Thursday, April 26, 2012

Capturing Trend Days

Linda Bradford Raschke

A trend day occurs when there is an expansion in the daily trading range and the open and close are near opposite extremes. 

The first half-hour of trading often comprises less than 10% of the day’s total range; there is usually very little intraday price retracement. Typically, price action picks up momentum going into the last hour — and the trend accelerates

A trend day can occur in either the same or the opposite direction to the prevailing trend on daily charts. The critical point is that the increased spread between the high and low of the daily range offers a trading opportunity from which large profits can be made in a short time. 

Traders must understand the characteristics of a trend day, even if interested only in intraday scalping. A trader anticipating a trend day should change strategies, from trading off support/resistance and looking at overbought/oversold indicators to using a breakout methodology and being flexible enough to buy strength or sell weakness. 

A trader caught off guard will often experience his largest losses on a trend day as he tries to sell strength or buy weakness prematurely. Because there are few intraday retracements, small losses can easily get out of hand. The worst catastrophes come from trying to average losing trades on trend days. Fortunately, it is possible to identify specific conditions that tend to precede a trend day. Because this can easily be done at night when the markets are closed, a trader can adjust his game plan for the next day and be prepared to place resting buy or sell stops at appropriate levels.

Classic Trend Day: A large opening gap created a vacuum on the buy side. The market opened at one extreme and closed on the other. Note how it made higher highs and higher lows all day. Also, volatility increased in the latter part of the day–another characteristic of trend days.

The Principle of Range Contraction/Expansion

Several types of conditions lead to trend days, but most involve some type of contraction in volatility or daily range. In general, price expansion tends to follow periods of price contraction, the phenomenon being cyclical. The market alternates between periods of rest or consolidation and periods of movement, or markup/markdown. Volatility is actually more cyclical than is price.

When a market consolidates, buyers and sellers reach an equilibrium price level — and the trading range tends to narrow. When new information enters the marketplace, the market moves away from this equilibrium point and tries to find a new price, or “value” area. Either longs or shorts will be “trapped” on the wrong side and eventually forced to cover, aggravating the existing supply/demand imbalance.
Trend Day Down

In turn, the increase in price momentum attracts new market participants, and pretty soon a vicious cycle is created. Local pit traders, recognizing the one-way order flow, scramble to cover contracts. Instead of price reacting back as in normally trading markets, “positive feedback” is created — a condition in which and no one can predict how far the price will go. The market tends to gain momentum rather than to check back and forth.

We can tell when the market is approaching the end of contraction or congestion because the average daily range narrows. We know a potential breakout is at hand. However, it is difficult to predict the direction of the breakout because buyers and sellers appear to be in perfect balance. All we can do is prepare for increased volatility or range expansion!

Most breakout trading strategies let the market tip its hand as to which way it wants to go before entering. This technique sacrifices initial trade location in exchange for greater confidence that the market will continue to move in the direction of trade entry.

The good news is that breakout strategies have a high win/loss ratio. The bad news is that whipsaws can be brutal!

Tick Readings for Short-term day trading – Volatility conditions are important to quantify even if you are a short term day trader. In a normal consolidation market, overbought/oversold type indicators, such as intraday tick readings, can work well for S&P scalps.
Conditions Preceding a Trend Day

Several key price patterns can serve as alerts to the potential for significant range expansion:

  1. NR7 — the narrowest range of the last 7 days (Toby Crabel introduced this term in his classic book, Day Trading With Short-term Price Patterns and Opening-range Breakout); 
  2. a cluster of 2 or 3 small daily ranges;
  3. the point of a wedge-type pattern (which usually exhibits contracting daily ranges);
  4. a Hook Day (wherein the open is above/below the previous day’s high/low — and then the price reverses direction; the range must also be narrower than the previous day’s range; leads traders to believe that a trend reversal has occurred, whereas the market has instead only formed a small consolidation or intraday continuation pattern);
  5. low volatility readings, based on such statistical measures as standard deviations or historical volatility ratios or indexes;
  6. large opening gaps (caused by a large imbalance between buyers and sellers);
  7. runaway momentum (markets with no resistance above in an uptrend or no support below in a downtrend. This condition differs from the above setups in that volatility has already expanded. 

In a momentum market, however, the huge imbalance between buyers and sellers continues to expand the trading range!)

Fading extreme tick readings can be dangerous – On a trend day, a countertrend strategy of fading extreme tick readings could result in substantial losses.
Ave. True Range highlights range contraction/expansion – The 3-Day Average True Range Indicator highlights how cyclical the phenomenon of range contraction/range expansion is. Volatility tends to be more cyclical than price.

Fading extreme tick readings can be dangerous – On a trend day, a countertrend strategy of fading extreme tick readings could result in substantial losses.

Ave. True Range highlights range contraction/expansion – The 3-Day Average True Range Indicator highlights how cyclical the phenomenon of range contraction/range expansion is. Volatility tends to be more cyclical than price.

Trading Strategies

A breakout strategy, or intraday trend-following method, can best capture a trend day. Wait for the market to tip its hand first as to which direction it is going to trend for the day. Rarely can this be determined by the opening price alone. Thus, most breakout strategies enter only after the market has already begun to move in one direction or the other, usually by a predetermined amount.

Add the following techniques to your repertoire. All of them will ensure you participate in a trend day. 

  • Breakout of the Early-morning Trading Range. The morning range is defined by the high and low made in the first 45-120 minutes. Different time parameters can be used, but the most popular one is the first hour’s range. Wait for this initial range to be established and then place a (1) buy stop above the morning’s high and a (2) sell stop below the morning’s low. A protective stop-and-reverse should always be left in place at the opposite end of he range once entry has been established.
  • Early Entry. Toby Crabel defined this as a large price movement in one direction within the first 15 minutes of the opening. The probability of continuation is extremely high. Once one or two extremely large 5-minute bars appear within the first 15 minutes, a trader must be nimble enough to enter on the next “pause” that usually follows. With many of these strategies, the initial risk can appear to be high. However, a trader must recognize that as the trading volatility increases so too does the potential for good reward. 
  • Range Expansion off the Opening Price. A predetermined amount is added or subtracted from the opening price. Though Toby Crabel also described this concept in his book, it was really popularized by Larry Williams. The amount can be fixed, or it can be a percentage of the previous 1-3 days’ average true range. With resting buy and sell stops in place, the trader will be pulled into the market whichever way price starts to move. Entry, often made in the first hour, can be made earlier than the breakout from the first hour’s range. In general, the further price moves away from a given point, the greater are the odds it will continue in that same direction. The ideal is continuation in the direction of the initial trend once the trade is entered.

Volatility tend to increase as a trend matures – Trend days also frequently occur in runaway momentum markets. There is little range contraction evident in the latter part of this trend move. Rather, emotions run high as the imbalance between supply and demand reaches an extreme. 

  • Price Breakout from the Previous Day’s Close. This strategy is similar to the above, with buy and sell stops based on a percentage of the previous 1-3 days’ range added to the previous close. The advantage to using the closing price is that resting orders can be calculated and placed in the market before the opening. The disadvantage is the potential for whipsaw if the market moves to fill a large opening price gap. (Another version of a volatility breakout off the open or closing price is the use of a standard-deviation or price-percentage function instead of a percentage of the average true range. All the above methods can be easily incorporated into a mechanical system.)
  • Channel Breakout. One of the more popular types of trend-following strategies in the nineties, Donchian originally popularized the concept by employing a breakout of the 4-week high or low. Later, Richard Dennis modified this into the “Turtle System,” which used the 20-day high/low. Most traders don’t realize that simply entering on the breakout of the previous day’s high or low can also be considered a form of channel breakout. (Another popular parameter is the 2-day high or low.)

Exit Strategies

One of the easiest and more popular ways to exit a breakout trade is simply to exit “Market-On-Close. ” The ideal trend day closes near the opposite extreme of the day’s range from the opening. This strategy keeps the trader in the market throughout the day, yet requires no overnight risk. Most breakout strategies actually test out better for trades held overnight because the next opening will so often gap in a favorable direction. Thus, another simple strategy is to exit on the next morning’s opening.

Instead of a strategy based on time, such as the close or the next day’s open, one can also use a price objective. One popular method is to take profits near the previous day’s high or low. One can also determine a target based on the average true range.

For the classic market technician, point-and-figure charts can provide a “count” which establishes a price target. This method is valid only if price breaks out of congestion or a well-defined chart formation.

Trade Management

In general when testing volatility breakout systems, the wider the initial money-management stop, the higher the win/loss ratio. With breakout strategies, the initial trade must be given room to breathe.

However, a discretionary day-trader will learn that the best trades move in his favor immediately. In this case, move the stop to breakeven once the trade shows enough profit. The stop can be trailed as the market continues to trend, but not too tightly. Because a great majority of the gains can occur in the last hour as the trend accelerates, try not to exit prematurely.

When trading multiple contracts, scale out of some to ensure a small profit in the event of a reversal. However, do not add to a position: The later the trade is established, the more difficult it is to find a suitable risk point.

A Few Words on Volatility Breakout Systems

Trading a mechanical breakout system can provide invaluable experience. The average net profit for the majority of these systems is quite low, so they may not guarantee a road to riches; but they serve as a terrific vehicle to gain a wealth of experience in a very structured format.

If you are going to trade a mechanical system, you must be willing to enter all trades! It is impossible to know which trades will be winners and which ones losers. Most traders who “pick-and-choose” have a knack for picking the losing trades and missing the really big winners. The hardest trades to take tend to work out the best! With most systems, a majority of the profits come from less than 5% of the trades.

Though most breakout methods have a high initial risk point, their high win/loss ratio makes them easier to trade psychologically. You might get your teeth kicked in on the losers, but, fortunately, big losses do not happen very often. Also, if trading a basket of markets, as one should with a volatility breakout system, diversification should help smooth out the larger losses.

To summarize the main benefits of trading a breakout system:

  •     it teaches proper habits, in that there is always a well-defined stop;
  •     you get lots of practice executing trades;
  •     it teaches the importance of taking every trade;
  •     it teaches respect for the trend.
Additional Considerations when using Breakout Strategies
  •     overall average daily trading range (must be high enough to ensure wide “spread”);
  •     volume and liquidity;
  •     seasonal tendencies (e.g., grains are better markets in spring and summer);
  •     relative strength;
  •     commercial composition.

Wednesday, April 25, 2012

ID/NR4 Pattern = April 24 in SPX

See also 
Toby Crabel's ID/NR4 Pattern = Trend-Continuation or Short-Term Breakout Set-up

An NR4 is a trading day with the narrowest daily range of the last four days. An ID or inside day has a higher low than the previous day’s low and a lower high than the previous day’s high. Combining the two conditions sets up an ID/NR4 day.

ID/NR4 pattern idnr4

Toby Crabel’s initial approach suggested a day-trading strategy following this setup (link). However, our research suggests that the trade should be held longer than one day.

In the breakout mode we can’t predict the direction in which we are going to enter the trade. All we can do is predict that there should be an expansion in volatility. Therefore, we must place both a buy-stop and a sell-stop in the market at the same time. The price movement will then “pull us into” the trade.
Here are the rules:
  1. Identify an ID/NR4.
  2. The next day only, place a buy-stop one tick above and a sell-stop one tick below the ID/NR4 bar.
  3. On entry day only, if we are filled on the buy side, enter an additional sell-stop one tick below the ID/NR4 bar. This means that if the trade is a loser, not only will we get stopped out with a loss, we will reverse and go short. (The rule is reversed if initially filled on the short side.)
  4. Trail a stop to lock in accrued profits.
  5. If the position is not profitable within two days and you have not been stopped out, exit the trade MOC (market on close.) Our experience has taught us that when the setup works, it is usually profitable immediately.
Here are a few examples.

ID/NR4 pattern idnr4 2
  1. An ID/NTR4 day. Tomorrow, we will place a buy-stop one tick above today’s high and a sell-stop one tick below today’s low.
  2. We are filled on the sell side. A second buy-stop order is placed one tick above yesterday’s high in case of a reversal.
  3. This type of sell off is fairly rare (18 points in five trading sessions!), but they are the reason to trade this setup.This strategy gives you small gains and small losses, eventually producing a setup such as this one.
ID/NR4 pattern idnr4 3
  1. The range of the S&P bar on March 9, 1995, is the smallest range mi four days and is an inside bar.
  2. Our buy-stop is placed at 488.20 (one tick above the previous day’s high) and is triggered on the opening at 488.50. The sell-stop placed at 486.10 (one tick below the previous day’s low) is doubled in size in case of a reversal. As you can see, the market explodes, closing at 495.00, up 6.50 points from the opening. As
    this position becomes more profitable throughout the day, a trailing stop should be used to lock in the profit.
  3. The market rises steadily over the next week. Our position has a healthy 10+ point profit, bringing us to another ID/NR4 setup on March 20. (For simplicity’s sake, let’s assume that we locked in our profits from March 10, 1995 and are flat.)
  4. This type of setup happens from time to time and is a good example of what you can occasionally expect.
  • ID/NR4 setup
  • Buy-stop filled at 500.75
  • Sell-stop and reversal sell-stop filled at 498.90
  • Next day (two days after the setup) the market closes .45 points above our sell point. The position is closed out.
  • The loss from the March 20,1995 setup is approximately 2.25 points plus
    slippage and commission.
If you trade this strategy and most other strategies in this manual, you must get used to this type of trade. As we mentioned in the previous example, this setup pattern often makes and loses small amounts of money, and occasionally you will get a trade that explodes, such as the one that occurred on March 10, 1995.

ID/NR4 pattern idnr4 4
  1. An NR4 inside day.
  2. A sharp 10 percent two-day sell-off.
ID/NR4 pattern idnr4 5
  1. An NR4 inside day.
  2. The breakout is to the upside. As you can see, the market opens on its low and doses on its high. You will often see this type of pattern from this setup.
  3. A trailing stop will ensure locking in profits as the position corrects itself. Also, notice how the market rallies a few days later. Unfortunately, we will miss these occasional moves to assure capturing the one to four day profits.  

“Street Smarts: High Probability Short-Term Trading Strategies” by Laurence A. Connors, Linda Bradford Raschke

LARRY: The reason to trade this strategy is because the losses are small, and occasionally a big winner will fall into your lap.
LINDA: The typical “GO FISH strategy! Keep dropping your pole in the water and once in awhile you’ll catch a big one.
LARRY: Yes. It’s also important for traders to realize the importance of stopping and reversing on a same-day whipsaw, because often that “big one” follows a “fakeout” losing trade.
LINDA: It’s amazing how sometimes the best trades occur after one group of market participants has been trapped. They’ll later become fuel for the fire when their losses deepen. It definitely takes a certain amount of fortitude to trade breakouts.
LARRY: Even if a trader chooses to skip trading patterns like these, it is vitally important to be aware of an initial low-volatility, range-contraction setup- At the very least, never try to trade against moves exploding out of these points. Better just to let the day go if you don’t feel comfortable climbing on board.
LINDA: That’s true. Many novice traders misunderstand swing trading as a license to buy weakness or sell strength. When a trend day comes along, they get their head handed to them. It is a sucker play because the initial low volatility creeping mode of a trend day lures people into thinking they can get by without a resting stop order in the marketplace. When the market starts to run away, it’s natural to freeze up. Almost every trader has experienced this. It is so important to identify the conditions when not to swing trade (i.e., low-volatility environments). Then we can work on capturing the breakout and learning how to jump on board this impulsive action.
LARRY: What other patterns from Toby’s book do you trade?
LINDA: One of the simplest concepts which I use regularly is Toby’s NR7. This represents the narrowest range of the last seven days. I automatically use this as a filter to switch to a breakout mode the day following an NR7. This means that I will not try to countertrend trade. Instead, I will try and enter the market in the direction it is

Monday, April 23, 2012

STD Green Week (April 23-27)


Tony Caldaro (link): The decline from last weeks Intermediate wave B at SPX 1393 clearly looks like Intermediate wave C. Thus far, we have had a three wave decline to SPX 1370, which we labeled Minor A. Then a rally to SPX 1387, which we labeled Minor B. Minor C is underway now. As soon as the OEW 1363 pivot range, (1356-1370), fails, the steep part of this declining wave should be underway. We continue to look for a correction low between SPX 1300 and 1340, and ideally between 1313 and 1327. Short term support is at the 1363 pivot and SPX 1340, with resistance at the 1372 and 1386 pivots. Short term momentum is nearly back to neutral after getting extremely oversold.

Francis Bussiere (link): Moon in Capricorn Low near Monday the 23rd?
Moon 20 degree High near Wednesday the 25th?  
Moon in Taurus Low near Monday the 30th?
Moon in Leo High near Monday the 6th?

The dual Moon cycles work best from May to October when they are in phase, and historically this is the weakest period in the market.

Nikolai D. Kondratieff: The Static and the Dynamic Views of Economics

The Sixth Kondratieff

Nikolai D. Kondratieff - The Long Waves in Economic Life

Martin A. Armstrong (1989 + 2011): Long Wave Theory - Kondratieff Wave Already Bottomed?

Friday, April 20, 2012

Market & Solar Activity

Yesterday a rapid increase in Sunspots went along with the market's decline.

Geomagnetic forecast suggests weakness also for next Monday, April 23. 

Monday, April 16, 2012

Recent STD Red Weeks

April 16-17 major High - sharp decline into April 20-23 Low - rally into mid May 
(follow upper STD scheme)

David McMinn: The Sun, the Moon, and the Number 56.

Saturday, April 14, 2012

The Kondratieff Cycle And Subdivisions

The economic long wave is a boom and bust cycle driving the global economy, first discovered by Russian economist Nikolai Kondratieff in the 1920s. Kondratieff was researching debt, interest rate, production and prices when he discovered the economic long wave. The Long Wave Dynamics approach calculates the ideal Kondratieff long wave cycle as 56 years in length, but it can run long and short in Fibonacci ratios to the ideal length in time.

The current long wave is of the long variety and began in 1949. Current analysis suggests that the current K-wave will end in 2013, running eight years and a Fibonacci ratio of 14.5% longer than the ideal 56 years. 

The late renowned Harvard economist Joseph A. Schumpeter, author of the book Business Cycles; A Theoretical, Historical, and Statistical Analysis of the Capitalist Processbelieved that the economic long wave is the single most important tool for economic prognostication.

The current long wave is now in the Kondratieff Winter season. Most investors wish they had access to this long wave season chart in 2007. Every long wave has four seasons, just like a year. The approximate length of a long wave season is 14 years, but they can run short and long. Each season typically contains four Kitchin cycles with an ideal length of 42 months. However, long wave seasons can have fewer or more Kitchin cycles than the normal four.

The Kitchin Cycles: Harvard’s Joseph Schumpeter concluded that every long wave was made up of 18 smaller business cycles or Kitchin cycles. In more recent years, with more sophisticated charting technology and market analysis, the research conclusions of market analyst P.Q. Wall, that the long wave is make up of only 16 market cycles, has been validated. This is an essential distinction in cycle research.

Schumpeter’s model of how all the cycles worked together to produce long waves included Kitchin cycles (the regular business cycle of 3-5 years) and Juglar cycles (7-11 years), with three Kitchins in each Juglar. Schumpeter also wrote of the Kuznets cycles (15-25 years), but didn’t put them in the charts below. The chart depicts the flow of the Kitchin and Juglar cycles integrated in 56-year long wave cycles. Note that Schumpeter’s model presented 18 business cycles in a regular long wave. See: schumpeter_business_cycles.pdf
Market cycles differ from business cycles in that they are identified on an index chart, and not necessarily in the economic data as a business cycle. However, they often correlate to the regular business or trade cycle. Every long wave appears to be made up of 16 market “Kitchin” cycles.

Chart 15.2 Kitchin Cycles Since 1982
The chart above demonstrates our count of the 15 Kitchin cycles that have come and gone in the current long wave since 1949 using stochastics. We are currently in cycle number 16, with its expected conclusion in the year 2013.

The 16 Kitchin cycles that make up a long wave are ideally 42 months in length, but they are rarely ideal and fluctuate in length both short and long, often in Fibonacci ratios of their ideal length in time. In each Kitchin Cycle there are ideally 36 dips or 36 Hurst "5 week" lows.

The Kitchin Third: The ideal Kitchin cycle is 42 months or 1277.5 days in length, the ideal Kitchin Third is 14 months or 425.83 days. A Kitchin cycle is made up of 9 Wall Cycles, therefore each Kitchin Third is made up of three Wall Cycles. PQ Wall had a general rule of third last and weakest. This goes for the final Kitchin Third in a Kitchin Cycle, but also goes for Wall Cycle #3, #6, and #9, or the final Wall Cycle in each Kitchin Third. The Kitchin Cycle often unfolds in the three Kitchin Third sections, but the Kitchin Third is not typically as distinct as the other cycles.

Kitchin 3rds
The chart displays the full Kitchin cycle #14 in this long wave, which began on September 1, 1998 and ended on October 10, 2002. This Kitchin cycle, like most in the current long wave, ran long. Therefore, the Wall cycles and Kitchin 3rds also ran longer than ideal. The nine Wall cycles and three Kitchin 3rds are all clear in this Kitchin cycle
Schumpeter’s model of how all the cycles worked together to produce long waves included Kitchin cycles (the regular business cycle of 3-5 years) and Juglar cycles (7-11 years), with three Kitchins in each Juglar. Schumpeter also wrote of the Kuznets cycles (15-25 years), but didn’t put them in the charts below. The chart depicts the flow of the Kitchin and Juglar cycles integrated in 56-year long wave cycles. Note that Schumpeter’s model presented 18 business cycles in a regular long wave.

The Wall Cycle (aka 20-Week Cycle):  The Wall cycle is the ideal trader’s cycle. Accurate technical analysis of the Wall cycle is essential for stock market traders. If you divide the ideal 56 year long wave by 144 you have the ideal Wall cycle. The mathematical relationship of these cycles indicates the Wall cycle is a miniature long wave. The approximate 20 week cycle (141.9 days) fluctuates short and long by Fibonacci ratios to the ideal length.
Wall Cycle
The chart presents the Wall cycle that ran from July 8, 2009 to February 5th 2010. The Wall cycles are currently expected to be running long due to government stimulus and aggressive monetary policy. If the ideal Wall cycle is 141.9 days, then an exact 50% extension of that is 212.85 days. July 8, 2009 plus 212.85 days is February 5th, 2010.

The Quarter Wall Cycle (aka Trader’s Cycle)

Quarter Wall Cycle
This chart is an example of the four Quarter Wall cycles in a Wall cycle in the DJIA and 8,5,5 stochastics. This is the Wall cycle that ran from October 10, 2002 until March 12, 2003. Tracking the Quarter Wall cycle is of critical importance for traders.
As the name implies, the Quarter Wall cycle reflects that the Wall cycle tends to unfold in four sections, or Quarter Wall cycles. The Quarter Wall cycle is a mini version of the long wave season. The ideal Quarter Wall cycle fluctuates in Fibonacci ratios in time relative to its ideal length of 35.475 days.The Quarter Wall is the critical cycle for traders.  Just like the other cycles, the Quarter Wall will run short and long relative to the ”ideal” in Fibonacci ratios in time. The forecasting power of the Quarter Wall forecasting tool is often startling.

"There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our ventures."

 William Shakespeare

"By the Law of Periodical Repetition, everything which has happened once must happen again, and again, and again - and not capriciously, but at regular periods, and each thing in its own period, not another’s, and each obeying its own law … The same Nature which delights in periodical repetition in the sky is the Nature which orders the affairs of the earth. Let us not underrate the value of that hint."

Mark Twain