Technical Analysis Digest

Commitments of Traders - Is it a Useful Tool to Time Markets?

2008-08-21T19:43:00.000-07:00

Trading with insider information is an illegal practice in the financial markets, however the Commodity Futures Trading Commission issues a report each week that might come as close to legal insider information that one can get, at least for the U.S. futures markets. But is it useful as a tool or method to help the trader to be on the correct side of the markets?

Before attempting to answer that question it is best to explain what this report is and what it contains in the way of useful information. The Commitments of Traders data (which I'll simply call COT data from this point forward) is released each Friday (or Monday if Friday is a holiday) based on data collected the previous Tuesday. This delay in the release of data may be a factor for very short-term traders, but should not be a concern to the longer-term position trader. This data breaks down the number of contracts held long and short for commercial traders, large traders, and small traders.

Every U.S. futures market is represented that has at least 20 large traders holding a position. The current data is available in text format and can easily be importing into an Excel spreadsheet. Also, all the history data is available in both text and Excel format. Once the data is in Excel, it can be plotted along with price and various technical indicators using charting software such as TradeStation. There are also software programs that can help manage the data, as well as vendors that sell the data, however the data is free for anyone to download directly from the government CFTC website.

When looking at the raw data, you will notice many columns of numbers. Most of these columns are of little value in analysis. On the CFTC site there is a page that tells you what each column represents. The only columns useful for analysis are the long and short positions of the large, reporting traders, the commercial traders, and the non-reporting traders, and of course the date. The reporting level will vary by market. Also, there are many oddball markets that most traders will never trade. I just delete or ignore these. Some markets with low open interest will appear one week and then be gone the next if the level of large trader participation drops below 20, so it is best to stay with the liquid markets.

One more point on the available data is that there are two reports: one showing the futures contracts only, while the other shows the combined futures and corresponding options. In the past the futures data was released on Friday, while the combined futures and option data was not available until the following Monday. For this reason most traders would collect the futures only data. Now both reports are released on Friday. Also, it seemed in the past that the true price driver was the futures contract, with the option being of less importance as it was often used by small traders, or for various spread strategies. Now with the growth in volume and interest in the futures markets in general, and especially the increase in hedge fund volume, options may have more significance in the analysis. There is debate on this issue. Use your own judgment. You can easily try both and see which method seems better for the markets you trade. On some contracts the futures only and combined reports produce similar results, while in other markets there is a noticeable difference.

Once the data is imported and plotted, along with the weekly prices of the underlying market, the most common way to view the data is to plot three indicator lines representing the net position of each of the three trader groups. You simply subtract the number of short contracts from the long contracts for the large traders to get the large trader net position, and plot that line in one color. Then do the same thing for the commercials and plot on the same sub-graph with a different color. And then do the same thing for the smaller, non-reporting traders in another color. If you want a quick view of what this looks like without having to manage the data, there are many web sites that one can visit with charts already posted, although your ability to do further study on this data will be limited, and in some cases the data may not be as timely or accurate as you might like.

So are these three lines of any help in trying to determine the future course of prices? There is a saying on Wall Street (and LaSalle Street) to follow the smart money. But what is the smart money? It would seem that the insiders and therefore the smartest money would be the commercials. They have the inside knowledge of what is happening with their own market. If they are farmers, they would certainly know the condition of their crop, what the weather is doing, what the demand should be for their crop. If they are a flour mill they should know the condition of the wheat crop and what the likely supply should be and what their needs will be for buying in the future. Since the insiders know everything that can be known about their supply and demand situation, it seems that it should be an easy matter to simply follow the smart money and just trade in the direction of that smart money. But a quick look at the price action shows that the commercials are almost always on the wrong side of the market. How can this be?

To explain this discrepancy it is important to understand the different motivation and resources of the commercial trader from that of the speculative trader. It is said that commercials have deep pockets and staying power, so they can ride out large adverse price moves. The basic function of the commercial is to lock in, or hedge the price of an asset or the need of an asset at some point in the future. If a farmer has crops in the ground and he has expenses to meet, he often can't take a chance that the crops will decline in value, so it is wise to fix the price now by hedging in the futures market. The fact that the farmer actually owns the crop and can deliver if needed creates the sense of deep pockets and staying power. Even if the price goes into an uptrend the producer of the commodity will often stay with the hedge so he doesn't have to worry about price fluctuations. So the motivation of the commercial hedger or user is far different from that of the trader betting only on price direction. Often commercials will bias their hedges based on future assumptions about price direction and lift or increase their hedges based on their view of the market conditions. However they, as a group, still have a different reason for being in the markets, and price speculation is of secondary concern, at least in theory. The large trader is only interested in where the price is going and has no interest in owning or delivering the actual commodity.

When looking at the net positions of the large, reporting traders, it seems that their net position is almost always a mirror image to the commercials. So if the commercials are the smart money, but generally are on the wrong side of the trends, then it would seems that the large traders are really the smart money, as their net position usually grows in the direction of the trend. This seems odd since most of the large traders, which are mostly hedge funds and pools that often rely on technical trend following systems, can't possibly posses the inside knowledge and fundamental information of the commercials. Yet the charts speak for themselves.

Could the answer be in using the small, non-reporting data. It is said that it is a good idea to fade, or trade against, the dumb money, and small traders are often regarded as dumb money. This assumption could be misleading. The non-reporting category is made up of traders that fail to meet the reporting requirements of that particular market. Also, there is no distinction between commercial traders and speculators when they fall under the reporting requirement. This group isn't made up necessarily of one and two lot traders. They could still be hedge funds and professional advisors. Just because their position is under the reporting requirement doesn't make them dumb, or even that small. There are many good traders that trade large size, but just not large enough at times to require reporting. In some cases the reporting threshold is very high for an individual or a small hedge fund, producer, or user. Also, since the small trader category is made up of both hedgers and speculators, the line on the COT chart is often bouncing around the zero line, or net neutral position, therefore offering little in the way of patterns or clues.

So it seems that of the three groups of traders, the obvious group worth watching to stay of the correct side of a trade is that of the large trader. In a trending mode this would seem to be the correct assumption. It seems wise to follow the money going into a market with the group that is speculating on the direction that price seems to be moving, rather that betting with the group that has other reasons for being in the market. But there does come a point where the composition of traders becomes too one sided. That perhaps is the key to interpreting and successfully using the COT data. There is a point where the large traders, in the case of an extended uptrend, become too long, and that is usually the same point where the commercials have gotten too short. It is difficult to put a number on the net position of the large trader where that point occurs. It is different with each market and with each trend.

It is pointless to curve fit what was successful in the past, because each occurrence will be unique. Extremes can often be gauged from experience by watching the interaction of price and the COT data over longs spans of data and over many markets. An aid to help determine the relative overbought or oversold level of the net position of each group is the use of a stochastic type indicator applied to the net position value. If the input parameter of the stochastic is set sufficiently large, such as back 52 weeks or longer, a relative value between the current net position level and a range of past levels can be evaluated that might not be apparent by looking at the net value by itself. In fact some markets, such as silver, rarely have a net positive position for the commercials, and using the stochastic on the net position makes determining overbought and oversold levels relative to the past range readily apparent.

In many instances the turning point of a market will occur by an extreme reading in the large trader net position, and then a sudden reversal, indicating that the funds that have been fully invested are now heading for the exits. Most often there is a corresponding opposite extreme reading in the commercial net position with a quick uptick indicating that the commercials are beginning to cover their shorts. This is always very clear in hindsight, but in real time this can be deceptive. What can look like a top in the market can be nothing more than some profit taking with the large traders eventually moving back into the market in even larger in size, with prices pushing higher that what seems logical. One can often trade the resumption of a trend by keeping close watch on the large trader net figure as viewed by the stochastic. If the uptrend is still intact, often an oversold reading of the stochastic will produce a good entry point. But it is important to keep a watch on the pattern of new highs if accompanied by lower highs, or divergences, in the large trader net position, viewed either directly from the COT large trader net position line, or by the stochastic indicator of that line. If prices continue to edge higher, but accompanied by less and less large trader participation, the uptrend may be tired and coming to a conclusion. The same analysis can be applied to the commercial net position data, but one has to look upside down, which makes the divergences more difficult to spot.

It seems at first glance that using the COT data is a lot of trouble for a method that seems so imprecise. There is indeed an art to interpreting this data so the information can become useful rather than confusing. It seems unlikely one could devise a mechanical system using this data since what can be gained from the information is quite subjective. But it is useful to know how the larger traders that influence price and create trends are positioned. No one indicator is perfect. One cannot build a house with just a hammer. But it would be very difficult to build a house without a hammer. The COT data is just one more element to consider, or one piece of the puzzle in determining price direction and possible turning points.

Doug Tucker has a blog with daily commentary on stock indexes, precious metals, and other markets. There are many articles on technical analysis and indicator design and interpretation. To visit go to: http://tuckerreport.com

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Isn't It Time For A Better TRIN (Trading Index) Indicator?

2007-10-13T17:21:00.001-07:00

By Barry M Taylor

The Arms Index, also known as the TRIN (Trading Index), was developed by Richard Arms in 1967 and since then has become a well-known measure of market strength. At the time, the idea was revolutionary. By combining two non-price variables in a very simple formula, the result was a single number that indicated whether market internals were bullish or bearish. Today, TRIN data is available for both the NASDAQ and NYSE markets.

TRIN Formula

The formula is as follows:
(Advancing Issues / Declining Issues) / (Advancing Volume / Declining Volume)

Where, Issues is the number of stocks rising or declining in price and Volume is the total volume traded of rising or declining stocks.

Problems with the TRIN

However, as revolutionary as it may have been, there are some problems with the Trading Index.

Problem 1: It not an intuitive value.

Values above 1 indicate that there is selling in the market. Values less than 1 point toward more buying activity. Normal convention would use the reverse - a high number should mean that the market is rising; a low number should mean that the market is falling.

Problem 2: It makes market data look unbalanced.

If stocks are bought and sold at equal rates, the TRIN value is 1. But after a day of heavy selling, the Trading Index could be as high as 3. Similarly, the Trading Index could dip to 0.3 after a day of heavy buying. When charted over time, the result is a graph with high spikes but shallow dips and, therefore, unbalanced.

Problem 3: When averaged over time, it provides an inaccurate picture of market trends.

Traditionally, traders average it over 10 days. Anything under 0.8 represents an overbought market, while a value of over 1.2 indicates that the market is oversold. However, because the data is lopsided to begin with, this average is a faulty calculation at best.

A Better Way to Calculate the Trading Index

It’s been 40 years since investors first began using the Trading Index as a market indicator. Can we do better? Yes! By making some simple mathematical adjustments in your charting software, the result is an adjusted value that is easier to interpret and more accurate when averaged.

Here’s What to Do:

Step 1: Take the Log of the value.
Step 2: Invert this value so negative values are positive and vice versa.
Step 3: Multiply the inverted Log value by 100.

Interpreting the Adjusted Value

If you have successfully followed the steps above, the adjusted data is easy to interpret at a glance and gives you a better idea of market trends when averaged.

Values range between -100 and +100, with 0 as the neutral point. Positive values indicate buying and a market on the upswing. Negative values indicate selling activity and downward moves in the market. Values are balanced, requiring the same amount of buying or selling for the indicator to be +100 or -100 and, therefore, averages are accurate.

Now, the Adjusted TRIN makes more sense to me!

Barry Taylor trades for a living and specializes in E-mini S&P500 stock index futures. His website http://www.Emini-Watch.com tracks leading market indicators and is a free resource to help you become a better trader. Be sure to check out his daily market commentary. Sign up for the RSS feed or have the free email newsletter delivered straight to your inbox. This article is available on his website with additional charts to illustrate key points. Check out the TRIN (Trading Index) article here: http://www.emini-watch.com/products/trading-index-trin

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Bollinger Bands - 3 Ways They Can Help Your Profits Soar

2007-09-27T17:50:00.001-07:00

By Monica Hendrix

Bollinger bands are a great trading indicator to use in your forex technical analysis and can help you in three ways to gain greater accuracy in your trading signals and increase profit potential. Let’s look at Bollinger bands in greater detail.

If you want to succeed in forex trading you need to be able to deal with volatility and the Bollinger band is an essential indicator to help you deal with it, turn it to your advantage and gain greater accuracy with your trading signals.

Bollinger bands will help you achieve the following in your forex trading strategy:

1. Help spot trend reversals

2. Spot trend changes

3. Time trading signals with greater accuracy.

Bollinger Bands Defined

Bollinger bands are volatility bands drawn around a simple moving average in the center giving you a total of three lines. Two outer bands and the inner moving average. The outer bands represent the standard deviation of price from the average mid band.

Moving averages are used to identify the underlying trend.

The distance between upper and lower Bollinger bands gives you the volatility of the market traded. The greater the distance the upper and lower bands are the more volatile price of the market traded will be.

Bollinger Bands

In any market, traded the price rises slowly over the longer term. Prices may become volatile in short periods of time, but will normally come back to the longer term moving average - which is defined by the centre band.

The center band the ”normal” value of the market traded that people are used to paying over time i.e it reflects the longer term trend.

The volatility of the outer bands shows how volatile prices are and how far away price is from “normal” value.

Short term price spikes historically away from the average and are normally caused by trader psychology and prices will return the mid band average.

Bollinger bands can therefore help with the following.

1. Spotting New Trends Developing

When a market makes trades in a narrow range, the Bollinger bands are also narrow and close to the central band this means volatility is low and when prices start to become more volatile a new strong trend and volatility are about to emerge.

When prices break above or below the upper or lower band, a signal is given that a trend is about to develop and a trader can position himself to enter the market on the break of the bands.

2. Timing Entry Levels

The Bollinger bands can when a trend is already in progress help you get into the trend with good risk / reward on a Price pullback.

A forex trader simply does this by looking for pullbacks to the center band (moving average) and then enters in the direction of the trend.

3. Market Turning points

When the price touches the top of the Bollinger band and starts to falter - a return to the middle band is likely, as prices have moved to quickly away from the average. On the other hand, when prices hit the bottom of the Bollinger band and momentum wanes a buy signal could be the right move.

Bollinger bands are an essential tool for warning of trending moves and they also help trader’s time entry into these trends with greater accuracy once they have developed.

Standard deviation is an essential concept for all traders to understand and deal with as volatility needs to be dealt with in any forex strategy and Bollinger bands help traders do this.

Using Bollinger Bands with Other Technical Indicators

Bollinger bands should NEVER be used to enter trading signals on their own - they need to be combined with other indicators to confirm trading signals.

Great indicators to combine with Bollinger bands are - RSI, ADX and the stochastic.

There is no better indicator for looking for potential set ups and when combined with momentum indicators such as those above, you have a powerful combination that can ensure greater timing accuracy on your forex charts and lead you to currency trading success.

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Do Fibonacci Numbers and The Golden Ratio Make Bigger Forex Profits?

2007-09-15T13:54:00.001-07:00

By Stephen Todd

The Fibonacci number sequence and golden ratio is found throughout nature.

The Fibonacci sequence was discovered by Leonardo Fibonacci in 1202, and the Fibonacci number sequence is based around the following equation:

How many pairs of rabbits can be generated from one single pair, if every month each pair produces a new pair, which, from the second month, starts producing more rabbits?

The Fibonacci number sequence and golden ratio was used to answer the above question and produced a number sequence that has importance throughout the natural world.

After the first few numbers of the sequence, the ratio of any number in relation to the next higher number is approximately .618, and the lower number is 1.618. These two figures represent the golden mean, or the golden ratio.

There are numerous examples of the Golden Ratio throughout the natural world:

Sunflowers, which have opposing spirals of seeds, have a 1.618 ratio between the diameters of each rotation.

In a beehive, divide the number of female bees by the number of male bees - and you will get 1.618.

This same ratio can be seen throughout nature – e.g. snail shells, galaxies, hurricanes, and even DNA molecules.

Fibonacci Numbers

When used in technical analysis, the golden ratio translates into three percentages: 38.2%, 50% and 61.8%. More multiples can be used when needed, such as 23.6%, 161.8%, 423%, etc.

Many Forex traders believe that these levels can be used as support and resistance, when a trend retraces these levels. These forex traders use them - but do they work?

The answer is: No, most of the time they don’t work.

Of course, you’ll see many examples when they do work, but in forex trading you could guess a level, and still get the same success rate.

It’s all very mystical, and appeals to the far out, wacky brigade - and those who think that markets move to scientific law. Of course, what these traders are forgetting is: If markets moved scientifically, there’d be no market – we’d all know the price in advance!

A currency market by its nature, involves uncertainty - that’s what makes a market move - the fact that human nature is un-predictable.

If you want to join the believers of Fibonacci numbers, go ahead – but do you really want to risk your money, with a theory derived from the copulation of rabbits?

I’m sure that if Leonardo Fibonacci were alive today, he’d be amused at the way his theory has been hijacked by the investment community - and put to use in an area where it has no significance at all.

If you want to win at forex trading, then forget scientific theory. Forex trading success comes from trading the odds - and you need to see currency trading as a game of odds - not a game of certainties.

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More on Moving Averages and a Lesser Known Indicator For Stockmarket Traders

2007-09-14T12:19:00.001-07:00

By Mike Estrey

Finding a suitable indicator that reliably defines a trend is one of the keys to successful investing, whether it is on the stockmarket, in forex trading or commodities. CFD traders are often faced with a bewildering array of trend indicators on their software, and when searching for the elusive holy grail of the perfect indicator, the idea is not to miss a major move but also not being whipsawed too often. There is of course no straightforward indicator, but this paper looks at the less well known TEMA.

The basic moving average

Traders usually begin with a basic simple moving average, which is easy to plot, and here there is a trade off in terms of the amount of data used. Longer term investors tend to begin with the 200 day moving average which is something of a yardstick, and the trend rules are very simple. If the share price is above the 200 dma, and the average itself is rising, this suggests a long term bullish trend or a buy signal. The opposite scenario is often used for selling, and long positions are often closed out if one of the above conditions is breached, but each investor has there own methodology.

The obvious problem here is that such a long term indicator misses the first few months of a change in trend, and whilst this is not such a problem for very long term players, it can result in the giving back of a large chunk of profits at the end of a trend. The benefits though are that very few changes need to be made to a portfolio, and there is a much lower chance of a quick reversal in the trend, which can often last many years.

As the length of a moving average shortens, more signals are giving as the average responds quicker to trend changes, but there is also more whipsaw action. In trading range markets, which can often last far longer than trending conditions, moving averages are of little use.

A quick word on the MACD

One refinement to standard moving average analysis is to use crossovers as signals, and one formula derived from this is the MACD which can be used to identify turning points, the momentum and the trend of any stock or index. The most popular MACD formula starts by subtracting the 26 day exponential moving average from the 12 day exponential moving average.

Crossovers between the moving averages are often used to provide golden and dead cross signals, and that formula provides the basic MACD line and the initial signals to watch for. What then happens is that a 9-day exponential moving average of that line is taken, and this is called the signal line, which gives various useful signals.

MACD has become very popular in recent years, and because of this there are now many false breaks and chaotic action which make its success rate questionable at the very least.

There is though another smoothing indicator which has been tested by some technical analysts to give more precise trend change recommendations. Again it works better in trending markets, but it has uses in spotting turning points, and some analysis suggests that it is better than the MACD as an all round indicator.

TEMA – Triple exponential moving average

TEMA is not that old and was developed by Patrick Mulloy in the early 1990s. His idea was to try and reduce the time (and profit) lag in moving averages as the moving average length increased, and his solution was a modified version of exponential smoothing but with less lagging.

TEMA is not simply a moving average of a moving average of a moving average, but it is a composite indicator using a single exponential moving average, a double exponential moving average, and a triple exponential moving average. As with any moving average based technique, the trader can use opening, closing, high or low prices, but usually closing process are chosen.

The TEMA formula

1 Establish a simple (exponential is better though) moving average (EMA1)

2 Calculate a double exponential (EMA2).

3 Calculate a triple exponential (EMA3).

4 TEMA equals: (three times (EMA1 minus EMA2) ) plus EMA3

As with all moving average based analysis, the longer the timeframe used, the less responsive the TEMA will be to trend changes, but it appears to work well in steady trending conditions and volatile stocks.

From experience TEMA can be defaulted reasonably well using 14 day or 21 day averages, and for a longer term trend indicator, a 70 day or 100 day TEMA might be appropriate. As with all indicators it is simply a matter of finding an approach that suits each individual trader.

It is possible to actually apply TEMA analysis to MACDs themselves, and some software systems include a custom indicator using this approach, but it is simply a question of trying it out.

After all, finding the underlying trend is just one out of many rules for successful trading.

Mike Estrey is the Head of Research for Blue Index, specialists CFD Brokers, providing seminars on how to trade CFDs and offering a Live Trading Simulator

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Volatility and Risk in Stockmarket Trading

2007-09-14T12:14:00.000-07:00

By Mike Estrey

If there is one area that is regularly ignored by CFD traders it is that of volatility, which is often confused with risk. Certainly in terms of grading different types of asset classes, the two are connected, and both the risk and volatility of a government stock for instance will usually be much lower than say a dot.com or emerging market smaller company.

But the bottom line is that risk is related to reward, and it simply measures the amount that it is possible to lose within each investment or trade. Volatility however measures how much prices rise or fall over a set time for each investment issue, sector or share, and this is very useful when constructing portfolios, assessing margin requirements and position sizing.

Standard Deviation – the basic measure of volatility

Standard Deviation is the basic statistical measure of the dispersion of a population of data observations around a mean (average), and is widely used in stockmarket trading, forex and commodity analysis. It is simply the square root of the variance, and is calculated as follows:

1. Establish the mean value over the chosen time period.

2. Measure the deviation of each data point from that mean.

3. Square each deviation (this ensures all the deviations are positive).

4. Total up the squared deviations.

5. Divide that figure by the number of data points less one.

6. The Standard deviation is the square root of that figure.

There are some variations on the way the STD can be constructed, but the above is the usual formula supplied with most trading software systems.

Problems with standard deviation

1. If using short term action, the validity of the STD becomes less certain due to the usual short term randomness in the market.

2. It is a retrospective measurement, and is of little use if there is a major change in volatility due to outside news. Having said that, there are certain technical buy and sell indicators which search for changes in volatility to establish potential new trading opportunities, and here it is very useful.

Implied Volatility

Many traders in the options markets will be aware of the use of implied volatility in terms of option pricing, and here the trader can use both the underlying price of the security and the prices of puts (rights to sell) and calls (rights to buy) to establish an expectation of future or implied volatility.

This creates arbitrage possibilities if the stock, or market, is incorrectly priced compared to underlying options available in it, and these disparities often occur after big price moves or panicky action. The formula for implied volatility is much more complex, but it is an interesting area for more sophisticated players to analyse, as it also includes dividend payments and interest rates.

What is beta?

Beta is another measure of volatility, and whilst totally different from standard deviation, it nevertheless provides another angle in portfolio or trade construction.

Standard deviation determines the volatility of a fund, market, sector or stock according to the disparity of its returns over a period of time, whereas beta determines the volatility in comparison to an index or other benchmark.

If an investor has a portfolio of shares with a beta of 1, this means that the list should generally match the underlying movement in that benchmark over time. It doesn’t mean that it will naturally perform better or worse on an individual stock basis, but if the FTSE 100 index was to rally by say 10% over one year, the portfolio with a beta of 1 would in total expect to improve by a similar amount.

On a trading level, each stock has its own beta which is important for CFD traders, and a beta of more than 1 suggests greater volatility than the benchmark, with a beta of less than 1 suggesting lower volatility.

A stock with a beta of 2 for instance would be expected to move 2 times more than the benchmark, or double the underlying index move. Clearly if a CFD trader has a balanced list of positions in terms of longs and shorts, the average beta on each side needs to be assessed in terms of the overall risk of big market moves in one direction.

Normally, but not always, the highest beta stocks are those with the greatest volatility as measured by the standard deviation, but also how much they are affected by the business cycle and interest rates. Fund managers, housebuilders and insurance companies for instance have much higher betas than supermarkets, pharmaceuticals and utility stocks.

In portfolio analysis, the beta coefficient, or financial elasticity (sensitivity of the asset returns to market returns and relative volatility), is a key parameter in the capital asset pricing model and is a way of separating an investor’s profits related to market action as opposed to the willingness to take risk. In essence this means how much added value there has been as opposed to just the luck from being in rising markets.

If one is highly bullish about the underlying market, it makes it easier to beat the market over the term in question by choosing high beta stocks. Equally, if a big fall is expected imminently, a CFD trader might prefer to take low beta long positions and high beta shorts if a balanced trading list was required.

The average true range indicator

This is an important indicator that can be used for setting stops and is also another way of measuring volatility, and is included in most software systems.

The ATR determines a share’s volatility over a set period that can be defaulted as desired. The daily ATR indicator is very simple to calculate and is the highest of:

The difference between the current high and the current low
The difference between the current high and the previous close
The difference between the current low and the previous close

Basically this is the maximum range in which the share has traded from the previous close to the current high and low. The average is then taken over a set number of days (ten is often used), and the stop is then calculated as a multiple of the ATR.

The reason traders like the ATR is that it captures more intra-day information, while the standard deviation only measures the volatility of closing prices (although it can be refined to include highs, lows, etc).

Reasons for volatility and what to look for

On a short term view, shares that have quotes in more than one market or currency may exhibit high volatility, but not necessarily a high beta. This is simply because of arbitrage possibilities, where traders buy the stock on one market and sell in another to take advantage of price discrepancies.

Changes in technology naturally affect the volatility of individual stocks because it takes a while for this information to become available to the wider investment community, so a period of volatility often ensues. Once the stock becomes more mainstream or loses its super-growth tag, volatility can often die down.

News-led events often lead to big changes in volatility, again as traders and investors begin to adjust expectations for future prices. This can include profit upgrades or warnings, unexpected changes in economic policy, natural disasters or geopolitical events.

If the volatility increases for the same investment amount, so does the potential risk and reward and trade sizes/stop losses should be adjusted accordingly for CFD traders.

Mike Estrey is the Head of Research for Blue Index, specialists in Online CFD Trading and Contracts for Difference and Online Forex Trading

Article Source: http://EzineArticles.com/?expert=Mike_Estrey
http://EzineArticles.com/?Volatility-and-Risk-in-Stockmarket-Trading&id=702018

Symmetrical Triangles – Using Them to Spot Big Profitable Moves

2007-09-13T20:31:00.000-07:00

By Kelly Price

Symmetrical triangles are highly reliable trading patterns and are normally pauses within major trends.

Prices normally break in the direction of the trend and move strongly, although a break in the opposite direction can be just as effective.

What is a symmetrical triangle?

The symmetrical triangle is often referred to as a coil, usually forms during a trend as a continuation pattern.

The symmetrical triangle contains at least two lower highs and two higher lows.

When the lines are drawn and connected up the symmetrical triangle takes shape and comes to a point.

Generally, the longer the pattern takes to form the more valid it is.

Why do they form?

Symmetrical triangles can be seen as areas of indecision by the participants.

Typically, the forces of supply and demand at that moment are considered in balance, with neither the bulls nor bears being able to take control.

Attempts to push higher are met by selling, while dips are seen as buying opportunities.

Each new lower top and higher bottom becomes narrower than the last one.

This gives the triangle its shape of a sideways coil.

Eventually, indecision about market is met with a new strong move as prices break either up, or down from the triangle.

Research has shown that symmetrical triangles normally resolve themselves in the direction of the major trend and are seen as continuation pattern.

Watching the break

You should not just trade symmetrical triangles without using some filters.

Ones to look for are the stochastic momentum that measures short term price strength.

It’s the most effective timing indicator there is and is discussed fully in other articles we have written.

The best signal is the stochastic turning bullish or bearish by a cross of the lines in the direction of the break with bullish or bearish divergence. In all case lines should point up for a break to the upside or down for a bearish break.

You should also look for the RSI to strengthen (on a break to the upside) or weaken (on a break to the downside)

There is normally a pick up in trading volume once prices start to break.

A great formation to spot explosive moves

The symmetrical triangle is a great formation and breaks can be dramatic.

To weed out “false breaks” make sure you use some filters (like the ones discussed above) to decide whether to take the trade or not.

Of all the continuation patterns we find this one the most effective and reliable and it can offer some great high odds profitable trades once the break occurs.

FREE ESSENTIAL TRADER PDF'S AND MUCH MORE

On all aspects of becoming a profitable trader including features, downloads and some great FREE Trading PDF's visit our website at http://www.net-planet.org/index.html

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Currency Technical Analysis Part 1: The Most Important Theory Ever

2007-09-13T20:22:00.001-07:00

By Stephen Todd

In currency technical analysis, the most important theory ever, for understanding market movement, is Dow Theory - but its influence is vastly under estimated by the bulk of traders.

The reasons why every trader (not just currency traders) should look at Dow Theory, and understand it, is the basis of this article. Understand Dow Theory correctly, and incorporate it in your trading strategy – then watch your profits soar.

Predictive Theory V Odds Theory

Many traders look for theories that predict - as they think making money is easy. Of course if they stopped to think about it, they would realize that if predictive theories worked, we would all know the market price in advance - and there would be no market!

Losing traders love theories, such as Elliot Wave, and Gann - which are supposed to scientifically predict market movements in advance - which of course they can’t.

So, forget about joining the far out investment crowd, and traders looking for easy money. Lets look at currency technical analysis with Dow theory - and gain a greater insight into market movement, that can lead to big profits.

In 1901, when writing in the Wall Street Journal, Charles H. Dow compared the stock market, to the tides of the ocean, - and the quote below neatly sums up the theory:

"A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned. This method holds good in watching and determining the flood tide of the stock market."

Probability is the Key to Currency Trading Success

Like the waves of the ocean, we all know that tides ebb and flow (come in and go out) - but we don’t know the exact spot, or the exact timing - we wait for confirmation.

Dow Theory is a theory of currency technical analysis that doesn’t predict - but gives us a chance to put the odds in our favor.

Just as waves don’t move to an exact scientific theory, neither do markets - but they do move in recognizable patterns - and with currency trading technical analysis, this is what we need to do - spot the patterns with the best chance of success, and trade them for profit.

The basis of currency trading technical analysis lies in getting the odds in our favor - not scientific prediction.

The Development of Dow’s Thoughts

Dow theory has been around for almost 100 years, and even in today's markets, the basic components of Dow theory remain valid. Dow theory not only addresses technical analysis, and price action - but also market philosophy.

Dow theory as set down by Dow himself, was later developed by two important analysts - Rhea and Hamilton, who take enormous credit for developing Dow theory, and bringing it to a wider audience.

Why is Dow Theory So Significant?

In today’s world of trading, many traders think that trading is easy – vendors, who peddle predictive theories, and easy ways to make money, perpetrate this hype.

However, even with the huge advances in computers, and the data crunching available today, there is no way of predicting the market - and their never will be.

Dow theory though, gives any sensible trader, a great form of currency technical analysis, which can get the odds in their favor.

We will cover the basics of this important currency technical analysis theory in part 2 of this article - where we show you how you can use the theory to enhance your profit potential.

New! A valuable FREE Currency Trader CD containing 9 critical trading reports, tips, strategies and technical analysis. Visit our web site now and grab your CD http://www.tradercurrencies.com

Article Source: http://EzineArticles.com/?expert=Stephen_Todd
http://EzineArticles.com/?Currency-Technical-Analysis-Part-1:-The-Most-Important-Theory-Ever&id=209727

Currency Technical Analysis Part 2: Dow Theory - Three Phases of the Trend

2007-09-13T20:20:00.000-07:00

By Stephen Todd

In part 1 of this series of articles: “Currency Technical Analysis Part 1: The Most Important Theory Ever” we discussed the general background to the Dow Theory.

Here we look at the three phases of the trend, and why currency-trading analysis must focus on the long-term trend - and how Dow Theory will help you capture every major trend.

Currency Technical Analysis – Market Discount

Dow Theory is based upon the classic view of currency technical analysis - that markets discount everything.

While Dow Theory accepts that the unexpected can always occur in the short term - the longer trend is unaffected - and if you think about it, this is true.

Central banks and geo political concerns can spike prices unexpectedly - but their influence tends to be short, rather than long term.

Currency technical analysis needs to be understood to make big money – and you need to focus on just the long-term trends.

The market reflects all available information - everything there is to know is already reflected in the markets - through the price.

Prices therefore represent the total of all the hopes, fears, and expectations, of all the participants in the market.

Interest rates, presidential elections, employment, consumer confidence - and everything else, is already priced into the market.

Short Term Moves should NOT be traded

The unexpected will often occur, in any form of currency technical analysis - but this will normally affect the short-term trend - but the primary trend will remain unaffected.

With this in mind, Dow Theory accepts limitations - but if you focus on the longer term trend, and trade with the odds in your favor, you can be a winner.

Look at any currency chart and you will see:

In currency technical analysis, primary trends tend to last for months or years.

This is why Dow Theory is so applicable to currency trading – this is not a day trading theory - which is a mugs way of trading currencies.

The Three Phases of a Trend

Dow and Hamilton identified three types of price movements:

1. Primary Movements

2. Secondary Movements

3. Daily Fluctuations

Primary Movements

Primary moves generally last a few months to several years. These primary moves represent the broad underlying trend of the market – the health of the underlying market in currency trading. These are the trends that currency traders should focus on, as they are the trends that yield the biggest profits.

Secondary Movements

Secondary Movements, also known as reaction movements generally last a few weeks to a few months - and move counter to the primary trend. These secondary movements are moves that can be affected by such things as, central bank manipulation, and geo political events.

Daily Fluctuations

Daily fluctuations generally move with, or against the primary trend - and last from a few hours to a few days - but usually not more than a week. These daily fluctuations moves, are really random - and are un-tradable in currency markets.

Currency Technical Analysis for the Serious Trader

Dow Theory provides a mechanism for investors to use that will help remove emotion from trading, and focus on the long-term trends.

Hamilton warned that investors should never be influenced by emotions. In the technical analysis of currency markets, you need to be objective and focused - see what is there, and not what you want to see.

Dow Theory provides a mechanism in the technical analysis of currency markets, to help you stay focused and disciplined at all times.

The methods for identifying the primary trend are laid down - and are NOT open to interpretation.

Reflecting Market Psychology

If you want a clear view of why Dow Theory works, then you need to know how trends build - and this is explained in 3 phases by:

. Accumulation

. The Big Move (excess and despair)

. Distribution

If you understand how these phases work in currency technical analysis, then you are well on your way to making big profits.

We will discuss these three phases - and the logic behind them, in part 3 of this series of articles.

New! A valuable FREE Currency Trader CD containing 9 critical trading reports, tips, strategies and technical analysis. Visit our web site now and grab your CD http://www.tradercurrencies.com

Article Source: http://EzineArticles.com/?expert=Stephen_Todd
http://EzineArticles.com/?Currency-Technical-Analysis-Part-2:-Dow-Theory---Three-Phases-of-the-Trend&id=210536

Currency Technical Analysis Part 3: Dow Theory – Bull and Bear Markets

2007-09-13T20:18:00.001-07:00

By Stephen Todd

In previous articles, we’ve looked at the history of Dow Theory, and why it's the best theory ever, for currency technical analysis.

The logic for spotting the big trends follows - and it’s these trends that we want to catch - as they yield the big profits!

Hamilton identified three specific phases, in both primary bull markets, and primary bear markets.

These stages are a reflection of the psychological state of the market - and their reflection in currency technical analysis.

A primary bull market was defined as: a sustained advance, marked by improving fundamentals, and investor confidence - a primary bear market is a mirror image – i.e. the exact opposite of a primary bull market.

In both primary bull markets, and primary bear markets, there will always be secondary movements, that run counter to the major trend. While Dow theory was developed for stocks, the format works perfectly, (if not better) in the currency markets.

Here we look at a bull market move, as defined by Dow Theory:

Primary Bull Market: Stage 1 – Accumulation

Hamilton concluded that the initial stages of a bull market were indistinguishable from the last reaction rally, of a bear market.

Pessimism, which was excessive at the end of the bear market, still remains at the start of a bull market.

It’s at this stage, that professional investors begin to accumulate positions - as the market is cheap, and now offers good value – This is true of any market.

In the first stage of a bull market, prices begin to find a bottom, and firm up, as these positions are established.

When the market starts to rise, there is skepticism that a bull market is emerging.

After the first leg peaks, and starts to head back down - this then confirms the bearish view of the majority.

It’s at this stage that careful analysis is needed, with Dow Theory - to determine if the decline is a secondary movement (a correction of the first leg up).

If it’s a secondary move, a low forms above the previous low, a period of low volatility will be present as the market firms - and the advance finally starts to get under way.

When the previous peak is surpassed, the beginning of the second leg forms - and the move is valid and confirmed.

Primary Bull Market: Stage 2 - Big Move

The second stage of a primary bull market is normally the longest - and represents an easily identifiable trend – clearly indicated with any form of currency technical analysis.

This period sees a sustained advance in prices - it’s a period marked by improving fundamentals, and increased confidence.

This is considered the easiest period to make money, as participation is broad and the trend followers are in - and investor confidence is high, with strong buying.

Primary Bull Market: Stage 3 – Excess

The third stage of a primary bull market is marked by excessive optimism, and excessive speculation.

During this third and final stage, the uninformed public are heavily involved. In reaction to this, prices are excessive, as confidence has soared - and greed takes over. Prices are being pushed by investor greed and we all know what happens next!

Primary Bear Market: Stage 1 – Distribution

Accumulation is the hallmark of the first stage of a primary bull market, and distribution marks the beginning of a bear market - as the "smart money" begins to realize, that prices are too far away from fair value.

The public is still full of greed at this stage, and are still heavy buyers – the fundamentals appear to be bullish - but this is how every major bull market ends.

Prices start to decline, but most investors remain bullish.

After a moderate decline, there is a reaction rally, (secondary move) which retraces a portion of the decline.

Hamilton noted that reaction rallies during bear markets were very swift and sharp.

This quick recovery movement gives confidence to the bulls - however, the reaction high of the secondary move will form - and will be lower than the previous high.

After making a lower high, a break below the previous low, will confirm the bull move is over.

The exact opposite happens in a bear market.

Dow Theory is the best way to catch a long term a trend, using currency technical analysis - and the logic is easy to understand.

New! A valuable FREE Currency Trader CD containing 9 critical trading reports, tips, strategies and Dow Theory. Visit our web site now and grab your CD http://www.tradercurrencies.com

Article Source: http://EzineArticles.com/?expert=Stephen_Todd
http://EzineArticles.com/?Currency-Technical-Analysis-Part-3:-Dow-Theory---Bull-and-Bear-Markets&id=211520

Swing Trading with Stochastics – The Essential Momentum Indicator

2007-09-13T20:16:00.001-07:00

By Stephen Todd

Markets don’t trend all the time - there are periods where they tend to be in channels, and consolidating. These are the markets where swing trading can work well.

This article is an introduction to swing trading, and highlights the best timing indicator - to time you swing trades for big profits.

What is Swing Trading?

Swing trading sits in the middle, between day trading, and trend following - and swing trades normally last a few days. The swing trader will enter a position one way, and exit with a profit - and enter a possible position the other way.

The Swing Traders Best Market

For the swing trader, it’s best to trade, when a market is going nowhere fast.

Swing trading does not work in strong bull and bear markets - where price moves strongly in one direction - without a swing in the other direction, the swing trader will lose.

The problem with both swing trading, and long-term trend trading, is that success is based on identifying what type of market we’re looking at - i.e. bull, bear, or a period of consolidation.

Once you’ve identified a market as moving in a sideways channel - then it’s time to look for swing trading opportunities.

The Best Tool for Swing Traders

The best tool by far - the “stochastic indicator” - which is ideal for swing trading. The stochastic indicator is a momentum oscillator, which can warn of strength, or weakness in the market - often in advance of a final turning point.

The logic of the stochastic is based on the assumption, that when a market is rising, it will tend to close near the high - and when a market falls, it tends to close near its lows.

The Calculation

The stochastic oscillator as developed by Dr. George Lane, is plotted as two lines called %K, a fast line and %D, a slow line.

· %K line is more sensitive than %D

· %D line is a moving average of %K

· %D line gives the trading signals

Although this sounds confusing, it’s actually very similar to the plotting of moving averages.

For example, take %K as a fast moving average, and %D as a slow moving average.

The lines are plotted on a 1 to 100 scale. "Trigger" lines are normally drawn on stochastics charts at the 80% and 20% levels – this indicates when markets are overbought, or oversold.

Using Stochastics

The 80% value traditionally is used as an overbought warning signal, while the 20% is used as an oversold warning signal.

The signals are most reliable if you wait until the %K, and %D lines turn upward, below 5% before buying - and in reverse, above 95% before selling.

For swing trading, look to trade the crossover confirmations.

For example, buy when the %K line rises above the %D line, and sell when the %K line falls below the %D line.

Beware of short-term crossovers that may generate false signals. The best crossover is when the %K line intersects, “after” the peak of the %D line (a right-hand crossover).

Don’t worry if the above confuses you - you don’t need to understand the logic. When you look at stochastics on a chart, all you're looking for is the visual signals - not the calculation behind them.

Do some research and practice, before trying swing trading with stochastics - but if you want an indicator to help you swing trade, and make some big profits - check stochastics out.

New! A valuable FREE Currency Trader CD containing 9 critical trading reports, tips, strategies and Dow Theory. Visit our web site now and grab your CD http://www.tradercurrencies.com

Article Source: http://EzineArticles.com/?expert=Stephen_Todd
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Currency Technical Analysis – The Pro's Secret to Maximizing Profits

2007-09-13T18:54:00.001-07:00

By Stephen Todd

Currency technical analysis can help you spot the big trends that yield the big profits. However, how do you stay with the trend, and make sure that you capture maximum profits - and not bank them early?

It’s a fact that traders who use technical analysis in the currency markets, snatch their profits too quickly, and miss the major profits.

Here we show you a strategy to stay with the trend, and catch the maximum amount of profit.

The Problem with Currency Technical Analysis

The problem with trend following is, it’s down right hard! Every correction in the market costs you money, and you have to decide whether to take your profit, or wait and see if the trend goes on and makes more money.

Most traders can’t hold on - they prefer to bank the small profit, and they miss the major moves.

Let’s face it, it’s hard to stick with long trends - and this causes most traders a psychological dilemma - one that they can’t handle.

Here we outline a strategy that you can incorporate in your technical analysis, to make riding profits easier - and give you peace of mind.

Use Options to Lock in Profits

Let’s say you’re long in the euro currency - and making $5,000 on a $10,000 trading account – that’s a nice profit - why not take it? Well, if the trend is in your favour - as indicated by your currency trading analysis, it could run on to make $15,000, $20,000, or maybe even more - so you should stay with it!

The solution is option hedging - options can help you manage your open profits, and protect you.

In the above example, you could buy a put option - so that you can establish a price floor beneath you. The great thing about this option strategy is that your upside remains unlimited - but you’ve completely capped your downside risk.

That’s what we call peace of mind - getting an option in, as insurance against unlimited losses. By doing this, you’ll be able to stay with the trend for longer, as indicated by your technical analysis chart.

So, What’s the Catch?

The negative aspect of this strategy is that options suffer from time decay - and you’ll lose all, or part of your premium - regardless of what the market does.

You’re basically buying an insurance premium - and this is the cost - you don’t get anything for nothing in this world!

You therefore need to make sure that you’ve already got enough profit to protect, to make this strategy worthwhile.

You also need to look at your technical analysis chart - and see a strong trend to the upside – i.e. the odds are in your favour, that there are more profits to come.

As a rule of thumb, avoid protecting profits of under $3,000 with this strategy.

When utilising this strategy, only use options that have between 45 – 60 days to expiry. Options with less than 30 days will not function optimally - due to their rapid time decay.

The Logic Makes Sense

If you’ve a good open profit, and your technical analysis shows more profits to come, then its worth protecting in this way - as the odds favour you making money in excess of the money you lose on the insurance policy.

Most traders simply can’t stay with long-term trends - and always bank early.

Currency trading technical analysis shows us that the big trends last a long time -sometimes months or even years - and it’s a fact that most traders bank early.

If you’re in a strong trend, use the above tool along with your currency trading analysis - and get ready to ride those big winning trades for all they’re worth.

New! A valuable FREE Currency Trader CD containing 9 critical trading reports, tips, strategies and currency trading info. Visit our web site now and grab your CD http://www.tradercurrencies.com

Article Source: http://EzineArticles.com/?expert=Stephen_Todd
http://EzineArticles.com/?Currency-Technical-Analysis---The-Pros-Secret-to-Maximizing-Profits&id=223744

WD Gann and The Edge

2007-09-13T18:51:00.001-07:00

By Peter Amaral

Stock traders, futures traders and forex traders are always looking for the Edge. That little bit of information about the markets that nobody else has seen yet. But when there are already a gazillion copies of TradeStation out there the oscillator combination that can give you, and you alone, the Edge becomes more and more difficult to find.

Legendary traders like W.D. Gann found the Edge, and not by looking under the same street lamp as everybody else. Much of what Gann wrote, and much of that written about him, is obscure to the point of uselessness. One thing that Gann did make clear enough, however, was his belief that all publicly traded markets move in repeatable cycles or patterns. Not so much easily discernible time cycles but cycles based on the relationship of price and time. One thing he said was that "When price and time square change is inevitable."

If left unexplained the significance of that particular quote would remain as obscure as his others. Gann did leave us with the Gann Wheel, however - a curious circle of numbers that is actually a square root calculator. It must have come in handy in the days before computers and electronic calculators. The Gann Wheel is the basis of the Square of Nine, and we believe the conceptual foundation of all Gann's work.

The Square of Nine is unique because unlike every other method of technical analysis, the Square of Nine is totally indifferent to whether the input variable is a price, a range of prices, or a number of trading days or calendar days. They are all the same and completely interchangeable. Say what? That can be a little hard to get your brain around after spending years studying chart patterns, exotic moving averages, and oscillators. That's the beauty of it.

Price and time become interchangeable by converting them to degrees of a circle. Squares and square roots are part of that process. Once price and time are conceptualized only as degrees of concentric circles we could care less about their actual magnitude. At that point we care only about their orbital relationship. Are they in opposition, conjunction or square? You will find that almost every significant high or low pivot point is indeed in opposition, conjunction or square to a previous price, range or time.

Is this what W.D. Gann meant in his 1909 Wyckoff interview when he said "just as the pendulum returns again in its swing, just as the moon returns in its orbit, just as the advancing year over brings the rose of spring, so do the properties of the elements periodically recur as the weight of the atoms rises." One other very special aspect of the Square of Nine is that the more you study it the more you learn how much you don't know!

(tradingfives.com offers insight into the exotic trading techniques of W.D. Gann and J.M. Hurst including a downloadable ebook that explains the Square of Nine in simple, easy to implement terms.

Article Source: http://EzineArticles.com/?expert=Peter_Amaral
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Bollinger Bands Strategies

2007-09-13T18:44:00.001-07:00

By Steven T. Ng

The Bollinger Band theory is designed to depict the volatility of a stock. It is quite simple, being composed of a simple moving average, and its upper and lower "bands" that are 2 standard deviations away. Standard deviations are a statistical tool used to contain the majority of movement or "deviation" around an average value. Bear in mind that when you use the Bollinger Band theory, it only works as a gauge or guide, and should be use with other indicators.

Normally, we use the 20-Day simple moving average and its standard deviations to create Bollinger Bands. Strategies some investors use include shorter- or longer-term Bollinger Bands depending on their needs. Shorter-term Bollinger Bands strategies (less than 20-Days) are more sensitive to price fluctuations, while longer-term Bollinger Bands (more than 20-Days) are more conservative.

So how do we use the Bollinger Band theory?

The Bollinger Band theory will not indicate exactly which point to buy or sell an option or stock. It is meant to be used as a guide (or band) with which to gauge a stock's volatility.

When a stock's price is very volatile, the Bollinger Bands will be far apart. In technical indicator charts, this is depicted like a widening gap. On the other hand, when there is little price fluctuation, hence low volatility, the Bollinger Bands will be in a tight range. This is depicted as narrow "lanes" along the chart.

As for how we use the Bollinger Band theory, here are a couple of guidelines.

History shows that a stock usually doesn't stay in a narrow trading range for long, as can be gauged using the Bollinger Bands. Strategies include relating the width with the length of the bands. The narrower the bands, the shorter the time it will last. Therefore, when a stock starts to trade within narrow Bollinger Bands, we know that there will be a substantial price fluctuation in the near future. However, we do not know which direction the stock will move, hence the need to use Bollinger Bands strategies together with other technical indicators.

When the stock starts to become very volatile, it is depicted in the chart by the actual stock price "hugging" or staying very close to either the upper or lower Bollinger Bands, with the Bands widening substantially. The wider the Bands are, the more volatile the price is, and the more likely the price will fall back towards the moving average.

When the actual stock price moves away from the Bands back towards the moving average, it can be taken as a signal that the price trend has slowed, and will move back towards the moving average. However, it is common for the price to bounce off the Bands a second time before a confirmed move towards the moving average.

As usual, and for the Bollinger Band theory in particular, it should be noted that individual indicators should not be used on their own, but rather with one or two additional indicators of different types, in order to confirm any signals and prevent false alarms.

Steven is the webmaster of http://www.option-trading-guide.com If you would like to learn more about Option Trading or Technical Analysis, do visit for various strategies and resources to help your stock market investments.

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The Secret Art of Backtesting

2007-09-13T18:42:00.001-07:00

By David Jenyns

If you have not back tested your trading system, you might as well trade with your eyes close.

In fact, whatever technical analysis criterion you use to trade with, be it moving averages, candle sticks, volatility breakouts, fibonacci retracements or any other trading system you have devised you're going to need to back test your trading system thoroughly and objectively in order to remove any possible doubt about it's capability.

To remove any self-doubt you need to thoroughly back test or simulate your trading system in such away that it matches the conditions under which it will be traded. Once you have established that you have a reliable and robust trading system only then will you be confident in trading your system.

When trading what is the question in most traders’ mind?

To answer this question I shall quote the introduction from Chapter 8 Back Testing of Mark Jurik’s book Computerized Trading:

Will my trading strategy be profitable? After having gone through the arduous process of crafting a trading strategy, these are the questions you must ask yourself. The ability to answer these questions are the great promises that back testing holds out for all traders. A successful back testing procedure will greatly reduce the probability that you will begin trading with either an unprofitable strategy or one that does not meet your expectations. By adopting a sound and rigorous back testing approach, you will:

Pinpoint which approaches to the market that are likely to be successful and which ones are not.
Generate good estimates of future performance for each trading strategy you test.
Create a record of your trading strategy's historical trading performance.
Produce data necessary for other components of your trading approach such as your asset allocation strategy.

Important Trading System Criteria

Profitability is not the only criteria by which a trading system should be evaluated. Drawdown and stress should equally be considered as well... for example, before you open a trading account:

Are you satisfied that your system is reliably profitable?
Will drawdowns wipe out your account?
Is your system trading in a way you can tolerate?
Can you tolerate long periods of no trading or too much trading?
Can you tolerate a large string of losses?

The only way to answer these questions is to subject your trading system to extensive back testing.

Lack of Confidence

Lack of confidence usually forces traders to question their own trading systems. They give into the temptation to modify their trading plan with devastating consequences. This temptation spawns on by a string of losing trades or an opportunity to replace their trading system with a whiz-bang indicator that is usually talked about in traders chat forums.

Anything that sounds to good to be true will attract the attention of a trader who is not satisfied with their own trading system simply because they have not properly tested their system in the first place. In addition, they have not built up the necessary confidence needed to successfully trade the system developed.

In the end these negative subconscious thoughts will only hinder and destroy your ability to trade successfully. To improve your confidence in your trading system you need to thoroughly and objectively back test it - simple as that! Only then will you be confident enough to commit time and money to it!

The Traders Dilemma

How can you test how a trading system will perform over a period of time when trading an arbitrary group of securities?

--- To truly evaluate the past performance of a trading system you need a trading simulator, which mimics the day-to-day trading activities of a typical trader. Until now this kind of software has been out of the reach of most traders. In fact, there has been some great headway in back testing software. Personally, I use TradeSim with MetaStock.

TradeSim is the first realistic true trading simulator/analyzer for Metastock that can quickly back-test and evaluate a trading system across a portfolio of securities. With its powerful data processing capabilities, TradeSim can evaluate the historic performance of a given trading system within a matter of minutes and do it with a realistic representation of a real-life trading scenario. Whether a single security or a multiple security portfolio, TradeSim answers the simple question:

"What would of happened if this system had of been traded in the past using an arbitrary portfolio of securities?"

Sounds simple - but is extremely complex if not impossible to do with Metastock as it stands alone. However, with TradeSim it is just a simple matter of running a Metastock exploration on a portfolio of securities using your own set of indicators. When the exploration has finished you just simply run TradeSim and analyse the resulting trade data.

Your system may look good with an expert overlayed on a single chart.

"But what about it’s real world trading performance?"

Typically, your system will consist of entry and exit triggers, prices as well as an initial stop loss. These five parameters basically define a framework for a trading system. The trouble with trying to back test a trading system is that the system tester built into Metastock is only extremely limited. As a result, this can give a very distorted view of your potential trading system performance. TradeSim addresses all of these issues whilst exploring new ground in technical analysis and uncovering new issues that have not been addressed by current software technologies.

Remember, no matter what back tester you go for, anything that sounds too good to be true will attract the attention of a trader who is not satisfied with their own trading system. This due to the fact that they have not properly tested their system in the first place and have not built up the necessary confidence needed to successfully trade it.

In the end, these negative subconscious thoughts will only hinder and destroy your ability to trade successfully. To improve your confidence in your trading system you need to thoroughly and objectively back test it - simple as that! Only then will you be confident enough to commit time and money to it! By testing your system, you have just put yourself into the top 1% of traders.

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comes to MetaStock & designing profitable trading systems.

His MetaStock website offers a huge free collection of trading
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http://EzineArticles.com/?The-Secret-Art-of-Backtesting&id=14148

Index Fund Trading Using Technical Stock Market Analysis - What Every Trader Should Know

2007-09-13T18:37:00.001-07:00

By Rockford Tapscott

Index Fund trading using technical stock market analysis can be one of the most profitable...or most costly exercises you will ever undertake.

While trading a basket of stocks has it's advantages, such as removing the risk of any single company you own going bust and taking all of your money with it, stock indexes (on which index funds are based) can tend to be highly volatile, especially the smaller ones.

The S&P 500 is probably one of the worlds best know stock indexes, and it has a long history of strong trends that have made and lost traders fortunes over the years.

By trading a managed fund that tracks the index, options over the index, futures contracts over the index or Contracts For Difference (CFD's), we can participate in the movements of the market.

The easiest way to do this (and the system that many mom and dad investors use) is to simply buy a managed fund like the Vanguard 500 Index Fund. This works fine when the trend is up, but what about when the trend is heading in the other direction?

There are several mutual funds that trade inversely to their respective index. One of these can be used to trade the downside when prices are falling, as they do from time to time, sometimes quite spectacularly.

The problem with most of these funds is you have no leverage. This is why many traders move on to index fund trading through derivatives such as futures contracts as an alternative to simply buying and holding mutual funds.

While the margin for the full S&P 500 futures contract is too high for the average trader, a smaller contract is available called the S&P Emini, which mirrors the larger contract, but is only 1/10th the size.

This allows anyone with an adequate account to safely trade this liquid, often strongly trending market.

The S&P Emini futures contract gives you tremendous leverage to movements in the underlying market. Of course, if you have no idea how to trade, this leverage is a double edged sword (and you'll most likely get cut).

Index Fund trading means you MUST have a good understanding of technical analysis and have clearly defined trading rules to make it work. It can be very profitable, but you have to learn how to do it right.

This is why learning how to trade profitably is far more important than the vehicle you use. You must possess the skills of profitable trading before the Emini futures market or any other financial product is going to help you create wealth. This is especially true when the concept of leverage is introduced, as it is with futures contracts.

The solution? Make it your goal to find a mentor with a successful track record as a trader who can teach you what he (or she) knows, and you will be in a position to trade profitably.

You need to know the difference between trends and counter trends - and then only trade trends. Once you have this training you will know, with a high degree of certainty, what the trend is and how to trade it. The lessons apply equally to both stocks and indexes, and will give you a good grounding in how to trade trending markets

By understanding trends (and understanding technical analysis will teach you this), you will be in a position to enter and exit trades with a high probability of success in any futures market or stock index you choose to trade.

Some of the common mistakes and attitudes that uneducated traders and investors make are:

* Not knowing where to start in trading or investing

* Holding losing trades, hoping they will go back up so they can get out without a loss

* Buying on rumor, tips or gut feel - always a great way to the poor house

* Continually trying to land a 'home run' to make back previous loses

* Closing out positions early as soon as they start to become profitable

* A feeling that the market is against you. The market has no memory; it doesn't know or care about you

* Buying expensive software analysis programs that don't work

All too often, people jump into index futures trading head first without a thorough understanding of exactly how they are going to approach the market. The result is usually nothing short of disastrous.

A successful trader treats trading as a business. The first step in the process of becoming a profitable trader is to construct a business plan, much like one that you would use for a conventional business.

A business plan to a trader is known as a trading system, and like a business plan it is used to define the exact strategy of actions that are used to create a profit.

The key to successful trading is a properly implemented strategy, not subjective decisions based on your opinion of the market or the news of the day. The three key ingredients to becoming a successful share trader are:

1. A proven trading system; look for RESULTS not hype when choosing a coach or mentor to teach you how to trade. Personal one-on-one coaching is best, so search out a coach who will be there for you

2. The tools to implement the system; don't reinvent the wheel. Use the proven tools your mentor shares with you and get started the right way

3. The ability to implement the system. Profitably trading, especially trading the Emini futures contract, requires a mindset that only a good teacher can install. Without this mindset, you will most likely fail to make it as a trader in this fast paced market.

Learn these three things and you have a wonderful opportunity to build a profitable Emini trading business. Without them, no matter whether you are trading index funds, options or futures, you'll always struggle to make it as a trader.

Rocky Tapscott is a trader who works with Professional Emini Trading Coach Sam Goldberg. Sam has written a Free 5 day Mini Course called 'The Futures Trading Mastery Course' that shows you step by step how to become a professional trader by finding a mentor who will coach you to success. Drop by http://www.futurestradingcoach.com/speminicourse.html for a Free copy.

Article Source: http://EzineArticles.com/?expert=Rockford_Tapscott
http://EzineArticles.com/?Index-Fund-Trading-Using-Technical-Stock-Market-Analysis---What-Every-Trader-Should-Know&id=409145

Instincts Vs. A Market Timing Strategy

2007-09-13T14:10:00.000-07:00

By Frank Kollar

Humans are born with basic instincts for survival. They need to protect themselves at all costs.

Certain critical instincts are inborn, such as hunger, self-survival, etc. But humans are complex creatures. We also have learned instincts, habitual ways of behaving that are so automatic and unconscious that they seem as if they are part of our very fabric.

Acting Without Thinking Logically

For example, as you drive in traffic, you "instinctively" slow down or change lanes when the car in front of you seems to be driving erratically.

You may have noticed that many drivers will make the lane change to avoid slowing down, and will even speed up to pass to take advantage of everyone else slowing down.

People react "instinctively." Some act without thinking "logically" about their options, without taking steps to avoid possible danger. They often tend to make poor decisions.

Behavioral economists have demonstrated that people also make automatic, unconscious decisions when trading the markets.

Most people are extremely risk averse. They enjoy the pleasure of a sure win, even a small one, but try to avoid the pain of losses at all costs. Yet there is no logical reason to show such an asymmetry regarding their decision making.

Investors also sell their winning trades prematurely so they can lock in their profits.

These unconscious and automatic decisions reflect a strong and universal human desire to avoid risk.

At FibTimer, all of our strategies are non-discretionary. Emotions are not allowed. Our strategies offer disciplined execution of non-emotional buy and sell signals.

The reason for following any timing strategy is to "remove" yourself from making emotional trades. To remove yourself from the herd, which is often headed in the "wrong" direction. Towards the nearest cliff.

Playing It Safe

As humans socially evolved, they learned to protect their survival by playing it safe.

Playing it safe may be prudent for very long-term investors, but for shorter-term investors... those who are unhappy with the losses incurred during numerous inevitable downtrends and who wish to avoid those losses or to capitalize on the downtrends, fear of risk and uncertainty is an impediment to success.

It is necessary to identify this need for safety and security and "reprogram" yourself to work around it.

Following The Masses

A common illustration of risk aversion happens when market participants follow the masses, as if they are wild animals banding together as a herd for protection.

They look toward others for direction, regardless of the consequences.

Over the past few weeks, for example, stock prices sold off dramatically. People following the herd participated in the selling with huge numbers selling near the bottom.

As more and more people saw prices drop, more and more participants sold. What else could they do? It is scary to see your investment values plummet.

Is the news going to get worse? Will the prices reach even lower lows?

Most people are afraid of pain. They are afraid that the price may go even lower, and they sell because they don't want to lose even more money.

Of course not all investors will sell. Some will become so panicked that they will be afraid to acknowledge their losses and want to leave them on paper, hoping that the prices will return to previous levels in the coming weeks. During a bear market this can be an even worse decision.

The masses try to avoid risk and pain, and by doing so, they tend to behave automatically.

Devoid Of Emotions

Active, serious market timers, in contrast, react more decisively.

They carefully follow a trading strategy that is completely devoid of emotions. They follow through on buy and sell signals with absolute precision.

They know that any one or more buy or sell signals may be wrong, but they realize that to trade profitably they must learn to trust their timing strategy and act on it. Only over time are substantial profits realized, and only by those market timers who stay the course.

Think Outside The Box

If you want to be a winning market timer, you must learn to identify your need to follow the masses, and teach yourself to avoid doing what your need for security compels you to do.

You must "reprogram" yourself to think outside the box. Rather than follow the masses, you must follow your timing strategy, which may be contrary to what most people would do.

Over time, and with extensive experience, you will develop the skills that will allow you to trade decisively.

Once you have "reprogrammed" your behaviors, you will not be tempted to follow the masses, but will instead recognize these feelings for what they are. Instincts for survival, which may work in the physical world, are likely to cause poor decisions and loss of capital in the financial world.

Rather than following the masses, you must learn to follow a timing plan, which is not affected by the emotions of the masses.

The more decisively you can follow the timing strategy, the more profits you'll realize.

Article Source: http://EzineArticles.com/?expert=Frank_Kollar
http://EzineArticles.com/?Instincts-Vs.-A-Market-Timing-Strategy&id=500689

Discretionary vs Mechanical Market Timing Strategies

2007-09-13T14:06:00.001-07:00

By Frank Kollar

Investors Or Traders?

Those who use the stock market to grow their assets have two choices. They can either be investors, which means they are "buy-and-hold" for the long term. Or, they are traders who try to use the ups and downs inherent in free markets to profit.

Buy-and-hold investors have much to worry about. Are they buying in at high prices? When they are ready to retire, will the markets be in a bear market? Obviously those who planned to retire in the years 2000 through 2002 faced a great dilemma. Aggressive buy-and-holders who were invested in Nasdaq stocks, had lost 70-80% of their capital. Even cautious S&P investors lost 50%.

Market timers, who are actually traders usually using mutual funds as their investment vehicle of choice, recognize these pitfalls. Their goal is never to give back much capital.

Yes, there are sometimes small losses in timing, especially at market tops and bottoms, but if you are trading trends (and historically the markets are in trends more than they are not) you will never take large losses to capital as you will exit immediately if the trend changes.

And... you will make your big profits from the inevitable long term trends when they occur.

Two Kinds Of Market Timers

Market timers, trading all trends, are the most successful over time. But even in market timing, there are two ways to determine your trades.

Discretionary timers depend on the sum total of their market knowledge to make decisions. Whether it be market analysis, a multitude of indicators, gut feeling, current or even potential future news events, hot tips, etc.

Discretionary trades are subjective. They can be changed and second guessed. There are no absolute guarantees that each individual trade is based reality and is not colored by any personal bias.

Mechanical timers, which use timing strategies based on an objective and automated set of rules, avoid the emotional biases inherent in discretionary trading.

They follow a set of rules to get them into, and out of, the markets. They know that some trades will not be successful, but they also know that they will always be in for the big trades. The ones that make the money and over time make them successful timers.

Mechanical systems make life much easier by "removing" the emotional aspect.

Based on Price

Mechanical timing strategies are based on "price." There is no other information in the stock market that is absolutely correct at all times.

Price tells all. Price is always correct.

It may seem a bit boring using a mechanical timing strategy. After all, where is the fun, the emotional highs, that many traders thrive on.

But let's get one thing straight. Mechanical timing strategies, which use price to determine trends, are not about fun. They are not about emotion and in fact they are designed to eliminate emotion.

Mechanical trading strategies are about "making money." Pure and simple.

They are about winning.

Following The Emotional Crowd

In fact, the entire stock market moves up and down because of millions of investors depending, for the most part, on emotional decisions. Fear and greed. That is why volume spikes near the tops of rallies, and again near to bottoms of corrections. Everyone is jumping on board.

There may be comfort in following the emotional crowd, but there is seldom profit.

Mechanical timing strategies, using "price" to determine buy and sell signals, actually "use" the emotional ups and downs of the market to make money.

The rallies and corrections are going to happen, so if we use price to tell us when they are happening, as trend traders we just jump on board and let the market take us along for our profits.

Conclusion

Discretionary traders sometimes have big winners. Toss a coin enough times and it always comes up heads eventually. But the only certain way to be successful for the long haul in the markets is to follow a "non-emotional" trading strategy and to always "stick-to-the-plan."

There is no second guessing. There are no worries. We know the strategies work over any two or three year period and that can be proved with historical data going back a hundred years or more.

Trend followers know that the markets are "in" trends most of the time. They also know that at tops and bottoms there will be times of whipsaws where small losses are endured.

But trend traders who understand the logic of their strategies, are excited at these times. Why? Because those times of sideways non-trending markets are the precursors of the next big trend.

Be sure to stick to the trading strategies. No one knows what will happen tomorrow, but trend traders "know" they will beat the markets and make great profits over time.

Article Source: http://EzineArticles.com/?expert=Frank_Kollar
http://EzineArticles.com/?Discretionary-vs-Mechanical-Market-Timing-Strategies&id=552123

Technical Analysis - The Art Of Trading

2007-09-13T13:23:00.001-07:00

By Ryan Lee

Performing technical analysis is a vital component of investing wisely in various securities and can be done to any type of security, including: stocks, mutual funds, bonds, etc. When you do a technical analysis on a specific security, you are looking for price fluctuations, trends and price patterns. Your final goal is to determine how you stand as an investor, i.e., should you buy or sell?

So, how do you do a technical analysis? Well, there are a few different methods; Some people do their technical analysis by studying charts of a security’s past activity, other people use technical indicators as part of their technical analysis process. The best way to do a technical analysis is to employ several different methods - pitting one against the other in a system of checks and balances.

Assumptions made during Technical Analysis

The methods for technical analysis make certain assumptions. The first assumption is that all securities have the tendency to form patterns in their fluctuations, which is fine, and is often the case, but the market is volatile and often unstable. The other assumption made is that the past is a good indicator of the present, and yet when dealing with the market, coming to this conclusion during technical analysis does not always lead you to profitable conclusions.

Why do it?

So then, how does one handle the concept of the “technical analysis”? Why do it if it isn’t completely accurate? Well, even though it isn’t 100%, you still stand a pretty good chance of coming to the correct conclusions, depending on the methods you used and how thorough you were while analyzing.

Technical analysis, then, offers you a way to make informed choices when it comes to making new investments in securities and determining what to do with your current investments. So even though it isn’t a sure thing, you can at least have confidence in knowing you did your absolute best.

Who does it?

Well, you can either perform the technical analysis yourself or hire people to do it. If you work through a firm that helps manage your investment accounts, chances are that they employ personnel to help gather data and analyze the market. They then pass this information along to their customers in an effort to guide them in their investment choices.

If you decide to do it yourself, it may take a while to get the hang of it. Even though science and math are used to do the analysis, many consider it an art. Yes, you can use formulas to give you a set of numbers, but it is the “art” that guides a person when determining what these numbers actually mean.

For more information visit at www.besttradinginfo.com and get FREE technical analysis lessons from professional traders. Learn form Ryan Lee, a successful, full-time, active investor and others, how to trade profitably.

Article Source: http://EzineArticles.com/?expert=Ryan_Lee
http://EzineArticles.com/?Technical-Analysis---The-Art-Of-Trading&id=287624

The Commitments of Traders Report: How To Profit From Legal Inside Information

2007-09-12T21:49:00.001-07:00

By Larry Holmes

The Commitments of Traders report (COT) is a weekly government report that is extremely valuable in knowing what the "smart money" is doing in various futures markets. There is a report for each futures market. Although COT reports have been around for years, the average investor not only doesn't know how to use it, but doesn't even know that it exists.

How To Read The COT Report

Here's what happens -- the government, specifically the Commodity Futures Trading Commission (CFTC), requires all those who hold a number of futures contracts above a specified limit to report their positions. For example, the threshold limit for S&P futures is currently 1,000 contracts. So only the really big players have to report. But they hold 70% to 90% of all outstanding futures contracts.

Here is where to view the reports for the various markets...

http://www.cftc.gov/cftc/cftccotreports.htm

The report is released on Fridays (except for holidays) based on data as of the previous Tuesday. So the information is released three days after the fact. That's OK, because it's timely enough to be valuable.

The column headings at the top of the report will be labeled NON-COMMERCIAL, COMMERCIAL, and NONREPORTABLE POSITIONS.

When an account is reported to the CFTC as holding positions above the specified reporting level number of contracts, the CFTC determines if the account is a commercial hedger or a large speculator.

Commercial - The CFTC classifies a futures account that meets the reporting level as a "commercial" when that account holder files a statement with the Commission that states it is commercially engaged in business activities hedged by the use of the futures markets. They're the ones that we're most interested in. For example, the commercial traders of S&P futures are the largest institutional players like banks, pension funds, mutual funds, hedge funds and the trading arms of Wall Street firms.

Non-commercial - Those classified as non-commercial are "large speculators." They don't deal with stocks as a part of doing business. An example of a large speculative account might be a large commodity pool (a fund) that trades futures for speculative profit. Managed futures accounts have grown into the billions of dollars and if they meet the reporting levels, their positions would be reported to the CFTC for monitoring.

Nonreportable positions - All traders, speculative and commercial, that have smaller positions than the reporting level are considered the "small speculators." In other words, they're everybody else who participates in the futures markets -- the proverbial "little guys."

The Three Players

To know how to use the COT data, it's important to take a closer look at the three types of players that are the report's focus -- the commercial trader, the large speculator, and the small speculator. We want to know what makes each of them tick.

Commercial traders dominate the market. That fact really shouldn't be a surprise to anyone given the nature of who the commercials are. For example, in the S&P futures market they are banks, pension funds, mutual funds, Wall Street brokerage houses and the like. They have vast research departments and have inside information that simply is not available to the average investor in a timely manner.

They also dominate because of their sheer size. They are so large that they actually become the market. So the commercial traders are the ones that we're most interested in. We want to try to determine what they're doing and tag along. History has shown that the commercial traders in most futures markets for that matter are right a great deal of the time. And when they're wrong, they are rarely wrong for very long. They will eventually end up on the right side of the market, whether it be on the upside or downside.

The large speculators tend to be trend followers. After the market has established a trend up or down, they will go the direction of the trend. It's interesting to know what they're doing in the market, but it shouldn't be critical to your decision making process.

The small speculators are usually on the wrong side of the market. In fact, it has been estimated that as many as 90% of small traders lose money in the futures markets. They tend to serve as "cannon fodder" for the big commercial traders. After all, the "smart money" has to have someone to take the opposite side of their trades. The small speculator is usually willing to accept that roll. Think of the Harlem Globetrotters vs. the Washington Generals. The commercials are the Globetrotters. The small speculators are the Generals -- the patsies who are bound to lose.

The commercial traders are the ones to follow. They're the smart money. When they have an extreme long or short position in relation to their positions in the past, it is a reliable indicator of market direction.

Larry Holmes invites you to visit http://www.smart-money-report.com/ Your common sense guide for financial and investment success.

Article Source: http://EzineArticles.com/?expert=Larry_Holmes
http://EzineArticles.com/?The-Commitments-of-Traders-Report:-How-To-Profit-From-Legal-Inside-Information&id=86465

Timing the Exit of a Trade After a Large Move

2007-09-12T17:51:00.000-07:00

By Doug Tucker

There are many examples of market blow-offs and subsequent crashes. It is a very difficult balancing act trying to decide whether to get out during the parabolic move, and possibly leaving huge gains on the table, or to hold on with the risk of overstaying the market and giving back much or all of the gains. There is no easy answer. However, many lessons can be learned from observing past large market moves and the inevitable crashes that followed. Gold in 1980 was a good case study, as was the Nasdaq blow-off in 2000. Many individual stocks make great studies as well, including many recently.

Is there a common characteristic that can warn of danger in a timely way? Does a bell ring at the top to suggest we stop acting like pigs and should take our profits? No, there isn't one bell that rings at the top, but there are many little warnings.

Sentiment indicators do try to give a warning when everyone seems to be on the same side of the trade. If almost all traders have the same opinion, and are all positioned on the same side of the market, who is left to buy or sell? This is obvious, but how do we measure it. Traders who agree on the current price, but disagree on value will characterize a healthy market that has room to move. If everyone agrees on both price and value, the market is sure to go the other way.

Most futures markets and stock indexes have many sentiment indicators that give an estimate of bullish or bearish bias. In addition, futures traders have the Commitment of Traders weekly report that separates the large traders, small traders, and commercial interests. The problem with these approaches is they are terrible for making timing decisions. Markets can stay overbought or oversold for months on end. Even extreme readings don't help when the market is in a sustained trend. And, I believe the market character has changed in recent years, and the sentiment indicators are becoming less and less useful. Everybody knows about them. What everybody already knows won't help much.

However, I still find one sentiment indicator that works almost perfectly. When a market has had an extended, directional move and if a market pundit is asked if the trend has possibly been pushed a bit too far, and the answer is "This time it's different," that's a sell signal. It is never different. It always looks different at the top because all the fundamentals that caused the previous price advance are now known, and reported by the media, and already in the price. What had caused prices to advance is now being learned, and now everything looks so bullish that it seems obvious that price has to now go up. But it already has gone up. It's now too late. The bus has not only left the station; it has already arrived at its destination.

I'm a visual person; therefore I view the ups and downs in the market visually, like a vehicle going up or down a hill. Imagine a bus going along a flat road with few passengers. Someone can easily get on the bus at each stop. This goes on for a few miles. The bus starts to climb a gradual hill, while more people get on at each stop. All of a sudden most of the seats are full. The hill the bus is climbing starts to get a bit steeper. It is a hot summer day. More and more passengers get in at each stop. Now it is standing room only, and the bus is climbing a very steep hill. It is struggling, trying to make it up the hill. A little bit of steam starts to come out of the engine compartment, but nobody notices. At each stop people keep climbing aboard. The passengers are oblivious to the straining of the bus. They are talking or reading. They just want to get to their destination. Now the bus is overcrowded and overheating. People are hanging out the windows and holding onto the outside of the bus. It keeps trying to get up the hill, barely moving at this point. One of the passengers asks a neighboring passenger if he thinks the bus will make it, citing an example of a previous bus trip where the bus broke down. The neighboring passenger replies "this time it's different, the bus was fixed since that trip." Right at that moment there is a big clunking sound with steam coming out of the engine. The ride is over. All the passengers get out in the worse possible location. Of course, the next day the bus is fixed and the whole process starts over.

So, back to markets and price charts and away from buses. There are some clues from the price charts, that in my opinion, are more direct and timely than watching sentiment. Divergences between prices making a new high, which are accompanied by lower oscillator readings, are an early warning. The problem is that there can be many divergences in a series before the market finally pays attention and turns around. In my experience, there will be a series of small divergences, and then one last push to a high accompanied by a larger divergence. Also, most likely going out to a larger time frame will show an overbought reading and possibly a divergence in that time frame as well.

Another clue is in the price bars themselves. There will often be a large bar up, or series of bars up, on unusually high volume. Often prices will accelerate into a parabolic curve on the last impulse move up. Other times will be the reverse; a large impulse move, followed by shallower and shallower impulses up. The former is probably a result of short covering, and the latter a result of traders just trying to keep the bull alive, despite declining momentum. Sometimes the conclusion will be left with one bar up there all by itself, with lower bars on each side. This is called an island reversal. This is usually a very timely and reliable signal when it occurs. But it is rare. And beware the retest. When perfect patterns appear, the market will often want to test one more time, just to make sure. Many times there will be upthrusts, or tall spikes, that fail, usually with the bars closing near their lows. The market often needs to retest these upthrust attempts many times, so don't be surprise to see a series of these upthrust bars at major peaks, often accompanied by declining volume, and declining oscillator readings. If prices fail to attract more buying and instead succeed in advertising for sellers, then it is best to leave the party on these failed attempts. It is hard to do because all the commentators and market letter gurus are saying the biggest gains are just ahead.

It is extremely difficult to pick a top. Markets can start to exhibit clues to a reversal, and then out of the blue the market takes off to the upside again. For more reliability, it is best to wait for a confirmation that a previous swing point low is taken out to confirm a trend change. However, in a runaway market this swing point is often far away and too much of the profit would be given back waiting for this point to be taken out.

There is no perfect rule for timing these events. Most of the time I get out too early, and if not I usually got out too late. It is easier to get out on strength, when the commentators on CNBC are jumping up and down with joy that the market, or stock, will never stop climbing because "this time it's different." It's far better to get out when everyone wants to buy, than when everyone is looking to sell. It is difficult psychologically to then watch the market climb ever higher without you being on board. It is even more difficult overstaying the trend and giving back much of what you had on paper.

Article Source: http://EzineArticles.com/?expert=Doug_Tucker
http://EzineArticles.com/?Timing-the-Exit-of-a-Trade-After-a-Large-Move&id=673989

Determine the Trend Before You Trade

2007-09-12T15:01:00.000-07:00

By Doug Tucker

Trend determination is obviously important for trend followers, but anyone trading in any style should be aware of the trend in the market they are trading. The overall trend can influence your trading style. If the trend is up, you probably will have a different way you treat buy signals from counter trend sell signals. If the trend is sideways, then applying a trend following method would be frustrating and probably not profitable. A downtrend in certain markets can have a different character than an uptrend. Beginnings of trends can be easier to trade than end of trends, in many cases. Therefore, it is important to know what the trend is.

But to complicate matters, there can be many trends at play in the same market, even on the same chart. There are trends within trends. Different period lengths on moving averages, or indicator inputs, can signal a different, often confusing and conflicting trend. There can be a counter trend down move on a 30-minute chart, while the daily chart is showing a powerful uptrend, while the monthly chart is showing a sideways trend. When they all line up, it is the most comfortable and reassuring time to take a trade, but if you wait for everything to be in synch you would probably trade very little, and often not in a timely manner. And often the comfortable and easy trade is the one everyone sees, and it often turns out to be untimely. It is best to keep it simple and just trade off the time frame of the chart you are analyzing.

Most of us want indicators to guide us, as indicators are quantifiable. We can lean on them with more confidence. However, the purest and fastest way to determine trend is just through studying the price structure. Price does not lag. Price is not derived from anything. It is current. It might frustrate, but it doesn't lie.

The easiest way to define a trend using price structure is by observing high and low swing points. Swing points, or pivot points, are price bars that have a high point surrounded by two or three lower highs on either side, or a low price bar surrounded by two or three higher lows on either side.

However you define the swing point, the idea is to have a series of prices that keep taking out the previous swing point in one direction. This is the same theory of a market making higher highs and higher lows, although this isn't always exactly true. Sometimes a pause will form in the price structure and prices temporarily go opposite to the trend, with the market making a lower high, but as long as a lower low is not taken out the uptrend is still intact.

These swing points are important to the price structure because they mark where prices stopped and reversed, at least momentarily. The market can then re-test these areas to see if price gets turned back again, or if price can overcome the previous resistance point and move beyond. The market is constantly testing whether trade is accepting or rejecting price and these swing points are the reference points for these tests.

I have not found any trend following indicators or approaches to be profitable as a stand- alone system. But I have found it not profitable trading against the trend. Therefore I want to know the most probable direction of the current trend of the market and time frame I am trading. Then I can enter on pullbacks against the trend, but always in the direction of the trend. It's taken me many years of frustration to learn this lesson. It might be gratifying to pick a top or bottom of a market, but there will most likely be higher odds of success in going with the flow of the trend. If you jump into a raging river you can either flow with the current effortlessly, or swim like mad trying to go upstream. Usually the best you can do is stay where you are. So know the trend, and trade only in that direction.

I have many examples on charts to better illustrate the use of swing points, as well as some other trend determination techniques. Please refer to by blog. The address is in the reference box below.

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Using Adaptive Parameters in Technical Indicators

2007-09-11T21:41:00.000-07:00

By Doug Tucker

Most indicators that come pre-programmed in technical analysis charting software use static input parameters. This is the simplest solution, but not necessarily the best.

Many indicators were originally designed for use on daily data, so an average cycle length was estimated based on a monthly cycle. Many momentum indicators by default had an input parameter, or lookback period, of 14 bars, supposedly reflecting a half cycle of 28 days in the month, since most momentum indicators are best using one half cycle period. However, there are only about 21 trading days per month, and a cycle measure of 20 is more accurate than 28 as an average on most daily charts. In my opinion the 14 period parameter just stuck because so many people started using it, even though it was probably based on a false assumption. Some charting software, by default, used a 9 period lookback rather than 14, probably in an attempt to reflect a more accurate monthly cycle.

Indicators that are moving average based should probably use a full cycle length, as the purpose of a moving average should be to filter out the noise in the market, and then leave the underlying trend. If noise isn't first filtered out, then the indicator is just giving a signal based on noise, rather than the filtered output, which should be the trend you want to track. A common problem with the CCI, or Commodity Channel Index, is that it commonly uses too short an input parameter. Lambert, the originator, originally thought 1/3 of a cycle would be good for the lookback period, but that didn't test out very well. Many trading chat rooms use a 14 period input, but that is far too short, and gives signal based purely on noise. Of course, if the cycle is so short that the 14 parameter is correct and reflecting the current cycle, you probably shouldn't be trading at that time because the market is most likely in chop.

The problem is in choosing a parameter, if you accept the above premise, is that the cycles keep changing. If markets traded in nice, even cycles, it would be a simple matter to select the correct input for the type of indicator you are using.

There have been many attempts to make moving averages and other indicators adaptive to volatility or some other characteristic, but rarely to make them adaptive to the actual cycle length. Most early attempt to measure cycles were visual estimation based on counting swing lows. This is fine to get a ballpark estimation, but it is difficult to keep changing the parameter on the indicator every time the cycle length shifts. And, it makes it difficult to test a strategy. It is better to let the computer estimate the cycle length.

The common way to measure cycles, if the cycles are nice and even such as a sine wave, is to use a Fast Fourier transform. But the problem with this approach is it takes many cycles before the output of the transform is stable and reliable. The better approach is to use a method that can try to extract the cycle as it is forming; using a method referred to as "instantaneous frequency measurement."

John Ehlers has done much excellent work in this area. There is no way I can do justice to his work in the few hundred words here, but there is much written on the subject on the internet and in print. I have a link to his website on my website (see link below) in the resources tab, as well as references to a couple of his books on my book tab. Many of his formulas are written out on either his web site or in his books, and probably elsewhere on the internet

Also, I have an article in the indicator tab on my web site called "CCI- Making it Better" that has many charts and examples comparing using static input parameters and using adaptive parameters. Although the focus of that article is the CCI, the same principles can be applied to a stochastic or the RSI, and most other indicators. Keep in mind you need to use just half the cycle measure on many of the momentum type indicators.

Once the type of cycle measure is decided, it is a simple matter to re-write the indicator in you charting software programming language, and then use the output of the cycle measure code in place of the static number. By making the effort to do this, an average indicator can become much better when it knows what cycle it is trying to measure and track.

This article is not meant to be a complete tutorial on the subject of using adaptive techniques to improve and enhance indicator usefulness. The purpose is just to be an introduction on the subject. If you are interested, there are many free resources on the internet to explore this topic in more detail. It is well worth the effort. When using technical indicators it is best, in my opinion, to find an approach not everyone else is using. One needs to find their own way, and stay out of the crowd.

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