, and techniques from several vantage points, providing insights integral to active investment management. Attendees will have the chance to learn and expand their professional network. The fee is $1,199 through March 31, 2017.

www.MTA.org

• Technical Analysis of Stocks & Commodities • 47

For this month’s Traders’ Tips, the focus is Ken Calhoun’s article from the February 2017 issue, “Volume-Weighted Moving Average Breakouts.” Here, we present the April 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. Figure 1: TRADESTATION. Here, the volume-weighted moving average indicator and strategy are applied to a 15-minute chart of Toll Brothers.

F TRADESTATION: APRIL 2017 TRADERS’ TIPS CODE In “Volume-Weighted Moving Average Breakouts,” which appeared in the February 2017 issue of Technical Analysis of Stocks & Commodities, author Ken Calhoun describes using a modified moving average calculation that combines price and volume information. The author states that by including volume, this technique can help avoid false breakouts. Here, we are providing the TradeStation EasyLanguage code for the volume-weighted moving average indicator. The indicator includes an additional simple moving average (SMA), making it useful for scanning for crossovers using the TradeStation Scanner. We have also provided a companion strategy as well as a function to allow you to easily use the volume-weighted moving average calculation in your own code. Indicator: Volume-Weighted Moving Average // Volume Weighted Moving Average // TASC APR 2017 // Author: Ken Calhoun inputs: Price( Close ), MALength( 70 ), VWMALength( 50 ) ; variables: MAValue( 0 ), VWMAValue( 0 ) ; VWMAValue = _MovingAvgVolumeWeighted( Price, VWMALength ) ; MAValue = Average( Price, MALength ) ; Plot1( VWMAValue, "VWMA" ) ; Plot2( MAValue, "MA" ) ; if VWMAValue crosses over MAValue then Alert( "VWMA cross above MA" ) ;

48 • April 2017 • Technical Analysis of Stocks & Commodities

Strategy: _Volume-Weighted Moving Average // Volume Weighted Moving Average // TASC APR 2017 // Author: Ken Calhoun inputs: Price( Close ), MALength( 70 ), VWMALength( 50 ), StopDollarsPerShare( 2 ), TrailEnableProftPosition( 200 ), TrailAmountPerShare( 2 ) ; variables: MAValue( 0 ), VWMAValue( 0 ) ; VWMAValue = _MovingAvgVolumeWeighted( Price, VWMALength ) ; MAValue = Average( Price, MALength ) ; if VWMAValue crosses over MAValue then Buy next bar at Market else if VWMAValue crosses under MAValue then Sell next bar at Market ; SetStopShare ; SetStopLoss( StopDollarsPerShare ) ; if MaxPositionProfit >= TrailEnableProftPosition then SetDollarTrailing( TrailAmountPerShare ) ; Function: _MovingAvgVolumeWeighted // Vol Weighted Mov Avg Function // TASC APR 2017 // Author: Ken Calhoun inputs: Price( NumericSeries ), Length( NumericSimple ) ; variables:

VSum( 0 ), PVSum( 0 ), AnyVol( 0 ) ; if BarType >= 2 and BarType < 5 then AnyVol = Volume else AnyVol = Ticks ; VSum = Summation( AnyVol, Length ) ; PVSum = Summation( Price * AnyVol, Length ) ; if VSum <> 0 then _MovingAvgVolumeWeighted = PVSum / VSum ;

To download this EasyLanguage code for the indicator and function, please visit our TradeStation and EasyLanguage support forum. The code for this article can be found here at https://community.tradestation.com/Discussions/Topic.aspx?Topic_ID=147651. The ELD filename is “TASC_APR2017.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

ruary 2017 S&C article “Volume-Weighted Moving Average Breakouts” can be easily applied in TC2000 version 17 using the new EasyScan columns and enhanced custom formula language. We used the new EasyScan features of version 17 to scan for stocks where the 50-bar VWMA has crossed up through the 70-bar simple moving average within the last five bars on a 15-minute chart. The chart in Figure 2 shows the VWMA crossover occurred within the last five bars (circled in red). If you would like a copy of this layout already set up with the scan and plots in place, just send an email to support@ tc2000.com and we’ll be happy to send it to you. —Patrick Argo Worden Brothers, Inc. www.TC2000.com

F METASTOCK: APRIL 2017 TRADERS’ TIPS CODE Ken Calhoun’s article in the February 2017 issue of Technical Analysis of Stocks & Commodities, “Volume-Weighted Moving Average Breakouts,” presented a trading system based on the volume-weighted moving average. The Meta­ Stock formulas for the buy and sell signals for this system are shown here. Buy Signal:

entry:= Cross( Mov(C, 50, VOL), Mov(C, 70, S) ); entry OR ( Mov(C, 50, VOL) > Mov(C, 70, S) AND H > Ref(HighestSince(1, entry, H),-1))

Sell Signal:

F TC2000 Version 17: APRIL 2017 TRADERS’ TIPS CODE The VWMA strategy described by Ken Calhoun in his Feb-

Figure 2: TC2000. This sample chart of KKR shows a 15-minute timeframe. We scanned 1,000 high-cap stocks to find where the crossover occurred within the last five bars. You can shorten or lengthen the “within last x bars” setting to suit your needs.

Cross( Mov(C, 70, S), Mov(C, 50, VOL) )

—William Golson MetaStock Technical Support www.metastock.com

F eSIGNAL: APRIL 2017 TRADERS’ TIPS CODE For this month’s Traders’ Tip, we’re providing the study VWMA.efs based on the formula described in Ken Calhoun’s article in the February 2017 issue, “Volume-Weighted Moving Average Breakouts.” In the article, the author presents a strategy of trading based on the crossover of a 70-period and 50-period volumeweighted moving average on a 15-day 15-minute chart. 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 3. To discuss this study or download a complete copy of the formula code, please visit the EFS Library Discussion Board April 2017

• Technical Analysis of Stocks & Commodities • 49

FIGURE 3: eSIGNAL. Here is an example of the VWMA study plotted on a 15-minute chart of FAS.

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 at Traders.com.

—Eric Lippert eSignal, an Interactive Data company 800 779-6555, www.eSignal.com

F THINKORSWIM: APRIL 2017 TRADERS’ TIPS CODE In the article “Volume-Weighted Moving Average Breakouts” in the February 2017 issue of Technical Analysis of Stocks & Commodities, author Ken Calhoun provides a concise, useful addition to the usual collection of moving average studies. Not only does he add value to the concept of trading

Figure 4: THINKORSWIM. Here, the VWMABreakouts strategy is added to a 10day, 15-minute chart of FAS. When the 50-period VWMA (blue line) crosses above the 50-period moving average (pink line), it is considered a buy signal.

50 • April 2017 • Technical Analysis of Stocks & Commodities

off of averages, but he also lays out a trading strategy using his ideas. We took this strategy and recreated it using our proprietary scripting language, thinkscript. We have made the loading process extremely easy; simply click on the link http:// tos.mx/ef1Xvj, then choose to view thinkScript strategy. In the image in Figure 4, you can see the VWMABreakouts strategy added to a 10-day, 15-minute chart of FAS. Based on the article, when the VWMA 50-period line (the blue line) crosses above the 50-period moving average (the pink line), it is considered a buy signal. This single strategy in thinkorswim contains the rules for entering the trade as well as exiting. More detail about the volume-weighted moving average breakout strategy can be found in the February 2017 issue of Technical Analysis of Stocks & Commodities. —thinkorswim A division of TD Ameritrade, Inc. www.thinkorswim.com

F WEALTH-LAB: APRIL 2017 TRADERS’ TIPS CODE The volume-weighted moving average (VWMA), which was discussed by Ken Calhoun in his February 2017 article in S&C, “Volume-Weighted Moving Average Breakouts,” offers an additional dimension to chart analysis by using volume in addition to price. Typically, the VWMA is used in conjunction with a simple moving average (SMA) of the same or different period. Among the many cases where including the VWMA could be useful are: · to help avoid false breakouts when there is no volume support · confirmation of trend direction · indication of a weakening trend when it moves below the SMA · a profit-taking or exit signal when the distance between the VWMA and the SMA tightens · and more.

Figure 5: WEALTH-LAB. This sample chart implementing the strategy highlights a successful trade in FAS.

Another example of where including the VWMA could be useful is the swing-trading setup that Calhoun outlines in his article, where the VWMA crossing above the SMA may signal a potential bullish trend change, and the opposite crossunder is used to close the position. We are providing some WealthScript code for this strategy. A sample chart implementing the strategy is shown in Figure 5. In Wealth-Lab, you will find the VWMA indicator under the “TASC Magazine Indicators” group after you update the Wealth-Lab TASCIndicators library to v2017.03 or later. You can plot it on a chart or use it as an entry or exit condition in a rule-based strategy without having to program any code yourself. Wealth-Lab 6 strategy code (C#): using System; using System.Collections.Generic; using System.Text; using System.Drawing; using WealthLab; using WealthLab.Indicators; using TASCIndicators; namespace WealthLab.Strategies { public class MyStrategy : WealthScript { private StrategyParameter paramPeriodVWMA; private StrategyParameter paramPeriodSMA; public MyStrategy() { paramPeriodVWMA = CreateParameter("VWMA Period",50,2,300,1); paramPeriodSMA = CreateParameter("SMA Period",70,2,300,1); } protected override void Execute() { var sma = SMA.Series(Close,paramPeriodSMA. ValueInt); var vwma = VWMA.Series(Bars,paramPeriodVWMA. ValueInt); for(int bar = GetTradingLoopStartBar(1); bar < Bars. Count; bar++) { if (IsLastPositionActive) { if( CrossUnder(bar,vwma,sma)) SellAtMarket(bar+1, LastPosition); } else { if( CrossOver(bar,vwma,sma)) BuyAtMarket(bar+1); } } PlotSeries(PricePane,vwma,Color.Red,LineStyle. Solid,1); PlotSeries(PricePane,sma,Color.Blue,LineStyle. Solid,1); } } }

Figure 6: NEUROSHELL TRADER. This NeuroShell Trader chart displays the volume-weighted moving average breakout system for FAS.

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

F NEUROSHELL TRADER: APRIL 2017 TRADERS’ TIPS CODE A volume-weighted moving average breakout trading system such as the one described by Ken Calhoun in his February 2017 article in S&C, “Volume-Weighted Moving Average Breakouts,” can be easily implemented in NeuroShell Trader. 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] CrossAbove(VolWgtAvg(Close,Volume,50),Avg(Close,70)) SELL LONG CONDITIONS: [All of which must be true] CrossBelow(VolWgtAvg(Close,Volume,50),Avg(Close,70))

If you have NeuroShell Trader Professional, you can also choose whether the parameters should be optimized. 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 6. —Marge Sherald, Ward Systems Group, Inc. 301 662-7950, [email protected] www.neuroshell.com

April 2017

• Technical Analysis of Stocks & Commodities • 51

www.TradersEdgeSystems.com/traderstips.htm Please note that I tested the author’s system using the NASDAQ 100 list of stocks on daily bars rather than intraday bars from 12/31/2008 thru 2/10/2017. Figure 7 shows the resulting equity curve trading the author’s system with the cross-down exit. Figure 8 shows the ASA report for this test. The annualized return showed about a 17% return with a maximum drawdown of 19%. !Volume-Weighted Moving Average Breakouts !Author: Ken Calhoun, TASC Apr 2017 !Coded by: Richard Denning 2/11/17 !www.TradersEdgeSystems.com !INPUTS: smaLen is 70. vwmaLen is 50. Figure 7: AIQ. Here are sample test results from the AIQ Portfolio Manager taking three signals per day and 10 concurrent positions maximum run on NASDAQ 100 stocks (daily bar data) over the period 12/31/08 to 2/10/07.

SMA is simpleavg([close],smaLen). VWMA is sum([close]*[volume],vwmaLen)/ sum([volume],vwmaLen). HasData if hasdatafor(max(smaLen,vwmaLen)+10)>max(smaLe n,vwmaLen). Buy if SMA < VWMA and valrule(SMA > VWMA,1) and HasData. Sell if SMA > VWMA. rsVWMA is VWMA / valresult(VWMA,vwmaLen)-1. rsSMA is SMA / valresult(SMA,smaLen)-1.

Again, the code and EDS file can be downloaded from www.TradersEdgeSystems.com/traderstips.htm.

—Richard Denning [email protected] for AIQ Systems

F TRADERSSTUDIO: APRIL 2017 TRADERS’ TIPS CODE The TradersStudio code based on Ken Calhoun’s February 2017 article, “Volume-Weighted Moving Average Breakouts,” can be found at: www.TradersEdgeSystems.com/traderstips.htm

Figure 8: AIQ. This shows the ASA report for the system, which shows the test metrics and settings.

F AIQ: APRIL 2017 TRADERS’ TIPS CODE The AIQ code based on Ken Calhoun’s article in the February 2017 issue of Technical Analysis of Stocks & Commodities, “Volume-Weighted Moving Average Breakouts,” can be found at: 52 • April 2017 • Technical Analysis of Stocks & Commodities

I tested the author’s system using the NASDAQ 100 list of stocks on daily bars rather than intraday bars from year 2000 through 2014. Figure 9 shows the equity curve trading the author’s system with the cross-down exit. The following code files are provided in the download: • Function: VWMA—A function that returns the value of the volume-weighted moving average (VWMA) • System: VWMA_SMA_XO—Code for the author’s system of going long when the VWMA crosses up over the simple moving average. Figure 9 shows the equity curve trading 200 shares of each of

Figure 9: TRADERSSTUDIO. Here is the equity curve trading 200 shares of each of the NASDAQ 100 list of stocks from February 2000 through July 2014.

Figure 10: NINJATRADER. Here, the VMABreakout is displayed on the FAS 15-minute chart in NinjaTrader 8.

the NASDAQ 100 list of stocks from February 2000 through July 2014. The system does relatively well during bull market periods but suffers during bear periods. Adding some simple trend-following market timing to the system would probably significantly reduce the drawdown during bear periods. I did not provide code to add the market timing. The code is shown here:

NinjaTrader 8: www.ninjatrader.com/SC/February2017SCNT8.zip NinjaTrader 7: www.ninjatrader.com/SC/February2017SCNT7.zip

'Volume-Weighted Moving Average Breakouts 'Author: Ken Calhoun, TASC Apr 2017 'Coded by: Richard Denning 2/11/17 'www.TradersEdgeSystems.com function VWMA(vwmaLen) VWMA = summation(C*V,vwmaLen) / summation(V,vwmaLen) End Function '--------------------------------------------------Sub VWMA_SMA_XO(vwmaLen,smaLen) Dim myVWMA As BarArray Dim mySMA As BarArray myVWMA = VWMA(vwmaLen) mySMA = Average(C,smaLen) If mySMA < myVWMA And mySMA[1] > myVWMA[1] Then Buy("LE",1,0,Market,Day) End If If mySMA > myVWMA Then ExitLong("LX","",1,0,Market,Day) End Sub '-----------------------------------------------------

—Richard Denning [email protected] for TradersStudio

F NINJATRADER: APRIL 2017 TRADERS’ TIPS CODE The VWMABreakout strategy, as discussed in the February 2017 S&C article “Volume-Weighted Moving Average Breakouts” by Ken Calhoun, is available for download at the following links for NinjaTrader 8 and NinjaTrader 7:

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. 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 VWMABreakout 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 VWMABreakout file. NinjaScript uses compiled DLLs that run native, not interpreted, which provides you with the highest performance possible. A sample chart implementing the strategy is shown in Figure 10. —Raymond Deux & Jim Dooms NinjaTrader, LLC www.ninjatrader.com

F UPDATA: APRIL 2017 TRADERS’ TIPS CODE Our Traders’ Tip for this month is based on the article by Ken Calhoun in the February 2017 issue of S&C, “Volume-Weighted Moving Average Breakouts.” In the article, the author proposes a volume-weighted average method of signaling when breakout patterns might have greater persistence. This system enters a net long position when the short-term average crosses the long-term average upwards, and enters a net short when the short-term average crosses the long-term average downwards. The Updata code for this article is in the Updata library April 2017

• Technical Analysis of Stocks & Commodities • 53

FIGURE 11: UPDATA. Here, the 50/70-period VWMA cross system is applied to the 3x leveraged ETF FAS.

and may be downloaded by clicking the custom menu and indicator library. Those who cannot access the library due to a firewall may paste the code shown here into the Updata custom editor and save it. ‘Volume Weighted MA Cross  PARAMETER “Period 1” #PERIOD=50 PARAMETER “Period 2” #PERIOD2=70   NAME VWMA   DISPLAYSTYLE 2LINES INDICATORTYPE TOOL COLOUR RGB(200,0,0) COLOUR2 RGB(0,0,200) @VP1=0 @VP2=0 FOR #CURDATE=#PERIOD+#PERIOD2 TO #LASTDATE      ‘VOLUME WEIGHTED AVERAGES    @VP1=SGNL(CLOSE*VOL,#PERIOD,M)/ SGNL(VOL,#PERIOD,M)    @VP2=SGNL(CLOSE*VOL,#PERIOD2,M)/ SGNL(VOL,#PERIOD2,M)      ‘ENTRY EXIT RULES    IF HASX(@VP1,@VP2,DOWN)       SELL CLOSE       SHORT CLOSE    ELSEIF HASX(@VP1,@VP2,UP)       COVER CLOSE       BUY CLOSE    ENDIF    @PLOT=@VP1     @PLOT2=@VP2   NEXT

Figure 11 shows the 50/70-period VWMA cross system applied to the 3x leveraged ETF FAS.

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

54 • April 2017 • Technical Analysis of Stocks & Commodities

Figure 12: AMIBROKER. This 15-minute chart of FAS shows crossover signals based on the 50-bar VWMA and 70 MA, replicating the chart from Calhoun’s February 2017 article.

F AMIBROKER: APRIL 2016 TRADERS’ TIPS CODE In “Volume-Weighted Moving Average Breakouts” in the February 2017 issue of Technical Analysis of Stocks & Commodities, author Ken Calhoun shows a simple swing trading strategy based on crossovers between the volume-weighted moving average and a simple moving average. A ready-to-use formula that implements a chart with the moving averages is given here. A sample chart is shown in Figure 12. vrange = Param("VWMA range", 50, 1, 200 ); mrange = Param("MA range", 70, 1, 200 ); vsum = Sum( Volume, vrange ); vpsum = Sum( Close * Volume, vrange ); vwma = vpsum / vsum; Plot( C, Date() + " Close", colorDefault, styleCandle ); Plot( vwma, "VWMA" + vrange, colorRed ); Plot( MA( C, mrange ), "MA" + mrange, colorBlue ); —Tomasz Janeczko, AmiBroker.com www.amibroker.com

F MICROSOFT EXCEL: APRIL 2017 TRADERS’ TIPS CODE The approach discussed by Ken Calhoun in his article in the February 2017 issue, “Volume-Weighted Moving Average Breakouts,” is designed around 15-minute interval bars with some reference to end-of-day levels as part of an exit strategy.

FIGURE 13: EXCEL. Using VWMA(2) and MA(3) we find the up-cross on 11/7/2016 and the down-cross on 11/16/2016, corresponding to Ken Calhoun’s article in the February 2017 S&C.

As there is not currently a free data source for historical intraday bars, we must upscale to end-of-day bars. There are 26 15-minute intervals in the standard US trading day of 9:30 am to 4:00 pm. Using the 50-bar and 70-bar specifications for the averages, we can derive three bits of useful information: a. 50 15-minute periods translates to (50/26 →) 1.923 trading days. Round up to two days. b. 70 periods translates to (70/26 →) 2.692. Round up to three days. c. 50 vs. 70 suggests a scaling factor of 1.4 when estimating a starting value of MA for any selected period of VWMA. No lockstep here. You are free to mix and match to see what works best. Let’s take a look at the daily version of the FAS ETF used in Calhoun’s article. Our calculated upscale from 15-minute bars to days seems to hold for this short uptrend. To see how it fares over a longer timeframe, let’s pull back a little and see what 200 days at these settings looks like. In Figure 14 things are a little messy with too many, some-

times daily, indicator crossovers to be profitable, especially if you consider the impact of commissions and slippage on such a frequency of trades. Primary entry and exits for this system are determined by the up-cross and down-cross of the moving averages. Figures 13 and 14 summarize the results of that bare logic using 2 and 3 as the settings for the moving averages. Checkboxes in system logic controls to the right of the chart allow the user to activate the two stop-out ways of exiting a trade and the ability to reenter on an upside breakout within a continuing trend. Try them out. With moving average settings of 2 and 3, the chart only gets more cluttered and appears to be a bit less profitable. User controls allow for setting your choice of VWMA and MA periods as well as adjusting the trailing stop dollar amount and the stop-out settings based on aggregate support days. With the 70 and 50 settings as shown in Figure 15, the moving averages almost kiss but do not cross at the 11/7/2016 beginning of the short, sharp uptrend we have been watching. Instead, we see that our most recent upcross takes place on 9/8/2016, and we are still in the trade as of 2/10/2017. The

FIGURE 14: EXCEL, ANOTHER VIEW. A wider view shows that settings of 2 and 3 make for lots of whipsaws. April 2017

• Technical Analysis of Stocks & Commodities • 55

FIGURE 15: EXCEL, MA SETTINGS. Here, the moving average settings are less frenetic.

FIGURE 16: EXCEL, SELL STOP HIT. The trailing stop values (blue horizontal bars) intercept the price on 9/15/2016. A trailing stop sell occurs on the next bar.

FIGURE 17: EXCEL, TRAILING HIGH. Pink bars represent trailing highs and only appear with the reentry selection while the VWMA is above the SMA. Reentry after a trailing or aggregate support stop-out requires a break above the previous (trailing) high to confirm a continuing uptrend. Using it here offers a slight improvement in profits over using a trailing stop alone.

number of simulated trades and our overall profitability are both down at these settings. There are a lot of “what ifs” that can be explored within this model. Enjoy! The spreadsheet file for this Traders’ Tip can be downloaded from www.traders.com in the Traders’ Tips area. To successfully download it, follow these steps: 56 • April 2017 • Technical Analysis of Stocks & Commodities

• Right-click on the Excel file link, then • Select “save as” or “save target as” to place a copy of the spreadsheet file on your hard drive.

—Ron McAllister Excel and VBA programmer [email protected]

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April 2017

• Technical Analysis of Stocks & Commodities • 57

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 (Mar '17) GBLX 4.4 18.7 2 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>> 10-Year T-Note (Mar '17) CBOT 1.3 17 7 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••> Crude Oil WTI (Apr '17) NYMEX 6 5.9 1 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••> Russell 2000 Mini (Mar '17) ICEUS 4.6 13.9 1 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• 5-Year T-Note (Mar '17) CBOT 0.8 19.4 14 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••• Euro FX (Mar '17) CME 2.8 8.6 2 •••••••••••••••••••••••••••••••••••••••••••••••••••• T-Bond (Mar '17) CBOT 2.9 17 3 •••••••••••••••••••••••••••••••••••••••••••••••••••• Ultra T-Bond (Mar '17) CBOT 3.8 18.9 2 •••••••••••••••••••••••••••••••••••••••••••••••• Nasdaq 100 E-Mini (Mar '17) GBLX 4.1 11.3 2 ••••••••••••••••••••••••• Soybeans (May '17) CBOT 5.1 10.5 3 •••••••••••••••••••• 2-Year T-Note (Mar '17) CBOT 0.3 17 19 ••••••••••••••••••• British Pound (Mar '17) CME 5.1 13.4 2 •••••••••••••••• Gold (Apr '17) COMEX 5.3 34.1 3 ••••••••••••••• Natural Gas (Apr '17) NYMEX 9.5 11.9 3 ••••••••••••••• ULSD NY Harbor (Apr '17) NYMEX 6 6.7 1 ••••••••••••••• Gasoline RBOB (Apr '17) NYMEX 6.3 7.8 1 •••••••••••••• Eurodollar (Jun '17) CME 0.1 13 25 ••••••••••••• Corn (May '17) CBOT 5.2 14 9 •••••••••• Dow Indu 30 E-Mini (Mar '17) CBOTM 4.1 15.5 2 ••••••••• Japanese Yen (Mar '17) CME 4.5 31 4 •••••••• Sugar #11 (May '17) ICEUS 8 15.6 6 •••••••• S&P Midcap E-Mini (Mar '17) GBLX 4.2 13.9 1 ••••••• Soybean Meal (May '17) CBOT 5.8 11.7 4 ••••••• Wheat (May '17) CBOT 4.8 7.9 5 •••••• Australian Dollar (Mar '17) CME 2.9 12.6 4 ••••• Canadian Dollar (Mar '17) CME 2.5 10.7 4 ••••• High Grade Copper (May '17) COMEX 3.7 12.5 3 ••••• Live Cattle (Apr '17) CME 4.3 8.9 3 ••••• 30-Day Fed Funds (Apr '17) CBOT 0.1 10.4 25 •••• Coffee (May '17) ICEUS 6.4 13 2 •••• Lean Hogs (Apr '17) CME 4.9 5 3 •••• CBOT Chicago Board of Trade, Division of CME Mexican Peso (Mar '17) CME 7.7 13.8 5 •••• CFE CBOE Futures Exchange Cocoa (May '17) ICEUS 9.1 12.7 5 ••• CME Chicago Mercantile Exchange Hard Red Wheat (May '17) KCBT 4.2 5.2 3 ••• COMEX Commodity Exchange, Inc. CME Group Silver (Mar '17) COMEX 7.1 29.1 3 ••• GBLX Chicago Mercantile Exchange - Globex Soybean Oil (May '17) CBOT 4 11.2 10 ••• ICE-EU Intercontinental Exchange-Futures - Europe U.S. Dollar Index (Mar '17) ICEUS 2 8.9 3 ••• ICE-US Intercontinental Exchange-Futures - US Cotton #2 (May '17) ICEUS 5.2 18.1 6 •• KCBT Kansas City Board of Trade Platinum (Apr '17) NYMEX 5.2 10.4 3 •• MGEX Minneapolis Grain Exchange Swiss Franc (Mar '17) CME 3.2 13.4 2 •• NYMEX New York Mercantile Exchange Brazilian Real (Mar '17) CME 8.4 20.9 5 • Crude Oil Brent (F) (Apr '17) NYMEX 5.9 5.5 1 • Feeder Cattle (Mar '17) CME 5.9 6.2 1 • New Zealand Dollar (Mar '17) CME 3.6 16.1 4 • 1704 S&P GSCI (Mar '17) CME 7.7 11.5 1 • 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).

58 • April 2017 • Technical Analysis of Stocks & Commodities

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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].

April 2017

• Technical Analysis of Stocks & Commodities • 59

Building Self-Confidence There are certain traits a trader needs to succeed, and self-confidence is one of them. But how do you develop it so that it benefits your trading skills? Let’s find out.

In

by Stella Osoba, CMT a previous article, I discussed the mastery of patience as an essential skill for the successful trader to cultivate. This article focuses on another essential skill: self-confidence. What is it, what isn’t it, and how do you go about becoming a self-confident trader?

What is self-confidence?

To put it simply, self-confidence is trust in one’s self, one’s abilities, and one’s own judgment. In trading, more than in almost any other endeavor in life, it is necessary to align your perceptions with reality and then to rely on your interpretation of what you are seeing to make decisions. This requires self-confidence—the 60 • April 2017 • Technical Analysis of Stocks & Commodities

Once traders learn to trust themselves, they can then free their mind to focus on market opportunities that present themselves instead of being wrapped up in a tight ball of fear, frustration and doubt. —John F. Carter, Mastering The Trade

SERGEY NIVENS/SHUTTERSTOCK

Free The Mind

knowledge and self-trust that you possess enough aptitude to make decisions and the steeliness of character to follow through on your conclusions, ignoring doubt and negative self-talk. Not many people are able to do this. There is a plethora of information out there such as 24-hour financial news channels, newsletters, chat rooms, gurus’ courses, analysts’ opinions, seminars, tutorials, trading books, and on it goes. Then there is the pervading aura surrounding Wall Street that you have to be very smart to trade. This is reinforced by the notion that as a small trader you are competing with the big institutions, which are composed of extremely smart people who know orders of magnitude more than you. It is therefore not surprising that for many people who aspire to trade successfully, acquiring self-confidence is a challenge. It is tempting for the small trader to look to others for guidance or confirmation. But analyst and historical figure Richard D. Wyckoff pointed to the folly in this. He said that many people who come to trading fail because they think they are studying the market but “all they are doing is studying what someone has said about the market … not what the market has said about itself.” Acquiring the confidence to block out the noise and listen only to the market is the mark of the self-confident trader.

at the close

What it is not

Self-confidence must not be confused with self-esteem. The former is an offshoot of the latter. While self-confidence comes from a trust in your ability to perform a particular task or reach a certain goal, self-esteem is an underlying confidence in your own self-worth. Without self-esteem, there can be no self-confidence. Sometimes, we will run into people who appear to be extremely self-confident, but they may actually have low self-esteem or what the psychotherapist Nathaniel Branden called pseudo self-esteem, which he defined as a “pretense at self-confidence or self-respect which they do not actually feel.” This is because at our deepest level of consciousness, there is a need for the mind to have learned to trust itself. Sometimes, this need is not met, as when, for instance, children are given messages that are designed to discount their need for self-actualization. The messages they learn tell them to discount who they really are because they are not enough, and to be sufficient, they should look to something outside of themselves. So they go through life looking for the thing that will make them feel sufficient, whether it is status, money, position, possessions, or the like. They may attain what they seek, but it is never enough. And in the process, they undermine further their self-esteem. Because the mind is not rational, people often compound matters by hiding from themselves their need for self-acceptance. The absence of self-esteem means the absence of true self-confidence. While in most aspects of life it is possible to successfully navigate your way through without self-esteem, when it comes to trading, the market will often act as a mirror to expose your deepest insecurities. This is a major reason why so many people who come to trading fail. To trade successfully, you must first get right with yourself. Without self-confidence, you will live in constant fear of making a wrong decision, and sooner or later the fear will paralyze your ability to think and make decisions. —Victor Sperandeo, Trader Vic: Methods Of A Wall Street Master

Building self-confidence

To build the self-confidence you need to trade successfully, you have to learn to do two things well: Manage your selftalk, and trust yourself. Mark Douglas, author of Trading In The Zone, puts it this way: Confidence and fear are contradictory states of mind that both stem from our beliefs and attitudes. To be confident, functioning in an environment where you can easily lose more than you intend to risk requires absolute trust in yourself. However, you won’t be able to achieve that trust until you have trained your mind to override your natural inclination to think in ways that are counterproductive to being a consistently successful trader. Learning how to analyze the market’s behavior is simply not the appropriate training. —Mark Douglas, Trading In The Zone

Acquiring self-confidence as a trader is a learnable skill. Managing your self-talk

Have you ever decided to put on a trade and then hesitated because a little voice somewhere in the back of your mind says something like, “It’s probably going to go up/down the moment I put it on. Maybe I should get more information (that is, see what others are saying about the stock) … ?” If the self-talk is convincing enough, you might decide to pass on the trade. Now what just happened? You had a strategy, you analyzed the market. You reached a decision and then your lack of self-confidence took over. Self-talk is our inner dialogue, and negative self-talk is a reflection of our lack of self-esteem. Branden said that: Self-esteem reflects our deepest vision of our competence and our self-worth…[it] is the disposition to experience oneself as being competent to cope with the basic challenges of life and of being worthy of happiness. It is confidence in the efficacy of our mind, in our ability to think. By extension, it is confidence in our ability to learn, make appropriate choices and decisions, and respond effectively to change. It is also the experience that success, achievement, fulfillment—happiness—are right and natural for us. The survival value of such confidence is obvious; so is the danger when it is missing.

If negative self-talk is devastating, positive self-talk is more than the sum of its opposite. It can liberate us to move toward goals as yet unseen. It can urge us to light fires that illuminate the road to success. It can unlock doors to barriers that had once seemed impassable. And more than that, it compounds; the more you use it, the more positive you feel about yourself, the more you are able to stick to your goals, and therefore the more likely you are to achieve success. So if you know on an intellectual level that the benefits of positive self-talk are so obviously positive, why is it so hard to apply in real life? Because habits, especially bad habits, are hard to break. Negative self-talk is a habit and breaking a habit takes time, persistence, and effort.

Trust yourself

Trusting yourself is about more than reciting affirmations and thinking fleeting positive thoughts. It one of the psyche’s most urgent needs, but it is something that is often neglected in the superficial demands of our modern society. In the words of Branden: The root of our need for self-esteem is the need for a consciousness to learn to trust itself. And the root of the need to learn such trust is the fact that consciousness is volitional: we have the April 2017

• Technical Analysis of Stocks & Commodities • 61

choice to think or not to think. We control the switch that turns consciousness brighter or dimmer. We are not rational—that is, reality-focused—automatically. This means that whether we learn to operate our mind in such a way as to make ourselves appropriate to life is ultimately a function of our choices. Do we strive for consciousness or for its opposite? For rationality or its opposite? For coherence and clarity or their opposite? For truth or its opposite?

Final words

Acquiring self-confidence as a trader is a learnable skill. Strategy, technique, and picking the right security to trade are all important, but none are more important than being right with yourself. As you progress on this most lucrative of journeys, the bonus will be if in the process, you are able to examine the unexamined core of who you are and do the work of aligning your reality with your perceptions. In seeing the truth of who you are as a whole person, and in that truth, knowing that you are good enough as you are, you can then begin to build trading knowledge on layers of strength, not weakness.

Further reading

Branden, Nathaniel, www.nathanielbranden.com Carter, John F. [2012]. Mastering The Trade: Proven Techniques For Profiting From Intraday And Swing Trading Setups, 2d ed., McGraw-Hill. Douglas, Mark [2001]. Trading In The Zone: Master The Market With Confidence, Discipline And A Winning Attitude, Prentice-Hall. Gopalakrishnan, Jayanthi [2003]. “Victor Sperandeo,” interview, Technical Analysis of Stocks & Commodities, Volume 21: July. Hartle, Thom [1997]. “Mark Douglas And The Disciplined Trader,” interview, Technical Analysis of Stocks & Commodities, Volume 15: January. Osoba, Stella [2016]. “Cultivating Patience,” Technical Analysis of Stocks & Commodities, Volume 34: October. Sperandeo, Victor [1993]. Trader Vic: Methods Of A Wall Street Master, John Wiley & Sons.

Stella Osoba is a freelance writer and trader. She has earned the Charted Market Technician designation and has written for several financial websites and publications. She is a frequent contributor to Technical Analysis of Stocks & Commodities magazine and Traders.com Advantage online publication. She may be reached via email at stellaosoba@ gmail.com.

MONTEVIRGEN / EXPLOITING GUTS, RISK, AND DECAY Continued from page 27

• Option contracts with a high level of open interest (between a minimum of 100 to 500) • Contract expiration for both legs should be one month or less to take advantage of decay • Exposure to the spread should be one month or less, as you would close the positions prior to expiration.

is it Worth the risk?

It depends. Although every one of us understands risk on an intuitive level, the concept of risk is far more complex and individualized than any term can express. Trading short guts isn’t for most traders. Not only must a trader deal with the inherent risks of the spread, but the trader him/herself will often introduce degrees of risk that are 62 • April 2017 • Technical Analysis of Stocks & Commodities

as unpredictable as the market dynamics he or she will face while trading it. But for those who have the experience, resources, and inclination to venture unlimited risk for a small profit, then short guts may be the Faustian bargain you have been looking for. Karl Montevirgen is a content designer/strategist at Halifax America LLC, a stocks/option, futures, and forex brokerage in Sherman Oaks, CA. In addition to creating and designing content, he has extensive knowledge of and experience with commodity futures and foreign exchange. He can be contacted through the Halifax America website at www.halifaxamerica. com or by email at [email protected].

further reading

Montevirgen, Karl [2017]. “Use Seasonality To Optimize Algorithmic Strategies,” Technical Analysis of StockS & commoditieS, Volume 35: January. †See Traders’ Glossary for definition

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