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Trading Triads: Unlocking the Secrets of Market

Structure and Trading in any Market
By Felipe Tudela
© Felipe Tudela

Notes

1. George Douglas Taylor, The Taylor Trading Technique, Traders Press, 1950. In
his book, the author tells how he actually traded market swings for short-term
profits. He offers us a glimpse of market structure as the foundation of swings.
2. Wyckoff is aware that each stock has its own personality. He says, ‘Stocks have
habits and characteristics which are as distinct as those of human beings or
animals. By a close study the trader becomes intimately acquainted with these
habits,’ and then he says that the ‘moods’ of the stocks should be studied. For
Wykoff, stocks can be ‘leaders’ or ‘followers,’ ‘stubborn,’ ‘aggressive,’ etc.
(Rollo Tape (R. D. Wyckoff), Studies in Tape Reading, 1910, Fraser Publishing
Co., 1987).
3. In his Trading Courses, Gann teaches the Gann swings, such as the ‘Three Day
Chart Swing.’ They are based on counting a selected minimum number of up
days with higher highs and higher lows to define ascending swings or a selected
minimum number of down days with lower highs and lower lows (see ‘Rule for
Keeping up 3-Day Chart,’ in W. D. Gann, 45 Years in Wall Street, Lambert Gann
Publishing Co., 1976, p. 63).
4. Rhea systematized Dow theory. He gives the designation of ‘hypothesis’ to the
main three postulates of Dow theory. Additionally, he added twelve theorems to
the three basic postulates (Robert Rhea, The Dow Theory, Fraser Publishing Co.,
1993, 12).
5. Both fundamental and technical analyses encompass the market. Fundamental
analysis deals with value, whereas technical analysis deals with price. However,
for trading, technical analysis beats fundamental analysis. The reason is that
technical analysis provides the best timing tool. A stock with strong fundamentals
can stay in the same price range for years without significant gains for the investor.
The way to avoid this is to use technical analysis. This was the experience
of Schwartz, who lost at playing the markets while he worked as a securities
analyst. This caused him to react, distancing himself from fundamental analysis
and recognizing that technical analysis afforded a much greater probability of
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winning. From then on, he became a trader using mainly technical analysis
and market timing tools (Martin Schwartz, Pit Bull, Lessons from a Wall Street
Champion Trader, HarperCollins, 1998, pp.16, 23).
Technical analysis does give false signals, but the same is true of fundamental
analysis. Dreman explains the reasons for these failures. What is little known is
that the forecast error of fundamental analysis ‘as a percent of reported earnings’
was in the range of 44 % for the 1991–1996 period (David Dreman, Contrarian
Investment Strategies: The Next Generation, Simon & Schuster, 1998, pp. 91,
92).
6. Thrust has been used by many master traders, such as Bayer, Livermore, Wyckoff,
or Gann, but it is Dunnigan who gives ‘thrust’ its full importance and scope in
trading (William Dunnigan, New Blueprints for Gains in Stocks and Grains, FT,
Pitman Publishing, 1997, p. 122)
7. The mean swing was calculated by adding the lengths or sizes of a set of swings
and dividing the total by the number of swings in the set. The median swing is
the value in the middle of a set of swings that have been arranged in ascending
or descending order of size. The mode swing is the swing size that occurs most
frequently in a given set of swings.
Sperandeo is a good example of a master trader for whom the study of the
fluctuations in price and time of each market, combined with measures of central
tendency, has been important. Before buying gold in October 1999, he studied
the time/price history of this market since 1981. He measured and tabulated all
movements that had durations of three weeks to three months. He found 18 such
movements. Measurements of these movements were: minima, 9.4 %; maxima,
68.8 %; and median, 15.2 % (see Victor Sperandeo, Trader Vic – Methods of a
Wall Street Master, JohnWiley & Sons, Inc., 1994, p. 172).
8. For Gann, the time/price ratio is essential, with time more important than price.
He tells us, ‘Time is the most important factor of all,’ and, ‘The time factor
will overbalance both Space and Volume’ (W. D. Gann, How to Make Profits in
Commodities, Traders Press, 1976, p. 56).
9. The White House, following the advice of Paul Volcker who was Chairman of the
Fed at the time, announced on 15 April 1980, a package of credit controls to curb
the double-digit inflation. This unprecedented measure caused the economy to
plunge and President Carter to lose the election. This was a Signature announcing
the Reagan era and the end, at least for a time, of Keynesianism as the main
foundation of economic policy in the US.
10. According to the nineteenth century French economist Bastiat, we only see the
first effect, but the chain of effects that follows is unseen. Therefore, the unknown
factors, invisible to us, are the most important ones. If we apply this principle
to our twenty-first century traders and investors, what they actually know is
minimal compared to the unknown factors behind the market scene (Fréderic
Bastiat, What Is Seen and What Is Not Seen, 1850).
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11. See note 10 on Fréderic Bastiat and the invisible chain of effects. Once more,
when trying to understand the mind of the market participants, we are confronted
by the invisible realm of the markets.
12. Triads are helpful in trading any kind of pattern. One of the best books on
patterns is the classic by Richard W. Schabaker, Technical Analysis and Stock
Market Profits, FT, Pitman Publishing, 1997. In it is an in-depth study of patterns.
Schabaker’s book is the source that Edwards and Magee used for their book on
TA. An excellent up-to-date manual is Thomas N. Bulkowski, Encyclopedia of
Chart Patterns, John Wiley & Sons, Inc., 2005.
13. See note 8.
14. Ted Warren, How to Make the Stock Market Make Money for You, Buccaneer
Books, 1994.
15. Boucher explains why vehicle selection is best. Vehicle selection beats market
timing by 10 to 1 and profits come mainly from vehicle selection (see Mark
Boucher, ‘Stock Selection 20,’ in The Science of Trading, IRA, 1996, and also
Mark Boucher, The Hedge Fund Edge, John Wiley & Sons, Inc., 1999).
16. Jesse Livermore constantly insists on the need to study general conditions (see
Edwin Lefèvre, Reminiscences of a Stock Operator, John Wiley & Sons, Inc.,
1994, p. 69). For Gann, the first rule is to determine the trend of the general
market (see W. D. Gann, 45 Years in Wall Street, Lambert Gann Publishing Co.,
1976).
17. Contrary to the current belief, Keynes, in fact, lost heavily in the markets. He
was almost wiped out in the 1929 crash. This was due to his flawed economic
thinking. He was not able to predict either the crash or the Great Depression
at a time when the Austrian economists already knew that the New Era Boom
was about to end. For a complete explanation see Mark Skousen, The Making
of Modern Economics: The Lives and Ideas of the Great Thinkers, ME Sharpe,
2001. Mark Boucher uses Austrian School economics plus market timing to
trade the markets. Austrian economics enabled him to anticipate moves in his
trading portfolios. His Midas fund had many years of above average returns. See
the chapter on Austrian Alchemy in his course, The Science of Trading, IRA,
1996.
18. Gann’s Rule 2 for trading stocks is: ‘Buy at Single, Double and Triple Bottoms’
(W. D. Gann, 45 Years in Wall Street, Lambert Gann Publishing Co., 1976, p. 7).
19. When explaining rule 2 for trading stocks, Gann explains why the Triple Bottoms
or Triple Tops are the strongest. About the Triple Top or Bottom, he says, ‘This
is often the safest place to buy or sell because the market moves away from a
Triple Top or a Triple Bottom much faster’ (W. D. Gann, 45 Years in Wall Street,
Lambert Gann Publishing Co., 1976, p. 8).
20. About tape reading, R. D. Wyckoff says, ‘It is not trading on chart indications
or by other mechanical methods,’ and he defines tape reading as, ‘The science
of determining from the tape the immediate trend of prices.’ He gives us Swing
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Trading Secret Tape Readers Used: Determine ‘The Immediate Trend.’ Trading
market fluctuations must be done only when the market provides a clear indication
that a trend is on (see Rollo Tape (R. D. Wyckoff), Studies in Tape Reading, 1910,
Fraser Publishing Co., 1987, pp. 9, 10).
21. In Gann, we find rules for buying market fluctuations based on their numbers.
Some of his rules for buying stocks are: ‘Rule 3. Buy and Sell on Percentages.’
He mentions buying or selling on the following percentage numbers: 3 to 5 %,
10 to 12 %, 20 to 25 %, 33 to 37 %, 45 to 50 %, 62 to 67 %, 72 to 78 %, and
85 to 87 %. Then he adds, ‘The most important resistance levels are 50% and
100 % and the proportional parts of 100%.’ ‘Rule 6: Buy or Sell on 5 to 7 Point
Moves.’ In Rule 6, he tells us to watch for reactions of 5 to 7 points, 9 to 10
points, 10 to 12 points and 18 to 21 ‘points up or down from any important Top
or Bottom’ (W. D. Gann, 45 Years in Wall Street, Lambert Gann Publishing Co.,
1976, pp. 8, 9).
22. Many successful traders use a 3:1 risk/reward ratio. One of them is Sperandeo
(see Victor Sperandeo, Trader Vic – Methods of a Wall Street Master, John Wiley
& Sons, Inc., 1994, p. 25).
23. The stops that Gann used came from observing the history of market fluctua-
tions and learning to place the stop where the market could not touch it if the
trade was correct. He said, ‘As a rule, when you buy or sell grain and it goes
against you, 3 to 5 cents, you are wrong and you may as well get out.’ He
added, ‘See how far advancing markets have run and how small their rallies
have been’ (W. D. Gann, How to Make Profits in Commodities, Traders Press,
1976).
24. Gann was an advocate of studying market history as the biggest help for a
trader. He said, ‘Nothing will help you more than going over the past history of
commodities, studying its actions under different periods ’ (W. D. Gann, How
to Make Profits in Commodities, Traders Press, 1976, p. 1).
25. Gann emphasizes the need for ‘long years of study and research.’ He places
‘knowledge’ and ‘hard work’ above all else as the key to success in trading. He
says, ‘There is only one key ( ) and that key is KNOWLEDGE.’ He also says,
‘Without knowledge, money is worthless’ (see W. D. Gann, How to Make Profits
in Commodities, Traders Press, 1976, p. 3).
26. For Jesse Livermore, as well as for W. D. Gann, overtrading is a trader’s worst
mistake. Overtrading must be avoided at any cost. The second rule of Gann’s
well-known ‘Twenty Four Never Failing Rules’ says, ‘Never overtrade.’ Wyckoff
tells us that lack of capital in Wall Street is caused by ‘overtrading’ and he
brings forward the epigram, ‘Overtrading is financial suicide.’ This is a common
belief among all successful traders (see W. D. Gann, How to Make Profits in
Commodities, Traders Press, 1976, p. 16, and Rollo Tape (R. D. Wyckoff),
Studies in Tape Reading, 1910, Fraser Publishing Co., 1987, p. 23).
27. See note 22.
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28. Livermore used to trade between 8 and 12 stocks. These stocks were from four
sector groups. This means that he used to follow two to three stocks per group
(Jesse Livermore, How to Trade in Stocks, Traders Press, 1991, p. 35, and Edwin
Lefèvre, Reminiscences of a Stock Operator, John Wiley & Sons, Inc., 1994,
p.182). Steward also advised during the 1950s to have between 8 and 12 stocks
(Cliff Steward, Magic of Making Money in the Stock Market, Sacred Science
Library, 2003, p. 30). Gann, in his rules, suggests trading four or five stocks (W.
D. Gann, 45 Years in Wall Street, Lambert Gann Publishing Co., 1976, p. 16).
29. Jesse Livermore added, after the initial position, each new lot after a one-point
rise (Edwin Lefèvre, Reminiscences of a Stock Operator, John Wiley & Sons,
Inc., 1994, p. 84). Steward, in 1951, advised traders to add after a rise of 3 to
5 points in stocks under $25 or 5 to 7 points in stocks over $25 (Cliff Steward,
Magic of Making Money in the Stock Market, Sacred Science Library, 2003, p.
10).
30. William Dunnigan, John Crane, Tom DeMark, W. D. Gann, and Jesse Livermore
are authors and traders who base their perspectives on market structure and not
on indicators. This is the reason why their market understanding and trading
setups really do work and are excellent trading tools. These authors should be
studied in depth by all market students.
31. Rashke advises new traders to first specialize in mastering one pattern only (see
Laurence A. Connors and Linda Bradford Raschke, Street Smarts, M. Gordon
Publishing Group, 1995, p. 2).
32. The difference between the Apollo projects and the Shuttle projects is illus-
trative of deficient testing – the result of not asking the questions, the an-
swers to which would protect against worst-case scenarios. Jim Longuski, an
Aerospace engineer, who worked for the Jet Propulsion Laboratory, tells us how
the Apollo engineers asked ‘what if’ questions about all of the worst case sce-
narios and that the answers were taken into account in the planning of Apollo
missions. This was not the case, he tells us, with the Shuttle missions, where
many important ‘what if’ questions were left ‘unanswered or poorly answered.’
This illustrates the difference between good planning and bad planning and
the consequences in reality. The same thing can be said of trading, for which
we must plan in advance for any adverse event that could occur before even
thinking of ‘launching’ our prototype in real trading. For the NASA exam-
ple, see Jim Longuski, Think Like a Rocket Scientist, Copernicus Books, 2007,
pp. 51–53.
33. Among the best trading psychology books today are: Mark Douglas, The Dis-
ciplined Trader, NYIF, 1990, Ari Kiev, Trading to Win: The Psychology of
Mastering the Markets, John Wiley & Sons, Inc., 1998, and Van K. Tharp, Trade
Your Way to Financial Freedom, McGraw-Hill, 2006.
34. When you have a losing trade, a way to recover from the emotional impact is
to review the trading statistics and also put down on paper all of your feelings
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and thoughts, negative and positive. This can be combined with a period of silent
meditation to detach yourself from your emotions and negative thoughts.
35. Some good money management and asset allocation books are: Ralph Vince,
The New Money Management, John Wiley & Sons, Inc., 1995, Nauzer J. Balsara,
Money Management Strategies for Futures Traders, John Wiley & Sons, Inc.,
1992, and Fred Gehm, Quantitative Trading and Money Management, Irwing,
1995.
36. See note 22.
37. See note 32.