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THE POWER OF
GROWTH STOCKS
Use this power calculation
to measure the strength of
a growth stock 8

THE SWING RULE

Project price targets using
this little-known pattern 14

TRUNCATED
INDICATORS
Improve how well cycle
indicators reflect price 20

USING SCALING LAWS

For FX trading models:
extending the concept 24

INTERVIEW
Jay Kaeppel 30

CHASING VOLATILITY
Beware the fear of
missing out 38
JULY 2020
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 CONTENTS JULY 2020, VOLUME 38 NUMBER 8

FEATURE ARTICLE columnist, where he shares his

8 The Power Of Growth Stocks know-how of option trading with
The Traders’ MagazineTM by Andreas A. Aigner, PhD, readers. He has also contributed
& Walter Schrabmair many articles to this magazine since
How can you measure the strength 1999. Kaeppel is the author of four
EDITORIAL
[email protected] of a growth stock? Can this be books on trading, and he also offers
quantified? Here’s a way to help regular market commentary on his
Editor in Chief Jack K. Hutson
measure it using concepts from website, JayOnTheMarkets.com.
Production Manager Karen E. Wasserman
digital signal processing. S&C Contributing Writer Leslie
Art Director Christine Morrison
Masonson wanted to know more.
Graphic Designer Wayne Shaw
Webmaster Han J. Kim 14 The Swing Rule
by Thomas Bulkowski 36 Dual-Candle Breakouts
Contributing Editors John Ehlers,
Anthony W. Warren, PhD. Here’s a technique that looks for a by Ken Calhoun
Contributing Writers Thomas Bulkowski, Martin Pring, particular pattern of price swings to Simply buying into an uptrend
Barbara Star, Markos Katsanos, Leslie N. Masonson,
project a price target as the exit. in isolation often leads to false
Karl Montevirgen breakouts. Instead, you may find
18 Futures For You more success if you scan for dual-
OFFICE OF THE PUBLISHER
by Carley Garner candle breakout patterns. Here’s
Publisher Jack K. Hutson
Here’s how the futures market how to find them.
Industrial Engineer Jason K. Hutson
Project Engineer Sean M. Moore really works.
37 Algo Q&A
ADVERTISING SALES 20 Truncated Indicators by Kevin J. Davey
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Last time, we looked at how scaling
Dividend Payers?
by Leslie N. Masonson
laws can be used to predict the
Author­i­za­tion to pho­to­copy items for inter­nal or per­sonal
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INTERVIEW by Jay Kaeppel
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 The editors of S&C invite readers to submit their opinions and information on subjects J(0),
K(0),
relating to technical analysis and this magazine. This column is our means of communi- TempPrice(0),
cation with our readers. Is there something you would like to know more (or less) about? TempRank(0),
Tell us about it. Without a source of new ideas and subjects coming from our readers, this Sum(0),
magazine would not exist. Signal(0);

Email your correspondence to [email protected] or address your correspondence Arrays:
to: Editor, Stocks & Commodities, 4757 California Ave. SW, Seattle, WA 98116-4499. All PriceArray[50](0),
letters become the property of Technical Analysis, Inc. Letter-writers must include their full Rank[50](0);
name and address for verification. Letters may be edited for length or clarity. The opinions For count = 1 to Length Begin
expressed in this column do not necessarily represent those of the magazine.—Editor PriceArray[count] = Close[count - 1];
Rank[count] = count;
End;
For K = 1 to Length Begin
CORRELATION AS A TREND INDICATOR Nonetheless, for the sheer fun of it, I count = Length + 1 - K;
Editor, coded the popular Spearman ranking For J = 1 to Length - count Begin
John Ehlers’ May correlation equation as an indicator If PriceArray[J + 1] < PriceArray[J]
Then Begin
2 0 2 0 a r t icle, using a bubble sort to do the price TempPrice = PriceArray[J];
“Correlation As A ranking. The code listing provides the TempRank = Rank[J];
Trend Indicator,” EasyLanguage for this indicator. PriceArray[J] = PriceArray[J + 1];
Rank[J] = Rank[J + 1];
was straightfor- The chart in Figure 1 shows the
PriceArray[J + 1] = TempPrice;
ward and easy to comparison of the original Pearson Rank[J + 1] = TempRank;
follow. However, correlation and the shorthand Spear- End;
when I went to look man ranking indicator, using a 20-bar End;
End;
up more details about the Spearman correlation period in both cases. Obvi- Sum = 0;
correlation formula, I found that when ously, the Pearson correlation produces For count = 1 to Length Begin
one of the variables is linear, like in this a smoother indicator on an apples-to- Sum = Sum + (count -
Rank[count])*(count - Rank[count]);
case, it is really the Pearson correlation, apples basis. An alternative interpreta- End;
and this is the formula used for the code tion could be that the Spearman ranking Signal = 2*(.5 - (1 - 6*Sum /
given in the article. The Spearman cor- indicator is more responsive to nonlinear (Length*(Length*Length - 1))));
relation formula is different. It measures price moves. Both approaches have a
Plot1(Signal);
monotonic relationships. It uses rank finite impulse response, and so the group Plot2(0);
order of raw variable values to come up delay of both is approximately half the
with its results rather than actual raw correlation period.
variable values, like the closes. Just to mention it, the Kendall correla-
Code listing: Spearman Rank Indicator
I would appreciate it if John Ehlers { tion is another type of ranking correla-
could expand and contrast between the Spearman Rank Indicator tion but it has no particular advantage
two methods, how significant the differ- (C) 2013-2020 John F. Ehlers as a technical indicator.
}
ence in results might be for the same set
of raw data, and which would be better Inputs: Editor’s note: Subscribers can find this
for our use. It obviously is easier to use Length(20); code in the article code section of our
raw data directly than to have to rank it website, Traders.com.
Vars:
first. But I’m wondering if the ranked data count(0),
might give a smoother indicator? Would
the indicator lag be the same?
Don Kraska

Author John Ehlers replies:

You are correct that the Spearman cor-
relation devolves into a Pearson corre-
lation when one of the inputs is linear.
There is a popular equation used for
ranking for the Spearman correlation,
but it carries the constraint that there
can be no tied ranks. In sampled market
TRADESTATION

data, we cannot guarantee there are no

ties in ranking—in fact, it is likely that
there are. FIGURE 1: COMPARISON OF PEARSON CORRELATION AND SPEARMAN RANKING INDICATORS

6 • July 2020 • Technical Analysis of Stocks & Commodities

THE 1ST AND 2ND CROSS vestment end
else investment = stockinvestment; else if marketposition < 0 and trend < 0
Editor, end; and mom < selltarget then begin
I have a quick buy to cover ("SPT") all shares next
question regarding if usefutures then size = investment/(avgtr bar on open;
uerange(20)*bigpointvalue); end;
Perry Kaufman’s else size = investment/close;
wonderful article totalpl = netprofit + openpositionprofit;
fasttrend = average(close,fastperiod); todayPL = totalPL - totalPL[1];
titled “The 1st and slowtrend = average(close,slowperiod); if psignal > 0 then longPL = longPL +
2nd Cross” (March osc = fasttrend - slowtrend; todayPL
2020 S&C). In the mom = TSM_Stochastic_ else if psignal < 0 then shortPL = shortPL
SlowK(osc,osc,osc,oscperiod); + todayPL;
article, Mr. Kauf- psignal = marketposition;
man describes an oscillator value based // trend changes, reset both crosses
if fasttrend crosses above slowtrend then // print PL
on the difference of the fast and slow begin if printPL then begin
moving averages. firstcross = true; adate = ELdatetostring(date);
In the section of his article titled “Us- secondcross = false; if currentbar = 1 then begin
trend = 1; print (file("c:\tradestation\2nd_Cross_PL.c
ing stochastic bands,” he writes that “We end sv"),"Date,size,marketposition,openPL,lon
can create multiple crosses by applying else if fasttrend crosses below slowtrend gPL,shortPL,netPL");
a slow-K stochastic to the momentum then begin print (file("c:\tradestation\2nd_Cross_De-
firstcross = true; tail.csv"),"Date,Open,High,Low,Close,Fas
value osc.” My question is, what is the secondcross = false; tMA,SlowMA,",
formula used to apply a stochastic to trend = -1; "Osc,Mom,Trend,1stCross,2ndCross,siz
end; e,marketposition,openPL,longPL,shortP
that calculated osc value? I don’t quite L,netPL");
understand how to calculate that, since // when first cross goes back above 50 end;
osc is not a series value. If more infor- change to second cross
if firstcross = true then begin print (file("c:\tradestation\2nd_Cross_
mation is needed for my question, please if trend > 0 and mom[1] < 50 and mom PL.csv"),adate, ",", currentcontracts:5:0,
let me know. >= 50 then begin ",", marketposition:4:0, ",", open-
Thanks a lot—love the magazine and firstcross = false; positionprofit:8:0, ",", longPL:8:0, ",",
secondcross = true; shortPL:8:0, ",", totalPL:8:0);
look forward to reading it each month. end print (file("c:\tradestation\2nd_Cross_De-
Paul Johnson else if trend < 0 and mom[1] > 50 tail.csv"),adate,",", open:8:4, ",", high:8:4,
and mom <= 50 then begin ",", low:8:4, ",",
firstcross = false; close:8:4, ",", fasttrend:8:4, ",",
Author Perry Kaufman replies: secondcross = true; slowtrend:8:4, ",", osc:8:4, ",", mom:8:4,
Here are the formulas: end; ",",
end; trend:5:0, ",", firstcross, ",", second-
Osc = fastMA - slowMA cross, ",", currentcontracts:5:0, ",", arket-
// test signals on second cross position:4:0, ",",
Stoch(t) = (osc(t) - lowest(osc,n))/
if secondcross then begin openpositionprofit:8:0, ",", longPL:8:0, ",",
(highest(osc,n) - lowest(osc,n)) if trend > 0 and mom < momlow then shortPL:8:0, ",", totalPL:8:0);
SlowK = average(stoch,3) begin end;
where t is today, n are bars back, and buy size shares next bar on open;
secondcross = false;
slowK is the 3-day average of stoch. end Editor’s note: Subscribers can find this
I will also provide this formula in the else if trend < 0 and mom > code in the article code section of our
form of the following EasyLanguage momhigh then begin website, Traders.com.
sell short size shares next bar on
code: open;
secondcross = false; ON-BALANCE VOLUME MODIFIED
// TSM 2nd cross end;
// Copyright 2020, P.J. Kaufman. All rights end;
(OBVM)
reserved. Editor,
// This strategy tries to profit from the // exit if trend changes I’ve been trading
second pullback after a new trend if marketposition > 0 and trend < 0 then
begin my own f unds
inputs: fastperiod(10), slowperiod(40), sell ("LTRrev") all shares next bar on for the past seven
oscperiod(5), momlow(10),momhigh(90), open; years, mostly using
buytarget(50), selltarget(50),usefu firstcross = true;
tures(false), printPL(true); end technical analysis.
vars: firstcross(false), secondcross(false), else if marketposition < 0 and trend > 0 I just wanted
then begin
fasttrend(0),slowtrend(0), trend(0),
buy to cover ("STRrev") all shares to thank Vitali
osc(0), mom(0), osctrend(0), size(0),
stockinvestment(10000), next bar on open; Apirine for his ar-
futuresinvestment(25000), invest- firstcross = true; ticle in the April 2020 issue on OBVM.
end;
ment(0), adate(" "), totalPL(0),
I have implemented OBVM in my trad-
todayPL(0), longPL(0),
shortPL(0),psignal(0); // exit if mom target reached ing system and I really like the signals
if marketposition > 0 and trend > 0 and it is providing. I have been looking for
mom > buytarget then begin
if currentbar = 1 then begin
sell ("LPT") all shares next bar on
if usefutures then investment = futuresin-
open; Continued on page 56

July 2020 • Technical Analysis of Stocks & Commodities • 7

8 • July 2020 • Technical Analysis of Stocks & Commodities
 VALUE INVESTING

In The Footsteps Of Benjamin Graham

The Power Of Growth Stocks

How can you measure the strength of a growth stock? and E is the earnings forecast. Multiplying out ac-
Can this be quantified? Here’s a way to help measure cording to equation 1, you get a forecast for the price.
it using concepts from digital signal processing. Looking at this equation another way, it states that a

W
stock with zero growth has a P/E of 8.5 and the price
hen we think of growth stocks, we think of is equal to 8.5 times earnings. This lower bound of
stocks that consistently trend in price and 8.5 is what Graham deduced from the market; we
that outperform the market average. They will not further investigate this here.
usually pay no or next to no dividend, as We can produce a five-year forecast of price by tak-
they save up earnings to expand their business ventures ing the five-year growth forecast (G) averaged over all
through development or aggressively buying out other analysts covering the stock and the five-year earnings
businesses to consolidate or vertically integrate. By forecast (E) by linearly interpolating between last year,
investing in this type of stock, you expect to profit current year, and next year earnings expectations.
from above-average market returns through price Calculating this across a set of ~2,253 US stocks, we
appreciation only. obtain price forecasts and can therefore calculate the
Benjamin Graham’s 1962 book Security Analysis annualized % returns for all stocks, which we will
contains a chapter titled “Newer Methods For Valuing subsequently just refer to as “growth.”
Growth Stocks” that offered a method to forecast the
annualized growth in stock price based on its earn- Power
ings and growth expectations. This gives us a good Growth stocks trend more than non-growth stocks.
starting point to categorize growth stocks, but how If the stock price is constant, there is no trend and no
do you verify the growth using the stock price alone? growth. If the trend is a straight line, we would expect
Can we prove that Graham’s formula corresponds to the trend to measure a constant. In physics, there is a
high-growth stocks? concept called power, which in digital signal process-
In this article, we will derive such a measure. We ing is applied to discrete signals. There, the power for
will present Graham’s formula, derive a formula to periodic signals is defined as the average energy over
measure the growth/trend, and finally, we will show a period and is given by this formula:
some results of how to improve upon Graham’s for-
1 N–1
mula using a new indicator, which we call the power
of a stock.
Power N =
N n=0 n Σ ⎢P ⎥
2
Equation 2

The absolute value of the signal P is taken but since

Growth our signal is not complex we could just drop it here.
Graham suggests that the “intrinsic value” of a stock We won’t discuss here what the energy of a stock rep-
is calculated by: resents, if it’s of finite or infinite length or aperiodic,
but this is certainly an interesting topic on its own.
P
(8.5 + 2 × G) × E = ×E Equation 1 We want to apply this estimate of power over a range
E
of N observations. It makes sense to look at changes
INGA POSLITUR

Here, G is the growth forecast in percentage points to an initial price Pj-N+1 (N-1 days ago) and normalize

by Andreas A. Aigner, PhD, & Walter Schrabmair

July 2020 • Technical Analysis of Stocks & Commodities • 9
FIGURE 1: LINEAR SIGNAL. This shows a stem plot FIGURE 2: SINUSOIDAL SIGNAL. This shows a stem
of a linear signal and its decomposition into signal plot of a sinusoidal signal and its decomposition into
and noise. signal and noise.

the signal by it. We therefore define a moving window of power signal processing,
(Power j) at each step in time j: and their decom-
position into signal FIGURE 3: SIGNAL & NOISE POWER RATIO, LINEAR
SIGNAL. This shows the signal and noise power ratio for
1 and noise. Figure 3 linearly increasing signals of slope 5, 10, and 20.
2
N–1
Pj–n
Power jN =
N Σ n=0 Pj–N+1 Equation 3 shows the result of
the power calculation for the case of linearly increasing func-
where Pj-0 is the last value of each moving window. tions with various slopes (5,10,20) plus some random noise
Next, we split the stock price into two components, signal of amplitude 0.1%. Figure 5 shows sinusoidal functions with
and noise: increasing amplitude (5,10,20) plus some random noise of
amplitude 0.1%. We have scaled power by a threshold, which
Price = Signal + Noise Equation 4 could be based off the intraday volatility, for example; its use
will become apparent later. Here, it is simply taken to be 0.1%
and define the signal to be the N-day moving average: of the signal, that is, the random noise. We also take the square
root since we want to arrive at a scale similar to the stock price
Signal = MA(P , N) = MA N Equation 5 again. You see the power ratio approaching a limit for the linear
signal and oscillating for the sinusoidal signal. You also notice
and define the noise to be the difference between the price that in all cases, the higher the amplitude or slope of the signal,
and signal: the higher the power measured is.
In Figure 4 and Figure 6 you see charts of the power ra-
Noise = P – MA(P , N) Equation 6 tios and actual values of signal versus noise. For the linear
signal, you see a linearly increasing signal because it is just
Hence, we can calculate the power of the signal: the moving average and you see the noise is constant. On the
right of Figure 4 you see both the signal and noise power ratio
MA j–n
N
1
2
N–1
PowerOfSignal Nj =
N Σ n=0 Pj–N+1
Equation 7

and the power of noise:

Pj–n – MA j–n
N
1
2
N–1
PowerOfNoise Nj =
N Σ n=0 Pj–N+1 Equation 8

We’ll look at two examples: a linear signal and a sinusoidal FIGURE 4: SIGNAL VS. NOISE, LINEAR SIGNAL. Here’s an example plot of signal
signal. Figures 1 and 2 show stem plots, as is usual in digital versus noise and the power ratios for a linear signal.

10 • July 2020 • Technical Analysis of Stocks & Commodities

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 FIGURE 6: SIGNAL VS. NOISE, SINUSOIDAL SIGNAL. This is an example plot of signal versus noise
and the power ratios for a sinusoidal signal.

Sharpe Ratio versus Signal & Noise Power Ratio

6.00
MA(50)

5.00 y = 1.5471x–2.6322 y = 0.63x - 1.3631

R2 = 0.305 R2 = 0.0846
MA(20)
4.00 MA(100)
y = 0.3095x - 2.2079
R2 = 0.1317

3.00 MA(50)
Sharpe Ratio

2.00
MA(20)
1.00
y = 0.0456x - 0.4057
R2 = 0.0034
MA(100)
-

(1.00)

(2.00)

(3.00)
0 5 10 15 20 25
Power Ratio

Signal 20MA Noise 20MA Linear (Signal 20MA) Linear (Noise 20MA)
Signal 50MA Noise 50MA Linear (Signal 50MA Linear (Noise 50MA)
Signal 100MA Noise 100MA Linear (Signal 100MA) Linear (Noise 100MA)

FIGURE 5: SIGNAL & NOISE POWER RATIO, SINUSOIDAL FIGURE 7: SHARPE RATIO AND POWER RATIOS. Here is a plot of the Sharpe ratio versus power ratios
SIGNAL. This shows a signal and noise power ratio for a sinu- for the 20-day, 50-day, and 100-day moving average power windows. Signal power ratios are colored in
soidal signal of amplitude 5, 10, and 20. grayscale and noise power ratios are colored in shades of brown, ranging from lightest (20) to darkest
(100).

are decreasing along a gentle slope (from top right to bottom We calculate the power ratios dividing by a threshold power,
left) as time passes. Also note that with a decreasing slope of which is defined by Wilder’s ATR (average true range), which
the linear signal, the signal & noise power ratio itself is also in turn is normalized by the last significant close (SIC), similar
decreasing. Figure 6 is a similar plot for the sinusoidal signal; to what we have done with the stock price in equation 3.
on the left you see signal and noise are tracing an ellipsoidal For a generic trend-following strategy to work best, you would
curve in space, as you would expect. On the right you see the select liquid names with high volume, preferably big cap and
noise power ratio staying fairly constant and the signal power larger stocks (market cap >= 300 bn USD), which is what we
ratio oscillating in a range horizontally. do here also. In addition, we also only look at stocks where
Graham’s formula (equation 1) forecasts a positive five-year
Results growth (>0). In order to evaluate the performance of this strategy,
We can apply J. Welles Wilder’s trend-following system (known we calculate the P&L and Sharpe ratio across all results using
as his Volatility System) to the set of ~2,253 US stocks over 100 three varying windows for the power calculation (20, 50, and
trading days and evaluate the performance of them with respect 100). They are plotted in Figure 7 depicting both the Sharpe
to the growth forecasts using Graham’s formula in equation 1. ratio versus the signal as well as the noise power ratio.
Plotting the linear regressions on top, there are several things
to note. All the linear regressions have a positive slope and
the 50-day moving average has the steepest slope of them all.
Higher power ratios lead to Furthermore, the slopes of the noise power ratios are steeper
drastically improved returns than the signal power ratios. The data turns positive around 2.5
for the noise power ratio and around 7.5 for the signal power
for all ranges of power ratio. Furthermore, we have Sharpe ratios that are largely
calculations. in excess of 1 and knowing that a buy-and-hold of the S&P
500 has a Sharpe ratio of around 0.5, this outperformance is
quite impressive.
12 • July 2020 • Technical Analysis of Stocks & Commodities
 before the big-, mid-, and small caps do. This lets us
believe that this power indicator is not only useful
in measuring and comparing “growth stocks,” but
that it can also give us insight into overall market
breadth and provides us a measure of the strength
of a trend overall.

Conclusion
In this article, we have shown that Benjamin Gra-
ham’s growth estimate for stocks can be improved
by calculating the power of a stock. Similar to the
power of a signal in DSP, it represents the amount
of displacement per unit time. Calculating a normal-
ized average energy over a period, we have split the
stock price into a signal and noise part. We have
compared the power calculation over a number of
FIGURE 8: POWER RATIO, MARKET-CAP WEIGHTED. This shows the market-cap weighted various ranges and signals, and have applied the
power ratio for the 20-, 50-, and 100-day moving average and the S&P 500. results to a generic trend-following algorithm such as
Wilder’s Volatility System from 1978. We conclude
that higher power ratios lead to drastically improved
returns for all ranges of power calculations and note
that Sharpe ratios in excess of 1.0 can be achieved,
which strongly outperform a buy-and-hold strategy.
We have also suggested a useful application as an
overall market power indicator when market cap
weighting all power signals across all names as a
whole or by market cap group.

Andreas A. Aigner has a PhD in mathematics from

Monash University, Melbourne, Australia. He spent a
number of years in research for various UK universi-
ties and worked almost 10 years for Morgan Stanley
in Controlling, Trading & Pricing for the Exotic
Derivatives desk in Hong Kong. He is now engaged
FIGURE 9: POWER RATIOS, PER MARKET CAP GROUP. This shows market-cap weighted power
full time in research and is building a signaling au-
ratios grouped by mega cap, big cap, mid cap, small cap, and S&P 500. tomaton (tradeflags.de) together with his longtime
friend and associate Walter Schrabmair.
Since we have obtained a measure of power for stocks, it Walter Schrabmair works at the Medical University of Graz
seems obvious to average the power across all stocks at each and the Technical University of Graz in various research roles
time step, and chart the time series of signal and noise of all and as a general computer whiz.
stocks with time. Since we want to compare like for like, it is Their contact emails are [email protected] and walter@
necessary to weight each stock power ratio by its market cap. tradeflags.at.
Figure 8 shows the signal and noise power ratio for 20-day,
50-day, and 100-day together with the S&P 500 as a reference. Further reading
Notice how the total power ratio for signal and noise is largest Graham, Benjamin, and David Dodd, et al. [1962]. Security
for the 100-day and smallest for the 20-day. Analysis: Principles And Technique (4th ed.), McGraw-Hill.
What is also interesting is to look at the power ratios of groups First edition published in 1934.
of market caps, such as mega caps (>300bn$), big caps (10bn$ Prandoni, P. and M. Vetterli [2008]. Signal Processing For
< M <= 300bn$), mid caps (2bn$ < M <= 10bn$), and small Communications, Communication And Information Sci-
caps (300m$ < M <= 2bn$). Again, we normalize by market ences, Lausanne, EPFL Press.
cap, but with regard to each market cap group instead of total, Wilder, J. Welles [1978]. New Concepts In Technical Trading
and chart them in Figure 9. Noticeable is that mega caps have Systems, Trend Research.
the highest power and that the power ratios diverge at rallies Aigner, Andreas, and Walter Schrabmair [2020]. “Power As-
and converge at selloffs. But you can also notice individual sisted Trend Following,” ResearchGate.
collapses of one group over another, such as, for instance, the
period around December 2019, where the mega cap power falls
July 2020 • Technical Analysis of Stocks & Commodities • 13
 It Does Mean A Thing

The Swing Rule

Here’s a technique that looks for a particular pattern of price because of the COVID-19 virus. In this example, the swing
swings to project a price target as the exit. rule works perfectly, alerting traders to a major downturn.
If you’re a short-term swing trader, read on because I’ll

If
by Thomas Bulkowski explain how well the swing rule works for shorter-term trades
(smaller swings).
you haven’t heard of the “swing rule,” you’re
not alone. I found the technique described in What to look for
the 1988 book Stan Weinstein’s Secrets For In his book, Weinstein gives guidance on what to look for. He
Profiting In Bull And Bear Markets. I’ll describe warns the technique “doesn’t appear often.” Begin by finding
what the swing rule is, test how it works, see how a peak “before an important decline sets in and subtract the
performance has changed over the decades, and next low price from it.” By next low price he means the low
optimize the rule. at valley B (refer to Figure 1).
The clearest way to describe the rule is by example. Figure How deep should the drop be? He doesn’t say but provides
1 shows a chart of how the rule should work. My computer three examples. The first stock shows a drop of 37%, the
found this example, and it’s included in the test results I’ll second measures 42%, and the last stock sees price plummet
SHUTTERSTOCKPROFESSIONAL/SHUTTERSTOCK

describe later. by 65%. In other words, we should look for a major decline.
The swing from A to B should approximate the rise from A The drop from A to B in Figure 1 measures 39%.
to C. If we plug in the numbers, the high at A is at 233.47, the After we find an important high-low swing, subtract the low
low at B is 142.00, and C peaks at 327.85. Compute the height from the high, and add the result to the high to get the swing
by subtracting the price of B from A. Add that result to the rule price target. That is, C=A-B+A.
high at A and we get the computed target of 324.94. Peak C How often does the swing rule work? He writes, “While
exceeds that by just a few points before the stock rounds over every swing-rule projection won’t turn out to be as perfect as
and heads lower over worries about Chinese production delays these [his three examples], the overwhelming majority will be
14 • July 2020 • Technical Analysis of Stocks & Commodities
 TRADING TECHNIQUES

surprisingly on target.”
C
That doesn’t tell me what I
want to know, so we’ll have to
find the answer ourselves. It’s
also possible that overwhelm-
ing majority applied in the
1980s, but no longer does. A
We’ll see.
For trading using the swing
rule, he suggests selling a
portion of your position at
the swing rule target and
letting a stop order cash out
of the rest.

TOM BULKOWSKI
More examples B
I’ll discuss two more exam-
ples, beginning with Figure 2. FIGURE 1: THE SWING RULE. Point C is found using the formula C=A-B+A.
The high at A is 193.47, the
low at B is 132.60, for a drop
of 60.87 (or 31%). Adding the
AB swing to A gives a target
of 254.34, which I show as
the horizontal red line. The Swing Rule Target
minor high to the left of C is
just under the target and the C
minor high after C sees price
rise above the line. The stock
hits an air pocket and drops A
almost 11%, to 232.
What happens next? The
stock recovers and makes a
new high, soaring well above
the target. In this example,
the swing rule worked, and B
allowed a trader to exit before FIGURE 2: EXAMPLE OF SWING RULE APPLIED. This stock turns at the target, drops 11%, but recovers to make a new
an 11% decline. However, the high.
stock quickly recovered and
soared 36%. The notion of D
selling a portion of the trade
at the swing rule target may Target
have worked well for a trader C
holding onto the rest.
Figure 3 shows another ex-
ample my computer program
found. The high at A is 28.97,
the low at B is 23.05, for a A
drop of 5.92 or 20%. That
swing would place the target
at 34.89. The stock climbs to
34.70 at C, just short of the
target.
You will notice that my
computer didn’t use peak D in B
the computation (in the swing FIGURE 3: ANOTHER EXAMPLE OF SWING RULE APPLIED. This stock falls just shy of the target at C, using the AB swing
down to B). Will the swing for the projection, not peak DB.

July 2020 • Technical Analysis of Stocks & Commodities • 15

 to the target. I accepted near misses, that is, I allowed a peak
1% below the target to qualify as a hit. Any peak at or above
A handy ratio is that price the target was also a hit.
I didn’t set a time limit for the stock to reach the target.
drops twice as fast as it rises. Because the AB drop can be large, you can expect a significant
time for recovery. A handy ratio is that price drops twice as
fast as it rises. I found that by experimentation and I comment
on it in my Encyclopedia Of Chart Patterns book. Figure 1,
rule work for this stock using point D in the calculation? It for example, sees price drop for about 3 months from A to
turned out that fears of Covid-19 dropped the stock down to B. Thus, it’ll take 6 months to return to the price of A and
12, meaning the D to B swing projection to a predicted target another 6 months to rise to C. Indeed, the stock reaches C in
of 52.11 did not work. about a year (measured from B).
I set a stop-loss target of a penny below the lowest low.
Methodology After returning to the price of the first peak (A), if the stock
I located 21,120 swing rule candidates in 1,320 stocks using then dropped to a penny below B, I concluded that the swing
daily price data from January 1990 to February 2020. Not all rule didn’t work.
stocks covered the entire range. The database includes stocks
that no longer trade. I removed the two bear markets in the And the winner is
2000s to concentrate on bull markets only. Figure 4 shows the first batch of results. I found that a massive
To find a suitable swing, I set the minimum AB drop to be 43% of the stocks in a bull market will be stopped out on their
5%, which is well short of the 37% to 65% Weinstein used in way to reaching the calculated swing rule target. That is, the
his examples, but I like the data to set the rules. stock makes a large drop from A to B and recovers to A. To
To find point A, the first peak, I looked for the highest be stopped out, the stock then has to drop to a penny below
peak within a window 21 days wide. That is, point A is the B during its attempt to reach C.
highest high from 10 days before to 10 days after the peak. When the swing rule works, does price continue rising, or
That technique worked well, but it still allows situations like does it peak? Recall that I found the peak closest to the calcu-
Figure 3 to be included (meaning the computer uses point A lated target (from 1% below to unlimited above the target).
and not point D). As Figures 1 to 3 show, the stock reaches the target at a
To find point B, the bottom of the swing, I looked for the peak and then drops, at least for a time. I set various window
stock to return to the high price at A (within a year) and then sizes to see how many stocks peaked within a window of the
found the lowest low between those two highs. Weinstein’s calculated target. I fixed the bottom of the window at 1% below
examples showed a peak to valley transit time of less than a the calculated price target (for near misses). Setting the top
year, so a year seemed like a reasonable maximum for the AB limit to 1% above the target, which I consider to be a direct
drop. The median time for the drop was 3 weeks (average is hit, showed that 26% of the stocks peaked within that +/- 1%
40 days), so a one-year limit seems more than adequate. window. Raising the top end of the window, we find 57% of
If the height from peak A to the lowest low was at least the stocks peaked within a -1% to 5% window. A window of
5% (or whatever minimum I chose), then I applied the swing -1% to +10% means that 76% of the stocks found a peak close
rule. After that, it was just a matter of finding a peak closest to the calculated target. The remainder saw price blow past
the target before peaking.

Performance over time

Window Size Results Decade Samples Success Rate
-1% to +1% 26%, direct hit 1990s 13,171 55%
-1% to +5% 57%, close 2000s 3,525 60% Let’s check how the swing rule worked over decades. Did it
-1% to +10% 76%, far away 2010s 3,841 62% work better in the past than it does today? Unfortunately, my
FIGURE 4: THE RESULTS. This 1990–2020 20,537 57% data does not extend back to the 1980s to check how well my
shows how often price peaks within FIGURE 5: PERFORMANCE OVER TIME. computer model matches Weinstein’s results.
a percentage of the calculated swing
rule target.
Here you see the performance of the swing The table in Figure 5 shows what I found. A failure means
rule over the decades.
the stock hit the stop-loss before reaching the target (that is,
Range Stopped Out Failures Success the stock returned to the price of A and then dropped below
5%–10% 3,114 47% 53% B before reaching C). I excluded any swing (from A to C) if
10%–20% 3,799 45% 55% it spanned two decades.
20%–30% 1,357 39% 61% The 1990s had the most samples and shows the lowest
30%–40% 475 32% 68%
success rate, 55%. More recent decades show higher success
40%–50% 176 26% 74%
50%–100% 70 17% 83%
rates, but fewer samples.
0%–100% 9,001 43% 57% The overall success rate for the three decades is 57%. Also
FIGURE 6: SWINGS SORTED BY SIZE. Here you see the performance of the recall that I removed all bear market swings, which affected
swing rule for varying-sized dips. the 2000s sample count.
16 • July 2020 • Technical Analysis of Stocks & Commodities
 Before you think that Wein-
stein was incorrect in his as-
sessment that the swing rule C
worked the overwhelming
majority of the time, Figure 5
shows dips of 5% and higher,
A
not the massive 30+% swings
his examples suggest. So let’s
look at the size of the dip and B
the success rate next.

Optimization: Sort
the dip
Figure 6 shows what I found
when I sorted the size of the
dip, in 10 percentage point
ranges. I don’t know what size
Weinstein used. I assume his FIGURE 7: SMALL-SIZE SWINGS. The swing rule works about half the time for small retraces.
dips were as large as the ones
he showed in his book (over 30%). They may not be.
For short-term (small swings) swing traders, the swing
rule works just over half the time (53%). For example, Figure
7 shows the swing rule for a dip that measures 6% from the
I found that 74% of the
high at A to the low at B. The high at A is 42.86 and the low stocks showed success
at B is 40.12, giving a target of 45.60. The peak at C reaches when using the swing rule.
a high of 45.58 or just two cents short of the target. I call that
a direct hit, but the stock continues higher and takes out the
target in any case two weeks later.
Figure 6 shows tests pulled from a pool of 21,120 samples. A to B. In other words, it takes about twice as long to recover
The swing rule saw price drop a penny below B 3,114 times from the dip (the move from the low at B to return to the price
or 47% of the 6,608 samples that qualified. That means the of A) and twice as long to reach the target (the rise from A to
rule worked the other 53% of the time. I didn’t check if the C) as it does for price to drop from A to B.
stock continued to make a higher high or if it changed trend The swing rule works at least half the time and it works
from up to down. better for larger dips than smaller ones. Because this test was
Read the remainder of the table the same way. Notice that done using a computer algorithm, adding your trading skills
as the size of the dip (10% to 20%, 20% to 30%, and so on) to the mix might improve the swing rule results.
gets larger, the success rate increases. Also notice that the last For traders, the swing rule might be a valuable tool to help
two rows have a wider range. The 50% to 100% row, which put money into your trading account.
is a huge drop, has only 424 samples. That may explain why
the success rate is so high. STOCKS & COMMODITIES Contributing Writer Thomas
The last row shows the number of failures for all sized dips: Bulkowski is a private investor and trader with almost 40
43%, leaving 57% as winners. years of market experience and considered by some to be a
Using the range provided by Weinstein’s three charts in leading expert on chart patterns. He is a best-selling author
his book, I plugged a 37% to 65% range into my spreadsheet of several books including Encyclopedia Of Chart Patterns,
and found that 74% of the stocks showed success when using Second Edition. His website and blog, www.thepatternsite.
the swing rule. com, have more than 700 articles of free information dedi-
cated to price pattern research.
That’s a wrap
Weinstein’s swing rule measures the peak-to-valley dip and Further reading
adds the difference to the peak to get a target. Traders can Weinstein, Stan [1988]. Stan Weinstein’s Secrets for Profiting
use the target as a method of determining when price might In Bull And Bear Markets, McGraw Hill.
peak. The stock may not make a lasting turn at the peak and Bulkowski, Thomas [2005]. Encyclopedia Of Chart Patterns,
it can take a long time to not only recover from the dip but Second Edition, John Wiley & Sons.
also to reach the target. ‡Tom Bulkowski
A check of the time for a stock to rise from the bottom of ‡See Editorial Resource Index
the dip to the target took 4.1 times as long as the drop from
July 2020 • Technical Analysis of Stocks & Commodities • 17
 FUTURES FOR YOU
INSIDE THE FUTURES WORLD
Want to find out how the futures markets really work? Carley Garner is the senior
strategist for DeCarley Trading, a division of Zaner, where she also works as a
broker. She has written four books on futures and options trading, with the latest
being a new edition of her book A Trader’s First Book On Commodities (third
edition, October 2017) as well as Higher Probability Commodity Trading (July
2016). Garner also authors widely distributed e-newsletters; for a free subscrip-
tion, visit www.DeCarleyTrading.com. To submit a question, email her at info@
carleygarnertrading.com or via www.DeCarleyTrading.com. Selected questions Carley Garner
will appear in a future issue of S&C.

A STRATEGY FOR VOLATILE FUTURES: prospects of unlimited profits and are merely needs to be right within a $10.00
THE OPTION BUTTERFLY willing to accept the scenario in which margin of error.
How can retail traders get into markets they are too right regarding direction and The cost of the spread would be
with high volatility and margin require- lose money. Additionally, when trading roughly 60 cents or $600 because each
ments? spreads, profits and losses occur at a penny is worth $10 to an oil trader.
In the aftermath of the May crude oil slower pace, which causes frustration The cost can be figured by adding the
futures contract blow-up in April 2020 if the underlying futures market makes premium paid for the two long options,
which temporarily drove prices into a hard and fast move in the desired di- then subtracting the premium collected
negative territory to the tune of $40.00 rection. Nevertheless, beggars can’t be for the two short calls. There is little, to
per barrel, retail traders were left with choosers; those looking to play in the no, margin required for an option but-
few “options” for oil speculation. Dur- oil market in mid-2020 without risking terfly if the strike prices of the wings
ing this time, the margin requirements their shirts or their marriage could have are equidistant.
needed to buy or sell futures contracts found solace in the butterfly strategy. The premium paid for the spread, $600
nearly tripled but, adding an additional Let’s take a look at an example. in this example, is the maximum risk to
layer of deterrence, most commodity A trader who believes oil would be the trader. If at expiration the price of
brokerages mitigated their risk by forbid- near $35.00 at the August option expira- oil was below $30.00, the spread would
ding clients from trading the front-month tion, or at least above $30.00 and below expire worthless, leaving the trader with
contract and requiring additional margin $40.00, could construct a call butterfly a full $600 loss plus any transaction costs
to initiate positions in the back months. spread by purchasing an August crude paid. If the trader was too right in the
Further, weeks of excessive volatility left oil $30.00 call, selling two of the $35.00 direction and the price of oil was above
the options markets grossly overpriced, calls and then buying the $40.00 call. In $40.00 at expiration, all of the options
shifting the odds of success for option essence, this trader need not pinpoint the
buyers toward impossible. In such an precise price of crude at expiration, he Continued on page 23
environment, there is
a better way to gain
exposure with higher
probabilities of profit
and low and limited risk.
Does this sound too good
to be true? It isn’t. Option
butterflies fit the bill.
An option butterfly
is a limited-risk trade
intended to profit if
the underlying futures
price settles within a
predefined range. Of
course, there are al-
ways opportunity costs
that come with low-risk
ventures; in the case
of an option butterfly,
traders are giving up the FIGURE 1: EXAMPLE CALL BUTTERFLY SPREAD
18 • July 2020 • Technical Analysis of Stocks & Commodities
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 A Simple Mathematical Technique To Improve Cycle Indicators

Truncated Indicators
An ideal cycle indicator is one that will help you locate and an example, I’ll show you the difference it makes, and I’ll
track cycles in price data to better anticipate price. Here is codify it for you so you can see the details of the process and
a straightforward technique for improving how accurately also implement it yourself.
a cycle indicator reflects price—including the handling of
extreme price events such as the market experienced recently. Why truncation?
Coding is provided to help you implement the technique. If you toss a rock into a lake, ripples will form. The rock may
disturb the body of water only for a minute in the grand scheme
by John F. Ehlers of things, but the ripples echo outward until they fade (or are

T
“attenuated”)—and the impact of the rock fades. But in the
he performance of some, but not all, indicators can meantime, the trail left by the ripples is noticeable, and the
be greatly enhanced by truncation. By “trunca- impact of the disturbance will distort the water.
tion,” I am referring to limiting the data range An indicator takes form by the data series on which it is
A N N TO N I A R T/ S H U T T ER S TO C K

automatically in ways that allow the indicator to based. A short disturbance in the data, like the rock in the
COLLAGE: CHRISTINE MORRISON

more accurately reflect price. water, can have an outsized impact on indicator output in the
But which indicators can be enhanced by it, time series, which is not always desirable. This is one situation
and why? In this article, I’ll tell you the type of where indicator truncation can be helpful, as I’ll describe.
indicator that can benefit from this mathematical technique, Another situation where indicator truncation is helpful
and I’ll show you a way to perform the truncation. Through has to do with the data window used for the calculation of an
20 • July 2020 • Technical Analysis of Stocks & Commodities
 DIGITAL FILTERS

indicator, and at what point in the data the calculations start.

A data series that begins, for example, at a price extreme—or
that just misses one—affects the output. Initialization is one
Digital filters: Finite vs. infinite problem that is resolved by
When it comes to digital filters, there are two fundamentally truncating the indicators.
different types: finite impulse response and infinite impulse
response.

Finite impulse response (FIR) two bars ago, and so on. Thus, the required history goes back
Finite impulse response or FIR uses a fixed window of data to infinity. The EMA equation can be rewritten as:
and is used to calculate a point of the filter output. That window
slides across the data, and the output points are connected (Output – (1-a)*Output[1]) = a*Input
to provide the indicator. A simple moving average (SMA) is
an example of such a filter. The RSI (relative strength index) If I change the notation at let Z-1 signify one bar of delay, the
and the stochastic oscillator are examples of indicators that equation is rewritten as:
use this principle.
FIR filters and indicators can only be degraded by trunca- Output*(1 – (1-a)*Z-1) = a*Input
tion.
The ratio of output to input is the transfer response of the
Infinite impulse response (IIR) filter, and so the transfer response of the filter, H, can be
IIR stands for infinite impulse response, where the computa- written as:
tion of the filter or indicator depends on a previous calculation
of that filter. The exponential moving average (EMA), and H = a / (1 – (1-a)*Z-1)
thus the MACD, as well as other indicators, are IIR types.
Of course, the computation of an IIR filter does not extend to Just to simplify notation, let (1-a) = c. The equation then
infinity. The filter computation can only start at the beginning becomes:
of the data being used.
Therein lies the problem. The answer you get from an IIR H = a / (1 – c*Z-1)
filter will be different depending on your data length. If the
data stream is sufficiently long, the answer may be the same for The denominator of the transfer response carries the re-
all practical purposes, but it will be different nonetheless. quirement for a calculation into the infinite past. However, if
So initialization is one problem that is resolved by trun- we create an infinite series by dividing the dominator into the
cating the indicators. The memory of IIR indicators can also numerator by long division, the equation becomes:
impact performance, because a major data disturbance can
cause the transient response of the indicator to ring like a bell, H = a*(1 + c*Z-1 + c2*Z-2+ c3*Z-3 + c4*Z-4 + c5*Z-5 + . . . .
using that data disturbance in its output long after the event ...)
has occurred. This is particularly important because market
data is nonstationary, that is, the data has time variable prob- Truncation of this equation is easy, because we can just stop
ability statistics. using the higher-power terms at any power we choose. Since
IIR filters are handy for a trader because you do not have (1-a) is a number less than unity, we can estimate the desired
to accept the group delay of an FIR filter, which is typically length of the truncation by computing when the coefficients
about half the length of the filter itself. no longer have an impact on the transfer response.
I will first describe several ways to perform truncation, and The EasyLanguage code fragment to compute a truncated
then I will discuss its performance impact. EMA of a fixed length as a summation of terms is:

Performing truncation Output = 0;

For count = 0 to Length Begin
An exponential moving average (EMA) is one filter that Output = Output + Power(c, count)*Input[count];
depends on previous calculated values. In EasyLanguage End;
notation, an EMA is: Output = a*Output;

Output = a*Input + (1-a)*Output[1]; One of the beauties of computers is that we can just brute-
force grind through calculations without resorting to math-
where Output[1] means the filter output one bar ago and where ematical sleight-of-hand tricks. This gives us more flexibility
a is the EMA constant (less than 1). in easily truncating higher-order filters. However, it requires
Of course, the output one bar ago requires its previous output a slightly greater understanding of computer coding. In the
July 2020 • Technical Analysis of Stocks & Commodities • 21
 In the sidebar “EasyLan-
guage Code For Standard And
Truncated Bandpass Filters,”
I give the EasyLanguage
code to compute a standard
bandpass filter in terms of its
center period and percent-
age bandwidth. The standard
computation as an IIR filter
uses the computed values of
the bandpass filter both one
bar ago and two bars ago. In
TRADESTATION

the truncated version, I use

the array Trunc. I first have to
FIGURE 1: TRUNCATED VS. STANDARD IIR FILTER. Both the truncated (in blue) and standard (in red) bandpass stack the array on every bar.
filters are shown in the bottom pane of this 2019 daily SPY chart. As you can see in this example, the truncated bandpass Then, in the next code block,
filter is a better indicator of price action.
I crunch the current value for
the array. I then convert the
example above, the terms input and output are variables. “Under current value of the filter to a variable so I can plot it just
the covers” of EasyLanguage, all variables are indexed to the like the standard computation.
current bar. Therefore, counting backwards from the current
bar is a snap. However, number-crunching backwards requires An SPY example
multiple indexing, and therefore variables are not useful. In- In Figure 1, I show the standard and truncated
stead, we need to use arrays and do our own indexing. With bandpass filters applied to daily bars of SPY for
output as an array, the code fragment to brute-force crunch roughly the calendar year 2019. In both cases,
a truncated EMA is: the center period of the filter is 20 bars and have
10 percent of the center period bandwidth. The
Output[Length + 1] = Input[Length]; //initialization standard bandpass filter is in red and the trun-
For count = Length DownTo 1 Begin
Output[count] = a*Input[count] + (1-a)*Output[count + 1];
cated bandpass filter is in blue. The truncated
End; bandpass filter only uses 10 bars of data in its computation at
EMA = Output[1]; //converts array to a variable every bar across the chart.
The big price dip in December 2018 certainly bangs the
A bandpass filter is one I am fond of using because it enables standard bandpass filter and causes it to ring out like a bell for
me to winnow out the tradable cycles in the market data. The at least five months. On the other hand, the truncated bandpass
bandpass filter is an IIR type, and I use the brute-force method filter has a dampened response to that major event. It further
of truncating this more complex filter. accurately describes the price action by staying above zero

EASYLANGUAGE CODE FOR STANDARD AND TRUNCATED BANDPASS FILTERS

{ BP = .5*(1 - S1)*(Close - Close[2]) + L1*(1 + S1)*BP[1] - S1*BP[2];
BandPass Filter and Truncated Bandpass Filter If CurrentBar <= 3 Then BP = 0;
(C) 2005-2020 John F. Ehlers
} //Stack the Trunc Array
For count = 100 DownTo 2 Begin
Inputs: Trunc[count] = Trunc[count - 1];
Period(20), End;
Bandwidth(.1),
Length(10); //must be less than 98 due to array size //Truncated Bandpass
Trunc[Length + 2] = 0;
Vars: Trunc[Length + 1] = 0;
L1(0), G1(0), S1(0), count(0), For count = Length DownTo 1 Begin
BP(0), BPT(0); Trunc[count] = .5*(1 - S1)*(Close[count - 1] - Close[count + 1]) +
L1*(1 + S1)*Trunc[count + 1] - S1*Trunc[count + 2];
Arrays: End;
Trunc[100](0); BPT = Trunc[1]; //convert to a variable

//Standard Bandpass Plot1(BP);

L1 = Cosine(360 / Period); Plot4(0);
G1 = Cosine(Bandwidth*360 / Period); Plot2(BPT);
S1 = 1 / G1 - SquareRoot( 1 / (G1*G1) - 1);

22 • July 2020 • Technical Analysis of Stocks & Commodities

during the uptrend into early May. During this time, the cyclic
price action is also accurately portrayed.
For example, the price swing peak in the third week of The price swing peak in the third
March 2020 is accurately reflected in the peak of the truncated
bandpass filter, whereas the standard bandpass filter is dead week of March is accurately
wrong at a cyclic valley at this time. Similarly, the truncated reflected in the peak of the
filter is above zero during the fourth quarter uptrend. The cy- truncated bandpass filter,
clic swings during August and September are also accurately whereas the standard bandpass
reflected in the truncated indicator.
In fact, you can track the cyclic swings across the entire filter is dead wrong at a cyclic
chart and see at a glance how they correlate with the price valley at this time.
movements.

A better indicator of price action

In summary, truncating IIR filters solves two problems See our Traders’ Tips section beginning on page 48 for commentary
associated with IIR filters. First, initialization errors are and implementation of John Ehlers’ technique in various technical
eliminated. Second, dampened transient responses of the analysis programs. Accompanying program code can be found in
truncated filters provide a more reliable indication of the the Traders’ Tips area at Traders.com.
current price action.
Further reading
John Ehlers, a Contributing Editor to Stocks & Commodi- Ehlers, John F. [2013]. Cycle Analytics For Traders, John
ties, is a pioneer in the use of cycles and DSP (digital signal Wiley & Sons.
processing) technical analysis. He is president of MESA [2016]. “The Super Passband Indicator,” Technical
Software and holds a comprehensive workshop in California Analysis of Stocks & Commodities, Volume 34: July.
in the fall each year. He can be reached through his website ‡TradeStation
at MESAsoftware.com. ‡See Editorial Resource Index

The code given in this article is available in the Article Code

section of our website, Traders.com.

FUTURES FOR YOU

GARNER/FUTURES is above the strike price of the first long
Continued from page 18 call enough to recoup the premium paid. Weeks of excessive
Thus, the breakeven point is $30.60; volatility left the
contained in the spread would be deep above this price, the trader is making options markets grossly
in-the-money with all of the profits and money intrinsically on the long call with
losses washing each other out. In short, the gains maxing out at the strike price
overpriced, shifting
it might as well have expired worthless of the short calls ($35.00). Above $35.00, the odds of success for
because it is worth nothing to the trader. the trader is giving profits back until run- option buyers toward
Yet, if the price of oil is at $35.00 at ning out of money 60 cents before the impossible.
expiration, the trader would profit $4.40 strike price of the second long option,
or $4,400 before considering transaction which leaves the second breakeven point
costs. This was figured by taking the at $39.40. At any point between $30.60 $4,400 without a margin requirement is
difference between the long and short and $39.40, the trade pays off something an attractive venture. However, we must
strike prices, $5.00, and subtracting the to the trader. For instance, if the price of also recognize that without a crystal ball,
premium paid for the spread and multi- oil was at $33.00, the trader would make even a nearly $10.00 profit range might
plying by $1,000 because each dollar is $2,400 because the first long call would not be enough in a wildly volatile market
worth $1,000 to a trader (($5.00 - 0.60) be in-the-money by $3.00 but the trader such as crude oil. Nevertheless, in mid-
* $1,000). paid 60 cents to enter, leaving him with 2020, butterflies were the only option
Because the trader paid 60 cents for the $2.40 in profits multiplied by $1,000. for shell-shocked retail traders.
spread, he doesn’t begin making money I think we can all agree a risk of $600
at expiration until the price of crude oil with a reasonable chance at making
July 2020 • Technical Analysis of Stocks & Commodities • 23
 viewed at different scales. Scale can mean
the altitude that a coastline is observed or
the time interval (such as 5 minutes, 1 hour,
or 1 day) selected for viewing a financial
time series. This property is called self-
similarity. If you look at a branch of a
tree, it will have many smaller branches
and each branch will also look like a
tree, but at a smaller scale. Significantly,
physical laws are independent of scale
so that the behavior of fractal systems is
scale-independent.
Scaling laws that represent the fractal
structure of FX rate data can be used to
predict the expectation value of FX pa-
rameters such as the average return of an
up/down trend or the duration of a trend.
This information is key to the development
of financial trading models.

What’s ahead
In my February 2020 article in this
magazine, “Using Scaling Laws For The
Development Of FX Trading Models,” I
described how scaling laws can be used
to develop trading models based on the
fractal properties of financial data. In the
following sections, I will give a brief recap
of the development of scaling laws for FX
data. A more detailed description can be
found in my February 2020 article, which
is listed at the end of this article.
I will describe four scaling law equa-
tions and introduce volatility as a key
Building More Predictable Models

Using Scaling Laws For

measure of scale for two of these scaling
laws. Then I will show how extending
the scaling concept into two dimensions

FX Trading Models:
allows the four scaling law equations to
collapse into two equations. Finally, I will

A Two-Dimensional
describe trading algorithms based on two-
dimensional scaling laws and show the
resultant trading model performance.

Extension A quick recap:

One-dimensional model
Previously, we looked at how scaling laws can be used to predict the behavior First scaling law:
of forex (FX) data. In this follow-up article, we look at how scaling laws can be Volatility vs. time interval
WATCH SPIRAL: MIKHAIL LEONOVFX LETTERS: MATTZ90/

extended into two dimensions: volatility and price change thresholds. Now, us- In 1990, the first scaling law for foreign
ing two-dimensional scaling laws, an even more accurate prediction of expected exchange (FX) rate data was found. (For
returns can be made. Find out how. more on this, see the article listed in

T
SHUTTERSTOCK/COLLAGE: NIKKI MOR

“Further reading” at end, “Statistical Study

by Richard Poster, PhD Of Foreign Exchange Rates, Empirical
Evidence Of A Price Change Scaling Law,
he jagged coastline of Norway, an old oak tree, and the EURUSD And Intraday Analysis.”)
time series have at least one thing in common—they all have fractal For this scaling law, a relationship ex-
geometries. This means they have the same form or structure when ists between the mean absolute change of
24 • July 2020 • Technical Analysis of Stocks & Commodities
 FOREX

logarithmic returns, sampled at time intervals

Δt, and the size of the time interval. The time
interval Δt can be the chart bar times, such as
5-minute, 15-minute, one-hour, four-hour, and so
on. In the following equation, the mean absolute
change of logarithmic returns is 〈ΔX〉 and the
sample time interval is Δt:

〈|ΔX|〉 = C( Δt ) D

where D is the drift exponent and D approxi-

mately equals 0.5. ΔX is a measure of volatility
for the time interval Δt and C is a constant for
the currency pair. This scaling law does not have FIGURE 1: NUMBER OF DIRECTIONAL CHANGES SCALING WITH THRESHOLD. The average
much practical use, but it spurred further research number of segments is accurately described by scaling with threshold, which provides the measure-
ment scale for the zigzag pattern.
into scaling laws for financial data.

Second scaling law: zigzag segments and the threshold Λ.

Number of directional changes vs. threshold Equation 3 describes the scaling law for the average return
In 1997, a second scaling law was found that relates the num- per segment , over the duration of the sample, and the threshold
ber of directional changes (NDC) in a zigzag pattern to the Λ. The threshold Λ and average return are both price changes
threshold for declaring a directional change. (For more on this, and are represented in pips.
see the article listed in “Further reading” at end, “From The
Bird’s Eye To The Microscope: A Survey Of New Stylized Facts
Of The Intra-Daily Foreign Exchange Markets.”) A change of
〈R(Λ)〉 = Λ (C ) M
Eq. 3

direction (up/down) in the zigzag pattern is declared when the The exponent M and C are constants for the currency
price changes by a threshold value compared to the highest pair.
or lowest price in the zigzag segment. The threshold, repre- Equation 3 can be rewritten in the log-log form as:
sented by Λ in equation 1, is a price change and is specified in
pips. The threshold Λ defines the amount of price movement
required to declare a new up or down segment in the zigzag
( )
log 〈R〉 = M log(Λ) + B Eq. 4

pattern. The number of directional changes (NDC) depends where M is the slope and B is the constant intercept for the
on the sample size S and the threshold Λ. fitted straight line. If you look at Figure 4 in my February
The scaling law for the average number of directional changes 2020 article, you will see that equation 4 accurately describes
(〈NDC〉) over a sample size of S bars and a threshold Λ is: the average return as a function of threshold.

〈NDC(Λ)〉 = Λ
R ( ) D
Eq. 1 Recap: Scaling in volatility
First volatility scaling law
where the exponent D and R are constants for the currency Volatility has a key role in the behavior of both the NDC and
pair. The scaling law equation can be rewritten in the log-log the average return. In this analysis, volatility (V) is defined
form as: as the average absolute value of the change in closing price
(P) from bar to bar.
( )
log 〈NDC〉 = D log(Λ) + B Eq. 2
N

〈| ΔP |〉 = 1 |P – P
where D is the slope and B is the constant intercept for the N Σ i i–1
|
i=1
fitted straight line.
The one-hour EURUSD data from 2004 to 2019 has been V = 〈| ΔP |〉
used for all data analysis. Figure 1 shows that the log 〈NDC〉
versus log threshold data is well described by the scaling law Volatility is specified in pips.
in equation 2. The 〈NDC〉 follows a scaling law with volatility as shown
in equation 5.
Third scaling law: Average return vs. threshold M
Additional scaling laws were reported in 2010 (see the article 〈NDC(V)〉 = V (G ) Eq. 5
listed in “Further reading” at end, “Patterns In High-Frequency
FX Data: Discovery Of 12 Empirical Scaling Laws”), includ- where V is the volatility and the exponent M and G are con-
ing a relationship between the average size of the return R of stants for the currency pair.
July 2020 • Technical Analysis of Stocks & Commodities • 25
 given a specific threshold selection and sample
size S bars.
Figures 1 and 2 show that the 〈NDC〉 scales in
both volatility and directional change threshold.

Second volatility scaling law

In my previous article, I also showed that the aver-
age return 〈R〉 scales with volatility V. However, the
linearity for average return versus volatility was
weaker than the other scaling laws. The scaling
law for average return is:
E
〈R(V)〉 = V
(F ) Eq. 7
FIGURE 2: NUMBER OF DIRECTIONAL CHANGES SCALING WITH VOLATILITY. The number
of directional changes scales with volatility, given a choice of threshold.

Summary of recap
We now have four independent scaling law equa-
tions (equations 1, 3, 5, 7) which relate average
return and average NDC to threshold and volatility.
In the following sections, I show how these four
equations can be collapsed into two equations,
each with three free parameters.

Extending scaling laws:

Number of directional changes
Two-dimensional scaling for number of direc-
tional changes
Figures 1 and 2 show that the 〈NDC〉 independently
FIGURE 3: NUMBER OF DIRECTIONAL CHANGES SCALING WITH VOLATILITY. The fitted lines
from equation 9 are shown with the data.
scales with volatility (given a threshold region) and
threshold (given a volatility region). But, is there
one equation that describes how 〈NDC〉 scales
with both volatility and threshold simultaneously?
The simplest relationship between 〈NDC〉 and
volatility and threshold would be:

D M
V
〈NDC(Λ,V) 〉 = Λ (R) ( ) G
Eq. 8

This equation presumes that the 〈NDC〉 has the

same log-log slope value (D) as a function of
threshold (Figure 2) for all volatility regions and
also that 〈NDC〉 has the same log-log slope value
FIGURE 4: NUMBER OF DIRECTIONAL CHANGES SCALING WITH THRESHOLD. The fitted lines
from equation 9 are shown with the data.
(M) as a function of volatility (Figure 1) for all
threshold regions. Equation 8 represents a two-
dimensional scaling law.
Equation 5 can be rewritten in the log-log form as: Equation 8 can be rewritten in the log-log form as:

( )
log 〈NDC〉 = M log(V) + H Eq.6 ( )
log 〈NDC(Λ,V)〉 = D log(Λ) + M log(V) + T Eq. 9

where M is the slope and H is the constant intercept for the where D and M are the two slopes on the log-log plot and T
fitted straight line. is an intercept constant.
Figure 2 shows log 〈NDC〉 versus log volatility data for Let’s see how well equation 9 describes the data. A chi
a specific threshold range of 35–40 pips. This scaling law square minimization program was used to find the three free
equation enables the prediction of the average segment parameters (D, M and T) in equation 9.
length L (〈L〉 = S/〈NDC〉) directly from measured volatility, Figure 3 shows the log〈NDC〉 versus log volatility for
26 • July 2020 • Technical Analysis of Stocks & Commodities
four threshold regions while Figure 4 shows the
log〈NDC〉 versus log threshold for four volatility
regions. In these figures, the fitted lines from equa-
tion 9 are shown along with the data. From Figures 3
and 4, we see that the assumption of common slopes
is actually correct! With just three parameters (two
slopes and an intercept), the value of 〈NDC〉 and
therefore the average value of the segment length
(〈L〉=S/〈NDC〉) can be predicted from the mea-
sured volatility and specified threshold.
Figure 5 shows that the predicted average NDC
from equation 9 closely matches the measured
average NDC for monthly values from 2004
through 2019. FIGURE 5: PREDICTED AND MEASURED <NDC> VALUES AT EACH MONTH END

Extending scaling laws:

Average return
Two-dimensional scaling for average return
The average return R can be evaluated in the
same way as the average NDC in equation 8. The
equation for the two-dimensional scaling law is:

M E
V
〈R(Λ,V)〉 = Λ (C ) ( ) F
Eq. 10

Equation 10 assumes that the exponents M and E

are constant for all volatility and threshold regions.
Equation 10 can be rewritten in the log-log form as: FIGURE 6: LOG RETURN VERSUS LOG VOLATILITY. The fitted lines from equation 11 are shown
with the data.

( )
log 〈R(Λ,V)〉 = M log(Λ) + E log(V) + Z

Eq. 11

where M and E are the two slopes on the log-log

plot and Z is the intercept constant.
A chi square minimization program was used
to find the three free parameters (M, E and Z) in
equation 11.
Figures 6 and 7 show the log return versus log
volatility and log threshold, respectively, along
with the fitted lines from equation 11. Using just
three parameters, equation 11 accurately predicts
the average return as a function of volatility and FIGURE 7: LOG RETURN VERSUS LOG THRESHOLD. The fitted lines from equation 11 are shown
with the data.
threshold.

Trading strategies
I developed two example trading strategies using a two-
dimensional scaling model. These strategies were implemented
with expert advisors in the MetaQuotes Language 4 (MQL4) Scaling laws provide
and run on the MetaTrader 4 platform using actual historical excellent tools for developing
tick level data. (Subscribers to this magazine will find these trading models because they
expert advisors at this magazine’s website, Traders.com, in
the “Article code” section of this issue.)
enable prediction of key
Both strategies use equation 11 to calculate the threshold pattern characteristics.
Λ based on a specified average return 〈R〉 and the measured
volatility V. From the computed threshold and measured
July 2020 • Technical Analysis of Stocks & Commodities • 27
 FIGURE 8: TEST PERFORMANCE OF REVERSAL STRATEGY. The profit performance shows a steady gain over the test period 2010–2019.

Strategy # Trades $ Profit Profit/Loss Profit/Trade % Loss average length 〈L〉 = S/〈NDC〉).
Trend 1006 13,233 1.72 13.1 12.0
Results for both strategies are shown in the next section.
Reverse 924 12,812 1.92 13.9 10.4
Model performance
FIGURE 9: TEST PERFORMANCE, EURUSD MINI LOT. This table shows the I ran the trend and reversal strategies on the MetaTrader 4
performance of the two strategies for the period January 2010 through December
2019 for a mini lot of EURUSD. Strategy Tester platform using historical tick data. This
provides very precise performance testing for expert advisor
volatility, equation 9 is used to calculate the average segment testing in currency trading. The performance for the reversal
length in the zigzag pattern. The trading strategies and expert strategy on one hour (H1) EURUSD data from 1/2010 to
advisor software are similar to those presented in my February 12/2019 is shown in Figure 8. An excellent profit/loss ratio
2020 article. However, determination of the zigzag threshold of 1.92 is achieved along with a steady profit gain over the
and average segment length now uses two-dimensional scal- period of test. A similar performance curve is seen for the
ing law equations. trend strategy.
For a lot size of 0.10 (mini lot) EURUSD, the table in Figure
First trading strategy: Trend strategy 9 shows the performance of the two strategies for the period
The first strategy is the trend strategy. An up or down zigzag January 2010 through December 2019.
segment is declared when the closing price change exceeds
the threshold. At the earliest possible point in time, a buy for Last thoughts
an up segment or a sell for a down segment can be executed. Scaling laws provide excellent tools for developing trading
Other information about segment average values and length models because they enable prediction of key pattern char-
of the current segment are used for the trading decision. acteristics. With newly observed and existing scaling laws
extended into two dimensions, the effects of volatility can
Second trading strategy: Reversal strategy be readily incorporated into a trading model and improve
The second strategy is the reversal strategy. In this case, the model’s overall performance. Since volatility changes
when the length and price change of the current (incomplete) over time, the model will optimize trading performance by
segment exceeds the average values for these parameters, a using scaling laws to vary key model parameters, such as the
reverse trade is executed. The average value of price change zigzag threshold.
and segment length are predicted by the scaling laws for
average NDC and average return per segment (with segment Richard Poster has been designing and implementing FX
trading models for 10 years along with private FX trading.
He has a PhD in physics and has used the many techniques
and methodologies from his experience in elementary particle
physics research and later developing electronic warfare
Scaling laws that represent systems. He is interested in applying neural networks, fuzzy
the fractal structure of FX rate logic, fractal analysis, and quantum mechanics to FX trad-
data can be used to predict ing models. He may be reached at [email protected].
the expectation value of FX
The MetaTrader 4 expert advisors discussed in this article
parameters such as the average are available in the Article Code section of our website,
return of an up/down trend or Traders.com.
the duration of a trend.
Continued on page 45
28 • July 2020 • Technical Analysis of Stocks & Commodities
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 INTERVIEW

Portfolio Manager, Author, Researcher, and Options Expert

A Conversation
With Jay Kaeppel
Jay Kaeppel has over 30 years of varied experience in options, equity, and
futures trading as a research analyst, trader and portfolio manager. Profession-
ally, he began his career as head trader at Essex Trading Co. managing futures
accounts for eight years, and as a programmer, he co-developed Option Pro
trading software, which was the winner of our Readers’ Choice Award for six
consecutive years in this magazine in the category of Options Trading Systems.
He then became a trading strategist and trading instructor for Optionetics,
writing a weekly column for nine years called “Kaeppel’s Corner.”
For the past five years he has been a vice president and director of research
at Alpha Investment Management, Inc. In addition, he offers regular market
commentary on his website JayOnTheMarkets.com.
He is a prolific writer, as evidenced by his authoring four books on trading:
Seasonal Stock Market Trends (Wiley), The Four Biggest Mistakes In Option
Trading (Wiley), The Four Biggest Mistakes In Futures Trading (Wiley), and
The Option Trader’s Guide To Probability, Volatility, And Timing (Wiley).
Kaeppel currently writes the monthly Explore Your Options column for this
magazine, as well as contributing many articles on a variety of subjects since
1999. Kaeppel can be reached at [email protected].
Stocks & Commodities Contributing Writer and ETF columnist Leslie N.
Masonson interviewed Kaeppel via email in early March 2020.
The main thing is finding
an “edge” and exploiting
it repeatedly.
You first became interested most people is “assume you are not
in the stock market in 1981. one of them.”
What has changed in the Connors, Linda Bradford Raschke,
markets since then? When did you first encounter technical and Tom McClellan
Everything moves faster analysis and how did you build your
because of technology. But trends are still knowledge base? All of their old books are still relevant.
trends, ranges are still ranges, breakouts During my first job out of college I In my opinion, Linda’s recent book,
are still breakouts, and human nature is went to the library at lunch and read Trading Sardines, is required reading
still human nature. Which reminds me everything I could get my hands on. for anyone considering trading as a
of one of my favorite sayings: “Human My primary influences were many and full-time career.
nature is a detriment to trading and in- I learned different things from different I would also mention the Trading Wiz-
vestment success and should be avoided people, such as: ards books by Jack Schwager. There are
as much as humanly possible.” two things to pick up from those books:
• Norman Fosback: quantitative 1) there are lots of trading methods that
Then you are a believer in an objec- analysis of various indicators plus work well. There is no one best way. The
tive, rule-based approach to trading seasonality trick is finding what works well for you,
rather than flying by the seat of your • Marty Zweig: the importance of and 2) the overwhelming importance
pants, right? price trends, interest rates and of risk control and minimizing losses.
Yes. Fear and greed are part of that the Fed They all touch on that as a primary key
pesky human nature and no one is im- • Yale Hirsch and Peter Eliades: to their success.
HONZA KREJ/SHUTTERSTOCK

pervious to it. An objective plan allows the value of seasonal and cyclical
an individual to take the emotion out. trends In your mind, is there a difference
While there are individuals who have • Martin Pring and Gerald Appel: a between investing and trading?
the ability to trade successfully by the variety of technical tools Yes, I think of them as separate en-
seat of their pants, my frank advice to • More recent influencers: Larry deavors. Investing is “putting money to
30 • July 2020 • Technical Analysis of Stocks & Commodities
work,” hopefully in some sort of objec- The second thing is that
tive manner to grow one’s capital over buying and holding a stock
time. Trading is about making money index fund with 100% of The best thing about option
here and now. Two completely different your capital is a mistake—in trading is that there are so
approaches in my mind. my opinion. I call it a “drift- many choices. The worst
ing with the tide” strategy. If
What would be your most important the sky is clear and the seas
thing about option trading
advice for traders? are calm, then it’s smooth is that there are soooooo
sailing. But storms are in- many choices!
1. Remember this phrase, “It’s not evitable for both the weather
how much you make when ev- and the stock market. And
erything goes right that matters, the longer the sailing has the terrific bull market in the past
it’s how much you keep when ev- been smooth, the more people forget decade, it is interesting to note that
erything goes wrong.” Bad things about the storms. from August 2000 through Janu-
happen to every trader, period. Job The peaks in the Shiller P/E ratio in ary 2020 (19 years and 5 months),
one is to be able to come back and 1929, 1937, 1965, and 2007 were followed the average annual compounded
be a trader again tomorrow, that is, by declines of -89%, -49%, -40%, and return for the Vanguard S&P 500
never, ever put yourself in a position -54% for the Dow and the 2000 peak was index fund (ticker VFINX) was just
to “lose the farm.” A lot of traders followed by an -83% decline for the Nas- +5.75%. Not exactly a stellar rate
who fail never take the time to learn daq 100. Prior to the 2020 selloff people of return for almost 20 years of a
proper position sizing. had forgotten all about this. But why ride “ride ’em out” approach.
2. In a nutshell, trading success or declines like that to the bottom?
failure is determined by the fol- So what would you suggest as an al-
lowing calculation: “# of winners Any other dangers of buy & hold in ternative approach?
divided by # of losers” times “av- your mind? Well, it’s more food for thought than a
erage winning trade divided by Yes. The stock market can go sideways formal suggestion, but consider this:
average losing trade.” That’s the for very long periods of time. Some
entire game in one number. A high people resolve themselves to believe • 30% invested buy & hold: While
value equals success, a low value that “timing is impossible” and that I don’t advocate 100% because
equals failure. So focus your efforts they have to simply ride out the bear the market does go up in the long
on maximizing this number. markets to get their long-term returns. run, it makes sense to always have
3. The day that you experience ab- But ironically, buy & hold success is also something in there.
solutely no emotion as you are actually a function of timing as well, • 30% invested using trend-fol-
stopped out of a properly managed that is, during which years were you in lowing: Occasional whipsaws are
losing trade is the day you gain the market? If you’re fortunate you are inevitable but the important point
the potential to become wildly in during the good years. But consider is that you don’t ride those -30%
successful in the markets. a little history: to -80% declines all the way to
4. Everyone knows Murphy’s Law, the bottom. The psychological
which says, “Whatever can go • From 1927 to 1949 the stock market benefit cannot be described, only
wrong will go wrong.” Traders went sideways for 22 years. Imag- felt. And you actually have some
need to live by what I call Murphy’s ine someone saying this in 1949: cash available to invest when things
Corollary, which says, “Murphy “Hey Honey, remember that money turn around.
hates you. Plan accordingly.” we put to work in the stock market • 30% invested using tactical
back in 1927? Great news! We’re strategies: This can be a single
What about for longer-term inves- back to breakeven!” I can only strategy or a variety of technical,
tors? speak for myself, but I would prefer seasonal, or even fundamental-
Two things. One, there is no such not to have that conversation. based strategies. Once again, the
thing as “one best strategy.” If you can • From 1965 to 1982, the stock point is that these types of strate-
combine, say, three non-correlated strat- market went sideways. While this gies are typically intended to: a)
egies you can generate a nice smooth is technically a 0% return over 17 outperform buy & hold over time,
upward-sloping equity curve over time. years, it was actually worse than and b) do something besides just
I call it “LLUR” for lower left to upper that. Because of high inflation dur- “sit there and take it” when things
right. That’s the goal. The more one’s ing this period, purchasing power go severely south. Also, it is useful
equity curve slopes up to the right, the declined a fairly shocking -75%. to combine strategies that—using
more likely they are to stick with their • From 2000 to 2012 the stock highly technical terms here—when
approach. market went sideways. Despite one “zigs” the other “zags,” which
July 2020 • Technical Analysis of Stocks & Commodities • 31
 that you do? If so, how do can be a little more creative (ATR-based,
you determine the stop x-day low, etc.)
There is no such thing as levels to exit?
“one best strategy.” If you As with everything else, What are the keys to trading and invest-
there are different philoso- ment success?
can combine, say, three phies. For example, I like The main thing is finding an “edge”
non-correlated strategies, Larry Connors’ work a and exploiting it repeatedly. A chart pat-
you can generate a nice lot. I have all of his books. tern, an indicator setup, a seasonal trend.
smooth upward-sloping Straightforward, rule-based, Maybe add in some trend-following to
and the numbers look good. make sure you are typically “going with
equity curve over time. Yet most of the strategies in the flow.” Something you are comfort-
his books advocate for not able with, something you believe will
using a stop-loss—and the continue to work. Then add in some
smooths out the volatility of the numbers associated with those strategies reasonable position sizing and some
equity curve. back him up. But my mindset is that if inviolable risk controls and have at it.
• 10% invested using whatever ap- I am going to risk a certain percent of
proach you want. A lot of investors capital, I have to have some way of do- From your research, what patterns
make the mistake of being afraid ing that, and a stop-loss—for better or have you found that repeat over time
to ever trust their gut and others worse—automatically cuts a loss. Just in the markets?
make the mistake of risking too a different mindset. The best way I’ve Well obviously, I am a big fan of sea-
much of their capital on their in- heard it put is this: “The purpose of a sonality. There are a few reasons why.
stincts. Think of a stock you wish stop-loss order is not to maximize profit- First, as I said, one key to success is
you had bought, or conversely, ability. The purpose of a stop-loss order “finding an edge.” The vast majority of
that you bought way too much of. is to save your sorry assets.” people in the market look at technical
Well, if you only risk 1% to 5% of Like I said, different people have dif- and fundamental information. Very few
your entire portfolio and the stock ferent philosophies and that’s okay. The look at seasonality. So I feel that you are
tanks, is that really the end of the main thing to remember is that successful more likely to find a unique edge if you
world? Go ahead and trust your traders: a) control risk ruthlessly, and b) look where others are not. Also, there
gut. Take your shot. Just don’t bet have short memories when it comes to are a lot of unique anomalies related to
the ranch. If you’re good at it you losing trades. They don’t drag them for- seasonality.
might just make yourself rich. And ward and allow them to influence future Now I will say that committing
if you are not, you will figure that trading decisions. By the way, it’s much capital based solely on the date on the
out in time too. easier said than done. calendar does require a leap of faith.
But that is not always the only way to
Obviously, splitting things up as I have What type of stops have you found most use seasonality. For example, one can
just described (Figure 1) can get a little useful (e.g., standard stops, stop limits, look at a particular seasonal trend that
involved. But it gives you the potential trailing stops, and ATR-based stops), is bullish—say, soybeans typically rise
to make money in any kind of market, and how do you determine where to during February into May—and then
and stands to insulate you from a lot of place them? add in some trend-following and ask “is
potential pain by avoiding riding the For purposes of limiting an initial loss price action actually bullish?” If some
market to the bottom, or just holding a standard stop order typically serves that asset is in an actual price uptrend during
on while the market goes sideways for purpose most efficiently. If you decided a typically bullish time of month or year
many years. you are going to risk x% on a trade and or whatever, that can be a pretty simple
you are down x%, cut bait, move on. yet pretty powerful combination.
One of the ways to limit losses is to use Period. No remorse. For a trailing stop—
stop orders on trades. Is that something where you are locking in a profit—one Since you are a believer in seasonality,
is it safe to assume you are an advocate
of “sell in May and go away”?
% Approach Purpose
Yes, but not necessarily in the way most
30% Buy & Hold Always have some market exposure
people think. The key as I mentioned is
30% Trend-Following Automatically reduce risk in a prolonged bear market finding an edge and exploiting it repeat-
30% Tactical Strategies Diverse opportunities; smoother equity curve; cut risk in a bear market edly. There is an abundance of research
10% Your Choice Trust your gut, be your own hero! regarding the fact that the stock market
FIGURE 1: ONE APPROACH TO STRATEGY DIVERSIFICATION. Investors can invest a percentage of their
tends to perform pretty well November
portfolio in four different approaches to gain the benefit of multiple opportunities, instead of just following one through April/May, especially if you
approach with 100% of their money. follow that approach over a five-year
32 • July 2020 • Technical Analysis of Stocks & Commodities
period. Certainly, a lot of volatility can tistically significant.” My theory and end of October, so it is not technically
happen along the way, but since 1949, is that this is because that’s where correct to call it a “bearish” period. But
buying and holding the Dow November 1 the bulk of growth occurs over two thoughts to keep in mind: First, from
through May 31 every year for five years time—that is, the midcap space is 1949 through 2019, the cumulative price
has showed a gain 64 out of 66 five-year essentially comprised of formerly gain for the Dow during June through
rolling periods. That’s 97% accuracy. small-cap stocks on their way to October was just +34%.
That’s a pretty consistent trend to hang becoming large-cap stocks—that Secondly, consider an alternative in-
your hat on. is, the growers. vestment. If we look at total returns for
3. For whatever reason, the power the S&P 500 index and three- to seven-
In the November 2019 issue of this zone in the US extends from No- year treasuries only during June through
magazine, you wrote an article titled vember 1 through May 31, while October since 1981, we find bonds earned
“Stock Market Seasonality: A Global the international power zone is 289% versus 107% for the S&P 500 stock
Phenomenon” based on the “sell in May November through April plus the index. Just as significantly, bonds had a
and go away” approach, using data month of July. If you had held the maximum drawdown of -2.5% versus
from seventeen single-country ETFs. MSCI EAFE Index during those -40.8% for the S&P. If you are focused
What conclusions did you reach, and power zone months starting in on consistency and low volatility, those
were you surprised by the outcome? November 1970, you would have numbers are pretty compelling.
Well, doing the research was a real gained +12,461% versus a loss of
eye opener. Most every study I had ever -46% if you had held during all What are some examples of seasonal
seen or done looked at the Dow and/ other months, which I refer to as trends that most investors may not be
or the S&P. But the reality is that the the “dead zone” (Figure 3). Call it familiar with?
“power zone”—as I like to call it—is data mining if you’d like, but the The bond market is extremely cycli-
a global phenomenon. Virtually every consistency is tough to beat. cal. Stock-correlated bond vehicles
single international stock index and such as ticker CWB (convertibles) and
every individual single-country stock And what about the rest of the year, HYG (high-yield) typically perform
index tested showed a strong net gain if or as you call it, the dead zone? Do best December through April. Long-
held every year November through April you suggest avoiding the stock market term treasuries (ticker TLT) have been
and—with one minor exception—they altogether? best between May and August, and
all showed significant losses over time The reality is that on a year-to-year intermediate-term treasuries (ticker IEI)
during the other months of the year. basis, the S&P and Dow do advance about are favored September through Novem-
60% of the time between the end of May ber. Using Vanguard funds VWEHX,
Did you uncover any other surprises in VUSTX, and VFITX in this manner,
researching this phenomenon? since all three funds were available in
I’ll give you three: 1991, has outperformed buying-and-
holding the three funds by over 3-to-1.
1. If you look at rolling five-year Almost no one is aware of this.
returns across a variety of index-
es—growth, value, large- cap, low Are there any other seasonal/cyclical
volatility, momentum, etc.—most factors at work in the bond market?
show a five-year cumulative power You bet. For years, long-term treasur-
zone gain 100% of the time, or close FIGURE 2: MSCI EAFE DURING POWER ZONE ies have made all their money during
to it. There is no guarantee that MONTHS OF NOVEMBER THROUGH APRIL PLUS
the 10th, 11th and 12th trading days of
JULY. Clearly, this equity curve illustrates the long-
this will last forever, but if you are term value of this approach, rising over 12,000% since the month and during the last five trad-
looking for an “edge,” this seems October 1970. ing days of the month. All other days
like a good place to look. combined have almost always shown
2. The top-performing index during consistent losses over time.
the power zone (Figure 2) histori-
cally over time has been the S&P Do you think this trend will continue
Midcap 400 index. Now the reality to hold if interest rates rise?
is also that it can underperform That’s an important question. Interest
for several years at a time as well. rates tend to move in roughly 30-year
However, since 1981, it has gained waves. We have now been in a downtrend
almost three times as much as the for almost 40 years, so conventional
FIGURE 3: MSCI EAFE DURING ALL OTHER
S&P 500 index during November MONTHS. As expected, the other months were much
wisdom argues that rates are due to rise.
through May. That’s what we quan- more volatile, but ending 50% lower, which is really an But now that I see negative interest rates
titative types refer to as, ahem, “sta- amazing contrast to Figure 3’s results. in many countries around the globe, I am
July 2020 • Technical Analysis of Stocks & Commodities • 33
 FSHOX as a proxy): No- to point out that the best thing about
vember through May up 30 option trading is also the worst thing
The vast majority of people times in 33 years and total about option trading.
in the market look at return 1986 through 2019
equals +8,584%. Mean- How’s that?
technical and fundamental while, cumulative return The best thing about option trading
information. Very few look for May through October is that there are so many choices. The
at seasonality. equals -63%. A pretty stark worst thing about option trading is that
difference, to put it mildly. there are soooooo many choices!

Energy (using FSESX as a In your opinion, what are the keys to

not so sure that it won’t happen here. If it proxy): Held June through November success in option trading?
does, long-term treasuries may still have every year since 1986 has lost -95%! The first thing is to determine what
a long way to go on the upside. Seriously, what is the point of bucking your objective is, both overall and on
At the same time, I read a study those kinds of odds? a trade-by-trade basis. The primary
somewhere that calculated that if the categories are: a) speculating on price
long bond yield rose from 2.8% to 6.2%, What about within a given month? direction, b) generating income, and c)
long-term treasuries would lose -65% in Let’s talk trading days of the month. hedging. What are you trying to achieve
principal. Now, one can argue that that Here is a crazy set of numbers. Let’s by taking this trade? The second thing is
type of rise in rates is unlikely anytime consider what would have happened if to learn which strategies can best serve
soon, but the point is, is anyone out there you held the S&P 500 stock index during your purpose. The last thing is to learn
worried about that, or even aware of the every day of the month except during how to put the odds as much in your favor
level of potential risk? the period from the 10th-to-last trading as possible on a trade-by-trade basis.
day of the month through the 5th-to-
Is there a way to avoid that kind of last trading day of the month. In other Can you give us an example of what
outcome? words, every month, you get out of the you mean?
One really simple way is to keep an eye market for those six days and then get Sure. If you think price is going up,
on the 10-year and 30-year yields (tickers back in. A lot of people will think about buying a call option is the most straight-
TNX and TYX) versus their respective that idea and their first reaction is, “well, forward approach. But from there, you
120-month—yes month—exponential that sounds like a pain in the rear.” And then have the decisions of which expi-
moving averages. If rates are below from a logistical real-world trading point ration month to trade and which strike
their long-term averages—as they have of view, it really actually is. price to buy.
been for most of the last 40 years—its But consider this. From the end of
okay to hold bonds. But if the 10- and 1949 through the end of 2019, the cumu- Are there any rules of thumb?
30-year yields establish an uptrend—that lative price gain for this approach was There are lots of rules of thumb, but
is, above their long-term average, it is +130,588% versus +19,268% for buy and there are no definitive “correct” answers.
imperative that investors avoid long-term hold. To put it another way, by holding As I alluded to, that’s what makes op-
bonds or they will never know what hit the S&P 500 only during the period from tion trading trickier than other types of
them until it’s too late. the 10th-to-last trading day of the month trading.
through the 5th-to-last trading day of the For example, if you think a stock is
Any other insights regarding season- month, for the past 70 years, you would going up, you can buy the shares and
ality? have lost -86%! This is an example of hold them for however long you’d like.
How much space do you have? Seri- “finding an edge” using seasonality. And If you are going to trade an option, it’s
ously though, yes, there are a lot. The realistically, is the whole world going different. If you absolutely believe the
thing to remember is that like anything to read this and adopt this strategy and stock is going to pop 3% in the next five
else, seasonality is not for everyone. negate this edge? Not likely. days, then you would likely make a dif-
Some people just cannot wrap their heads ferent trade than if you just expect it to
around the idea that certain things tend to You write the monthly column on op- work its way over the course of several
move at certain times. And that’s fine. If tions for this magazine (“Explore Your months. If you have a specific outlook,
someone is not comfortable with a certain Options”), so let’s turn our attention you can take a more or less aggressive
idea, they should not attempt to use it there. Do you see option trading as dif- trade. Which goes back to my earlier
because it violates the “use a method you ferent from other kinds of trading? point: It’s great to have the flexibility—
are comfortable with” rule. That being Absolutely. With stocks, futures, or but it can also complicate things a bit if
said, here are some quick mentions: ETFs you are either long, short, or flat. you are not entirely focused.
With options you can achieve any kind Probably the most useful rule of thumb
Housing and construction (using of exposure you want. Which leads me is that the best way to make money in the
34 • July 2020 • Technical Analysis of Stocks & Commodities
long run is to avoid trying to make all the forth in terms of relative perfor- of internationals (Figure 4).
money in the world in the short run. mance. US stocks outperformed in • Second, unbeknown to most inves-
the 1970s, the 90s, and in the most tors, the midcap space is where the
When you hear or read an article recent decade. Internationals led bulk of growth takes place. From
by a market commentator, financial during the 1980s and the 2000s. I 1981 through 2019, the S&P 400
advisor, or brokerage firm indicating am keeping a close eye on the SPX/ gained +13,225%, the S&P 500
that market timing can’t be done suc- EAFE ratio. When it turns down in gained +6,468% and the Russell
cessfully, how do you respond to that a meaningful way, chances are it 2000 gained +4,155%. In recent
and what is your take on the validity will signal a long-term shift in favor years the large caps have outper-
of market timing? formed. I expect the midcap space
I ignore them. If that is their opinion, to re-exert itself in the years ahead
what do I care? I do what I do, they do relative to the other indexes.
what they do, the world keeps turning • Lastly, commodities are the dogs
and the markets keep fluctuating. of the investment world, and have
been for some time. This is unlikely
You have written four books. Is there to last forever. The ratio of the
another book in your future? And if Goldman Sachs Commodity Index
so, what would be its focus? to the S&P 500 had been trending
I would love to. It would probably be FIGURE 4: US STOCK INDEX PERFORMANCE steadily lower since the peak in
RELATIVE TO INTERNATIONAL STOCK INDEX
along the lines of my last book Seasonal PERFORMANCE 1971–2019. Look for a change 2008. Now the bottom has pretty
Stock Market Trends since I have a lot in direction to signal a buying opportunity for inter- much dropped out. This won’t last
of material on the topic. I would also national stocks. forever. At the same time, no one
love to combine seasonal trends with knows “how low is low,” so as a
trend following and other overbought/ trend-follower at heart, I haven’t
oversold indicators to use as a basis for really acted on this idea so far.
trading rather than just seasonal trends The good news for investors is
on an esoteric basis. that when the trend starts to turn
in favor of commodities, they can
You also write a blog called JayOnThe- now gain exposure to commodities
Markets.com. What do you write about through ETFs rather than having to
there? FIGURE 5: COPPOCK GUIDE SIGNALS FOR THE
get into the futures market.
Whatever comes to mind pretty much. S&P 500, 1971–2020. This indicator overall had
Sometimes it’s options, sometimes it accurate calls, but be sure to use other confirming In the November 2001 issue of Stocks
seasonals or commodities, or economic indicators as well. & Commodities, you wrote an article
indicators, trading setups—whatever. I on a monthly Fidelity Select funds
refer to it as “the ramblings of a market- Buy Sell Held % +(-) trading system you called the “pure
addled mind.” I don’t make recommen- 9/30/1970 9/30/1971 12 months +16.8% momentum system.” Have you run
dations or offer trading advice, it is just 1/31/1975 1/31/1976 12 months +31.0% these models for the 2000 to 2010
“here is what I see,” or at least, “what 4/28/1978 4/30/1979 12 months +5.1%
timeframe (for example, double bear
I think I see.” It’s fun for me because I market period) to see if the strategy
can just put the ideas out there and the 8/31/1982 8/31/1983 12 months +37.6%
works as well as during bear market
reader can agree, disagree, use it, ignore 12/31/1984 12/31/1985 12 months +26.3% years compared to the blistering bull
it, whatever. But I have been doing it for 9/30/1988 9/30/1989 12 months +28.4% market of the late 1980s and 1990s?
six years now so there is a lot of material 2/28/1991 2/28/1992 12 months +12.4% Interestingly, the good news is that
there in the archives. 1/31/1995 1/31/1996 12 months +35.2%
it vastly outperformed the S&P 500
index during 2000 through 2009; +125%
Any changes in the future you see 1/31/2002 4/30/2002 1 month (-4.7%)
versus -9%. The bad news is that in the
forthcoming? 5/31/2002 7/31/2002 2 months (-14.6%) past 10 years it underperformed pretty
I am not too good with “predictions,” 8/30/2002 9/30/2002 1 month (-11.0%) substantially: +193% versus +257%.
but I am pretty good at identifying cycles 3/31/2003 3/31/2004 12 months +32.8% Overall, since November 2001, the me-
and relationships, and there are a few that 5/29/2009 5/31/2010 12 months +18.5%
dian 12-month gain was 14.9% for the
I believe will change again in the years strategy versus +12.8% for the S&P 500.
ahead. In no particular order: 5/31/2016 5/31/2017 12 months +15.0%
So still a viable long-term strategy. To
FIGURE 6: COPPOCK GUIDE BUY SIGNALS. Buy on
signal date, and sell 12 months later or if the indicator
tie some things together, in my mind, a
• US stocks and international stocks turns back down sooner. Note the negative performance
have a long history of back and confined to 2002. Continued on page 62
July 2020 • Technical Analysis of Stocks & Commodities • 35
 TRADING ON MOMENTUM

Taking The Highway Onramp

Dual-Candle Breakouts
Simply buying into an uptrend in iso- Step-by-step action plan early in the breakout move. This is similar
lation often leads to false breakouts. Here’s how you can start using this to using technical indicators such as the
Instead, you may find more success if you strategy: average true range (ATR) as it increases
scan for dual-candle breakout patterns. in value, revealing an acceleration to the
Here’s how to find them. Step 1: Visually scan for charts in upside in price action.
which a sequence of two candles in an
Trade management tips

W
by Ken Calhoun uptrend is seen, in which the second
candle has a height of at least twice When entering your first breakout in a
hen it comes to correctly the previous candle height. sequence, it is usually a good idea to use
entering uptrending charts, a very small share size. When setting
your goal should always be Step 2: Enter your position on the day your stop-loss, the price that proves this
to find the strongest price following this dual-candle breakout pattern wrong would be an obvious loss
action breakouts. One of pattern once price is above the high of support under both candles. In addition
the easiest patterns to look for is one in of the second candle. to identifying your first entry, you can
which uptrending candles are getting also use this dual candle pattern later
taller in size, indicating increasing buy- Step 3: Use an initial stop-loss at the in the lifecycle of your swing trades to
ing strength. When daily trading ranges low of the candle pattern. scale in and buy more shares. This pat-
expand during an uptrend it indicates a tern is relatively easy to spot visually
technical breakout that you can capital- Insights: Why this and is a core pattern I use in my own
ize on. This month’s column will explain technique works swing trades.
how to visually scan for this pattern and Think of price action breakouts like
trade it. driving onto a freeway—you want to Ken Calhoun moderates a popular live
accelerate your speed when driving; in trading room for active traders. He is
Sequence of taller trading, you want to enter your trades as the founder of TradeMastery.com, an
candles price is going higher relatively quickly. interactive webinar site for active trad-
Simply buying into an uptrend in isola- This momentum-based trading approach ers, and is a UCLA alumnus.
tion often leads to false breakouts, much is designed to help us enter our positions
to every trader’s frustration. Instead, during strong price action, relatively
you may find more success
by looking for dual-candle
breakout patterns, in which
the height of the second of
two candles is taller than the
first candle in an uptrend, as
seen in Figure 1, Moderna
Inc. (MRNA). Note that this
pattern needs to occur at a
new one-month high to be
valid; you do not use this for
entries when the candle pat-
tern is observed inside the
previous trading ranges or
near lows. Also, the volume
of the second candle needs to
be higher than the volume of
the first candle, as illustrated
in Figure 1. You enter on the
day following this dual-candle
eSIGNAL

breakout pattern. FIGURE 1: DUAL-CANDLE BREAKOUT IN PROGRESS (MRNA). As price action breaks to new highs, this candle pattern
shows how strong the breakout can subsequently move.

36 • July 2020 • Technical Analysis of Stocks & Commodities

 Algo Q&A
ALGORITHMIC TRADING
Have a question about system or algo trading? Kevin J. Davey has over 25 years of
system trading experience. Davey is a full-time trader, and he also teaches and con-
sults via his Strategy Factory online workshop (http://kjtradingsystems.com). He is the
author of several bestselling trading books, including Building Winning Algorithmic
Trading Systems and Introduction To Algo Trading. Send your questions or topic sug-
gestions to Kevin Davey at [email protected]. Selected questions will
appear in a future issue of S&C.
Kevin J. Davey

DATA BACKUP AND MANAGEMENT ready to restore any corrupted data. I but also to their internet router. Having a
I just tried to open my trading platform also manually export my workspaces, partial or whole house generator is also
today, and all my indicators and strate- strategies, and studies to a USB stick, a good idea.
gies are gone. HELP! and keep that offsite. Finally, I clone my
There is nothing worse than opening hard drive every few weeks. Broker connection
your trading platform on Sunday night That leaves me with four unique loca- What happens if there is a major shut-
before the market open and seeing… tions where my trading data is stored. down of the internet or the connection to
nothing. All the custom charts you cre- In case of corruption, I will still be your brokerage, and you cannot access
ated…gone. All the strategies, indicators inconvenienced, but not permanently your brokerage? I keep phone numbers
and studies you created…gone. It is a dead in the water. for my brokerage’s trade desk close by, in
sickening feeling, and if you think it Additionally, I have a backup PC that case I am unable to access my brokerage
can’t happen to you, sooner or later you can quickly be brought online in case the online. So worst case, I can always call
are in for a rude awakening. primary PC crashes. I also can use the them and exit trades.
When this happens—and it likely will VPS for this purpose. Having multiple My rule of thumb with all my backup
at some point, regardless of the platform ways to access your trading platform is plans is to be up and running within 15 to
you use—what can you do? I follow a wise idea. 30 minutes, regardless of the root cause.
a data backup and management plan, If I find myself “in the dark” for longer
which encompasses not only corruption Internet connection than this, I know I have to improve my
issues, but also general fault points with Having multiple ways to access the inter- backup plan. Occasionally, I simulate a
my whole setup. net is a key part of a backup plan. Many failure, just to keep my recovery skills
Let’s walk through some of the impor- traders have internet service from two sharp, and to ensure I’ve covered all
tant pieces of a trading backup plan. different providers, and there are routers possibilities.
that will seamlessly switch providers Obviously, details will vary from
Local PC or virtual private server? should one go down. I personally use trader to trader, but having a backup plan
Most retail traders use their home PC my cell phone hotspot as an emergency for every key piece of your trading setup
or smartphone to control their trades. backup. I also have a few trusted places is really important. The best practice is
I personally use a home PC for most where I can take my laptop to connect to have this plan written down and eas-
automated trading, although I’ll switch via wi-fi. Again, having redundancy in ily accessible. The last thing you need
to a virtual private server (VPS) if I am your setup is key. during stressful events is panic and rash
traveling for an extended time. I have a decision-making. Having a good backup
cloud-based backup service for all my Power connection plan will eventually save you a lot of time
personal data (I use Backblaze). I also Everyone trading from home should and aggravation.
use my trading platform’s backup feature have a battery backup that supplies
on a weekly basis, so I have an archive emergency power not only to their PC,

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July 2020 • Technical Analysis of Stocks & Commodities • 37

 Staying The Course

The Chase Of Volatility

The fear of missing out (FOMO) can create a psychological the trader’s framework, and especially if trade entries are the
challenge for traders. Here are some steps you can take to result of FOMO.
help prevent emotions from entering into your trading deci- History suggests that Dan Herman first identified the syn-
sions and wreaking havoc on your trading plan. drome of the “fear of missing out” in 1996 and described it
in an academic paper published in 2000. However, Patrick

B
by Robert van Eyden, PhD McGinnis famously coined the term “FOMO” in 2004.

ehavioral finance has grown over the past twenty FOMO

years—and the conclusion is that investors rarely FOMO is embedded in human nature. But it has shown up
behave rationally. Extending the principles of as an increasing tendency over the last few years with the
behavioral finance into the trading realm can be proliferation of constant information, constant updates, and
useful, especially when it relates to trading psy- social media. Traders can easily become seduced into want-
chology and the behavior of traders. According ing to participate in market movements, even if it doesn’t fit
to the late John Bogle, founder of The Vanguard Group, “The into their normal trading plan or risk-to-reward management
MARIO BREDA/SHUTTERSTOCK

two greatest enemies of the equity fund investor are expenses framework. The desire is brought about by a fear of miss-
and emotions.” This is the case for traders as well. ing out on the movement—especially in volatile markets. In
It is well documented that risk and trade management are reality, during periods of market volatility, the best course
far more critical components for trading success than is trade of action may very well be to take no action, although this
identification, especially if trade identification occurs outside feels counterintuitive.
38 • July 2020 • Technical Analysis of Stocks & Commodities
 TRADING PSYCHOLOGY

FOMO can also influence the forma-

tion of long-term trading goals and can
influence a trader’s perception of what
a valid entry signal is. FOMO could
result in the placing of an emotional
trade, which could go against the trader’s
trading plan or go against what the trader
normally considers a valid entry signal.
Possible reasons for taking a FOMO
trade could be a result of:
• Fear, uncertainty, and doubt
(FUD)
• Overconfidence
• The herding behavior bias
• Trading the long bar
FUD FIGURE 1: LONG BARS ON THE DJIA (DAILY). The chart shows the long bars in red. The blue line depicts the
Markets are driven by two powerful preceding 5 or 10 bars before the long bar. If a trading signal is generated on the long bar, a good trading plan
emotions: greed and fear. Traders can
would discard the signal, since this scenario can lead to a higher-risk/lower-reward trade.

succumb to these emotions at times of

heightened volatility or uncertainty, and that can have a pro- over a series of trades.
found and potentially undesirable effect on trading outcomes. Traders can negate the overconfidence siren song by plan-
Picture the Greek literary character Ulysses, who heads home ning the trade and trading the plan, with confidence.
after the fall of Troy. He sails past the island of the sirens
(think of the ocean as market volatility), and these danger- The herding behavior bias
ous creatures (think of them as FUD) lure sailors with their A trader’s preexisting belief influences the way he experiences
enchanting voices to shipwreck on the rocky coast of their a trade. A trader should always take care that he is not merely
island (think of that as a poor trading outcome). reacting to a market happening!
In that scenario, a rational solution could have been to simply Prevailing market conditions may influence a trader’s emo-
bypass the island. In the tale, Ulysses had his crew stop up tions; for example, going against the trend or missing out on
their ears with beeswax to block out the siren calls, and had a trend. Herd behavior/mentality can amplify during market
himself bound to the mast. In doing so, he was taking steps upswings and downturns, which could result in entering into
to constrain his future behavior. He knew that he was human, a trade-based emotion rather than within a trading plan or
fallible, and was likely to succumb to temptation. framework. A possible explanation for this behavior is that
Likewise, in trading, there are times when a trader’s best there are two systems of reasoning, intuitive and delibera-
intentions will be insufficient to overcome the force of tive. For most decisions, the two are very carefully aligned.
short-term desires. Unfortunately, in such cases, emotional When it comes to trading decisions, however, they become
trades can be made, usually to the determent of the trader’s very misaligned. The trader’s objective should be to achieve
equity curve. a positive, upward-sloping equity curve over a reasonable
time, and yet this can be discarded when a trader’s emotional
Overconfidence self takes over.
Overconfidence in a trader can occur as a result of:
• Attributing past successes to the trader’s own skills and Trading the long bar
attributing past failures to bad luck The long bar is essentially an entry bar that is two times the
length of the average length of the preceding 5 or 10 bars
• Focusing on output (that is, price) instead of on the (Figure 1). The reason why traders should not trade the long
process (that is, the trading plan). Position sizing and bar? At that stage, the market has “burned up” a lot of its
capital at risk are generally underemphasized, which volatility. This implies two things for the trader:
can lead to unsound bets being placed with catastrophic First, it will take a while to build up enough volatility to
consequences. move substantially again. Second, it has used up enough
Successful traders know that each trade executed is random volatility to not move back much.
from the previous and the next. A past winner is not indica- By virtue, a long bar entry necessitates a proportionally
tive of a future winner, and that the equity curve is a random larger stop. Given that price action has “burned up” a lot of
distribution of wins and losses. The only thing that matters
is that the average winner is greater than the average loser Continued on page 45
July 2020 • Technical Analysis of Stocks & Commodities • 39
 Investing In Our Infrastructure

Utility ETFs: Power Up With

Dividend Payers?
Investing in our infrastructure power is critical to our daily Utilities have a long history of dividend payments and are
lives. Without adequate energy, our country would grind to sought after by investors as a portfolio component when the
a halt. Conservative investors may want to invest a portion economic and stock market conditions soften, but they most
of their funds in this defensive sector for capital appreciation likely would not perform as well as fixed-income vehicles. Most
and dividends. Since 2007, they have provided an annualized of the companies have very stable earnings and management
return of 8.52% compared to 8.81% for the S&P 500 with with bright futures if they harness their brainpower to plan
less volatility and drawdown. ahead. However, investors need to realize that even utilities
are not shielded from price declines in bear markets.
by Leslie N. Masonson

U
Review of seven utility ETFs
tility companies are the backbone of the power This article provides comparative data on the seven largest
industry in the United States. And some of these domestic utility ETFs based on assets under management
companies have had a rough going with natural (AUM). Utilities are one of the most homogenous company
disasters, man-made conflagrations, and compet- groups and the ETF offerings in the category clearly show
ing technologies. Nevertheless, this industry is this to be the case, especially with regard to their very similar
an essential component of our well-being and the portfolio holdings.
nation’s future growth. Solar power and other initiatives have All the data provided in the tables were obtained by XTF.
put pressure on utilities to become more efficient and reduce com. Figure 1 provides the ticker symbols and names of the
PHOTO BY ALEKSANDAR PASARIC

their operating costs. Less expensive natural gas has caused ETFs covered. In addition to these ETFs, there are others in
nuclear power plants financial strains, resulting in closings, the utility space that were not included because they had a low
such as the April 30, 2020 Indian Point Unit 2 reactor in New XTF.com rating, a small amount of AUM or very low daily
York closing down operations that were operational since 1974, trading volume or a combination of all three criteria. These
since its generating capacity had diminished to only 65%. include PSCU, JXI, and JHMU. In addition, for the more
40 • July 2020 • Technical Analysis of Stocks & Commodities
 WHY TRADE ETFS?

aggressive investors, there are three ETF Name Ticker Symbol Metric ranking was 89% (100% is
leveraged ETFs not evaluated here: Utilities Select Sector SPDR Fund XLU the highest). All these measurements
UPW and SDO from ProShares, and are proprietary measures of XTF.
Vanguard Utilities ETF VPU
UTSL from Direxion. Information com and are explained in detail on
iShares U.S. Utilities ETF IDU
about these ETFs can be found on their website.
their sponsors’ websites. Fidelity MSCI Utilities Index ETF FUTY XLU’s annualized one-year return
The common characteristics of the First Turst Utilities AlphaDEX Fund FXU of 4.9% and its similar three-year
ETFs reviewed here are that they are Invesco 500 Equal Weigh Utilities ETF RYU return of 7.82% were the highest of
all open-end investment companies, Invesco DWA Utilities Momentum ETF PUI the group. Incoming fund flows over
listed on NYSE Arca (except for PUI, FIGURE 1: UTILITY ETFS. The five largest ETFs in the the past year were an amazing $3.37
which lists on the Nasdaq), equity only, utility category are shown with their tickers. Note that Invesco billion, clearly at least ten times larger
mostly large-cap or broad multi-cap, sponsors two of them. than its nearest competitor, Vanguard
style of core or blend, cap-weighted Utilities ETF. About 78% of its capi-
(except for FXU, which is weighted based on various funda- talization was large-cap with 22% mid-cap. Electric utilities
mentals, and RYU, which is equally weighted), and passively accounted for 60% of its industry exposure with multi-utilities
managed (except for FXU and RYU, which use an enhanced coming in second at 32%. This ETF is the only one of the
strategy that will be explained shortly). The standard deviation group to offer both options and futures.
over three years for all these ETFs was right around 23% with
only FXU at 22%. Figure 2 provides the comparative data I’ll Vanguard Utilities ETF (VPU)
discuss here in more detail. This Vanguard ETF came into existence on January 30, 2004,
five years after XLU, and has been able to capture $3 billion
Utilities Select Sector SPDR Fund (XLU) in AUM, which far exceeds that of IDU with a 3.5-year lead
This ETF, issued by SSGA Funds Management, Inc., was the in June 2000. No doubt the Vanguard reputation and lowest
first one in this category with a December 16, 1998 inception expense ratio of 0.10% played a big role in its asset growth.
date. Therefore, it has the longest track record of almost 22 Its annual dividend yield of 3.06% is third best of the group.
years, and has garnered a huge $12 billion in AUM. Based Companies in its portfolio include similar ones to XLU, but
on its early entry and huge presence, it is the behemoth of also include those that are power producers and distributors,
the group by far. This ETF is one of eleven Sector SPDRs as well as nuclear and nonnuclear facilities. Its average daily
and comprises the utility companies in the S&P 500 Index. trading volume of 265,000 is fourth best of the group.
They include companies such as electric and gas utilities, The portfolio holds 67 positions, the largest of the group.
multi-utilities, independent power producers, and energy The top five holdings account for 37.5% of the assets: NEE, D,
traders. XLU has a 99.9% correlation with FUTY and VPU, DUK, SO, and AEP. This ETF’s XTF rating is a solid 9.8 out
and 99.8% with IDU and 99.7% with RYU. These four ETFs of 10, and its Structural Integrity rank of 97% is the highest
are basically clones, as the all have similar if not exact top- of the group. Lastly, its Investment Metric was 81%, placing
five holdings. it at a tie for second lowest of the category.
Its expense ratio of 0.13% is in the lowest third of its VPU’s annualized one-year return is a disappointing 2.86%,
competitors, and its an-
nual dividend yield is Category XLU VPU IDU FUTY FXU RYU PUI
the highest at 3.31%.
XTF Rating 9.9 9.8 9.3 9.7 8.8 9.6 7.7
The average daily trad-
ing volume of nearly 20 Investment Metric Rank 89% 81% 81% 82% 87% 88% 64%

million shares dwarfed Structural Integrity Rank 95% 97% 85% 95% 74% 87% 71%
its competitors, whose Market Cap $12B $3B $889M $805M $792M $312M $82M
numbers ranged between Expense Ratio 0.13% 0.10% 0.43% 0.08% 0.63% 0.40% 0.60%
32,000 to 314,000. The Annual Dividend Yield 3.31% 3.06% 3% 3.22% 2.65% 2.87% 2.5%
portfolio holds 28 posi- Avg. Daily Volume 19,959,195 265,880 93,079 266,035 314,615 32,187 72,207
tions with the top five Avg. # of Components 28 67 48 65 35 28 35
accounting for 28.5% of
Inception Date 12/16/1998 01/30/2004 06/20/2000 10/21/2013 05/08/2007 11/07/2006 10/26/2005
the assets: NEE, D, DUK,
SO, and AEP. This ETF’s Annualized Period Return 1 Year 4.9% 2.86% 2.48% 2.79% -2.31% 1.25% -0.65%

XTF rating is 9.9 out of Annualized Period Return 3 Years 7.82% 7.55% 7% 7.49% 1.91% 6.62% 6.14%
10 (10 is the highest), and Net Asset Flows - 1 Year $3.37B $364.66M $157.91M $217.78M $-27.56M $-2.50M $-136.75M
its Structural Integrity Net Asset Flows - 3 Years $4.14B $1.17B $87.16M $511.40M $-515.57M $122.33M $-68.63M
rank is a very high 95% Standard Deviation 3 Years 23.33% 23.34% 22.94% 23.14% 21.62% 23.33% 23.5%
(100% is the highest). FIGURE 2: COMPARISON OF UTILITY ETFS. Critical comparative data is shown for each ETF. They are arrayed in AUM mag-
Lastly, its Investment nitude from left to right.
July 2020 • Technical Analysis of Stocks & Commodities • 41
 enter the category. Its AUM of $805 million is fourth best,
but a very good performance considering the late entry to the
Utilities have a long history ETF arena in general, especially compared to Vanguard, which
beat them to the punch over nine years earlier. The quality
of dividend payments and recognition by investors of the “Fidelity” brand name
and are sought after by definitely played an important role in rapid asset generation,
investors as a portfolio impressive yearly inflows and better-than-average trading
component when the volume in the category.
Its annual dividend yield of 3.22% placed it second in
economic and stock market the rankings. The average daily trading volume of 266,000
conditions soften. shares is second highest of its competitors. The larger-than
-average utility portfolio holds 65 positions with the top five
accounting for 37.5% of the assets: NEE, D, DUK, SO, AEP.
This ETF’s XTF rating of 9.7 is very good and third highest,
but it was second best, and its three-year return of 7.55% was and its Structural Integrity rank of 95% ranks in the top two.
also second best. Incoming fund flows over the past year were Lastly, its Investment Metric ranking was 82%, placing it in
a solid $364 million, and $1.17 billion over three years, the the middle of the group.
second best. About 69% of its capitalization was large-cap, IDU’s annualized one-year return is a minimal 2.79% and
21% mid-cap, and 10% small-cap. Electric utilities accounted its three-year return of 7.49% were both right in the middle of
for 56% of its industry exposure with multi-utilities coming the group. Incoming fund flows over the past year were a solid
in second at 30%., and natural gas utilities at 5%. This ETF $218 million, and $511 million over three years, third best.
offers just options, no futures. VPU has a 99.9% correlation About 69% of its capitalization was large-cap, 21% mid-cap,
to FUTY, XLU, and IDU with 99.6% to RYU. and 9% small-cap. Electric utilities accounted for 56% of its
industry exposure with multi-utilities coming in second at
iShares U.S. Utilities ETF (IDU) 30%, and natural gas utilities at 5%. This ETF offers neither
Black Rock Inc. is this fund’s issuer with an inception date options nor futures.
of June 20, 2000, the second oldest of the category. Its AUM
of $889 million is third best, but well under the top two by First Trust Utilities AlphaDEX Fund (FXU)
a wide margin. With a start date two decades ago, its asset First Trust Advisors LP is this fund’s sponsor with an incep-
size would probably have been much larger if Vanguard had tion date of May 8, 2007. Its AUM of $792 million places it
not entered the arena four years later. IDU is reconstituted fifth. This ETF uses an enhanced index approach, which uses
quarterly and currently holds 48 positions. Its annual expense the AlpaDEX stock selection methodology to pick stocks
ratio of 0.43% is at least three times higher than its top two from the Russell 1000 Index. The stocks are ranked using
rivals, and is the third highest of the group. their performance ranking over 3-, 6-, and 12-months, their
Its annual dividend yield of 3.00% placed it dead center of sales to price and one-year sales growth, and finally, based
the competitors. The average daily trading volume of 93,000 on value factors including book value to price and cash flow
shares is dwarfed by its competitors and places it fifth out to price. The stocks receiving the highest scores are selected
of seven. The portfolio holds 48 positions with the top five for inclusion in the portfolio.
accounting for 38.6% of the assets: NEE, D, DUK, SO, AEP. Based on this highly fine-tuned multistep investment process,
This ETF’s XTF rating of 9.3 is very good, and its Structural one would assume that this firm had found a methodology that
Integrity rank of 85% ranks it third lowest. Lastly, its Invest- would work well, and at least keep up with the performance of
ment Metric ranking was 81%, equal to VPU, but in the lower the more traditional cap-weighted competition. Unfortunately,
third of the group. that is not the case, as it actually had the worst one-year an-
IDU’s annualized one-year return is a measly 2.48%, and nualized performance of -2.31%, and the worst three-year
its three-year return of 7% were both right in the middle of performance of 1.91%. Moreover, for this poor performance,
the group. Incoming fund flows over the past year were a solid First Trust charges a 0.63% annual expense ratio, the highest
$157 million, and $87 million over three years, fifth best. of its competitors. Also, its annual dividend yield of 2.65%
About 71% of its capitalization was large-cap, 22% mid-cap, is next to the lowest.
and 7% small-cap. Electric utilities accounted for 57% of its Interestingly, its average daily trading volume of 315,000
industry exposure with multi-utilities coming in second at shares is second best, eclipsing that of VPU and FUTY by
30%, and natural gas utilities at 5%. This ETF offers options, about 50,000 shares a day. The portfolio holds 35 positions
but not futures. with the top five accounting for 22.8% of the assets: NRG,
VST, UGI, NFG, and CNP. None of these positions matches
Fidelity MSCI Utilities Index (FUTY) that of its competitors, which is not surprising based upon
Fidelity Management & Research is this fund’s issuer with their selection filters. This ETF’s XTF rating is 8.8 and its
an inception date of October 21, 2013, the latest large firm to Structural Integrity rank of 74% ranks it next to last. Lastly,
42 • July 2020 • Technical Analysis of Stocks & Commodities
its Investment Metric ranking of 87% was very close to the positive side, the three-year flows were $122.3 million. About
top two in the group. 56% of its capitalization was large-cap, and 44% mid-cap.
Instead of receiving incoming fund flows, FXU has expe- Electric utilities accounted for 47% of its industry exposure
rienced outflows of $515 million over three years and $28 with multi-utilities coming in second at 36%, and alternative
million over the past year, the worst three-year record of all. and renewable energy at 6%. This ETF offers neither options
About 39% of its capitalization was large-cap, 39% mid-cap, nor futures.
and 19% small-cap. This allocation was much different than
its competitors, especially the high percentage of small-caps. Invesco DWA Utilities Momentum ETF (PUI)
That probably accounts for some of its weak performance, as Invesco is also the sponsor of its second ETF in this category
the small-caps have been market laggards. Electric utilities with an inception date of October 26, 2005—about one year
accounted for 43% of its industry exposure with multi-utilities earlier than RYU was brought to market. Its low AUM of $82
coming in second at 23%, alternative and renewable energy at million brings it in at dead last. Being available for 14.5 years,
11%, and natural gas utilities at 5%. This ETF offers options, its asset base is not impressive. This ETF uses the Dorsey
but not futures. Wright selection approach, which uses point & figure charting,
as well as relative strength analysis and ranking to determine
Invesco S&P 500 Equal Weight Utilities ETF (RYU) the strongest performers to place in the portfolio. This ETF
Equal-weight ETFs are common and RYU is the only one in is rebalanced and reconstituted quarterly.
this grouping from Invesco Capital Management LLC. This Its annual expense ratio of 0.60% is the second highest. The
ETF’s goal is to replicate the performance of the S&P 500 annual dividend yield of 2.50% is the lowest offered in the
Equal Weight Telecommunications Services and Utilities category. The average daily trading volume of 72,000 shares
Index. Since its inception date of November 7, 2006, it has is second lowest, which makes both Invesco ETFs the least
been able to gather AUM of $312 million, second from the transacted in the group. The portfolio holds 35 positions with the
bottom of the group, but a decent showing. Its annual expense top five accounting for 21.2% of the assets: NEE, WEC, XEL,
ratio of 0.40% is in the mid-range. Its annual dividend yield SO, and ETR. This ETF’s low XTF rating of 7.7 coupled with
of 2.87% places it just below the middle of the pack. its low Structural Integrity rank of 71% result in the weakest
The average daily trading volume of 32,000 shares is performance of all. Moreover, its Investment Metric ranking
dwarfed by its competitors and places it in last place. The of 64% was at the bottom of the rankings. Overall, the XTF
portfolio holds 28 positions matching XLU as the smallest scores are way below average for the utility category.
portfolio size. The top five holdings account for 19.5% of the With all its high-powered momentum and ranking criteria,
assets: NRG, AES, CNP, SRE and DTE. This ETF’s XTF its one-year negative return of -0.65% was very disappointing.
rating of 9.6 is very good, and its Structural Integrity rank of Moreover, its three-year return of 6.14% placed it next to last.
87% is mid-range. Lastly, its Investment Metric ranking of Another big letdown was the negative $137 million in cash
88% is second best. outflows over the past year, and $69 million outflows over
IDU’s annualized one-year return is lower than average three years, the worst one-year and second-worst three-year
at 1.25%, with its three-year return of 6.62% about one per- performance. About 37% of its capitalization was large-cap,
centage point below its competitors. On the negative side are 35% mid-cap, and 24% small-cap. The small-cap underper-
the outflows over the past year of -$2.5 million, but on the formance also was disappointing. Electric utilities accounted

FIGURE 3: ETF PRICE PERFORMANCE SINCE MAY 10, 2007. This chart excludes FUTY since it only debuted in October 2013. Vanguard Utilities had the highest
return, but the S&P 500 index surpassed it by 39 percentage points.

July 2020 • Technical Analysis of Stocks & Commodities • 43

 Although Blackrock’s IDU came out only 1.5 years later than
XLU, it has not been able to come close to matching its rival’s
Investors should realize outstanding overall performance in the data attributes just
delineated. Vanguard’s VPU has overpowered IDU starting
that even utilities are 3 and one-half years later in all the attributes as well.
not shielded from price Although Fidelity was a late entrant into the ETF world
declines in bear markets. overall, it has been able to amass a decent AUM since its in-
ception in late 2013. Invesco Capital Management has placed
two ETFs in this category. RYU is an equally-weighted port-
folio that came to market on November 7, 2006, and PUI is
a momentum-based ETF that was introduced about one year
for 40% of its industry exposure with multi-utilities coming earlier. Why Invesco decided to offer two ETFs in this heavily
in second at 25%, and natural gas and water utilities at 5% populated category with the big behemoths grabbing most of
each. This ETF offers neither options nor futures. the AUM born earlier is hard to understand in retrospect. And
to top it off, the poor relative performance and asset outflows
Comparison of price performance make matters even worse.
Performance-wise, you’d expect the long-term numbers to be One concerning negative common characteristic of FXU,
quite similar for ETFs with highly correlated assets. That is RYU, and PUI is their cash outflows for the past one and
exactly the case, as illustrated in Figure 3. The top performer three years. This is not a good sign going forward, as their
was VPU with 118% total return for the 13-year period, competition is picking up hundreds of millions of dollars in
followed closely by RYU at 116%, then XLU and IDU at this category.
112%. Trailing the pack were PUI at 105% and FXU at 92%. With the recent coronavirus pandemic, investors are con-
Interestingly, these latter two ETFs had custom weightings, cerned about the possible reduction of power usage by com-
as explained earlier, but had the worst performance. Not a mercial and industrial firms, which could result in reduced
good showing. forward earnings for utility companies. Moreover, individuals
One popular time-tested strategy is “sell in May and go who are not working and those on unemployment will be late
away,” also known as the best six months strategy, which payers or non-payers, which is another revenue concern. Utili-
invests from November 1 through April 30 and remains in ties may have to request rate increases in the future to make
cash for the other six months. Using XLU as the investment up for the shortfalls in the near term, but regulars may not be
vehicle, as representative of the utility space, and comparing sympathetic. So, with possible delinquencies building as time
it to the SPY resulted in a return of -10.9% for XLU for the moves forward, investors need to take this revenue shortfall
period November 1, 2019 through April 30, 2020 compared to into account that could not only negatively impact the stock
-4.2% for the SPY. So the SPY held up better, as growth stocks prices, but also the safety of future dividend payments.
beat defensive issues like utilities. Of course, this is only the
most recent result of this strategy and a backtest going back Are you interested in learning more about using exchange
at least 50 years is necessary to obtain more reliable results, traded funds (ETFs) in your trading? Leslie N. Masonson, who
assuming there is sufficient data available. actively trades ETFs daily, is president of Cash Management
Looking at performance another way, we can compare the Resources, a financial consulting firm that focuses on ETF
performance of the Select SPDRs over the 2011 through 2019 strategies. He is the author of Buy—Don’t Hold: Investing
period. If we ranked each of the 10 S&P sectors from best With ETFs Using Relative Strength To Increase Returns
to worst performer in each calendar year, we would find that With Less Risk; and All About Market Timing, as well as
XLU was the top performer in 2011 and 2014 and second Day Trading On The Edge. His website is buydonthold.com,
best in 2018. On the other hand, it was the bottom performer where he writes a monthly blog. To submit topics for future
in 2009, 2012, and 2013. In 2015 and 2017 it was third from columns, reach him at [email protected].
the bottom, and in 2010 it was next to last. So overall, utili-
ties have not been a very good performer compared to the Resources
benchmark S&P 500. • www.direxion.com • www.fidelity.com • www.invesco.com
• www.ishares.com • www.proshares.com • www.ssga.com
Conclusion • vanguard.com • xtf.com
Based on a review of the data presented on seven utility ETFs,
the clear winner is XLU with the most AUM, highest dividend
yield, best overall price performance numbers for one and
three years, second-lowest annual expense ratio, largest daily
trading volume approaching 20 million shares, highest cash
inflows, options and futures trading, and last but not least,
the highest ratings in three proprietary xtf.com categories.
44 • July 2020 • Technical Analysis of Stocks & Commodities
POSTER/SCALING LAWS Guillaume DM, Dacorogna MM, Davé RD, Müller UA, Ol-
Continued from page 28 sen RB, Pictet OV. From the bird’s eye to the microscope:
a survey of new stylized facts of the intra-daily foreign
FurTher reading exchange markets. Finance Stoch 1997;1:95.
Poster, Richard [2020]. “Using Scaling Laws For The Devel- Glattfelder JB, Dupuis A, Olsen RB [2010]. Patterns In High-
opment Of FX Trading Models,” Technical Analysis of Frequency FX Data: Discovery Of 12 Empirical Scaling
StockS & commoditieS, Volume 38: February. Laws. Quant Finance; 11:599. Reprinted by permission of
Müller UA, Dacorogna MM, Olsen RB, Pictet OV, SchwarzM, the publisher (Taylor & Francis) at www.tandfonline.
Morgenegg C. Statistical study of foreign exchange rates,
empirical evidence of a price change scaling law, and
intraday analysis. J Bank Finance 1990;14:1189.

VAN EYDEN/CHASE OF VOLATILITY a checklist should never be rushed. Pilots review their
Continued from page 39 checklists carefully and systematically, which ensures
safety. A trader’s “nudge” is their trading plan, and it
volatility, the trader ends up with a larger stop (risk) with less also should never be rushed.
potential (reward). That makes it a trade motivated by emotion, Applying the Ulysses principle, learn to ignore (or manage):
rather than by a sound reward-to-risk ratio as determined by • social media noise
the trading plan.
Traders should not trade the “long bar” entry. Emotional • news
traders tend to make this trade because FOMO drives them to • human tendencies.
do it. It is a costly emotional entry, which can be prevented!
Conclusion
The anti-FOMO checklist While volatility is simply the rate of change in price, the
Here are some things to remember to help prevent the placing fact is, volatility can be small at times or large—and this is
of an emotionally driven trade: normal. Traders should not chase volatility if it is counter to
their trading plan. The correct course of action may be to
• Stick to a trading plan. The trader needs to meet the take no action.
trading plan requirements consistently with no second- Behavioral biases are a part of human nature, such as
guessing. FOMO. There is no avoiding them. However, with awareness
and strategy, there is a way to navigate them.
• Trading is a long-term game. Trading is about the next
Bringing back Ulysses again, a trader should only discard
series of trades and not just about a single trade; the
the beeswax and the rope once a valid trading signal is gener-
market will provide other opportunities.
ated by the system, a signal that is aligned to the trading plan.
• Knowledge of the markets is essential. Every trader Without a recognizable trading signal, there is no way for a
should study and understand the markets and do their trader to
justify a position, short or long.
analysis to make informed trades. The market is always
right; a trader should never have an opinion. The market Robert J. Van Eyden, PhD, is CEO of a stockbroking and
rewards a disciplined trader. portfolio management business. He is the author of The
• Take stock with a critical self-analysis. If you are suf- Money Fountain (2013). He may be reached at rvaneyden@
fering from anxiety, depression, irritation, or self-doubt, icloud.com.
then don’t trade!
Further reading
• Interact with a mentor or coach. Coaches or mentors
Herman, Dan [2000]. “Introducing Short-Term Brands: A New
should hold the trader accountable to the process rather
Branding Tool For A New Consumer Reality,” Journal of Brand
than to the outcome.
Management, 7 (5):. DOI:10.1057/bm.2000.23.
• The use of nudges. Nudges help the trader to put Lauren Foster, quoting Greg Davies, https://blogs.cfainstitute.org/
themselves in high-probability situations to succeed, investor/2012/02/17/avoiding-the-siren-song-of-emotions-notes-
thus ignoring FOMO. Nobel Prize-winning economist from-the-wealth-management-conference/#.T0AHtponJKY.
Richard Thaler and his co-author introduced the con- wordpress
cept of “nudge” a few years ago. In essence, a nudge is Thaler, Richard H., & Cass R. Sunstein [ 2008]. Nudge: Improving De-
a checklist. The checklist should be automatically fol- cisions About Health, Wealth, And Happiness, Caravan Books.
lowed to ensure that the best outcome is achieved every Van Eyden, Robert J. [2013]. The Money Fountain.
time, in order to override human tendencies. Similar
to the way a pilot reviews a checklist before takeoff,
July 2020 • Technical Analysis of Stocks
tockS & CommoditieS • 45
commodities
 Explore Your Options

Got a question about options? Jay Kaeppel has over three decades of experi-
ence in the options markets. He was a head trader for a CTA firm, an options
trading software developer, and is a portfolio manager for an investment
management firm. He also spent several years writing a weekly column titled
“Kaeppel’s Corner” and now publishes a blog, “Jay On The Markets” (http://
jayonthemarkets.com). He is the author of several books, including The Four
Biggest Mistakes In Option Trading; The Option Trader’s Guide To Probability,
Volatility, And Timing; and Seasonal Stock Market Trends. Send your ques-
tions or topic suggestions to Jay Kaeppel at [email protected]. Selected Jay Kaeppel
questions will appear in a future issue of S&C.

HEDGING INDIVIDUAL STOCK TLT recently experienced an explosive Trader A:

POSITIONS advance and has since been consolidat-
I have certain stock holdings that I ing without making a new high. Trader • Sells 1 190 call with 56 days left until
would prefer not to sell—either for tax A does not expect a long-term upside expiration for $1.44
reasons or simply because I think they reversal in interest rates (which would • Buys 1 170 put with 56 days left until
will do well over time. However, I am likely result in a decline in the price of expiration for $5.58
extremely nervous about the prospects TLT) anytime soon, but is concerned that
for the overall stock market in the months TLT may have hit resistance and is due To enter this position, Trader A must
ahead. I’ve never had much success with for a reasonably sized pullback sometime pay the difference between the two op-
trying to hedge an overall portfolio. So, in the next several weeks. tions, or $558 minus $144, or $414.
is there a way to hedge the positions I Since Trader A does not want to sell The particulars for this collar position
am most concerned about on a position- his shares of TLT and incur a taxable appear in Figure 1 and the risk curves
by-position basis? event, he or she might consider a collar. through expiration appear in Figure 2.
Of course. One approach is simply to For the sake of example, we will assume As with most things in life, with a collar
buy a put option. If the stock declines by that with TLT trading at $170.84 a share, there is no “free lunch.” The good news
enough, the put option can offset part of
the loss on the stock position. However,
this can get expensive over time, since
you have to pay cash to buy the puts. An
alternative is a commonly used strategy
referred to as a “collar.” A collar can be

OPTIONSANALYSIS.COM
especially useful if you simply think that
a stock that you hold is in a longer-term
uptrend but is due for a reasonable price
pullback in the near term.
A collar involves: FIGURE 1: TLT COLLAR POSITION DETAILS

• Holding shares of stock

• Selling a call option
• Buying a put option

With a collar, you sell a call option

(typically out-of-the-money, although
that is not a requirement) and then use
the proceeds to pay for some (or in
some cases, all) of the put premium. As
always, the best way to illustrate is with
an example.

Ticker TLT
In this example trade, Trader A holds
100 shares of ticker TLT, an ETF that
tracks the long-term treasury bond. FIGURE 2: TLT COLLAR POSITION RISK CURVES

46 • July 2020 • Technical Analysis of Stocks & Commodities

Explore Your Options
is that the maximum possible risk for Considerations in choosing the • A key question is, “How long do you
this position through option expiration is options to use in a collar want to hold the collar?”
-$498. So, if TLT does in fact experience There are many possible call/put/month
a pullback in the weeks ahead, Trader combinations to consider for most Obviously, a collar can simply be held
A cannot lose more than that amount as stocks. In general, there are two basic until option expiration. However, in
long as the collar is in place, no matter approaches: many cases, an investor enters a collar
how far the price of TLT may fall. in anticipation of a period of potential
The bad news is that upside potential is • One approach focuses on having the risks, such as prior to a crucial earnings
capped as long as the collar is in place. In call option sold pay for most or all of announcement, after a sharp, unexpected
this case, the maximum upside potential the put option purchased. The advan- advance starts to lose steam, and so on.
is +$1,502. tage to this approach is obviously that Once that period passes, the investor may
the call and put portion of the collar choose to lift the collar (that is, sell the
Some thoughts on trade management is entered at little or no additional put and buy back the call) and return to
There are a number of things that can cost to the trader. The downside is a long stock position.
happen after a trader enters a collar, and that this can leave the trader with
there are a number of potential responses a 50/50 (or worse) upside reward • It can make sense to lift one side of
to any situation. to downside risk equation. Unlike the collar
One possibility is simply to hold the the example trade shown here with
collar until expiration. In this case there about a 3-to-1 reward-to-risk ratio, If the underlying stock declines in
will be one of three outcomes: picture a trade with upside reward price, the long puts will limit the amount
of say +$300 and downside risk of of loss. If in the meantime, the price of
• If TLT is above $190 a share, one -$300. The trader puts up less (or the call option falls significantly, the
possibility for Trader A is to let the possibly no) cash to enter the collar investor may choose to buy back the
call option be exercised, in which and has less downside risk (-$300 calls if he or she can do so at a much
case the 100 shares of TLT will be versus -$498 in our example trade), lower price than where they were sold.
called away at $190 a share. The 170 however, he or she also has very little For example, in our TLT trade example,
put option will expire worthless and profit potential as long as the collar if TLT shares fall in price and the call
the net profit from the time the collar is in place. option declines from $1.44 to, say, $0.40,
was entered will be +$1,502. • The other approach focuses on main- the investor might consider buying back
• If TLT is below $170 a share, one taining more upside potential (as in the call, which turns the trade back into
possibility for Trader A is to exercise our example trade). This approach an unlimited profit potential position.
the put option and sell the 100 shares typically (though not always) requires
of TLT at $170 a share. The 190 call the trader to pay more for the long
option will expire worthless and the put than he or she receives for the
net loss from the time the collar was short call—that is, there is additional
entered will be -$498. cost to enter the collar. However, if
• If TLT is between $170 and $190 a the trader wants to maintain decent YOUR ONLINE
share, both the call and the put will
expire worthless and the profit or
upside potential and a favorable
reward-to-risk ratio, this is often
RESOURCE
loss will depend on the price of TLT necessary. FOR
shares at the time of expiration. In
addition, Trader A would need to Things to consider regarding a collar TECHNICAL
decide whether to enter a new collar • In a standard collar, the investor will
or to simply revert to holding shares sell 1 call and buy 1 put for every 100 ANALYSIS
of TLT unhedged. shares of stock held
Join us on Facebook
Prior to option expiration, Trader A A 100 shares × 1 call × 1 put ratio is
at www.facebook.com/
can at any time exit either or both parts not mandatory. For example, if you hold STOCKSandCOMMODITIES
of the collar. For example, if the price of 500 shares of stock, you can buy 5 puts
TLT declines—thus causing the price of and sell only 4 calls, for example. The Follow us on Twitter
the short call to decline—the trader can tradeoff is this: The fewer calls you sell, @STOCKSandCOMM
buy back the short call and continue on the less premium you take in and the
with what is essentially a “married put” higher the net cost of entry. One reason
position, that is, long stock shares and for selling fewer calls would be to avoid
long a protective put option. capping your upside potential.

July 2020 • Technical Analysis of Stocks & Commodities • 47

 The focus of Traders’ Tips this month is At Traders.com you can also right-
John Ehlers’ article in this issue, “Trun- click on any chart to open it in a new
cated Indicators.” Here, we present the tab or window and view the chart at a
July 2020 Traders’ Tips code with pos- much larger size.
sible implementations in various soft- The Traders’ Tips section is provided
ware. to help readers implement a selected
The code for the following Traders’ technique from an article in this issue or
Tips selections is posted here: another recent issue. The entries here
are contributed by software developers
• Traders.com → S&C Magazine → or programmers for software that is ca-
Traders’ Tips pable of customization.

+ L1 * ( 1 + S1 ) * Trunc[count + 1]
- S1 * Trunc[count + 2] ;
end ;
F TRADESTATION: JULY 2020 TRADERS’ TIPS CODE
In his article “Truncated Indicators” in this issue, author John BPT = Trunc[1]; //convert to a variable
Ehlers introduces a method that can be used to modify some Plot1(BP, "BP Filt" ) ;
indicators, improving how accurately they are able to track Plot2( BPT, "Trunc BP Filt") ;
and respond to price action. By limiting the data range, that Plot4( 0, "ZL" ) ;
is, truncating the data, indicators may be able to better handle Strategy: Truncated BP Filter
extreme price events. A reasonable goal, especially during
times of high volatility. // Truncated BP Filter
// John F. Ehlers
Here, we are providing TradeStation EasyLanguage code // TASC JUL 2020
for both an indicator and strategy based on the author’s
inputs:
work. Period( 20 ),
Bandwidth( .1 ),
Indicator: Truncated BP Filter
Length( 10 ) ;
// Truncated BP Filter
variables:
// John F. Ehlers
L1( 0 ), G1( 0 ), S1( 0 ),
// TASC JUL 2020
count( 0 ), BP( 0 ), BPT( 0 ) ;
arrays:
inputs:
Trunc[100]( 0 ) ;
Period( 20 ),
Bandwidth( .1 ),
//Standard Bandpass
Length( 10 ) ;
L1 = Cosine( 360 / Period ) ;
variables:
G1 = Cosine( Bandwidth * 360 / Period ) ;
L1( 0 ), G1( 0 ), S1( 0 ),
S1 = 1 / G1 - SquareRoot( 1 / ( G1 * G1 ) - 1 ) ;
count( 0 ), BP( 0 ), BPT( 0 ) ;
BP = .5 * ( 1 - S1 ) * ( Close - Close[2] )
arrays:
Trunc[100]( 0 ) ;

//Standard Bandpass
L1 = Cosine( 360 / Period ) ;
G1 = Cosine( Bandwidth * 360 / Period ) ;
S1 = 1 / G1 - SquareRoot( 1 / ( G1 * G1 ) - 1 ) ;
BP = .5 * ( 1 - S1 ) * ( Close - Close[2] )
+ L1 * ( 1 + S1 ) * BP[1] - S1 * BP[2] ;

If CurrentBar <= 3 then

BP = 0 ;

//Stack the Trunc Array
for Count = 100 downto 2
begin
Trunc[count] = Trunc[count - 1] ;
end ;

//Truncated Bandpass
Trunc[Length + 2] = 0 ;
Trunc[Length + 1] = 0 ;

for count = Length downto 1

begin
Trunc[count] = .5 * ( 1 - S1 ) FIGURE 1: TRADESTATION. The truncated bandpass filter indicator and strategy
* ( Close[count - 1] - Close[count + 1] )
are applied to a daily chart of the SPY ETF.

48 • July 2020 • Technical Analysis of Stocks & Commodities

 + L1 * ( 1 + S1 ) * BP[1] - S1 * BP[2] ;

If CurrentBar <= 3 then

BP = 0 ;

//Stack the Trunc Array
for Count = 100 downto 2
begin
Trunc[count] = Trunc[count - 1] ;
end ;

//Truncated Bandpass
Trunc[Length + 2] = 0 ;
Trunc[Length + 1] = 0 ;

for count = Length downto 1

begin
Trunc[count] = .5 * ( 1 - S1 )
FIGURE 2: WEALTH-LAB. Here is an example of creating a rule-based strategy
* ( Close[count - 1] - Close[count + 1] )
+ L1 * ( 1 + S1 ) * Trunc[count + 1] with the truncated bandpass in Wealth-Lab.
- S1 * Trunc[count + 2] ;
end ;

BPT = Trunc[1]; //convert to a variable

if BPT crosses over 0 then

Buy next bar at Market
else if BPT crosses under 0 Then
SellShort next bar at Market ;

To download the EasyLanguage code, please visit our

TradeStation and EasyLanguage support forum. The files
for this article can be found here: https://community.trades-
tation.com/Discussions/Topic.aspx?Topic_ID=168100. The
filename is “TASC_JUL2020.ZIP.” For more information FIGURE 3: WEALTH-LAB. The example trading system is applied to a daily chart of
TQQQ. (Data provided by AlphaVantage)
about EasyLanguage in general, please see http://www.trad-
estation.com/EL-FAQ. Step 1. Install (or update) the TASCIndicators library to its
A sample chart is shown in Figure 1. most-recent version from our website or using the built-in
This article is for informational purposes. No type of trading
Extension Manager.
or investment recommendation, advice, or strategy is being made,
given, or in any manner provided by TradeStation Securities or Step 2. Add an entry and exit block, then drag and drop
its affiliates. “Indicator crosses above (below) value” from general
—Doug McCrary indicators under the conditions tab on top of each one
TradeStation Securities, Inc.
(respectively).
www.TradeStation.com
Step 3. For each entry and exit, choose the Truncated-
BandPass as Indicator and zero as the value to cross where
prompted.
Figure 2 shows an example of creating a rules-based strat-
F WEALTH-LAB: JULY 2020 TRADERS’ TIPS CODE egy in Wealth-Lab.
In his article in this issue, “Truncated Indicators,” author A quick test shows we’re onto something, and with some
John Ehlers shows how to improve a bandpass filter’s ability more tweaking, we may be able to make a trading system out
to reflect price by limiting the data range. Filtering out the of it, as we’ve done in Figure 3.
temporary spikes and price extremes should positively affect Whether you’ve prototyped the trading system code using
the indicator stability. Enter a new indicator—the Truncated- our strategy from rules feature described above or whether
BandPass filter. you’ve downloaded the code from Wealth-Lab (hit Ctrl-O
Despite the math behind it may not appear as easy to some, and choose download...), to peek into the code behind it,
Wealth-Lab proves that prototyping a trading system should simply click “Open code in new strategy window.”
not be a complex task. In fact, our strategy from rules fea-
ture makes it possible for everyone to achieve without having Wealth-Lab strategy code (C#):
to invest much effort. using System;
For example, crossovers of the truncated bandpass with using System.Collections.Generic;
zero could indicate a trend change. Let’s see if the idea has using System.Text;
using System.Drawing;
merit: using WealthLab;

July 2020 • Technical Analysis of Stocks & Commodities • 49

 using WealthLab.Indicators; Description:
using TASCIndicators; Truncated Indicators
by John F. Ehlers
namespace WealthLab.Strategies
{
public class TASC2020_07 : WealthScript Version: 1.00 05/13/2020
{
protected override void Execute() Formula Parameters: Default:
{ Period 20
var tbp = TruncatedBandPass.Series(Close, 20, 0.10, 10); Length 10
Bandwidth 0.1
HideVolume();
ChartPane pane1 = CreatePane( 25,true,true); Notes:
PlotSeries( pane1,tbp,Color.MidnightBlue,LineStyle. The related article is copyrighted material. If you are not a sub-
Solid,1); scriber of Stocks & Commodities, please visit www.traders.com.

for(int bar = GetTradingLoopStartBar( 21); bar < Bars. **********************************/

Count; bar++) var fpArray = new Array();
{ var bInit = false;
if (IsLastPositionActive)
{ function preMain() {
Position p = LastPosition; setStudyTitle("Bandpass and Truncated");
setCursorLabelName("Standard", 0);
if (CrossUnder(bar, tbp, 0)) setCursorLabelName("Truncated", 1);
SellAtMarket( bar + 1, p); setPriceStudy(false);
} setDefaultBarFgColor(Color.RGB(0x00,0x94,0xFF), 0);
else setDefaultBarFgColor(Color.RGB(0xFE,0x69,0x00), 1);
{ setPlotType( PLOTTYPE_LINE , 0 );
if (CrossOver(bar, tbp, 0)) setPlotType( PLOTTYPE_LINE , 1 );
BuyAtMarket( bar + 1); addBand( 0, PLOTTYPE_DOT, 1, Color.grey);
}
} var x=0;
} fpArray[x] = new FunctionParameter("Period", FunctionParam-
} eter.NUMBER);
} with(fpArray[x++]){
setLowerLimit(1);
—Robert Sucher & Gene (Eugene) Geren, Wealth-Lab team setDefault(20);
}
MS123, LLC
fpArray[x] = new FunctionParameter("Length", FunctionParam-
www.wealth-lab.com eter.NUMBER);
with(fpArray[x++]){
setLowerLimit(1);
setUpperLimit(98);
setDefault(10);
}
fpArray[x] = new FunctionParameter("Bandwidth", FunctionPa-
F ESIGNAL: JULY 2020 TRADERS’ TIPS CODE rameter.NUMBER);
with(fpArray[x++]){
For this month’s Traders’ Tip, we’ve provided the study setLowerLimit(0);
“TruncatedIndicators.efs” based on the article in this issue by setDefault(.1);
John Ehlers, “Truncated Indicators.” The study is designed to }
}
improve cycle indicators by introducing truncation.
The study contains formula parameters that may be con- var bVersion = null;
var L1 = null;
figured through the edit chart window (right-click on the
chart and select “edit chart”). A sample chart is shown in
Figure 4.
To discuss this study or download a complete copy of the
formula code, please visit the EFS Library Discussion Board
forum under the forums link from the support menu at www.
esignal.com or visit our EFS KnowledgeBase at http://www.
esignal.com/support/kb/efs/.
/**********************************
Provided By:
Copyright 2019 Intercontinental Exchange, Inc. All Rights Re-
served.
eSignal is a service mark and/or a registered service mark of Inter-
continental Exchange, Inc.
in the United States and/or other countries. This sample eSignal
Formula Script (EFS) is for educational purposes only.
Intercontinental Exchange, Inc. reserves the right to modify and FIGURE 4: ESIGNAL. Here is an example of the study plotted on a daily chart of
overwrite this EFS file with each new release. the SPY.

50 • July 2020 • Technical Analysis of Stocks & Commodities

var G1 = null; The eSignal formula script (EFS) is also available for
var S1 = null;
var BP = null;
copying & pasting from the Stocks & Commodities mag-
var BP_1 = null; azine website at Traders.com in the Traders’ Tips section.
var BP_2 = null; —Eric Lippert
var BPT = null; eSignal, an Interactive Data company
var Trunc = [];
var xClose = null; 800 779-6555, www.eSignal.com

function main(Period,Length,Bandwidth) {
if (bVersion == null) bVersion = verify();
if (bVersion == false) return;

if ( bInit == false ) { F NINJATRADER: JULY 2020 TRADERS’ TIPS CODE

L1 = Math.cos(2 * Math.PI / Period)
G1 = Math.cos(Bandwidth * 2 * Math.PI / Period) The BandPassFilter indicator discussed in John Ehlers’
S1 = 1 / G1 - Math.sqrt(1 / (G1*G1) - 1) article in this issue, “Truncated Indicators,” is available for
xClose = close();
BP_1 = 0;
download at the following links for NinjaTrader 8 and for
BP = 0; NinjaTrader 7:
for (var i = 0; i <= 100; i++){
Trunc[i] = 0 NinjaTrader 8: www.ninjatrader.com/SC/July2020SCNT8.zip
} NinjaTrader 7: www.ninjatrader.com/SC/July2020SCNT7.zip

bInit = true;
}
Once the file is downloaded, you can import the indicator
into NinjaTader 8 from within the Control Center by select-
if (getCurrentBarCount() <= Length) return; ing Tools → Import → NinjaScript Add-On and then select-
if (getBarState() == BARSTATE_NEWBAR) {
BP_2 = BP_1; ing the downloaded file for NinjaTrader 8. To import in Nin-
BP_1 = BP; jaTrader 7, from within the Control Center window, select
} the menu File → Utilities → Import NinjaScript and select
if (getCurrentBarCount() <= 3) BP = 0; the downloaded file.
else BP = .5 * (1 - S1) * (xClose.getValue(0) - xClose.getVal- You can review the indicator’s source code in NinjaTrader
ue(-2)) + L1 * (1 + S1) * BP_1 - S1 * BP_2; 8 by selecting the menu New → NinjaScript Editor → Indi-
//Stack the Trunc Array cators from within the Control Center window and select-
for (var i = 100; i > 1; i--) { ing the BandPassFilter file. You can review the indicator’s
Trunc[i] = Trunc[i-1]
} source code in NinjaTrader 7 by selecting the menu Tools →
Edit NinjaScript → Indicator from within the Control Center
//Truncated Bandpass window and selecting the BandPassFilter file.
Trunc[Length + 2] = 0;
Trunc[Length + 1] = 0; A sample chart is shown in Figure 5.
for (var i = Length; i > 0; i--) { NinjaScript uses compiled DLLs that run native, not in-
Trunc[i] = .5 * (1 - S1) * (xClose.getValue(-i + 1) - xClose. terpreted, to provide you with the highest performance pos-
getValue(-i - 1)) + L1 * (1 + S1) * Trunc[i + 1] - S1 * Trunc[i + 2];
} sible.
—Jim Dooms
BPT = Trunc[1] //convert to a variable NinjaTrader, LLC
return [BP, BPT]
www.ninjatrader.com
}

function verify(){
var b = false;
if (getBuildNumber() < 779){

drawTextAbsolute(5, 35, "This study requires version 10.6 or

later.",
Color.white, Color.blue, Text.RELATIVETOBOTTOM|Text.
RELATIVETOLEFT|Text.BOLD|Text.LEFT,
null, 13, "error");
drawTextAbsolute(5, 20, "Click HERE to upgrade.@
URL=http://www.esignal.com/download/default.asp",
Color.white, Color.blue, Text.RELATIVETOBOTTOM|Text.
RELATIVETOLEFT|Text.BOLD|Text.LEFT,
null, 13, "upgrade");
return b;
}
else
b = true;

return b;
FIGURE 5: NINJATRADER. The BandPassFilter indicator is shown on SPY from
}
December 2018 to December 2019.

July 2020 • Technical Analysis of Stocks & Commodities • 51

 FIGURE 7: QUANTACULA. The resulting equity curve for the example TruncBand-
Pass trading model is shown.

over time. We used $100,000 starting capital, a trade size of

FIGURE 6: QUANTACULA. Shown here is the TruncBandPass trading model 15% of equity, and 1.5:1 margin. Over the past 10 years, the
mocked up in Quantacula Studio Building Blocks. model performed quite well, returning an annualized gain
of 19.84% (see Figure 7).
—Dion Kurczek, Quantacula LLC
[email protected]
www.quantacula.com

F QUANTACULA STUDIO: JULY 2020 TRADERS’ TIPS CODE

John Ehlers’ article in this issue, “Truncated Indicators,” fea- F NEUROSHELL TRADER: JULY 2020 TRADERS’
tures his bandpass indicator, which we’ve already integrated TIPS CODE
into the Quantacula TASC library. This means the indicator is The truncated bandpass filter described by John
ready for use both in Quantacula Studio and the Quantacula. Ehlers in his article in this issue, “Truncated Indicators,” can
com website. be easily implemented in NeuroShell Trader using Neuro-
We decided to test the indicator out by creating a trad- Shell Trader’s ability to call external dynamic linked libraries
ing model using drag & drop building blocks in Quantacula (DLLs). DLLs can be written in C, C++, and Power Basic.
Studio. This type of model is composed of entry, exit, condi- After moving the code given in Ehlers’ article to your
tion, and qualifier blocks. You drop conditions onto entries
and exits to specify when to get into and out of a trade. You
can drop qualifiers onto conditions to give them more spe-
cific criteria (see Figure 6).
We used two conditions for the entry here, indicator new
high/low to specify that TruncBandPass should make a 100-
bar new low. The second condition we used is indicator
turns up/down, to specify that TruncBandPass should turn
up, that is, move up after having moved down. We used the
qualifier within the past N bars to give the first condition
some flexibility. This results in a buy after the TruncBand-
Pass turns up after having hit a 100-bar low sometime within
the past 10 bars. We exit the trade when TruncBandPass hits
a 50-bar new high.
We backtested the trading model on the Nasdaq 100
stocks, using the QPremium universe that automatically ac- FIGURE 8: NEUROSHELL TRADER. This NeuroShell Trader chart shows the stan-
counts for symbols that dropped into and out of the index dard bandpass and truncated bandpass filters.

52 • July 2020 • Technical Analysis of Stocks & Commodities

preferred compiler and creating a DLL, you can insert the
resulting indicator as follows:
1. Select new indicator from the insert menu.
2. Choose the external program & library calls category.
3. Select the appropriate external DLL call indicator.
4. Set up the parameters to match your DLL.
5. Select the finished button.
Users of NeuroShell Trader can go to the Stocks & Com-
modities section of the NeuroShell Trader free technical
support website to download a copy of this or any previous
Traders’ Tips.
A sample chart is shown in Figure 8.
—Marge Sherald, Ward Systems Group, Inc.
301 662-7950, [email protected]
www.neuroshell.com

F T HE ZORRO PROJECT: JULY 2020 TRADERS’

TIPS CODE FIGURE 9: ZORRO PROJECT. The chart displays a truncated narrow bandpass
Cumulative indicators, such as the EMA or (blue line). For comparison, the green line is a nontruncated medium-wide band-
pass filter.
MACD, are affected not only by previous candles, but by a
theoretically infinite history of candles. Although this effect The following code shows how the truncate function is
is often assumed to be negligible, John Ehlers demonstrates used with our narrow bandpass filter:
in his article in this issue that it is not so. Or at least not for a
function run()
narrow-band bandpass filter. {
Bandpass filters are normally used for detecting cycles in BarPeriod = 1440;
price curves. But they do not work well with steep edges in StartDate = 20181101;
the price curve. Sudden price jumps cause a narrow-band fil- assetAdd("SPY","STOOQ:SPY.US"); // load price history from
ter to “ring like a bell” and generate artificial cycles that can Stooq
cause false triggers. As a solution, Ehlers proposes to trun- asset("SPY");
cate the candle history of the filter. Limiting the history to UnstablePeriod = 10;
10 bars effectively dampened the filter output and produced vars Prices = series(priceClose());
var PB = BandPass(Prices, 20, 0.1);
a better representation of the cycles in the price curve. var Trunc = truncate(BandPass, Prices, 20, 0.1);
For limiting the history of a cumulative indicator, we’re plot("Bandpass",BP,NEW|LINE,RED);
not using Ehlers’ code here, but instead we’ll write a general plot("Truncated",Trunc,LINE,BLUE);
}
“truncate” function that works for any indicator:
var indicator(vars Data,int Period,var Param);
var truncate(function Indicator,vars Data,int Period,var Param)
{
indicator = Indicator;
var *Trunc = zalloc(UnstablePeriod*sizeof(var));
var Ret;
int i;
for(i = UnstablePeriod-1; i >= 0; i--) {
SeriesBuffer = Trunc;
Ret = indicator(Data+i,Period,Param);
shift(Trunc,0,UnstablePeriod);
}
return Ret;
}

This function does basically the same as Ehlers’ code for

his bandpass filter. It accesses the internal history buffer of
the cumulative indicator that’s passed as the first argument.
The SeriesBuffer variable replaces that buffer with an ex-
ternal array that’s temporarily allocated on the C heap. Un-
stablePeriod is a global variable already used for limiting
FIGURE 10: ZORRO PROJECT. Shown for comparison are sine chirp responses
the history range of traditional indicators, such as EMA or from three bandpass variants (the original narrow bandpass, the truncated narrow
MACD. bandpass, and the wide bandpass).

July 2020 • Technical Analysis of Stocks & Commodities • 53

 The chart shown in Figure 9 confirms Ehlers’ observa-
tion that the truncated narrow bandpass (blue line) repre-
sents cycles better than the original bandpass (red line). For
comparison I’ve added a medium-wide bandpass filter as it
is normally used in trading systems (green line). This filter
doesn’t “ring” either, truncated or not. So what’s the better
choice for detecting cycles, a truncated narrow bandpass or
a nontruncated wide bandpass?
To find out, we feed the three bandpass variants with a
sine chirp and compare their responses. The resulting plots
are shown in Figure 10.
The top panel is the chirp, a sine wave with a period rising
from 5 to 60 cycles. The panels below that show the chirp FIGURE 11: TRADERSSTUDIO. The bandpass (BP) and truncated bandpass (BPT)
responses of the original narrow bandpass, the truncated indicators are shown on a chart of MSFT.
narrow bandpass, and the wide bandpass. We can see that
the truncated bandpass got a wider bandwidth, artifacts at
low cycles, and a shifted center frequency. A nontruncated
filter with an already wider bandwidth seems here the better
solution.
The advantage of truncating is that the indicator output
is clearly defined, regardless of the lookback period of the
trading system. A disadvantage is speed—truncating makes
indicators much slower because they run in a loop. Not very
relevant for normal trading systems, but relevant for HFT
(high-frequency trading) systems.
The truncate function and the test scripts can be down-
loaded from the 2020 script repository on https://financial- FIGURE 12: TRADE NAVIGATOR. This chart displays the Ehlers truncated band-
pass filter.
hacker.com. The Zorro platform can be downloaded from
zorro-project.com. Zorro version 2.27 or above is needed.
—Petra Volkova the program update by clicking on the telephone button (or
The Zorro Project by oP group GmbH use the file pulldown menu, then select update data). Then
www.zorro-project.com select download special file, and click on the start button.
You will then be guided through an upgrade of your Trade
Navigator. If prompted to “re-import libraries,” please do so.
F T RADERSSTUDIO: JULY 2020 TRADERS’ This will import the new tools into the software. Once that
TIPS CODE is completed, you will find a study named “Ehlers BandPass
The importable TradersStudio files based on filters.”
John Ehlers’ article in this issue, “Truncated Indicators,” can You can insert these indicators onto your chart by open-
be obtained on request via email to info@TradersEdgeSystems. ing the charting dropdown menu, selecting the add to chart
com. The code is also available on this magazine’s website at command, then on the studies tab, finding the new study,
Traders.com in the Traders’ Tips section. selecting it, then clicking on the add button.
I coded the indicators described by the author. Figure 11 If you need assistance with upgrading or applying the
shows the bandpass (BP) and truncated bandpass (BPT) in- study, our technical support staff is happy to help via phone
dicators using the default lengths of 20, 0.1, 10 on a chart of or via live chat through our website.
Google (GOOGL). A sample chart is shown in Figure 12.
—Richard Denning —Genesis Financial Data
[email protected] Tech support 719 884-0245
for TradersStudio www.TradeNavigator.com

F TRADE NAVIGATOR: JULY 2020 F MICROSOFT EXCEL: JULY 2020 TRADERS’ TIPS CODE
TRADERS’ TIPS CODE In his article in this issue, “Truncated Indicators,” John Ehlers
In “Truncated Indicators” in this issue, takes us aside to look at the impact of sharp price movements
author John Ehlers presents a truncation technique for cycle on two fundamentally different types of filters: finite impulse
indicators and demonstrates the technique using a truncated response, and infinite impulse response filters. Given recent
bandpass filter. market conditions, this is a very well timed subject.
To install these new tools into Trade Navigator, first obtain In this article, Ehlers suggests “truncation” as an approach
54 • July 2020 • Technical Analysis of Stocks & Commodities
to the way the trader calculates fil-
ters. He explains why truncation is
not appropriate for finite impulse
response filters but why trunca-
tion can be beneficial to infinite
impulse response filters. He then
explains how to apply truncation
to infinite impulse response filters
using his bandpass filter as an ex-
ample.
Figure 13 replicates the figure
from his article using Excel. FIGURE 13: EXCEL. Bandpass and truncated bandpass filters.
Next, it seemed appropriate to
take a look at this concept within
a filter or indicator that uses the
normal bandpass filter as a start-
ing point.
A quick dive into my Traders’
Tips spreadsheet archive brought
me to an August 2019 S&C article
by John Ehlers titled “A Peek Into
The Future.” That article intro-
duced the Voss predictive filter,
where the first step in the Voss FIGURE 14: EXCEL. Voss predictive filter. Note: The Voss article used a wider bandwidth setting of 0.25.
computation is the bandpass fil-
ter.
Three columns of cell formulas
make up the Voss filter and I al-
ready have the bandpass column.
So it is a simple exercise to port
the Voss filter forward to the cur-
rent spreadsheet to demonstrate
the result of bandpass truncation
in a more complex environment.
Figure 14 replicates the chart
from Ehlers’ August 2019 article.
Figure 15 is the same chart using FIGURE 15: EXCEL. Voss filter calculated using the truncated bandpass filter.
the truncated bandpass filter as
the first stage of Voss calculations. Figure 16 below puts the as a feedback input.
two Voss calculations side by side. Truncation requires that we break that backward reference
At this writing, we are well into the impact that Covid-19 at the specified truncation length. The EasyLanguage code
is having on the world economy. Figure 17 takes a look at the given in the sidebar in his article introduces a pair of zero
recent S&P 500 index with the Voss filter and the truncated feedback values just beyond the truncation length to provide
Voss filter. that break.
Between the truncated version needing the two oldest
Some technical explanations behind the creation of this feedback values to be zero, the complexity of the bandpass
spreadsheet filter formula itself, and the requirement that it be calculated
User-defined function: BPTrunc—A VBA code implementa- fresh at each bar, I was stymied as to how to create a purely
tion of Ehlers’ truncated bandpass filter. Excel cell formula computation for this.
In his article in this issue, Ehlers mentions “mathematical Perhaps a better mathematician than I could figure out a
sleight of hand tricks.” refactoring of the bandpass filter, similar to Ehlers’ discus-
In the time available, I have not been able to come up with sion in his article of the “transfer response of a filter,” that
any mathematical jujitsu that would keep an implementation would allow this bandpass truncation to be coded with na-
of the truncated bandpass filter entirely within native Excel tive Excel cell formula capabilities.
cell formula capabilities. The problem is due to the bandpass Instead, I have used VBA to create a user-defined function
filter formulation requiring two of its previous output values (UDF)—“BPTrunc”—that can be used directly in complex
July 2020 • Technical Analysis of Stocks & Commodities • 55
 cell formulas.
The only real drawback to the
UDF approach is that it is inher-
ently slower to calculate than a
native cell formula solution. Thus,
for this spreadsheet, there is a no-
ticeable delay in response when
the user changes any of the con-
trol values or buttons.
For this spreadsheet, I have cho-
sen to use BPTrunc in a column by
itself to facilitate on-chart side by FIGURE 16: EXCEL. Voss filter and truncated Voss filter.
side comparisons. But it is not a re-
quirement of BPTrunc to be used
standalone in a cell formula. The
BPTrunc function is portable.
The following is for those com-
fortable with VBA and who might
wish to try the truncated bandpass
filter in other spreadsheets that
have used the bandpass filter.
The easiest approach is to have
the VBA editor export a copy of
the module from this spreadsheet
FIGURE 17: EXCEL. Forward space the chart in Figure 16 to today.
to your hard drive.
Close this spreadsheet. Open
your target spreadsheet and use the VBA editor to import download it, follow these steps:
the “truncated bandpass” module from where you stored it. • Right-click on the Excel file link, then
Then modify cell formulas that use the bandpass filter, simi- • Select “save target as” to place a copy of the spreadsheet
lar to what I have done here for the Voss filter calculation. file on your hard drive.
—Ron McAllister
To download this spreadsheet Excel and VBA programmer
The spreadsheet file for this Traders’ Tip can be downloaded [email protected]
from Traders.com in the Traders’ Tips area. To successfully

LETTERS TO S&C Modified (OBVM)”]. Historically, I have you for his articles. In my opinion they
Continued from page 7 not had a lot of success using OBV (and are some of the very best published by
other volume indicators), but it should StockS & commoditieS. I hope he
an updated volume-based indicator to be interesting. continues to submit his ideas.
use and I think OBVM is exactly what I have had the most success lately E.K.
I need. using a variation of his exponential
Thanks again and best wishes. deviation bands. Author Vitali Apirine replies:
F.D. One of the things I have struggled a bit Thank you for the high evaluation of
Author Vitali Apirine replies: with over the years is using shorter-term my articles.
Thank you for the good words about my indicators with some kind of a trend filter We trade in a high-risk market right
latest article. Happy trading! (such as only taking long trades when now. As I write this, the Volatility Index
the trend is up, or short when the trend (VIX) is higher than 50 every day. I
ON-BALANCE VOLUME MODIFIED is down). I have used his moving average am careful with any indicators in such
(OBVM) stochastic as a trend filter at times, and I a time.
Editor, very much like this indicator. However, No one knows when the threat from
Thank you very much for Vitali Apirine’s like all trend filters, I get frustrated when the coronavirus will pass. Thank you
superb articles. Over the years I have it lags. I am wondering if there any trend again and stay safe.
found his articles helpful and fun to filters that he uses that he particularly
use. I will play around with his latest likes and finds useful?
idea about OBV [“On-Balance Volume In any case, I wanted to write to thank
56 • July 2020 • Technical Analysis of Stocks & Commodities
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July 2020 • Technical Analysis of Stocks & Commodities • 57

 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

Contracts to
Effective
Commodity Futures Exchange % Margin Trade for Equal Relative Contract Liquidity
% Margin
Dollar Profit
S&P 500 E-Mini (Jun ’20) CME 8.9 33.3 3 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>>
Ultra T-Bond (Jun ’20) CBOT 6.2 18.9 2 •••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
10-Year T-Note (Jun ’20) CBOT 1.6 10.2 6 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
T-Bond (Jun ’20) CBOT 3.7 15.3 3 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
5-Year T-Note (Jun ’20) CBOT 0.7 6.8 10 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••>
Ultra 10-Year T-Note (Jun ’20) CBOT 2.5 12 4 ••••••••••••••••••••••••••••••••••••••••••••••••••••••••••••
2-Year T-Note (Jun ’20) CBOT 0.3 5.9 13 ••••••••••••••••••••••••••••••••••••••••••••••
Crude Oil WTI (Jul ’20) NYMEX 39.5 17.9 2 ••••••••••••••••••••••••••••••••••••••••••••
Russell 2000 E-Mini (Jun ’20) CME 5.8 19.4 3 ••••••••••••••••••••••••••••••••••••••••••••
Soybean Meal (Jul ’20) CBOT 0.8 1.9 2 •••••••••••••••••••••••••••••••••
Nasdaq 100 E-Mini (Jun ’20) CME 8.7 21 2 •••••••••••••••••••••••••••••••
Gold (Jun ’20) COMEX 5.8 17.1 2 ••••••••••••••••••••••••••••
Soybean (Jul ’20) CBOT 2.1 8.1 6 •••••••••••••••••••••••
Eurodollar (Jun ’20) CME 0.2 6.9 21 ••••••••••••••••••••••
Euro FX (Jun ’20) CME 1.8 12.5 7 •••••••••••••••••••••
Natural Gas (Jul ’20) NYMEX 11.5 7.3 4 ••••••••••••••••••••
Corn (Jul ’20) CBOT 6.9 13.9 17 •••••••••••••••••••
Gasoline RBOB (Jul ’20) NYMEX 23.6 20.2 3 ••••••••••
ULSD NY Harbor (Jul ’20) NYMEX 18.5 13.5 2 •••••••••
30-Day Fed Funds (Jul ’20) CBOT 0.1 5.9 14 ••••••••
S&P Midcap E-Mini (Jun ’20) CME 11.1 35.5 3 •••••••
Silver (Jul ’20) COMEX 11 31.4 4 •••••••
Sugar #11 (Jul ’20) ICE/US 8.4 19.8 26 ••••••
British Pound (Jun ’20) CME 3.9 22.1 10 •••••
Crude Oil Brent (F) (Dec ’20) NYMEX 21.8 16.9 3 •••••
Dow Futures Mini (Jun ’20) CBOT 10.8 41.1 4 •••••
Wheat (Jul ’20) CBOT 6.1 24.6 21 •••••
Australian Dollar (Jun ’20) CME 3 12.9 9 ••••
High Grade Copper (Jul ’20) COMEX 6.7 19.2 6 ••••
Live Cattle (Aug ’20) CME 7 18.8 9 ••••
Canadian Dollar (Jun ’20) CME 2.4 15.5 12 •••
Cotton #2 (Jul ’20) ICE/US 10 15.2 7 ••• CBOT Chicago Board of Trade, Division of CME
Hard Red Wheat (Jul ’20) KCBT 7 21.9 19 ••• CFE CBOE Futures Exchange
Coffee (Jul ’20) ICE/US 11.2 29.4 9 •• CME Chicago Mercantile Exchange
Japanese Yen (Jun ’20) CME 3.8 56.6 17 •• COMEX Commodity Exchange, Inc. CME Group
Lean Hogs (Jul ’20) CME 14 20.7 9 •• ICE-EU Intercontinental Exchange-Futures - Europe
Platinum (Jul ’20) NYMEX 10.6 26.5 7 •• ICE-US Intercontinental Exchange-Futures - US
Bitcoin CME Futures (May ’20) CME 36.8 31.9 2 • KCBT Kansas City Board of Trade
Brazilian Real (Jun ’20) CME 8.1 9.5 9 • MGEX Minneapolis Grain Exchange
Cocoa (Jul ’20) ICE/US 8.7 33.1 21 • NYMEX New York Mercantile Exchange
Feeder Cattle (Aug ’20) CME 8.3 32.9 8 •
2007
Mexican Peso (Jun ’20) CME 9.7 30.3 20 •
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).

58 • July 2020 • Technical Analysis of Stocks & Commodities

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July 2020 • Technical Analysis of Stocks & Commodities • 59

 Trading Perspectives

SOME PERSPECTIVES ON THE EQUITIES WORLD

Rob Friesen is a professional trader and president & COO of Bright Trading (www.
stocktrading.com), a proprietary trading firm hosting independent trader/members,
an online trading school, and utilizing the StockOdds database (www.stockodds.
net). This column shares his thoughts and outlooks on trading, locating opportunity,
probabilistic outcome, and maintaining perspective throughout industry changes. He
can be reached at [email protected] or via www.stocktrading.com.
Rob Friesen

TRADING! A PERFECT STAY-AT- ground. Over the years, I have worked spend everything they make, as tempt-
HOME JOB? with people from many different indus- ing as that may be. Building adequate
Whether you are just starting to look into tries and fields of expertise who were capital reserves will allow you to ac-
trading or are already an active career interested in pursuing trading as a career. complish more.
trader, have you given enough thought They tended to share a common message: Some may be attracted to the excite-
to what contributes to the viability of Despite being in work that they trained ment of the markets—the thrill of the
trading? Here, I’ll offer some reflections to do or have credentials in, they disliked trade and the endorphins that can result.
on what I believe it takes to be success- or even hated what they did each day. But the money a trader makes actually
ful at trading. I hope it resonates with Adding to that may be a dislike of the comes from doing the boring things: the
you and also gives you some ideas on daily commute, the expense of parking hours poured into research & analysis,
how you can help ensure more success or transit, a dislike of their bosses or the preparation, the planning, reviewing
in your trading career, especially for coworkers, corporate politics, and so on. & journaling, monitoring positions, ag-
newer traders. Some of those challenges may end up gregating data, testing and more testing.
being resolved post-pandemic as more It also comes from being able to process
Getting started in trading? companies shift to remote work. But not and manage stress, and from developing
These days, as the pandemic continues all jobs can be performed from home. mental and emotional strength for each
and the economy is suppressed, some new day and to meet the myriad of events
people are considering getting into that can arise.
trading. Maybe they have lost their job Trading is a probability- Let me offer this quote from our
temporarily or permanently. Maybe they based endeavor and StockOdds podcast episode 2, which
are rediscovering their entrepreneurial the fact is, there are presented a talk with Dennis Dick, CFA,
spirit that has been laid to waste with proprietary trader with Bright Trading,
the pandemic. Or maybe they are just no guarantees, no and host of the Benzinga premarket
ready for a change, and a trading career safety net, and no set morning show:
sounds plausible. After all, as the pan- salary.
demic forces many to stay home, trading [Having] a trading career affects
may offer to some an opportunity to stay your thinking—the way I analyze
home and still make money. Daytrading has often been advertised everything in my life. It’s risk–return.
as a career in which someone can pay I look at, you know, what’s the risk?
Volatile markets themselves a good income within a year. What’s the reward? And I analyze even
Many investors are finding the investable Is this reality? Some traders have done normal decisions and daily activities
landscape uncertain and the volatility quite well early on in their trading career, [that way].
high, which may cause them to shorten but most take many years to develop
their timeframes and rotate positions the knowledge, experience, and skills Why do you want to be a trader?
more frequently, which leads to increased necessary to pull money from the market Being a trader has been compared to
activity and inventory turnover. They consistently. As with most skills, being being an athlete, since trading is similar
may be trading more frequently rather able to trade profitably and consistently to an individual sport. Trading is also a
than sitting on positions for long dura- takes many hours of practice. business, an art form, a job that requires
tions. Of course, all retail traders and attention and focus, and it’s also a prob-
investors need to be mindful of the tax The less dreamy aspects of trading ability game. As with any accomplish-
consequences of buying and selling New traders also should realize the ment, doing that “one thing well” can
securities. importance of building capital reserves, bring happiness and contentment, but
and many new traders don’t do this ad- the journey of sacrifice and the hard-
The dream equately. Even if someone starts making ships along the way are underestimated
Becoming a successful trader is the a little money while they are developing by most new entrants.
dream of many, regardless of back- their skills, it’s important that they don’t Yes, there are perks, but it is not fair
60 • July 2020 • Technical Analysis of Stocks & Commodities
 Trading Perspectives
and balanced to only present the ben- day I might be making 200 trades. So expenses like commissions, losses
efits. So first, let’s run down some of we’re trading quite a bit. And inevitably from mistakes, losses from events
the benefits: in trouble every single day! You can’t be beyond their control, and edges that
Traders may be able to trade from any- right 100 percent of the time, so you’ve diminish—even though the trader
where as long as they have good internet got to learn how to work yourself out is doing the right things. When the
connectivity, giving them freedom to be of trouble. markets are changing and strategies
where they want. Traders may be able “I’ve seen this through the years: The are not performing, it is challenging
to set their own hours, which lets them traders that aren’t willing to take a loss to know when to shelve it or whether
attend events or schedule vacations when will struggle in this business and usu- to continue. If you do shelve it and
they want. There are no employees to ally blow up their account very quickly. pick up another strategy, then testing
have to hire and look after. No suit and Traders add to losers, thinking ‘it’s got that new strategy also costs money,
tie is needed as with many finance-related to come back.’ [But the market] doesn’t even if it’s done perfectly, since you
jobs; trade in your pajamas if you want! have to do anything. The markets can have to prove out the strategy, usually
And finally, the ultimate benefit and what stay irrational much longer than you can with real money at some point.
everyone who enters trading dreams of: stay solvent, and this applies to daytrad- • You must have good data. It needs
no cap on your potential income. ing more than anything. to be accurate, and with corporate
But are you ready for all the chal- “The number one thing is when I en- adjustments applied.
lenges, the surprises, and the realities ter a trade, I’m not thinking about how
of trading? Do you understand that you much money I can make. I enter the trade Are there off-the-shelf strategies that
can do the wrong thing and get great thinking about how much money I can work?
results or can do the right thing and get lose. I am really a risk manager. I put It’s really about the validation of new or
terrible results? my capital to work when I see the risk existing strategies, no matter whether
There are many setbacks on the road to relatively low or I see myself having a you get them from a book, a friend, a
becoming a successful trader, depending website, or even from an advanced quant
on your level of education, experience, site. Do they work? That is for you to test
skill, and discipline. What you may Discipline is the and prove to yourself. If you do not take
need to overcome will vary with the personal ownership of the idea and make
individual. overwhelming it fit for you and where you are at, you
Trading results also tend to clump, key factor in any may fail even if the strategy works.
with setbacks and dry spells along the individual’s success in I’ve seen a common theme in many
way. Unfortunately, having a good work becoming consistently working strategies: These strategies are
ethic will not guarantee success. You also long/short orientated, and the traders
need to have a gaming theory mindset. profitable. using them are focused on taking slices
You can have an edge, but you may from the noise rather than trying to hit
have to live through many times when it homeruns. These often focus on com-
does not work as intended. Trading is a potential out, but I always enter the trade pounding rather than on one-off setups
probability-based endeavor and the fact having a contingency plan.” from a signal-based strategy. If you are
is, there are no guarantees, no safety net, trading for a living, you will want to be
and no set salary. What is needed? able to scale and take the same types of
In my view, here is what is needed to be trades repeatedly.
What does it take to be a consistently a successful trader:
profitable trader? How long can an edge last if a trader
Discipline is the overwhelming key fac- • Having a trading plan with all the discovers one?
tor in any individual’s success in becom- essential ingredients: profit expec- Edges usually do not last as long as a
ing consistently profitable. Many people tancies, loss parameters, entry and trader would like. There is very little
want to go into trading without fully exit guidelines, position sizing, and low-hanging fruit these days but there are
understanding the level of commitment models or variations of strategies for still many soft edges, which come and
it takes to make profits in the long run. the context of the day. go as market regimes shift and change.
It takes more dedication and discipline • Discipline, diligence, and persever- I am a firm believer that many past
than most think. ance. No matter what the difficul- strategies that are thought to no longer
“A lot of traders get themselves into ties are, overcome them as best work can be dusted off and repurposed,
trouble and they don’t know how to work you can. looking at them through today’s lenses.
themselves out of trouble,” continues • Capital. As with any business, you So traders can consider: What were the
Dennis Dick in our podcast episode. can fail by not having enough for past obstacles for some strategies that
“On any given day I might make 50 or the journey. The trader must ac- today’s technological developments
100 trades, or maybe on a really crazy count for fixed expenses, variable can solve?
July 2020 • Technical Analysis of Stocks & Commodities • 61
 Trading Perspectives
Pair trading strategies have been helpful tool, and you may even want to
widely used by professional traders for If you do not take add basic to advanced Python program-
many years. (I’ve discussed pair trading ming to your mix of skills, as this skill
strategies in this column several times personal ownership of goes a long way in gathering data as well
before.) There is the need to always an idea and make it fit as executing and managing positions.
adapt and understand the dynamics of for you and where you Python can also assist you in creating
outperformers versus underperformers are at, you may fail your own systems to trade with.
in peer groups. Do not get caught in the
trap of thinking there are guarantees for even if the strategy Treat trading like a business
trades. Weak stocks can catch up to strong works. It is important to educate yourself
stocks in time or they could continue before taking on the risks of trading in
to diverge. Fundamentals, statistical the markets, just as you would not start
measures, technicals, sentiment, and trading strategies have stood the test of a business without extensive research,
news all play a role in how things play time and have contributed to the long calculations, and planning. I am a
out. These forces must be considered for and successful careers of some profes- proponent of investing in yourself first
optimum results. sional traders. and having an opportunity to do what
Pair trading is only limited to one’s you love.
imagination, as there are so many What kind of technology or tech skills If you think trading is for you or if you
combinations that one can employ, and are needed? need help to improve your trading career,
each pair acts like a trading business Since everything is online these days, I welcome that conversation.
employee: Either it is doing a great job there’s no question about it: computer I also hope you will check out our new
for us, or we may have to tell that position skills are needed for trading. Excel (or podcast series.
that it’s “fired.” In my observation, pair another spreadsheet program) can be a

INTERVIEW/KAEPPEL like a lot of other indicators, just when Trading, Wiley.

Continued from page 35 you think it’s infallible you get a flurry [2006]. The Four Biggest Mis-
of errant signals—see 2002. takes In Option Trading, Wiley.
Including the 2002 whipsaws, the [2000]. The Four Biggest Mis-
strategy like this fits nicely in that 30% average gain was +16%. If you exclude takes in Futures Trading, Wiley.
of a portfolio that uses tactical strategies. the 2002 signals, the average 12-month [2002]. The Option Trader’s
An objective, rules-based approach that gain following a buy signal was +26%. Guide To Probability, Volatility, And
cranks out market-beating gains over So it is certainly worth paying attention Timing, Wiley.
long periods of time—provided you have to. But you can’t really base your whole [2020]. “Seeking Long-Term
the financial and emotional wherewithal investment strategy on it. Growth With The Power Zone/Dead
to follow it. Zone Approach,” Technical Analysis
Jay, thank you very much for your of StockS & commoditieS, Volume
Do you still follow the Dow Jones insights on many different trading 38: January.
Industrials 11-month rate of change ideas. I am sure some readers will now [2019]. “Stock Market Seasonali-
indicator? How accurate has it been, have a more in-depth understanding ty: A Global Phenomenon,” Technical
and when was its last signal? of how to benefi t from seasonality, Analysis of StockS & commoditieS,
It’s technically known as the Coppock options trading, and other strategies Volume 37: November.
guide (Figure 5). The calculation is actu- you covered. [2001]. “Trade Sector Funds
ally a little more involved and I use the Thank you, Les. I appreciate the op- With Pure Momentum,” Technical
S&P 500 stock index now. When it goes portunity to share some examples of Analysis of StockS & commoditieS,
negative and then turns up, you buy and market anomalies and insights that I’ve Volume 19: November.
hold for 12 months or until the indicator worked with over many years. [1999]. “A System For Trading
turns down—whichever comes first. This Fidelity Select Funds,” Technical
is more of a “weight of the evidence” type FURTHER READING Analysis of StockS & commoditieS,
of indicator. By that I mean: 1) every Kaeppel, Jay [2009]. Seasonal Stock Volume 17: July.
once in a while it generates a signal, 2) Market Trends: The Definitive Guide
typically those signals are useful, but 3) To Calendar-Based Stock Market
62 • July 2020 • Technical Analysis of Stocks & Commodities
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