Traders Toolbox: Williams %R
MarketClub is known for our “Trade Triangle” technology. However, if you have used other technical analysis indicators previously, you can use a combination of the studies and other techniques in conjunction with the “Trade Triangles” to further confirm trends.
Williams’ %R oscillator, attributed to Larry Williams, is a variation of the stochastics indicator previously discussed. Because the two oscillators are essentially the same, only minor modifications to the formula are required. The formula for calculating %R is: %R = Hn – C / Hn – Ln where Hn = highest high of the period, C = Close of the current period and Ln = lowest low of the period.
The %R oscillator differs from the %K formula in the stochastics indicator because the outcome of each formula is inverse to the other. In other words, %K compares the close with the lowest low, whereas %R compares the close with the highest high. Similar to other oscillators, %R is plotted with horizontal zones of 20% and 80%. When the indicator has a reading of -80% or below it signifies an oversold condition. Similarly, a reading of -20% or above signals an overbought condition.
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You can learn more about the Williams %R and Larry Williams by visiting INO TV.
Traders Toolbox: Elliott Wave Theory
MarketClub is known for our “Trade Triangle” technology. However, if you have used other technical analysis indicators previously, you can use a combination of the studies and other techniques in conjunction with the “Trade Triangles” to further confirm trends.
Elliott Wave Theory categorizes price movement in terms of predictable waves. Beginning in the late 1980s, R.N. Elliott developed his own concept of price waves and their predictive qualities. In Elliott theory, waves moving with the trend are called impulse waves, while waves moving against it are called corrective waves.
Impulse waves are broken down into five primary price movements, while correction waves are broken down into three. An impulse wave is always followed by a correction wave, so any complete wave cycle will contain either distinct price movements. Breaking down the primary waves of the impulse, correction wave cycle into sub-waves produces a wave count of 34 (21 from the impulse wave plus 13 from the correction wave), producing more Fibonacci numbers. Elliott analysis can be applied to time frames as short as 15 minutes or as long as decades, with smaller waves functioning as subwaves of larger waves, which are in turn sub-waves of still larger formations. By analyzing price charts and maintaining wave counts, you can determine price objectives and reversal points.
A key element of Elliott analysis is defining the wave context you are in: Are you presently in an impulse wave uptrend, or is it just he correction wave of a larger downtrend? The larger the time frame you analyze, the larger the trend or wave you find yourself in. Because waves are almost never straightforward, but are instead composed of numerous sub-waves and minor aberrations, clearly defining waves (especially correction wave) is as much an art as any other kind of chart analysis.
Fibonacci ratios play a conspicuous role in establishing price objectives in Elliott theory. In an impulse wave, the three principal waves moving in the direction of the trend are separated by two smaller waves moving against the trend. Elliotticians often forecast the tops or bottoms of upcoming waves by multiplying precious waves by a Fibonacci ratio. For example, to estimate a price objective for wave III, multiply wave I by the Fibonacci ratio of 1.618 and add it to the bottom of wave II for a price target. Fibonacci numbers also are evident in the time it takes for price patterns to develop and cycles to complete.
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You can learn more about the Elliott Wave Theory by visiting INO TV.
Traders Toolbox: How to use the Directional Movement Index
The Directional Movement Index, commonly called the DMI, is a powerful trend-following indicator. Many false signals generated by indicators such as the stochastics are filtered out by the DMI. Subsequently, this trading and analytical tool gives few signals, but, when generated, they tend to be very reliable.
Many, who at first glance are strangers to the DMI, find they are familiar with the prime component of the index: The ADX or average directional movement index. This discussion will center on the main use of the ADX, the turning point concept.
The DMI consists of three components: The + DI, which represents upward directional movement; the - DI, indicating downward movement; and the ADX, which signifies the average directional movement within a market.
In STRONG UPTRENDING moves, such as the late 1989 and early 1990 rally in the CRB, the + DI and the ADX turn up early in the move and move higher, with the + DI generally holding above the ADX. A high probability signal the uptrend has stalled or ended is generated when the ADX crosses above the +DI and turns down. This signal commonly occurs on the trading period of the trend change or slightly before. It rarely takes more than a few periods past a true trend shift to see the ADX turn down.
The rules for signalling a potential bottom are the same as for a top: Simply substitute the - DI for the + DI. There appears to be one slight difference between tops and bottoms: Generally, the ADX turns from a higher level when marking a top.
Several chart services plot only the ADX. In these instances, it can generally be assumed that a downturn in the ADX which occurs after crossing above 40 will have seen the ADX cross above the + DI if the market had been in an uptrend and above the -DI if in a downtrend. In simple terms, a move by the ADX above 40 followed by a downturn generally signals a probable trend change.
Signals such as those which occurred in May, 1990 and February, 1991 in the CRB index (arrows) can be very valuable in confirming a turn which had been projected by unrelated methods of technical analysis. ADX signals can help confirm the expected completion of a wave structure or to underscore a turn within a critical time period.
The DMI is based on a certain number of periods. I have had the most success with 14 days on daily charts. And with the exception of Treasury Bonds, for which I use 14 weeks, I prefer to use 9 periods on the weekly and monthly charts.
Editors note: While the examples shown are somewhat dated the concept and use of the ADX is not. The ADX indicator is available on MarketClub.
Traders Toolbox: Traders Toolbox: Divisions of eight
Studying the writings of traders who were active in the first three or four decades of this century has often inspired me to do additional research. This has allowed me to develop additional tools and theories. In reality, what I present in this segment will not “pure” Gann. Instead, I will present applications and approaches which I have found to be useful and successful. Hopefully, this will provide a foundation for anyone who wants to study further on his/her own.
Many of the successful traders from the first half of this century have a reputation of being almost mystical. To many, this is especially true of W.D. Gann. Trader after trader has searched for Gann’s “secret” to unlock the mysteries of the market. Many of his tools, and mine as well, are relatively simple and are not secrets. However, after delving into his writings, I have come to the conclusion that his biggest “secret” consisted of two things: HARD WORK and COMMON SENSE. Unfortunately, many would-be traders seem unwilling to do the first and lack the ability to use the latter.
Probably the easiest place to start explaining analytical tools is with a simple method to determine support and resistance levels. To locate what should be among the most important areas of support and resistance in a market, divide the move from one extreme to the other by eight.
As an example, oats posted a high in the summer of 1988 which may hold for some time to come. The monthly oats chart shows the range from the all-time low near 14 posted in 1932 to 393, the 1988 high, divided by eight. These eight points should prove to be important areas of support and resistance for years to come. One way to check this range is to examine whether the eight points have proven significant in previous action. In the oats, it is fairly clear the eighth points have been effective in previous years, which should give one a high degree of confidence these levels will be important in the future.
Gann indicated that the 1/3 and 2/3 divisions of a range (broken lines on monthly oats chart) were important as well. I have found the 1/3 and 2/3 points to be significant, but they will generally take a secondary role to the eighth points.
The divisions of price, primarily the eighth points, can be placed on not only the long-term monthly and weekly charts but on the daily charts as well. As the daily perpetual chart of December oats reveals, the long-term levels of support and resistance are significant to daily action. It was no surprise to see December oats find support at the 250 level as manifested during July and August, 1988. Since the point of the all-time range at 250 had been clearly broken, one would have expected to see this market fall to the level near 202 (which it later did).
The divisions of a range are not limited to the move from all- time low to all-time high. Any sizable range of movement can be divided by eight to determine lesser-degree levels of support and resistance. Note the upmove in 1991 in December silver from February to early June. Following the June high, the eighth points provided reasonable areas of support and resistance on the ensuing decline. The boxed area on the weekly December silver chart represents the action shown on the daily chart. The weekly chart didn’t indicate this range was very significant, essentially a corrective rally; yet, the eight divisions still provided valuable reference points.
The power of this tool is obvious.The large-degree eighth points are invaluable as reference tools for support and resistance. Yet, the same principle we’ll work on daily charts, smaller ranges and, yes, even intraday charts.
Credit to Glen Ring for this work
Traders Toolbox: More basic Gann
One of the most important ways a contestant can prepare for competition is to know as much about the opponent as possible. In trading commodities, the primary opponent is the trader’s own emotions. Once the emotions are under control, the “opponent” is the marketplace.
Know your market! While there are many analytical tools which may be applied to all markets, not all markets are identical. Markets have individual personalities or tendencies. It is important to study individual markets to learn specific identities.
A clear example of individuality is seen in seasonal patterns. The seasonal tendencies of each commodity are somewhat unique. Identifying a historical pattern can be very beneficial in the process of trade selection. To illustrate, a study of the monthly corn chart reveals March is a poor month in which to initiate a major short position.
With the exception of 1977, since 1972, a sale made in the corn market during March could have been bettered by waiting until later in the year. While impressive on the monthly corn chart, this pattern is even more clear for the December contract (not shown). How is such information applied?
Corn Belt farmers typically face a large portion of production expenses from late February through early April. Obviously, corn is a primary source of income for these producers and the need to generate capital spurs sales of corn in the period of need. By knowing March is a low probability month for favorable prices, plans can be made to market corn prior to the period of seasonal weakness or to postpone sales into later months. Also, producers should avoid selling the new crop (December) during March as the probability of selling at equal or higher prices later in the season is 100 (since 1972).
The applications for traders are rather obvious. If a trader is bearishly inclined, the information would suggest patience needs to be exercised to wait for a higher period of probability to initiate a short position. Bullish traders would try to accumulate long positions during March.
Seasonal tendencies are only one of many individual traits to study. Many markets have certain types of top or bottom formations which occur more often than not. For example, soybeans generally post some form of a triple top when marking a major high. Some markets respect support or resistance levels much better than others. Certain markets like to post a high percentage of turns on a specific day of the week or month. The list goes on.
There is only one way to learn market tendencies: study and study some more. Through hard work comes knowledge. W.D.Gann stated the importance of knowledge very well: “The dif- ference between success and failure in trading commodities is the difference between one man knowing and following fixed rules and the other man guessing. The man who guesses usually loses.”
Traders Toolbox: Forward to Gann theory
To TRULY be a success at almost any profession takes commitment — the type of commitment which comes from the heart, not the mind. Most successful people I know have a dedication towards their chosen path which was forged through hunger. Hunger for knowledge, hunger for power, hunger for wealth, and, in many instances, the hunger associated with survival. It’s hard to be “rich” if you haven’t been “poor”; “happy” if you haven’t been “sad”; or “satisfied” if you haven’t been “hungry”.
I believe Gann’s biggest secret consisted of hard work and common sense. Hard work follows a true commitment and a desire to learn. Common sense is sharpened by the process of learning from experience. In my opinion, THERE IS NO SUBSTITUTE FOR HARD WORK AND AN OPEN MIND.
In trading commodities, a critically important early step towards success is learning about yourself and how you function. You can learn about yourself quickly in the marketplace. By far, the weakest tool in a trader’s arsenal is the TRADER. In this business, it is so very true that you are your own worst enemy. It is critical to understand yourself and to bring your emotions under control.
Emotions are tamed by confidence. Confidence is gained by knowledge. Knowledge is achieved by dedication to study and willingness to learn from experience. The entire process takes persistence. Persistence is fed by desire and hunger. You stay hungry by realizing and believing there will always be more to learn Never reach the point where you consider yourself an “expert” instead of a student. Stay humble, lest the markets humble you.
Become an independent thinker. Don’t concern yourself with what “they” say. Don’t conform your opinions for the sake of conformity. I constantly tell myself, “don’t take the advice of another unless you know they know more than you know. Dare to be a success without fearing failure.
Do not apologize for failures nor be embarrassed by them. Instead view failures as an opportunity to learn. Much more will be learned from losing trades than from winning trades. Failures are a challenge of your commitment and can make you stronger if you will meet the challenge. Failures are the fuel to keep the hunger burning.
Through the learning process, you will develop the important patience and discipline needed to become a winner. In his book, “How to make Profits in Commodities”, which I highly recommend, W D Gann listed 28 rules for success in the commodity markets. The vast majority of these deal with money management and/or mental discipline. Some of the sharpest analysts I know are not successful traders because they cannot overcome their own mental weaknesses.
Success does not come easily, nor should it. I CANNOT OVER EMPHASIZE the importance of mental preparation and self-examination. As an additional aid, I suggest Rudyard Kipling’ s poem If.
Traders Toolbox: Reversals
Reversals In my opinion, one of the most misused and abused terms in technical analysis is the reversal or key reversal. I often get calls from both new and experienced traders who are excited about a market because it has just posted a “key reversal.” While the action these traders point to often marks a reversal day, such a day (week or month) by itself actually has little significance. There is research which indicates single period reversals mark a turn only about 50% of the time. Which gives about the same odds of indicating a turn using a coin flip.
In my studies, I use a set of rules which help me ferret out reversals which have a much higher probability of marking a turn. Before going any further, I want to clarify the term reversal when used in technical analysis. A reversal does not mean a market will necessarily reverse a trend. A reversal is a formation which may mark a top or a bottom. However, a top or bottom only signals the preceding trend has come to an end. In other words, a top will indicate an uptrend has come to an end. It does not indicate whether the new trend will be down or sideways.
Now, on to the rules. There are six rules which I use to identify a valid reversal. To clarify these rules, I have provided an example of the pattern which I watch for to mark a reversal in the circle on the weekly T- bond chart. I am listing the six rules to identify a reversal high; for a reversal low, simply reverse the parameters where warranted.
To mark a reversal high, first, the market must make a new high for the last six to eight weeks. Second, the market must close lower than the previous day’s (or week’s) close. Third, the market must reverse the previous day’s (or week’s) action. To clarify rule three, the day or week preceding the reversal must have posted a positive close. Fourth, the market must post follow through action the next day (or week). Again, to clarify, the market must close lower on the day (or week) following the reversal. Fifth, the reversal must be accompanied by moderate to high volume. And, finally, the reversal must occur in a terminal (critical) area.
Rules one through four deal with the pattern which the market must trace out and are basically self-explanatory. Rule five insures the reversal is not marked on a low-volume day (or week) such as is common in a holiday period. And rule six essentially means the market must be in an area of price or time where a turn could be expected to occur.
Notice the weekly T-bonds chart and the numerous turns which were marked by the valid reversal pattern. If you examine the chart closely, you will notice there are a number of reversal weeks which did not see followthrough action which failed to turn the market. However, it is rare to find a reversal which saw followthrough action that failed to mark a significant turn.
Traders Toolbox: Bottoming behavior
Markets which have been in a persistent downtrend often exhibit a common pattern as the end of the decline is approached. The pattern is to post a sharp rally followed by one final decline to new lows.
Sharp rallies formed recently in both pork bellies and gold. Following the rallies, both markets plummeted to new lows. However, once new lows were made, the declines stalled. The failure to sustain the break on the move to new lows indicated the selling was effectively exhausted and potential bottoms had formed. A similar pattern marked the low in soybeans prior to the 1983 bull market.
The logic behind this type of bottoming action is that the persistence of the downtrend has finally forced the bulls out of the market. As the last longs are liquidated, the burden of keep- ing the downmove going falls totally on the shoulders of the bears to keep pressure on. Any faltering of the bears to keep the pressure on can lead to a sharp short-covering rally as the sellers “all” turn buyers.
Any hint of bullish news accompanying the short covering rally will tend to entice the emotional bulls back into the market. Then, as the bullishness diminishes, the sellers try to reassert them- selves. Often a push to new lows occurs and the stops of the early bulls are triggered. The stops provide additional short-term sell- ing pressure. When this subsides and the bears find no more selling entering the market, they head for cover in a more orderly fashion.
A relatively gentle upmove starts as the market searches for the levels which will entice sellers back into the market. From there, the burden of proof falls on the market to determine if the bulls are now the strong hands or if the bears can regain their control.
Traders Toolbox: Psychology of a bottom
As bull markets roar to a top, it is relatively easy to see the emotional or psychological signs of an impending top. Virtually every source of news will provide coverage of the seemingly endless climb towards higher levels. Greed infests the public as the inexperienced flock to get a piece of the action. Finally, when it is “impossible” for a market to decline and everyone who wants to buy is in, the top will be struck. Buyers become sellers and a downmove ensues.
To an extent, the same sort of pattern unfolds at major bottoms. However, since the events surrounding the decline are not as exciting or newsworthy as those in a bull market, the signs are harder to see. Instead of greed permeating the atmosphere, fear becomes the emotion of significance. As the news becomes per- ceived as increasingly bearish, traders who had been bullish give up. The emotional stress of margin calls and “bad” news finally forces long liquidation.
Despair, disgust and disillusionment abound among the public traders. Producers resign themselves to selling their production near current levels and, in fact, often sell future production as well. They become convinced the market is destined to move even lower. As the bearish attitude spreads, an important sign of a nearing bottom is declining open interest. This is especially true if this long liquidation of futures positions drops the open interest below recent low levels. In markets where individuals are the original holders of production, an additional sign is liquidation of cash positions.
Traders and marketers take any rally as a “gift” to sell on. Bullish fundamental conditions which may exist are discounted as the memory of the persistent downtrend remains entrenched. As a market starts up from the lows, the rallies are viewed with suspicion. Even the few who remained bullish don’t trust the rebounds and often take advantage of early rallies to liquidate long positions. Setbacks from the early rallies are often sold as the participants don’t want to miss the next washout to new lows. And, if enough gain this attitude, the break will not continue and traders then have to wonder why the markets won’t go down on “bad” news. Eventually, their short covering triggers additional gains.
A final important component of an approaching bottom is the inability of a market to sustain a downmove on bearish news. The most common form of this action is seen when government reports are released. The bulls no longer rationalize a bearish report into a bullish one. Instead, the bulls resign themselves to additional declines. Bears move towards overconfidence and start selling the breaks as well as the rallies. Bearish reports often trigger downmovement, initially, but then additional declines fail to materialize. Moves to new lows are rejected as everyone who wants to be short already is and the longs have been liquidated, thereby leaving the markets with no one to initiate new selling. And, as at the top, but in reversed roles, the sellers become buyers.
Traders Toolbox: Reactions within a downtrend
Many traders, especially those who have not traded very long, find trending declines very difficult to trade. Many trad- ing and analytical tools which perform well in uptrends, or even in sideways pat- terns, often perform differently in down- trends. This is not to say such tools will not work well in a downtrend, but, real- istically, many perform differently.
Many traders (once again, especially those with little experience) tend to be biased to the long, or buy, side of the market. Such traders often have difficulty adapting to the changes which may occur in the performance of their favorite tools in declining markets. Thus, many tend to shy away from the short side of markets. This is unfortunate as markets often fall more quickly than they go up. As a result, profits can be potentially harvested faster in a down move than in an uptrend.
While some traders tend to avoid the short side of markets altogether, others would be interested in selling short if only they could find a way to get on board trending declines. As mentioned earlier, while many tools don’t appear to work as well in a down- trend, there is a pattern which occurs often enough to be helpful in analyzing and trading.
The reliable pattern which often develops within down trending moves is a consistency of the upward reactions. The consistency within upward reactions can be in terms of time or price or both. However, most patterns tend to involve time, either alone or in combination with price.
Generally speaking, upward reactions in true downtrends tend to last from 1 to 3 days. The reactions are not limited to 3 days; however, many declines will follow this pattern.
To be more specific, individual markets often mark the maximum time span of most upward reactions with the first rebound in a downtrending pattern. For example, if the first upward reaction lasts two days, many of the subsequent rebounds within the downtrend will last two days or less. A good example of this phenomenon occurred in the February/March, 1991 collapse in the currency markets.
The first rebound in the Swiss franc, following the posting of the February high, lasted for about a day and a half. From that point forward until the primary downtrend came to an end in late March, no upward reaction (arrows) lasted much more than a day and a half. And, when the Swiss franc rebounded for more than a day and a half, (circle) it proved to be a signal the clean portion of the downtrend had come to an end.
The trading strategy is quite simple. In general, traders may look to sell 1- to 3-day rebounds in downtrending markets. If a reaction lasts longer than the longest previous reaction, the strategy then moves to either being stopped out or to look for a gracious way to move to the sidelines on the next break. This is done because, even if the market eventually moves lower, what remain, compared to the previous trending portion or “meat” of the move, often prove to be the “crumbs.” Obviously, the strategy is adjusted when a specific market has marked its reaction time.
The spring, 1991 situation in the new-crop corn market pres- ents an example of a time span longer than three days being marked as the primary reaction time. After collapsing from the March high, December corn marked its key reaction time with the sharp rebound into early April. This 4-day bounce set the stage for subsequent reactions to last from 1 day to 4 days. In addition, December corn has marked the likely size, in terms of price, of most subsequent reactions.
The rebound posted in December corn into early April was 13.25(E. This is likely to be the approximate size of the largest subsequent rebound which occurs within the downtrending move. A rebound which is substantially larger than 13.25 cents is likely to signal an end of the primary decline. However, on a daily degree, it is rather obvious that a 13.25C rebound in corn is a large reaction. While a 4-day reaction time is realistic, most reactions in price are likely to be smaller than 13.25 cents.
Notice the 4-day rebound which followed the posting of the April high. This upward reaction was 5cents. From this point on, it was/is reasonable to expect most reactions to be in the neighborhood of 5(t or Go; and to last from 1 to 4 days. However, it would be wise to allow for at least one larger-degree rebound of about 13 cents.
In the spring, 1991 situation in the December corn market, a possible trading approach would be to sell rebounds from a new low of 5cents to 6cents. Risk could be limited to a point which is 14cents or 15cents above a new low. Thus, the effective risk should be about 8cents to l0cents. Once a new low is posted, if one were using “tight” stops, the risk could be limited to about 7cents to 8cents above each new low. Otherwise, a 14cent or 15cent trailing stop above each new low should keep one in position for the bulk of a move. While this is a possible approach, it is not necessarily a specific or the only approach to trading a short position.
As always, knowing the personality of a market can prove beneficial. In the spring, 1991 corn market, it was wise to allow for one rebound in time of up to ten days. This is due to the presence of such rebounds in time in potentially similar previous downtrends in the corn market.
The tendency for consistent reactions in a downtrend should be an attractive addition to one’s technical “toolbox”. This pattern offers a low-risk method to reap potentially substantial rewards.
