traders mag 2016jan

7/26/2019 Traders Mag 2016JAN

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UGLY DOUBLE

BOTTOM SETUP

rot from bottom shing 8

DECISION AREAS

N DAYTRADINGdentifying probableurning points 12

ALIASING

void data distortions 18

HIGH-VOLUME

BREAKOUTS trading strategy 26

NTERVIEWKevin Davey,

ystems developer 32

REVIEWTC2000 Version 16

HE TRADERS MAGAZINE SINCE 1982 www.traders.com AUGUST 201HE TRADERS MAGAZINE SINCE 1982 www.traders.com JANUARY 201

JANUARY 2016
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8 Bottom Fishing & The UglyDouble Bottom Setupby Thomas BulkowskiProting from bottom shing isnotoriously difcult, but this setupmay help.

12 Decision Areas In Daytradingby Peter HillIts impossible to know whenthe market will suddenly turnand move in another direction.But there are tools you can applyto your charts to identify thoseprobable turning points. Heresa simple technique any intradaytrader can use.

18 Aliasingby John F. EhlersSince you are likely using sampleddata when trading, there is a chance

that there could be some distortionsin the data. Heres what you can doto avoid those distortions.

22 Trading Vs. Forecasting:Whats The Difference?by Tyler Yell, CMTTrading is about recognizingpresent opportunities wherethe risk-to-reward is favorable.Forecasting, on the other hand, isoutcome dependent. Find out howyou can use both and take advan-tage of those opportunities.

26 High-Volume Breakoutsby Ken CalhounIn this nal article in a seriesweve been presenting on breakouttrading strategies from this profes-sional daytrader and educator, welook at the role that volume andprice-action breakout patterns playin conrming entry signals.

n Cover: William L. Brown

n Cover concept: Christine Morrison

4 January 2016 Technical Analysis ofSTOCKS& COMMODITIES

Copyright 2015 Technical Analysis, Inc. All rights reserved. Information in this publication must not be stored or reproduced in any form without written permission from the publisher. Technical Analysisof STOCKS& COMMODITIES(ISSN 0738-3355) is published monthly with a Bonus Issue in March for $89.99 per year by Technical Analysis, Inc., 4757 California Ave. S.W., Seattle, WA 98116-4499. Periodicals

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4757 California Ave. S.W., Seattle, WA 98116-4499 U.S.A.Printed in the U.S.A.

INTERVIEW

FEATURE ARTICLE

CONTENTS JANUARY 2016, VOLUME 34 NUMBER 1

REVIEW42 TC2000 Version 16

Product review: Stock marketcharting software

DEPARTMENTS 6 Opening Position 7 Letters To S&C

46 Traders Tips57 Advertisers Index57 Editorial Resource Index58 Futures Liquidity59 Classified Advertising59 Traders Resource60 Books For Traders

30 Explore Your Optionsby Tom GentileGot a question about options?

32 Developing StrategiesWith Kevin Daveyby Jayanthi Gopalakrishnan

Kevin J. Davey is a professionaltrader and systems developer. Heis the author ofBuilding WinningAlgorithmic Trading Systems: ATraders Journey From Data Min-ing To Monte Carlo Simulation ToLive Trading. An aerospace en-gineer and MBA by background,Davey has been an independenttrader for over 25 years. He placedrst once and second twice inthe World Cup Championship ofFutures Trading during the years20052007. We spoke with himabout how a retail trader can tradealgorithmically.

38 Failing Successfullyby Stella Osoba, CMTWere groomed to think of lossesas a sign of failure, which is whytrading is difcult. But experienc-ing losses is part of a traders lifeand is something you have to ac-cept. Heres how to approach theidea in a healthy way.

40 Q&Aby Rob Friesen

This professional trader answersa few of your questions.

45 Futures For Youby Carley Garner

Heres how the futures marketreallyworks.

AT THE CLOSE

61 The Green Lineby Ron JaenischKnowing when to exit a trade

can work wonders for your trad-ing returns. Heres one tool thatcan help you make that criticaldecision.


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OPENING POSITION

we approach another year, it may

be a good time to reect on whatyou expect to accomplish in 2016. A good

starting point may be to look at what goals

you set for 2015 at the same time last year.

Did you meet your goals? Did you follow

your strategies as you intended to? For the

most part, 2015 was a strong year in the

nancial markets. There were times when

there was some volatilityespecially in

August and Septemberbut the markets

recovered. Also, we are in the midst of a season that has historically been strong

for the US markets. Its easy to get comfortable or complacent with how you

have done when markets are strong. But its not something you can afford todo. Look at how your trading systems performed during August 2015. Did you

apply good risk-management strategies or did you hold your positions hoping

that the markets would rebound? If you did the latter, you can count your bless-

ings since you would have recovered your losses. But we know too well that

this doesnt always happen, and living on hope isnt going to give you the edge

you are looking for.

ut how do you gain that edge? Youre playing in the same domain as large

institutions who invest billions of dollars into building sophisticated algo-

rithms and communications infrastructure to place trades in nanoseconds. As a

retail trader, you dont have access to any of this sophisticated technology. Youvegot to come up with your own game plan. Coming up with a system is only one

piece of the puzzle. You have to put your systems through rigorous tests so you

know your systems are rock-solid before you start trading with them. And after

all that testing, theres a chance they could still not work the way you expect them

to. Even a simple system that enters and exits trades based on moving average

crossovers will have to be tested. And when your system is no longer working,

its time to abandon it and come up with a new one. Its a never-ending process.

Even though the markets will always be about buying and selling and making

and losing money, the dynamics change. Youve got to be prepared to adapt and

change your trading systems.

Be prepared to face the markets with systems that give you an edge. Theres

nothing more empowering than having control over your own systems. Heres

wishing you a protable 2016. Happy trading!

Jayanthi Gopalakrishnan,

Editor

EDITORIAL

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Editor Jayanthi Gopalakrishnan

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Contributing Editors John Ehlers,Anthony W. Warren, Ph.D.

Contributing Writers Thomas Bulkowski, Martin Pring,Barbara Star, Markos Katsanos

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January 2016 Volume 34, Number 1

6 January 2016 Technical Analysis ofSTOCKS& COMMODITIES

M

iamiDowntown

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B

As


7/64January 2016 Technical Analysis ofSTOCKS& COMMODITIES 7

The editors of S&C invite readers to submit their opinions and information on subjects

relating to technical analysis and this magazine. This column is our means of communi-

cation with our readers. Is there something you would like to know more (or less) about?

Tell us about it. Without a source of new ideas and subjects coming from our readers, this

magazine would not exist.

Email your correspondence to [email protected] or address your correspondence

to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All

letters become the property of Technical Analysis, Inc. Letter-writers must include their full

name and address for verication. Letters may be edited for length or clarity. The opinions

expressed in this column do not necessarily represent those of the magazine.Editor

Continued on page 31

IN MEMORY OF DON BRIGHT

Editor,

I enjoyed reading Don Brights column

each month. He died too young.

THOMASBULKOWSKI

THANKS FOR YOUR MAGAZINE

Editor,

Your magazine is informative and

touches different areas of the industry.

I especially enjoy Dirk Vandyckes and

Melvin Dickovers articles and their ap-

proach to the markets and trading.

Other things that I would like to read

about in your magazine are the so-called

quant traders and the quantitative

trading techniques and systems and

their use. Any resources regarding thiswould be helpful.

Another thing I think could be helpful

is a column from the point of view of a

novice trader for those just starting out

in this business. It could be a how-to

column with the required steps for start-

ing out, including advice, choosing the

right hardware, platforms, and systems,

and incorporating as a business, up to

the particulars of different markets and

the best way to trade them.

Thank you for your magazine and for

the hard work you put into making the

magazine a reality. Im looking forward

to reading more interesting articles.

MIHAIARNAUTA

SIMPLIFY IT: SCREENING AND

AVERAGE DAILY VOLUME

Editor,

I read with great interest James and John

Richs article in the November 2015 is-

sue of Technical Analysis ofSTOCKS&

COMMODITIES, Simplify It, on their

trading channel strategy.

My question relates to scanning for

stocks that are trading more than one

million shares a day. Over what period

of time do the authors use to measure

the average daily volume of one million?

(That is, two days? ve days? 20 days?40 days? 60 days?)

I did a scan for one million stocks over

a 20-day period and many of my results

had a current daily volume, on the day of

the scan, of far below one million.

My scan for volume of over one million

shares, using StockCharts.com, was as

follows:

[Daily SMA(20,Daily Volume) >

1000000]

This scanned for an average daily volume

of the last 20 days that was over one

million shares.

Feedback from the authors would

be most welcome. And thank you for

presenting a workable, simple trading

strategy.

WILLIAM

Lansing, MI

Author James Rich

replies:

As long as you use 20

days or more, I dont

think its going to

make any difference,

since the point is to

avoid thinly traded

stocks. Using 20 days is equal to four

trading weeks, and theres always the

possibility of picking up a low-volume

day or even a low-volume week, but youll

still have stocks with enough volume to

be traded by institutions.

SIMPLIFY IT: MOVING AVERAGE

CRITERIA

Editor,

Thank you for the November 2015 article,Simplify It, by James and John Rich. As

an individual trader, I appreciate the way

they simplied the process and I liked

the ideas expressed in their article.

A quick question for the authors:

When they are using their 50-day SMA

of the SPY to initially determine market

direction, what specic criteria do they

use to base this determination on? For

instance, does the last 50d need to be

higher than the reading 10 periods prior

(and if so, is there a % requirement)?

Ive attached two sample charts [not

shown] (I quickly grabbed wheat charts

for this example but I would use SPY for

stock scanning, of course). These are

showing the 50d trending in a direction,

but obviously in very different degrees

of trending. The downtrend of the rst

is clear, but while the uptrend of the

50d in the second is going higher, it

is happening in a rather range-bound

sideways market.

Winner

13 years

in a row!

Maybe its time to try

something NEW!

Build powerful trading

systems in MINUTES,

not hours or days.

www.NeuroShell.com

301.662.7950
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8/648 January 2016 Technical Analysis ofSTOCKS& COMMODITIES

how to improve the setup.

Ill begin with a chart pattern I call

an ugly double bottom. In Figure 1

you see an example of this at points

AB. In a traditional double bottom,

price makes a valley, bounces, and

forms a second valley at or near theprice of the rst one. In the case of an

ugly double bottom, you are looking

for a second, higher valley.

In this example, price makes a

new yearly low at A, bounces to the

horizontal blue line, and forms a

higher bottom at B. When I rst tested

this pattern several years ago, I set a

minimum price difference between

bottoms of 5%. This example shows

bottom B 7% above A.

The ugly double bottom conrmsas a valid chart pattern when price

closes above the top of the pattern.

That occurs at C in Figure 1, although

it may be hard to see on the chart.

Notice how price drops to D and

then recovers. Testing shows that a

stop placed below B is not ideal, but

it will cut losses almost in half. The

tradeoff is a drop of 20 percentage

points in the win/loss ratio. I prefer

a stop below A. Ill discuss testing

results later in this article.

TRADINGSETUP

The setup described here is easy

enough to follow. Look for an ugly

double bottom when the stock

makes a new yearly low. Here are

the steps.

1. Only look for stocks during a

bull market.

2. Find a stock making a new

yearly low.

3. Locate an ugly double bot-

tom where the rst bottom

sets the yearly low.

4. Place an order to buy the

stock on or after the pattern

conrms.

5. Place a stop-loss order a

penny below the rst bottom.

6. Use your favorite sell signal

to exit the trade.

A Turn For The Better

Bottom Fishing &The Ugly Double Bottom

Setup

Proting from bottom shing is notoriously difcult, but this setup may help.

by Thomas Bulkowski

uy low, sell high. How many times have you tried to do that and lost money?

Heres a trading setup for buying stocks making new yearly lows. A shorter

phrase for that is bottom shing. The technique Ill describe here is not per-

fect. You can still lose money, perhaps a lot of it, but the setup gives you an

indication of how often bottom shing works. Perhaps you will have ideas on

BRoc

ksweeper/Shutterstock



how far the bottoms should be from one another (price scale),

best exit technique, and so on. Then I applied the setup to the

larger group of stocks and also ran some of the tests going

back as far as 1990. I didnt see any performance difference

between in-sample and out-of-sample data that would change

the setup.

PERFECTTRADES

The rst question bottom shers will want answered is how

often will trades be stopped out? If you were to trade the

setupperfectly(using ugly double bottoms with bottoms 5%

to 20% apart), it wins 87% of the time, making an average

of 48% from winning trades, but incurring an average loss

of 17% on losing trades. Overall, you could make an average

of 40% per trade.

To nd those statistics, I used a stop-loss order placed a

penny below the bottom of the chart pattern, triggered on a

close at or below the stop price, and sold at the open the next

day. Otherwise, the stock sold when it reached the ultimate

Step 1: Only bottom sh in a bull

market. In a bear market, price

tends to keep going down and it

busts ugly double bottoms. Testing

results reinforce that belief. The

median trade in a bull market

gained 32%, but in a bear marketit lost 20%.

Step 2: Using the yearly chart,

look for price to set a new low

for the year at the rst bottom of

the ugly double bottom.I did not

test variations with the rst bottom

higher in the price range, so that is

something you can explore.

Step 3: The second bottom should

be between 5% and 20% above therst one.The larger the difference

between bottoms, the larger the

potential loss, but the number of

winning trades increases. I tested a

5% to 25% range and found that the

sweet spot is 10% and above.

Step 4: The pattern conrms

when price closes above the top

of the pattern.That means buying at the open the next day.

However, I often use a buy stop placed a penny above the top

of the chart pattern to get me into a trade. Using a close abovethe top helps avoid one-day price spikes that would otherwise

trigger a premature entry.

Step 5: Placing stops.I tested two stop locationsa penny

below the rst bottom and a penny below the secondtriggered

on a close at or below that price. Neither stop locations work

well in my opinion. I will discuss stop placement later in this

article.

Step 6: Apply a sell signal.I tested moving averages from

10 to 250 days, trailing stops from 5% to 25% below a high-

water mark, and a target price exit based on the height of the

chart pattern.

TESTING

I used 59 stocks for in-sample data and 425 for out-of-sample

data starting January 2000 (yes, in the middle of the bear

market whose trades I discarded but logged anyway) to June

2015. Not all stocks covered the entire range.

To nd ugly double bottoms automatically, I looked for the

lowest low within a sliding window of ve trading days wide.

That means nding the lowest low from ve days before to

ve days after the bottom (11 days total) and then looking for

the next adjacent bottom.

I used in-sample data to determine the best stop location,

TRADING STRATEGIES

FIGURE 1: THE UGLY DOUBLE BOTTOM.An ugly double bottom appears at AB and confirms as a valid pattern at Cwhen price closes above the top of the pattern.

If you were to trade the setup

perfectly, it wins 87% of thetime, making an average of 48%from winning trades.



high. The ultimate high is the highest peak before price closes

at least 20% below that peak. This is not the same as a trailing

stop set 20% below a high-water mark. The exit sells at thehighest peak before the stock tumbles, so it is unrealistic.

The 20% price swing is what many use to distinguish a bull

market from a bear market. I simply applied that mechanism

to stocks. I used 867 perfect trades, so dont expect your

results to duplicate it in actual trading. For a more realistic

exit signal, I selected selling when price reached a target. The

target was a multiple of the height of the ugly double bottom

added to the top of it.

RESULTS

The table shown in Figure 2

illustrates how performance

varied depending on the height

of the target and stop placement.

These are out-of-sample results

using ugly double bottoms withbottoms between 5% and 20%

apart (narrower than the 5% to

25% test range). Consider the

1x height for bottom 1. I placed

a stop one penny below the rst

bottom of the chart pattern to

limit losses (again, triggered only

at close and sold at the open the

next day). For the target exit, I

computed the height of the chart pattern, added the height to

the top of it, and then placed a sell stop at that price.

Trades won 75% of the time. Winning trades made 15%but losers lost 19%. The combined average of winning and

losing trades was a gain of 7% (average) or a median of 12%.

There were 862 trades.

Since you are buying at the top of the pattern and getting

stopped out at the bottom of it, the loss is large, about 20%

for stops placed below bottom 1. If you use bottom 2 as the

stop location (a penny below it), the loss drops from 19% to

11%. However, the win/loss ratio drops to 56%, so fewer trades

work. The overall prot drops from 7% to 4%, too.

I narrowed the price difference

between the two bottoms in the

ugly double bottom from 5% to10% (second column from the

right). The results are shown in

the table in Figure 2. The win/

loss ratio climbs marginally from

66% to 68%. Losses increase

from 20% to 22% but the aver-

age and median prots rise dra-

matically, 14% to 19% and 22%

to 32%, respectively. If I were to

trade this setup, the 10% to 20%

range with a 2x height would be

my choice.

The table shows that as the

price target gets further away,

prots increase but losses stay

about the same. That makes

sense because the loss size is

determined by how tall the pat-

tern is (with a stop below the rst

bottom). If you raise the stop-loss

location, then you will have more

losing trades and you will be

stopped out of potentially win-

ning trades, decreasing prot.FIGURE 3: TRADING EXAMPLE.Here, the two bottoms are at least 10% apart but no more than 20%. The entry istriggered a penny above the top of the pattern. This ugly double bottom trade leads to a 29% gain.

1x Height 1x Height 2x Height 2x Height 2x Height 3x Height

Bottom Stop 1 2 1 2 1 1

Bottom Diff 5%20% 5%20% 5%20% 5%20% 10%20% 5%20%

Win/Loss 75% 56% 66% 47% 68% 60%

Avg Win 15% 15% 31% 32% 39% 46%

Avg Loss -19% -11% -20% -11% -22% -20%

Avg Profit 7% 4% 14% 9% 19% 20%

Median Profit 12% 8% 22% -4% 32% 26%

No. of Trades 862 855 818 865 420 771

FIGURE 2: TRADING RESULTS.Here, you see the performance statistics for the ugly double bottom setup.



Tall patterns helpassure, but notguarantee, thatthe stock haschanged trend.

HERESANEXAMPLE

The chart in Figure 3 shows an example

of how the ugly double bottom setup

works, using what I call the preferred

setup. The preferred setup has bottoms

at least 10% apart but no more than

20%, and entry triggers using a buy

stop placed a penny above the top ofthe chart pattern.

Price makes a new yearly low at A,

at 57.55, in a bull market. At B, 64.91,

the stock makes a higher bottom. The

difference between those two bottoms

is 13%, falling within the 10% to 20%

range.

A buy stop placed a penny above the top of the pattern

(67.21) starts the trade at C. The exit price target is twice the

height of the ugly double bottom, or 2 x (67.21 - 57.55) = 19.32.

Add the height to the top of the pattern (or the buy price) to

get a target of 86.53.As the chart shows, the stock makes a strong recovery and

soars to D, where it sold for a 29% gain (not including com-

missions and fees). If the trade failed, it would have meant a

potential loss of almost 15%. Notice that a stop placed below B,

the second bottom, would have triggered on the drop to E.

THATSAWRAP

The ugly double bottom setup is awed because the stop is

placed below the bottom of the chart pattern. This is necessary

because stocks making new lows tend to make lower lows.

Tall patterns help assure, but not guarantee, that the stock

has changed trend. When the trend changes from down to up,

bottom shers can prot from the rise.

Since the potential loss is large, this setup is best for inves-

tors, those willing to buy and hold a stock for the long term.

They are willing to risk money in the short term to boost

prots over the long term. Swing and position traders may

also benet from this setup, too.

Although I used the height of the chart pattern as the exit tool,

you may wish to use your own stop-loss and exit mechanisms

to perfect this setup for the markets you trade.

S&C Contributing Writer Thomas Bulkowski (who may be

reached via email at [email protected]) is a private investor

and trader with more than 30 years of market experience and

considered by some to be a leading expert on chart patterns.

He is the author of several books including Getting Started

In Chart Patterns, Second Edition and the Evolution Of A

Tradertrilogy.His website and blog, www.thepatternsite.com,

have more than 600 articles of free information dedicated toprice pattern research.

FURTHERREADING

Bulkowski, Thomas [2013]. Fundamental Analysis And

Position Trading: Evolution Of A Trader, John Wiley &

Sons.

[2014]. Getting Started In Chart Patterns, 2d. ed.,

John Wiley & Sons.

[2013].Swing And Day Trading: Evolution Of A Trader,

John Wiley & Sons.

[2013]. Trading Basics: Evolution Of A Trader, John

Wiley & Sons.

[2015]. 10 Selling Tips,Technical Analysis ofSTOCKS

& COMMODITIES, Volume 33: May.

[2015]. Four Lessons From Three Decades Of Trad-

ing, Technical Analysis of STOCKS & COMMODITIES,

Volume 33: August.

http://thepatternsite.com
http://traders.com/http://www.vectorvest.com/SC



WILLIAML.

BROWN

TRADING SYSTEMS

Its impossible to know when the market will suddenly

turn and move in another direction. But there are

tools you can apply to your charts to identify those

probable turning points. Heres a simple technique

any intraday trader can use.

trader with a small account is in a precarious

situation judging when to take a position or to

stay out of the action. He is normally a personwho wants to be trading in the markets, who is anxious

to be involved and often thinks more of the reward

than the risk. This is the reason that so many people

who try to scalpthat is, take intraday positions for

short periods trying to capture a few points during the

dayso often come to grief. Trying to guess which

way the market will go from one minute to another is

a perilous adventure. Often, you can be right in one

time frame and wrong in another, and if youre wrong

in the smaller time frame, it may be too late for youby the time youre justied in the longer term.

With its high degree of leverage, the futures market

is unforgiving of mistakes. That makes it necessary

for the small trader to take his position at the optimal

moment, the one during which he will know within

narrow limits whether he has made a good decision

or not. Between these boundaries is the area I call the

decision area within which the trader needs to take

his position or keep it or abandon it before being hurt.

Since so many traders are not able to withstand a large

drawdown, my task was to nd a way to trade a small

amount of money in such a way that prots could be

made while taking the least possible risk.

ENTERFIBONACCI

The genesis of this project was my observation of the

effect of Fibonacci analysis on the prices of virtually

any product in the securities markets. Im certainly not

the rst to notice this phenomenon of prices bouncing

around between numbers whose basis is a thousand-

year-old mathematical formula, but I had not seen the

particular analysis of intraday price activity that I found

when I started my experimentation. After watching

Fibonacci calculations seeming to exert great pressure

on prices in the larger time frames, I had become a

fan of this method. But it was when I looked at thesmaller time frames that I saw I could make the power

of the study a safety factor in daytrading.

Of the hundreds of mathematical studies available

on computer platforms that are used to access the

stock, option, and futures markets, I had found Fibo-

nacci study to be easily the most accurate predictive

study of all. It has many devotees, which I believe is,

in itself, the reason it is so powerful. Some have an

almost mystical belief in this system, thinking that

there is a metaphysical force expressing itself in theway that the Fibonacci number series applies to things

like the formation of galaxies and the shells of turtles,

the golden ratio in art, and other kinds of analysis.

But I think its enough that many traders see the ef-

fects of the study and thus they use it for guidance

when they put in their orders to buy and sell. That is

what makes it seem as though the Fibonacci levels

are ordained by heaven itself.

The determination of value, meaning the right

price for a securities product, is the job of all market

participants, including banks, pension funds, hedge

funds, and the daytrader. Their opinions about the

worth of things vary with changing conditions; they

are always approximate, and, to a large extent, partici-

pants differ according to the time frame in which they

are observed. The time frame is the most important

factor for the daytrader, who is, by denition, out of

A

Looking Beyond Price

Decision AreasIn Daytrading

by Peter Hill



the marketwhen it is closed and therefore unconcerned aboutwhether it is going up or down in the longer term. He is inter-

ested only in the prices of things from 9:30 am until 4:15 pm

US Eastern Time. During these six and three-quarters hours,

prices change in ways that may well look unpredictable to those

without experience and the proper tools.

VIEWINGTHECHARTS

The security with which I am concerned, and which I will use

in this article, is the futures contract that tracks the S&P 500

index. It is an instrument of interest to traders over the entire

world and it trades nearly 24 hours a day, ve days a week, and

on a good day, over two million contracts will be exchanged,making it highly liquid. Liquidity is not just an advantagefor

the daytrader; it is a necessity. The daytrader must be able to

jump in and out of the market without delays. Another impor-

tant advantage of trading in the futures market as opposed to

the stock market is that you do not have to own the product in

order to sell it. A seller can take his position in the hope of a

decline in price, after which he can take a prot. This can also

be done in the stock market, of course, but you need the ction

of ownership by borrowing the stock in order to sell it. The

effect is the same as long as the stock is not difcult to borrow,

but all in all, its easier with futures, especially in daytrading.

There are two basic ways of describing the nancial mar-

kets. One is appropriate for longer-term investors: it concerns

itself with the fundamentals of nancial products, the analysis

of the economy, monetary system, and so on. This is usually

applied to the equity market by people who want to nd the

best stock to own for the next 20 years. The daytrader is not

interested in the next 20 years, and he is not interestedat least

immediatelyin the balance sheet and quarterly report. But he

is interested in the rst effect that those things have on other

people, mainly other traders. And where others may use the

daily newspaper, or even listen to the CEOs conference call to

decide whats valuable, the daytrader, along with others traders,

uses intraday charts. The charts tell him what effect the CEOs

call had on other market participants. They tell him if people

are more enthusiastic about buying

than selling, or the opposite. The

charts are pictures of the drama

of the market. These images tell

a story that can be grasped im-

mediately, which reams of written

data cannot.In Japan, in the 17th century,

charts were hand-drawn by rice

traders, and even some contem-

porary traders have drawn their

charts by hand. Those were

naturally daily charts, but with

the conquest of the computer in

the mid-90s, everything changed,

and intraday charting came into its

own. The computer does it easily,

manipulating data and putting it in

a form that can be appreciated at a glance. The trader can usethese charts to nd those areas where price may be too high

or too low, that is, whether the instrument has value or not,

even on the most eeting basis. I think charts have become

ascendant because most people are visually oriented and like

the perspective that charts can provide.

The chart that I believe is best for the small tradersince

were interested here in safetyis one that is of a very small

time frame. I prefer two minutes; others like tick charts,

which paint bars (or candles) according to a specied number

of trades. These are best for the scalpersso-called because

of their hit-and-run style, taking a little out of the market here

and therebecause it is the safest way to be in what could be adangerous environment. There are longer-term investors here,

too; the two classes of market participants are there together,

but its the scalpers that determine the minute-by-minute ups

and downs of the price action. It is the scalpers who are making

their living on this price action, minute by minute, in between

and sometimes using the activities of the long-term investors

as grist for their mills. Of course, they are equally grist for the

mills of the long-term investors. Fair is fair.

Though this is an arena for long-term investors in the end,

its one that could not exist without the scalpers. It is supported

by the scalpers in the same way that our farmers are supported

by the speculators who are willing to buy their crops before

they have even sprouted from the ground. The farmers could

not remain in business without the speculators, and in the same

way, the investors need the scalpers to function.

Lets look at a basic intraday chart in Figure 1. Theres not

much to go on here. The chart (one day in two-minute incre-

ments) makes market action look like a brawl. Sometimes the

buyers are winning and sometimes the sellers. It looks like

theres no way to predict what will happen next. Clearly, the

chart, in and of itself, is not enough. This is where the Fibonacci

tool makes itself felt in the intraday environment. The toolas

opposed to the Fibonacci mathematical system that gave birth

to itis another invention of the last few decades: mathematical

studies applied in visual form to price action. The wild-looking

FIGURE 1: A BASIC INTRADAY CHART.You can see that its difficult to figure out whats going on here. Sometimes thebuyers are winning and sometimes the sellers are winning. Theres no way to predict whatl l happen next.

TDAMERITRADE



chart that you saw in Figure 1 can be tamed to a large degree

with this tool. It clearly puts some order into the chaos of the

chart in Figure 1.

The chart in Figure 2 has horizontal lines (blue on my charts)

laid across the price activity that were calculated by the Fibonacci

system. You can see in this chart how the price often pauses

at the blue lines, sometimes right on the tick, or sometimes

clustering, and then often turning to go in the other direction. It

is almost as though the price was poured into an oddly shaped

mold, the Fibonacci lines being its edges. There is occasional

spilling over, but it is unusual for price to ignore these lines

even at times when excitement and volatility are high.

Those Fibonacci levels are landmarks in the alien territory

that we saw in the rst chart, a wasteland that gave no clues as

to where we were or what to do. You need to have something to

judge whether the product you are trading was well or poorly

priced. With the Fibonacci levels, you dont need to buy or

sell blindly with no good idea of whether prices will go up or

down; instead, you have something

to go by.

WHATARETHECHARTS

TELLINGYOU?

Now that you have the Fibonacci

levels on the chart, the next step isto gure out what they are telling

you. In my observations I have

found that they are, sometimes

for just moments, the boundar-

ies of what we call support &

resistance. This idea may be the

most important one in the world

of trading. The traders idea of

support & resistance will be his

reason for buying or selling or

doing nothing. When the trader

believes the price of something is atsupport, he will be willing to buy,

and when its at resistance, he wont

buy, and may sell instead. Support

can be dened as a level at which

buyers are willing to pay up for

the product in question, expecting

that they will be able to get more

for it in the future, even in the next

couple of minutes. Resistance, on

the other hand, comes about when

buyers are no longer willing to

pay up, and also where the sell-ers, a little anxious, are willing

to take whatever is bid for their

holdings, generally a little less

than they would otherwise have

held out for.

Naturally, there are many valid

ways to determine support & re-

sistance. Every trader has at least one, and I am not trying

to gainsay any other theory. But the evidence I have found

shows that the delineations that result from the proper use of

the Fibonacci tool become excellent estimations of support &

resistance, at which times a majority of orders moves the price

either up from support or down from resistance. Traders will

respond to these numbers as denitions of the high and low of

an area of value.

But is everyFibonacci line a level of support or resistance?

From the chart in Figure 2 you can see that price often changes

direction at the blue lines. But these numbers are not always

exact, and sometimes the turn is too small to be of use. You

need something else to give you the condence to take a posi-

tion, and to assure you that the change in direction you expect

will have some follow-through. The thesis here is that there

is an important relationship between the price and Fibonacci

levels, but this fact turns out to be insufcient by itself for ef-

fective trading.

FIGURE 2: ADDING FIBONACCI LINES.Here, you can see how the price often pauses at the blue lines, sometimes righton the tick, or sometimes clustering, and then often turning to go in the other direction.

FIGURE 3: ADDING AN INDICATOR.Here, the stochastic oscillator is used as a confirmation to the Fibonacci levels.Meeting of price and Fibonacci levels combined with a high or low level on the stochastic gives a good indication of whatwill happen next.



ADDINGCONFIRMING

INDICATORS

The Fibonacci tool is not magi-

cal. What is needed is one more

indicator that will act like a

compass at Fibonacci levels,

telling you which way to go,whether it is appropriate to take

a position or not, whether to

buy or sell, and whether there

may be follow-through from

the point at which you take a

position. Its another of those mathematical studies made visual:

the stochastic oscillator. There are others of this variety, but I

like this one.

Notice on the chart in Figure 3 the coincidence of price

meeting a Fibonacci level and the position, high or low, of the

stochastic. (The ovals are drawn at the same times on the upper

and lower panels of each part of the chart. This is the coordina-tion youre looking for.)

Its clear on this chart that the meeting of price and the Fibo-

nacci levels combined with a high or low level on the stochastic

gives a good indication of what will happen next. The prob-

abilities are very high that this combination will be predictive

of the direction that price will go, and that there will be enough

follow-through to make the trade worthwhile. You dont want

to make a trade only to have the thing do an about-face as soon

as you click the buy or sell button. Ideally, you see the price

rise along with the stochastic and then see the price meet a Fib

level while the stochastic is high in its range. That will signal

an opportunity to sell. Itll be the opposite for buys.By the time the market opens, Fibonacci calculations have

been made for the day: the levels are on the chart. (See sidebar

Calculating Fibonacci Levels for the method of deriving these

numbers.) At the open, or even earlier, we look for an indica-

tion of which way prices will go. Where is the Fib level? Is the

stochastic high or low, if either? These are the things that will

give indications of what the market wants to do.

The chart in Figure 4 shows the rst two hours of activity of

the S&P emini futures contract on a recent day. (The verticallines are put in to show the connection between the stochastic

and price levels.) You can see that price opened (9:30 am Eastern

Time, the rst of the vertical lines) up against a Fibonacci level

at about 2096 and the stochastic was quite high in its range. This

made for a reasonable sell of the contract, which went down to

2083 before reversing for the day. There were various points at

which you could get in or out, but the possibility is clear that a

skillful trader might have captured 13 points on this contract.

Small time frames like this have the advantage of letting the

trader know quickly when a trade is not working as expected.

A large trader might use a ve, or 15-minute, or even larger

time frame because he doesnt need to worry as much aboutthe drawdown that can happen while a single bar (or candle) is

beingpainted. If a small trader tries to use even a ve-minute

time frame he may nd himself in trouble before he knows

it. That, combined with the use of the Fibonacci system, is

specically geared to keep the small trader out of trouble. The

trader has what I am calling a decision area within which

he is safe. The large trader might be able to afford to take 15

minutes to make his decision, but the little guy has sometimes

only a few moments. You want to quickly know when you are

wrong. You need to have guideposts that you respect because

otherwise you will be tempted to think that you know better

than that mathematician who is long dead, and try to pit yourselfagainst the market, which is always a mistake.

I believe that this system, simple as it is (one chart with two

CALCULATING FIBONACCI LEVELSHeres how the Fibonacci tool is used

to create intraday levels of support &

resistance, creating some order in the

chaos. On the two-minute chart in

Sidebar Figure 1, the trader simply,

before the market opens, drags the

drawing icon labeled Fibonacci

retracements from the low of the

overnight session to its high (the areas

designated by the red squares). The

numbers upon which the lines are

based correspond to percentages of

the range of that overnight session

(38.2%, 50%, 62.8%, etc., up to 423%).

You then do the same thing from the

high to the low so you have numbers

that would be appropriate to the mar-

ket going lower. This way, youll be

ready for anything.P. Hill

SIDEBAR FIGURE 1: CALCULATING FIBONACCI LEVELS.You can prepare for any market scenario by creatingintraday levels of support & resistance.



indicators), would provide a way for the small trader to function

in the market without taking a lot of risk. I think its just what is

needed by so many who inhabit the chat rooms on the Internet

waiting for gurus to tell them what to do. This can be learned

by anyone and can give all the guidance that a guru could give,

at least insofar as daytrading index futures is concerned.

THETRADINGPLAN

You can see in the chart in Figure 4 that the system does fail

at certain points, mostly when the market is volatile. However,

these instances are so rare that a trade will be safe from any

serious drawdown as long as the trader always uses stop-loss

orders, especially for those volatile times, and as long as the

trader respects those orders. The stop-loss order has to be un-

questionable once it has been decided generally how much the

trader can afford to risk on a trade. In my backtesting, Ive found

that the price will only rarely overrun the Fibonacci level by

more than two points before going in the desired direction, so I

use a 10-tick, or 2 point, stop-loss, and it is rarely hit. Taking

these losses is not terrifying as long as I know that the ratio of

wins to losses is positive, and as long as I keep my trade size

appropriate to the size of my account, never

risking more than I can afford to lose.

With these things in mind, the trader can see

what the uses of the Fibonacci levels are. They

dene a place on the chart with the number

that may well be the exact point at which the

price turns. My view is that it is good to putorders to buy or sell the Fibonacci numbers

as early as possible. Discretion has to be used

in this situation: be wary of a fast-moving

market. Each trader is competing for a place

in the queue of the exchange, which will ex-

ecute orders on the basis of the time they were

entered. If all the traders who are looking see

that 2089.75 looks like a good number to sell,

they will be putting in their orders to do so as

soon as they can. If I am late in deciding that

it would be a good deal, my order may not be

lled. My order will be left in the queue whilethose ahead of me will get into the market.

Then, next time, I will have to get ahead of

the others by using a lower number for sales

and higher for buys by a tick or two, which

may work but which will make my stop-loss

more vulnerable. This may not be a terrible

problem, but it is something to consider. It is always possible

to cancel orders that look like they might be overrun because

there is too much volatility or the stochastic is not in the right

position for that particular trade.

Finally, though this is not an attempt to cover all the aspects

of trading, I would be remiss if I didnt remind anyone whowants to use this system that it is always necessary to keep an

eye on the general conditions of the day, especially the breadth

indicators that will warn the trader of volatility and direction in

the wider market. For example, if there is a strong trend in the

downward direction, it doesnt mean that he cant take coun-

tertrend trades, buying signicant levels, but it does mean that

he is in more danger doing so, and should not expect as much

from that buy trade as he would get if he were sellinga good

number that he could go with for a longer, and better, trade.

Going with the trend of the day is normally best, as usual, but

days without trend are as promising for this system as trending

days, and possibly safer.

Peter Hill was an equities trader until he made a bad specula-

tive investment in English real estate. The loss of capital in that

deal led him to feel the need to use the higher leverage offered

by the futures market. After investing a great deal of time and

money in learning how to trade in the futures markets, he

came up with a methodology to trade that offers discipline and

reasonable expectations of what might happen in the markets.

He may be reached via email at [email protected].

TD AmeritradeSee Editorial Resource Index

This system, simple as it is (onechart with two indicators), wouldprovide a way for the small trader

to function in the market withouttaking a lot of risk.

FIGURE 4: TRADING THE S&P 500 EMINI FUTURES CONTRACT.At around the open, price was upagainst a Fibonacci level at about 2096 and the stochastic was qui te high in its range. This would have beenan indication to sell. From the chart, you can see there were several opportunities to buy and sell.
http://traders.com/



samples per cycle is called theNyquist frequency. The theoryis demonstrated in Figure 1, where the shorter cycle depicted

by the red line is sampled at a rate less than two samples per

cycle. Since there are less than two samples per cycle of the

real data of the red sine wave, the data is interpreted as the

phantom aliased blue sine wave. Just imagine the impact on

your trading if your data is subject to aliasing!

Mathematically, the process of sampling is multiplying a

sine wave at the sampling frequency with the cycles in the

continuous data. From your high school trigonometry class

you may recall this equation:

Sine(A)*Sine(B) = 0.5*(Sine(A+B) + Sine(A-B))

If A represents the sampling frequency and B represents the

frequencies of the continuous data, the sampling frequency is

heterodyned with the continuous data with upper and lower

sidebands. This is exactly the same process as with your AM

I

Since you are likely using sampled data when trading, thereis a chance that there could be some distortions in the data.

Heres what you can do to avoid those distortions.

by John F. Ehlers

imagine that most traders consider the price data they

use for analysis to be a continuous function. Nothing

could be further from the truth. And, depending on your

trading style, the impact of this assumption can range

from trivial to dramatic. The fact is that the data is sampled

data. The sample rate is once per day on daily bars, once per

hour on hourly bars, and so on. It doesnt matter if you aver-

age the high, low, and close; you still only have one sample

per day on daily bars.

One impact of sampled data is that it can lead to aliasing. In

my youth, the old cowboy movies had a sample rate of only 16

frames per second, letting the eye integrate those individual

still photographs to produce motion, albeit with a little icker.

Aliasing at this slow sample rate made the wagon wheels look

like they were turning backwards, and the effect was really

weird. Aliasing can also produce some weird effects on your

market data.

The theory of sampled data states that you must have at

least two samples per cycle. Otherwise, the sampled data will

result in aliasing. The frequency at which there are exactly two

FRED

FOKKELMAN/SHU

TTERSTOCK/DIGITALCOLLAGE:NIKKIMORR

FIGURE 1: THEORY OF SAMPLED DATA.Sampling less than twice per cycleproduces phantom aliased signals.

Uncovering Hidden Truths

Aliasing



TRADING TECHNIQUES

radio, where you tune your re-

ceiver to the carrier frequency and

the information is contained in the

upper and lower sidebands. Since

the sampling process is nonlinear,

aliasing can include harmonics of

the sampling frequency mixingwith different harmonics of the

data to produce a really gnarly

soup of noise superimposed on

the information contained in

the data.

Heres the important part for

market data: there is nothing

inherent in the data to preclude

content whose period is shorter

than that of the Nyquist frequency.

That means you should expect the

upper sideband to be folded backinto the lower sideband, producing

a false composite signal due to

aliasing. The real question is how

badly the aliased composite wave-

form affects your trading. Figure

2 shows the closes of daily prices

of SPY as the green line, while the

red line shows the majority of the

aliased signals removed by lter-

ing in the composite waveform at

the cost of a half bar of lag.

JUSTHOWBADISIT?To get a more quan-

titative estimate of

aliasing effects,

start by making a

model of market data. It is well

established that market data is

fractal. That is, a chart using

weekly data looks exactly like

a chart using daily data if you

remove the scales. In other words,

the amplitude of the swings

in market data is proportional

to the wavelength of the cycle

components in the data. Simply

put, longer cycles have bigger

swings. Using this model, you can

extend the theoretical shape of the

market spectrum on both sides

of the Nyquist frequency. Figure

3 shows the spectrum amplitude

of the data at frequencies below

the Nyquist frequency as the blue

line and, with the upper sideband

FIGURE 3: ALIASING IMPACT.The lower sideband blue line shows the ampl itude doubling every time the cycle perioddoubles. In this simplified model, the red line represents the aliased upper sideband amplitude simply added to theamplitude of the blue line signal.

FIGURE 2: HOW DOES THE ALIASED COMPOSITE WAVEFORM AFFECT YOUR TRADING? Here you see that aliasingproduces short-term volatility in the composite data.

FIGURE 4: ALIAS AMPLITUDE.The aliasing impact becomes insignificant two octaves below the Nyquist frequency.



folded back about the Nyquist frequency, the amplitude of the

composite sidebands show as the red line. The lower sideband

blue line shows the amplitude doubling every time the cycle

period doubles. In this simplied model, the red line repre-

sents the aliased upper sideband amplitude simply added to

the amplitude of the blue line signal.

The aliasing impact is better demonstrated in Figure 4,

where the ratio of the composite signal plus alias is shown as

a ratio to the signal in terms of decibels. The maximum im-

pact is at the two-bar cycle periodthe period of the Nyquist

frequency. Two octaves below the Nyquist frequency, at the

eight-bar cycle, the impact is less than 0.5 dB, and therefore is

basically insignicant at longer cycle periods. Other

theoretical models of the market can be created, and

these generally show that the aliasing impacts depicted

in Figures 3 & 4 are a conservative estimate.

So what does all this mean to a trader? If you are a

trend follower and are using tools like a 50-day mov-

ing average or a 200-day moving average, the cycleperiods of the data you are using is so far removed

from the Nyquist frequency that you can just ignore

the impact of aliasing. On the other hand, if your

technique involves recognizing short-term patterns

in the range of two to ve bars, you should seriously

rethink your approach because aliasing produces

illusory patterns. Short-term traders using cycles or

mean reversion should take active measures to mitigate

the impacts of aliasing.

WHATCANBEDONE

TOMITIGATEALIASINGEFFECTS?The rst line of defense to avoid

problems associated with aliasing

is to just accept that you should

not work with cycle

periods within two

octaves of the pe-

riod of the Nyquist

frequency. For daily

data, that means

you should not ex-

pect to use cycleperiods shorter than

eight bars. Even with

this constraint you

should reduce the

swing of the com-

posite waveform by

ltering. For exam-

ple, if you wanted to

use a cycle having a

four-bar period, you

need to recognize

that the composite

signal at the Nyquist

frequency has the same amplitude as your desired signal.

Therefore, it is imperative that a low-pass lter of some kind

be used to reduce the amplitude of the frequency components

near the Nyquist frequency. A simple two-bar moving aver-

age is often adequate, because this average has a theoretical

zero of transmission at the Nyquist frequency.

The frequency response of a two-bar simple moving

average is shown in Figure 5. This is an effective way to be

sure that aliasing effects are removed. But when it comes

to ltering, more is often better, if there is not a price to be

paid in terms of lag. Therefore, I also recommend using my

SuperSmoother lter set to a four-bar cutoff period.

FIGURE 5: FREQUENCY RESPONSE OF A TWO-BAR SIMPLE MOVINGAVERAGE.here you see that a simple two-bar moving average can removemuch of the aliasing impact.

FIGURE 6: OVERSAMPLING RESULTS IN SMOOTHER EQUIVALENT FILTERED DATA. The top chart shows a four bar SuperSmootheras the red line. The bottom chart shows the equivalent 52 bar SuperSmoother using 30 minute data. The green dots show the sampleddata in both cases. The filter output using the oversampled data is much smoother.



FIGURE 7: SMOOTHER INDICATORS WITH REDUCED LAG.Reducing the cutoff period of the oversampled SuperSmoother filter to 26bars resulted in the smoothed waveform with less lag.

If you are using short-term patternsin the range of two to five bars, theeffect of aliasing is dramatic.

FURTHERREADINGEhlers, John F. [2013]. Cycle Analytics For Traders, John

Wiley & Sons.

[2015]. Decyclers, Technical Analysis of STOCKS&

COMMODITIES, Volume 33: September.

MESASoftware.com, Stockspotter.com, TradeStation

A trader can also elect to oversample the data by using a dif-

ferent sample rate. For example, there are 13 half-hour samples

in the trading day. So if you use 30-minute data instead of

daily data, the data of interest is nearly three octaves below

the sample rate. The top chart in Figure 6 shows a four-bar

SuperSmoother as the red line while the bottom chart shows

the equivalent 52-bar SuperSmoother using 30-minute data.

The green dots show the sampled data in both cases. The lter

output using the oversampled data is much smoother.

More important, oversampling enables the trader to cre-

ate a higher-delity waveform closer to the original Nyquist

frequency. For example, the cutoff period of the oversampledSuperSmoother lter was reduced to 26 bars, resulting in a

smoothed waveform with less lag as shown in the lower graph

of Figure 7.

ITMAYIMPACTYOURTRADINGMarket data aliasing is real, but its impact on your trading

depends on your style. If you are a trend trader using relatively

long moving aver-

ages or slowly mov-

ing indicators, you

can just ignore it. On

the other hand, if youare using short-term

patterns in the range

of two to ve bars,

the effect is dramatic

and you might want

to rethink your ap-

proach. Nonetheless,

its a good idea to be

aware that aliasing is

real and its a good

idea to mitigate its

effects just by apply-

ing a simple two-bar

moving average or

the SuperSmoother

lter to the data be-

fore using any other indicator. More adventurous technicians

might want to explore oversampling using intraday data.

S&C Contributing Editor John Ehlers is a pioneer in the use

of cycles and DSP technical analysis. He is president of MESA

Software. MESASoftware.com offers the MESA Phasor and

MESA intraday futures strategies. He is also the chief scien-

tist for StockSpotter.com, which offers stock trading signals

based on indicators and statistical techniques.

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number of ways to hit 21, often blind to the hundreds of ways

to go bust or have the dealer beat you, traders often think of a

favorable outcome instead of thinking about what can go wrong.

Traders who are condent in their market forecast often focus

narrowly on their outcome materializing, instead of focusing

on the data and validating their proposed outcome.

WHEREFORECASTERSGETITRIGHT

ANDWRONG

Philip Tetlock, who has a new book out titled SuperFore-

casters, recently brought to light a great analogy of common

forecasting personalities. He explains it well in his prior book,

Expert Political Judgment:

The intellectually aggressive hedgehogs knew one big thing

and sought, under the banner of parsimony, to expand the

explanatory power of that big thing to cover new cases;

the more eclectic foxes knew many little things and were

content to improvise ad hoc solutions to keep pace with a

rapidly changing world.

M

Trading is about recognizing present opportunities where the

risk-to-reward is favorable. Forecasting, on the other hand,

is outcome dependent. Find out how you can use both and

take advantage of those opportunities.

by Tyler Yell, CMT

ost of us are conditioned to make all our trading deci-

sions based on what we see on the hard right side of a

chart. When you look at a chart, price movement that

occurred in the past may look like it had only one likely

outcome. But when you look at a chart in real time, you dont

know what the outcome will be. There could have been multiple

scenarios, and credible people will argue for price to move in

completely different paths from a specic point.

Price charts and potential outcomes often play cruel tricks

on the brain. Trading, on the surface, is similar to a casino in

that it informs you of the prize of a low-probability outcome

while the quantitative edge that the casino holds is purposely

hidden from you. Just as the blackjack player thinks about the USbill:Yama

bika

Y/Euro

bill:

Wha

tap

ho

to/Dao:gguy

/Shu

tters

toc

k/co

llage:

J.

Barre

tt

Wanna Bet?

Trading Vs. Forecasting:Whats The Difference?



Bringing this analogy to trading, you would likely be better

served by adding incoming data to see if your outcome is more

or less likely to come to fruition as opposed to putting your

head in the sand, hoping you are proven right.

Another rock star in the world of nonmarket forecasting

is Nate Silver, who predicted the outcome of the 2008 US

presidential election with far more accuracy than highly paidpolitical forecasters. He attributes his methodology of fore-

casting to Bayes theorem, an algorithmic approach for which

its namesake is an 18th-century pastor. Bayes theorem opines

that recently available evidence should be used to bring down

or bring credibility to an outcome. Nate Silvers model used

individual states high-credibility polls in the 2008 election to

predict the likelihood of the winner and updated his forecast

the night of the elections as individual state outcomes were

being announced.

The trading equivalent to this is to look for obvious failures

toward your desired outcome developing in real time. An

Elliott wavebased trader will consider invalidations of a

primary market view as casting doubt or outright invalidating

his forecasts. The point here is that you should not be married

to any one outcome but be exible with your outlook, because

markets appear chaotic in real time.

In Michael Tomas informative book The Risk Of Trading:

Mastering The Most Important Element In Financial Specu-

lation, he walks traders through the process of identication,

assessment, control, measuring, and monitoring of trading

risks. The purpose is to show traders that when trading, thereis more to risk management than placing a stop-loss. Similarly,

traders would likely be better served by focusing on how their

forecast could be nullied as opposed to validated.

CLASHOFTRADING

& FORECASTING

When looking at the present, a new

thought often creeps into your mind

as a trader. First, you think if I can

only gure out the future I will be

able to avoid a loss and book a prot.

Daniel Kahnemans prospect theory

from his book Thinking Fast And

Slowstates that people (traders included) emotionally prefer

to avoid losses than achieve gains.

Unpacking this nding further, traders will often hold

onto forecasts and hope that it will prove true so they do

not have to take a loss. While the desire to avoid a loss is

understandable, the unwillingness to accept a loss is futile.

To avoid such a fallacy, you are probably better off holding

your strong opinions or forecasts with consistent pessimism.

In other words, hold your strong opinions weakly so that you

do not nd yourself overrelying on an assumed outcome that

doesnt take place.

FOREX FOCUS

FXCMSMARKETSCOPE/TRADINGSTATIONII

The financial crisis

Many people believe we must hit parity (1.000) or below

2008 Top

A

bd

a c

e/B

i

ii

iii

iv?

v/C

Labels are from the technical forecasting methodology known as Elliott wave

Some people believe well have

another strong bounce off the trendline,

at least to midline.

FIGURE 1: WHICH WAY IS THE EUR/USD HEADING?There are often compelling views that the market will go higher or lower but only one of these forecastswill be proven correct. Here, some traders may have reason to believe that price will have another strong bounce off the lower channel line whereas others

may feel that prices will break below that lower channel line.

The desire to avoid a lossis understandable, but theunwillingness to accept aloss is futile.



their well-researched views. That said, there are often com-

pelling views that the market will go higher or lower. Only

one of these forecasts will be proven correct, although in a

sideways market, both could be correct, revealing the need

for combining risk management with forecasting.

SUMMARYLearning how to forecast and nding an accurate trading

method should play a separate role from learning how to trade.

Forecasting is outcome dependent, and the road toward the

realized outcome is often full of unpredictable developments.

Trading is about recognizing present opportunities where

the riskreward tradeoff is presently favorable, and taking

advantage of those opportunities. Ironically, yet importantly,

you can be incorrect in forecasting but place a good trade, and

likewise, you can be good at forecasting but poor at trading.

The latter is surprisingly common.

Regardless of your method of forecasting, recognizing a

good riskreward trade setup as per your preferential trad-ing methodology is crucial. It is best to avoid the mistake of

believing the market must end up at a certain juncture a week,

month, or quarter from now and overexposing your account on

that hope. Rather, it is best to use a forecast as a springboard

for entering the market and then analyzing how the market

is reacting to your forecast to see whether or not more weight

should be given to that outcome coming to fruition.

Trade (as opposed to forecast) well.

Tyler Yell, CMT, is a currency analyst and trading instructor

for DailyFX.com, a forex market news and analysis site.

FURTHERREADING

Spitznagel, Mark [2013]. The Dao Of Capital: Austrian In-

vesting In A Distorted World,Wiley.

Tetlock, Philip E., and Dan Gardner [2015]. Superforecasting:

The Art And Science Of Prediction, Crown Publishers.

Tetlock, Philip E. [2005]. Expert Political Judgment: How

Good Is It? How Can We Know?Princeton University

Press.

Toma, Michael [2012]. The Risk Of Trading: Mastering The

Most Important Element In Financial Speculation, John

Wiley & Sons.

Yell, Tyler [2015]. Gold & The Yen, Technical Analysis of

STOCKS& COMMODITIES, Volume 33: October.

_____ [2015]. Bond Markets & FX Effects,Technical Analy-

sis of STOCKS& COMMODITIES, Volume 33: August.

Marketscope/Trading Station II (FXCM)

See Editorial Resource Index

MARRYINGTHETWOWORLDSOF

FORECASTING& TRADING

Businesses are fond of making a premortem prior to major

projects. A premortem is an explanation of potential causes

of failure for an important project. As you can imagine, the

goal of the premortem is to think outside of the hedgehog

view so that you may act accordingly before the start of the

real project.

In trading, a premortem will hopefully cause you to trade

smaller or use less leverage than you might have otherwisedone with a more condent but likely awed forecast. Second,

a premortem may help you identify where, as a trader, you may

want to ip your bias and potentially your exposure. Either way,

optimism surprisingly has little room in a traders career.

Mark Spitznagel, the hedge fund manager and former head

trader for Naseem Taleb, notes in his book The Dao of Capital

that to survive, you must learn to hate to win, love to lose. As

a multibillion-dollar hedge fund manager, he obviously needs

prots to attract new investors. Spitznagel is driving home the

point that staying in a losing position is the quickest way out

of the business. In addition, poor forecasting or overreliance

on your market forecasting methods is one of the quickestways to convince yourself to stay in a bad position.

LITTLEBETS

Many traders come to the market with a per-

verted view of their likely success. In other

words, it is common for them to look at stories

on nancial news networks regarding the one

big trade that made someones career like bet-

ting on subprime mortgages in 2003 or betting

against them in 2007. However, the one big bet

can often turn into one big loss, since few things

unfold in a straight line.

Instead of placing one big bet, a better approach would be

to place multiple small bets. Sure, if your one big bet is large

enough and you come out on the winning side, someone may

write a book about you, but the likelihood of that is under-

standably small. As a trader looking for double-digit returns

year over year, the better approach is often to manage your

downside aggressively, while strategically looking for a multi-

percentage move in the direction of a shorter-term forecast,

which of course, can still be wrong.

The chart in Figure 1 shows the EURUSD, the most heavily

traded currency pair in the spot forex market. My role at Dai-

lyFX gives me exposure to a myriad of the top-tier investment

bank (sell-side) research that makes very compelling cases for

You can be incorrect inforecasting but place a goodtrade, and you can be good atforecasting but poor at trading.
http://traders.com/


25/64

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high-volume breakout patterns when

youre entering your trades.

A popular Wall Street professional

traders saying is that traders vote

with volume, and prot with price

action. Its wise to wait for volume

conrmation prior to entering anybreakout trade, because you want to

have high volume serve as the wind

beneath your wings to support an up-

side technical price move whenever

you trade. Its not enough to simply

buy new highs for breakout entries.

You want price to continue upward

after you enter your trade, and seeing

strong volume is one of the best ways

in which you can achieve this. Here,

then, are some high-volume breakout

patterns you can look for to help withnding good entries.

High-volume breakouts & cups

The rst volume breakout pattern

to look for is one in which volume

increases steadily near the right

side of a bullish cup, as it tests prior

resistance. You will often notice an

uptrend in the height of volume bars,

in addition to an upward sharp move

in price. The volume bar uptrend

should make a triangle-type pattern,with the highest volume bars on the

right side.

You can see this pattern illustrated

in the chart of Oceaneering Interna-

tional, Inc. (OII) in Figure 1, in which

the cup breakout is conrmed by a

high-volume breakout on October 2,

2015. The volume trended up heavily

during this triangle breakout pattern.

When youre scanning for these pat-

terns, a good entry strategy is to enter

a new swing trade anywhere from 50

cents to a dollar above the high of the

breakout pattern day on a subsequent

day (in this case, an entry near $44

on October 5, 2015).

You may often come across these

high-volume breakout patterns after

theyve made their initial move. The

good news is that entering above new

highs on a day following this pattern

is ne, as long as it has remained in an

uptrend following the initial volume

breakout day, as seen on the chart in

Figure 1. A simple criterion for con-

Heighten Your Confdence

High-VolumeBreakouts

In this nal article in a series weve been presenting on breakout trading strategies

from this professional daytrader and educator, we look at the role that volume and

price-action breakout patterns play in conrming entry signals.

by Ken Calhoun

many traders know, the two most important technical trading signals are

price and volume. By combining price-action breakout patterns with spe-

cic volume conrmation signals, you can identify strong trading entries

as theyre moving to new highs.

You can spot high-volume breakouts whenever volume increases signicantlythat

is, at least 30% higher than their average trading volumealong with a move up in

price. These are important because strong volume indicates institutional buying is at

work, which can help you nd good entries. In this ar ticle, Ill show you how to nd violetkalpa/Shutterstock

As



rming a new breakout en-

try is to determine if volume

and price are both at 15-day

highs. If price alone is at a

15-day high, you may still

wish to take the trade, but

to be cautious, you shouldtrade a smaller share size.

If price and volume are at

15-day highs, then you can

trade a larger size.

This is an effective guide-

line for helping to decide

how many shares to trade;

you can also use volume bar

height to help you visually

see if your trade size should

be small versus large, based

on overall trading volume. Ifcurrent volume for the chart

youre considering is un-

changed during an uptrend,

then you trade a small size.

If, however, current (most

recent) volume is at least

30% higher than average, in an uptrend or other breakout

pattern, then you can consider trading a larger size.

Volume gap continuations

The most common high-volume day is one in which price has

gapped up (or down), as seen on the chart of EMC Corp. (EMC)in Figure 2. These minor

gaps of less than one to two

points will often continue

in the direction of the gap,

often for several days. When

you see a high-volume gap

continuation pattern like

this, its a smart trading

idea to gure out how to

enter your trade during the

two to three days following

the gap day.

You will likely nd that

these patterns make for a

primary trading strategy,

since high-volume gap

traders mag 2016jan

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