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THE TRADERS’ MAGAZINE SINCE 1982

THE SMART MONEY When they fail

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Price Projections

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SWING TRADING When is a breakout really a breakout?

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INTERVIEW

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CONTENTS

NOVEMBER 2014, Volume 32 Number 12

FEATURE ARTICLE

10 When The Smart Money Fails by Giorgos E. Siligardos, PhD The Commitments Of Traders aggregated report is a handy tool for watching the moves of the most significant players in the markets. But what happens when the “smart money” fails? You may be able to gain some insights from the reports. Find out how.

20 Price Projections, Part 5

TIPS

by Sylvain Vervoort Here in part 5 of Sylvain Vervoort’s “Exploring Charting Techniques” series, he looks at techniques such as measured moves, Fibonacci projections & retracements, and daily pivots to estimate future price levels.

25 Explore Your Options

by Tom Gentile Got a question about options?

26 Swing Trading With Momentum On Your Side

by Ken Calhoun Seeing a simple breakout may convince you to place a trade, but how do you know if a breakout is really a breakout? Here’s one way you can jump into a trade and not get caught off-guard.

32 Trading Forex: Understanding The Basics, Part 1

by Imran Mukati In this first part of a new series on foreign exchange trading, you’ll get an overview of the basics of trading currencies.

35 Q&A

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

INTERVIEW

36 Battling The Futures With Larry Levin

by Jayanthi Gopalakrishnan Larry Levin is president and founder of Trading Advantage, a firm specializing in trading education. Trading Advantage has made it its mission to teach students to trade online. We spoke with him about what it takes to start trading futures.

REVIEW 48 • thinkorswim Sharing Product review: Social media sharing tools and online community for thinkorswim users

DEPARTMENTS 6 8 54 57 57 59 59 61 62 63

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

41 Futures For You

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

42 Slow Down: Equity Curve Ahead

by Robert Cocchiola The equity curve judges the success or failure of your system. What makes an equity curve good or bad? What does it take to achieve a good equity curve? We’ll take a look.

TIPS

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

n Cover: David Goldin n Cover concept: Christine Morrison

Copyright © 2014 Technical Analysis, Inc. All rights reserved. Information in this publication must not be stored or reproduced in any form without written permission from the publisher. Technical Analysis of Stocks & Commodities™ (ISSN 0738-3355) is published monthly with a Bonus Issue in March for $89.99 per year by Technical Analysis, Inc., 4757 California Ave. S.W., Seattle, WA 98116-4499. Periodicals postage paid at Seattle, WA and at additional mailing offices. Postmaster: Send address changes to Technical Analysis of Stocks & Commodities™ 4757 California Ave. S.W., Seattle, WA 98116-4499 U.S.A.

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4 • November 2014 • Technical Analysis of Stocks & Commodities

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November 2014 • Volume 32, Number 12

Opening Position

The Traders’ MagazineTM EDITORIAL

[email protected] Editor in Chief Jack K. Hutson Editor Jayanthi Gopalakrishnan Production Manager Karen E. Wasserman Art Director Christine Morrison Graphic Designer Wayne Shaw Staff Writer Dennis D. Peterson Webmaster Han J. Kim Contributing Editors John Ehlers, Anthony W. Warren, Ph.D. Contributing Writers Don Bright, Thomas Bulkowski, Martin Pring, Barbara Star, Markos Katsanos

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Author­i­za­tion to pho­to­copy items for inter­nal or per­sonal use, or the inter­nal or per­sonal use of spe­cific cli­ents, is granted by Tech­ni­cal Anal­y­sis, Inc. for users reg­is­tered with the Cop­y­right Clear­ance Cen­ter (CCC) Transactional Reporting Serv­ice, pro­vided that the base fee of $1.00 per copy, plus 50¢ per page is paid directly to CCC, 222 Rosewood Drive, Danvers, MA 01923. Online: http://www.copyright.com. For those organ­iz­ a­tions that have been granted a photocopy license by CCC, a sep­a­rate sys­tem of pay­ment has been arranged. The fee code for users of the Transactional Reporting Serv­ice is: 0738-3355/2014 $1.00 + 0.50. Sub­scrip­tions: USA: one year (13 issues) $89.99; Foreign surface mail add $15 per year. Air mail: Europe add $25.50 per year; else­where add $39 per year. Sin­gle copies of most past issues of the cur­rent year are avail­a­ble pre­paid at $8 per copy. Prior years are avail­ab ­ le in book format (without ads) or from www.traders.com. USA funds only. Washington state res­i­dents add sales tax for their locale. VISA, MasterCard, AmEx, and Discover accepted. Subscription orders: 1 800 832-4642 or 1 206 938-0570. Technical Analysis of Stocks & Commodities™, The Traders’ Magazine™, is prepared from information believed to be reliable but not guaranteed by us with­out further verification, and does not purport to be complete. Opinions expressed are subject to revision without notification. We are not offer­ing to buy or sell securities or commodities discussed. Technical Anal­ysis Inc., one or more of its officers, and authors may have a position in the securities discussed herein. The names of products and services presented in this magazine are used only in an editorial fashion, and to the benefit of the trademark owner, with no intention of infringing on trademark rights.

E

ven though traders may convince themselves otherwise, most enter and exit positions based on intuition or emotions. Rarely do they make their trading decisions based purely on objective reasoning. Many people don’t realize that participating in the markets based on intuition is the reason traders or investors get so shattered when the market falls sharply. Not knowing what to do, they freeze and just watch their profits turn into losses, surprised that things can turn around so quickly. The sad reality is that it’s natural to get drawn to the idea of making profits, so if a stock keeps moving up, you sometimes buy it without giving it much thought. We forget that the markets are not logical. They thrive because of the irrational nature of our emotions. In fact, if the market was a living being, it would probably get a good dose of daily entertainment observing our actions. The thought of making money gets us excited, but when it comes to thinking of how to protect our capital, we write it off thinking it won’t be necessary. Yet protecting our capital is what will separate us from the average, unsuccessful trader. Only a handful of people give importance to or take pride in protecting capital, which is probably why there are more unsuccessful traders than successful ones.

P

opular media plays a big role in luring people into participating in the markets, since they always hype up bullish markets. As tempted as it may be to get swayed by what you hear, step away from the market chatter and see what is really going on. Invest time in figuring out what variables will help you identify the market internals. Is it volatility, market breadth, money flow, or some other variable? What will make you scratch your head and say to yourself that something is not right? If you look back at the past market crashes, you’ll find that they took place because of some anomaly in the market. Something didn’t sync, and as a result, the markets crashed and took away profits from those who were unprepared. There’s no reason for you to be in that camp. Before I sign off, I would like to mention that voting in our annual Readers’ Choice Awards poll has begun. Please take a moment to visit our website at Traders.com and vote for your favorite products, services, and articles. The results of this poll, which will be published later in our annual Bonus Issue, can be helpful — who knows, you may discover something new that may just help you figure out how to identify those market anomalies. Happy trading!

6 • November 2014 • Technical Analysis of Stocks & Commodities

Jayanthi Gopalakrishnan, Editor

I watch for the perfect moment

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

OPEN NOTE TO READERS Editor, I’ve been reading TAS&C since its beginning [in 1982], but lately I’ve seen a tendency for comments to request and stress specific parameters, especially for indicators. I’d like to share my experience in hopes that it will be meaningful to some of the newer technicians. Please note that these are generalizations. There are always exceptions, but exceptions are not the rule. • An indicator is not a system. Don’t try to make it one. It is a tool to help entry & exit timing. • There are too many requests for “optimal parameters” and too many authors showing the “best parameters.” There is no such thing as “the best.” There is only “the best” for one example. • One or two examples of good performance does not make a robust system. • The more parameters and the more rules, the less chance of future success. • Unless you’re looking to capture noise, longer calculation periods improve results while price noise will make shorter patterns unreliable. • Finding the optimal parameters is an exercise in overfitting and ultimately, in losing money. What you do want is: • To use an indicator for timing; • Show that an indicator is “scalable,” that is, it generates a predictable increase or decrease in signals as the calculation period is made shorter or longer;

• A smoother indicator for more reliability (see some of John Ehlers’ past articles in this magazine as my favorite example); • Calculation periods that are coordinated with the primary strategy; and • Robustness, which means an indicator that works over a wide range of time periods and for many markets. Most indicators transition from trending to mean reversion as the calculation periods get shorter. And because we can’t know what calculation period will work in the future, you’ll want to use multiple time periods to give more stable results. Above all, remember: “Loose pants fit everyone.” Perry Kaufman [email protected] Thank you for sharing your comments, which are based on several decades of market research and which will no doubt benefit many readers. And thank you, of course, for being one of the original subscribers to this magazine. Perry Kaufman is the author of several books on market analysis, including the seminal Trading Systems And Methods, now in its fifth edition (Wiley). Kaufman’s most recent articles in this magazine were “A Better Trend” (April 2014) and “Slope Divergence: Capitalizing On Uncertainty” (June 2014). Our most recent interview with him appeared in our July 2014 issue (“Keeping Abreast With Perry Kaufman”), in which he discusses the evolving markets and the importance of evolving your strategies with them. Subscribers to S&C can read past S&C articles at our website, www.traders.

8 • November 2014 • Technical Analysis of Stocks & Commodities

com, in the Complete Article Archive area. Readers can also visit the Complete Author Archive at www.traders.com and search for “Kaufman” to help locate his past S&C articles or to look up John Ehlers’ past articles.—Editor LOOKING AT CYCLES Editor, I just wanted to compliment Koos van der Merwe for his September 2014 S&C article, “Looking At Cycles.” No one else gets it right like he does. Mike, New Jersey

Thank you for your feedback. Readers who enjoy van der Merwe’s work — and appreciate his insights from his 45 years of history in the markets — may also be interested in his posts at our Traders.com Advantage online publication at Traders.com, available to all S&C subscribers (http://technical. traders.com/tradersonline/home.asp). Past S&C articles by van der Merwe can be found in the Complete Article Archive area of Traders.com.—Editor BINARY OPTIONS Editor, I read Gail Mercer’s September 2014 article in S&C, “Binary Options: Scam Or Trading Methodology?” with great interest, since I have always been very skeptical about this kind of offering due to the low payout rate. Thus, I was surprised to find a payout table (Figure 6 in the article) suggesting that with a payout rate of 70%, after 500 wins and 500 losses the trader would have netted $3,500. In my mind, the net payout would be $-1,500. If my stake is $10 (as in the example) and the payout rate is 70% ($7.00), I would win $7 on my stake (not $10 plus the $7 payout) which, after 500 wins, would equal $3,500. Taking the 500 losses with a stake of $10 into con-

LETTERS sideration, which would equal $-5,000, my balance would be $-1,500. To win with this kind of system, you would need a win ratio of 59% (590 trades out of 1,000 x $7 win = $4,130 against 410 trades with a $10 loss = $-4,100; net win = $30). This would be a return of only 3% after 1,000 trades with a negative win probability (41/59). Thomas Blees

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Author Gail Mercer replies: On payout, the broker pays the original stake of $10 plus the 70% return. Thus, it’s not $7 * 500 but rather $17 * 500, or $8,500. You need to calculate in the original “bet,” which was $10. When the binaries pay out, they return the original bet ($10) plus the 70% increase ($7) for a total payout of $17 per trade. The table in Figure 6 is not a profit & loss table. It shows the total net payout. For example, if the trader started with a $1,000 account in binaries, had 500 winners, followed by 500 losers, at the end of 1,000 trades he would have an increase of $3,500 in profit (over his initial deposit of $1,000). But if he started with a $5,000 account and had 500 negative trades immediately, he would have blown his account. And if it was just random winnings and losers, then he could potentially still end up with a profit of $3,500 at the end of 1,000 trades. The percentage-based payouts on binaries do not pay commissions.

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November 2014

• Technical Analysis of Stocks & Commodities • 9

10 • November 2014 • Technical Analysis of Stocks & Commodities

INDICATORS

Because… Nobody Is Infallible

When The Smart Money Fails The Commitments Of Traders aggregated report is a handy tool for watching the moves of the most significant players in the markets. But what happens when the “smart money” fails? You may be able to gain some insights from the reports. Find out how.

T

BARRY BRUNER

he year 2008 was an important year for stock market analysts, not just because it was one more crash to study but also because it debunked the myth of infallibility of some highly regarded market participants. In this article I will first provide a brief, yet comprehensive, overview of the Commitments Of Traders (COT) aggregated report along with its characteristics and the way most analysts use it. Next I will discuss the commercials’ failure to anticipate the crash of 2008 and the lesson to be learned from their fiasco. Finally, I will provide a short overview of the disaggregated and Traders In Financial Futures (TFF) reports introduced a few years ago by the Commodity Futures Trading Commission (CFTC). COT basics Each week, the CFTC, an independent agency created by the US Congress to regulate the US commodity futures and option markets, releases the aggregated COT report to the public from its website, www.cftc. gov. The report is free of charge for transparency reasons and contains the collective positions of all market participants and the major players in various derivatives markets based on their volume of trades and predominant role in the marketplace. Since its

by Giorgos E. Siligardos, PhD

inception, the COT report has gone through various changes, such as the increase in frequency of release, use of combined futures & options positions, and introduction of the disaggregated report. However, its core purpose is always the provision of information about the sum of long and short positions of the most influential market participants. This is accomplished in aggregated reports through the release of the positions of two major categories: commercial hedgers and large speculators. The commercial hedgers (or simply “commercials”) are the large and influential market participants who are theoretically not interested in price speculation but use the derivatives market to hedge their business risk associated with the underlying instruments. A large wheat producer and a wholesale commercial consumer are typical examples of “commercials” in the wheat market. Both hedge their risk regarding wheat prices. An oil-producing firm and a transportation company are examples of “commercials” in the oil market. The first hedges its risk of descending oil prices whereas the second exerts hedging to be protected from rising prices by locking in the delivery of oil at a specific price. In the stock and bond markets, examples of commercials are capital market mutual funds, insurance companies, and pension funds offering hybrid products to their clients. In the currency markets, examples of commercials are large firms who sell or buy products internationally. The large speculators (or “large specs”) are large market participants who try to profit from the price fluctuations of the derivatives market. Their business is almost always completely unrelated to the underlying products of the derivatives they trade. A speculative fund that applies algorithmic trading in November 2014

• Technical Analysis of Stocks & Commodities • 11

futures & options on the S&P 500 is an example of a large spec. The official name of large specs in the COT report is reportable non-commercials. The commercials and the large specs are what the CFTC calls reportable categories (since they are required to report their positions to the CFTC). But the COT report also contains information about the total positions of all market participants. Subtracting the positions of commercials and large specs from these totals, the CFTC derives the positions of all those who don’t have the obligation to individually report their positions. These form the COT’s non-reportables category, or the small speculators (“small specs”). As you have probably guessed by now, the small specs include all the small fish or all those who engage in either hedging or pure speculation but are significantly undercapitalized compared to the other two categories. The discrimination between the small specs and the other categories is thus based on their average trading volume. The small specs do not meet the CFTC’s reportable level of trading volume. It is important to emphasize the following: n The small specs category contains small hedgers (who

use the underlying for their business) and pure speculators. Most traders in this category however, are pure small speculators.

n The

classification of a market participant for a commodity depends on his trading volume and his major role in the marketplace for that particular commodity. The CFTC states that it classifies traders by market and not by trading activities. Thus, a market participant may be classified by the CFTC as a commercial in some commodities and as a non-commercial in other commodities. Once a trader is classified as a commercial for a commodity, all his activities are reported in the “commercials” category of the COT report for that commodity. For example, if a cotton producer is classified as a commercial for cotton but he engages in some speculative trading in the cotton futures market, his positions will still be presented as commercial activity in the COT report for cotton.

n Most derivative contracts never go to actual delivery of

the underlying. Hence, it is profound that the commercials are those who primarily participate in the exercising and delivery procedure, since they are the ones interested in

Greed, panic, and the inability to know future prices should be assumed even for the ultrainformed market players.

12 • November 2014 • Technical Analysis of Stocks & Commodities

using the underlying in their off-the-market business. The large specs almost always close their positions before expiration since they are only interested in price speculation. Even though a small part of the small specs category uses the derivatives for hedging their business risk, the participation of small specs in the exercising and delivery processes is negligible compared to that of the commercials. n The

term hedge fund can be a misnomer. Almost all modern hedge funds are unregulated pooled investment vehicles of private equity that engage in high-risk trading strategies on behalf of affluent venturous clients. I therefore deliberately avoid using the term hedge fund in this article to prevent misunderstandings. Instead, I use the term speculative fund.

Smart and dumb money

The commercials are widely considered to be the most knowledgeable when it comes to the fundamentals of supply or demand in the underlying instruments of the derivatives markets. Since the primary motive for their engagement in derivatives is to hedge their business risk, they are considered more unbiased when it comes to evaluation of price exaggerations. The ideal situation for a large wheat producer, for example, is to know that he can sell his product at a specified price in the near future. The more he believes the prices will fall in the future, the more he is in need of hedging his increased risk. He can do this by either taking a short position in the wheat futures market or by buying puts in the wheat options market. The summative net position of all commercials’ positions in the wheat futures and options uncovers their general perception about the future price for this commodity. Since they are considered the most informed and prudent of all market participants when it comes to the future prospects of their products, that is, they know the information from its source, they have earned the term smart money in the market jargon. The large specs, on the other hand, are considered less knowledgeable about the fundamentals of the markets than the commercials. Due to the nature of their job, they are only interested in speculation and are more vulnerable in assuming risks and following price trends. They generally do not have the same quality and timing of information as commercials do. The small specs are considered the uninformed public. Their small financial assets make them much more susceptible to low-quality, lagging information. The speculative part of the small specs category usually assumes reckless risk blinded by eagerness for quick and large profits. Even the hedgers of this category are often the last to know when a trend change is imminent. Because of this they are granted the nickname dumb money by analysts who study COT reports.

Noisy indicators delay your analysis

Classic COT analysis

If you plot the individual net positions (longs minus shorts) of commercials, large specs, and small specs as three separate indicators below the chart of the underlying commodity, you can see how the various market participants value the prospects of that particular commodity. The sum of the three values of these indicators is always zero. The three classes of participants in the derivatives markets sell and buy contracts to (and from) each other. These indicators, therefore, slice the zero-sum of all open interest into three numbers, which are the net positions of commercials, large specs, and small specs. A typical COT analyst watches for extreme values in relation to their past. This is because each indicator has specific idiosyncrasies that may vary from time to time. For example, it is typical for the indicator of commercials in physical commodities to be negative (see sidebar “Commercials Are Usually Net Sellers”). Hence, it doesn’t help to wait for a positive reading of that indicator to arrive at the conclusion that the smart money bets in a bull market, generally speaking. Some analysts even apply volatility bands around these indicators or construct stochastic-like oscillators to quantify occasions when the COT indicators are relatively high or low with respect to their past. The ideal situation for a trend-reversal signal from a prolonged bullish market seems to be a relatively low value for the commercials indicator (indicating that the smarts are afraid that the market is prone to decline) and a relatively high value for the small specs indicator (indicating that more and more of the dumb money blindly and emotionally enter the uptrend when the party is about to end). Similarly, if during a prolonged downtrend the commercials indicator is relatively high and the small specs indicator is relatively low, a trend reversal from bearish to bullish is considered to be likely. Many analysts who study COT reports would also like to see the large specs and small specs indicators following a trend while the commercials indicator goes against it during extreme trending conditions. That would indicate that even

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the professional speculators are emotionally positioned at the wrong side, drunk by the ferocity and duration of the trend. That is widely considered a perfect scenario to apply contrary opinion. Note that the indications from the commercials are generally of value for long-term analysis and not short-term. Commercials usually build their hedging positions slowly and don’t focus on being protected by sluggish short-term price swings. As a result, the commercials indicator readings are not timing signals but alerts as to whether the prices have moved too far above or below reality-justified levels.

THE COMMERCIALS ARE USUALLY NET SELLERS

In most cases (during the history of COT report), the commercials have usually been net sellers and consequently, the commercials indicators have been negative for significant periods of time. For the physical commodities, this is because a lot of the commercials are producers, which means they are long the underlying. They therefore hedge their risk by taking the short side of the price either via futures or options. Wholesale buyers of the underlying products, who are also considered commercials, may hedge their risk of high prices by going long the price via derivatives. However, since they can usually transfer a portion of the high prices to the end consumers, they are generally not as worried as the producers and are not so aggressive in hedging. But if extreme and sudden shortages are projected, it can send the prices of commodities flying. At those times, the wholesale buyers step in and hedge their risk by going aggressively long the

prices in the derivatives market. This drives up the commercials’ indicator, and when an indicator that is usually negative starts taking high positive values, it tells you something. Since many of the commercials are conservative investment firms, when it comes to the bond and stock markets, they need to protect their portfolios from depreciation, and this again makes them more willing to take the short side of the prices via derivatives. In the currency markets, there is no general bias for the commercials to be net sellers or buyers.

November 2014

• Technical Analysis of Stocks & Commodities • 13

S&P 500

1

2

3

4

Commercials

Large specs

Small specs

5 firmly bullish. To their surprise, the S&P 500 fell quickly during the following months and they turned into bears and took their most negative net position near the worst time, that is, close to the reversal point at line 3. The large specs were also completely out of reality near the bottom, as they had a negative net position. Since the commercials and the large specs were largely net short at the bottom, the small specs were largely net long and consequently they had the right position at the right time. Then, all of a sudden, the behavior of commercials and small specs followed the textbook model I discussed earlier. During the times represented by lines 4 and 5 in particular, their behavior correctly indicated that the setbacks of the S&P 500 were only minor corrections in the context of a longterm uptrend.

When in doubt, get out

Microsoft Excel

Before discussing why the smart money fails at times and to put it in a rational frame, I find it worthwhile to elaborate on two concepts. The first has to do with the definition of failure of the commercials, and the second has to do with the importance of filtering your 2005 2006 2007 2008 2009 2010 2011 2012 2013 perceptions and analysis tools through the touchstone of technical analysis. Figure 1: cot indicators before and after the crash of 2008. During the times indicated by lines Regarding the first concept, I loosely define 1, 2, and 3, the commercials indicator was strikingly incorrect, whereas at times 4 and 5, it correctly showed that “failure” for the commercials as wrong sigthese setbacks of the S&P 500 were merely temporary pauses in the context of a long-term bullish trend. nals generated by the commercials indicator according to the classic guidelines I set forth The crash of 2008 earlier. For example, when the commercials indicator is unusuAre the commercials right all the time? The crash of 2008 gives ally high with respect to its past, but in the sequence it declines us a case to study. In Figure 1 you can see a chart of the S&P swiftly and the market falls significantly (see, for example, the 500 with three subcharts below it. The first subchart shows the behavior of the commercials indicator between lines 1 and 3 in commercials indicator, the second shows the large specs indica- Figure 1), then this constitutes a failure. It is important to clarify tor, and the third shows the small specs indicator. There are also this because the commercials are predominantly hedgers. They five vertical (enumerated) dotted lines that pinpoint five time participate in the derivatives markets to lessen or eliminate instances. You will notice that there is no scaling in the vertical the risk they have on their open positions or their opportunity y-axis except the zero lines in the COT indicators. This is done cost in the spot markets. Consequently, failure for them must in order to concentrate on the juice of the charts. logically mean an inability to make a good hedge. Later in this The time represented by line 1 near the end of 2007 finds the article, however, you will see that the commercials engage in commercials indicator positive and making a historic multiyear soft speculation or they alter their rigid hedging rules at times, high (not clearly shown in this chart due to the limited time and this adds more common-sense meaning to the term failure span it covers). At the same time, the large specs indicator was in relation to their COT indicator. sharply negative, whereas the small specs indicator was in a Regarding the second concept, let me show you how I dealt downtrend albeit in highly volatile fashion. Could it be that the with the commercials’ failure in 2008. During the last days of smart money was seeing something that the large specs and the 2007, while the stock market seemed to be in the early stages of dumb money were unable to see? a correcting phase, I wrote an article titled “What The End Of A couple of months before the summer of 2008 (line 2), the 2007 Showed” (see “Further reading”), which first went public S&P 500 fell, giving blatant sell signals according to almost all in January 27, 2008. The purpose of that article was to report classic technical analysis disciplines. The commercials, on the the conflicting signals of four non-strictly technical tools I use other hand — albeit more wary than previously — were still to gauge the long-term prospects of the stock market: the COT 14 • November 2014 • Technical Analysis of Stocks & Commodities

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Figure 2: technical “sell” signals in S&P 500 just before the strongest part of the crash. The technically weak situation of the S&P 500 at that time was obvious.

indicators, the insiders’ activity, the sector rotation model, and the cash levels of mutual funds. The first two were severely bullish whereas the others were clearly bearish. Although I couldn’t arrive at a firm answer regarding what to expect for 2008 due to this and other conflicts, and given that there was no firm technical signal for trend reversal at that time — the long-term uptrend had technically ended and the stock market was nondirectional — I stated in the article that I was leaning toward the continuation of the bullish environment after the correction was over. I gave some nontechnical arguments for this, including my strong belief as to the importance of the bullish signal from the commercials. Here’s how my article concluded:

several non-strictly technical indicators (including the COT report) being still positive. In that article I wrote:

…all the indications require confirmation from the market and this is where technical analysis comes in. During the last months of 2007, the stock market is fluctuating, trying to find a direction and the strong multiyear uptrend that started in 2003 is in serious danger. The technical signals in the broad stock market indices will give the final answers. One thing is for sure, however: This unusual coexistence between extreme readings in the four indicators and its implications should be noted for future reference when similar situations emerge.

(Note: The Figure 4 that I refer to can be seen as Figure 2 in this article). Then, in the final paragraphs I concluded:

A couple of months later, you could see how important these words were with respect to the technical factor in such conflicting situations. I wrote one more article that went public in April 20, 2008. The title of the article was “Interest Rates And The Stock Market: The Current State” (see “Further reading”). In that article I first reported the bullish behavior of interest rates at that time along with the steep upward-sloping yield curve that facilitates bull markets in stocks. I then contrasted the bearish technical situation of the S&P 500 index. The market had already fallen from its January levels, triggering sell signals according to any rational technical analysis discipline despite

What does technical analysis say about the current situation? My proprietary technical indicators stopped considering the long-term trend of the S&P 500 as bullish in November 2007 and the current trend of the S&P 500 is considered bearish by almost any classic technical analysis tool. In Figure 4 you can see that the S&P 500 is under its 200-day simple moving average and both the horizontal support HL-2 and the upward trendline TL-1 are broken. Also, near the horizontal line HL-1 (a previous resistance), the S&P 500 index created a confirmed reversal formation (double top or head & shoulders, whichever you prefer).

Undoubtedly, the current state of interest rates sends bullish signs for the stock market via the bond uptrend and the normal steep yield curve, but the final trigger must be given by technical analysis. One should not only look at what the market must do but he must also look at what the markets are doing. The current stock market status is technically bearish, and “playing” a bearish game from the long side is not appropriate. I am not comfortable when my technical analysis contradicts my other analysis tools, and my answer when being asked my opinion about the current situation is: “Well, my perception is bullish… but you know, the trend became bearish and I don’t argue with the trend.” In those tough times when you get contradictory signals from your various analysis tools, the minimum you can do is stop trading aggressively and consider significantly reducing your risk exposure using the derivatives market. If the contradictory signals are really strong and you feel uncomfortable then you can always stop trading completely until all things become clear. November 2014

• Technical Analysis of Stocks & Commodities • 15

The market viciously plummeted a few weeks later. What initially seemed to be a sharp correction in the context of a bull market back then is seen as the highs of a steep waterfall in today’s historical charts.

Financials vs. physical commodities

Let’s now move into some subtle issues of the COT report by stressing an important difference between the commercials in the financial markets (stocks, bonds, and currencies are what CFTC puts in the financials category) and the commercials in the classic commodities markets. As I mentioned earlier, the commercials are theoretically not interested in price speculation (unlike large specs) but they use the derivatives market to hedge their business risk associated with the underlying instruments. The discrimination between the commercials and large specs is pretty clear when the classic commodities are concerned (like agricultural or mined products), but for the case of financial markets, this discrimination is a bit hazy. This is because doing business in the financial sector (especially in the stock market) is often translated in seeking additional profits from the price movements of the financial instruments. For example, a large corn producer isn’t really focused on making a profit from the price fluctuations in the corn market. But an actively managed conservative mutual fund that uses fundamental analysis to invest long term in large-cap stocks mostly for their dividends usually expects some additional profits through capital appreciation. The corn producer and the mutual fund can be categorized as commercials — those who need to hedge their risk. The corn producer would prefer the price of corn to be relatively stable, but the mutual fund would prefer some volatility for its stocks so that it could exploit possible cheap opportunities to add to its portfolio. This places the mutual fund closer to — although not exactly — a large spec than the corn producer. This subtle idiosyncrasy of the commercials in the financial markets makes them less unbiased and more prone to assume some kind of extra risk by being less hedged for the sake of additional profits. Undertaking risk is the nature of the financial services business. Since it is common for some commercials in financials to expect some profit from the price movements of the underlying instruments, they are doomed to employ valuation techniques in order to find times when it is best to be loosely hedged. This adds a guessing factor and of course room for errors. Yes, they are more knowledgeable, more informed, and more prudent than the pure speculators, but they don’t know the future. In fact, they can be wrong at times. Most important, they will possibly be wrong at the worst times, that is, at those times where sudden unforeseen news strikes the markets. This is because the smart money, by definition, foresees the news that can be foreseen; otherwise, it wouldn’t be called “smart.” Now, consider this: What happens when striking news hits the financial markets and the most informed players are positioned on the wrong side? They will have to cut short their losses by altering their hedging positions of course, and since they are big fish (otherwise they wouldn’t be in the COT’s reportable category) they will also be tumultuous on their way out. But perhaps the most important 16 • November 2014 • Technical Analysis of Stocks & Commodities

effect of their sudden change of view is the psychological shock to all those who watch and respect their actions. The feedback loop takes care of the rest. Note also that the money entering and leaving the stock market investing funds — even the most conservative ones — is strongly affected by market prices. A mutual fund investing in large S&P 500 stocks, for example, may be forced to liquidate positions in order to satisfy redemptions from frightened investors during a severe bear market. This may alter its hedging needs in S&P futures.

Even the commercials can be emotional

Although there is a lot of automatic trading behind the scenes to facilitate and objectify the hedging process, the trading is planned and overseen by humans. Who is to say that even a commercial participant in nonfinancial commodities, who knows the fundamentals of his market well, will not buckle in front of a potential opportunity for big profits and resist in altering his strict hedging rules? For example, in the paper “Why Do Hedgers Trade So Much?” (see “Further reading”), the authors argue that hedgers in wheat, corn, soybeans, and cotton markets frequently change their futures positions over time for reasons unrelated to output fluctuations. This implies a form of speculation. Recall that earlier I stressed that commercials in a commodity can at times engage in speculation for that commodity but their trading activity is still reported in the commercials category (since their categorization is based on their predominant trading activity), and you will understand that the scenarios I presented are not pure fiction. Consider what will happen when these deep-pocket smart types realize that they are positioned on the wrong side of the market and they have also deviated from their strict hedging plan. What will happen to a stock mutual fund or wheat producer (who is typically long in the stock and wheat spot markets, respectively) when they realize that they are softly hedged against price declines at a time when a sudden crash occurs for whatever reason? They’ll panic. Was greed the reason for the commercials’ unusually high net long position in the S&P 500 near the beginning of the crash of 2008? Or was fear the reason for the commercials’ large net short position near the end of the crash? I don’t know, but what I know is that greed, panic, and inability to know the future prices should be taken for granted even for the most prudent and ultra-informed market players. It must come as no surprise to see the commercials following a trend, especially in markets where the concept of risk-taking is interwoven with the concept of doing business. If all big players were prudent, there would be no bankruptcies for large firms. Later, you will see how the advent and significant presence of swap dealers in the markets made it possible for pure speculative or diversification actions (unrelated to fundamental supply/demand) to sneak into the commercials’ positions.

Smart does not mean neutral

Even if there are commercials who will at times engage in some kind of speculation, most of them are mainly concerned

about hedging their business activities. The amount of hedging they would need to undertake would depend on their views and expectations with respect to the fundamentals of their business. In other words, even if their motive is benign and they are focused only on hedging their business risk, they may conservatively change their hedging from time to time based on their estimations about their products’ prices. Though the commercials do not base the prosperity of their business on projecting the market price swings, and even if they may not be interested in extra profits from them, they have a projected price — acting more like a fair value — for their commodity in their mind. When they anticipate deviations from that price, or the market moves away from that price, they tighten or relax their hedging. Is it a bad thing that the commercials may conservatively accommodate their hedging according to their perception about the price of their business products? Not necessarily. The commercial hedgers in the derivatives market have, by definition, an opposite position in the spot market. If their business is in physical commodities and they always perform 100% hedging, then the commercials’ indicators will move in sync with the current production or demand levels of these commodities. That is good, but it is the slight deviation from full hedging that conveys some extra piece of information regarding the projected supply & demand from the commercials’ deep knowledge to the COT analyst. Yes, this makes room for errors, but hey, we can’t have it all, can we? The moral, therefore, is that there is no waterproofing in the markets. The commercials are usually right in their view of when the prices of physical commodities or financials are unusually high or low because they know the fundamental information from its source. However, they can also fail at times because nobody knows the future. When the smart money fails, it means that some serious reason — which is extremely difficult, if not impossible, to be known beforehand — was the culprit. Further, since the commercials are the most influential in reputation, don’t be surprised if their failures are of epic proportions due to the cascading effect of feedback loops.

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November 2014

• Technical Analysis of Stocks & Commodities • 17

THE DISAGGREGATED COT REPORT

The producers/merchants/processors/users (includes the large producers and consumers of the underlying) and the swap dealers substitute for the commercials category of the legacy report

whereas the managed money, along with the other reportables, substitutes for the large specs category. The managed money includes participants such as Commodity Trading Advisors, Commodity Pool Operators, and speculative funds (market participants who are engaged in managing and conducting large-scale organized futures trading on behalf of clients), whereas the other reportables include deep-pocket participants who don’t fall into the other categories (for example, affluent individuals who trade their own accounts). Again, the positions of small specs can be indirectly derived by subtracting the positions of the reportable categories from the sum of positions of all market participants. The categories of disaggregated report are currently applied to classic commodities futures markets like metals, agricultural products, and livestock as well as for goods like lumber and energy (gas, oil, etc.).

A special type of hedger

A new class of reports

The original aggregated report (now called the Legacy Report) breaks down each Tuesday’s open-interest positions of all major derivatives contracts that have more than 20 traders into commercials and large specs, whereas the disaggregated report for the classic commodities markets breaks down the same open interest into the following categories: • • • •

Producer/merchant/processor/user Swap dealers Managed money Other reportables

There is a group of market participants falling into the commercials category of the aggregated COT report whose activity — although clearly hedging in nature — arises from, and conveys actions from, ambiguous incentives. This is the group of swap dealers (SDs). An SD is defined by the CFTC as an entity that deals primarily in swaps for a commodity and uses the futures markets to manage or hedge the risk associated with those swaps. The SDs are overthe-counter (OTC) dealers offering swap agreements tailored to the needs of large firms and institutions. The SDs need to hedge the risk exposure from their positions in those swaps, and when they cannot do it in the OTC markets, they do it in the organized exchanges. In this sense, the SDs act to transport positions from OTC markets to the exchange markets. Say that a large firm enters a swap agreement with an SD, which implies a long position in oil. The SD is therefore short oil and needs to hedge its risk via either the OTC market or the oil futures market, taking an appropriate long position. As a result, the long position in oil for the firm raised from the OTC swap agreement may finally be transformed into a long position in the oil futures market, and it is reported to the CFTC as the SD’s hedging position. The character of the firm that entered the swap and motives for its actions are unknown and, although in most cases it just tries to satisfy its business needs, it could be an outright speculator. Regardless, this OTC action was transformed in an action categorized as hedging due to the involvement of the SD. As another example, consider a firm that enters a swap just to diversify its risk with no particular interest in the underlying instruments. Any implied position from the swap may finally result in a commercial’s reportable position in the COT report because of the involvement of the SD. It is apparent that since SDs hedge their positions using the exchange derivatives markets, they must be registered as hedgers in the exchanges. Hence, they must be categorized as a type of commercial. However, their massive trading volume and ambiguous character as potential conveyors of speculative or otherwise non-hedging positions from the OTC markets to the exchanges is what motivated the CFTC to start reporting the so-called disaggregated and TFF reports a few years ago. To avoid misunderstandings, these reports do not contain the commercials designation. 18 • November 2014 • Technical Analysis of Stocks & Commodities

In 2009, the CFTC began publishing a more detailed, or disaggregated, version of the COT report for physical commodities with four categories of market participants as a way to cope with the SDs’ ambiguous role in the marketplace. In the sidebar “The Disaggregated COT Report,” there is a detailed explanation of this relatively new version of trader categorization. For the sake of transparency in financial instruments, the CFTC started publishing the Traders In Financial Futures (TFF) report in 2010. The TFF redistributes the positions of commercials and large specs in financials into four categories. In the sidebar “The Traders In Financial Futures Report,” you can see a comprehensive overview of the TFF report. It must be stressed that although the disaggregated COT data for physical commodity markets can be re-aggregated to get back to the three categories of the old type of report (called the Legacy Report), the TFF is not a disaggregation of the legacy report for the financial futures markets, and it is for this reason the CFTC does not use the term disaggregation for the TFF (see sidebar “Re-Aggregating The New COT Data”). The CFTC, as of now, continues to publish the legacy reports along with the disaggregated and TFF ones. The new reports are a significant improvement in terms of transparency and information. Their history, however, is short and, at present, it is difficult to derive fact-based conclusions about how they could be used to gain additional insight on the market dynamics. The TFF in particular is different from the legacy report of the financials and it should not be uncritically compared to it. The aim of these new reports is to weed out the commercials category from hybrid or ambiguous cases. It will be interesting to see how the new pure commercials will weather future market crashes and booms. For the time being, it is important to keep in mind that the commercials in the legacy report may contain possible speculative positions brought from the OTC world.

How much can they fail?

Since the COT indicators are not derived from price or volume, they offer a different view of the market than classic technical analysis does. It is helpful to keep an eye on them for additional information. The COT’s smart money can experience bad times, which is when the statement “when smarts fail, their failure is

THE TRADERS IN FINANCIAL FUTURES REPORT

The Traders In Financial Futures (TFF) report breaks down the open-interest positions of all major derivatives contracts in financial instruments into the following categories: • • • •

Dealer/intermediary Asset manager/institutional Leveraged funds Other reportables

The main idea behind the TFF report is to divide the financial derivatives market participants into sell and buy sides. The term buy & sell here has nothing to do with the long/short positions these participants might take but rather with their role in the marketplace. It remains to be seen how this division will be of practical use for the COT analysts since, contrary to the legacy report, it separates the (previously considered similar) roles of institutional investment funds from the creators and dealers of financial products. The dealer/intermediary category represents the sell side and includes market participants (mostly large banks and swap highly likely to be of epic proportions” comes to light. When such an event takes place, small traders have a distinctive advantage over the big players because they can get in and out of the market quickly and efficiently. The small traders can weather the failures of the big players when they happen by filtering the commercials indicator. It is important to cut both your losses and your risks short. When something doesn’t act the way it should, such as the market ignoring the commercials’ indicator calls, and you start to worry, there’s no point waiting for a loss to appear. It’s time to cut your risk short and get out. In Jack Schwager’s Market Wizards, Michael Marcus said that he was heavily long in soybeans during the late 1970s. He was expecting the market to be limit-up for the next three days because of extreme soybean shortages and bullish government reports. But on the first day, the market opened limit-up and it then started trading down. Here is how Marcus reacted (in his own words): “I said to myself, ‘Soybeans were supposed to be limit-up for three days and they can’t even hold limit-up the first morning?’ I immediately called my broker and frantically told him to ‘sell, sell, sell!’” Giorgos Siligardos holds a doctorate in mathematics and a Market Maker certificate from the Athens Exchange. He is a financial software developer, coauthor of academic books in finance, frequent contributor to this magazine, and scientific contributor in the Department of Finance and Insurance at the Technological Institute of Crete. Material from his course writings on derivatives has been used in educational enchiridia for bank managers. His academic website is http://www.tem. uoc.gr/~siligard and his current views on the markets can be found at http://market-calchas.blogspot.gr/. He may be reached at [email protected].

Further reading

Braswell, Jason [2005]. “Commitment Of Traders Report: Demystified,” Technical Analysis of Stocks & Commodi-

dealers) who design and sell various financial assets to clients. The traders in this category could be thought of as commercial producers for the financials since their business is mostly to create financial products and earn commissions from selling them. The other three TFF categories represent the buy side of market participants who predominantly buy what the sell side creates and offers. More precisely, the asset manager/ institutional, who could be thought as commercial consumers for financials, includes large institutional investors and organizations such as mutual and pension funds, insurance companies, and institutional fund managers who are what we think of as large (mostly conservative) investors. The leveraged funds are primarily speculative investment pools that engage in systematic or proprietary aggressive trading on behalf of clients who prefer high-risk investments. The other reportables category includes affluent individuals who trade their own accounts as well as some other market participants who — according to CFTC’s judgment — don’t fall into one of the other categories such as corporate treasuries and credit unions.

RE-AGGREGATING THE NEW COT DATA

It is possible to derive the legacy report from the disaggregated one for the physical commodities. The producers/merchants/ processors/users and swap dealers form the commercials category. The managed money and other reportables form the large specs category. For the financials, it is not possible to re-aggregate the TFF report to get back to the legacy report. This is because — as the CFTC points out — participants classified into one of the four categories in the TFF are drawn from either the commercial or noncommercial categories of traders in the legacy report. ties, Volume 23: August. Briese, Stephen [2008]. The Commitments Of Traders Bible: How To Profit From Insider Market Intelligence, Wiley Trading. _____ [1990]. “Commitments Of Traders As A Sentiment Indicator,” Technical Analysis of Stocks & Commodities, Volume 8: May. Cheng, Ing-Haw, and Wei Xiong [2004]. “Why Do Hedgers Trade So Much?” available online at SSRN, http://ssrn. com/abstract=2353218 CTFC, “Disaggregated Commitments Of Traders Report: Explanatory Notes,” http://www.cftc.gov/ucm/groups/ public/@commitmentsoftraders/documents/file/disaggregatedcotexplanatorynot.pdf _____ “Traders In Financial Futures: Explanatory Notes,” http://www.cftc.gov/ucm/groups/public/ @commitmentsoftraders/documents/file/tfmexplanatorynotes.pdf McEwan, Ron [2012]. “Mining For Gold,” Technical Analysis of Stocks & Commodities, Volume 30: November.

Continued on page 52 November 2014

• Technical Analysis of Stocks & Commodities • 19

Exploring Charting Techniques

Price Projections Part 5

Here in part 5 of Sylvain Vervoort’s “Exploring Charting Techniques” series, he looks at techniques such as measured moves, Fibonacci projections & retracements, and daily pivots to estimate future price levels. by Sylvain Vervoort

P

rice projections estimate future price levels. Last month in part 4, I discussed some basic price projection techniques based on support & resistance and trendlines. But there are also other methods to project prices. I’ll start with measured moves.

20 • November 2014 • Technical Analysis of Stocks & Commodities

measured move? A measured move is a price projection based on a previous price swing. The idea behind it is that any new price swing is of approximately the same size as the previous swing. For the definition of the swings, I will use my SVEHLZZCandlepattern zigzag indicator that was introduced in my article in the July 2013 issue of Stocks & Commodities. In addition, I will use my 1-2-3 wave count as introduced in my article in the June 2013 issue of Stocks & Commodities as a reference to calculate measured moves. In Figure 1, you see that after a down move, a wave 1 up was followed by a first pullback wave 2 with a higher bottom. This typically indicates the start of a change in trend, in this case, a change from a down- to an uptrend. The first logical target for wave 3.1 — as it is for any wave 3 — is at least the height of the previous correction wave 2. This is because you expect a higher top than the previous top. In general, after a new wave 1 starts, you can expect the first wave 3.1 to have at least the same height as wave 1. I have identified this on the chart in Figure 1 with yellow rectangles. Following wave 3.1 is a new corrective wave 2. After this correction a new wave 3.2 started. You can now expect a further move up with a height that is equal to (give or take 10%) the height of the previous wave 3.1. If however, the previous wave 3 is the first of the wave 3s (as it is in this case with wave 3.1), and the first 1-2-3 wave is relatively small, you can try to use the complete height of that 1-2-3 wave to determine the next move. I have identified this as blue rectangles in the chart in Figure 1. As you can see, wave 3.2 is reached, and it is followed by a wave 2 correction and a new swing up. You next take the height of the previous wave 3.2 and use that as

NIKKI MORR

What is a

CHARTING

NinjaTrader

your projection for wave 3.3 (green). Similarly, you find the projections for waves 3.3 (brown) and 3.4 (red). Figure 2 is a continuation of the chart in Figure 1. After the top of wave 3.4 there is a valid wave 2 correction. After the correction, you would expect a new wave 3.5 up. However, price turns down again after about a 50% correction of the previous wave 2. Price reached the same level as the previous wave 2 correction, so you still have a valid wave 2 correction for wave 3.4. Next, you take the height FIGURE 1: MEASURED MOVES IN AN UPTREND. Here you see measured moves on range bars with the high–low zigzag in an uptrend. of the previous wave 3.4 and Note how you can effectively use the height of previous waves to determine the length of future price moves. project it up (yellow rectangle). A wave 3.5 is completed just a fraction above wave 3.4. generations, became known as Fibonacci numbers. The number sequence was known to Indian mathematicians This could be a top, or price could move into a trading range. The best thing you can do here is to wait for a reversal signal. as early as the sixth century, but it was Fibonacci’s Liber Abaci The reversal only takes place after the moderately higher top that introduced it to the West. Fibonacci numbers have the folat 3.7 when the correction wave 2 is no longer valid (purple) and lowing sequence: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, and it becomes a new downward wave 1. You measure the height of so on. Each number is the sum of the two previous numbers. The higher up in the sequence, the closer two consecutive this new wave 1 and project it for wave 3.1 down (purple). To project wave 3.2, you use the height of wave 3.1 (green) numbers of the sequence divided by each other will approach instead of the complete 1-2-3 wave, since wave 3.1 is large the so-called golden ratio (approximately 1:1.618, or 0.618:1). enough. Next, you take the height of wave 3.2 to project wave 3.3 (brown). Since wave 3.3 is barely breaking the low of wave Fibonacci levels 3.2, you have to wait for wave 3.4 (brown) to reach that level. Charting Fibonacci levels is done by first drawing a fictitious Note that there are still lower highs and lower lows. Last but vertical line between two turning points. Next, you draw not least, you use the height of wave 3.4 (red) from the start of wave 3.3 to project wave 3.5 (red).

Fibonacci price

projections Leonardo Pisano Fibonacci was an Italian mathematician born in 1170. In Liber Abaci, Fibonacci introduced the so-called modus Indorum (method of the Indians), which today is known as Hindu-Arabic numerals. Liber Abaci also presented, and solved, a problem involving the growth of a hypothetical population of rabbits, which was based on idealized assumptions. The solution was a sequence of numbers that, over several

FIGURE 2: MEASURED MOVES IN A DOWNTREND. Here you see measured moves on range bars with high-low zigzag in a downtrend. Paying close attention to the retracements will help you determine when a trend reverses. Here you see how an uptrend changed to a downtrend. November 2014

• Technical Analysis of Stocks & Commodities • 21

or down move, you can draw these types of Fibonacci projections to project future price targets. Historical Fibonacci projection Oftentimes, and based on the idea that resistance becomes support and vice versa, you can also use historical data turning points to create a Fibonacci projection. In FIGURE 3: FIBONACCI RETRACEMENTS AND TARGETS. Once you have that first reaction point after the start of an up or down move, you can Figure 4, the emini reaches a top in an draw these types of Fibonacci projections to project future price targets. up move. At point 1 horizontal lines through retracement levels at 100%, 61.8% where the downturn starts, there is no forward reference to (100*0.618), 50% (not a Fibonacci number), 38.2% (61.8*0.618), draw a standard Fibonacci projection. To create a projection, 23.6% (38.2*0.618), and 0%. you can use the previous (historical) upturn to create the Then you draw horizontal lines at three or more Fibonacci downward projection. As you can see, price reaches the target target levels at 161.8% (100*1.618), 261.8% (161.8*1.618), and of 161.8% with a nice profit. 423.6% (261.8 * 1.618). After price moves up or down, there often will be a partial retracement, which will find support Single-point reference (SPR) Fibonacci projection & resistance near Fibonacci levels. Another possibility is making a projection from a single referIn Figure 3 you see a four-tick modified renko chart of the ence point. To begin a projection, you can select any single emini (ES). A projection between the low at the beginning of turning point confirmed by a zigzag. In the five-pip modified the chart and the first reaction point after an up move shows all renko chart of the EURUSD in Figure 5, I used the point labeled retracement levels and the target levels at 161.8% and 261.8%. SPR as my starting point. Once you have that first reaction point after the start of an up The first target at 1.3540 is mainly a reference to detect a smaller pullback leg. If price does not move beyond this first target point, there often will be no change in trend. This can be seen at the beginning of the chart (the first shaded yellow box). From the SPR starting point, the second projection target is reached at 1.3560. Notice how price hovers around this point before continuing to the next target at 1.3585 and then moving straight FIGURE 4: HISTORICAL FIBONACCI PROJECTION. You can use historical price data to create projections. Here, price reaches the target of through to the next level at 1.3630. Price 161.8% with a nice profit. 22 • November 2014 • Technical Analysis of Stocks & Commodities

remained here for a longer per iod of time, moving around that level, and then continuing to move up slowly to the next level at 1.3700. The projection targets I have used are based on the Fibonacci golden ratio and are shown in Figure 6. Note that you need to use some multiplier to adapt the basic FIGURE 5: SINGLE-REFERENCE POINT FIBONACCI PROJECTION. To begin a projection, you can select any single turning point confirmed by a zigzag. Here, I used the point labeled SPR as my starting point. reference values to the price level of the underlying. I used a basic multiplier of 0.11 and multiples of this value. In Figure 5, I used a multiplier of 0.22.

Daily pivots

Daily pivot levels that are calculated based on the previous day’s high, low, and close provide important intraday support & resistance levels. Here’s how the various levels are calculated: PH = Previous day’s high PL = Previous day’s low PC = Previous day’s close Pivot point

FIGURE 6: SINGLE-REFERENCE POINT FIBONACCI CALCULATION. The projection targets used here are based on the Fibonacci golden ratio. You need to use some multiplier to adapt the basic reference values to the price level of the underlying. I used a basic multiplier of 0.11 and multiples of this value.

(PP) = (PH + PL + PC)/3

Resistance level R1: R1 = (2 * PP) - PL Resistance level R2: R2 = PP + PH - PL Resistance level R3: R3 = R1 + PH - PL Support level S1: S1 = (2 * PP) - PH Support level S2: S2 = (2 * PP) - PH - PL Support level S3: S3 = S1 - PH - PL

I have created an indicator that draws these levels on a real-time chart using different colors. You can adapt these colors if required. In the properties window of this indicator (Figure 7), which is called “SVEPivotsUtcRt,” you can see the colors used. You can download this indicator from my website at http://stocata.org/ninjatrader/formulas.html or from the Stocks & Commodities website at http://www.traders.com/ files/VervoortNov2014.html. This indicator can only be used on charts with a fixed horizontal time relation. Please note

A new price swing is of approximately the same size as the previous swing. FIGURE 7: PIVOT PROPERTIES. Different colors are used to identify the different support & resistance levels calculated based on pivot points. November 2014

• Technical Analysis of Stocks & Commodities • 23

FIGURE 8: REAL-TIME PIVOT LEVELS ON 30-MINUTE CHART (UTC +1). Here you see the pivot lows, pivot highs, support & resistance levels, and pivot points.

that the SVEPivotsUtcRt indicator uses some nonsupported NinjaTrader 7 script language. It is provided as-is. Calculating and showing these levels on a chart that trades during normal US trading hours will not be a problem because the trading session break, high, low, and close are clearly defined. For any underlying that trades continuously such as currency pairs, it is necessary to define where a trading day ends. If each trader uses his local time zone, then everyone would be using different support & resistance levels. The most common time used as the end of a trading day’s session is the Coordinated Universal Time or UTC (GMT) zero hours. Most people use charts displaying local time in the x-axis. That means you will have to shift to UTC:0 for starting the new day’s support & resistance levels at the correct local time. The good news is that the indicator will do this for you automatically.

Putting it together

In Figure 8 you see a 30-minute chart of the EURUSD with UTC+1 local time. The first date on the chart is September 25, 2013 and it begins with a move toward the median pivot level PP, but falls back to the previous day’s low PL. Then an up move starts up to the previous day’s high PH. A reaction follows after which the up move continues up to the second resistance level R2. During the remainder of the trading day, price finds support at the previous day’s high. On September 26, 2013 price falls further to the support of the median PP pivot level. This support does not hold and price falls through, followed by an attempt to move up again. However, the PP resistance level is too strong and price drops to the level of S1 support. Now that we know various ways to project price movements, the next step is to apply our knowledge to identify the larger cyclical moves. I will discuss this in the next part of my series. 24 • November 2014 • Technical Analysis of Stocks & Commodities

Sylvain Vervoort is a retired electronics engineer who has been studying and using technical analysis for more than 35 years. His book Capturing Profit With Technical Analysis received a bronze medal from the 2010 Axiom Business Book Awards in the category of investing. The book is a technical analysis reference introducing a trading method called LockIt. His latest Band Break System trading expert is available on DVD. Vervoort may be reached at [email protected] or via his website at http://stocata.org. The code for this article is available at the Subscriber Area at our website, www.Traders.com, in the Article Code area, as well as at the direct link http://www.traders.com/files/VervoortNov2014.html, and also from the author’s website at http://stocata.org/ninjatrader/ formulas.html.

Further reading

Gopalakrishnan, Jayanthi [2014]. “Swing Trading With Sylvain Vervoort,” interview, Technical Analysis of Stocks & Commodities, Volume 32: May. Vervoort, Sylvain [2014]. “Exploring Charting Techniques, Part 1,” Technical Analysis of Stocks & Commodities, Volume 32: July. [2014]. “Exploring Charting Techniques: Basic Chart Trading (Part 2),” Technical Analysis of Stocks & Commodities, Volume 32: August. [2014]. “Exploring Charting Techniques: Creating A Trading Strategy (Part 3),” Technical Analysis of Stocks & Commodities, Volume 32: September. [2014]. “Exploring Charting Techniques: Demystifying Support & Resistance (Part 4),” Technical Analysis of Stocks & Commodities, Volume 32: October. [2013]. “Indicator Rules For Swing Trading Strategies, Part 1,” Technical Analysis of Stocks & Commodities, Volume 31: May. [Parts 2–7 appeared in the June–November 2013 issues.] ‡NinjaTrader (NinjaTrader, LLC) ‡See Editorial Resource Index

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 co-authored 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://Message-Boards.Traders. com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Tom Gentile

THE STARBUCKS/COFFEE CORRELATION As I have stated on several occasions before here in this column, I am a rulesbased trader. I don’t like trading off tips, recommendations, analyst buys or sells, or so on. I like one plus one to equal two before I take a short-term trade. But long term? That’s a different story. I hate to say it, but sometimes I get my best ideas for long-term trades while reading the news or watching TV. As I write this article, I am hearing a news story that somehow seemed to pass over my desk until now. Coffee, that stuff that’s just to the left of my keyboard every morning, is up 65% to date this year. Looking at the chart in Figure 1, you can see that coffee (the solid green line) has indeed bounced off the bottom of 2014 and looks to have made a 50% retracement from its highs of 2011. Though it has hit resistance earlier this year, this is still a far cry from where it began the year. As a contrarian trader, I pay attention to what the crowd is doing. Looking at the chart of Starbucks (SBUX) once again, I want to draw your eyes to the waves indicated by the numbered circles 3, 4, and 5. The third wave on the chart had the strongest up move, indicating that institutions were buying up SBUX in light of the drop in coffee prices. At that time, SBUX nearly doubled in price, moving from the low $30s to above $60 in 2012. The following year saw a much-needed pullback, at the same time that the price of cash coffee was retracing from its lows. This happened between April and August 2013. Since then, SBUX has been on a rise, doubling in price again, from near $40 in April 2013 to $80 recently. Bullish scenario A quick look at the chart in Figure 1

suggests that it’s time for SBUX to roll ward would be five points minus the $1.55 over, but I would also look at the price cost, or a reward of $3.45. of coffee. If coffee moves to fresh highs for the year, that could be the signal for Bearish scenario SBUX to move lower. Now obviously, If you take the contrarian approach, then it’s anyone’s guess as to where SBUX, or you believe SBUX will fall into spring. coffee for that matter, will be as we turn In that case, you’re looking for a bearish into 2015. Just remember, our summer is approach that limits upside risk while South America’s winter. Couple that with maximizing profit if SBUX drops. A a robust (pun intended) stock market and bearish spread is similar to the bullish it could lead SBUX to higher prices into spread, but involves puts. The higher next spring. How can you take advantage strike put would be bought, and a lower of a potential move higher while limiting strike put would finance the other to lower risk exposure? Continued on page 52 The case study in Figure 2 inBullish Projection above 82 volves a bull call spread, which is Top in Starbucks? a bullish spread where you finance one option with another to lower the cost and overall Bearish Projection below 72 risk of the position to its expiration. In Bottom in coffee? this case study, I am long the April Figure 1: INTERESTING CORRELATION. Even though the price of coffee dropped, 2015 80/85 call Starbucks (SBUX) stock rose. How can you take advantage of this potential move spread last priced higher? at 1.55. This means for $155 plus commissions, you have the right to buy 100 shares of SBUX at $80 a share, but you are also obligated to sell it at $85 a share if a buyer chooses to exercise. This is precisely what I would want — buy it at $80 and sell Figure 2: bullish scenario. In this bull call spread, for $155 plus commissions it at $85. In such you have the right to buy 100 shares of SBUX at $80 per share but also are obligated a scenario, the re- to sell at $85 a share. November 2014

• Technical Analysis of Stocks & Commodities • 25

Candles, Cups, Gaps, And Pivots

Seeing a simple breakout may convince you to place a trade, but how do you know if a breakout is really a breakout? Here’s one way you can jump into a trade and not get caught off-guard.

D

by Ken Calhoun

eveloping a consistent approach to identifying and trading breakouts that continue in an uptrend after a trade has been placed is a common challenge faced by active traders. Traders may often enter a position based on a simple breakout above new highs, which subsequently consolidates or pulls back, causing stop losses. Trading breakouts based on simple price action or candle-

26 • November 2014 • Technical Analysis of Stocks & Commodities

stick patterns alone runs the risk of buying near a pivot or exhaustion area. Similarly, relying too heavily on complex lagging indicators like moving average convergence/divergence (MACD) crossovers, relative strength index (RSI), or stochastics can generate false positive entry signals and lead to overtrading weak signals. One solution is to combine the best of strong, wide-range candlestick breakouts with cups, average true range (ATR) expansions, and gap continuations. These techniques are designed to help experienced swing traders capitalize on price volatility breakout patterns. Swing trading is defined as trades lasting from several days to several weeks in duration, using 90-day daily candlestick charts and 15-day, 15-minute candle charts.

KEN SMITH

Swing Trading With Momentum On Your Side

TRADING TECHNIQUES

A simple, strong breakout pattern is found whenever a wide-range candle occurs at the rightmost side of a bullish cup pattern. A “wide range” is defined as one in which the height of the candle is at least twice the height of the prior two daily candles. For example, in the 90-day daily chart of Tesla Motors, Inc. (TSLA) in Figure 1, you can see that on July 16, 2014 and August 7, 2014, the widerange candle at the right side of each bullish cup pattern led to more than a week of subsequent new-high breakout price action. FIGURE 1: Wide-range Candles & Cups. Finding taller-than-average candles at the right side of bullish cup patterns often These wide-range candle provides good breakout entry signals. days often attract new institutional money flow, as seen by the taller volume bars on versus increasing candle heights. These will visually show each of those days. An astute swing trader will wait until the ATR patterns. An example of both of these is illustrated in day following one of these high-volume wide-range candle the 90-day daily chart of Bituato Holdings Ltd. (BITA) in days to enter a new trade. A visual scanning process includes Figure 2. Similar to a classic three-line break (exhaustion) looking through 90-day daily candlestick charts to identify pattern, three decreasing-height candles leads to consolidation those charts in a reasonably strong uptrend that show this or reversal of price action. In contrast, when there’re three pattern, and developing a trading plan to initiate new entries increasing candles, this momentum of taller candles often above the highs of these wide-range candles. leads to a breakout continuation.

Average true

ranges and widerange candles On a 90-day candlestick chart, the visual pattern of increasing candle heights shows increasing ATRs. Spotting emerging new momentum breakout volatility therefore becomes a matter of simply looking for taller candles above key support/resistance areas (like the bullish cup highs I mentioned earlier). Rather than depending on a derived ATR pattern, it becomes easier to spot breakouts by looking at increasing candle heights (daily trading ranges), over several days’ time. On a 90-day daily chart, one pattern to look for is a series of three decreasing

Figure 2: Average true ranges and Candles. Looking for a sequence of three increasing vs. decreasing candle height patterns provides clues as to price exhaustion vs. breakout continuation. November 2014

• Technical Analysis of Stocks & Commodities • 27

eSignal

Swing trading wide-range candles & cups

fact, gaps often continue in-trend whenever characterized by high volume on the gap day and a wide-range candle. In the chart of US Steel (X) in Figure 3, this technical pattern is easily confirmed. Price action gapped from 28 to 32 and subsequently continued up an additional five points in the two weeks following the gap. Gaps — or windows in candlestick terminology — often occur after earnings releases or following a news release that impacts the price of the stock. A technical entry patFigure 3: Gap Continuation Entries. Gaps often continue in the direction of the gap, especially when the gap day has a wide-range high tern confirmation is volume breakout candle pattern like in this chart. found when price action takes out new Gap continuation highs during the two to three days following the gap day. entry patterns It’s often wise to avoid entering on the day of the gap, A common trading myth is that gaps often unless you are daytrading, because gaps will often have a fill, and that buying new gap highs is risky. resting or low-volatility day or two following the gap. In Nothing could be further from the truth; in the chart of Noodles & Co. (NDLS) in Figure 4, this is seen on the two days following the gap down: August 17 and August 18, 2014. In this chart, no short entry would be indicated unless price action loses the three-day support at 19.50. By waiting to confirm an entry on a technical confirmation signal like this following a gap, you can avoid the uncertainty that occurs during the immediate day or two following a gap chart.

Exiting

Figure 4: Resting Day Following Gap. Price action will often consolidate or rest following a major gap. It’s best to wait for new direction prior to entering.

28 • November 2014 • Technical Analysis of Stocks & Commodities

winning gap swing trades Once in a winning long gap continuation trade, it becomes important

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Steady continuous uptrends attract new money flow from institutional technical traders and retail traders.

to identify signals that indicate a slowing of breakout momentum. The two most important, as always, are price action and volume. In the chart of Canadian Solar Inc. (CSIQ) in Figure 5, there’re two warning signs, Figure 5: Exiting After Winning Gap Trades. Once entered, it’s important to look for clues that breakout momentum may be indicating that if you had declining, such as a series of decreasing candles on lighter volume. bought the initial gap up, you should now be looking to tighten in trailing stops to protect your profit. mentum. The second warning sign is the decreasing volume The first signal is the decreasing candle heights during bars, which indicates that buying momentum is slowing down the most recent three trading days. The candles are getting as well. So it’s a smart time to start closing out the trade with progressively smaller, indicating a slowdown in buying mo- tight trailing stops. November 2014

• Technical Analysis of Stocks & Commodities • 29

Figure 6: Retracement Following Gaps. Following gaps that fill, price action will often retrace to near a 50% zone and then resume the initial direction of the gap.

Gap reversals: 50%

gap fill buyers, to near a 50% retracement zone. If you look for these types of pivot zones, you can use a position-sizing approach where you would enter a small position once price action makes its initial pivot, followed by a secondary scale-in entry to add to the initial position once price action has taken out new 15-day highs, above the gap high. In this case, that would mean an initial entry in the 20.30–20.90 region, and a second entry above 22.60 for a scaled-in continuation breakout trade.

Pivots and moving averages

As has been the case in the S&P 500 index during 2013–14, price action will occasionally find support at the 50-, 100- and/ or 200-day simple moving average (SMA) support areas on a 90-day daily candlestick chart. Looking for classic candlestick hammer patterns at these major moving average areas can help you identify likely pivot points to use for your trade entries. You would enter your trades above these pivot points. In the example of the chart of Southwest Airlines (LUV) in Figure 7, classic daily hammers are found at the 50-day SMA lines, indicating long entries could be entered above the high of each hammer. As a general guideline, it’s best to enter above daily hammers on 90-day candlestick charts that find support at the 50-day SMA (as opposed to the 100- or 200-day SMA), since price pullbacks and selling pressure are less at the nearer 50-day SMA signal. When selling pressure has taken price action all the way down to the 100- or even 200-day SMA, there’s less strength for long trades indicated. While still viable, they should be entered more cautiously than with hammers that pivot early, off Figure 7: Hammers and moving averages. Pivot entries can be found following hammers that rest on a 50-, 100-, or 200-period of the 50-day SMA as seen in Figure 7. simple moving average line. retracement zones On the rare instances where weak gaps retrace, they will often pivot near a 50% retracement zone, as seen in the 15-minute, 15-day chart of SunEdison, Inc. (SUNE) in Figure 6. A minor gap that fails to take out new highs on the day following the gap day will occasionally drop and chop to near a 50% midline retracement area, after which it may get buyers and pivot back to the upside. The same is true of gaps down that bounce up, attracting long

30 • November 2014 • Technical Analysis of Stocks & Commodities

Developing an action plan

After making thousands of real-money trades, I have found during the last 15 years of trading that a key to success is to focus on the simplest, strongest, and most obvious breakouts. Steady continuous uptrends, punctuated by occasional bullish gaps and/or wide-range high-volume candle days, are much better because they are the charts that best attract new money flow from institutional technical traders and astute home retail traders. Developing a personal action plan can be as simple or complex as meets the needs of the individual trader. It helps to troubleshoot problem charts and failed trades by looking at which charts led to wins versus stops, and key differences between them. Keeping a traditional trading journal is often a useless exercise because traders don’t specify the exact technical entry signals used to enter a trade, nor the profit & loss (P&L) trade-management process used to produce wins versus stops. A technical trading journal that combines the best of the momentum breakout entry signals along with profit & loss per trade can be a much more effective strategy. Keeping technical analysis simple yet consistent is the hallmark of a good trader. Looking for the story of net buying vs. selling pressure with the help of candle heights (combined with traditional Western technical signals like volume, cups,

and gap patterns) can provide a potentially successful trading approach for savvy technical traders. Ken Calhoun produces trading courses, live seminars, and video-based training systems for active traders. A UCLA alumnus, he is the founder of DaytradingUniversity.com, an online educational site for day and swing traders.

Further reading

Calhoun, Ken [2012]. “Daytrading Price Volatility Breakouts,” Technical Analysis of Stocks & Commodities, Volume 30: June. Nison, Steve [2009]. Beyond Candlesticks: New Japanese Charting Techniques Revealed, John Wiley & Sons. ‡eSignal (Interactive Data) ‡See Editorial Resource Index

2015 Readers’ Choice Awards Winners will be announced in the Bonus Issue, available February 2015. If you are a current subscriber, go to Traders.com and log in to vote. Not a current S&C subscriber? Become one today! Call 1-206-938-0570 or go to Traders.com to subscribe. Subscribers to Stocks & Commodities can access our back library of articles at our website, Traders.com. For those interested, here are a few related articles, among others: Arms Jr., Richard W. [1991]. “Cross Your Arms,” Technical Analysis of Stocks & Commodities, Volume 9: May. _____ [1989]. “What Volume Is It?” Technical Analysis of Stocks & Commodities, Volume 7: December. Hartle, Thom [1991]. “Arms On Arms,” interview, Technical Analysis of Stocks & Commodities, Volume 9: July.

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November 2014

• Technical Analysis of Stocks & Commodities • 31

F

orex, foreign exchange, FX — they all refer to the trading of, or exchange of, one foreign currency for another. While the practice began simply as one of many routine banking mechanisms, it has recently evolved into a speculative market — that is, some people and institutions trade currencies strictly to make money.

Starting Out

Trading Forex: Understanding The Basics Part 1

In this first part of a new series on foreign exchange trading, you’ll get an overview of the basics of trading currencies. by Imran Mukati 32 • November 2014 • Technical Analysis of Stocks & Commodities

forex markets From the 19th century until World War I, the economically developed nations of the world adhered to the gold standard. To simplify a complicated issue, a nation’s wealth depended on how much gold it possessed, because the currency of any nation on the gold standard had a set value relative to gold. The British pound, for example, was fixed at the equivalent of 113.00 grains of pure gold, while the US dollar was fixed at 23.22 grains. This meant that a nation could only issue the total amount of currency that it could back with its gold reserves. In practice, some nations held a combination of gold and other currencies also backed by gold, but the end result was the same — a limit on its total currency in circulation. You may have already realized that such limits on a country’s currency also limit its government spending. This is precisely why World War I caused a breakdown in the gold standard system. Wars are expensive, and since the Great War (as it was then known) involved most of the world’s developed nations, it became necessary to spend vast sums on armies, navies, weapons, and warfare. The only way to accomplish this

DAVID GOLDIN

The advent of

FOREX FOCUS

was to decouple currency and gold reserves. After the war ended, a few nations returned to the gold standard briefly, but most did not. Then came another war, which left the developed world (except for the US) in shambles. Out of World War II came the Bretton Woods agreement, which created an international currency system tied not to gold but to the US dollar. In other words, other currencies would have their values determined in relation to the US dollar. However, the US pledged to make its own currency exchangeable for gold, so an indirect gold standard remained in effect. Economic realities of international trade and the costs of the Vietnam War eventually made the linkage between gold and the US dollar untenable. On August 15, 1971, President Richard Nixon unilaterally severed that linkage, announcing that the US would no longer exchange dollars for gold. It took a few years for the global economic system to adjust to this new reality, but what eventually replaced Bretton Woods was a system of managed floats. Theoretically, currencies change value, or float, freely relative to each other in the marketplace. In practice, the various central banks step in to moderate the value of their respective currencies should those values grow too strong or too weak. Both cases have negative economic consequences for a national economy. The emergence of this system of floating-value currencies is what permitted the creation of the modern forex marketplace.

n

United Kingdom: 4% n Canada: 3% n Australia: 2% n Switzerland: 1% Together, these seven countries generated 68%, or two-thirds, of the world’s economic activity! And as you’ll see later in this series, currency value and economic strength are intimately related. Of the majors, three pairs represent about half of all trading activity: EUR/USD at roughly 27% of trading volume, USD/ JPY at about 13%, and GBP/USD at about 12%. Obviously, the world has far more than just seven currencies, many of which can be traded, and these make up what are called exotic currency pairs. Matched against the US dollar, these currencies represent countries that are smaller players in the grand economic scheme of things. As you’ll see when we discuss the nuts and bolts of currency markets, the exotic pairs are riskier and much more expensive to trade. Here are some examples: n

USD/TRY: Turkish lira USD/SEK: Swedish krona n USD/SGD: Singapore dollar n USD/ZAR: South African rand n USD/MXN: Mexican peso n USD/HKD: Hong Kong dollar n USD/THB: Thailand baht n

Currency pairs

Because the forex marketplace is all about the value of one currency relative to another currency, all forex trading takes place in currency pairs. Today, seven currency pairs represent about 85% of all forex trades: n n n n n n n

Euro vs. US dollar (EUR/USD) US dollar vs. Japanese yen (USD/JPY) British pound vs. US dollar (GBP/USD) Australian dollar vs. US dollar (AUD/USD) US dollar vs. Swiss franc (USD/CHF) US dollar vs. Canadian dollar (USD/CAD) New Zealand dollar vs. US dollar (NZD/USD)

If you study this list for a moment, two things will become clear. One is that the countries shown here represent some of the world’s largest economies. Major countries like Germany and France use the euro, and although China’s yuan technically floats, in truth, the Chinese government closely manages its value. The other is that the US dollar is part of every one of these seven major pairs, making it the most traded currency worldwide. The reason these seven pairs are the majors is simple: economic power. Consider the contributions each represented country made to total global economic output in 2010: European Union: 26% n United States: 23% n Japan: 9% n

Finally, there are currency pairs that do not include the US dollar. Since these cross two foreign (for US traders) currencies, they are known as crosses. Following are just a few examples: n n n n n n

Euro vs. British pound (EUR/GBP) Canadian dollar vs. Japanese yen (CAD/JPY) Australian dollar vs. Swiss franc (AUD/CHF) Euro vs. Japanese yen (EUR/JPY) British pound vs. Swiss franc (GBP/CHF) Swiss franc vs. Japanese yen (CHF/JPY)

You probably get the idea; it’s possible to match any two non-USD currencies to get a cross. As long as they represent two major currencies, trading costs won’t be unreasonable.

The almighty dollar

Between the majors and the exotics, the dollar is involved in the vast majority of currency trades worldwide. If you’re wondering why this is the case, that’s an astute question. As it happens, no single factor accounts for this dominance. One reason is the lingering effect of Bretton Woods. For a quartercentury after World War II, the US dollar was the official reserve currency, and that didn’t change with the flick of a switch even after Nixon locked and barred the gold exchange window at the US Treasury. November 2014

• Technical Analysis of Stocks & Commodities • 33

The greatest benefit of this massive trading volume can be summed up in one word: liquidity. Another has to do with stability. While the American economy has its ups and downs like any other, overall it is stable and well-managed. The US also does not have problems with political instability or violence, like coups or civil wars or border conflicts, which contributes tremendously to economic stability. Directly related to the stability of the American economy is its size. US businesses engage in economic activity around the world, and that means many different currencies have to be exchanged to and from dollars. Coca-Cola, for example, has to trade dollars for pounds to pay wages or vendors for its operations in Britain, and trades pounds for dollars to bring its profits home. The size of the economy also translates to massive financial markets. People and institutions in countries around the world want to trade in the US markets, and to do so they have to have dollars. Finally, many major commodities are traded only or mostly in dollars. Oil is foremost among them, thanks to an agreement with Saudi Arabia that was inked in the 1970s. One consequence of this linkage is that when the US dollar is weak (that is, less valuable against other currencies), oil becomes more expensive in absolute terms — dollars per barrel.

Market basics

The global forex market is massive. Daily trading volume is currently equal to about $4 trillion — and again, that’s daily volume. By comparison, the US gross domestic product (GDP) for all of 2010 was $14.5265 trillion, and the McKinsey Global Institute reported that at the end of 2010, global equity (stock) market capitalization and outstanding bonds and loans represented about $212 trillion. In other words, the world’s total financial value changes hands on the forex markets every 53 days. Most of this trading volume comes from governments, central banks, private banks, multinational corporations, and institutions that are moving money for financial reasons, not for speculative reasons. But regardless of the source, the greatest benefit of this massive trading volume can be summed up in one word: liquidity. Some investments are more liquid than others. If you own land or a house, you can sell it, but doing so will probably take weeks or months. If you own a Picasso or Renoir painting worth millions, you can sell it too, but doing so could take even longer. That’s because everyone needs a place to live, though not everyone has the funds, or can secure a loan, to buy a house, but 34 • November 2014 • Technical Analysis of Stocks & Commodities

a rare painting has value to a small group of people (and even fewer have the millions needed to pay for it). Neither real estate nor collectible art is considered a liquid asset in that they cannot readily be exchanged for cash. Certain assets, like stocks or commodities, are much more liquid, since there is more demand for them and they can be sold fairly quickly. But keep in mind that some stocks are more liquid than others. If liquidity is a measure of how quickly something can be exchanged for cash, currency is cash! Of course, it’s not necessarily the currency that a trader wants. But the tremendous amount of currency changing hands every day means there are plenty of buyers and sellers in the market, and that means a high level of liquidity. This is part of what makes trading exotic pairs riskier — liquidity is much lower for low-demand currencies than for the majors, in the same way that IBM or Apple stock is more attractive than penny stocks.

Their nature

The last aspect of the markets that you need to understand is their nature. For investors accustomed to equity markets, the notion of a central marketplace is almost second nature, reinforced by images in the business news media of the trading floor of the New York Stock Exchange. As it happens, even most equity trading now takes place purely electronically. But the forex markets have no central trading arena or clearinghouse. Instead, currency traders sell directly to one another, a market system called over the counter. Unlike a stock exchange, which has a uniform set of rules for buying and selling the stocks listed there, each currency’s home country has its own rules and regulations governing the movement of money across its borders. For that reason, it’s more efficient for the world’s major banks to act as wholesalers of currency, governing the flows and setting prices. From them, pricing flows to electronic brokering services, which distribute quotes down the chain. Midsized banks act as intermediaries, and it is at this level that most institutional traders (like large companies and hedge funds) trade. Below those smaller banks are retail brokerages serving individual investors. It has really been the advent of the Internet that has permitted individuals to participate in the forex markets. As an individual trader, you are functioning in the cracks of the market, making relatively tiny trades compared to the massive sums of money moved by major players, and it is those players that drive prices, in combination with external factors, of course. In my next article of this series, I’ll look at the mechanics of trading currency pairs. Imran Mukati is the Managing Director of fixed income securities at Fairbridge Capital Markets, Inc. He may be reached via http://www.linkedin.com/in/imranmukati.

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

AND NOW FOR THE BASICS Mr. Bright, I have finally put together enough money to trade live, and I’m now setting up my workplace. I have two computers with multiple screens. I recall that a while back you had some tools and setups that you and your traders were using. Has much of that changed in the last couple of years? I know there are many ways of setting things up, but I was hoping for an update.—J. Keller Thanks for the question and for reading previous columns. Although I am not sure which specific column you are recalling, I did find enough to get you started. I’ll try to cover the basics to the more complex setups so you can determine what fits your style of trading. First, a quick review of the basics. Each new trader at Bright Trading has a choice of using either RediPlus or RealTick, with other options available for specific uses. I’ll use RediPlus for my examples. Other data vendors have similar screens available. The first window is what we call the basic quote monitor. This is where you can cut & paste a list of symbols into the first column (symbol). This is standard on all platforms. We like to pick and choose the columns in such a way that it is easy to determine what is happening in real time, for any symbol. For the sake of simplicity, I’ll provide a good example of column headings and their uses: Symbol: We generally place the indexes before individual stocks. For example, Dow Jones Industrial Average (INDU), S&P 500 spot price (SPX), Nasdaq 100 (NDX), euro vs. dollar (FXE), VIX, TICK, and any specific index you may be trading in

Last price: The last trade price or index value Change: Price change from previous day’s closing price Pct change: Percentage change in price. Here is how I set up mine, and why: Bid price: Current consolidated best bid price — I say “consolidated” to account for ECNs and other market centers. You may use “primary market” instead with some vendors Ask price: Same as bid price, but for the best offering price Last trade size: I like to see if this symbol is trading in small units or big blocks Last one: The previous trade size (as a horizontal ticker) Last two: The previous trade before the above Volum e weighted average price (VWAP): The VWAP is particularly helpful near end of day Open: Opening price for that stock Day high: High for the day Day low: Low for the day Volume: Volume for day, excluding premarket Alert low: Set alerts to trigger a flash of some sort when hitting your predetermined buy prices Alert high: Set alerts to trigger sell prices, or for entries after a breakout price is hit. This is about all I can focus on here, but there are many other columns that are of value, such as ex-dividend date, amount of dividend, and yearly high and low. Below the quote monitor we have an order entry window. This screen has November 2014

buy & sell buttons (and sell short, of course), symbol, price type (limit or market), destination (be careful not to pay for providing liquidity when you can receive money for it), quantity, price, time in force, and probably some sort of account reference. Everything can be done from this screen, but many use other screens like a montage. A montage will show Level 2 data (depth of market), can be personalized to fit your needs, and have autoupdates of orders (bid or offer changes, and so on). We also have a message monitor that shows order entries, executions, or cancellations. This has a tab to show what you’ve done for the day, average prices, and other helpful information. We tie our data vendor (front end) with (at minimum) an Excel spreadsheet. RediPlus has an add-in for Excel, which allows us to put together a spreadsheet that is linked to RediPlus. The data can be transferred to the spreadsheet using direct data exchange (DDE) links. You can organize all data into a spreadsheet, add in the current fair value, and have a formula for determining if the futures are trading at a premium or discount, which is helpful information. You can keep track of your trades at any time during the trading day, set up conditional formatting such as coloring the cells red or green, and much more. I don’t have the space here to get into more advanced tools this month, but I’d love to get into how to write to the various application program interfaces (APIs) and automated execution programs, and various other tools. Perhaps next month; stay tuned.

• Technical Analysis of Stocks & Commodities • 35

INTERVIEW

Stop, Be Realistic!

Battling The Futures With Larry Levin Larry Levin is president and founder of Trading Advantage, a firm specializing in trading education. Levin started out over 25 years ago as a runner at the CME futures exchange, then quickly climbed the ranks from phone clerk to desk manager to eventually trading his own account. At the height of his trading career, he averaged between 2,500–3,000 S&P contracts per day trading. Since he recognized early on the inevitable shift away from the open outcry pits to an electronic marketplace, Trading Advantage has made it its mission to teach students to trade online. He has made regular appearances on major financial media outlets including CNBC, Bloomberg TV, and Fox Business News. His daily blog can be found at www.tradewithlarry.com. Stocks & Commodities Editor Jayanthi Gopalakrishnan spoke with Larry Levin on September 8, 2014 about what it takes to start trading futures. Larry, we last interviewed you for our January 2007 issue. So what’s been going on with you since then? We’ve been around for 20 years, teaching people to trade. We’re getting ready to expand again. We now have 61 employees in three different cities. We have an office in Miami, an office in Los Angeles, and a really large office across the street from the Board of Trade in Chicago. We’ve also expanded our course offerings. We don’t just teach futures anymore. We teach options, stocks, back options, futures options, and currencies. We’ve been pretty busy since we last spoke. You got your start trading futures. Say someone wants to start trading futures and has no experience. Why would they even trade futures? A lot of people that we come across trade futures because they’re looking for one of two things: They’re either looking for a second income, that is, they are already employed, or they want to trade full-time. Trading futures gives you a lot of leverage, and that means it carries risks, just like any type of investing. There are good opportunities available in trading the futures markets. You can make money quickly but you can also lose money quickly. I think the possibility that you could have a second income or

even a first income is what gets people interested in trading futures. Do most people who come to you already have experience trading something else such as equities, or do they want to start out by learning to trade futures? I’d say it’s about half and half. Half of the people who approach us have some investing experience, usually in equities. But it’s not always people who trade for themselves. Most of them have financial advisors who give them advice or place the trades for them. A lot of these people have never traded futures. We also get a lot of people who’ve never invested at all when they come to us. They would have seen us on the Internet or seen me on television. To be honest with you, it’s the people who have no experience at all who are usually the easiest people to train. Why do you think that is? It’s because they don’t have any preconceived notions or bad habits that you have to work through. That sometimes makes it easier. How difficult is it for those trading equities to transition to trading futures? These days, most people — unless they have fairly deep pockets — aren’t going to be daytrading stocks. You need to have at least $25,000 if you fall within the category of being a daytrader. We

36 • November 2014 • Technical Analysis of Stocks & Commodities

Traders have to keep practicing the techniques and recipes, and make sure all their rules are met before entering a trade. teach people to daytrade, so when those who have traded equities start trading futures, trading those shorter time frames is a big change for them. Sometimes in futures, you can have trades on for five or 10 minutes, or even less. But regardless of whether somebody has traded before — equities, futures, or anything — what I want to do with everybody is to first teach them our methods and techniques, and second, get them on a simulator for an awfully long period of time. That, to me, is the key. You shouldn’t trade with real money when you first start. The simulator has to be fairly sophisticated. There are a lot of simulators that work in such a way that if your desired price is touched, you get filled. But that’s not realistic, which is why it’s important to trade on simulators that are sophisticated and realistic. Why do you focus on daytrading futures instead of holding them for a longer time period? One reason is that if you’re going to

daytrade, you’re able to get away with using less money or less margin. That also usually lessens the risk. Unfortunately, people usually keep the losers on and take the winners off. That’s a big problem in the industry. Another reason is you have more opportunities to make money when daytrading. Those opportunities have risk associated with them, but if you are looking to make income every day, then leaving trades on for weeks, or what people call swing trading, will leave you with days or weeks with no income. You will need to trade every day if you are looking to make an income. When you’re trading something for such a short time period, are there certain markets that you trade? Yes, we love to trade the S&P emini contract. It has a lot of liquidity, strong volume, and is very popular. There’s a lot of information available about it, but you don’t have to limit yourself to the S&P emini. We trade different commodities such as oil, soybeans, and gold. Gold is really exciting and has great liquidity. The four major commodities we trade are the S&P emini, oil, soybeans, and gold. When you teach people to trade, what do you encourage them to look for when it comes to identifying which market to trade? If people have no experience at all, we like them to trade the S&P emini for a couple of reasons. One is that the liquidity and interest is very high. That goes a long way to making sure that you can get decent fills. Beyond that, if

someone has traded before and they are interested in a specific market to trade, we won’t push them away from it. But if they don’t have any particular markets that they’re interested in, I believe the S&P emini is the easiest market to train people on because it’s got so much movement. There are so many opportunities when it comes to trading the S&P 500 emini. It’s very popular so it’s easy to find lots of information about it. It’s a great place to start. But going back to what I said earlier, no matter what market someone starts trading or what type of experience they have, they still need to start on a simulator so they can learn the techniques and methods without risking any money. Otherwise, they could lose a lot of money when they start, which will get them frustrated and at that point, they’ll stop learning. When it comes to trading futures, including the four markets you just mentioned, what kind of fundamental data should traders look at? What is important these days — and you wouldn’t necessarily put a trade on because of this — is to be aware of the Federal Reserve (Fed) and the influence they’ve had in our markets since 2008. That’s something you want to watch. You want to keep an eye on the movement of interest rates. The Fed can influence the movement of interest rates so it’s important to pay attention to what they are up to. Are they going to continue with the monetary easing or are they going to continue to pull away from that? I wouldn’t necessarily put on a trade based on the Fed’s decision, but if I was long equities or long stock index futures contracts and the Fed announced that they were planning to pull away from monetary easing sometime in the future, I would lighten my load. The second thing I would pay attention to, as far as fundamental activity is concerned, is the economic data that is released almost on a daily basis, whether it’s new home sales, the employment report, or anything. All of those things

38 • November 2014 • Technical Analysis of Stocks & Commodities

have a big influence on the way futures move on a daily basis. For example, the employment number that was released this past Friday was worse than expected. A layman would think that if a number is much worse than expected, that the market would drop on that day. But the market did the opposite. So you have to be careful how you interpret and apply the data. You have to connect the dots. The likely reason the market went up on Friday is because the Fed is not going to be easing and not get out of the way. All those things are connected and you have to have basic knowledge about them. You have to be careful not just about the data that is released but also about how they affect the market. You need to do some research and have some knowledge about the fundamental data and how they are likely to influence the market. How important is it to understand the specs of a particular market that you are trading? I would say that knowing the fundamentals is much more important than knowing the specs of a particular market. Obviously, you need to know what a tick is worth and what the dollar value of each tick is, but I would say that you’d be hardpressed to find too many professional traders that really know what the specs of a contract are. Obviously, they know the tick values, and they know when they are getting close to the upside or downside limits, but beyond that, I don’t think it’s necessary to know other details. It’s not bad to know the details of a contract; it’s just not necessary to know them to trade the contracts. Knowing the support & resistance levels is more important. Since you’re looking at such short-term movements on something that’s very liquid, what type of technical indicators or patterns do you look at? We look at a lot of technical data. In fact, we’re much more technical than we are fundamental, but both are extremely important. You wouldn’t want to have one without the other. We use a number of technical indicators, and we use algorithms. That’s one of the things we teach our students when they’re trading

It’s important to trade on simulators that are sophisticated and realistic. the S&P emini. We’re also big fans of Market Profile, which was introduced by Peter Steidlmayer. We use that same Market Profile chart with the letters and the bell curve, like we did before there were computers. Even though it’s done on computers nowadays, it’s still the same thing in that you’re looking at those bell curves and finding where the distributions are taking place. We also use something called a buyer vs. seller indicator, which charts the volume and who’s winning the wars. In electronic trading, you basically have two dynamics: You either buy the offer or you sell the bid. This indicator tells you who is winning that war. Are more people buying the offer or are more people selling the bid on a moment-by-moment basis? If you’re long, you obviously want more people to be buying the offer than you do selling the bid. If you see more people buying the offer and the indicator shows you that the trend is continuing, then you feel fairly comfortable staying with the long trade. On the other hand, if you’re long and you’re getting more people selling the bid or pushing that bid lower, and you see that in the indicator, that may either make you exit the trade or move your stop-loss up. The buyer vs. seller indicator is an important tool for us. We want to know who is winning that war. Are there any other indicators such as trend-following indicators that you look at? We have several individual trading techniques. One is called the slo-mo. One of our algorithms is a reversion to the mean. Those are all individual techniques. They work on almost any futures market. We use these techniques mostly on the S&P emini because that’s what we teach, but it can work on soybeans, gold, or oil. The reversion to the mean is seeing a trade or trend picking up in one direction and then waiting for a pullback to that mean or average price before entering the trade. All of our techniques are what I call “recipe-based.” What that means is that we have five or six rules that need to line up before you take the trade. So let’s say

you have an algorithm trade, and you’re looking for the reversion to the mean or for the market to come back to the average. The first rule may be to look for the market to come back to the middle. If it automatically puts a stop-loss in for you at that point, you want to make sure that stop-loss is less than two points in the S&P emini. There will be five or six rules like this and if one of them doesn’t line up, then you don’t want to take the trade. You only take the trade if all the rules are met. That’s what that recipe-based technical trading is about. Is that a technique you apply to discipline traders? Absolutely; most people come into trading without much discipline. Even as they’re learning the trade, it’s difficult to put the discipline into practice. Having those recipe-based techniques helps people know when to stay out of the trades and when to get into them. That really teaches discipline. It’s easy for us to — for lack of a better way to put it — catch our students doing the wrong things that way. We can go through their rules and tell them something like, “You have three rules that didn’t get checked off, but you still did the trade.” The student’s response might be something like, “Well, the other three were okay.” We can respond by saying, “Yes, but we need all six.” I hope they learn from that so they won’t do it next time. It’s a good way to get them to be disciplined without them realizing it. That’s why I coined that term recipebased trading. If you are baking a cake, you have to follow a recipe and it has to be exact if you want it to be good. You can’t just throw a bunch of sugar and a bunch of flour in a bowl and hope your cookies turn out. Trading should also be very exact. It shouldn’t be a random activity in any way. Are these five or six rules just for the entries? Yes, the rules are for the entries. There are different techniques to manage the trade. That’s where we apply the buyer vs. November 2014

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www.NeuroShell.com 301.662.7950 seller indicator, which is being aware of who’s winning that war. In other words, are more people buying the offer or are more people selling the bid? Within that, there are specific rules, but I wouldn’t call it a recipe. It’s more of a numbers-based indicator. I’ll give you an example. Say the buyer vs. seller indicator is at 1,000, and one of your rules to manage the trade is that it stays above 1,000. One of the rules for entering the trade may be that the number of people buying the offer exceeds 1,000. Say that all six rules for entering the trade were met and you were in the trade. When the buyer vs. sellers indicator drops below 1,000, regardless of what’s happening, you need to exit that trade. You’re looking for that continuation, and if it’s not there, you want to be out of that trade. In addition to these techniques, do you encourage the use of stop-losses? Always! For every trade we place in any market, except perhaps when it comes to buying options, we require stop-losses. The stop-losses are pointbased. We rarely, at least in the S&P emini, risk more than two points or $100

• Technical Analysis of Stocks & Commodities • 39

per contract. Most of the time you’ll know where your stop-loss needs to be, so you’ll base your entry on that. For example, if you don’t want to risk more than two points, and you place your stop at 1505 in the S&P emini, then you can’t buy it if it’s higher than 1507. Oftentimes, you’ll use the stop-loss as a map point to determine where you can get in because you know where your stop-loss needs to be. Since you’re not going to risk more than two points, you can’t buy any higher than two points above that stop-loss. If it’s higher than that, you have to wait until the market comes down or leave the trade alone. Earlier, you mentioned that people tend to hold onto their losers but sell their winners. This is typical, since people don’t want to admit they’re wrong. What’s a good way for them to overcome that type of thinking? It’s easy, really. All you have to do is practice, practice, and practice without using real money. It’s important to understand everything with the simulator. We’ve had students on simulators for as long as a year. We’d love to have the student off sooner, but if they’re not having success and they can’t get a grip on the mindset, then they continue practicing on the simulators. They’ve got to keep practicing the techniques and recipes, and make sure all their rules are met before entering a trade. It’s really important to use a realistic simulator and keep watching the news at the same time. It’s similar to a flight simulator in that it tries to recreate a similar environment. A flight simulator recreates a realistic environment for the pilot so he can learn to fly. Similarly, when you are learning to trade, you want the environment to be as close to the real trading environment as possible. You have to get realistic fills, not just those that take place when price hits a certain level. Trading in an unrealistic environment gives people false hopes and they’re not practicing in the right environment. Only if you practice correctly will you be able to get over holding onto losers and selling the winners. In addition to practicing under realistic conditions, their reactions to market

conditions have to be as if they’re second-nature, so doesn’t consistency play a role? It does, and we even take it a step further. We teach the emotional side of trading, and one thing I take pride in is our visualization techniques. We encourage our students to spend some time away from the screen, close their eyes, and visualize their trades. We want them to visualize their good trades, their bad trades, and what they’re trying to accomplish. This is similar to what lots of athletes do. Learning to trade is difficult. We try not to give anybody false hopes or make them think they’re going to make millions of dollars right away. We let everyone know that it’s extremely difficult to be a good trader. If you have a lot of bad habits you’ve picked up from trading for several years and you’re not following rules or you’ve fared poorly, you’ll find it even more difficult to accomplish what you want. The only way anyone can learn to trade successfully is to learn the way they did in school. They need to learn the material, they need to learn the techniques, and they need to be able to practice what they are learning. It takes a while. People need to realize that they need to put their time in. They think it’s a quick and easy way to make money since you don’t have to get a degree to trade. All you need is a trading account and be able to either press the buy or sell button or tell your broker to. And if you’re lucky, you could make money that way. Unfortunately, if you make money the first time you trade, you probably think you know what you’re doing.

stop-loss in, to me, it’s suicide. All it takes is one instance when you don’t have a stop-loss in place and the market flushes all the way down, wiping out your entire account. There’s no time machine to go back in time to fix that.

I would think continuous learning is necessary because markets never behave in the same way. You never know what you’re going to face at any time. It is not objective like many other professions are. That’s a good point. Even if the chart formation looks similar to previous ones, Janet Yellen, chairman of the Federal Reserve, could say, “We’re going to raise interest rates tomorrow,” and that would change everything. That’s why stop-losses are so important to place on any open position. If you don’t have a

Thank you for sharing your thoughts, Larry.

40 • November 2014 • Technical Analysis of Stocks & Commodities

No, you just have to get comfortable taking that loss. Yes, and here’s what is unfortunate: If someone lost their entire account (which was, say, about $10,000) because they never put a stop-loss in and never exited the trade, then they want that $10,000 back right away. Prior to the loss, they may have only been looking to make $300 or $400 a day. Now all of a sudden, they need to make $10,000. That’s just not realistic. We have to avoid those types of situations and make sure they never happen in the first place. But when they lose that much, wouldn’t they be tempted to blame the trading system they learned and move on to a different technique taught by someone else? They would lose consistency, since there are so many different ways to trade. And they would end up making similar mistakes, wouldn’t they? For sure. The wheels come off, and they lose a significant amount of money because they didn’t put a stop in or something like that. They then go to another educator. It’s just too late at that point. They may be better off not going down that road again. After such an emotional turmoil, you want to make that money back, but it’s so difficult to get back on your feet and start trading and be successful.

Further reading

Gopalakrishnan, Jayanthi [2007]. “Larry Levin Has Those Traders’ Secrets,” interview, Technical Analysis of Stocks & Commodities, Volume 26: January. • www.tradingadvantage.com • www.tradingadvantage.tv • www.tradewithlarry.com

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 Group, where she also works as a broker. She authors widely distributed e-newsletters; for your free subscription, visit www.DeCarleyTrading.com. Her books — Currency Trading In The Forex And Futures Markets; A Trader’s First Book On Commodities; and Commodity Options — were published by FT Press. To submit a question, post your question at http://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.

SO MANY CHOICES (PART 2) Shopping for a commodity brokerage is overwhelming; what should I be looking for? (part 2 of 2) Last month in part 1 of my response to this question, I discussed the various types of brokerage firms along with the pros and cons of doing business with each format. This month, I’ll focus on various levels of service available to futures traders and briefly consider which makes the most sense for typical traders of differing skill and experience levels, as well as accounting for the cost of errors when considering an appropriate commission rate. Choosing a brokerage service level • Full-service (broker-assisted) Technically, “broker-assisted” describes a moderately lesser service than “fullservice,” but for simplicity and brevity, I lump them together. Full-service brokers generally offer their clients a substantial amount of hand-holding; this most often involves trade placement and execution, market guidance, trading recommendations, and other hands-on tasks such as margin call management. Most important, they attempt to steer clients clear of the most common pitfalls in commodity trading. Full-service brokerage service comes at an additional cost in terms of commission, but it might be cheaper than paying costly tuition to the markets in the form of trade placement errors and other avoidable mistakes. Unlike the days of old, a good fullservice broker should be able to accommodate your orders during market hours via telephone, email, instant message, or maybe even text message, during market

hours. Obviously, brokerage firms must keep records of all client communications, so in some cases, electronic communications are preferred due to the ease of compliance monitoring. • Self-directed online Traders with enough experience to have garnered the basic knowledge necessary to navigate a trading platform — such as commodity symbols, available trading months, and calculating risk — might opt to save money on commission and place orders through an online platform. However, before doing so they must be capable of emotionally coping with the urge to overreact, or worse, overtrade. I’ve seen too many beginning traders rush into online trading. Their goal is to

There is no such thing as a perfect brokerage firm, but there is likely a perfect brokerage for your individual needs. save money, but the goal of trading is to make money, not to save it. There are unlimited numbers of examples in which traders choosing this service type for economic reasons end up losing thousands of dollars in the markets making rookie mistakes. For example, I’ve witnessed traders trade the domestic sugar futures rather than the more liquid world futures contract. This simple mistake can easily cost you several hundred dollars on a single contract because of the lack of liquidity. To put this into perspective, the day I wrote this article, the world sugar futures contract for March had traded nearly 37,000 contracts but the domestic sugar November 2014

Carley Garner

contract for the same expiration month traded only five contracts. Quite simply, if you make the mistake of getting into domestic sugar, you might have a hard time getting out at a reasonable price. Other common mistakes are trading the wrong year or month, buying when the intent was to sell or vice versa, not being aware of open and close times of each market, and not fully understanding the difference between stop and limit orders. Further, it isn’t uncommon for beginning traders to sell a contract that is locked limit up. In such a scenario, the exchange’s daily price limit has been reached, leaving an environment in which you are able to sell but not buy. The justification beginning traders often use for selling into a limit move is that prices cannot go against them because of the price limit. They see it as a risk-free trade; however, nothing could be further from the truth. Although price cannot go up in the current session, you may not be able to exit the position until the next session, at which time prices might be considerably higher, maybe even limitup to trap them into the position with large losses. Each of these mistakes is costly but can be easily avoided with proper experience. If you are not ready to trade online, you should be willing to pay a little extra for the expertise of a full-service broker and work your way toward being an online trader. Simply put, don’t trip on dollars while chasing pennies. • Discount online Traders opting for this level of service should be experienced and highly capable of operating with little help from their Continued on page 52

• Technical Analysis of Stocks & Commodities • 41

This One Is Just Right!

Slow Down: Equity Curve Ahead

T

by Robert Cocchiola

echnical analysis can lead to successful trading, but only if you have a good equity curve. A good equity curve, like a bad one, is constructed from various parts of your project. The success or failure of your efforts will be revealed in the equity curve, which is the ultimate judge of your creation. Success in trading is not found in the final value of the account. What makes an equity curve good is the way it indicates steady growth in your account without scary pullbacks. What makes an equity pullback scary? It causes loss of sleep. Your eyebrows start to fall out. You can’t eat because everything tastes like week-old flounder. But most of all, it makes you stop trading and want to kill the friend who convinced you that

42 • November 2014 • Technical Analysis of Stocks & Commodities

daytrading was a swell idea for a person as smart as you. To help avoid those little unpleasantries, here are a few steps you can take.

Tools of the trade

Let’s start by examining your tool bag. The basic building blocks of a trading system are: the platform, the optimizer, the bars, and the algorithm. The platform you select depends on your skill level and your need for something special or particular offered by a given platform. Since I can’t know every reader, this will be all that I will say about platforms. What’s an algorithm? It’s a set of one or more rules that articulate the conditions necessary to enter and exit trades. These rules may, and almost always do, contain variables that control the sensitivity of some type of threshold. The thresholds inside the rules are there to filter out undesirable patterns in the data. It is these thresholds that are manipulated by the optimizer to warp the rules into effective filters.

SPEED BUMP: SERGLY 1975; ART: CHRISTIne MORRISON

The equity curve judges the success or failure of your system. What makes an equity curve good or bad? What does it take to achieve a good equity curve? We’ll take a look.

TRADING TECHNIQUES

What about bars? They’re filters too. Their job is to be the right type and size to absorb noise in the data and reflect patterns of meaningful change in the data. And finally, what is the optimizer? Its purpose is to marry the bars to the algorithm by tweaking the variables in the algorithm across many iterations to generate good trades in the past and create a behavior that will carry on into the future and make you rich. Okay! We’re all set. Go forth and subscribe to a platform. Take some courses and buy some DVDs that describe moneymaking systems. Plug some historical data into a chart. Plug in your get-rich-quick algorithm. Run the optimizer and start trading tomorrow. By the next week, everyone who reads this will be in receipt of a perpetual annuity and my email inbox will be flooded with all your notes of thanks, right? I don’t think so, and here’s why that won’t happen. The proprietary trading system described on that DVD for $89 or $5,000 no doubt claims to reveal wonderful mechanisms to get you to the promised land. But I’m here to tell you that I have spent many hours with clients who spent good money on “the answer.” Here is the truth of it. If you had a system that generated steady profits, would you: a) Trade your account and reinvest all your profits to compound your return and become a multimillionaire very quickly or b) Go through the headache of publishing DVDs containing your system so that lots of folks can use your concept against you? Given that in every transaction on an exchange, one person just did a smart thing and the person on the other end of the trade didn’t, is the answer really b? And another thing to consider is this: If the system really is useful, how can it stay useful if 10,000 traders buy the system and begin using it, and they all get the same signals that you do, all at the same time? If all of you tried to place a buy order at the same time, who is selling, and at what price? In my line of work, I have seen all the “unique, confidential, and proprietary” systems than I care to remember, along with the traders who believed in them. The problem is that, regardless of platform, everybody is trying to solve the exact same problem with the exact same tools. After a suitable amount of frustration, they find themselves subconsciously fashioning a hangman’s noose, frozen with analysis paralysis, and they become desperate enough to try anything.

Zeroing in

Let’s go back and take a closer look at the tools and examine our role in using them. The optimizer is a useful piece of software. Any lack of desired outcomes that it produces is generally caused by a discrepancy between what it does and what you hope it does. You hope that it will place your algorithm on steroids

and conquer the market. But what it really does is fairly straightforward: It manipulates parameters to find the least objectionable configuration of an algorithm. The task boils down to creating an aperture, using your supplied bars and algorithm, which will allow the most hopeful data patterns to pass through while blocking the most objectionable. The difficulty is that objectionable data occurs above and below the desirable data. So as it changes your filter’s amount of acceptance and sets the thresholds higher or lower, it is simultaneously rejecting certain nasty data that was out of reach, while readmitting data that was previously rejected on a prior iteration. When it finishes, it presents the least objectionable result. Generally, this result is only ideal for very little of the data, even though you thought that you would get ideal settings. You are thinking positively while the tool is working somewhat negatively. So what can you do? Think negatively. If you understand its limitations, you can partner with it and remove some of the burden. The single most effective thing I’ve seen is a do not trade indicator. It is part of the logic that identifies patterns in the data where no trade should be attempted. In order to design this logic, you must understand what behavior your formula needs to succeed and focus on blocking as much as possible of the data structures that it can’t reasonably handle before asking the optimizer to find compromise. So first, you need to build the positive formula that does what you want it to do. Next, look at the bar size of the data. What’s going to happen to your algorithm if it hits a patch of big bars? How about a patch of small bars? How about a sequence of three bars up and then three bars down? Any of these conditions and many more can generate losses based on the needs and vulnerabilities of your formula. Note that many formulas don’t like bars that are too big or too small, just like the proverbial Goldilocks, and the optimizer will try to adjust the thresholds to accommodate this. Think of the potential assortment of bars and sizes as Goldilocks’ 3,000 bears. You’ve got to find the “bed” that’s just right or you’ll wake up in a painful state indeed.

Which one is “just right”?

The optimizer doesn’t have your brain power or your knowledge of what you’ve built. One possible scenario is that you may have a productive set of parameters that produce some nice trades when they are in their element. Unfortunately, when bars of a dangerous configuration are evaluated during optimization, the damage exceeds the good. The optimizer will then walk away from this setting. Remember the concept of the least objectionable behavior. If you can eliminate the dangerous bars for the optimizer, then it might find that the current iteration has now become a sweet spot. For index futures and all stocks, the potentially nastiest bars can come at 9:30 am US Eastern time (ET). That’s the open of the US markets. If your algorithm finds this data to be unpredictable and consequently draws you into bad trades, then block trading at this time until the market settles. One of the quietest times is around 1:00 pm ET. Apparently, people take a break or eat lunch or get up and stretch. Whatever the cause, that time is November 2014

• Technical Analysis of Stocks & Commodities • 43

The straightness of the equity growth is far more important than the final value of the account. much calmer than the open. So pick your poison. Avoid trading times that scare your algorithm. Use hard-fixed rules to offload that headache from the optimizer. How can you identify data that is too aggressive or too bland? Consider the ATR (average true range), the RSI (relative strength index), the r from linear regression, the relationship between two moving averages, and the current bar’s high, low, and close. I can’t offer specific formulas here because they depend on knowing the strengths and weaknesses of the rest of your logic. Here’s a brief statement about expectations. Trend-following methodologies tend to have win/loss ratios in the vicinity of 30–35%, while scalps or reversion-to-mean strategies tend to have higher win/loss ratios. Keep in mind that the trendfollowers need to score some decent trends to make up for all the losers. Meanwhile, in the mean reversions, you’ll win more trades but the duration of a pullback is shorter, which limits your profit, and when your trade fails, the size of your loss will be substantially larger.

You and your optimizer: A little help for your friend

What else can you do to help your optimizer? You could fix the bars. Bar data consists of signal and noise. Signal is a collection of bars moving in one direction. Noise is one or more bars that go the other way without starting a reverse trend. Bars come in types and they absorb data to create signal patterns and noise traps. The usual bar types are time-based (for this discussion, we’ll consider minute bars and hourly bars only), range bars, volume bars, and renko bars. Time bars absorb everything in their time frame. If you have two minutes of signal data and three minutes of noise data and if this occurs continuously within the confines of a five-minute boundary, then congratulations, you’re going to be rich! You will put up a five-minute chart and it will be noiseless. All you have to do is trade the trends. They will be obvious. Of course, as we know all too well, that’s not going to happen. So observe this: A time bar in a tight time frame will usually be compatible with all other same-sized time bars in the same-time window. That is, you could possibly get good results from a strategy based on time bars that run from 9:45 am ET to 10:15 am ET because the volatility and trading ranges will be similar across days. By confining the times, you offload some of the burden from your partner, the optimizer. If you would like to continue trading, optimize a second strategy for the next hour. Again, the teamwork between you and your optimizer will pay off. Now take a good look at your main logic. Observe the lag 44 • November 2014 • Technical Analysis of Stocks & Commodities

in the functions that you use and also the minimum window size needed for a successful trade. If your function uses a 10bar simple moving average either explicitly or internally like a Bollinger Band, it will generate five bars of lag. This means that something that you care about will occur and you won’t be able to recognize it for five bars. So if you’re going to put on a trade — and this is part of the logic — then you will need to move five bars in a direction to get in and then five bars the other way to get out. You’re going to need a data stream of at least six or seven bars in one direction to have time to get in and out and still be able to harvest something. Remember that your logic is held back by the function with the worst lag.

What can you do about this?

Smaller bars will generate longer sequences for a directional move at the expense of releasing more noise as data. Range, volume, and renko bars can replace time bars and generate longer sequences while absorbing more noise than their time-based counterparts. The bottom line is that for any collection of data (defined at the tick level of a symbol), there is only one type of bar in only one size that will give the best result for one of your algorithms. You can turn that around and realize that your concept will work best with a certain bar type and size and will disappoint if used in the wrong environment. If you think that your idea is not performing as it should, hold the idea steady and change bar types and sizes along with the time window and observe the variety of results that can come from a single recipe and a given dataset.

The power of the equity curve

Finally, we come to the fruit of our labor: the equity curve. This is the bar-by-bar accounting of the cash value of your portfolio. The straightness of the equity growth is far more important than the final value of the account. If you have a daytrading system that yields $30,000 a year and never pulls down the equity by more than $300, then you’re good. You can sleep well and have confidence that you’ve built a bulletproof system. Take a second mortgage on the house, sell the dog and cat, and get the kids to start a lemonade stand to raise cash for you to trade with. In other words, bet the farm. Put as much money as possible into slow, steady, and safe growth and you will achieve the best results. However, if you only focus on the final account value, you might drown. A system with a final yearly return of $60,000 may be hazardous to your health. Many times, a system will achieve a high level of profit midway through the out-of-sample period and then give back half of it near the end of the data. This is something you must consider. Say a system started at zero, then ran up to $120,000, and then down to $60,000. If you began using this system near its $120,000 high point, by the end of the period, the system would show a nice net profit of $60,000, but you would have

Neuroshell DayTrader

FIGURE 1: AN IDEAL EQUITY CURVE. The pullbacks in the equity curve in the middle window are unnoticeable. It generates 82% winning trades and yields $100,000 in profits. The starting equity is $2,300. The bottom window shows what happens when you start with a $40,000 account and trade 75% of equity, reserving 25% for possible pullbacks.

a substantial loss. Slow and steady wins the race. Moreover, if your system is prone to equity swings, then you must ask yourself whether you would stay the course when it gives back profits or whether you would panic and halt trading until your blood pressure drops. To do this work, you need an understanding of your tools. You have help files and the Internet (and this magazine) to explain what’s going on inside an RSI, a stochastic, or a Bollinger Band. If you don’t know the internals of your project, then you can only guess about how to avoid pitfalls. You also need imagination. You will struggle if you are doing the same thing as everyone else. Say you construct a well-reasoned algorithm. When you test it against historical data, you may learn that it doesn’t produce the outcome you expect. One possible explanation is that many other traders are using that same logic, and the limited historical profits are a result of too many shares trading in the same direction at the same time and thus distorting the market. You must do something different.

Thinking outside the box

Let’s step outside the box. Watch your head; I’ve seen people knocked unconscious trying to step out of the box. Here, I’ll give some examples of something different. (But first, a note and disclaimer. The examples shown here are

based on futures trading; $4 roundtrip commissions; daytrading with conservative margins; and charts built around static data that can be used for optimization and measurement of outcomes on your favorite platform. I am not presenting actual market experience. No slippage is assumed. The ideas I present here are applicable to equity markets and forex markets.) The chart in Figure 1 of the emini S&P continuous futures contract, which looks at two months in 2013, indicates what I believe is an ideal equity curve. Look carefully at the equity curve in the middle window. The pullbacks are almost unnoticeable. Here, one contract of the emini S&P futures contract is traded. It generated 82% winning trades. It made 8,535 total trades yielding a $100,000 profit and a 35,500% APR. To begin trading, it required a $2,300 account. This chart is out-of-sample. What’s so different about this example? When you have a high-quality equity curve, then you can test for a more normal trading pattern. No one who achieves that kind of result would keep on trading one contract. The bottom window shows what happens when you start with a $40,000 account and trade 75% of equity, reserving 25% for possible pullbacks. As you can see, the two-month profit goes to $47+ trillion. However, before you try to place a down payment on the purchase of Costa Rica, please keep in mind that the required trade volume cannot be executed. The other thing that makes this different is that November 2014

• Technical Analysis of Stocks & Commodities • 45

FIGURE 2: NEURAL NET INPUT. Using the curve shown here as the only input to a neural net generated the trades shown in this backtest.

it behaves the same way when applied to any time frame for the S&P contract, and it requires no optimization. Here’s another example of thinking outside the box. The

chart in Figure 2 shows the input to a neural net. The neural net input shown is the only input. No price data or anything else is input. From this sole source, the neural net was able

FIGURE 3: ANOTHER GREAT EQUITY CURVE. This system generated 73% winning trades. There were a total of 81 trades yielding $13,575 in profit and a 1,572% APR.

46 • November 2014 • Technical Analysis of Stocks & Commodities

FIGURE 4: REMOVING THE NOISE. Using renko charts to absorb the noise resulted in 78% of trades being profitable, a $74,000 profit, and an APR of 99,000%.

to configure itself to generate the trades shown. Figure 3 shows the data of Figure 2 when zoomed out. Note the equity curve when one contract is traded. This data is from four months in 2014. It generated 73% winning trades. It made 81 total trades yielding a $13,575 profit and a 1,575% APR. To begin trading it required a $2,900 account. As before, I asked the system to set up a $40,000 account and trade 75% of equity while holding back 25% for drawdowns. As you can see, this resulted in a $2,750,000 profit in four months with a 31,000% APR. You will also notice that the small pullbacks in the one-contract equity curve are magnified by the compounded profits. Still, considering the performance, I would expect that these temporary losses should be tolerable. The chart in Figure 4 uses optimized renko bars to absorb the noise. The noise removal is so effective that the trading strategy consists of only two statements. The simple rule is: Compare the current optimized renko bar to the previous one and place the appropriate trade. Note that the renko bars are not displayed. Only the underlying ticks are shown. Again, this system was set up with a $40,000 account and to trade 75% of the account balance, reserving 25% to cover drawdowns. The final equity curve is excellent, with 78% of the trades being profitable. The final result is a profit of $74,000 with an APR of 99,000%.

Know your optimizer well

the total number of variables that can be manipulated. As this number rises, it becomes easier for the optimizer to give you a great backtest and terrible out-of-sample results. Remember, you and the optimizer are partners. Find a fixed (nonoptimized) way to block data that the optimizer can’t accommodate and you will generate superior results. Robert Cocchiola is a consultant and the author of the Interchart Tools series of add-ons for NeuroShell Trader software. These programs allow NeuroShell Trader’s optimizer to select the correct bar size for a given symbol and algorithm. The optimized bars work with all 800 NeuroShell functions and are tradable on TradeStation accounts. Cocchiola may be reached by email at [email protected] or by contacting NeuroShell Trader sales at Ward Systems (301 662-7950).

Further reading

Peterson, Dennis [2011]. “NeuroShell Trader 6,” product review, Technical Analysis of Stocks & Commodities, Volume 29: September. Sherald, Marge [2010]. “Neural Network Pair Trading,” Technical Analysis of Stocks & Commodities, Volume 28: February. ‡NeuroShell DayTrader (Ward Systems Group)

In summary, the equity curve is everything. In the three charts shown, there are no lagging functions of any kind. The first chart’s algorithm predicts the next bar and generates 82% profitable trades. If that sounds difficult, it is. If you’re going to use optimizable functions, then you must keep an eye on November 2014

• Technical Analysis of Stocks & Commodities • 47

product review

thinkorswim Sharing TD Ameritrade, Inc. AND AFFILIATES Website: www.thinkorswim.com, www.mytrade.com Email: [email protected] Product: Social media sharing tools and online community for thinkorswim users Price: Free for TD Ameritrade account holders

O

by Donald W. Pendergast Jr.

nce an individual makes the important decision to pursue the goal of becoming a successful trader, chooses a stock/option/forex/ commodity broker, and funds his account, he may then find himself faced with some vital questions that, for many newer or struggling traders, could take years to get answered — if at all. In the meantime, new traders may lose so much trading capital that they could end up quitting in disgust and frustration. Some of these vital questions could be along the lines of: n

n

n

“How can I shorten the learning curve so I can eventually trade successfully?” “Who can help teach me the key charting, systems, scanning, analysis and trading workflow routines that can help me toward consistent profitability — thus saving me lots of trial and error?” “How/where can I find other traders to interact with; those who are willing to share the acquired wisdom and trading procedures that have helped them become successful?”

n “Are any/all of the above resources

available to me in a convenient, easy-to-access venue, and free of charge?”

Shortening the

learning curve Traders who use thinkorswim as their broker and trading, charting, and analysis platform might just find that all of those pertinent questions — and more — can be answered within the thinkorswim/MyTrade section of this comprehensive analysis and trading platform. The platform already offers a myriad of unique technical, analytical, and forecasting tools for serious traders and investors. Experienced traders using the thinkorswim/MyTrade tools will have an eager audience of newer and maturing traders with whom they can freely share their trade ideas, charts, scans, watchlists, and chart layouts. The exposure that up-and-coming market participants get to the nonstop stream of meaningful market-related content has the potential to dramatically shorten their learning curve. Here, newer traders may be able to:

1. Learn the operation of the charting, scanning, and analysis tools within the platform 2. More effectively analyze simple to complex option trades 3. Gain access to prewritten trading strategy code for backtesting 4. Learn more about order entry tactics and position management 5. Analyze charts and other visual forecasting tools to identify promising trade opportunities 6. Maintain a productive trading mindset; the social interaction with skilled traders can be vital for traders just starting on the sometimes arduous pathway to success in the markets. Before we continue, I’ll provide a quick primer for some of the terminology related to the thinkorswim/Sharing tools

48 • November 2014 • Technical Analysis of Stocks & Commodities

found both within the thinkorswim platform and the thinkorswim web-based trading platform: n

thinkorswim is the actual trading and analysis platform; a web and mobile version are also available

n

thinkorswim/Sharing is the broad, descriptive name that encompasses all of the sharing features linked to thinkorswim

n

thinkorswim/MyTrade is a website and section within the thinkorswim platform where user-posted trades, ideas, and charts are distributed to other MyTrade users

n

thinkorswim/MyTrade is subdivided into four sections: Think Share, Dashboard, My Page, and People. The Dashboard allows complete customization so you can organize all of your charts, watchlists, quotes, company links, stock headlines, and RSS/blog feeds. The People section lists those you follow on a single web page. I’ll discuss the Think Share and My Page features a little later.

Basics

For this review, I used thinkorswim in its paperMoney demo version (a live, simulated trading account offering all the same features that thinkorswim live trading accounts have) and its MyTrade features on my Windows 8 64-bit notebook computer equipped with an Intel Core I7 processor and 8 MB of RAM; my Internet connection was a standard DSL line. After downloading the software, installation was fast and trouble-free and the real-time datafeed operated flawlessly, as did every feature I subsequently used within the platform. Although thinkorswim is a desktop computer application, users can also log into a convenient web-based platform that allows all of their basic trading and

order entry processes; mobile users are also afforded the same kind of access. The desktop version obviously has many more features, one of which is the thinkorswim chat room; however, anyone with web or mobile access who is following others in MyTrade can still receive all of the same trades ideas and charts as those using the desktop version. Since MyTrade makes use of Twitter, Facebook, and email, web and mobile users can always stay abreast of what’s going on with the financial instruments and markets they choose to analyze and trade. MyTrade is integrated within thinkorswim; users can also log in at the website at http://www.mytrade.com/ thinkshare/.

Share and share alike

The MyTrade section of the platform provides thinkorswim users with a continuous stream of fresh trading ideas, complete descriptions of trade setups, charts, market commentaries, and other useful information that keeps thinkorswim/MyTrade users abreast of what’s moving in the markets, along with practical ways to trade the related setups. Users can also link their Twitter accounts to their MyTrade page, along with the RSS feed from their personal blogs. Users also have access to the thinkorswim chat room, which opens up yet another way for traders to share and discuss trade setups, charts, scans, watchlists, and code in greater depth. Users can opt to receive all content or only content from those they follow, and there’s tons of it in a never-ending flow. Posts from users appear under the Think Share tab, with data organized into two main categories:

It’s a terrific, easy-access venue in which traders with a solid track record and topnotch trading skills can get noticed.

cells containing content related to AAPL will populate your screen within a few seconds. Once you locate a trade setup you like — all of them provide detailed buy/sell information, and some even come with a descriptive video clip — simply click the copy trade icon to the right of the trade and then hit the paste icon at the top right corner of the page. The same exact trade will appear in your order entry screen within thinkorswim. You can modify it in any way you like (quantity, buy/sell, option strike price, and so on) if needed, and then you can send the order in to be executed by thinkorswim. You can elect to have your trade shared on your MyTrade page, and any thinkorswim users who are following you via Twitter will instantly be alerted to your latest (and hopefully greatest) trade. If you choose not to share trading setups, advice, charts, scans, and watchlists but simply prefer to follow those who do, the process works the same way, only in reverse. Let’s say you’re a very talented chartist and technical analyst; you’ve visually identified an attractive chart pattern, trading signal, or breakout move on your favorite stock and you want to share it with your followers. Once you’ve detailed

your chart with your studies and/or trading strategy, just hit the share button and your chart will be ready to share with others via your MyTrade page, Twitter, Facebook, and email accounts. Your followers will get the chart and will be able to use it as-is or tweak and adjust it to suit their own trading biases or needs. Meanwhile, if you’re a follower, you can do the same with the charts that your MyTrade feed sends your way. Your followers can also save your exact workspace study and trading strategy parameters for future use, thus saving time and “trial-and-error” misadventures that can eat up valuable trading capital.

My trade becomes

your trade I decided to visually scan through daily charts of key S&P 500 index (SPX, SPY) stocks and I located a very promising buy opportunity in shares of Autodesk Inc. (ADSK); the stock staged a sharp, wide-range, big-volume rally on Friday July 18, 2014 after having tested several significant support levels. It only took a moment to draw the linear regression channels on the chart (Figure 1), and then I applied the thinkorswim LongHaul filter by clicking on the charts tab

n Trades n Ideas

and charts

A filtering feature enables you to opt to receive all posts in both categories or to only receive content from those sharers you choose to follow. Alternatively, you can search for specific content on a particular keyword or ticker. For example, let’s say you are interested in trading Apple Inc. (AAPL); just type “AAPL” into the search box on the Think Share page, and a plethora of

FIGURE 1: A PROMISING OPPORTUNITY. Once a thinkorswim MyTrade user has detailed his chart with buy/ sell signals, trading strategies, drawings, and other visuals, simply clicking the share icon will launch the next step of the sharing process. November 2014

• Technical Analysis of Stocks & Commodities • 49

FIGURE 2: SHARING A CHART. The next step in sharing a chart from within the thinkorswim sharing window is deciding whether to send it via email, Facebook, and Twitter or to have it posted directly to your MyTrade page.

in thinkorswim and then following this pathway: Studies/Add Study/Stocks and Commodities Magazine/A-R/LongHaul Filter

The LongHaul Filter is a basic visual alert for potential buy opportunities in trending stocks (the little blue/white light bulb icon near the bottom of the chart identified the last four signals). This filter is based on a complete trading strategy that I described in my article that ap-

peared in the 2014 Bonus Issue of this magazine (“A Trading Method For The Long Haul”). The actual strategy code for the thinkorswim LongHaul Filter (as well as many other code listings) can be accessed via the thinkScript Strategy webpage at http://tos.mx/fIH5JZ. Once I had detailed and annotated my ADSK chart to my liking and saved it to my computer’s drive, I wanted to share it with the rest of the thinkorswim sharing community, which was very easy to do, once I was logged into MyTrade at http://

FIGURE 3: DISTRIBUTING CONTENT. thinkorswim users can also share directly from the MyTrade website at http://www.mytrade.com/thinkshare/. After clicking share a chart, this popup window appears for entering a description and comments. A thumbnail image of the chart is also displayed. Hitting submit sends the chart and text to the user’s MyTrade page.

50 • November 2014 • Technical Analysis of Stocks & Commodities

www.mytrade.com/thinkshare/. I clicked the Think Share tab and then the share a chart link on the top right side of the page. A small window popped up and I entered the ticker symbol (ADSK) and a title for my post before clicking browse so I could upload my ADSK chart from my drive to MyShare (Figure 2). Once it’s ready to be uploaded, a small preview image of the chart will appear in the popup window. All that was needed now was for me to add my trade-detail comments for the chart (Figure 3). When I was satisfied with my chart and comments, I simply hit submit and everything appeared at the top of the ideas and charts column in the Think Share portion of MyTrade. A much larger version of my chart and comments also appeared in the My Page section of MyTrade; this is the area where sharers can post their social media contact information, a photo and a brief biography (Figure 4). Sharers need expend little effort to distribute their content within thinkorswim MyTrade, and it’s a terrific, easy-access venue in which traders with a solid track record and top-notch trading skills can get noticed by the rest of the thinkorswim sharing gang.

Less can be more (useful)

Given the enormous amount of content being posted, tweeted, and emailed via thinkorswim/Share, here are some ideas on how to streamline your daily workflow within thinkorswim/MyTrade, especially if you are new to the world of trading: n

Limit your trading focus to a small, specific, diversified group of stocks and ETFs (or forex or commodity markets)

n

Trade the same time frame for each portfolio you construct. If you work at a day job, then trade end-of-day (daily or weekly charts) only

n

After reviewing the final trade results of those you follow within MyTrade, boot those with marginal or losing track records and then focus on the two or three sharers whose trading approach produces winning outcomes and whose methodologies most

closely resonate with your own trading psychology (Figure 5) n

Use a thinkorswim paperMoney simulated trading account to paper-trade the output of your favorite sharers before you put real money on the line in the markets; when you’re satisfied with the simulated results, begin trading with just a small fraction of your trading capital.

Summary

The thinkorswim/Sharing concept may just be the ultimate fulfillment of the trader’s dream of a “one-stop shopping” venue for financial market participants, one where dedicated traders and educators can meet, learn, research, analyze, test strategies, share trades, charts, ideas, and then place trades with a higher degree of confidence than ever before. Thinkorswim has always been one of the preeminent option analysis/trading platforms, and the new sharing features elevate this already first-rate platform to an even higher level for retail traders.

FIGURE 4: SHARING ACCOMPLISHED. I posted this chart and commentary to the MyTrade website on July 19, 2014. It was also shared to the Think Share and My Page sections within the thinkorswim trading platform, as well as to my Twitter account. Sharers can list a brief biography of themselves, their location, and other contact details on the MyTrade website.

Donald W. Pendergast Jr. has contributed articles and reviews to this magazine since 2008. A trader, market technician, and system developer, he is a consultant who offers stock-specific trading signals and customized analysis. He can be reached at [email protected] and via his website http://ezstocksignals. sitespawner.com/.

Further reading

Pendergast Jr., Donald W. [2014]. “A Trading Method For The Long Haul,” Technical Analysis of Stocks & Commodities, Volume 32: Bonus Issue. [2013]. “Swing Trading With Three Indicators,” Technical Analysis of Stocks & Commodities, Volume 31: December. Peterson, Dennis [2012]. “Thinkorswim. com,” product review, Technical Analysis of Stocks & Commodities, Volume 30: May. ‡thinkorswim (TD Ameritrade Inc.) ‡See Editorial Resource Index

FIGURE 5: MANY WAYS TO SHARE. Here is a small sampling of the MyTrade/Think Share content for Apple Inc. (AAPL) on July 23, 2014. November 2014

• Technical Analysis of Stocks & Commodities • 51

Explore Your Options Continued from page 25

the cost and overall risk of the position to its expiration. In this case study, I am long the April 2015 75/70 put spread last priced at $1.70 (Figure 3). This means for $170 plus commissions, you have the right to sell 100 shares of SBUX at $75 a share, but you are also obligated to buy SBUX at $70 a share if a buyer chooses to exercise. It’s not a bad scenario: Sell SBUX at $75 and be forced to buy it lower at $70. With this case study, the reward would be five points minus the $1.70 cost, or a reward of $3.30. You could create a doppio (another pun) and trade the call and put position

at the same time. This is called a short condor, but the combination would cost more and reward less, so keep that in mind. It depends on your outlook — either bullish, bearish, or both — and your risk tolerance. One thing is for certain: you will know the outcome of this and all stocks in due time.

FIGURE 3: BEARISH SCENARIO. Since you are long the April 2015 75/70 put spread priced at $1.70, it means that for $170 plus commissions, you have the right to sell 100 shares of SBUX at $75 a share but are also obligated to buy SBUX at $70.

FUTURES FOR YOU Continued from page 41

brokerage firm. In essence, a discount online brokerage firm provides clients with access to the markets and account statements, but generally, the service ends there. For some traders, this makes sense. After all, there is no need to pay for service you absolutely do not need. Even if you are an experienced trader, you must understand that you will always get what you pay for. Occasionally, there could be technical issues with an exchange or Internet outages that might require additional service from your brokerage. In general, the firms offering highly discounted commission rates cannot afford to hire a large, or experienced, staff; so you can expect long hold times, delayed service, and other obstacles should an emergency arise. When trad-

ing leveraged futures contracts, being on hold for several minutes can be a pricy experience. Many of the clerks working at such firms are inexperienced and are offering their services at minimum wage with small opportunities for earning commission incentives. Thus, your service expectations should be tapered and you should be willing and capable of performing on your own. • Hybrid (broker-assisted/self-directed) A good brokerage firm will offer clients the option of a hybrid service level in which they have access to a live broker throughout the day in addition to the ability to place orders via a computer platform. This is a great option for those who prefer to have somebody to bounce ideas off of, or don’t always have computer access during market hours but

SILIGARDOS / WHEN THE SMART MONEY FAILS Continued from page 19

Schwager, Jack [1993]. Market Wizards: Interviews With Top Traders, Harper Paperbacks. Siligardos, Giorgos [2008]. “Interest Rates And The Stock Market: The Current State,” online article available at http://www.trade2win.com/articles/1100-interest-ratesstock-market-current-state/p/1 _____ [2008]. “What The End Of 2007 Showed,” online article available at http://www.trade2win.com/ 52 • November 2014 • Technical Analysis of Stocks & Commodities

would like to place most orders through a platform. It is the best of both worlds — high level of service with the convenience of online account access and moderately lower commission rates. WHICH ONE SHOULD YOU CHOOSE? There is no such thing as a perfect brokerage firm, but there is likely a perfect brokerage for your individual needs. Finding the appropriate brokerage relationship will take a considerable amount of work, and shouldn’t be overlooked; nor should the decision be made solely on the price of commission. After all, choosing a brokerage firm might just be the most important trading decision you’ll ever make.

articles/1098-what-end-2007-showed Upperman, Floyd [2005]. Commitments Of Traders: Strategies For Tracking The Market And Trading Profitably, Wiley Trading. Williams, Larry [2005]. Trade Stocks And Commodities With The Insiders: Secrets Of The COT Report, Wiley Trading. Wikipedia: “Swap (finance)” entry, https://en.wikipedia.org/ wiki/Swap_(finance)

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Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before trading options. Contact us at 800-672-2098 for a copy. The Sizzle Index is the ratio of an underlying’s volume/implied volatility for the current day against the simple average of the prior five days. Delta is a measure of an option’s sensitivity to changes in the price of the underlying asset. Market volatility, volume and system availability may delay account access and trade executions. Offer valid through 3/31/15. Minimum funding (within 60 days) of $2,000 required for up to 500 commission-free Internet-equity, ETF or options trades. Contract fees still apply. See Web site for details and other restrictions/conditions. TD Ameritrade reserves the right to restrict or revoke this offer at any time. This is not an offer or solicitation in any jurisdiction where we are not authorized to do business. TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2014 TD Ameritrade IP Company, Inc. All rights reserved. Used with permission.

For this month’s Traders’ Tips, the focus is mainly Sylvain Vervoort’s article in this issue issue, “Price Projections” which is part 5 of his Exploring Charting Techniques series. Here we present the November 2014 Traders’ Tips code with possible implementations in various software. Code for NinjaTrader was already provided with Vervoort’s article by the author. S&C subscribers will find that code at the Subscriber Area of our website, www.Traders.com. (Click on “S&C Article Code” from the homepage.) Presented here is an overview of some possible implementations for other software as well. Traders’ Tips code is provided to help the reader implement a selected technique from an article in this issue or another recent issue. The entries here are contributed by various software developers or programmers for software that is capable of customization. Readers will find the November 2014 Traders’ Tips code and formulas at our website, Traders.com, in the Traders’ Tips area. Here, you can read some discussion of the techniques’ implementation by the Traders’ Tips contributors as well as some example charts. To locate Traders’ Tips at our website, Traders.com, click on the Traders’ Tips link from our “Home—S&C Magazine” menu at the top of the home­page, or scroll down to the “Current articles” section and click on the Traders’ Tips tab.

F TRADESTATION: NOVEMBER 2014 TRADERS’ TIPS CODE In “Price Projections” in this issue, which is part 5 of an ongoing series titled Exploring Charting Techniques, author Sylvain Vervoort introduces several methods he uses for defining possible support & resistance levels. In the article, Vervoort provides code for his version of a daily pivot indicator that calculates support & resistance based on the prior day’s high, low, and closing prices. We are providing TradeStation

Figure 1: TRADESTATION. Here is a sample 30-minute chart of the SPY with the daily pivot indicator applied.

54 • November 2014 • Technical Analysis of Stocks & Commodities

EasyLanguage code for a daily pivot indicator based on the calculations given in Vervoort’s article. To download the EasyLanguage code, please visit our TradeStation and EasyLanguage support forum. The code can be found at http://www.tradestation.com/TASC-2014. The ELD filename is "_TASC_SVEPivots.ELD." For more information about EasyLanguage in general, please see http://www.tradestation.com/EL-FAQ. A sample chart implementing the indicator 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

F eSIGNAL: NOVEMBER 2014 TRADERS’ TIPS CODE For this month’s Traders’ Tip, we’ve provided the formula SVEPivotsUtcRt.efs based on the formula described in Sylvain Vervoort’s article in this issue, “Price Projections” in his ongoing Exploring Charting Techniques series. 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 implementing the study is shown in Figure 2. To discuss this study or download a complete copy of the formula code, please visit the EFS Library Discussion Board forum under the forums link from the support menu at www. esignal.com, or visit our EFS KnowledgeBase at http://www. esignal.com/support/kb/efs/. The eSignal formula script (EFS) is also available for copying & pasting from the Stocks & Commodites website at www.traders.com in the Traders’ Tips area. —Eric Lippert eSignal, an Interactive Data company 800 779-6555, www.eSignal.com

Figure 2: eSIGNAL. Here is an example of the study implemented on a 30-minute chart of the Euro Composite.

Figure 3: WEALTH-LAB, PIVOTS. Here is a sample Wealth-Lab 6 chart illustrating the application of the floor trader pivots trading system on a five-minute chart of Twitter (TWTR).

F WEALTH-LAB: NOVEMBER 2014 TRADERS’ TIPS CODE In his article in this issue, “Price Projections,” which is part 5 of his ongoing series on exploring charting techniques, author Sylvain Vervoort introduces his SVEPivotsUtcRt indicator as a way of drawing daily pivots on the chart. In today’s trading platforms, the ability draw pivots is commonplace, and Wealth-Lab is no exception. Thus, we don’t need to provide any custom code. After you download all the available strategies using the download button in the open strategy dialog, look for the strategy named “floor trader pivots.” Likewise, the other techniques mentioned by Vervoort — namely, the step candle pattern and 1-2-3 wave count — are also ready to be explored as downloadable strategies in Wealth-Lab. A sample chart showing some floor trader pivots is in Figure 3. —Eugene, Wealth-Lab team MS123, LLC www.wealth-lab.com

F NEUROSHELL TRADER: NOVEMBER 2014 TRADERS’ TIPS CODE In “Price Projections” in this issue, author Sylvain Vervoort discusses more elements of charting in his ongoing series on exploring charting techniques, including measured moves, Fibonacci projections & retracements, and daily pivots. Here, we’ll take a look at how some of the charting techniques he describes can be invoked in NeuroShell Trader. Price levels and projections can be easily implemented in NeuroShell Trader using the following methods: 1. Turning points. The Turning Points add-on for NeuroShell Trader helps find local peaks & valleys in a price series. It allows implementation of price swings and projections into automated trading systems. Among other things, the turning points indicator computes support & resistance lines from prior price swings; Fibonacci retracement lines from each price swing; and the prob-

Figure 4: NEUROSHELL TRADER. This sample NeuroShell Trader chart displays a few of the turning point add-on indicators.

ability that the current price level is at a new turning point based on statistical measures. 2. Past price swings. Sylvain Vervoort’s SVEHLZZperc indicator, which he introduced in his June 2013 Stocks & Commodities article “The 1-2-3 Wave Count,” uses the zigzag indicator to identify past price swings on the chart. This indicator is available for download from our support site www.ward.net. 3. Fibonacci levels. You can draw Fibonacci retracements, Fibonacci projections, and even Fibonacci timelines on the chart using NeuroShell Trader’s built-in drawing tools. 4. Pivot points. Create daily pivot indicators using a few of NeuroShell Trader’s 800+ indicators. Simply select “New Indicator …” from the Insert menu and use the indicator wizard to create the following indicators: Pivot Point PP: Avg3(DayHigh(High,1), DayLow(Low,1), DayClose(Close,1)) Resistance R1: Subtract(Add2(PP, PP), DayLow(Low,1)) Resistance R2: Add2(PP, DayRange(High,Low1)) Resistance R3: Add2(R1, DayRange(High,Low1)) Support S1: Subtract(Add2(PP, PP), DayHigh(High,1)) Support S2: Subtract(PP, DayRange(High,Low1)) Support S3: Subtract(S1, DayRange(High,Low1))

5. Projected price swings. Use NeuroShell Trader’s built-in neural network predictions to find patterns in past data and then use those patterns to identify likely future price swings. Users of NeuroShell Trader can go to the Stocks & Commodities section of the NeuroShell Trader free technical support website to download a copy of this or any previous Traders’ Tips. A sample chart is shown in Figure 4. November 2014 • Technical Analysis of

Stocks & Commodities • 55

—Marge Sherald, Ward Systems Group, Inc. 301 662-7950, [email protected] www.neuroshell.com

F METASTOCK: NOVEMBER 2014 TRADERS’ TIPS CODE Sylvain Vervoort’s article in this issue, “Price Projections,” includes his version of daily pivots. The following MetaStock formula is designed to change “days” when the Coordinated Universal Time (UTC or GMT) shows midnight. The formula prompts the user to enter his time zones UTC adjustment. If the indicator is being plotted on a daily or higher interval, the UTC adjustment is not used. rollmod:= Input(“Coordinated Universal Time (or UTC) adjustment”, -12, 13, -5); rolltime:= If(rollmod >= 0, rollmod, 24-rollmod); roll:= If(rolltime = 0, Hour() < Ref(Hour(),-1), Hour() < rolltime AND Hour() >= rolltime); intraday:= LastValue(Max(Cum(Hour())<>0, Cum(Minute())<>0) >0); new:=If(intraday, roll, ROC(DayOfWeek(),1,$)<>0); yh:=ValueWhen(1,new, Ref(HighestSince(1,new,H),-1)); yl:=ValueWhen(1,new, Ref(LowestSince(1,new,L),-1)); yc:=ValueWhen(1,new, Ref(C,-1)); pp:=(yc+yh+yl)/3; r1:=(pp*2)-yl; s1:=(pp*2)-yh; r2:= pp+r1-s1; s2:= pp-r1+s1; r3:= pp+r2-s2; s3:= pp-r2+s2; r3; r2; r1; pp; s1; s2; s3;

Figure 5: AMIBROKER. Here is a sample EURUSD 30-minute chart with daily pivots and support/resistance levels shown. S2 = 2 * PP - PH - PL; S3 = S1 - PH - PL; Plot( C, "Price", colorDefault, styleBar | styleThick ); Plot( PH, "PH", colorGreen, styleNoRescale ); Plot( PL, "PL", colorViolet, styleNoRescale ); Plot( PP, "PP", colorBlack, styleNoRescale ); Plot( R1, "R1", colorBlue, styleDashed | styleNoRescale ); Plot( R2, "R2", colorLightBlue, styleDashed | styleNoRescale ); Plot( R3, "R3", colorAqua, styleDashed | styleNoRescale ); Plot( S1, "S1", colorRed, styleDashed | styleNoRescale ); Plot( S2, "S2", colorOrange, styleDashed | styleNoRescale ); Plot( S3, "S3", colorDarkYellow, styleDashed | styleNoRescale );

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

—William Golson MetaStock Technical Support www.metastock.com

F AMIBROKER: NOVEMBER 2014 TRADERS’ TIPS CODE In “Price Projections” in this issue, author Sylvain Vervoort continues his article series on charting techniques, including using daily pivot points to estimate future price levels. A ready-to-use AmiBroker formula for daily pivots is presented here. A sample chart is shown in Figure 5. ph = TimeFrameGetPrice("H", inDaily, -1 ); pl = TimeFrameGetPrice("L", inDaily, -1 ); pc = TimeFrameGetPrice("C", inDaily, -1 ); PP = ( PH + PL + PC )/3; R1 = 2 * PP - PL; R2 = PP + PH - PL; R3 = R1 + PH - PL; S1 = 2 * PP - PH;

56 • November 2014 • Technical Analysis of Stocks & Commodities

F AIQ: NOVEMBER 2014 TRADERS’ TIPS CODE The AIQ code for this month is based on Sylvain Vervoort’s article in this issue, “Price Projections,” which is part 5 of his ongoing series on exploring charting techniques. The AIQ code and EDS file can be downloaded from www.TradersEdgeSystems.com/traderstips.htm. The code runs on daily bars only and computes the various support & resistance levels for the next day’s intraday trading. The levels cannot be plotted on the real-time alerts chart. In Figure 6, I show a report that was run on the major indexes for 9/10/2014. The code is as follows: !PRICE PROJECTIONS !Author: Sylvain Vervoort, TASC Nov 2014 !Coded by: Richard Denning 9/10/2014 !www.TradersEdgeSystems.com C is [close]. H is [high]. L is [low]. !To get next day levels we will be running the report at the end of day

Continued on page 58

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Editorial Resource Index Microsoft Excel . . . . . . . . . . . . . . . . . 14 NinjaTrader . . . . . . . . . . . . . . . . . . . 21 eSignal (Interactive Data) . . . . . . . . . . . . . 27 Neuroshell DayTrader (Ward Systems Group) . 45 thinkorswim (by TDAmeritrade) . . . . . . . . . 48 TradeStation . . . . . . . . . . . . . . . . . . . 54 Wealth-Lab . . . . . . . . . . . . . . . . . . . 55 MetaStock . . . . . . . . . . . . . . . . . . . . 56 AmiBroker . . . . . . . . . . . . . . . . . . . . 56 AIQ . . . . . . . . . . . . . . . . . . . . . . . . 56 TradersStudio . . . . . . . . . . . . . . . . . . 58 updata . . . . . . . . . . . . . . . . . . . . . . 60

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November 2014

• Technical Analysis of Stocks & Commodities • 57

Continued from page 56

Figure 6: AIQ. Support & resistance levels are calculated based on end-of-day data as of 9/10/2014 for the major indexes. The levels are for use in intraday trading for the next day (9/11/2014).

!so prior high will be the current H, etc. The report will give the !values for the next day but cannot be ploted on a real time chart !since we are using daily end of day data to compute the levels. !THIS CODE RUNS ON DAILY DATA: P is (H+L+C)/3. R1 is (2*P) - L. R2 is P + (H - L). R3 is (2*P) + (H - (2*L)). S1 is (2*P) - H. S2 is P - (H - L). S3 is (2*P) - ((2*H) - L). NextDayLevels if C > 0 and H > 0 and L > 0 and H - L > 0.

—Richard Denning [email protected] for AIQ Systems

F TRADERSSTUDIO: NOVEMBER 2014 TRADERS’ TIPS CODE The TradersStudio code based on Sylvain Vervoort’s article in this issue, “Price Projections,” is provided at the following websites: • www.TradersEdgeSystems.com/traderstips.htm • www.TradersStudio.com → Traders Resources → Traders Tips

The following code files are provided in the download: • Function PIVOTS: Returns the pivot point and all the support & resistance levels based on daily high, low, and close of the input data. This is the value for the next day if the input is the current end-of-day close • Indicator plot PIVOTS_IND: Plots the six support & resistance levels from the PIVOTS function on the next day’s intraday bars shifted back one day • System DISPLAY_PIVOTS: This is not a trading system but just my way of displaying the levels on a chart.

The support & resistance levels can be displayed on any historical intraday chart. The code uses the same data file compressed to daily data by setting it up as the child datastream with the type set to “daily.” Note that this cannot be used to trade intraday, as TradersStudio does not as of yet have a 58 • November 2014 • Technical Analysis of Stocks & Commodities

Figure 7: TRADERSSTUDIO, SUPPORT & RESISTANCE. Here is a sample chart of the emini futures contract (ES) 60-minute bars with the support & resistance levels calculated from yesterday’s daily bar data.

real-time module. In Figure 7, I show a chart of the emini futures contract (ES) 60-minute bars with the support & resistance levels calculated from yesterday’s daily bar data. The code is as follows: 'PRICE PROJECTIONS 'Author: Sylvain Vervoort, TASC Nov 2014 'Coded by: Richard Denning 9/10/2014 'www TradersEdgeSystems.com Function PIVOTS(PriceH as bararray,PriceL as bararray,PriceC as bararray,ByRef P,ByRef R1,ByRef R2, ByRef R3, ByRef S1, ByRef S2, ByRef S3) 'THIS CODE RUNS ON DAILY DATA AND COMPUTES THE NEXT DAYS SUPPORT AND RESISTANCE LEVELS: 'Dim P As BarArray P = (PriceH+PriceL+PriceC)/3 R1 = (2*P) - PriceL R2 = P + (PriceH - PriceL) R3 = (2*P) + (PriceH - (2*PriceL)) S1 = (2*P) - PriceH S2 = P - (PriceH - PriceL) S3 = (2*P) - ((2*PriceH) - PriceL) PIVOTS = P End Function '------------------------------------------------------------------------------------'INDICATOR PLOT CODE: Sub PIVOTS_IND() Dim priceH As BarArray Dim priceL As BarArray Dim priceC As BarArray Dim P As BarArray Dim R1 As BarArray Dim R2 As BarArray Dim R3 As BarArray Dim S1 As BarArray Dim S2 As BarArray Dim S3 As BarArray priceH = H Of independent1 priceL = L Of independent1 priceC = C Of independent1 P = PIVOTS(priceH,priceL,priceC,P,R1,R2,R3,S1,S2,S3) plot1(R1[1]) plot2(R2[1]) plot3(R3[1]) plot4(S1[1])

Continued on page 60

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Self-directed traders, as Stocks & Commodities readers usually are, have more choices than ever in their search for speed, pricing efficiency, and good accounting when it comes to brokerages. First, you have to find a brokerage that handles your tradable; you can choose between a full-service brokerages or a discount brokerage. Full service would mean you would sit down with your broker, whereas discount brokerage would involve trading online without any advice from a professional. Most institutions that offer full service brokerages also have the discount broker option. Other considerations are what kinds of tools or services do they provide? Do they provide real-time data? Which markets do they give you access to? Do they have account minimums? How fast are their executions? How much are their commissions? What kind of support do they offer? With the presence of freely available company information online, retail brokerage research is less valuable than it ever has been. Nevertheless, if you’re in less intensively studied but highly commercial markets such as futures, a brokerage’s ability to provide market statistics, hedging activity reports, and other commercial information may be critical to your trading and investing decisions. Finally, don’t forget the security of your money. Inquire about a brokerage’s clearing operations, and if you’re in equities, about Securities Investor Protection Corp. (Sipc) coverage.

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1. Interactive Brokers 2. Forex Capital Markets LLC (FXCM) 3. optionsXpress 4. Scottrade 5. TradeStation 6. Fidelity Active Trader Pro (Fidelity Investments) 7. TD AMERITRADE, Inc. 8. E*TRADE Group, Inc. 9. Global Futures Exchange & Trading Company, Inc. 10. Infinity Futures These are the 10 Brokerages viewed most often on the Traders’ Resource website, where each company is listed in order of clicks received. This is not an editorial rating or ranking. For more information on specific products and services, try checking store.Traders.com for archived S&C product reviews.

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].

November 2014

• Technical Analysis of Stocks & Commodities • 59

Continued from page 58

Figure 9: NINJATRADER, CHOPPINESS INDEX. This screenshot shows the indicator applied to a 15-minute EuroFX futures chart in NinjaTrader. FIGURE 8: UPDATA, PIVOT POINTS. Here is an example of Sylvain Vervoort’s described technique for finding pivot points applied to the currency pair EUR/USD in 60-minute resolution. plot5(S2[1]) plot6(S3[1]) End Sub '----------------------------------------------------------------------------sub DISPLAY_PIVOTS() Dim DailyData As BarArray DailyData = C Of independent1 If BarNumber > BarSize Then Buy("LE",1,0,Market,Day) If BarNumber = LastBar - 1 Then ExitLong("LX","",1,0,Market,D ay) End Sub '-------------------------------------------------------------------

—Richard Denning [email protected] for TradersStudio

F UPDATA: NOVEMBER 2014 TRADERS’ TIPS CODE Our Traders’ Tip for this month is based on the article “Price Projections” in this issue by Sylvain Vervoort, which is the fifth part of his ongoing series, Exploring Charting Techniques. In the article, Vervoort defines a set of pivot points, which are supposed places of support or resistance, based on ratios of the previous day’s high, low and close. These levels are then plotted over the current day’s price. Hardcoded versions of Fibonacci levels already exist in Updata, so we don’t need to provide custom code for those. The Updata code for Vervoort’s technique of finding pivot points has been introduced into the Updata Library. You can download the code by clicking the custom menu and then indicator library. Those who cannot access the library due to a firewall may paste the code shown in the Traders’ Tips area of www.traders.com into the Updata custom editor and save it. A sample figure is shown in Figure 8. —Updata support team [email protected], www.updata.co.uk

60 • November 2014 • Technical Analysis of Stocks & Commodities

F NINJATRADER: NOVEMBER 2014 TRADERS’ TIPS CODE Since NinjaScript code for NinjaTrader was already given in Sylvain Vervoort’s article in this issue (“Price Projections”) for his techniques in this month’s installment of his “Exploring Charting Techniques” series, we’ll focus here on another topic: the choppiness index. The choppiness index was designed to help determine whether the market is choppy (that is, trading sideways) or not (trading with a trend in either direction). This study is not meant to predict the future market direction, but rather, it’s just a metric to be used for defining the market’s trendiness. Higher values equate to more choppiness, while lower values signify more directional trending character in price. However, it can be hard to determine the exact trend in which the market is making with the lower values. With this in mind, we have included additional checks for when our values are falling and our closing prices start to go below or above a moving average. If the market is trending up, we will see a green study plot; if down, a red one. This indicator is available for download at www.ninjatrader. com/SC/November2014SC.zip. Once you have it downloaded, from within the NinjaTrader Control Center window, select the menu File → Utilities → Import NinjaScript and select the downloaded file. This file is for NinjaTrader version 7 or greater. You can review the indicator source code by selecting the menu Tools → Edit NinjaScript → Indicator from within the NinjaTrader Control Center window and selecting the “ChopIndicator” file. NinjaScript uses compiled DLLs that run native, not interpreted, which provides you with the highest performance possible. A sample chart implementing the choppiness index is shown in Figure 9. —Raymond Deux & Cal Hueber NinjaTrader, LLC www.ninjatrader.com

NEW CERTIFICATION PROGRAM FOR INDIVIDUAL TRADERS OR INVESTORS The Technical Securities Analysts Association San Francisco (TSAA-SF) has launched a new exam for certification in technical analysis. The exam was developed by industry experts, is administered by the TSAA-SF, and is sponsored by StockCharts.com. The program includes a self-study course, online practice questions, the ChartSchool at StockCharts.com, a practice exam, and a TSAA-SF Certificate of Completion after successfully passing the final exam.

www.tsaasf.org, StockCharts.com

SITE UPGRADE includes ADVANCED stock analysis tools The Bollinger On Bollinger Bands website (BBands.com) by Bollinger Capital Management was created to support John Bollinger’s book of the same name. The website provides access to the analytic and trading approaches introduced in the book, plus technical analysis tools. The recent upgrade to the website was done to commemorate the 30th anniversary of the creation of John Bollinger’s Bollinger Bands. The revamped site features a new look and new technology and provides:

interactive charting; technical indicators and overlays; Bollinger Bands Expert, an artificial intelligence system to analyze stocks delivered via audio or text; customized chandelier and parabolic stops; BBScript programming and backtesting for creating custom indicators and trading systems; a patternrecognition system; a stock-screening program; portfolio tracking; an “Edge” Shift Theory Ratio indicator feature that highlights expected strength and weakness; new video tutorials; and The Shift Theory Ratio indicator is curwidgets for quick access to news and rently available as an add-on for the Ninpersonalized features. jaTrader, TradeStation, and MultiCharts www.BollingerOnBollingerBands.com, platforms, and soon for eSignal. Platform www.BBands.com users can create simple crossover or other strategies in these platforms based on the FX BROKERAGE COMPARISON FEATURE indicator to help identify trend conditions, FXStreet announced an improved Bro- with no programming necessary. kers Comparative Table and updated its www.shift-theory.com design with real-time spread data. The company reports its FXStreet Brokers NeuroShell Now CONNECTS TO FXCM Table now supports 21 regulated brokers, The latest release of NeuroShell Trader with more to follow, and six currency from Ward Systems includes a built-in pairs, designed to help investors track, connection to FXCM brokerage services compare, and analyze pricing activity. and data for FXCM account holders, Ward Real-time updates allow users to see the Systems reports. real-time contrast between broker offerNeuroShell Trader software allows usings. The table also lists commission costs. ers to create their own trading systems and FXStreet stated the data published in the predictive models. The point-and-click table comes from real accounts. interface lets users to build, optimize, A historical study of currency prices and test trading systems without coding. offered by each broker provides informa- Users can develop trading systems with tion to traders about how prices behave traditional indicators and rules combined around key levels. Content is provided by with genetic optimization and neural Myfxbook, an online automated analyti- network predictions. Trading systems and cal tool for forex. Myfxbook data shows predictive models can be built for multiple not just spreads but also the impact of instruments in one pass. implicit costs such as slippage. www.neuroshell.com, www.fxcm.com www.FXStreet.com

ADD-ON INDICATOR FOR PLATFORMS Shift Theory offers its Shift Theory Ratio indicator to help solve three of the biggest issues many traders have: recognizing choppy conditions; trading signal lag or delays; and signal noise. It is intended to help eliminate data that can cause false trading signals and noise. The Shift Theory Ratio is aimed at either short-term or longer-term traders, as well as spread or pairs traders, and on markets including stocks, commodities, index futures, futures, and forex. The indicator is based only on price action, not volume data. According to the company, this may make the indicator appropriate for forex trading. November 2014

UPGRADED COMPANION APP FOR MARKET DATA AND NEWS Barchart.com, a provider of market information, announced upgrades to its free companion app. The app for iOS or Android devices provides data for US and Canadian stocks and indexes, futures, and forex markets. In addition to standard charting and data, users can access analysis and information, company income statements, related stock options, headlines and news, and company performance reports. The app is designed to help users more easily see correlations and impacts of market fluctuations and global financial news on their portfolio. www.barchart.com

• Technical Analysis of Stocks & Commodities • 61

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.

Integrating Technical Analysis For The Investor (136 pages, $ 9.99 Kindle edition, August 2014, ASIN B00N7V6V D E ) by B C L o w, published by Technical Analysis Consultancy. Technical analysis has always been seen as a tool for short-term trading rather than investing. However, this author believes that technical analysis can also be used for investing and not just for trading. He shares with investors an original approach to technically define trends for various time frames — daily, weekly, monthly, and so on — and explains which time frame dictates a market’s behavior. He then shows how to invest better with this knowledge. The book also seeks to help investors integrate technical indicators (trend, timing, and price) for optimal market entry & exit in trending and nontrending market environments, so the investor isn’t just relying on signals from a single indicator. The author is a past president of the Singapore Technical Analysts & Traders Society (STATS) and was a senior lecturer at Singapore Polytechnic where he taught technical analysis. www.taconsultancy.biz

Tramline Trading: A Practical Guide To Swing Trading With Tramlines, Elliott Waves And Fibonacci Levels (184 pages, 2014, ISBN 978-0-857-19395-7 softcover, $ 56.70, 978-0-857-19434-3 ebook, $45.50) by John Burford, published by Harriman House. This book outlines a trading method to forecast markets based on patterns. The author holds a doctorate in physics. The method incorporates Fibonacci levels, basic Elliott wave theory, and the author’s own tramline concept, which is based on a small number of pat-

terns that the author considers highly reliable and that can be used on any market. The book details how to put the method to use, including how to spot developing patterns for high-probability, low-risk trades; where to place entry orders and stop-losses; and what the author considers as the five best setups to look for. Charts are included to illustrate the author’s points. Also included is a trading diary of a four-month trading campaign in gold and the Dow Jones Industrial Average to demonstrate application of the method. www.harriman-house.com

Statistically Sound Machine Learning For Algorithmic Trading Of Financial Instruments: Developing Predictive-ModelBased Trading Systems Using TSSB (503 pages, $129.95 softcover, 2013, ISBN 978-1489507716) by David Arondson and Timothy Masters, self-published. This book, in a tutorial style, teaches the importance of using sound statistical methods to evaluate a trading system before it is put to real-world use. Arondson is author of Evidence-Based Technical Analysis (Wiley, 2006); Masters has a doctorate in statistics. The book also shows how the authors’ free program TSSB (Trading System Synthesis & Boosting) can be employed to develop and test trading systems. The software, downloadable from TSSBsoftware.com, offers machine learning and statistical algorithms. To accommodate readers with limited mathematical background, the techniques are illustrated with step-by-step examples using actual market data, and examples are explained in plain language. The stated goal is to give the reader the tools to build portfolios of trading systems and rigorously test their expected performance by using the book’s methodology and software. TSSBsoftware.com

62 • November 2014 • Technical Analysis of Stocks & Commodities

Non Random Profits ($9.95, an ebook re-release, hardcopy originally published in 1978) by R. Hanson and R. Mann, published by CT Financial. Author Robert K. Mann, a financial advisor, has used this method of stock selection for nearly four decades and originally outlined it in the 1978 hardcopy version of this book. The authors do not promise their approach will be the quickest path to riches nor do they claim it will spot every winner, but Mann’s premise is to identify stocks with good profit potential and limited, definable risk. Mann’s method is to seek value in the least popular areas and left-behind names. His method puts forth two specific rules to help investors locate stocks meeting these criteria. He suggests the investor use online charting to identify stocks with the given characteristics, and that the investor build a risk-management system to diversify and control risk. The main principle behind the method is tracking market cycles. www.elevenquarterstocks.com

Decoding The Hidden Market Rhythm, second edition (237 pages, $145 softcover, 2014, ISBN 978-1-499-56259-0) by Lars von Thienen, self-published by WhenToTrade.com. This book discusses the correlations that the author believes arise between markets and external energy cycles such as gravity and geomagnetism. Digital signal-processing techniques are used in an attempt to reverse-engineer W.D. Gann’s master cycles in order to design a mechanical, cyclebased trading system. The book introduces nonlinear indicators and weighs in on the significance of a cyclic sentiment predictor for the Dow Jones Industrial Average. The book includes some programming code to build the indicators and trading systems, as well as some generic pseudo code and step-bystep guidelines. www.WhenToTrade.com

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 E-Mini S&P 500 GBLX 3.9 8.4 5 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>> 10-Year T-Note CBOT 1.2 12.8 20 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••> 5-Year T-Note CBOT 0.6 10.7 33 ••••••••••••••••••••••••••••••••••••••••••••••••• Russell 2000 Mini ICEUS 3.9 8.4 4 ••••••••••••••••••••••••••••••••••••••••••••••• Corn CBOT 16.4 10.5 9 •••••••••••••••••••••••••••••••••••••••••••••• E-Mini Nasdaq 100 GBLX 2.7 5.5 6 ••••••••••••••••••••••••••••••••••••••••••• Soybeans CBOT 9.8 10.7 5 •••••••••••••••••••••••••••••••••••••••• T-Bond CBOT 2.5 20.3 14 ••••••••••••••••••••••••••••••••••••••• Gold COMEX 7.5 15.5 4 ••••••••••••••••••••••••••••••••••••• S&P 500 Index CME 3.9 8.4 1 •••••••••••••••••••••••••••••••• Silver COMEX 11.8 10.6 2 •••••••••••••••••••••••••• Ultra T-Bond CBOT 2.9 16.7 9 •••••••••••••••••••••••••• Japanese Yen CME 2.3 5.3 5 ••••••••••••••••••••••••• Euro FX CME 1.5 14.2 13 •••••••••••••••••• Crude Oil WTI NYMEX 5.4 23.2 11 ••••••••••••••••• Sugar #11 ICEUS 9.1 11.2 16 ••••••••••••••• CBOE S&P 500 VIX CFE 8.4 4 7 ••••••••••••• Wheat CBOT 13.6 13.8 10 ••••••••••• Natural Gas NYMEX 6.3 9.6 9 ••••••••••• DJIA mini-sized CBOTM 3.2 8.1 7 •••••••••• E-Mini S&P Midcap GBLX 3.2 6.6 3 ••••••••• 2-Year T-Note CBOT 0.1 15.2 115 •••••••• Gasoline RBOB NYMEX 5.8 15.1 6 ••••••• Soybean Meal CBOT 8.7 11.1 9 ••••••• Soybean Oil CBOT 8.8 11 15 •••••• Australian Dollar CME 1.9 8.2 11 ••••• High Grade Copper COMEX 7 22.2 10 ••••• Heating Oil NYMEX 5.3 22.6 9 •••• Live Cattle CME 2.1 7.3 12 ••• Cotton #2 ICEUS 7.9 11.7 11 ••• Coffee ICEUS 7.4 16.8 8 ••• CBOT Chicago Board of Trade, Division of CME British Pound CME 1.3 13.7 24 ••• CFE CBOE Futures Exchange Eurodollar CME 0.1 40.4 274 ••• CME Chicago Mercantile Exchange Cocoa ICEUS 5.6 13.1 16 •• COMEX Commodity Exchange, Inc. CME Group Hard Red Wheat KCBT 8.9 12.8 12 •• GBLX Chicago Mercantile Exchange - Globex Lean Hogs CME 3.7 9.3 15 •• ICE-EU Intercontinental Exchange-Futures - Europe Canadian Dollar CME 1.2 8.2 17 •• ICE-US Intercontinental Exchange-Futures - US U.S. Dollar Index ICEUS 1.6 13.2 23 • KCBT Kansas City Board of Trade Swiss Franc CME 1.7 16.8 18 • MGEX Minneapolis Grain Exchange Palladium NYMEX 6.5 19.5 9 • NYMEX New York Mercantile Exchange Spring Wheat MGEX 12.1 13 9 • Mexican Peso CME 5.9 51.3 53 • Crude Oil Brent (F) NYMEX 5.1 16.2 8 • Platinum NYMEX 5.8 18.6 11 • 1411 Nasdaq 100 CME 2.7 5.5 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). November 2014

• Technical Analysis of Stocks & Commodities • 63

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