THE TRADERS’ MAGAZINE SINCE 1982 [Link].

com DECEMBER 2016

Futures Margins
What, why, and how 8

Pair Trading
With a twist 10

Applying DEWEY’S
CYCLE Harmonics
To hunt for cycles 18

Is Wall Street
A Casino?
Simulate a roulette wheel
to find the answer 26

INTERVIEW
Denham Ward &
Marge Sherald on
machines that think 44

review
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 CONTENTS DECEMBER 2016, Volume 34 Number 13

8 Futures Margins: What, 30 Trading the Nonfarm

Why, And How Employment Report software to mimic how you think.
by Roger Barone by Gail Mercer To help shed light on the subject,
Most traders are familiar with Trading the nonfarm employment we picked the brains of two
how margins on equities work, but report can be dangerous and result people who have the knowledge
what about margins on futures? in a margin call if you are on the and expertise in applying neural
Here we look at the unique wrong side of the market. Here’s networks to the financial markets:
characteristics of futures margins a better way to take advantage of Denham Ward (CEO ) and Marge
to understand their nuances. high volatility using binary options. Sherald (president) of Ward
Systems Group.
FEATURE ARTICLE 33 Explore Your Options AT THE CLOSE
10 Pair Trading With A Twist TIPS by Tom Gentile
by Domenico D’Errico Got a question about options? 60 How Much Can I Really
Trading stock pairs may be some- Make From Trading?
thing that you may not think about 34 Using Ratios by Azeez Mustapha
much. But if market conditions are by Daniel J. Subach We trade because we want to
such that no trading methodology Sometimes adding a sprinkle make money, but how much can
of yours is going to work, it’s best of fundamental analysis to your a trader realistically make per
to keep your options open. Here, toolkit doesn’t hurt. Here are some day, week, month, quarter, or
we look at pair trading to find ratios you could use to judiciously year? Read on to find out what
which approach works best for evaluate your trading decisions. goal you should set.
trading them.

18 Applying Dewey’s 40 Mean-Reversion

Cycle Harmonics Swing Trading
by Ken Calhoun
by Lyle Pai Here’s a technique for entering a
Faced with a large and ever- long position in a trend continu-
expanding list of possible cycles ation following a pullback after a PRODUCT REVIEW
to choose from, how does anyone breakout.
find the right cycles to trade with? 49 • ChartCon 2016
Here’s a look at some of the dif- Virtual conference for
ferent approaches to cycle analysis 42 Q&A [Link] users
and what drives these types of by Rob Friesen
cycles so you can hunt for those This professional trader answers
that best suit your needs. a few of your questions. DEPARTMENTS
6 Opening Position
25 Futures For You INTERVIEW 7 Letters To S&C
by Carley Garner 44 Denham Ward & 51 Traders’ Tips
Here’s how the futures market Marge Sherald On 56 Futures Liquidity
really works.
Machines That Think 57 Advertisers’ Index
by Jayanthi Gopalakrishnan 57 Editorial Resource Index
26 Is Wall Street A Casino? How can the intelligence of
by Norman J. Brown machines help you in your trading?
59 Classified Advertising
Do stocks have a random charac- As it turns out, with the help of 59 Traders’ Resource
teristic similar to a roulette wheel, neural networks, you can use your 62 Books For Traders
and can we gain a winning edge by
trading equities? Here, we simulate
Wall Street stocks on an artificial This article is the basis for
TIPS Traders’ Tips this month.
n Cover: Jose Cruz
roulette wheel to find the answer. n Cover concept: Jose Cruz / Christine Morrison

Copyright © 2016 Technical Analysis, Inc. All rights reserved. Information in this publication must not be stored or reproduced in any form without written permission from the publisher. Technical Analysis
of Stocks & Commodities™ (ISSN 0738-3355) is published monthly with a Bonus Issue in March for $89.99 per year by Technical Analysis, Inc., 4757 California Ave. S.W., Seattle, WA 98116-4499. Periodicals
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4 • December 2016 • Technical Analysis of Stocks & Commodities

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 December 2016 • Volume 34, Number 13
Opening Position
The Traders’ MagazineTM

We
EDITORIAL
editor@[Link]

Editor in Chief Jack K. Hutson

Editor Jayanthi Gopalakrishnan
are approaching the end of
Production Manager Karen E. Wasserman another year, one that has
Art Director Christine Morrison been quite a roller-coaster ride. In the early
Graphic Designer Wayne Shaw part of the year, we thought perhaps there
Webmaster Han J. Kim would indeed be a market crash but look-
Contributing Editors John Ehlers,
Anthony W. Warren, Ph.D.
ing back at the chart of the S&P 500 index,
Contributing Writers Thomas Bulkowski, Martin Pring,
you’ll see that it hit a strong support level
Barbara Star, Markos Katsanos and retreated after that. What can we look
forward to in 2017?
OFFICE OF THE Publisher We have a newly elected President who
Publisher Jack K. Hutson will take office in 2017. That’ll probably not
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Project Engineer Sean M. Moore change anything in the short term. The one thing we know for sure is that all
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6 • December 2016 • Technical Analysis of Stocks & Commodities

 profitable criterion didn’t improve the
The editors of S&C invite readers to submit their opinions and information on subjects
performance significantly. In addition,
relating to technical analysis and this magazine. This column is our means of communi-
the results were rather erratic, with
cation with our readers. Is there something you would like to know more (or less) about?
the net profit ranging from $1,700 to
Tell us about it. Without a source of new ideas and subjects coming from our readers, this
$26,000, the PF from 1.15 to 5.3, and the
magazine would not exist.
max intraday drawdown from -$17,000
Email your correspondence to Editor@[Link] or address your correspondence
to -$10,600. All out-of-sample simula-
to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All
tions performed better on a % profitable
letters become the property of Technical Analysis, Inc. Letter-writers must include their full
basis, but none managed to beat the
name and address for verification. Letters may be edited for length or clarity. The opinions
net profit criterion used in my article
expressed in this column do not necessarily represent those of the magazine.—Editor
on a net profit basis. As you can see in
both in- and out-of-sample results, the
KAUFMAN EFFiciENcy RAtio the current price in the numerator of ER period was the most critical value
Editor, the formula would improve the VHF’s affecting performance. Increasing the
I was very pleased to see the efficiency rather poor performance. period improved the % profitable trades
ratio (ER) included in Markos Katsanos’ I totally agree with you that normally, but reduced the number of trades and
October 2016 article, “Which Trend In- the percentage of profitable tests should net profit.
dicator Wins?” and also gratified that it be used to select the best parameters If you would like to replicate the
ranked well in performance. Katsanos’ values. In this case, however, the best results, you can find the optimization
approach was very consistent in the way % profitable results produced very few range in Figure 1. I used TradeStation
he defined the rules, sensible, and quite trades (about one trade per year), which to test all systems. The strategy proper-
different from the way I have used ER reduced the statistical significance of ties were:
to define a trend, that is, as a variable for the results (see Figure 2). I decided,
the exponential smoothing factor. therefore, to use the best net profit op- Commission: 0.01 per share
Slippage: 0
Because in-sample optimization often timized parameter values as long as the
Max number of bars study will reference: 50
finds values considered overfitted, I % profitable and profit factor metrics Round down to nearest: one share
would have liked some additional infor- were in the upper range. Interest rate: 0
mation on the variation in the results. I I repeated the tests and selected the
have found that, if the range of values optimized parameters produced by the
for the variables tested is reasonable best % prof-
(some common-sense decision), then itable results
the percentage of profitable tests can be (Figure 3) us-
used as a measure of robustness. Then, ing the opti-
if 65% or 70% of all combinations were mization range
profitable, we would have much more in Figure 1. In
confidence in the results. the last column
Perry kaufman of Figure 3, I FigURE 2: iN-sAMplE tEst REsUlts pRodUciNg thE bEst % pRoFitAblE
tRAdEs (>70%). The second column depicts the results presented in my article using
[Link] calculated the the best net profit as a criterion for selecting the best parameter values.
average values
Author Markos Katsanos replies: of the param-
I realize you didn’t intend for the ER to eters produc-
be used as a trend detection indicator ing the highest
but I decided to include it in the com- % profitable
parison test because I was curious to trades (> 80%)
see if substituting the highest price with i n - s a m p l e . FigURE 3: pARAMEtER vAlUEs coRREspoNdiNg to FigURE 2 REsUlts. The
I then tested second column depicts the results presented in my article using the best net profit as
OPTIMIZATION RANGE t h e s y s t e m a criterion.
FROM TO STEP out-of-sample
TDI PERIOD 24 34 2 using the op-
TDI SMOOTHING 2 4 1
TDI TREND 0.34 0.4 0.02 timized values
TDI MAX 0.4 0.44 0.02 in Figure 3. As
TDI CRIT 0.24 0.3 0.02 you can see
LAG 3 5 1 in Figure 4,
MULT 2.5 4 0.5 FigURE 4: oUt-oF-sAMplE tEst REsUlts coRREspoNdiNg to thE pARAM-
the out sample EtER vAlUEs iN FigURE 2. The test could start producing signals on 4/29/11 as
FigURE 1: RANgE oF pARAMEtER vAlUEs UsEd performance the system needed 50 days to calculate all indicators. The second column depicts the
iN optiMizAtioN using the % results presented in my article.
December 2016 • Technical Analysis of StockS & commoditieS • 7
 Take An Inch, Not A Mile

Futures Margins:
What, Why, And How
Most traders are familiar with how margins on equities that whoever is trading has money in their account to pay for
work, but what about margins on futures? Here, we look at possible losses on that trade.
the unique characteristics of futures margins to understand
their nuances. Forward to the futures
SWORD:MICHELAUBRYPHOTO/GOLD: NATALLLIA K/SHUTTERSTOCK/ collage: nikki morr

With margin in futures trading, the unique characteristics are

by Roger Barone the relatively low amount required and that you do not have to

M
pay interest on the margin balance. Most people are familiar
argin, when trading futures, is a little different with how you have up to 50% margin in stock trading, giving
than for other securities. Think of it as a perfor- you the ability to buy, say, $20,000 worth of stock with only
mance bond. It’s the minimum amount of money $10,000 in your account; you would be required to pay interest
required to be in your account with your broker on the $10,000 you are borrowing.
in order to trade a particular futures contract or However, with futures margins, you may only need to have
futures option contract. This amount of money as little as 1% or so of the contract value on hand with your
varies from market to market and can differ for daytrading broker and you do not pay interest on the remaining 99%. If
versus position trading (that is, holding positions overnight). the emini S&P (ES) is trading at about 2000.00 and each point
The purpose of this deposit (or earnest money) is to make sure is worth $50, the total contract value would be $100,000, and
8 • December 2016 • Technical Analysis of Stocks & Commodities
 TRADING FUTURES

according to CME’s guidelines, the margin required would be

$4,620 (initial). In fact, for any reputable futures commission
merchant (FCM) that doesn’t mark up or surcharge the amount
that the exchange determines sufficient, the exact amount
Think of futures margin as
needed for the initial and maintenance margin is determined a performance bond.
by the exchange. It’s fairly static, with the only variation being
in the expiration or last trading day of the contract.
The margin requirements for futures and futures options are
established by each exchange through a calculation algorithm posted on the exchanges' websites. When referencing position
known as standard portfolio analysis of risk (SPAN). This trade margins, there are two numbers to be aware of. First,
calculation evaluates overall portfolio risk by calculating the you will see something called the initial margin, which is the
worst possible loss that a portfolio of derivative and physical amount needed to initially put on the trade ($4,620 currently
instruments might reasonably incur over a specified time for the ES) and then there is the maintenance margin, usually
period (typically one trading day). This is done by computing 80–90% of the initial margin depending on the market, which
the gains and losses the portfolio would incur under differ- is the amount of money required to maintain in your account
ent market conditions. The most important part of the SPAN after the position is put on ($4,200 currently).
methodology is the SPAN risk array, a set of numeric values Should your account balance fall below this maintenance
that indicate how a particular contract will gain or lose value margin, you will be on a margin call. Margin calls are treated
under various conditions. Each condition is called a risk on a case-by-case basis, but typically, your position may be
scenario. The numeric value for each risk scenario represents liquidated and/or you may be required to deposit more money
the gain or loss that particular contract will experience for a (enough to bring your account back above the initial margin
particular combination of price (or underlying price) change, requirement) with your broker to keep the position.
volatility change, and decrease in time to expiration.
This means you need $4,620 to position trade one contract Be aware
or only about 4.62% of the total contract value. So as you Here is an example of a new $15,000 account that buys two
can see, futures margins are much lower than stock margins. ES (futures contracts), which turns into a losing position trade
At the same time, it’s a double-edged sword. The smaller and incurs a margin call:
margin requirement means a small move in the futures price
can equate to a large move relative to the amount of money Starting account balance
in your account. If you are correct with your trade, that’s a = $15,000
good thing. But if your trade isn’t working out, then it’s not = $9,240 (2 × $4,620) initial margin required
so great; in fact, it becomes dangerous. = $8,400 (2 × $4,200) maintenance margin

How is it figured? In this example, the account starts with more than the initial
Daytrade margins are set by the individual brokerage firms margin ($9,240), so a position trade of two ES contracts can be
and are even less than position trade margins. For example, the Continued on page 41
daytrade margin with some FCMs for the ES is only $500 per
contract, which means that with a contract value of $100,000,
Some useful links
the margin required is only about 1/2% (that is, 200:1 leverage)
of the contract value. Note that FCMs have discretion to set
CME SPAN master link
their own margin levels for trades that are closed out the same
[Link]
trading session in which they are opened. This is different than
[Link]
CME margins that are required for positions held overnight
or past the day’s close of the regular trading session.
SPAN technical
As you can see, this further increases the leverage and
[Link]
therefore risk of futures trading, making small moves even
SPAN+Overview
more magnified. To qualify for daytrade margins you need
to make sure you are flat (that is, have no positions) on the
The advantages of SPAN margin (Investopedia)
market's close, which, for example, is 3:15 pm Central Time
[Link]
for the ES.
02/[Link]
Position trade or overnight margins reference the amount of
money required to hold a position in a particular market past
CME historical margins since 2003 or so
the closing time of that market. This margin amount is dictated
[Link]
by the exchange (the CME), which determines the value based
[Link]
on the market value of the futures contract and its volatility
(SPAN). These margins are subject to change and are typically
December 2016 • Technical Analysis of Stocks & Commodities • 9
10 • December 2016 • Technical Analysis of Stocks & Commodities
 TRADING SYSTEMS

The Right Cocktail

Pair Trading With A Twist

Trading stock pairs may be something that you may ■ They require a high level of math skills
not think about much. But if market conditions are ■ All of them (or most of them) are mean-re-
such that no trading methodology of yours is going verting.
to work, it’s best to keep your options open. Here, we
look at pair trading to find which approach works Why the high level of math skills? That’s because they
best for trading them. deal with statistical arbitrage and statistical tools such
as regression or correlation models. Most of them are

M
ature markets like US/European stocks based on mean reversion because they mostly trade
and futures exchanges are getting only correlated assets. I wanted to analyze the mean-
crowded. Globalization, easy access to reversion concept further.
trading platforms, and low brokerage
commissions are attracting thousands of people from ■ Will the price ratio of two correlated assets
all over the world to trade financial markets. Although really revert back to the mean all the time?
this increases trading volume and brings more liquid- ■ Is the correlation between two stocks a stable
ity to the markets, it can cause an exponential noise parameter or will it change depending on the
increase on price charts. market’s condition?
It is not unrealistic to expect that mature markets
will be tougher to trade, and that means that traders I will try to answer these questions by looking
need to think out of the box to find new ways to trade. at some common stock pairs. In Figure 1 you see
Over the years, I have come up with an approach to the price ratio between Coca-Cola (KO) and Pepsi
stock pair trading and market-neutral strategies that (PEP). There’s a clear four-year downtrend. The two
I would like to share here. companies are in the same sector, but trading this
pair with mean-reverting logic will most likely not
About those pairs be successful because the pair didn’t reverse at all
Pair trading—it’s defined as
a strategy where you match
a long position with a short
position in two stocks, indexes,
ETFs, or anything else, that
are usually in the same sector.
This creates a hedge against the
sector and overall market the
two stocks are a part of.
Trading libraries offer sev-
eral strategies related to stock
tradestation

pair trading. They have two

JOSE CRUZ

things in common: Figure 1: TWO STOCKS IN THE SAME SECTOR. You can see there is a clear downtrend here. Trading this pair with
mean-reverting logic will most likely not be successful.

by Domenico D’Errico
December 2016 • Technical Analysis of Stocks & Commodities • 11
 ■ A downtrend from 2006 to
2009
■ A sideways move from 2009
to 2013
■ An uptrend from 2013 to 2016

Although SPY and DIA are supposed

to be highly correlated markets, their
price ratio moved sideways only in four
years out of 10. Consequently those
who traded mean reverting strategies
from 2006 to 2009 and from 2013 to
2016 would have lost money.
In Figure 3 you see a pair chart
from the energy sector, namely Exxon
Figure 2: an index pair. Although SPY and DIA are supposed to be highly correlated markets, their price ratio
moved sideways only in four years out of 10. (XOM) vs. Chevron (CVX). It’s the
same story as in the previous chart—
the ratio moved in an up trend, a down
trend, and then sideways like any other
financial tool. It doesn’t seem to be
different than a regular candlestick
chart.
In Figure 4 you see a chart of McDon-
alds (MCD) vs. Yum Brands (YUM)
pair. After an upward-trending move
from 2006 to 2009, this pair traded
sideways but with some sharp moves
at the end of 2008 and mid-2015.
In Figure 5 you can see the spread
ratio between the September 16 and
October 16 crude oil futures contract.
We now, finally, have a mean-reverting
FIGURE 3: AN ENERGY PAIR. The ratio moved in an uptrend, a downtrend, and then sideways like any other example. The spread ratio came back
financial tool. to 0.99, so if you traded this pair ap-
plying mean-reverting logic, you may
have made money.
In these examples, with the exception
of the crude oil example, the other stock
pairs moved just like any other financial
tool: They can trend up, trend down,
or move sideways. And that tells me
that correlation is perhaps not a stable
parameter, because it changes, just like
anything else in the market.

But isn’t forex a pair?

A forex pair or cross is a price ratio
between two different currencies. In
other words, when you buy EURUSD,
you are buying euros and selling US
FIGURE 4: MCDONALDS AND YUM BRANDS. After an upward-trending move from 2006 to 2009, this pair traded
sideways but with some sharp moves at the end of 2008 and mid-2015. dollars simultaneously. Have you ever
thought of trading forex crosses only
through mean-reversion strategies?
during this time. That, my friends, could be suicidal.
Now if you look at the chart of the SPY and DIA pair in I strongly believe that two classical approaches—trend-fol-
Figure 2 you see three different moves: lowing and mean-reverting—can work the same for stock pairs
12 • December 2016 • Technical Analysis of Stocks & Commodities
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It comes down to using

the right tools
I decided to make it simpler, so I got
rid of correlation analysis and other
interesting but complicated statistical
tools and focused just on price-ratio
action:

■ If two stocks are not correlated,

their price ratio will show a
trend.
■ If two stocks are correlated,
FIGURE 5: FUTURES PAIRS. Here you see the spread ratio between the September 16 and October 16 crude oil
their price ratio will be choppy. futures contract. This pair did mean-revert. Note how the spread ratio came back to 0.99.

But how do you achieve this task? How

do you know if the pair is trending or
choppy? Technical analysis may be
able to help.
Let’s have a look at some price-ratio
charts with technical indicators applied
to them. In Figure 6 you see a sector
vs. an index pair: XLE vs. SPY. After
about a year of moving sideways (July
2013 to July 2014) as confirmed by
flat moving averages, the pair started
a downward move that ended in early
2016. During this period, the four-week
moving average (green line) was below
the 40-week moving average (red line).
At the beginning of 2016, the two FIGURE 6: APPLYING TECHNICAL ANALYSIS TO SECTOR VS. INDEX. Here, moving average crossovers and linear
moving averages converged, and then regression channels show if the XLE/SPY pair is moving in a trend or if it’s choppy.
the price ratio crossed above the faster
average, indicating that a reversal was
in place. The reversal was confirmed
by the linear regression channel and by
the moving average crossover in June
2016. The new low made in January
2016 is the current support level. The
moving average cross histogram in the
subchart shows six different changes in
the trend’s setup.
In Figure 7 you see an example
from the energy sector—Chevron vs.
the energy sector ETF (XLE). After
a down move from July 2013 to July
2014, the pair made a rally and then
showed a distribution pattern. The
FIGURE 7: ENERGY SECTOR. In this example, you see from the chart that there were seven different changes in
moving average cross histogram in the the trend’s setup.
subchart shows seven different changes
in the trend’s setup.
In Figure 8 we move to the technology sector and look at from the moving average crossover in April 2016, which is
IBM vs. the technology sector ETF (XLK). There’s no doubt confirmed by a rising regression channel. The new low made
the pair is trending down. There may be some signs of strength in November 2016 is the current support. The moving aver-
14 • December 2016 • Technical Analysis of Stocks & Commodities
age cross histogram in the subchart is
quite stable, showing only four different
changes in the trend’s setup.
Next, look at the financials in Figure
9, where you see JPM vs. the financial
sector ETF (XLF). It seems that the pair
has been moving sideways since 2012, of-
fering some potential for mean-reverting
strategies. The moving average cross his-
togram in the subchart shows 14 different
changes in the trend’s setup, confirming
there was no defined direction.

And the backtests

show … FIGURE 8: TRENDS IN TECH PAIRS. It’s clear this pair is trending down. The moving average cross histogram in
To understand whether this approach the subchart is quite stable, showing only four different changes in the trend’s setup.
makes sense, I crunched some numbers
and tested the following three different
technical approaches on the S&P 500
stock pairs versus the SPY:

a. Trend-following strategy based on

two moving averages cross
b. Mean-reverting strategy based on a
single moving average
c. Trend & pullback strategy (a com-
bination of A and B).

Settings
Time frame: Weekly
Period: Jan 2002–Aug 2016
Leg2: SPY
Fast moving average length = 4 FIGURE 9: NO DEFINED DIRECTION IN FINANCIALS. The pair has been moving sideways since 2012, offering
Slow moving average length = 40 some potential for mean-reverting strategies. The moving average cross histogram in the subchart shows 14 dif-
ferent changes in trend’s setup, confirming that there was no defined direction.
No commissions and slippage included.

Trading rules
■ Trend-following
o When the price ratio fast moving
average crosses above the slow
moving average, you buy the
stock and sell short the SPY
o When the price ratio fast moving
average crosses below the slow
moving average, you close both
stock and SPY positions
■ Mean-reverting
o When the price ratio goes below
the fast moving average, you
buy the stock and sell-short the
SPY FIGURE 10: THE TREND-FOLLOWING STRATEGY AT WORK
o When the price ratio goes above
the fast moving average, you
close both stock and SPY positions. slow moving average and the price ratio goes below the
■ Trend & pullback fast moving average, you buy the stock and sell-short
o When the price ratio fast moving average is above the the SPY
December 2016 • Technical Analysis of Stocks & Commodities • 15
 FIGURE 11: BACKTESTING RESULTS FOR TREND-FOLLOWING, MEAN-REVERSION, AND TREND & PULLBACK

o When the price ratio fast moving average is below the

slow moving average and the price ratio goes above Managing the number of
the fast moving average, you close both stock and SPY shares in market-neutral
positions.
strategies is similar to
In Figure 10 you can see a trend-follower entry/exit example managing ingredient portions
on the pair IBM/SPY. when you prepare cocktails.
Position sizing does matter
Managing the number of shares in market-neutral strategies ■ All three strategies show a positive P&L, which is a
is similar to managing ingredient portions when you prepare good start; the trend & pullback approach seem to be
cocktails: You may have the right ingredients, but if the portion the most profitable for long and short trades.
sizes are incorrect you’ll end up with a crappy cocktail. ■ All three strategies show a negative P&L for the short
I am going to use a dollar-neutral approach for my back- side, meaning the hedging impact is probably too
tests. I also hedged 100% of the trade value. Let’s analyze heavy. It could be reduced by downsizing the short
the backtesting results provided in Figure 11 and Figure 12. trading sizes a bit.
The main considerations are: Continued on page 58

Stocks Pairs Strategy: Back-Testing Results S&P 500

P&L Hit Rate %

8,000,000 70%
6,000,000 60%
4,000,000 50%
40%
2,000,000
30%
0
20%
-2,000,000 10%
Total Long Short
-4,000,000 0%
Total Long Short
Trend Following Mean Reversion Trend & Pullback Trend Following Mean Reversion Trend & Pullback

ROA Average Trade

4.00 1,000
3.50 800
3.00
2.50 600
2.00 400
1.50 200
1.00
0.50 0
0 -200
Total Long Short
Trend Mean Trend & -400
Following Reversion Pullback Trend Following Mean Reversion Trend & Pullback

FIGURE 12: BACKTESTING RESULTS BY P&L, HIT RATE %, ROA, AVERAGE TRADE

16 • December 2016 • Technical Analysis of Stocks & Commodities

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 While still very
speculative at this
142.0 213.9 319.5 point,479.3
researchers
of human decision-
making abilities are
Increasing research 71.0 106.5 looking at factors
159.8
into the behavioral that Dewey claimed
aspects of investing exist “out there.”
such as the herding 35.50 53.25
instinct of humans
including “fight or
flight” is gaining
17.75
momentum.

5.92 8.88

1.97 2.96 4.44

0.66 0.99 1.48 2.22

In Dewey’s paper “The Case
For Cycles,” market cycle
0.22 0.33 harmonics
0.49 are calculated
0.74 1.11
from a “base” cycle of 17.75
figure 1: years. Well-known cycles
include Kondratiev waves,
Kuznets swing, Juglar cycles,
Kitchin cycles, and the Grand
Super Cycle.
292.6 438.9 658.3 987.4 1481.2

146.3 219.4 329.1 493.7

Hunting For Clues

Applying Dewey’s
73.1 109.7 164.6

Cycle Harmonics
36.57 54.86

18.29
Faced with a large and ever-expanding list of possible cycles to tell anyone who was interested in these wonderful cycles
to choose from, how does anyone find the right cycles to trade that he and his colleagues at the Foundation for the Study of
with? Here’s a look at some of the different approaches 6.10 to Cycles were finding in all walks of life. From cycles of the
9.14
SEAMUSS/SHUTTERSTOCK/COLLAGE: NIKKI MORR

cycle analysis and what drives these types of cycles so you Canadian lynx to pig iron production, from sunspots to the Dow
can hunt for those that best suit your needs. Jones Industrial Average, he wrote that he had irrefutable proof
2.03 3.05that these cycles existed and that they were not the product of
4.57

W
by Lyle Pai chance. These cycles had a clear regularity of timing (periodic-
ity). They persisted through changing conditions. Sometimes
hat’re cycles without a 0.68 little history? In 1967,
1.02Edward they would
1.52 disappear for2.29
a while then the same cycle would
Russell Dewey wrote and published “The Case For reappear later but inverted. If it was only a few dozen cycles
Cycles.” It was an attempt by Dewey, and not his first, that he had found he might have chalked it up to chance, but
18 • December 2016 • Technical0.23
Analysis of Stocks &0.34 Commodities 0.51 0.76 1.14
figure 2:
 such as the herding
instinct of humans
including CYCLES
“fight or
flight” is gaining
momentum.

there were hundreds and thousands of them. Alas, the only

thing he couldn’t find was a comprehensive theory that could We are now in the first Kondratiev
explain what was causing all these same cycles to appear over
and over again in so many different fields of study.
wave of the 21st century which is
Most probably, his inability to find the source for this well- slated to end around 2049. The 2049
spring of cycles drove him on and on to find even more cycles, end will also be the end of the Grand
In Dewey’s paper “The Case
hoping one day the causes of all these cycles would finally Super CycleForthat wemarket
Cycles,” arecycle
currently in.
reveal themselves to him. Unfortunately, his failure to find a harmonics are calculated
plausible explanation for what caused all these cycles meant from a “base” cycle of 17.75
that decades of work by him and his colleagues at the Founda- years. Well-known cycles
tion would be relegated to the scrap heap of “pseudoscience” year cycles were ofinclude
little use to me; I don’t think anyone other
Kondratiev waves,
Kuznets swing, Juglar cycles,
by learned men in academia. Milton Friedman was asked to than maybe Warren Buffett would
Kitchin cycles, andmake a trade based on those
the Grand
write a review of Dewey’s 1947 book Cycles: The Science cycles! However, the
Superthree-year
Cycle. cycle was probably something
Of Prediction. Acerbic as ever, Friedman wrote: “Its closest I could use, I thought, along with the nine-month and the
analogue is the modern, high-power advertisement—here, of 3.25-week cycles. So off I went to apply what I learned. Then
book length and designed to sell an esoteric and supposedly I quickly hit a wall. How do I apply the nine-month cycle? To
scientific product. Like most modern advertising, the book what markets or to which instruments? When do I start the
seeks to sell its product by making exaggerated claims for it ... cycle? What do I use to track these cycles with?
showing it in association with other valued objects which really So, like most people in this business without a PhD in
don’t have anything to do with it ... keeping discreetly silent physics, I started with technical analysis. I started by drawing
about its defeats or mentioning them in only the vaguest form trendlines on my Commodity Perspective chartbook. Over the
... and citing authorities who think highly of the product.” years, I graduated to the TradeStation platform.
Boy, after a review like that, I would’ve probably crawled into
some deserted corner of the world and committed hara-kiri. Finding the right cycles
But not Dewey. He simply picked himself up and continued his Faced with a large and ever-expanding list of possible cycles
excellent work for the next 30 years. By now, you’re probably to choose from, how do you find the right cycles to trade with?
wondering, hey, if I am supposed to be reading an article about You only need to look to John T. Burns’ Cycles In Humans
the Grand Super Cycle, what’s Dewey got to do with it? Well, And Nature: An Annotated Bibliography to get a sense of
he was the one who discovered it. He just didn’t know it. how many cycles there are. There are 12.5-hour tidal wave
cycles all the way up to 510-year civil war cycles. What do
How I became a cyclomaniac tidal wave cycles and war cycles have to do with financial
It all started back in the early ’80s when I was sitting in the markets? Everything, actually. They all spring from the same
vaulted trading room of a large investment bank on Wall “something out there…” that Dewey had been searching for
Street. I was the new kid on the block so I sat in the back of all his life. All the well-known cycles—the Kondratiev wave,
the room. Luckily, that’s where the Tradecenter machine was the Kuznets swing, the Juglar cycle, the Kitchin cycle, and of
and I could play with it all day long. I would glance over at course, the Grand Super Cycle proposed by a number of market
it repeatedly throughout the day, looking at Treasury bond analysts—all these cycles are interrelated. But how?
futures and currency futures trading out of Chicago. After Dewey had the answer, sort of. From the 50-plus years of
a while, I could see regular rhythmic patterns in the price research that he and his Foundation completed, Dewey came
movements. Sometimes, they would disappear, only to return up with a pattern of harmonic relationships that he thought
again and again … sound familiar? Most of you who have was crucial. In his paper titled “The Case For Cycles,” he
traded financial instruments or commodities, be it crude oil or presents a table of cycle harmonics calculated from a “base”
currency futures, have seen those rhythmic patterns as well. cycle of 17.75 years. He calculated multiples and fractions
The cycles for some markets are clearer than for others; they of this base cycle using double and triple progression, which
are in the monthly, weekly, daily and intraday charts. Ever means that he calculated them by multiples and fractions of
since those early days, I’ve been cycle hunting in the financial twos and threes (Figure 1).
markets, for over 30 years now. So I guess it’s official—I’m Now, let’s make sure we understand this. The 17.75-year
a cyclomaniac. cycle is at the center of two (point to point) triangles, sort of
I probably came across some of Dewey’s research years like a big X. The progression going from top left to bottom
ago but never took the time to examine it thoroughly, prob- right on the diagonal is arithmetic or by progressions of twos.
ably because I just couldn’t see any relationship between the The progression going from the top right to the bottom left on
Canadian lynx and currency exchange rates. I did buy a copy the diagonal is geometric or by progressions of threes. The
of JM Hurst’s The Profit Magic Of Stock Transaction Timing numbers inside the middle of the triangle are calculated from
in the late ’80s when I was working in Hong Kong. What had a combination of double and triple progressions.
impressed me then were the cycles that Hurst had identified Let’s see how this works. From the top left down to the bot-
using something called spectral analysis. The nine- and 18- tom right: 71.0/2 = 35.5Y/2 = 17.75Y/2 = 8.88Y/2 = 4.44 years.
December 2016 • Technical Analysis of Stocks & Commodities • 19
 and in human activity. There’s the 53.3-year Kondratiev wave,
142.0 213.9 319.5 479.3
along with the 17.75-year Kuznets infrastructure cycle and
142.0 213.9 319.5 479.3
the 8.88-year Juglar fixed-investment cycle plus the 4.44-
71.0 106.5 159.8 year Kitchin inventory cycle. They’re all there, in one happy
harmonic relationship.
A burning question I had was how Dewey came up with that
71.0 106.5 159.8
35.50 53.25
table. I probably would’ve had some slightly different numbers
35.50
17.75
53.25 up there. I know from a lot of research, including the Founda-
tion’s own research, that there was a 54-year cycle, an 18-year
17.75 cycle, a nine-year cycle, a six-year cycle, and a three-year cycle
5.92 8.88
in stocks that I have personally profited nicely from in the past.
5.92 8.88
In fact, if you look at Figure 18 from Dewey’s own “The Case
1.97 2.96 4.44 For Cycles” paper, you’ll see those cycles displayed there.
Although this chart is just a tabular sum of all the different
cycles that the Foundation has discovered over the years, the
1.97 2.96 4.44
0.66 0.99 1.48 2.22
graph looks surprisingly like a spectrogram.
0.66 0.99 1.48 2.22
0.22 0.33 0.49 0.74 1.11
Pythagoras who?
How does this new set of numbers I just presented square with
figure 1:
FIGURE 1: DEWEY’S
0.22 0.33 HARMONIC RELATIONSHIPS.
0.49 Interestingly, this pattern
0.74 1.11 of
harmonic relationships calculated from a “base” cycle of 17.75 years using double
figure 1: triple progressions exposes many of the cycles that appear to persist in nature
Dewey’s table? Are the numbers close enough? Is it a matter
and
and in human activity.
of measurement error? Why did Dewey use double and triple
292.6 438.9 658.3 987.4 1481.2 progressions instead of other numbers such as the Fibonacci
series? Dewey never explained publicly how he came up with
292.6
146.3
438.9
219.4
658.3
329.1
987.4
493.7
1481.2 that table and those numbers. So I did a little digging myself and
had to go back 2,500 years to find the answer. The man who
146.3 219.4 329.1 493.7 came up with that table originally (well, actually, half of that
73.1 109.7 164.6
table) was Pythagoras. Remember him from your high school
73.1 109.7 164.6
algebra and geometry classes? Yes, the man who came up with
36.57 54.86 the formula a2 + b2 = c2. Pythagoras was a Greek mathemati-
cian, musician, and philosopher. Pythagoras was instrumental
in identifying many of the relationships between music and
36.57 54.86
18.29
mathematics. For example, the ratio 2:1 is an octave in music,
6.10
18.29
9.14 while 3/2 is a perfect fifth and 4/3 is a perfect fourth.
Pythagoras’ lambda, which is sort of an inverted V in the
6.10 9.14 Greek alphabet, gave the interrelationship between these mul-
2.03 3.05 4.57
tiples of threes and twos, namely, the progressions of perfect
2.03 3.05 4.57
fifths in music. The perfect fifths are among the most pleasing
0.68 1.02 1.52 2.29 combination of notes in music to the human ear because they
are harmonious—harmonious in the mathematical sense. It is
believed that Plato, living some 100 years after Pythagoras,
0.68 1.02 1.52 2.29
0.23 0.34 0.51 0.76 1.14
figure 2: had actually invented the X table of multiples and fractions
0.23 0.34 0.51 0.76 1.14 that Dewey used.
figure 2: Let’s go back briefly to the Pythagorean formula of a2 + b2
FIGURE 2: MODIFIED HARMONIC RELATIONSHIPS. By changing the base
year from 17.75 to 18.29, you still have the perfect harmonic relationship between
= c2. The simplest set of numbers for a, b, and c are 3, 4, and
these three major cycles. 5—the Pythagorean triple. Yet there are other combinations
of a, b and c that could work equally well. For example, 5,
From the top right to the bottom left: 159.8Y/3 = 53.5Y/3 = 12, 13 and 7, 24, 25. So what does this mean? It means that
17.75Y/3 = 5.92Y/3 = 1.97Y, etc. Dewey’s original table contains there are other “fundamental” numbers that could replace
the formula for all the calculations. I urge everyone to try it for Dewey’s 17.75-year base cycle that can produce equally valid
themselves by plugging in those numbers and the formulas into harmonic relationships.
an Excel spreadsheet, as I did. (This example Excel file can
be downloaded from the Stocks & Commodities website at An alternative pattern
[Link] The boldfaced In my old cycle hunting days some 15–20 years ago, I was
values are those cycles that Dewey and his Foundation have perplexed by this question as well. I knew the cycles that were
found over the years. From one simple mathematical table, cited were usually averages of the cycles that were measured
we have many of the cycles that appear to persist in nature using manual or spectral analysis methods; they were not the
20 • December 2016 • Technical Analysis of Stocks & Commodities
true cycles. I wanted to find what I believed were the true cycles
so that I could compare these cycles against the measured
cycles. The only way to do this was by playing around with
numerical sequences like simple arithmetic sequences: 1, 2,
3, 4, etc. and looking at multiples, squares, cubes, etc. to see
if there were any patterns. I found the simplest sequence to
be 2n: 2, 4, 8, 16, 32, 64, 256, 512, 1,024. I then divided these
numbers by other mathematical sequences like arithmetic
sequences, geometric sequences, and so forth.
Interestingly, the numbers 18.29, 9.14, 5.47, and 2.29 would
appear in one sequence. When I changed 256 to 512, the
sequence 73.14, 36.57, 18.29, and 9.14 would show up in the
same positions as before. Finally, when I replaced 512 with
1,024, the numbers 146.29, 73.14, 36.57, and 18.29 would show
up. Of course, I didn’t know what this meant 15 years ago. I While still very
knew of course that 9.14 x 2 = 18.29 x 2 = 36.57 x 2 = 73.14 speculative at this
x 2 = 146.29, but so what? It wasn’t until I saw Dewey’s table point, researchers
did I realize what I was looking at. of human decision-
If you replace Dewey’s 17.75 base year with 18.29, you’ll see making abilities are
the sequence I found 15 years ago on the double progression
Increasing research looking at factors
into the behavioral that Dewey claimed
diagonal: 146.3, 73.1, 36.6, 18.29, 9.14, 4.57, 2.29 (Figure 2).
aspects of investing exist “out there.”
Since 18.29 had shown up the most times, its position at the
such as the herding
center seems appropriate. instinct of humans
When I look at Figure 2, I see a zigzag sequence of thirds, “fight or
including
which I have highlighted in red and yellow. Why this sequence
flight” is gaining
and what does it mean? If the ideal Kondratiev [Link] 54.9
years, then the Kuznets swing is its third harmonic at 18.29
years and the third harmonic of the Kuznets swing is the The Grand Super Cycle
Kitchin cycle of 6.10 years. We then have a perfect harmonic Identifying the Grand Super Cycle
relationship between these three major cycles. The Juglar is simple now. I just look at my table
cycle for fixed investments at 9.14 years comes in as the sec- and see that the Grand Super Cycle
ond harmonic of the 18.29-year cycle. I have also highlighted proposed by some market analysts
some of the other cycles that have appeared regularly in the should be the 109.7-year cycle, which
Foundation’s research, for example, the 36.6-year cycle found InisDewey’s
the next double
paper progression up
“The Case
in some agricultural prices like cotton and wheat and also a from 54.9 years. WhyFor notCycles,”
the 164.6-year
market cycle progression,
triple
4.57-year cycle found in pig iron prices. Finally, the 1.52-year you ask? I happen to harmonics
know thatarepeople are talking about a
calculated
or 18.29-month and the 0.76-year or 9.14-month cycles appear 1,000-year millennium fromcycle, and cycle
a “base” 987.4 ofyears
17.75seems about
in stock and commodity prices. Very interestingly, the har- right for that. The third harmonic
years. of 987.4
Well-known cyclesyears is 329.1
monic relationships are “self-similar,” just as the underlying years, and the third harmonic of 329.1 years
include Kondratiev waves,is 109.7 years.
Kuznets swing, Juglar cycles,
time series data is. Most economic and financial time series By the way, the Foundation has identified a 108-year cycle in
Kitchin cycles, and the Grand
data exhibit “self-similarity” generated from a chaotic or crises and panics. Super Cycle.
fractal process. The next obvious question is: Do these harmonic cycles
And if you look at Figure 18 in Dewey’s original paper, you’ll work? Well, we have now solved one half of the problem,
see all those cycles there. Of course, according to Pythagoras’ which is the length of ideal cycles and their harmonics. In
equation, we are equally likely to be looking at 53.5, 17.75, order to identify and use the cycles, what we need now is a
8.88, and 5.92. The main difference between these two sets starting point or a turning point from a previous cycle. As
of harmonic patterns is that the pattern I found was derived anyone can tell you, if you start from the wrong starting
from exact numerical relationships, whereas Dewey found his point, even with the best of directions, you’ll still end up in
17.75-year base cycle through historical averages. The main the wrong place. Presumably, these cycles didn’t just start on
problem with historical averages is the potential for measure- a certain date. To answer this question of efficacy, we have
ment error. I would like to propose an alternative pattern of to look at some very long-term price charts and speculate a
harmonic cycles to that of Dewey’s, knowing full well there little. We know that there are consumer prices going back
may be other, equally valid patterns of harmonic relationships nearly a millennium and security prices that go back to the
out there. I welcome any constructive views on how these 1550s in England. Let’s see how far back we can go to find a
harmonic relationships may be better constructed. reasonable starting point.

December 2016 • Technical Analysis of Stocks & Commodities • 21

 Kondratieff wave
American Revolutionary War War of 1812 American Civil War World War I World War II
1775–1783 1812–1815 1861–1865 1914–1918 1939–1945

Mississippi Next
Bubble American recession depression?
1718–1720 1762 Oct. 1929 Crash 2040
South Sea First American Panic of 1873 Great Depression Crash of 1987
Bubble depression 1931–1933
1720 1819

Super Cycle

1700 1720 1740 1760 1780 1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000 2020 2040

FIGURE 3: CYCLE PROJECTIONS. In this chart, the 1720 collapse of the South Sea Company and the Mississippi bubble were the identifiable cyclical turning point.
From there you can see when the next Kondratiev wave would’ve begun.

Kondratiev wave and depression in the United States that caused the economic
the GWhile Super
randstill very Cycle separation between the northern and southern states, ultimately
Let’s dospeculative
a little speculating.
at this If we use the 1720 triggering the US Civil War from 1861–65 and the panic of
collapsepoint,
of the South Sea Company and the
researchers 1873 that followed; the stock market crash of 1929 and the
Mississippi bubbledecision-
of human as an identifiable cyclical ensuing Great Depression from 1931–33 that sowed the seeds
turning point, theabilities
making next Kondratiev
are wave would’ve for World War II; and the October 1987 crash happened just
looking at factors
begun around 1775, just before the birth of the United States a few years before the 1994 end of the last Kondratiev wave.
that Dewey claimed
of America (Figure 3).existThe“out
yearthere.”
1819 saw the first economic That was less than 10 years before the attacks on the World
depression that originated from this new land, some 10 years Trade Center in New York and the Pentagon in Washington,
before the 1830 end of the Kondratiev wave that started in DC. Of course, we know what has happened since 2002. The
1775. This was also the end and the start of the next Grand 2049 end of the current Kondratiev wave coincides with the
Super Cycle of 109.7 years. The Kondratiev wave that started end of the Grand Super Cycle and the 329-year Super Grand
in 1830 would’ve ended around 1885, just over 10 years after Super Cycle. I can’t wait to watch it on DVD.
the panic of 1873, which saw the shuttering of businesses
across the East Coast. How to use cycle harmonics in trading
The Kondratiev wave that started in 1885 would’ve finished While it may be nice to know that the world may come crash-
around 1939. Once again, this was some 10 years after the 1929 ing down between 2030 and 2049 (though some of us may not
stock market crash and the Great Depression that followed. be around to see it), there is still the problem of what to do for
The 1939 end of the Kondratiev wave coincided with the end now. Going back to the harmonics table I presented, we see
of the 109.7-year Grand Super Cycle. Can you start to see the that the 3.05-year cycle is a part of this harmonic structure.
pattern now? According to this wave sequence, the last Kon- How can we use this information? Remember, a cycle is much
In Dewey’s paper “The Case
dratiev wave of the 20th century would’ve ended just before more than just a sine wave or a cosine wave, which is what we
For Cycles,” market cycle
1995 and
harmonics are the real estate boom and bust cycle from 1985–93
calculated normally use to represent cycles. Unfortunately, since we don’t
had just finished.
from a “base” cycle of 17.75This real estate cycle was considered by have a clear picture of underlying dynamics of each individual
[Link] a repeatcycles
Well-known of the real estate boom and bust cycle of the cycle, a sine wave is the simplest and easiest method to trace
1920–30s.
include Wewaves,
Kondratiev are now in the first Kondratiev wave of the the path of an idealized cycle. In Figure 4, you see the Dow
21st swing,
Kuznets century, withcycles,
Juglar this wave slated to end around 2049. The Jones Industrial Average with a 3.05-year cycle. Amazingly,
2049
Kitchin end will
cycles, and also be the end of the Grand Super Cycle that
the Grand the start of this particular pattern of cycles is 1924. There are
Super weCycle.
are currently in. And just remember how the last Grand also signs of a 6.1-year cycle, found in a lot of US stocks by
Super Cycle ended before 1939. Dewey and the Foundation research team.
As you can see from my projection of the last five to six Remember, the underlying cycles of a market are clearer
Kondratiev waves spanning almost 300 years, the repetitive with lower-frequency data (annual, quarterly, monthly) than
nature of the Kondratiev wave with higher-frequency data (daily, intraday, tick) due to the
An interesting side story and the Grand Super Cycle is lower level of noise. Having said that, you can see on the in-
Dewey’s father bought Brady’s quite chilling. The beginning traday chart of the Shanghai Composite Index in Figure 5 that
Bend, a 6,000-acre iron works of each major Grand Super short-term cycles can be identified from the same harmonic
property in the Allegheny Valley Cycle starts with a major relationship and tracked on an intraday basis the same way as
near Pittsburg, after the turn of meltdown in regional and/or for longer-term cycles. However, due to the higher noise level,
the century for $60,000 and only global economic conditions: these cycles will be harder to identify and track. Knowing
$5,000 cash down. The property the 1720 collapse of the South key turning points of the past will help to track the changing
had been listed for $7.5 million Sea Company that pushed the dynamics of these short-term cycles. We are working on new
before the panic of 1873. American settlers toward in- ways to identify these key turning points.
dependence by 1775; the 1819 Also remember that knowing the underlying cyclical rhythm
22 • December 2016 • Technical Analysis of Stocks & Commodities
 of a market is not going to give you a clear 18,000

entry signal. As you can see, when the 16,000

market cycle is turning, it can take weeks 14,000
or even months to complete a turn in the
monthly charts, and hours or days in an
12,000

intraday chart. Depending on the level

10,000

of noise and/or other chaotic components

8,000

that may be present, the market will never 6,000

turn just like a sine wave does when it is 4,000

changing direction. The sine wave can only 4.00

3.00

provide a simple and partial dynamic picture 2.00

1.00

of the underlying rhythms of the market.

0.00
-1.00
-2.00

You’ll still need to have clear, tested rules -3.00

-4.00

for entering and exiting a market, which is 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

something to discuss in another article. FIGURE 4: CYCLE HARMONICS AND THE DOW. Here you see the chart of the Dow Jones Industrial Aver-
age using a sine wave to trace the path of an idealized cycle. Amazingly, the start of this particular pattern

A final note
of cycles is 1924. There are also signs of a 6.1-year cycle, which was found in a lot of US stocks by Dewey
and the Foundation research team.
Nearly one Kondratiev wave
after Dewey’s death, the
academic community may 3,100

be finally coming Whilearound

still very
speculative at this 3,050
to see things his way. point, There
researchers
is now increasingof human research decision-
3,000

into the behavioral aspects ofmaking investing,

abilities are 2,950
esearch including the relationship between lookinglunar
at factors
avioral that Dewey claimed
phases and stock market returns, and the
2,900

vesting exist “out there.”

herding potential impact of geomagnetic waves on 2,850

mans human psychology and therefore on human 2,800

ht or decision-making abilities. Seasonal affec-
ing
tive disorder (SAD) and changes in weather
4.00
3.00

patterns may impact people’s moods to the

2.00
1.00

point that their decision-making is affected.

000
-1.00

We already know about the herding instincts

-2.00
-3.00

of humans and other animals in “fight or 4/21 4/25 4/27 5/1 5/5 5/11 5/17 5/23 5/27 6/1 6/7 6/13 6/17 6/23 6/29 7/5 7/11 7/15 7/21 7/27 8/1
-4.00
8/9 8/17

flight” situations. Of course, this is all still FIGURE 5: HARMONICS FOR THE SHORTER TERM. In an intraday timeframe, cycles may not be as clear
speculative at this point, but at least the as in daily, weekly, or monthly charts. However, on this intraday chart of the Shanghai Composite Index, the
researchers are starting to look at the factors short-term cycles can be identified from the same harmonic relationship and tracked on an intraday basis
Dewey In claimed
Dewey’s topaper
exist “out
“The there”
Case beyond
the same way that longer-term cycles are.

our outerForatmosphere.
Cycles,” marketWe may
cycleyet discover
the truthharmonics
about what areiscalculated
driving all these cycles to appear around Dewey, E.R. [1967]. “The Case For Cycles,” Cycles: July.
us. Withfrom
that, I wishcycle
a “base” you all happy cycle hunting.
of 17.75 Friedman, Milton [1948]. “Review Of Cycles: The Science
years. Well-known cycles
include Kondratiev waves,
Of Prediction,” Journal Of The American Statistical As-
Lyle PaiKuznets
has been a student
swing, Juglarof the financial markets for nearly
cycles, sociation, Volume 43: March.
40 years. He began
Kitchin cycles,hisandstudies
the Grandof foreign exchange markets Kaiser, Ronald W. [1997]. The Long Cycle In Real Estate,
at the University
Super Cycle. of Chicago in the late 1970s. He is currently Bailard, Biehl & Kaiser.
an independent trader based in Asia. He can be contacted Kaustia, Markku, and Elias Rantapushka [2016]. “Does
at lpai69@[Link]. He is grateful to Gaston Sanchez Mood Affect Trading Behavior? Journal Of Financial
of TradeStation Securities and Scott Cooper for reviewing Markets, June.
earlier drafts of this article. Wilson, Louis [1964]. Catalogue Of Cycles, Part I: Econom-
ics, Foundation for the Study of Cycles.
The Excel file mentioned in this article can be found at the Stocks Yuan, Kathy, Lu Zheng, and Qiaoqiao Zhu [2006]. “Are In-
& Commodities website at [Link] vestors Moonstruck? Lunar Phases And Stock Returns,”
Journal Of Empirical Finance, Volume 3, No. 1.
Further reading
Burns, John T. [1994]. Cycles In Humans And Nature, An
Annotated Bibliography, The Scarecrow Press, Inc.
24 • December 2016 • Technical Analysis of Stocks & Commodities
 FUTURES FOR YOU
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner is the se-
nior strategist for DeCarley Trading, a division of Zaner, where she also works
as a commodity broker. She has written multiple books on futures and options
trading, the latest is titled Higher Probability Commodity Trading. Garner also
authors widely distributed e-newsletters; for your free subscription visit www.
[Link]. To submit a question, email her at info@carleygarner-
[Link] or via [Link]. Selected questions will appear
Carley Garner
in a future issue of S&C.

USING STOP ORDERS IN COMMODITY aren’t necessarily ideal for option trad- option market illiquidity and temporary
OPTION TRADING ers either. Yet they are certainly worth ballooning bid–ask spreads rather than
How can commodity option sellers a mention. actual adverse price movement. To avoid
protect positions from unlimited risk the hassles that come with inexperienced
using stop orders? Stop-loss orders traders experiencing stop-loss slippage
Selling commodity options is attrac- Most commodity option traders are on their options, such as complaints to
tive because each individual endeavor is aware that the Chicago Mercantile Ex- the commodity exchange and commodity
a high-probability venture. It has been change (CME) does not accept stop-loss brokers, the exchanges have deemed it
said that anywhere from 70% to 90% orders for options. For clarification, a preferential to not accept this order type
of all options expire worthless, which stop-loss order is one that becomes a at all for option trading.
immediately gives an edge to the seller market order (an instruction to execute
of an option over the buyer of the same at the best possible price at that exact Stop-limit orders
option. Nevertheless, despite favorable time) once the stated stop-loss price is Now that we’ve explained why exchanges
odds of success on each trade, option reached. The nature of stop orders cre- don’t allow traders to place stop-loss
sellers must contend with the risk of the ates an opportunity for the order to be orders on options, let’s take a look at a
low-probability losers eating the profits filled at a worse price than the stop order similar order type that exchanges will
of successful trades, and worse, blowing stated; this is known as slippage. In the accept. A stop-limit order is a modified
up a trading account should an unusually stop-loss order. Identical to a stop-loss
volatile event materialize. Accordingly, order, a stop-limit order becomes a
it is important to have some sort of plan The ability to name market order once the stated stop price
in place to prevent the aforementioned the amount of slippage is reached. Yet, in the case of a stop-
devastation from occurring. received on a stop-loss limit order, the trader states the amount
Futures traders, as opposed to op- of slippage he is willing to accept. In
tion traders, tend to look to stop-loss order sounds like an such an order, the risk of abnormally
orders as their primary means of risk incredible advantage, large slippage rests solely on the trader
management. A stop-loss order can be but there is a catch. himself. Accordingly, the exchange is
used to either initiate or exit a trade, but giving traders the ability to determine
it is most often used to exit a trade in a how much is too much and allow the
market that is moving adversely to the case of options—and on rare occasion, trader to place the order based on their
position. As the name implies, it is an futures—it is possible for the slippage tolerance level.
order to “stop the loss” if a market goes to be shockingly large. This is because So, for instance, a trader who is short
against the trade enough to reach the options aren’t nearly as liquid as futures a December emini S&P 500 2,000 put
named stop price. To illustrate, a crude contracts and, therefore, have wider bid– for 20.00 in premium might place a stop-
oil futures trader long the market from ask spreads. limit of 35.00/40.00. This trader is telling
$48.00 might place a stop-loss order at If exchanges did accept stop orders the exchange they would like to place a
$47.00, which instructs the exchange to for options, then during highly volatile stop-loss order to exit their positions if
exit the trade should the price of oil reach market conditions or in thin overnight the price of the option reaches 35.00 (a
his pain threshold of $47.00. trading, it’s possible that a stop-loss loss of 15.00) but will not accept a fill
I argue that although simple, stop- order, which becomes a market order, price in excess of 40.00.
loss orders are not the optimal tool for could easily cause hundreds or thousands The ability to name the amount of slip-
futures traders due to their propensity of dollars in slippage. Adding salt to page received on a stop-loss order sounds
to be elected at precisely the wrong the wound, exiting the trade might be like an incredible advantage, but there is
time, forcing traders out of the market completely unnecessary in that the stop-
prematurely. Similarly, stop-loss orders loss order was triggered at the hands of Continued on page 41
December 2016 • Technical Analysis of Stocks & Commodities • 25
 Double Up Or Not

Is Wall Street A Casino?

Do stocks have a random characteristic similar to a roulette resulting profit/loss spread. Then this thought occurred to
wheel, and can we gain a winning edge by trading equities? me: Why not use the same approach to simulate Wall Street
WALL ST. BULL: STUART MONK / COLLAGE: CHRISTINE MORRISON

Here, we simulate Wall Street stocks on an artificial roulette stocks (equity type) on an artificial roulette wheel, with the
wheel to find the answer. required adjustments, and then study the output with Monte
Carlo simulation?

In
by Norman J. Brown
Are stocks random?
my August 2016 S&C article “The Subtle Aspects The first concept to consider is whether or not stocks have a
Of Expectancy,” I developed a larger winning random characteristic such that the random-like roulette wheel
level for roulette that retained the same in-house is a reasonable vehicle. Many books and articles have been
winning expectancy of 5.62% and indicated the written on whether the stock market is random, some of which
26 • December 2016 • Technical Analysis of Stocks & Commodities
 MONEY MANAGEMENT

you can find referenced in my previous S&C articles. I will

take a simplistic approach based on two assumptions:
A random wheel can generate
1 Similar to flipping a fair coin, you would expect the bias a favorable bettor bias if it is
(number of heads/number of tosses) to vary around 50%. unbalanced or has a payoff tilt
After evaluating 250 of the stocks in the S&P 500 index, favorable to the bettor.
I concluded the average bias is about 53% (see left side of
Figure 1). This is consistent with a slightly biased “fair
coin” such that the head side slightly dominates the tail
side. With long-term averaging, it will show 53% heads How do you adjust? In my August 2014 article, I define tilt
with 47% tails, which is still considered random albeit as a term that acts as a depressing effect downward on the
with a bias. I then compared those stocks with a random APR at a net-day negative rate of N * B * T (where T=0.05) or
series created in Excel showing a similar distribution. a decrease of -6.7 days so the new net days become 15.1 - 6.7
= 8.4 or a final APR = (1.01)^ 8.4 = 8.7%, which is very close
2 I then used my one-rank (OR) technique, which was to the VFINX (Vanguard, S&P 500 Index) APR I reported
explained in detail in my past S&C articles, with the key in the same article.
equation that the random switch rate (S) is given by:
No more bets
S = N * B * (1–B) It’s now time to spin our synthetic roulette wheel by entering
the RAND() function into Excel. I explained this function in
where N=252 market days and B is the bias. my article “Effects Of Volatility On Trading” that presents
information on Monte Carlo trading, the roulette wheel, and
If the series is random and the bias is 50%, then S=63 expectancy. I chose the following parameters to iterate this
switches/year or 126 buy/sells, such as a random series (N=4) spin: B=.53, T=-.05 (R=.95), bets of 1% and 2%, with the time
with two heads followed by two tails (on average). I then period 40 trading days (N=10,080) and 100 iterations.
compared stocks with the same random series. As you can see Figure 2 displays the results for bet = 1% (Roc- = -1%) with
from the right-hand side of Figure 1, stocks are remarkably three parameters varied: T=0, T=-.05, T=-.10. This resulted
random, at least in two terms of that parameter. in the three curves of APR at the bottom of the figure. At the
How do you construct the appropriate roulette wheel? The top is the resulting maximum drawdown (Mdd%) that results
American wheel has 38 numbered slots in which a ball may with these random series over a 40 year period.
fall, so we increase that to 252 slots (to simulate a stock trading Why is it that the APRs lie along a curve and the Mdd
year) and assign 133 winning green slots with 119 losing red is highly chaotic (scattered)? Over a multiple period for N,
slots, a bias of 52.8%, which is close
enough for illustration (in the Monte Distribution 0f Bias (B) & S vs. Random & Persistent Data
Carlo simulation you can adjust the bias
to any desired value and I subsequently
B = .50 B = .54 S = 63
100
used 53%). In my article “Parameters
Affecting Stock Returns,” which ap- 90
peared in the August 2014 issue of Random Series
Stocks
Stocks
80
S&C, I presented two equations ap-
plicable to my synthetic roulette wheel. 70
Equation 3 states that the approximate
Number of Events

linear equity is given by Roc- * E * N. 60

Roc- can be thought of as the amount 50

bet in trading (or buy & hold) and is
also proportional to volatility, and E 40
is expectancy. 30
What is the buy & hold (BH) APR
if the series (roulette wheel) is truly 20
random with a B=53% and S=63? The
Random Series
10
answer is 252*(2B-1)*1% or 16.2%
MICROSOFT EXCEL

(equivalent to 15.1 net up days). But 0

stocks generally generate 9% or 10% 45 50 55 60 65 70
Bias (B) Switches/Year (S)
APRs over long periods of time (I will
use 40 years, or N=10,080 days in my FIGURE 1: WHERE’S THE BIAS? The average bias is about 53% (see left side). This is consistent with a
simulation later). slightly biased “fair coin” such the head side slightly dominates the tail side. In other words, stocks are random.

December 2016 • Technical Analysis of Stocks & Commodities • 27

 averaging a given value for B, T,
BH Rtn & Mdd vs. Bias (B), Bet = 1%, N = 40 yrs., 100 Iterations and N, the APR is deterministic and
100 given by the expectancy equation I
mentioned earlier. Mdd, on the other
Mdd% R = .90 hand, is erratic, with the Mdd decreas-
80
ing steadily as T approaches zero
and B approaches a maximum. This
BH & Mdd Return%

60
Mdd% R = .95
clearly shows the debilitating effect
of negative tilt (T) that I emphasized
40 in my article “Parameters Affecting
Mdd% R = 1.0
Stock Returns.”
What needs to be noticed is the
20
BH Rtn% R = 1.0
rapid increase in APR as B increases
BH Rtn% R = .95
and for high values of the odds (R),
0 which can be expressed as “tilt,” T=R-
BH Rtn% R = .90 1. There is also a concurrent improve-
-20
ment in Mdd as the average curves
0.515 0.52 0.525 0.53 0.535 0.54 0.545 decrease significantly as B increases
Bias (B) and for large values of R.
Figure 3 shows similar data with
FIGURE 2: RETURNS AND MAXIMUM DRAWDOWN. Notice the rapid increase in APR as B increases and for high
the bet level doubled to 2% showing
values of the odds (R), which can be expressed as “tilt.” There is also a concurrent improvement in the maximum
drawdown as the average curves decrease significantly as bias increases and for large values of R. a square root rate improvement in
APR (slightly more than a doubling)
but with a concurrent deterioration in
Mdd due to the doubling of volatility
BH Rtn & Mdd vs. Bias (B), Bet = 2%, N = 40 Yrs., 100 Iterations
(standard deviation).
100
Mdd% R = .90
In Figure 4 I compared both pre-
vious graphs and plotted the square
80
Mdd% R = .95 root change in going from 1% to 2%
bet for APR and Mdd that showed
Mdd% R = 1.0
a high degree of correlation. Notice
BH & Mdd Return%

60 APR increases at a faster rate than

the Mdd decreases. For example, if
40 APR=10% for bet 1%, it will increase
exponentially to 21%, which is a 2.1
improvement. The Mdd increases at a
20
square rate and becomes 0.5^2=0.25
BH Rtn% R = 1.0
or a 75% Mdd, a factor of 1.5. That
0 BH Rtn% R = .95 is, of course, not to say that the Mdd
has improved relatively, since an
Mdd of -75% is extremely onerous,
BH Rtn% R = .90
-20
0.515 0.52 0.525 0.53 0.535 0.54 0.545 as market investors know from the
2008 to 2009 period.
Bias (B)

FIGURE 3: DOUBLE YOUR BETS. When you increase your bets, APR increases and drawdown decreases. This Roulette vs. buy & hold
is mainly due to an increase in volatility. A well-balanced roulette wheel will
come up (say) red every 18/38 spins
(bettor win rate 47.4%), thus creating the long-term house
A well-balanced roulette wheel winning percentage of 5.26%. Some years ago, a few
MIT financial/technical wizards were able to measure a
will come up (say) red every 18/38 defective roulette wheel in which red came up more than
spins (bettor win rate 47.4%), 50% of the time, transferring the odds from the house
thus creating the long-term house to the bettors. This resulted in a windfall to the wizards,
winning percentage of 5.26%. but the house quickly figured out what was happening
and brought in a well-balanced wheel (restarting their
“edge”) and negated the wizards’ earlier advantage. The
28 • December 2016 • Technical Analysis of Stocks & Commodities
point is a random wheel can generate
BH Rtn & Mdd vs. Bias (B), Bet = 1%, 2%, N = 40 Yrs., 100 Iterations
a favorable bettor bias if it is unbal-
anced or has a payoff tilt favorable 100
to the bettor.
90
I believe my data indicates that Mdd Bet = 2%
equity stock returns are near enough 80
to random that the data presented Sq Root Rate

will give some insight to buy & hold 70

BH & Mdd Return %

investors as important parameters are
changed. You could easily argue that 60
Mdd Bet = 1%
stocks are more complex than my un-
50
derlying assertions, but I believe that
even though the data would change, 40
the rules and rates I have presented
will still be of value. 30
Sq. Root Rate
BH Rtn Bet = 2%
In lieu of the author’s contact in- 20
BH Rtn Bet = 1%
formation, please see the memorial
10
below.
0
Further reAding 0.515 0.52 0.525 0.53 0.535 0.54 0.545
Abel, Phil [2003]. “Casino Bias (B)
Trading,” Technical
Analysis of StockS FIGURE 4: SQUARE RooT CHANGE. APR increases at a faster rate than the Mdd decreases.
& commoditieS, Vol-
ume 21: November.
Brown, Norman J. [2014]. “Parameters Affecting Technical Analysis of StockS & commoditieS, Volume
Stock Returns,” Technical Analysis of StockS 34: August.
& commoditieS, Volume 32: August. Ehlers, John F., and Ric Way [2014], “The Real Reason Traders
[2014]. “Effects Of Volatility On Trading,” Lose Money,” Technical Analysis of StockS & commodi-
Technical Analysis of StockS & commoditieS, tieS, Volume 32: May.
Volume 32: December.
[2016]. “The Subtle Aspects Of Expectancy,”

In Memoriam: Norman J. Brown

We are sad to report the passing of Norman Brown on October 3, his never-ending interest in advancing the
2016. He was 88. He continued writing and working on articles for topic of probable outcomes—all tested,
StockS & commoditieS right up to the end, even while in hospice demonstrated, and proven statistically.
care with a rare form of non-Hodgkin’s lymphoma. His interest in His articles in S&C explored the technical
studying mathematical concepts and the statistical aspects of side of risk, position size, randomness, and
market data never waned. reward expectancy. He introduced the concept of one rank and
A retired electrical engineer and private investor, Norm was a continued on this theme throughout his contributions.
longtime reader of StockS & commoditieS magazine as well as Some of his dozen-plus S&C articles include “A One Rank
a contributor, both in the form of articles and letters to the editor. Screening Technique For Mutual Funds,” “Trading Multiple Stocks,”
With expertise in statistical analysis and a penchant for probability “Enhanced Returns With Mutual Funds,” “Quantifying Stocks For
analysis, he read articles with a critical eye. A stickler for accuracy Nonrandomness,” “Trading Tradeoffs With Risk Vs. Reward,”
and an acute parser of words and numbers, we heard from him “Expectancy Risks In Trading,” “Parameters Affecting Stock Re-
often—as did many S&C authors!—in response to details in turns,” “Effects Of Volatility On Trading,” and “The Subtle Aspects
articles he wanted to question or explore. He never let articles Of Expectancy.” S&C subscribers will find all these articles in our
that truly captured his interest escape his scrutiny. article archive at [Link].
Despite the occasional but unrelenting grillings we’d receive As someone who was a highly interested and involved reader
from him, we grew fond of his keen insights into statistical analy- of and contributor to this magazine, he will be greatly missed by
sis, the generosity of his time, his careful readings of text, and this staff.

December 2016 • Technical Analysis of StockS & commoditieS • 29

 Labor Of Love

Trading the Nonfarm

Employment Report
Euro US BILLS: PIXELJOY/NYSE: NICL STARCHENKO/SHUTTERSTOCK/COLLAGE: JOAN BARRETT

Trading the nonfarm employment report can be dangerous the average movement for each of the instruments from my
and result in a margin call if you are on the wrong side of 2015 market volatility report in the table in Figure 1.
the market. Here’s a better way to take advantage of high
volatility using binary options. Mind volatility
This year, the markets have seen even more movement because

T
by Gail Mercer of the potential upcoming rate increase. For example, in June,
when the numbers came out much worse than anticipated, in
he nonfarm employment report is known to create mar- one 15-minute bar, gold went up from a low of 1223.2 to a
ket volatility, which can move the forex, commodities, high of 1246.1 (almost 23 points or 230 ticks). The USD/JPY
and futures markets. To get an idea of how markets can went down from the high of 108.81 to a low of 107.77 within
move when this report is released, I have summarized a 15-minute bar (or 104 pips). Then in July, when the numbers
30 • December 2016 • Technical Analysis of Stocks & Commodities
 options

came in higher than anticipated, the USD/JPY went up 105 pips, Nonfarm
while gold came down more than 22 points (or 220 ticks). Employment change
Although there are many binary option brokers, as I described
YM 81
in my S&C article last month, “Choosing A Binary Option
Provider,” there are only three binary option exchanges that ES 42
are regulated and currently offer binary options in the United NQ 72
States. They are: DAX 109
GC 133
• Cantor Exchange LP CL 47
• North American Derivatives Exchange, Inc. AUDUSD 59
(NADEX) EURUSD 78
• NYSE ByRDs
GBPUSD 64
The Cantor Exchange LP offers limited binary options on USDCAD 84
forex and gold, and the NYSE ByRDs are offered on limited USDCHF 62
stocks for a weekly expiration. Nadex (North American De- USDJPY 84
rivatives Exchange, Inc.) offers binaries on a much broader Figure 1: EFFECT OF Nonfarm Figure 2: order-entry ticket. Here
market including Asian indexes, European indexes, US indexes, EMPLOYMENT REPORT. Here you see the strike statement and expiration,
you see the average movement of current price, hours and minutes till expira-
commodities, and forex. Since Nadex offers a much broader indexes, commodities, and forex tion, price for going long and short, max loss,
array of instruments, I have used the Nadex exchange for this pairs for 2015 after the release of the and max profit.
article to discuss trading the nonfarm employment report. nonfarm employment report.

The good about binaries trading around $50 of risk, the further the trader goes away
Binary options, in general, provide traders with limited risk from the currently traded price, the lower the risk is. However,
and limited reward on every trade. Binary options have a you need to keep an eye on market volatility to make sure
maximum payout of $100. Traders choose their risk level that price can move sufficiently close to being in-the-money
on entry and they cannot lose more than they pay on entry. (ITM), which simply means that the binary option expires in
Because binary options limit risk on entry, they are ideal the trader’s favor.
for trading during high-volatility periods such as during the For example, using the USD/JPY binary option chart in Fig-
release of market reports. ure 3, if the trader has a bias to the upside, his choices are:
The binary option order ticket provides you with all the
information you need to make a decision on whether to enter • ITM strike at 103.34, which has $63.75 of risk and is one
the trade or not. For example, shown in Figure 2 is a typical strike below where price is currently trading
order-entry ticket. • ATM strike at 103.38, which has $50.75 of risk, and is
The order ticket immediately identifies the following: where the price is currently trading
• OTM strike at 103.42, which has $38.25 of risk, and is
• Strike statement and expiration (based on New York one strike above where price is currently trading.
time)
• Current price (Nadex indicative index) Although the chart in Figure 3 shows only four strikes for the
• Hours and minutes till expiration USD/JPY two-hour binary options, there are always 19 strikes
• Price for going long or short
• Maximum loss (red box)
• Maximum profit (green box).

In the case of Figure 2, the strike statement is USD/JPY > Pivot daily

103.46 by 8 am on October 19, 2016. If the trader agrees

OTM
that the USD/JPY will be greater than 103.46 by 8 am, he
buys the strike. The risk is $30 per contract or $300 if trad- ATM
ing 10 contracts (red arrow). His maximum profit, if held
till expiration and price expires greater than 103.46, is $700 ITM
(green arrow). S2
S2

Since market reports create volatility, traders can limit their

risk even further by using out-of-the-money (OTM) binary
options. OTM binary options are trades that are placed either Data is indicative only
one or more strikes away from where price is currently trad- FIGURE 3: FOUR STRIKES AND MANY MORE. Here you see four strikes for the
ing. Since at-the-money (ATM) binary options are always USD/JPY two-hour binary options although there are many more available.

December 2016 • Technical Analysis of Stocks & Commodities • 31

 Instrument Strike Risk on Entry Profit Potential Risk management
Using the October 7, 2016 nonfarm employment report as an
Gold Long 1259.7 by 10 am $160.00 $317.50
example, immediately prior to the release, here’s what these
USDJPY Long 103.38 by 9 am $132.50 $377.50 other markets were trading at:
FIGURE 4: EXECUTED TRADES. Five contracts were traded on each of these
using out-of-the-money (OTM) binary options to lower the risk. • Gold: 1256.8
• USD/JPY: 103.61
USD/JPY - 15 min. forex
As identified in the nonfarm employment report in Figure 1,
103.900 the average movement for gold is 133 ticks (or 13 points) and
103.800 84 pips for the USD/JPY. Since the trader needs price to move
103.700 two strikes ITM, a good rule of thumb is to divide the average
103.600 movement by four to identify how far OTM you should go.
In this case, you should not go further than three points on
103.500
USD/JPY > 103.38 gold (13 points divided by 4) or 21 pips on the USD/JPY (84
103.400 pips divided by 4).
$26.50 p/ct. 103.300 Using OTM binary options to lower the risk, trading five
103.200 contracts on each, the trades you see in Figure 4 were ex-
103.100 ecuted.
103.000
Expired ITM by 9 am
resulting in $73.50 profit p/ct. 102.900
102.800 Since market reports create
volatility, traders can even
22.00 10/7 02:00 04:00 06:00 08:00 further limit their risk using
FIGURE 5: HOW DID USD/JPY PERFORM? Immediately after the announce-
ment, the USD/JPY moved against the binary option trades but then resumed the
out-of-the-money (OTM)
downward movement and expired in-the-money (ITM). binary options.

@GC - 15 min. COMEX

1276 The total risk exposure for the trader, trading five contracts
1274 on each instrument, was locked in at $292.50. The total profit
potential, based on a maximum payout of $100 minus the risk
1272
paid on entry, was $707.50. If all the trades expire ITM, the
Exit at $87.50 for a
1270 return on investment would be 242%.
profit of $55.50 p/ct 1268 Unlike with futures or forex trading, where stops can be
1266
jumped and you can lose more than what your initial risk
limit was, with binary options, the risk is guaranteed. In other
1264
words, you can’t lose more than the $292.50 that you paid on
1262 entry regardless of the outcome of the report.
Gold > 1259.7 by 10 am 1260 In addition, you have now defined with precision what
$32 p/ct your potential outcomes are if you hold the trades through
1258
expiration. If held till expiration, there will only be one of
1256 two potential outcomes:
1254
22.00 10/7 02:00 04:00 06:00 08:00 • You either lose the amount you paid on risk, or
FIGURE 6: HOW DID GOLD PERFORM? The gold trade immediately moved in • You receive the full profit potential.
favor of the trade and the profit target was filled.
However, with Nadex binary options, you can also exit early
using a profit target. For example, since the gold binary op-
available and the strike width (distance between the strikes) is tion did not expire until 10 am, the following profit target
four pips. For the gold two-hour binaries, there are a total of was set:
nine strikes offered and the strike width is one point. This is
vital information when combined with the average movement Gold: profit target set to capture $367.50.
for the nonfarm employment because traders can now calculate
how far they can go out with their strikes for the report. Continued on page 43
32 • December 2016 • Technical Analysis of Stocks & Commodities
 Explore Your Options
Got a question about options? Tom Gentile started his trading career on the floor
of the American Stock Exchange in 1994. He has appeared on many financial
TV and radio shows, as well as hosting a weekly talk show himself, and has co-
authored many books on the markets. He can be found at [Link].
To submit a question for Tom Gentile, post it to our website at [Link]
[Link]. Answers will be posted there, and selected questions will
appear in a future issue of S&C.
Tom Gentile

’Tis the season to buy it only took two weeks to make a move Monsanto (MON)
commodities like this back in September. Right now, Monsanto Company (MON) provides
December is here, and for most of you, with the option implied volatility on the agricultural products for farmers world-
it’s time to watch the landscape change high side, selling out-of-the-money put wide. Its biggest product space is in
from green to not-so-green. There is, credit spreads during this month may be seeds and agricultural productivity. Not
however, another green I am interested the best way to take money on the bull a stranger to the price of commodities,
in looking at, and that has to do with side without excessive time risk. this company has seen its ups and downs
seasonal trades that typically happen for 2016. With a low of 83.73 in Febru-
in December. John Deere (DE) ary, the stock climbed to 114.26 just a
Now that the presidential election is Deere (DE) manufactures agriculture few short months later. It has currently
out of the way and the idea of a new equipment as well as construction and pulled back and is sitting just above $100
president has been digested (along with forestry equipment around the globe. a share. But December is good to this
Thanksgiving dinner), stuffing our stock- The biggest thing they are known for stock as well, as nine of the last 10 years
ings with holiday trades does make a lot is tractors, both commercial and retail, have produced rising prices during this
of sense, so let’s look at that landscape for and related service parts. The stock price month. In fact, the average price change
December patterns in the stock market. weighs heavily on the economy, interest between now and January 5 has been
Commodity stocks have ruled Decem- rates, and of course, the global outlook for $7.31. That’s more than a 7% move in
bers past, so, in order, here are my top growth. Energy prices sometimes move a little more than a month. January call
three commodity-based stocks to buy the stock, but that’s secondary. options also look good in terms of time
for a fruitful holiday season. Deere is running on all cylinders (no value, and as the price of this stock has
pun intended) and the stock is currently risen, volatility has fallen.
United States Steel (X) hitting new highs as we approach year’s Coincidence? Perhaps, but there’s no
United States Steel Corporation (X) end. Couple this with the fact that over guarantee that the future will be anything
is one of the oldest companies around the last 10 years this is Deere’s shining like the past. As you sit tight and wait
and is headquartered in Pittsburgh, PA. month, with an average $4.37 move in for another potential tightening by the
The company primarily produces and the last decade between December and Federal Reserve, this could be the one
sells steel products in North America January 6. The option premium on DE risk you cannot spot in the charts. A rate
and Europe. It produces a variety of is quite cheap, and with the stock trad- hike would put pressure on commodities
steel and sheet metal for different uses. ing at nearly $90 a share, buying call and stocks such as the ones discussed
This company is highly correlated to options that are slightly in-the-money here. Only time will tell and the best you
the price of steel and aluminum on the may make the most sense for limited can do is limit your downside risks.
commodities exchange. You can almost risk and unlimited upside reward.
overlay the chart of X to that of Alcoa
Aluminum, another company that is
highly correlated to the metals.
US Steel started out the year at less
than $8 a share, but by July had jumped
over 400% before pulling back. The
holiday pattern sees the stock moving
higher during the month of December in
nine of the last 10 years and the average
move has been $5.63 during this time-
frame (Figure 1). With the stock trading
around $20 a share, a move of this size
would represent a 25% move during
the month. Impossible, you say? Well, Figure 1: SEASONAL PATTERNS. The stock price moves higher during the month of December.

December 2016 • Technical Analysis of Stocks & Commodities • 33

 Compare them
One method you could apply to
help appraise the financial condi-
tion, efficiency, and profitability of
a business is to compare indicators
and measures. It is helpful to relate
financial data to each other to ob-
tain ratios that express a significant
comparison more useful than the raw
figures themselves. This has never
been truer than now, considering
the uncertainty of the stock market
and the external forces imposed on
investment decisions.
There are limitations to using ra-
tios. The most obvious drawback lies
in the differences found among the
accounting methods used by various
companies, which seriously impair
the comparability of many situations
even in the same industry. Methods
of recording and valuing assets,
write-offs, costs, expenses, and so
on vary with the customs, policies,
and character of the company you
are investigating. For example, the
various methods of establishing in-
ventory values leave a great leeway
to management, just as the amount
of depreciation claims can fluctuate
widely. In other words, the balance
sheet accounts do not necessar-
ily correspond to the value of the
firm, either as a going concern or in
liquidation, and liability accounts
may be incomplete or understated
(for example, non-recording of lease
obligations). No business is exactly
comparable to any other.
Financial statements are based on
past performance and past events,
Liquidity, Leverage, Activity, & Profitability and you must project your evaluation

Using Ratios
from this basis. For any such evalu-
ation, the significance lies in that
which can be expected to happen.
Past events are guides only to the
Sometimes adding a sprinkle of fundamental analysis to your toolkit doesn’t hurt. extent they can reasonably be consid-
Here are some ratios you could use to judiciously evaluate your trading decisions. ered as clues to the future. You must
temper their use by the best possible
by Daniel J. Subach knowledge about the outlook for the

W
business. Remember, it has been said
screen: leungchopan/SHUTTERSTOCK

hich stocks should you invest in? A technical analyst may not give much weight that ratios and financial statements
to fundamental analysis and may pick stocks by looking at charts. But that can are like perfume—to be smelled but
sometimes lead to trading stocks that may not be ideal, resulting in bad trades not swallowed.
that you may hold onto for much longer than you had expected. To avoid such So where is the usefulness of ratio
situations, it may be worth your while to look at a few fundamental indicators. analysis? Ratio analysis will provide
34 • December 2016 • Technical Analysis of Stocks & Commodities
 ANALYSIS TOOLS
Noisy indicators
delay your analysis
guides and clues, especially in spotting trends toward better
or poorer performance and in finding significant deviations
from any average or relatively applicable standard. It is in the
interpretation of such trends and deviations that you will use
your skills and experience to the greatest extent.

What’s the theme? Jurik algorithms

Ratio analysis employs financial data taken from a company’s deliver low lag,
balance sheet and income statement. It is important to under- low noise analysis
stand the interrelation of these reports to fully understand the
significance of the various financial ratios. The basic financial
statements include: Tools for: TradeStation, AmiBroker, Investor/RT, MultiCharts, NeuroShell Trader, eSignal,
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1. The balance sheet, which shows the firm’s financial
position as a point in time
Jurik Tools on live charts, on the web !
2. The income statement, which reports on operations [Link]/jurik-online
during a point in time
3. Retained earnings, which shows the amount of profits
reinvested in the business.
Jurik Research
Recognize that retained earnings represents funds reinvested
in the business through years, and that retained earnings are 2010 -- 2011 -- 2012 -- 2013
not held as cash and are not generally available for anything. Add-In software

They have already been invested in physical assets.

For fun, I’ll pose a few questions along the way related to [Link] • 800-810-3646 • 719-686-0074
the concepts discussed for you to consider and I’ll include my
answers at the end of the article.
B. Leverage ratios measure the exposure of the com-
Question 1: Sales of the company you want to invest in pany to debt financing. It is critical to earn more on
are up 20% over the last year. The previous two years’ borrowed funds than the company pays in interest to
sales were average, according to the industry segment, but magnify the return to your investment.
this firm had a downward trend (5% to 4.8%). Meanwhile,
Debt
inventories have risen from $30,000 to $42,000. What por- a. Debt proportion =
tion of this increase in inventories is due to sales growth Total assets
and what portion to changing inventory control? (The This is the percentage of total funds provided by creditors.
answer can be found at the end of the article.)
EBIT
b. Interest coverage =
You want to classify financial ratios into four types: I
Operating earnings (net income before interest and taxes,
A. Liquidity ratios that measure the firm’s ability to EBIT) divided by interest charges (I). This ratio measures
meet maturing short-term obligations the extent to which earnings can decline without resultant
financial embarrassment to the firm because of inability to
a. Current (CA) = (Current assets) meet annual interest costs.
(Current liabilities)
C. Activity ratios measure how effectively the firm is
Current assets = cash, marketable securities, using its resources.
accounts receivable, inventories
Sales (S)
Current liabilities = accounts payable, short-term a. Total assets turnover =
debt, current maturities of long-term debt, taxes, Total assets (TA)
other accrued expenses This ratio indicates how well the company utilizes its assets.
A low ratio suggests the company is not generating sufficient
(Current assets – Inventories) volume for the size of the asset investment.
b. Quick (QR) =
(Current liabilities) Sales (S)
b. Fixed asset turnover =
Both provide a measure of immediate liquidation or short- Fixed assets (FA)
term solvency. Fixed asset turnover (FAT) measures the efficiency of fixed as-
December 2016 • Technical Analysis of Stocks & Commodities • 35
 set utilization. A low ratio indicates idle capacity of assets.

c. Inventory turnover =
Sales (S) Ratios and financial statements
Inventory (I) are like perfume—to be smelled
A high inventory turnover demonstrates that a company does but not swallowed.
not hold excessive stocks of inventory. Consideration should be
given if the company’s business is highly seasonal or if there
has been a strong upward or downward sales trend during the
Net income after tax
year, such as introduction of a new product. c. Return on equity =
Equity (investment)
Receivables
d. Avg. collection period =
Sales per day
This measures the efficiency in collection of accounts receiv- Trend analysis
able. The sooner payment is made, the more positive cash You need to examine the different ratio coefficients over time
flow is. and against corresponding industry and company averages to
identify strengths and weaknesses of the respective company.
D. Profitability ratios measures management’s overall This analysis should be done for a particular firm for a period of
effectiveness as shown by the returns generated on several years to compare ratios over time to determine if your
sales and investment. target investment is improving or deteriorating. A comparison
to companies within the target industry will assist to identify a
Net income after tax
a. Return on sales = good investment candidate. Comparative analysis is comparing
Sales the key ratios of the firm with those of other similar firms in
the industry or with the industry average. Always look over
Net income after tax
b. Return on total assets = a period of time, not one point in time.
Total assets

The Cash Flow

Production Cycle
∆E ∆L -T -I -D
∆E = Change in equity
∆L = Change in liabilities
T= Taxes
I= Interest Production CASH Inventory AR
D= Dividends

The movement of cash to in-

ventory, to accounts receivable Cash & Credit Sales
(AR), and back to cash is the
firm’s working capital (WC)
cycle. The company puts cash
into the production operation Investment
and produces the product which
is placed in inventory. Cash
turns into the sellable product.
Cash is composed of immediate
Fixed Assets Depreciation
sales and receivables. As assets
are utilized, every item passing
through the factory takes with
it a small portion of the value of the fixed assets, which is by the change in equity, liabilities to maintain the business,
accounted for through depreciation. In order to maintain and by the outflow of taxes, interest, and dividends. Finan-
production, the firm must invest part of its cash in new or cial ratios can now be placed into the cash flow cycle with
maintained fixed assets. The amount of cash returning from a focus on activity and profitability ratios for the purpose
the WC cycle and the investment cycle must exceed that of security analysis. You are now in a position to see how
amount of cash that started the journey. Cash is impacted things work.

36 • December 2016 • Technical Analysis of Stocks & Commodities

 Question 2: How can you determine if Situation Assets Equity Debt Sales EBIT
the correct measure of a firm’s financial A 100 100 ----- 1,000 50
performance is the firm’s stock price B 100 50 50 1,000 50
or its ROE?
C 100 50 50 1,000 20
In any financial analysis endeavor, your D 100 50 50 1,000 15
interest is in investing funds and secur- Situation (1) (2) (3) (4) (5) (6)
ing a good return. The financial ratios are
useful in security analysis in that respect. A 0.050 10 1.0 1.00 .5 .25
The principle emphasis is on the long-run B 0.050 10 2.0 0.80 .5 .40
profit potential of the company. The focus C 0.020 10 2.0 0.33 .5 .10
is, therefore, on the activity and profitability
D 0.015 10 2.0 0.33 .5 .05
ratios over time. And remember, “banker’s
utter in an ominous, low mutter, ‘Watch ROED = (1) x (2) x (3) x (4) x (5) = (6)
cash flow’” (see sidebar “The Cash Flow Situation ROA Total FL* EAT/EBT ROED**
Production Cycle”).
A .50 1.00 .5 .25
The advantage of ROED is that it enables a *TA/E x EBT/EBIT
more meaningful decomposition of the total B .50 1.60 .5 .40
return to equity into three components: C .20 1.00 .5 .10 **ROED = ROA x Total
FL x EAT/EBT
D .15 0.66 .5 .05
Financial leverage (FL) = TA × EBT FIGURE 1: Examples of Leverage Effect Using FL
E EBIT

The tax effect, which can be allowed for

by the ratio Here are the six factors that make up the ROED equation.
The first five factors explain the ROE.
EAT
EBT 1. Margin: Revenues affected by commercial policies
and costs of sales due to marketing, productive, and
EAT administrative efficiency.
ROED = ROA × FL ×
EBT 2. Turnover: General efficiency in asset use as well as
sales volume. Variations in ROA would reflect the
Since ROED = impact of the company’s “business risk.”
EBIT S TA EBT EAT EAT 3. Balance sheet effect: Relationship between total as-
x x x x = sets and total equity financing. If all sources of funds
S TA E EBIT EBT E
are provided by the owners it will be unity.
(1) (2) (3) (4) (5) (6) 4. Income statement effect: It is affected by interest
charges and both numerator and denominator are
where before taxes.
EBIT = Earnings (E) before (B) interest (I) and taxes (T) 5. Reflects the tax policies of the government and is
EBT = EBIT – I generally beyond management’s reach to influence
EAT = EBIT – I – T results.
6. This is the overall efficiency and total risk.

ROA = EBIT × S Question 3: ROE suggests that debt financing leverages

S TA ROE into a higher ROE. What situation could lower the
ROE?

ROE = EAT × S × TA Let’s look at four companies with respect to ROED (Figure
S TA E 1). In situation B, the total leverage (1.6) is favorable to ROE,
ignoring risk. In situations A and C, the leverage effect is
ROED then becomes exactly 1. In the first case, debt is not used, and in the second
case, the cost of financing is just equal to ROA. In case D,
there is an unfavorable leverage effect because the interest
EAT
ROA × FL × costs exceed the ROA. For situations B, C, and D, the current
EBT leverage effect used in typical analysis, that is, TA/E, shows a
December 2016 • Technical Analysis of Stocks & Commodities • 37
 consistent value of 2.0, implying that the use of leverage has Further reading
doubled the return on assets before taxes, whereas in terms Bailey Jr., H.S. [1975]. Publishers Weekly, January 13, R.R.
of FL, only one situation is favorable and then merely by a Bowker Company.
60% increase. Subach, Daniel [2013]. “Systematic & Unsystematic Risk And
CAPM,” Technical Analysis of Stocks & Commodities,
Debt Volume 31: January.
A useful definition of debt is

D = ND + FD + SD AND THE AnswerS ARE ...

1. Sales are up 20%, so it is reasonable to expect that inven-
where tories will also increase 20% to $36,000 ($30,000 + 20%
ND = negotiated debt, interest bearing × $30,000). The remaining $6,000 increase, or 50% of the
FD = free debt, such as taxes payable total, must be due to lack of management control.
SD = spontaneous debt, usually without an explicit cost,
such as suppliers credit 2. You should plot (market value equity)/(book value equity)
vs. (weighted average return of equity (%)) of recent annual
FL should only include ND, since FD and SD are assumed ROEs for the representative companies in the industry. You
to be free or without implicit cost. will find a high correlation in each graph, which suggests
that high-ROE firms tend to have high stock prices relative
to book value. Some industries, such as chemicals, have
TA EBT a high correlation coefficient. Others, such as beverages,
FL = ×
E EBIT have a lower correlation coefficient. Variations you observe
might cause you to do further analysis into the company’s
operations.
TA = E + ND + FD + SD = E + D
3. If the firm’s earnings are so low or the interest rate pay-
EBT ND + E TA ment on debt is so high, the percentage decline in earnings
FL = × × due to the increased interest expense more than offsets the
EBIT E ND + E
increase in leverage to the ROE. In this case, increasing
leverage would actually reduce ROE.
Pure financial leverage (PFL) is

EBT ND + E
PFL = ×
EBIT E

ROED ratio analysis incorporates cases where non-negotiated

debt is important to the firm’s financial structure, as well as
where these sources of finance are negligible. By incorporating
FL or PFL, ROED constitutes a simple and useful verifica-
tion of the relationship between interest costs and corporate Your online resource
return. It also offers the possibility of assessing the magnitude
of the leverage effect for the company in a particular security For Technical analYsis
sector.

Daniel Subach has a master’s degree in physics, a doctor-

Join us on Facebook
ate in chemistry, and an MBA in marketing and financial at [Link]/
planning. He is CEO of Proteome Diagnostics, LLC, and STOCKSandCOMMODITIES
President of InPro Technologies, LLC. He provides stock
analyses, strategic planning, product development, and Follow us on Twitter
marketing services for asset investment, private equity, @STOCKSandCOMM
and individuals and corporations. He can be contacted at
db17976@[Link]. His primary research interests are in the
areas of risk minimization, oscillating models to describe
stock performance, predictors of future stock performance,
and elderly and college investments.
38 • December 2016 • Technical Analysis of Stocks & Commodities
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 TRADING ON MOMENTUM

Mean-Reversion Swing Trading

This month, we take a look at a technique for entering a long pullbacks (that is, less than 50%) or major pullbacks (that
position in a trend continuation following a pullback after is, more than 50%) in uptrends is a hit-or-miss proposition.
a breakout. Instead, if you enter after a “close-to-exact” 50% drop that
then starts to recover, you’ll find it may be a more successful
by Ken Calhoun trading strategy.
When you see one of these mean-reversion patterns, you

E
ntering new trades following a 50% retracement, also can enter once a price-action breakout starts to emerge and
known as a mean reversion, can provide you with a recovers above the 50% technical support price. All you have
second opportunity to enter a strong-trending stock to do is find a strong trending chart that has pulled back to the
following a pullback. You can use this technical trad- exact middle of the prior trading range and is now starting to
ing strategy with multiple timeframes, including both swing trend back up (preferably on increasing volume).
and daytrading. This article will show you how to swing trade
mean-reversion pivot entries (I’ll cover intraday trading in an Step-by-step action plan
upcoming issue). Here’s how you can put this strategy to work in your swing
If you have ever missed an initial strong breakout, this tech- trades.
nique can help you enter a trend continuation, once you know
what to look for. Entering your trade after a reversion to the Step 1: Look for a chart that has trended up for at least five
mean during an upside recovery of price action can also help days with a classic 45-degree angle uptrend, as seen in the
when adding to winning trades or as the first trade in a new chart of Anadarko Petroleum Corp. (APC) in Figure 1 from
position-sizing sequence. I call these simply “1-2-3 patterns” September 2–8, 2016.
since there are three major moves in the chart.
Step 2: Next, calculate the mean of this trading range (in
Trading strategy: Buying after a mean Figure 1, this is ($59 + $53)/2 = $56). This is your mean-
reversion reversion pivot price.
It is important to understand that this strategy primarily
works for pullbacks of nearly exactly 50%, no more and no Step 3: Wait until a day after the 50% mean-reversion
less. It has been my experience that buying pivots of minor pivot price to see if price goes up, as seen on September
15, 2016.

Step 4: Set your buy signal

to enter your trade once price
has moved at least $0.50
above the mean-reversion
pivot price (in this example, it
is $56 + $0.50 = $56.50).

Step 5: Use a $1 initial stop for

risk management. A second
entry occurs once price action
has broken above the prior
15-day high. Use this to add
to your winning position.

Insights: Why this

technique works
The mean-reversion technical
trading strategy uses a well-
known professional traders’
esignal

50% retracement pivot entry

Figure 1: Mean Reversion In Action In Anadarko Petroleum Corp. (APC). Here you see an example of entering in an already-trending strong
a swing trade after a 50% retracement. stock chart. If you wait until
40 • December 2016 • Technical Analysis of Stocks & Commodities
 TRADING ON MOMENTUM

after a full 50% retracement before you enter a pivot long,

it helps you avoid weak bounces that do not continue up in If you enter after a “close-to-exact”
your favor. 50% drop that then starts to recover,
Trade management tips you’ll find it may be a more successful
From a risk management standpoint, you can use a tight $1.00 trading strategy.
initial stop-loss value (in this case, $56.50 - $1 - $55.50),
because a loss of the initial 50% mean-reversion support is a
price that proves the trade wrong. You can use this strategy
to build longer-term position trades as well as with opening- Ken Calhoun, a professional daytrader and educator, is a
range intraday breakouts. The best thing about this pattern is producer of trading courses, a live room, and video-based
its simplicity—you can instantly see if the 50% mean-reversion training systems for active traders. He is a UCLA alumnus
pivot is developing, such as the one on September 15, 2016 and is the founder of [Link], an educational
in Figure 1. resource site for active traders. In this “Trading on Mo-
There should be no ambiguity in seeing if a chart has pulled mentum” monthly column, he covers the topic of breakout
back to 50% of its prior trading range and is now pivoting trading techniques.
upwards. As always, it is best to swing trade charts in the
$20–$70 price range and avoid cheap, haphazard sub-$20
stocks or poorly leveraged over-$70/share stocks.

Barone / Futures Margins must understand how account margin affects your capital
Continued from page 9 requirements and leverage availability.

placed. Say the trade goes sour and the account Roger Barone currently owns and operates a proprietary
balance falls to $8,200, which is $200 below the trading firm specializing in futures options. He also regularly
maintenance margin. You are now on a margin call of $1,120 consults with firms, funds, and individuals seeking to launch
($9,240 [initial margin] - $8,200 [new account balance]) and new funds or improve returns of existing ones. He has over
therefore will need to add at least $1,040 to your account or 10 years of experience in this current endeavor. He may be
get out of one or both of your ES to meet the margin call. reached via email at optproj@[Link].
So as you can see, the rules governing margins in futures
trading is different than for equities, and to trade futures, you

FUTURES FOR YOU

garner This version of the order leaves the trader leave the strategy of using stop-limit or-
Continued from page 25 open for 25.00 in price slippage, which ders for risk management a questionable
is substantial, but it gives the exchange one. Perhaps a more efficient means of
a catch. If for some reason the price of more room to work to ensure the order risk mitigation is the use of long options
the option explodes and cannot be filled doesn’t simply go unfilled, leaving the (preferably cheaply priced), antagonis-
by the exchange at a price between 35.00 trader with “naked” risk. tic short options, or even long or short
and 40.00, the order simply dies, leaving futures contracts to hedge option risk.
the trader without a stop-loss order at all. Is it a good solution? If you are interested in learning more, I
Option traders can reduce the odds of a Hopefully, it is clear by now that while talk a lot about these strategies and others
stop-limit order “dying,” leaving them stop-limit orders can be a useful tool for in my latest book, Higher Probability
with unlimited risk, by stating a wider option traders to keep tabs on risk, it is Commodity Trading.
stop-limit. For instance, a trader could not a perfect solution. Massive slippage
enter a stop-limit order at 35.00/60.00. and the risk of having no protection at all
December 2016 • Technical Analysis of Stocks & Commodities • 41
 Q&A

SINCE YOU ASKED

Confused about some aspect of trading? Professional trader Rob Friesen, president
& COO of Bright Trading ([Link]), an equity trading corporation,
answers a few of your questions. To submit a question or suggest a topic, email him
at robfriesen@[Link], or post your question to our website at http://
[Link]. Answers will be posted there, and selected questions
will appear in a future issue of S&C.
Rob Friesen

INCREASING PROFIT CONSISTENCY (that is, the same amount of capital is and that statistical imprint is measurable,
Last December, I wrote in this column used for his combined longs as for his similar to behavior in humans. It may
about why the Fed couldn’t raise inter- combined shorts), he prefers to utilize not be able to predict what will happen
est rates. Well, what did they go and do? the five-day average true range (ATR) the next day, but it gives you insight as
They raised rates, just to prove me wrong. of each stock. ATR balancing more to how a particular stock has behaved
This December, I didn’t want to touch accurately reflects the differences in in the past with similar streaks. This
that topic again, so I decided to treat volatility between the two stocks. additional information helps Trader Z
you to hearing from a newer proprietary There are lots of opportunities in play- construct baskets. For example, he can
trader at Bright Trading—we’ll call him ing the relative performance between be long stocks that have a higher prob-
Trader Z—to see his changing perspec- a basket of long and short stocks. You ability of being up the next day. He also
tive on the market and look at the path benefit when the longs slightly outper- runs backtests as a way to streamline his
his career is taking. form the shorts. You can research and selections and likes to test ideas each day
First, he has learned to improve his select these baskets through fundamental outside the scope of any production.
trading consistency. Trader Z does this research, technical analysis, or number
with: crunching, but the principle remains Have lists of stocks ready to deploy
the same. It’s always helpful to have lists of stocks
• Hedged trading ready to deploy based on market condi-
• High-probability trades tions. Creating lists for risk-on and risk-
• A predetermined lists of stocks Characteristics off days is the key. It’s a good idea to
of stocks reveal break those lists each morning premarket
Trading hedged instead of one-sided into four categories:
naked trading
themselves through
Trader Z’s trading style has evolved events, and that • Aggressive longs
toward relative performance arbitrage statistical imprint is • Defensive longs
from single-instrument directional bets. measurable. • Aggressive shorts
Prior to this adaptation, he struggled to • Defensive shorts
stay consistent in method as well as in
grinding out some gains. Trading one- Stacking the odds: sticking with the If the market is risk on, Trader Z will
sided as a naked trader resulted in a high probabilities deploy the combination of aggressive
variance to his account equity. He now Probabilities come in streaks—stocks longs and defensive shorts.
maintains the discipline to only trade that are up multiple days in a row eventu- If the market is showing weakness
hedged or not at all, which has increased ally run out of steam. It gets to a point and is risk off, he will deploy aggres-
his consistency of moving forward with- where the probability of a reversal is sive shorts and defensive longs. The
out taking three steps back. higher than the continuation of the trend. rationale is that during a risk-on day the
Hedged to him means he will not put on Trader Z uses the Stock Odds service and aggressive longs will slightly outperform
a long position without simultaneously that gives him some visibility into the the defensive shorts. For a risk-off day
putting on a short. This provides him odds of streaks that equities can sustain. the aggressive shorts will slightly un-
with reflective time, insulates him from By entering some basic criteria, it will derperform the defensive longs, so the
sudden volatility in the market, removes reveal the probability of the stock con- aggregate shorts will go down more than
the need for him to be directionally tinuing in that trend or reversing. It relies the aggregate longs go down. Screening
right within a short period of time, and on past data in order to determine that and the market on the day before and then
increases his confidence by reducing of course it cannot predict the future; it’s again premarket prepares you for the
vulnerability. all about probabilities. Characteristics of day. Of course, you can filter further by
Although he could be dollar-neutral stocks reveal themselves through events, checking the news.
42 • December 2016 • Technical Analysis of Stocks & Commodities
 Q&A
Then, after the market shows its hand, from reacting emotionally. It helps to global, commodities, and bond markets.
you can deploy these lists in various accept the risk of loss prior to executing The opening print, opening range, and
combinations. Doing it this way helps any trades, and helps with developing an directional move out of that can provide
Trader Z to chase hot news and story if-then framework. information to help focus in on key areas.
stocks of the day. This methodology has Say utilities are outperforming financials
increased his discipline and produced Let the market go first: Use pre- or that basic materials are stronger than
more consistency. market and the opening to gather healthcare. As the information comes,
information Trader Z can take small trades to gather
Run scenarios ahead of time There is often an engine of the day or even more information. One key has been
Running a series of scenarios on what some news driving sectors, industries, to use small position sizing and then as
would happen if the market went up, side- and the market at large. Macro forces he gets confirmation that his trades are
ways, or went down from its current level move the market and sometimes those working, he can size up.
has helped Trader Z be more disciplined. catalysts are obvious and allow you to On some days, the market has no
Using his imagination to visualize these act ahead of the market move confirma- recognizable engine, so he focuses on
scenarios and how to respond to each tion. Other times, you can’t act first and the boring, business-as-usual pair trades,
one has provided him with context and have to allow the market to go first. So or executes his planned basket lists at
prepares his mind to take the correct ac- observe, listen, and gather information the market open. Occasionally, he will
tions. Running scenarios in advance has that will allow you to execute your choice use the day for research projects and
helped him with his risk management. of prepared lists. review, since sometimes, the best trade
If he thinks about what his actions will In terms of the macro economic engine is no trade.
be once his profit target is achieved or if of the day, Trader Z screens for news and
the trade goes against him, it keeps him information premarket. This includes
options
options

MERCER / TRADING THE NONFARM 10:30 am US Eastern Time. The crude oil inventory report
EMPLOYMENT REPORT offers trading opportunities on both crude and the USD/CAD
Continued from page 32 forex pair (USD/CAD typically will move in the opposite
direction of crude).
The 15-minute charts in Figures 5 & 6 show what happened Incorporating binary options into your arsenal allows you
after the announcement (profit and risk is per contract and the to trade during those times when report releases could bring
black line indicates where the instrument was trading on entry). some volatility in the markets. And if the market goes against
The red arrow on the USD/JPY chart in Figure 5 shows the you, binary options can help limit your risk.
price bar where the short binary option trade was executed.
The green arrow on the gold chart in Figure 6 shows the price Gail Mercer, founder of TradersHelpDesk, is a trader, mentor,
bar where the long binary option trade was executed. author, and speaker residing in North Carolina. She has over
Immediately after the announcement, the USD/JPY initially 15 years of experience in trading and in the development of
moved against the binary option trader but then resumed the custom indicators. She is experienced in trading futures, forex,
downward movement and expired ITM. However, the gold and binary options using volume analysis as well as divergence.
trade immediately moved in favor of the trade and the profit She can be reached via email at gm@[Link].
target was filled.
FURTHER READING
OTHER REPORTS MATTER TOO Mercer, Gail [2016]. “Choosing A Binary Option Provider,”
Although the nonfarm employment report creates volatility Technical Analysis of StockS & commoditieS, Volume
in the markets, there are a multitude of market reports that 34: November.
can be traded using binary options. For example, the crude ‡North American Derivatives Exchange, Inc.
oil inventory report is typically released every Wednesday at

December 2016 • Technical Analysis of Stocks & Commodities • 43

 INTERVIEW

Buy Or Sell Showdown

Denham Ward & Marge Sherald

On Machines That Think
How can the intelligence of machines help you in your trad-
ing? As it turns out, with the help of neural networks, you can
use your software to mimic how you think. To help shed light
on the subject, we picked the brains of two people who have
the knowledge and expertise in applying neural networks to
the financial markets.
Denham Ward is CEO of Ward Systems Group. He started
in the neural network field programming neural network
hardware acceleration boards for Ward Systems Group over
a college summer break. He then worked at the University of
Colorado applying neural networks in medical and anesthe-
siology research. After graduating with a master’s degree in
electrical engineering, he began working with Ward Systems The good thing about a neural
Group as the lead developer of NeuroShell Trader before net is you can look at five to 10
becoming CEO. datastreams at a time and figure out
Marge Sherald is president of Ward Systems Group and a pattern, which is more than your
has authored several articles on financial forecasting, ex-
pert systems, and neural networks. She teaches NeuroShell brain can usually process.
Trader seminars and assists customers in developing trading
models. She creates training videos and documentation for Stocks & Commodities Editor Jayanthi Gopalakrishnan
both NeuroShell Trader and their general purpose artificial spoke with Denham Ward and Marge Sherald via phone on
intelligence software. Sherald has a BS in communications October 5, 2016. We have indicated each of their comments
and computer science. by their initials.

C
an you tell us a little bit about iar with neural networks. Could you average crosses over the longer one, you
yourself and how you got inter- briefly describe what neural networks buy, or in the converse, you sell.
ested in the financial markets, and artificial intelligence are? In neural networks, there’re no actual
Denham? MS: Neural nets are a mathematical hard rules. Instead, what neural networks
DW: I have a master’s degree in electri- tool that can learn patterns and historical do is look at the historical data and at
cal engineering and I’ve been working in data, which is relevant for what traders the input you give it from that historical
the neural network field for over 25 years. do. After all, traders have been doing it data. The input can be things like other
Initially, I did work with neural networks visually for years. The good thing about indicators. The neural network then
in the medical field—anesthesiology a neural net is you can look at five to 10 builds a model that simulates the brain,
and whatnot. But the customer base for datastreams at a time and figure out a which is what neural networks basically
Ward Systems Group increased, and pattern, which is more than your brain do. It looks at this past data and creates
most of our customers were using neural can usually process. So you can look at connections. It creates these internal—
networks and artificial intelligence for the pattern and say, “Okay, this time it not really rules—mathematical models
financial applications, even more so was a good buy signal. This other time that give you an idea of where the mar-
than for some of the industrial type of it was a sell signal.” That information is ket is going to go, the changes you can
applications. So that’s how we ended useful in trading. expect in the market, or whatever you
up moving toward the financial markets want to predict with markets. It doesn’t
and being interested in applying neural How do you apply neural networks to even have to be changes. It can be other
networks to financial markets. We found trading? indicators that can be used to predict, it
that neural networks are a great tool to DW: The traditional way of analyzing could be values, or anything really. So it
apply to financial markets. the markets was with moving average learns off that past data, and now when
crossovers and things like that, where you you go into the future with it, it’ll take
A lot of our readers may not be famil- set rules such as if the shorter moving the current data and create those predic-
44 • December 2016 • Technical Analysis of Stocks & Commodities
 Chart
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 tions based on the patterns it found in MS: Right, and you
that past data. can combine everything. Neural networks are a tool
You can feed in neural that can learn patterns and
And what kind of past data does it nets, you can feed in historical data—something
look at? trading rules, and math-
MS: Well, any data you give it. We ematical algorithms can traders have been doing
generally don’t recommend putting just pick from that whole visually for years.
price data in the model. It works better if set of inputs and decide
you use technical indicators. And you can what’s more important.
use things like astrological data, moon One other thing we do is called an So what neural network software does is
distance, Gann sequence, or any type of ensemble system. You could build two merge artificial intelligence with techni-
data. I know some of these may sound rule-based systems and you build a neural cal analysis data into one package.
esoteric, but there are people who do use net system, or you could combine two
that type of data to identify patterns in neural network systems and a rule-based And how does it work when it comes
the financial markets. system into a single trading system. to anomalies? For example, let’s take
DW: I’d say more typically, it’s the When you use the ensemble system, the Brexit incident we witnessed earlier
standard technical analysis indicators you’ll see the statement “two of which this year. When you have things like
that you feed in, such as stochastic in- must be true.” We have a mathematical that happening, how do the neural
dicators, relative strength index (RSI), proof that shows that you have a higher networks respond?
or statistical data like regressions and probability of generating successful DW: The beauty of neural networks is
z-scores. You can mix a lot of those trading signals when you build these they’re based on past historical data, but
together to make a more robust model. ensemble systems. they do a little more generalization than
a standard technique does. For example,
Neural networks and artificial intel- That’s interesting. How can a trader when you use a standard moving aver-
ligence are often used interchangeably. benefit from using neural network age crossover, there are really only two
Are they similar? software? In other words, how will a scenarios: It crossed over or it didn’t.
MS: They are not similar. Neural trader be able to use the software to Neural networks are able to look at a
networks are a branch of artificial in- trade effectively? wide variety of conditions and can sort
telligence. There are things like expert DW: Our neural network software al- of look between the lines. They can look
systems, which are generally thought lows you to combine everything you do at scenarios that weren’t exactly like the
of as rules. An example is if it’s cloudy in traditional technical analysis packages past but happen to be similar going into
outside, it’s going to rain. But if you ap- like charting, indicators, and traditional the future. So in a way, if there were
ply it to the market, neural nets can look trading systems with artificial intelli- other anomalies in your trading data, it
at different inputs, such as indicators, to gence techniques like neural networks, associates forward to similar anomalies
model and find a pattern. Then there’s genetic algorithms, and fuzzy logic. You that could happen in the future.
fuzzy logic. can then choose to use the software with Obviously, as with all trading, there
Genetic algorithms are something or without artificial intelligence. If you are going to be times when you’ll have
we also use in NeuroShell Trader. Let’s put indicators on a chart, you can create situations when the markets shut down
just say you’re using an indicator such trading systems based purely on indica- and the system isn’t going to be able to
as RSI calculated over five periods as an tors if you want to. respond well. It’s similar with neural net-
input to a neural network. Well, a genetic And you can then go beyond just those works and artificial intelligence. They’re
algorithm can do a smart search and say, standard technical analysis systems by not going to be all knowing.
“Hey, you’re a lot better off with this stock adding neural networks and optimizing MS: The best thing you can do is enter
using seven periods in that model.” So it with genetic algorithms to either improve trailing stops, manage your position
could simply indicate your parameters upon the systems you already have or cre- sizes, and things like that so you have
and pick and choose indicators. ate entirely new systems you may never your backup system in place.
And if you have a series of trading have been exposed to or able to think of
rules that you use, neural nets can tell if you had just used traditional analysis. Absolutely, since risk management is
you which rules are more important in important. Given that we have a presi-
making your decisions. dential election coming up as we speak,
does the software look at past election
From what it sounds like, neural net- data and see what the market forecasts
works give you a lot of flexibility, not were based on that data?
just in terms of your input data but DW: It could do that. You can apply
also based on the effectiveness of your neural networks and artificial intel-
indicators. ligence and with all kinds of different
46 • December 2016 • Technical Analysis of Stocks & Commodities
timeframes. You could use monthly bars
to look at longer-term trends. If you were
to do that, you would want to use inputs
such as data from past elections and use
timeframe indicators.
Then there are traders who look at
much shorter timeframes such as five-
minute or one-minute bars. In such
scenarios, I don’t think that the elections
are going to make much of a difference.
Well, it may make a difference the day
after the elections, but on a day-to-day
basis, it’s just like at any other time—it Newly Redesigned Software for
has to do with other graphs or other
markets. Futures, Forex & Stock Traders
You can add different markets as
inputs. For example, when you’re pre-
dicting stock price movement, there’s a
chance the forex or commodities markets
have an impact on the movement of that Over 500 User Driven
specific stock. So you would input data
from these markets. Those may be more Enhancements Including:
of the things you look at on an intraday
basis. But you could take a broader scope Fully multi-threaded core for greater performance
and use a daily timeframe for end-of- Modern user interface with simplified navigation
day predictions. Some people may be
Major charting enhancements
working at a day job, in which case they
would prefer to set up their trades for the Up to 10X speed improvement in backtesting
day, next day, week, or even month. They Add custom columns & indicators to SuperDOM
could use neural networks with election
Historical bid/ask data
data or things of that nature to predict the
general trend for their daytrading. Expanded C# development support
MS: And the nice thing about our
software, NeuroShell Trader, if you have
the Power User version, is that it lets you
mix timeframes. For example, you could
put in some monthly data, mix it on a NinjaTrader 8 is always FREE to use for advanced
chart for hourly bars, and get a bigger
picture of the trend and then trade it with charting, strategy backtesting and trade simulation.
smaller bars.

Speaking of the future, what develop- out and tell you this, but a lot of their com- and high-frequency traders are using
ments do you see happening in the field puterized trading is being controlled by neural networks?
of neural networks? neural networks. And the smaller traders MS: We’ve seen a lot of institutional
DW: I think the field of neural networks are, in a way, at a disadvantage because traders purchasing neural network
is definitely growing. There was a time of that. I think we’ll see a lot more of software. But how they’re using them is
when people weren’t giving it the credit it neural network technology trickling something we don’t know. They’re not
was due. But these days, if you look at, for down to the smaller traders so they have going to give away their secrets.
example, Google’s image search engine, a better competitive advantage. DW: To add to what Marge said, I’ve
all of it is done using neural networks. I think the self-directed traders need seen a lot of indications in the news about
Companies are creating self-guided cars to get access and gain the knowledge neural networks, which to me indicates
that literally drive themselves down the that the larger institutional traders have. that’s what a lot of computerized trading
road without a driver. That’s created The tools are there and they need to start is based on. They’re not going to come
using neural networks. using them. out and say, “Hey, this is what we’re do-
In the financial markets, the larger ing.” But if you read between the lines,
institutional traders aren’t going to come Are you saying that algorithmic traders you can see that.
December 2016 • Technical Analysis of Stocks & Commodities • 47
 patterns, plus, the news cycle is different.
The entire world now reacts faster to what
happens in another country.
And the good thing is there are some
neural nets that are adaptive, so as ev-
ery new bar comes in, the network can
retrain. So it’s not like you have a fixed
model where, as data gets added, it won’t
retrain until you decide to retrain it. Some
people like that control, but most like to
be kept up to date with new bars coming
in all the time.
Neural networks are not as mysterious
as people think they may be. In fact,
NEUROSHELL TRADER

these days, with the advancement in

technology, you don’t have to set a lot of
the neural net parameters. The algorithm
we use doesn’t have things to set. It’s not
FIGURE 1: NEURAL NETWORK SIGNALS. Neural network trading systems produce buy/sell signals just like hidden from the users. It was developed,
for the most part, with trading in mind
rule-based systems do.

and to simplify the process for the user.

To get an understanding of how neural Would you say that it’s mostly daytrad- Essentially, you get some inputs, figure
network software works, if I were to ers who are interested in using neural out what’s going on, and then generalize
bring up a chart of something after networks in their trading? well into the future.
inputting all the data and running the MS: We have seen interest leaning
neural network on it, will the chart more toward daytraders using neural I agree in that a lot of people are intimi-
display which way prices are likely networks. But I can only base my answer dated by neural networks. They need
to move? on sales data. to understand that it’s another tool to
MS: The default prediction with a analyze the markets with.
neural net is the percent change in open You’ve been in this business for quite MS: And what we are trying to do is
from the next open. And that can be so a while. Have you seen any dramatic make this tool less intimidating. In our
many bars into the future, so many days, shifts in the way the markets are or the software, everything’s done through a
or it could be a week or a month depend- way the traders approach markets? wizard that guides you through building
ing on the data you have. Obviously, MS: I think I’ve seen markets changing the model. That means the user doesn’t
with changing markets, the closer you faster than they used to. That’s probably have to code anything. You can if you
are to your current timeframe, like one one of the biggest differences. Plus, with want to, but you have the option of using
day ahead, it’s better to train the model more techniques, I see other markets what’s available in the software so you
for current timeframes because you just around the world affecting, say, what’s don’t have to tax your brain too much.
have yesterday’s data. You know what going on in the US or vice versa a bit
was happening yesterday because you more than they used to. Let the machine do the thinking.
can see that data. Thank you both for your time. We look
DW: There certainly is variability in So when you say you see the markets forward to what else the future holds
the markets, where the farther out you’re changing faster, do you mean in terms for artificial intelligence and neural
trying to predict, the less accurate you’re of how they behave? networks.
going to be. I think anyone can guess MS: I have seen shifts in their trading
what tomorrow is going to do. If you ask Further reading
me what the market is going to do in two Sherald, Marge [2010]. “Neural Network
months or three months or four months, Pair Trading,” Technical Analysis of
there are lots of variables that come into Stocks & Commodities, Volume
it that you may not be able to predict 28: February.
or even know about. So sometimes the [2002]. “Trading Fuzzy Pat-
smaller timeframes have a better chance terns,” Technical Analysis of Stocks
of giving you better results. Neural & Commodities, Volume 20: Sep-
network trading systems produce buy/ tember.
sell signals just like rule-based systems
(Figure 1).
48 • December 2016 • Technical Analysis of Stocks & Commodities
 product review

ChartCon 2016
[Link] out messages to attendees as well as to also be put on hold, fast-forwarded, or
11241 Willows Rd., Suite 320 receive their questions. rewound at any time.
Redmond, WA 98052 Chip Anderson, founder of Stock-
Internet: [Link] Presentations by [Link], kicked off the first day with
Email: support@[Link] technical titans a presentation covering some of the basics
Product: Technical analysis website In order to accomplish the conference of how the conference would be run, and
Price: Subscription packages range goals, a dozen top-notch leading tech- then discussed the components of build-
from $14.95 to $49.95 per month. For nicians spoke including John Murphy, ing a profitable trading system as well as
details, see website. Martin Pring, Greg Morris, and Arthur his own trading approach. He reviewed
Hill, among others. All speakers were how to use GuideBook, and then covered

S
by Leslie N. Masonson associated with the StockCharts firm in some background on key concepts and
different capacities, such as providing rules to keep in mind for successful
[Link] broadcast its daily or weekly commentary, articles, investing. He used a typical investor’s
first virtual ChartCon confer- and short webinars or blog posts. They trading day to make his points.
ence from Napa Valley, CA on provided their insights on investing During the morning of day 1, the qual-
September 23–24, 2016. Almost and trading the stock market using the ity of the video was not very high and it
1,400 registrants from around extensive charting capability of the was difficult to make out the words on
the world tuned in via their computers, StockCharts software accompanied by some of the slides. This was corrected
laptops, and phones. This was the fourth PowerPoint slides. by midday and for the remainder of the
year for the ChartCon event, but previ- Most of the 60-minute presentations conference. All the slides were provided
ously, attendance was in person. This had a 20-minute Q&A period afterward to everyone in two separate daily PDF
live-streamed event focused on technical for questions sent in by attendees via their files for them to view during and after
analysis as well as provided an investment smartphones using a mobile app provided the conference.
education to help attendees improve their by the sponsor, GuideBook. In addition
skills and generate better results. to the ability to send in questions, this Unique features of
Most of those attending the confer- app provided the ability for attendees to [Link]
ence are current users of the software, contact each other, see the schedule of A few of the presentations focused
subscribing to either the free service or events, review speaker bios, and answer completely on using specific features
one of the three levels of paid subscrip- survey questions. Attendees without a of the StockCharts technical analysis
tion—Basic, Extra, or Pro. And their smartphone could use their PCs with a program, including RRG (Relative Rota-
level of technical analysis knowledge limited version of the app. tion Graphs) charts, SCTR (StockCharts
ranged from beginner to advanced trad- All attendees were provided with un- Technical Rank), and momentum trad-
ers. A breakdown of the attendees who limited online video access to the confer- ing. The presenters not only used the
responded to a pre-conference survey ence for one year. Thus, any particular slides but also offered live use of the
indicated that about 60% were 60 years sessions could be reviewed again in their software to show how to bring up various
or older, and about 23% were 50-59, with entirety or in part. The recording could screens, sort through the data, and arrive
the remainder younger at 20–49.
Furthermore, 24.4% of the respondents
typically make several trades a month
while 18.4% make one trade a week.
Interestingly, 37.8% made two or more
trades a week. The top three brokerage
firms used by respondents were, in order,
Fidelity, TD Ameritrade, and Schwab.
Interactive Brokers came in fourth.
This reasonably priced $199 confer-
[Link]

ence was transmitted over Livestream

video-streaming service with a vir-
tual DVR that enabled the viewer to
go backward in the content during the
FIGURE 1: RELATIVE ROTATION GRAPH. This chart shows weekly rotation from weak to leading performance
live presentations. In addition, Twitter for the S&P 500 sectors. Here, XLK and XLF have both made moves to the leading green quadrant over a
was used during the conference to send number of weeks. The data in this graph is as of September 26, 2016.

December 2016 • Technical Analysis of Stocks & Commodities • 49

 FIGURE 3: TENSILE TRADING 10 STAGES OF
STOCK MARKET MASTERY. Displayed are the
steps for stock market success as presented by Gatis
FIGURE 2: STOCKCHARTS TECHNICAL RANK. Pipelines, semiconductors, and other energy-related stocks Roze at the conference, as detailed in his book with
were the top-ranked stocks as of September 28, 2016 intraday. All column headings can be clicked to sort the a similar title.
data from high to low or in alphabetical order.

at the highest-probability investment into your investment repertoire. Another with an enhanced education in techni-
opportunities. by Martin Pring was on using his Special cal analysis using the [Link]
Three presentations focusing on other K indicator to locate major market lows features, and it also provided attendees
topics included Bruce Fraser’s explana- and highs; one by Gatis Roze on offered with guidance on ways to improve their
tion of Richard D. Wyckoff’s classic “The 10 Stages of Successful Technical investment returns using trading rules
approach to trading. Greg Morris focused Trading” (see Figure 3); and one by Erin and other useful tools.
on truths and misconceptions about tech- Heim was on using DecisionPoint to im-
nical analysis and why he uses technical prove your investment results. In another Leslie N. Masonson is a trader and the
analysis to manage his own money as one, Arthur Hill illustrated how to create author of Buy, Don’t Hold and All About
well as when he managed money at a and use a momentum trading system by Market Timing. He writes a bimonthly
mutual fund company in a prior job. Tom reviewing many charting examples. He column on ETFs for this magazine.
Bowley presented daily seasonal trends focused on using trends, market timing, His blog is at [Link].
that have persisted over decades and that and momentum indicators. He can be reached at lesmasonson@
have produced exceptional results. The last session on day 2 was a panel [Link].
A relatively new feature of Stock- discussion titled “Technical Titans,”
[Link], Relative Rotation Graphs where four technicians answered ques- Further reading
(RRG), were reviewed by their developer, tions from the moderator on various Masonson, Leslie N. [2016]. “StockCharts.
Julius de Kempenaer. In Figure 1, you see topics sent in by attendees. Interest- com,” product review, Technical Analy-
a sample chart that is part of StockCharts. ingly, in a number of cases, there were sis of Stocks & Commodities, Volume
com free and member services. This divergent views on interpreting certain 34: July.
graphing feature can be used on any user- chart patterns. This back-and-forth dis- [2014]. “StockCharts University,”
defined group of stocks, indexes, com- cussion was useful in making the point Quick-Scan, Technical Analysis of
modities, currencies, or ETFs to compare that investors need to understand there Stocks & Commodities, Volume
32: April.
each security to each other over the past are different ways of analyzing daily or
Davis, Summer [2011]. “ChartCon 2011,”
year or more on a daily or weekly basis. weekly data, for example. Moreover, the
Quick-Scan, Technical Analysis of
The graph combines relative strength timeframe that each investor uses for his
Stocks & Commodities, Volume 29:
and momentum to show which tickers trading/investing activity will determine December.
are strongest to weakest over time and which charts are more suitable. Even Gopalakrishnan, Jayanthi [2010]. “Stock-
how strong or weak they are currently. experienced technicians with decades of [Link],” product review, Technical
Thus, shifts between the four quadrants experience will have differing views on Analysis of Stocks & Commodities,
can be observed and acted on to achieve how to interpret a chart, as was clearly Volume 28: August.
higher-probability trades. demonstrated numerous times during S&C staff [2009]. “[Link],”
There were other information-packed this discussion. product review, Technical Analysis
presentations as well. One was by Greg Anderson closed the conference at of Stocks & Commodities, Volume
Schnell on using SCTRs (Figure 2) to the end of day 2 with a brief summary 27: May.
select the highest-ranked candidates for of some key points of each presenter Roze, Gatis and Grayson, Tensile Trading
purchase. Another one was by John Mur- using a few of their slides. Overall, this ChartPack.
phy on integrating intermarket analysis virtual conference provided attendees
50 • December 2016 • Technical Analysis of Stocks & Commodities
 For this month’s Traders’ Tips,
the focus is Domenico D’Errico’s
article in this issue, “Pair Trad-
ing With A Twist.” Here, we pres-
ent the December 2016 Traders’
Tips code with possible imple-
mentations in various software.
The code for the following Traders’ Tips selections is
posted here:
• [Link]  Home–S&C Magazine 
Traders’ Tips
The Traders’ Tips section is provided to help readers im-
plement a selected technique from an article in this issue
or another recent issue. The entries here are contributed
by software developers or programmers for software that
is capable of customization.
Figure 2: eSIGNAL. Here is an example of the Pair_Trading.efs study plotted on
a daily chart of IBM.

forum. The code can be found at [Link]

F TRADESTATION: DECEMBER 2016 TRADERS’ TIPS CODE [Link]/Discussions/[Link]?Topic_ID=142776. The
In “Pair Trading With A Twist” in this issue, author Domenico ELD filename is “TASC_DEC2016.ELD.”
D’Errico describes several approaches to pair-trading strategies For more information about EasyLanguage in general,
that he has developed. He defines “pair trading” as matching a please see [Link]
long position with a short position in two separate but related A sample chart is shown in Figure 1.
securities. Here, we are providing the TradeStation EasyLan- This article is for informational purposes. No type of trading or in-
vestment recommendation, advice or strategy is being made, given or
guage code for the ratio indicator as well as the pair-trading
in any manner provided by TradeStation Securities or its affiliates.
strategy based on the author’s concepts.
—Doug McCrary
TradeStation offers a number of tools to assist the trader TradeStation Securities, Inc.
with testing and implementing strategies such as these. The [Link]
built-in Algo–Pairs Trading indicator allows the trading of
multiple symbols from a single chart, and Portfolio Maestro
allows you to backtest the system and view the results in a
single performance report. F eSIGNAL: DECEMBER 2016 TRADERS’ TIPS CODE
To download the EasyLanguage code for the strategy, For this month’s Traders’ Tip, we’ve provided the study
please visit our TradeStation and EasyLanguage support Pair_Trading.efs based on the formula described in Domenico
D’Errico’s article in this issue, “Pair Trading With A
Twist.” In the article, the author presents a strategy for
trading stock pairs.
The eSignal study contains formula parameters
that may be configured through the edit chart win-
dow (right-click on the chart and select “edit chart”).
A sample chart is shown in Figure 2.
To discuss this study or download a complete copy
of the formula code, please visit the EFS library dis-
cussion board forum under the forums link from the
support menu at [Link] or visit our EFS
KnowledgeBase at [Link]
kb/efs/. The eSignal formula script (EFS) is also avail-
able for copying & pasting from the Stocks & Com-
modities website at [Link] in the Traders’ Tips
area.
—Eric Lippert
eSignal, an Interactive Data company
Figure 1: TRADESTATION. Here, the pair-trading strategy and spread indicator are applied 800 779-6555, [Link]
to weekly XLE/SPY charts.

December 2016 • Technical Analysis of Stocks & Commodities • 51

 the pairs being traded, we broke the strategy into two differ-
ent strategies that when used congruently provide entry and
exit points for both the long and short securities traded in the
F THINKORSWIM: DECEMBER 2016 TRADERS’ TIPS CODE pair—one to give signals on the chart for the long symbol of
In “Pair Trading With A Twist” in this issue, author Domenico the pair and a second for entries on the symbol of the pair to
D’Errico investigates an updated method of an old trading be shorted.
technique. Historically, most pair traders have used statisti- We have made the loading process extremely easy; simply
cal regression or correlation models and mean reversion for click on the links [Link] and [Link]
entry and exit points. D’Errico’s article notes that this does 2WBd then choose to view thinkScript strategy. Choose to
not always produce satisfactory results and so he looks to add rename your study “PairTraidingLong” for the first link and
technical analysis, namely moving averages, to increase the “PairTraidingShort” for the second.
probability of success. To use these for entry and exit points, two charts will be
We took this strategy and built it using our proprietary required (either detached or in a grid). On the first chart, en-
scripting language, thinkscript. To allow greater flexibility in ter the symbol of the pair that will be traded long. Then add
the strategy PairTradingLong from the edit studies
→ strategies window. Then click the gear on the
strategy and enter the symbol of the pair that will
be shorted into the “second symbol” field. Complete
the reverse on the second chart, with the symbol of
the pair to be shorted entered as the symbol for the
chart, and the symbol to be traded long entered as
the “second symbol” for the PairTradingShort strat-
egy. Entry and exit points for each of the symbols of
the pair will be displayed on the corresponding chart
(Figures 3 & 4).
—thinkorswim
A division of TD Ameritrade, Inc.
[Link]

F WEALTH-LAB: DECEMBER 2016

Figure 3: THINKORSWIM. Here, signals are shown for the long symbol (IBM) of the pair, with TRADERS’ TIPS CODE
the short symbol of the pair (SPY) as the secondary symbol. Below in Figure 4, signals for the To help traders using Wealth-Lab draw their own
short symbol in the pair are shown. conclusions on how Domenico D’Errico’s pair-trading
strategies work, which were discussed in his article
in this issue (“Pair Trading With A Twist”), we’ve
coded all three pair-trading ideas into one system. To
build your stock pair versus the SPY, run it on a single
symbol’s chart, which is an S&P 500 component. It’s
possible to apply the strategy to any instrument.
To switch between mean-reverting, trend & pull-
back, and trend-following modes, you can drag the
respective slider strategy mode on the bottom left
part of the screen. Likewise, it’s possible to adjust
the fast and slow moving average periods. Wealth-
Lab will apply changed parameters so you have a
chance to see how entries & exits change interac-
tively on the chart (Figure 5).
If you need more trading ideas, you could com-
pare the strategies from D’Errico’s article to similar
pair-trading strategies presented in previous S&C
articles that are already available for download from
Figure 4: THINKORSWIM. In this chart, the primary symbol (SPY) is the short symbol of the our website, [Link], that were covered in
pair, with signals shown on the chart. The secondary symbol (IBM) is the long. past Traders’ Tips columns. These articles include
52 • December 2016 • Technical Analysis of Stocks & Commodities
 Vote Now!

2017 Readers’ Choice Awards

Winners will be announced in the Bonus Issue, available February 2017

If you are a current subscriber, go to [Link] and log in to vote.

Not a current S&C subscriber? Become one today! Call 1-206-938-0570 or go to [Link] to subscribe.
Voting ends December 31, 2016. Must use your subscriber ID number to vote.

Join us on Facebook at [Link]/STOCKSandCOMMODITIES Follow us on Twitter @STOCKSandCOMM

 Figure 5: WEALTH-LAB. This chart stacks three chart panes: individual stocks’
candlesticks (top), the price ratio with its moving averages (middle), and the first
stock of the pair (bottom). Trade arrows are displayed in the bottom pane.

Figure 6: NEUROSHELL TRADER. This NeuroShell Trader chart displays the pair-
“Pairs Trading” (March 2001 S&C), “Developing A Multi- trading system as implemented in NeuroShell Trader.
level Strategy” (September 2012 S&C), “Timing The Market
With Pairs Logic” (March 2014 S&C), and “Market-Neutral
VIX-Based Pair Strategy” (Active Trader magazine, October Close,Verizon Communications Close,AMERICAN TOWER
2010). CORP Close,Prediction: 0 bar AMERICAN TOWER CORP
On a closing note, to scan for different pair combinations Close,4.61),1)
in any markets, you can use a study such as the one created
SELL LONG CONDITIONS: [All of which must be true]
by a Wealth-Lab community member. Named correlation ProxyExit(Close,AMERICAN TOWER CORP Close,Prediction:
matrix, it calculates and displays the correlations of all sym- 0 bar AMERICAN TOWER CORP Close,0.38,12.95)
bols in a watchlist.
The Wealth-Lab code is shown at [Link] in the Trad- SELL SHORT CONDITIONS: [All of which must be true]
A=B(ProxyEntry(Close,AMERICAN TOWER CORP
ers’ Tips area. Close,Verizon Communications Close,AMERICAN TOWER
—Eugene, Wealth-Lab team CORP Close,Prediction: 0 bar AMERICAN TOWER CORP
MS123, LLC Close,4.61),-1)
[Link]
COVER SHORT CONDITIONS: [All of which must be true]
ProxyExit(Close,AMERICAN TOWER CORP Close,Prediction:
0 bar AMERICAN TOWER CORP Close,0.38,12.95)
F NEUROSHELL TRADER: DECEMBER 2016
TRADERS’ TIPS CODE POSITION SIZING METHOD:
The mean-reverting pair-trading system described Fixed Dollar
by Domenico D’Errico in his article in this issue, “Pair Trad- 5,000.00 Dollars
ing With A Twist,” can be easily implemented in NeuroShell
Trader through use of the pair-trading indicators from the If you have NeuroShell Trader Professional, you can also
Advanced Indicator Set 3 add-on. choose whether the parameters should be optimized. After
To identify which instruments should be traded in a pair, backtesting the trading strategy, use the detailed analysis
you can use a neural network to select one stock from a group button to view the backtest and trade-by-trade statistics for
of stocks to predict another. The trick is to limit the neural the strategy.
net to one input and it will find the best pair. For more detailed information on how to implement the
Once the pair is identified, the trading strategy will de- use of proxy pair-trading indicators in NeuroShell Trader,
termine when the prediction crosses the actual price of the please refer to the February 2010 article in Stocks & Com-
predicted stock to generate trading signals. Simply select modities, “Neural Network Pair Trading.”
“New trading strategy” from the insert menu and enter the Users of NeuroShell Trader can go to the Stocks & Com-
following in the appropriate locations of the trading strategy modities section of the NeuroShell Trader free technical
wizard: support website to download a copy of this or any previous
Traders’ Tips.
TRADING RULES A sample chart is shown in Figure 6.
—Marge Sherald, Ward Systems Group, Inc.
BUY LONG CONDITIONS: [All of which must be true]
A=B(ProxyEntry(Close,AMERICAN TOWER CORP
301 662-7950, sales@[Link]
[Link]

54 • December 2016 • Technical Analysis of Stocks & Commodities

Figure 7: NINJATRADER. The trend-following strategy is shown on an IBM
weekly chart with the spread candlestick moving averages as well as the spread
moving average cross histogram.

FIGURE 8: UPDATA. This chart shows the spread candles as applied to the GDX/
GDM ETF pair in daily resolution.

F NINJATRADER: DECEMBER 2016 TRADERS’ TIPS CODE

The NinjaTrader coding based on “Pair Trading With A Twist” and system library. Those who cannot access the library due
by Domenico D’Errico in this issue is available for download to firewall issues may ask our helpdesk for a copy.
at [Link]/SC/[Link]. A sample chart implementing the strategy is shown in
Once you have it downloaded, from within the NinjaTrader Figure 8.
Control Center window, select the menu File → Utilities →
Import NinjaScript and select the downloaded file. This file
is for NinjaTrader Version 7. PARAMETER "Select Ticker" ~TICKER=Select
NAME "Spread Candles" ""
You can review the strategies’ source code by selecting DISPLAYSTYLE Candle
the menu Tools → Edit NinjaScript → Strategy from within INDICATORTYPE Chart Replace
the NinjaTrader Control Center window and selecting either @SpreadOpen=0
the “Trend Following,” “Mean-Reverting,” or “Trend & Pull- @SpreadHigh=0
@SpreadLow=0
back” file. @SpreadClose=0
NinjaScript uses compiled DLLs that run native, not in-
terpreted, which provides you with the highest performance FOR #CURDATE=0 TO #LASTDATE
possible.
If #CURDATE>0 AND Open>0 AND Open(~TICKER,0) >0
A sample chart implementing the strategy is shown in
Figure 7. @SpreadOpen=Open/Open(~TICKER,0)
—Raymond Deux & Patrick Hodges @SpreadClose=Close/Close(~TICKER,0)
NinjaTrader, LLC
[Link] @SpreadHigh=Max(Close/Close(~TICKER,0),Max(Open/
Open(~TICKER,0),Max(High/High(~TICKER,0),Low/
Low(~TICKER,0))))
@SpreadLow=Min(Close/Close(~TICKER,0),Min(Open/
Open(~TICKER,0),Min(High/High(~TICKER,0),Low/Low(~TICKE
F UPDATA: DECEMBER 2016 R,0))))
TRADERS’ TIPS CODE @PlotOpen=@SpreadOpen
Our Traders’ Tip for this month is based on the article in this @PlotHigh=@SpreadHigh
issue by Domenico D’Errico, “Pair Trading With A Twist.” @PlotLow=@SpreadLow
@Plot=@SpreadClose
In the article, D’Errico outlines the benefits of trading a
spread of two similar products that are correlated in returns, EndIf
and then using the pair to enter mean-reversion strategies
when at an extreme. The key to a good strategy is finding NEXT
a stable pair that mean-reverts. Perhaps cointegration tests —Updata support team
would serve better here than correlation-based pair selec- support@[Link]
tion. [Link]
The Updata code based on this article is in the Updata
library and may be downloaded by clicking the custom menu

December 2016 • Technical Analysis of Stocks & Commodities • 55

 FUTURES LIQUIDITY

T
rading liquidity is often over- very high volumes. The greatest number three-year period. Thus, all numbers in
looked as a key technical of dots indicates the greatest activity; this column have an equal dollar value.
measurement in the analysis futures with one or no dots show little Columns indicating percent margin
and selection of commodity activity and are therefore less desirable and effective percent margin provide
futures. The following explains how to for speculators. a helpful comparison for traders who
read the futures liquidity chart pub- Courtesy of CBOT wish to place their margin money ef-
lished by Technical Analysis of Stocks ficiently. The effective percent margin
& Commodities every month. is determined by dividing the margin
value ($) by the three-year price range of
Commodity futures contract dollar value, and then multiply-
The futures liquidity chart shown be- ing by one hundred.
low is intended to rank publicly traded
futures contracts in order of liquidity. Stocks
Relative contract liquidity is indicated Trading liquidity has a significant ef-
by the number of dots on the right-hand fect on the change in price of a secu-
side of the chart. rity. Theoretically, trading activity can
This liquidity ranking is produced by serve as a proxy for trading liquidity
multiplying contract point value times All futures listed are weighted equally and equals the total volume for a given
the maximum conceivable price motion under “contracts to trade for equal dol- period expressed as a percentage of the
(based on the past three years’ historical lar profit.” This is done by multiplying total number of shares outstanding. This
data) times the contract’s open interest contract value times the maximum pos- value can be thought of as the turnover
times a factor (usually 1 to 4) for low or sible change in price observed in the last rate of a firm’s shares outstanding.

Trading Liquidity: Futures

Commodity Futures Exchange % Margin Effective Contracts to Relative Contract Liquidity
% Margin Trade for Equal
Dollar Profit
S&P 500 E-Mini GBLX 4.3 22.9 4 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>>
10-Year T-Note CBOT 1.1 19.4 10 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
T-Bond CBOT 2.5 11.1 2 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
Ultra T-Bond CBOT 2.8 11.7 2 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
Crude Oil WTI NYMEX 6.3 5.6 1 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
Euro FX CME 2.7 9.5 2 •••••••••••••••••••••••••••••••••••••••••••••••••••
5-Year T-Note CBOT 0.7 30.4 25 ••••••••••••••••••••••••••••••••••••
Nasdaq 100 E-Mini GBLX 4.1 12.9 2 •••••••••••••••••••••••••••••••••••
Russell 2000 Mini ICEUS 5 21.6 3 ••••••••••••••••••••••••••••
Soybeans CBOT 5.4 9.5 3 •••••••••••••••••••••••••••
British Pound CME 5.2 12.8 2 •••••••••••••••••••••••••
Natural Gas NYMEX 8.1 6.9 2 ••••••••••••••••••••••
Corn CBOT 5.6 11.9 9 •••••••••••••••••••••
Gasoline RBOB NYMEX 7.2 6.8 1 •••••••••••••••••
Sugar #11 ICEUS 6.3 11.4 5 •••••••••••••••••
ULSD NY Harbor NYMEX 6.2 5.9 1 •••••••••••••
Wheat CBOT 5.4 7 5 •••••••••••••
2-Year T-Note CBOT 0.3 25 30 ••••••••••••
Eurodollar CME 0.1 18.9 40 ••••••••••••
High Grade Copper COMEX 4.8 7.3 2 •••••••••••
Silver COMEX 6.6 20.6 3 •••••••••••
Japanese Yen CME 4.1 23.2 3 ••••••••••
Australian Dollar CME 2.6 9.9 4 •••••••
S&P 500 VIX CFE 39.9 40.7 5 •••••••
Canadian Dollar CME 2.3 8.1 3 ••••••
Dow Indu 30 E-Mini CBOTM 4.4 28.4 5 ••••••
Hard Red Wheat KCBT 5.5 5.3 3 ••••••
Coffee ICEUS 5.4 12 3 •••••
Crude Oil Brent (F) NYMEX 6.4 5.2 1 •••••
Mexican Peso CME 6.4 13.9 6 •••••
S&P Midcap E-Mini GBLX 4.5 21.7 2 ••••• CBOT Chicago Board of Trade, Division of CME
Cotton #2 ICEUS 5.1 12.4 5 •••• CFE CBOE Futures Exchange
Lean Hogs CME 7.9 3.6 2 ••• CME Chicago Mercantile Exchange
Swiss Franc CME 3.1 14.4 3 •••
COMEX Commodity Exchange, Inc. CME Group
U.S. Dollar Index ICEUS 2 10 4 •••
GBLX Chicago Mercantile Exchange - Globex
New Zealand Dollar CME 3.6 15.6 4 ••
ICE-EU Intercontinental Exchange-Futures - Europe
Soybean Meal CBOT 8.1 12.2 4 ••
30-Day Fed Funds CBOT 0.1 22 53 • ICE-US Intercontinental Exchange-Futures - US
Brazilian Real CME 7.7 16.9 5 • KCBT Kansas City Board of Trade
Cocoa ICEUS 6.7 26 11 • MGEX Minneapolis Grain Exchange
Feeder Cattle CME 6.1 6 1 • NYMEX New York Mercantile Exchange
Live Cattle CME 4.9 7 3 •
Palladium NYMEX 6.2 13.2 3 •
S&P GSCI CME 8.2 10.5 1 •
Soybean Oil CBOT 3.4 12.2 13 • 1612
Trading Liquidity: Futures is a reference chart for speculators. It compares markets “Relative Contract Liquidity” places commodities in descending order according to
according to their per-contract potential for profit and how easily contracts can be bought how easily all of their contracts can be traded. Commodities at the top of the list are easi-
or sold (i.e., trading liquidity). Each is a proportional measure and is meaningful only est to buy and sell; commodities at the bottom of the list are the most difficult. “Relative
when compared to others in the same column. Contract Liquidity” is the number of contracts to trade times total open interest times a
The number in the “Contracts to Trade for Equal Dollar Profit” column shows how volume factor, which is the greater of:
many contracts of one commodity must be traded to obtain the same potential return In volume
as another commodity. Contracts to Trade = (Tick $ value) x (3-year Maximum Price 1 or exp –2
In 5000
Excursion).

56 • December 2016 • Technical Analysis of Stocks & Commodities

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December 2016 • Technical Analysis of Stocks & Commodities • 57

 D’Errico/pair trading with a twist ■ Stock pairs can be traded with opposite approaches
Continued from page 16 like any other financial tool: you cannot predict if the
pair will move in a trend or sideways since it is the
■ In terms of hit rate percentage, the mean-reversion market that decides.
strategy shows the best results, with 66% profitable ■ You don’t necessarily have to use complicated statisti-
trades for long and 40% for short. This is something cal calculations where classical technical analysis is
we can expect for reversal strategies. Hit rate percent- more than enough.
age refers to how many trades are profitable out of ■ Yes, the mean-reversion approach works, but trend-
100. following is better. And when you combine the two,
■ In terms of average trade, for both the long and short it’s even better—you’re looking for pullbacks inside
side, the trend & pullback strategy with 12,956 trades the main trend.
and an average of $317 (3.17%) is the best, while the
mean-reverting results are quite poor due to the large Domenico D’Errico has a statistics background, is an app
number of trades (97,432). developer, and works as an advisor for asset managers and
■ It’s the same story for return on account (ROA), professional traders from different countries. He may be reached
showing that trend & pullback (ROA 3.72) improves via his website [Link].
the trend-following approach (ROA 3.35), while the
mean-reverting performs worse (ROA 2.56). ROA is a See our Traders’ Tips section beginning on page 51 for commentary on
strategy performance measure calculated by dividing implementation of D'Errico's technique in various technical analysis
the total profit by the maximum strategy drawdown. programs. Accompanying program code can be found in the Traders’
Tips area at [Link].
Trends and pairs
We can draw the following conclusions:

Stock pair scanners the analysis techniques available and created a complete stock
The most common trading platforms don’t provide technical pair indicators library.
analysis tools for stock pairs. What you can find are some But how do you scan thousands of different pair combi-
spread-ratio indicators. But this is not enough for us, because nations in the US stocks/ETF universe? You need to create
we need to clearly visualize price-ratio moves. We need some type of market scanner that monitors your strategies on
candlesticks, trend indicators, and reversal indicators, all of thousands of pairs without opening a chart. In sidebar Figure
them applied to price ratios. This is why we redesigned most of 1 you see an example of a scanner I created.

SIDEBAR FIGURE 1: A PAIR SCANNER FOR STOCKS

58 • December 2016 • Technical Analysis of Stocks & Commodities

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ESchramm@[Link] • (206) 938 0570 TRADERS'

RESOURCE

TOP 10 VIEWED books for traders

LINKS
Whether you choose to turn a physical page or a
virtual one using your favorite high-tech reading Book Company
device, tablet, or platform, books today are alive
and well, available in more formats than ever before. 1. Trader’s Manifesto Worden Brothers, Inc.
With so many to choose from, including classic texts
2. Charting the Stock Market: The Wyckoff Method Technical Analysis, Inc.
published long ago and the most recent arrivals on
the scene, you can find numerous books that will 3. Candlestick Charting Explained [Link], Inc.
teach you what you need to know about trading and the techniques
to trade better. 4. John Murphy on Chart Analysis DBdesign 2016
[Link], Inc.
This month’s Traders Resource is the tip of the iceberg when it CLIENT: RxCrossroads/Omnicare
5. Intermarket Technical Analysis [Link], Inc.
comes to all the available books out there for traders and investors. JOB #: DIP101
Websites such as TraderPlanet ([Link]) and Traders’ 6. The Visual Investor SIZE: 2.25 [Link],
11.5” Inc.
Library ([Link]) can help you locate nearly any trading
DATE: 4/25/2016
or investing book. In addition, [Link] and BarnesandNoble. 7. Candle Patterns [Link], Inc.
ARTIST: db
com, among other websites, can help you home in on a subject and
8. Street Smart Chart Reading,PROOF:
Vols. 1 & 2 2 Worden Brothers, Inc.
suggest other related and popular material.
Beginning traders should be sure to read the writings of Robert Stocks & Commodities
9. Technical Analysis of the Financial Markets [Link], Inc.
Edwards and John Magee, Jack Schwager, J. Welles Wilder, Martin
Pring, Perry Kaufman, and Edwin LeFévre to start your education 10. Trading Chaos II Profitunity Trading Group
down the right path. And traders of every level and experience should These are the 10 book listings clicked on most often on the Traders’ Resource website. Each entry is listed
discover new sources from the information available at the Traders’ in order of clicks received. This is not an editorial rating or ranking. For more information on specific products
Resource database at our website. Good reading! and services, try checking [Link] for archived S&C product reviews.

Traders’ Resource at [Link]

Traders’ Resource is available at our website, [Link], services, courses and seminars, newsletters, consultants, software, trading
you’ll find listings of books on trading and investing offered by systems, and more. All you have to do is click on the Traders’ Resource link.
various publishers and distributors. You’ll also find information on Then follow the category link, or use the search feature (shown here) to find
products and services in other categories, such as brokerages, data products or services with specific attributes you’re looking for.

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

December 2016 • Technical Analysis of Stocks & Commodities • 59

 Are your expectations
realistic?
A respected friend once asked me
how much I make per month in my
trading. I mentioned that I seek only
1% per month, no matter my account
size, and in some months I make more
than that. He was anticipating that I’d
say I make between 20% and 50%
and so he was disappointed with my
response. Fantasizing can be pleasant
but not necessarily realistic.
Yes, you can make money from
trading, and you can be a reliably vic-
torious trader. But how much could
your income be? When it comes to
the amount that could be earned over
a given period of time, people usually
have unrealistic expectations.
Many people are used to mak-
ing an hourly, weekly, or monthly
wage. But in the trading business,
you have to think about things dif-
ferently. Given the uncertain nature
of trading, you cannot expect to get
the equivalent of a steady paycheck.
You can’t automatically achieve a set
target amount every trading day. On
many days, you may put in a solid
eight hours without realizing any
profit at all.
I have seen people who want to
become rich by investing $500. I
have seen those who want to turn
$100 into a growing income. These
expectations are unrealistic, though
they may be attainable in the short
term when traders gamble and hit a
stroke of luck. Even so, most people
Onward & Upward

How Much Can I Really

don’t consider the difference between
making a 5% profit on a $500,000
account versus a 5% profit on a

Make From Trading?

$1,000 account.
Certain so-called professionals in
the industry promise unrealistic re-
oak tree: ZERBER/OCEAN: D. POLONSKY/SHUTTERSTOCK/COLLAGE JOAN BARRETT

turns because this plays into people’s

We trade because we want to make money, but how much can a trader realistically mindset. A more realistic return of
make per day, week, month, quarter, or year? Read on to find out what goal you 1% per month just doesn’t sound as
should set. appealing. And yet rational people
will agree that a 1% return per month

H
by Azeez Mustapha is good. That return can ultimately
make you wealthy. In reality, very
ow much can I make from trading? This is the question that most traders, few traders make a 15–30% return
from beginners to pros, ask. But the question doesn’t have a straightforward year after year.
answer. Our goal, as traders, is to make money, although money is really a It’s actually not feasible to make
by-product of a good trading plan. 10% per month without experiencing
60 • December 2016 • Technical Analysis of Stocks & Commodities
 AT THE CLOSE

a single losing month, or to make 1.27% profit per day. I am not

saying that 10% per month or 1.27% per day isn’t possible in When you go for small but
the short term, but that would be based on luck, and successful
trading needs far more than just luck. Someone aiming for
consistent profits, you are more
such inflated goals won’t likely last long as a trader. likely to end up with wealth.
If you are a real estate investor, you know there is no way
property can appreciate by 100% in 24 hours. You need to
have more realistic expectations. The same can be said about all your capital. You believe you care about your capital, yet
fixed deposits and bonds. Could you force 5% appreciation you don’t apply the correct protections on your capital.
on each of them on a monthly basis? No, and yet most people Meanwhile, those who treat capital as being more important
won’t even accept the idea of 5% profit per month in trading, than profits tend to employ safe trading approaches such as
let alone 1%. applying stops, using small position sizes, and scaling out of
Warren Buffett is a great investor, but what makes him a losses with the goal of protecting their capital. Ironically, it is
great investor is the number of years he has been doing it. these traders who are more likely to be profitable in the long
His secret is time, which is why it is good to start trading run because they care about the safety of their capital and
while you are still young. Little drops of water can make a know they can only make money after they stop losing it.
mighty ocean. A sane speculator will not allow greed to scuttle his long-
term interests. Neither will he have a longing for gargantuan
Sensible traders don’t have returns. He is thankful for whatever the market throws at him,
preconceived notions no matter how little.
There’s no way you can know how much you will make before You must always respect the current situation surrounding
you open a position. Sometimes, having no expectations is the the market and then use your experience to squeeze out some
best way to go, since any amount of profit will then exceed gains. At times, you make nice profits and at other times you
your expectations. have nothing to show for your efforts. But you should still
Setting targets may be tenable in other fields, but that’s not always view your gains in the long run, not the short run.
the case with trading. Setting target amounts is sensible only
in situations in which things are under your control. You can- Trade small and consistently
not control the market; neither can you predict its movement. When you go for small but consistent profits, you are more
So why set targets? likely to end up with wealth. Thanks to the power of com-
You can target 2% in one week or one month and end up pounding, even a 1% appreciation of your capital per month
losing -4% in that week or month. You can target 1% in a week will make you richer in the long run.
or month and end up making 11% in that week or month. It In some years, difficult markets will deter your profits, while
all depends on what is happening in the market, and that’s in other years, you will make large gains. What matters most is
something that’s out of your control. that you lose as little as possible in the worst years in order to
You can only plan how many trades you want to open in a protect your capital. This has the added advantage of making
week or a month and the maximum you can lose in that week life easier on yourself so you can have more peace, as opposed
or month. You cannot predetermine how much you’ll make to making things more difficult for yourself.
in that week or month. Failure to accept this reality is one of I will end with a story about a trader who shorted gold in
the reasons people get frustrated with trading. July 2014 and later took his large profit at the end of October in
the same year. He didn’t know anything about how to forecast
Focus first on capital, not profit or how to read charts. He just entered the market and let his
A wise fund manager recently told me that it’s difficult to profits run. He didn’t set any weekly or monthly targets or look
manage money for greedy people. Some of his investors for quick profits. The moral is, don’t set unrealistic expecta-
would complain he did not make enough profits, and the key tions for something you can’t control. Follow the market and
word here is enough. It is this type of person who would risk take a little of what it gives you.
too much of his capital and end up blowing up his account if
he were to trade on his own. Even if you have a lot of capital Azeez Mustapha is an analyst with Instaforex Companies
with which to earn a sustainable income from trading, you Group and a blogger at [Link], as well as a freelance
still need to be mindful of your risks. author for trading magazines. He is a trading signal pro-
The reality is that people often don’t appreciate what they vider for some websites and has additional articles at www.
have until they lose it. The most important thing in trading [Link]. He may be reached at azeez.
is the safety of your capital; making profits comes only after mustapha@[Link].
that. Those who place more importance on profits than on their
capital tend to employ dangerous trading approaches such as
not using stops, risking too much, and adding to losers. If you
follow those risky approaches, you are likely to end up losing
December 2016 • Technical Analysis of Stocks & Commodities • 61
 The following selection of book descriptions represents a sampling of recent wasting time delivering software that exceeds
book releases in the investing field. Books described here may be from some of performance objectives—thus, either under-
the major book publishers as well as some independent book publishers. These performing or gold-plating, both of which
are not critical reviews or editorial evaluations, but rather a brief look at the book
are undesirable. As data analytic software,
marketplace to help keep readers up to date on new or recent book offerings.
SAS transforms data into information and
ultimately knowledge and data-driven de-
cisions. Often, quality requirements exist
FinTech Innovation: From Robo-Advisors thinking framework designed to help orga- for data and data products yet not for the
To Goal-Based Investing And Gamification nizations create value through focus, align- software that undergirds them. This book
(180 pages, $50 ment, and better communication. Written by demonstrates how to prioritize, implement,
hardcover, $32.99 two OKRs consultants and researchers, the and evaluate all dimensions of software
ebook, August book seeks to help organizations quantify quality within risk management and project
2016, ISBN 978- qualitative goals and help their teams meet management frameworks of the software
1-119 -22698 -7) them. The book details how OKRs came to development life cycle (SDLC).
by Paolo Sironi. be in the 1980s and how companies use [Link]
FinTech Innova- them every day to help employees stretch
tion examines the their thinking about what’s possible. From the
rise of financial basic framework to best practices, this guide Statement of Ownership, Management, and Circulation
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Date
Jack K. Hutson
4757 California
Technical Ave.
Analysis of SW, Seattle,
Stocks WA 98116-4499
& Commodities 9 September 2016
the global banking
7 2 6 8 3 0
[Link]
_
Telephone (Include area code)
4. Issue Frequency 5. Number of Issues Published Annually (206) 938-0570
6. Annual Subscription Price

Monthly with aaBonus

Monthly with BonusIssue
Issue
in in March 13
March $89.99
8. Complete Mailing Address of Headquarters or General Business Office of Publisher (Not printer)

industry. Social 4757 California Ave. SW, Seattle, WA 98116-4499

7. Complete Mailing Address of Known Office of Publication (Not printer) (Street, city, county, state, and ZIP+4 ®)

4757 California Ave. SW, Seattle, WA 98116-4499

Contact Person
Jack K. Hutson
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media, big data analytics, and digital tech- SAS Data Analytic
Publisher (Name and complete mailing address) (206) 938-0570
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Jack
4757 K. Hutson,
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WA 98116-4499
4757 California Ave. SW, Seattle, WA 98116-4499
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Jayanthi Gopalakrishnan, 4757 California Ave. SW, Seattle, WA 98116-4499

Publisher (Name and complete mailing address)

Wealth managers are experiencing a tectonic Dimensions Of Jack K.

Jack [Link],
Hutson,4757 California
4757 Ave. SW,
California Seattle,
Ave. SW,WA
Managing Editor (Name and complete mailing address)

Editor (Name and complete mailing address)

98116-4499
Seattle, WA 98116-4499

shift as established economic interests col- Software Qual- Jayanthi Gopalakrishnan, 4757 California Ave. SW, Seattle, WA 98116-4499
Jayanthi Gopalakrishnan, 4757 California Ave. SW, Seattle, WA 98116-4499
10. Owner (Do not leave blank. If the publication is owned by a corporation, give the name and address of the corporation immediately followed by the
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Technical
12. Analysis
Tax Status (For ofbyStocks
completion & Commodities
nonprofit organizations authorized to mail at nonprofit rates) (Check one)
October
October 2016
2016
October 2016
and client-centric advisory processes, and software and help managers build software
The purpose, function, and nonprofit status of this organization and the exempt status for federal income tax purposes:
Hasand
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Monthly with a Bonus Issue in March Each Issue During Issue Published

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a. Total Number of Copies (Net press run)

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36,615 37,155
37,155

come a survival skill for financial advisors. duces and parallels the International Orga- b. Paid
(1) Mailed Outside-County Paid Subscriptions Stated on PS Form 3541 (Include paid
distribution above nominal rate, advertiser’s proof copies, and exchange copies) 30,039
30,039 30,984
30,984

0 00
Circulation Mailed In-County Paid Subscriptions Stated on PS Form 3541 (Include paid
(2) 0

This book not only illustrates the changes nization for Standardization (ISO) software
(By Mail distribution above nominal rate, advertiser’s proof copies, and exchange copies)
and

1,966 2,166
Outside Paid Distribution Outside the Mails Including Sales Through Dealers and Carriers,
the Mail) (3) 1,966 2,166
Street Vendors, Counter Sales, and Other Paid Distribution Outside USPS®

already underway, it provides insight into product quality model, demonstrating 15 (4)
Paid Distribution by Other Classes of Mail Through the USPS
(e.g., First-Class Mail®) 2,444
2,444
3,740
3,740

the changes yet to come. performance requirements that represent 34,379 36,890
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d. Free or
Nominal
(1) Free or Nominal Rate Outside-County Copies included on PS Form 3541 00 00
[Link] dimensions of software quality, including: Rate
Distribution (2) Free or Nominal Rate In-County Copies Included on PS Form 3541
(By Mail
and
00 00
Free or Nominal Rate Copies Mailed at Other Classes Through the USPS
265
265
265
265

reliability, recoverability, robustness, execu-

Outside (3)
the Mail) (e.g., First-Class Mail)

(4) Free or Nominal Rate Distribution Outside the Mail (Carriers or other means) 00 00

Objectives And Key Results: Driving Focus, tion efficiency (speed), efficiency, scalability, e. Total Free or Nominal Rate Distribution (Sum of 15d (1), (2), (3) and (4))
265
265 265
265

34,644 37,155
Alignment, And portability, security, automation, maintain-
f. Total Distribution (Sum of 15c and 15e) 34,644 37,155

g. Copies not Distributed (See Instructions to Publishers #4 (page #3))

2,026
2,026
00
Engagement With ability, modularity, readability, testability, h. Total (Sum of 15f and g)
36,405
36,405
37,155
37,155

OKRs (224 pages, stability, and reusability. A common fault in 99.23% 99.28%
i. Percent Paid
(15c divided by 15f times 100) 99.23% 99.28%

Statement of Ownership, Management, and Circulation

* If you are claiming electronic copies, go to line 16 on page 3. If you are not claiming electronic copies, skip to line 17 on page 3.
(All Periodicals Publications Except Requester Publications)
$49.95 hardcover, many software development environments is 16. Electronic Copy Circulation

Technical Analysis of Stocks & Commodities

Average No. Copies
Each Issue During
Preceding 12 Months
No. Copies of Single
Issue Published
Nearest to Filing Date

September 2016, a focus on functional requirements—the what a. Paid Electronic Copies

7,125
7,125 5,590
5,590

41,504 42,745
ISBN 978-1-119- and how—to the detriment of performance
b. Total Paid Print Copies (Line 15c) + Paid Electronic Copies (Line 16a) 41,504 42,745

c. Total Print Distribution (Line 15f) + Paid Electronic Copies (Line 16a) 41,769
41,769 43,010
43,010

25239-9) by Paul requirements, which specify instead how d. Percent Paid (Both Print & Electronic Copies) (16b divided by 16c Í 100) 99.36%
99.36% 99.38%
99.38%

R. Niven and Ben well software should function or how easily X I certify that 50% of all my distributed copies (electronic and print) are paid above a nominal price.
PS Form 3526, July 2014 (Page 2 of 4)
17. Publication of Statement of Ownership

Lamorte. Objec- software should be maintained. Without the X If the publication is a general publication, publication of this statement is required. Will be printed
December 2016
in the ________________________ issue of this publication.
Publication not required.

tives And Key Re- definition and communication of performance 18. Signature and Title of Editor, Publisher, Business Manager, or Owner Date

9 September

sults is a reference requirements, developers risk either build-

2016
I certify that all information furnished on this form is true and complete. I understand that anyone who furnishes false or misleading information on this form
or who omits material or information requested on the form may be subject to criminal sanctions (including fines and imprisonment) and/or civil sanctions

guide for a critical ing software that lacks intended quality or

(including civil penalties).

62 • December 2016 • Technical Analysis of Stocks & Commodities

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