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Thom Hartle Trading Strategy and Analysis collection

Vol. 1: 2001-2004

2 On-target trading (Active Trader, July 2001)

7 Finding value opportunities (Active Trader, Aug. 2001)

13 Know thy market: Gauging typical price behavior (Active Trader, Oct. 2001)

18 Fundamentally technical trading (Active Trader, July 2002)

22 Familiarity breeds profitability (Active Trader, Sept. 2002)

30 Bull vs. Bear The details matter (Active Trader, Nov. 2002)

36 Equity curve drawdown management (Active Trader, Feb. 2003)

40 Opening shots (Active Trader, April 2003)

43 What goes up must come down (Active Trader, May 2003)

49 What's the time? (Active Trader, Aug. 2003)

54 Trend, consolidations and unchanged volume (Active Trader, Oct. 2003)

57 The telltale spread (Active Traderr, Nov. 2003)

61 Choosing the proper time frame (Active Trader, Dec. 2003)

65 The method trader (Active Traderr, April 2004)

71 Nasdaq 100 volume and the QQQ (Active Trader, July 2004)
TRADING Strategies

ON-TARGET trading
Taking profits is a balancing act: Hold on too long
and you risk giving back your gains. Get out too soon
and your gains might not be worth holding on to.
By using a scientific approach to solve this puzzle
you can establish intelligent profit targets that
BY THOM HARTLE enhance your performance.

T rading, like any other pro-

fession, is an acquired set of
skills. Granted, certain indi-
viduals naturally possess
the prerequisite abilities for successful
trading: a superior memory for pattern
recognition, supreme confidence and
day moving average of the closing price
is an observable condition with only one
of three possible outcomes: Today’s close
is either greater than, less than or equal
to the moving average.
The advantage of using technical
approaches with such precise definitions
outcome of a particular chart reversal
pattern. Seeing the outcome together
with the pattern may bias your review
process. For example, it’s possible you’ll
see the pattern at market tops but fail to
recognize it (or a similar pattern) in the
middle of a trend when no reversal
plenty of capital. As a result, they hit the is that you can convert the definitions occurs. Or you may convince yourself
ground running. into trading rules or procedures and that you’d know when to trade the pat-
However, there’s a learning curve for then test them on historical data to deter- tern when it was accurate, and know to
the rest of us — a step-by-step process of mine the outcome. avoid it in the situations it failed.
obtaining skills in areas such as trade For example, let’s compare two tech- Hindsight is one thing, but in real-time
entry, trade exit and money manage- nical analysis concepts that point to an trading you don’t know the outcome —
ment (taking profits and controlling expected outcome. The first is the close you can’t see the pattern and the result,
risk). How to set a target for taking prof- vs. the moving average, as described together, in advance — and your judg-
its is an essential part of this process. above. The second is the break of the ment may fail to provide the same
trendline referred to as the “neckline” of advantage you assumed existed when
the head-and-shoulders top pattern. you did know the outcome. Such circum-
Before explaining the method of setting The first is very specific, while the lat- stances can reduce your confidence and
targets, we’ll review the basic guidelines ter is difficult to precisely define. Can raise your anxiety level — both major
of the trading process we’ll be working you precisely define the head-and-shoul- obstacles in the path of effective trading.
with. ders chart pattern in combination with However, once you have precise defi-
First, technical analysis lends itself to the break of the neckline in such a way nitions, a whole new world of develop-
a scientific approach of defining your that you can create a rule and test its out- ing trading procedures opens to you.
trading procedure. The word lends is come? If you can, great. If not, you might
important here, because not all technical want to avoid this kind of analysis.
analysis methods can be used in a scien- What is the problem with not having This idea of using precise definitions is
tific way. For example, the relationship precise definitions? Imagine you are really the foundation of the scientific
between today’s closing price and a 10- reviewing charts, trying to measure the continued on p. 3

2 • July 2001 • ACTIVE TRADER

ting profit targets using the steps of the
At point A, the MACD histogram went positive (on the close) at a price of scientific method.
1,656.54, triggering a buy. The MACD histogram switched to a short position
on the close at point B at 1,673.62, for a 17.07-point profit. The peak price Step 1: State the problem. You can’t
while in the trade was 1,749.29, for an MFE of 92.75 points. solve a problem unless you know what
the problem is. Our problem is to deter-
Nasdaq 100 Index (NDX), 30-minute mine where to take profits after a trading
Trading range signal is triggered. Consequently, the
MACD system -1 1,760
MFE solution is twofold: We have to define,
first, an entry signal and, second, the tar-
geting technique.

1,680 Step 2: Research the problem. Look to

other people’s work in the area of entry
1,640 signals and taking profits. There are
many sources for trading signals (which
1,600 we will mention shortly), but regarding
profit-taking, we’ll use John Sweeny’s
1,560 book, Campaign Trading: Tactics and
Strategies to Exploit the Markets and a
research technique he calls measuring
-.04 maximum favorable excursion.
Maximum favorable excursion (MFE)
-8.6 is the positive price movement of a trade
-17.15 from beginning to end. After we enter
3/16/013/19/01 3/20/01 3/21/01 3/22/01 3/23/01 3/26/01 3/27/01 3/28/01 into a trade there will be a range of pos-
Source: Fibonacci Trader sible price movement. Some trades may
have little, or possibly zero, positive
price movement. For example, a long
entry executed at the high of the day
In addition to the trading range period shown in Figure 1, the test period also would have no positive price movement.
included trend periods. During this downtrend, the MACD histogram signaled On the other hand, if the entry occurred
two good short trades. at what turns out to be the start of a sub-
1,800 stantial trend, the positive price move-
MACD Nasdaq 100 Index (NDX), 30-minute
ment for this trade will be the best under
system 1 Downtrend 1,750
review. In between these two extremes
1,700 of maximum favorable excursions lie the
1,650 outcomes of all of the other trades.
1,600 For example, if you bought a stock at
20 and it rallied to 30, but your exit tech-
nique didn’t trigger an exit until it sub-
sequently dropped to 27, your profit
1,450 would be seven points but the MFE
1,400 would be 10 points. Let’s define our
1,350 entry signals.
We will use the difference between the
MACD line and its signal line (referred
8.81 to as the MACD histogram) to indicate
1.24 trend and trigger long and short posi-
tions. (For more on the MACD, see
-6.33 Indicator Insight, p. 88.) The entry signal
-13.9 will be to buy when the MACD his-
3/27/01 3/28/013/29/01 3/30/01 4/2/01 4/3/01 4/4/01 4/5/01 4/6/01 togram turns positive, staying long until
Source: Fibonacci Trader the MACD histogram turns negative.
The sell-short rule is the opposite: Sell
method credited to Sir Francis Bacon. One reason to follow the steps outlined short when the MACD histogram turns
The scientific method requires you to in the scientific method is to remove any negative and stay short until the MACD
follow certain steps toward understand- bias the researcher may bring to the situ- histogram turns positive. This system is
ing and finding a solution to a problem. ation. We’ll approach the problem of set- always in the market. Now, on to Step 3.

3 • July 2001 • ACTIVE TRADER

Step 3: Form a hypothesis or solution FIGURE 3 DAILY PERSPECTIVE
to the problem. We will assume there
will be positive outcomes from the trad- The Nasdaq 100 rallied into late January and then entered a persistent
ing signals and we will measure the downtrend during February and March.
MFE for each signal. It may turn out the
entry signal concept is flawed, which is Nasdaq 100 Index (NDX), daily
valuable information. Most likely, with 2,600
such a simple approach, the entry rules Uptrend
are a starting point, and by using MFE 2,400
analysis, you can review the results and
repeat the process with the new infor-
mation. (The importance of testing any 2,200
trading idea cannot be stressed enough.
This research ultimately saves you a con-
siderable amount of money.) 2,000

Step 4: Test the hypothesis. To perform 1,800

this test we will review 30-minute bars
of the Nasdaq 100 from Dec. 22, 2000, to
April 4, 2001. (This is too short a time 1,600
period for confidence in the system
itself, but more than adequate to demon- 1,448.24
strate the analytical concept.) The 140,000
January 2001 February March April
Nasdaq 100 can be traded using the
Nasdaq 100 tracking stock (QQQ) or the 26 2 8 16 22 29 1 5 12 20 26 1 5 12 19 26 2
Nasdaq 100 futures contact. Source: Fibonacci Trader
Figure 1 (opposite page, top) shows a
series of trades during March when the there was a persistent
Nasdaq 100 was in a trading range; downtrend during FIGURE 4 PERFORMANCE SUMMARY
Figure 2 (opposite page, bottom) shows February and March. The system posted a profitable return of 1,897.28
trades during a trending period. At the points (not including slippage or commissions).
close of a bar when the MACD his-
togram crosses into positive territory (a Figure 4 (bottom right) Performance Results for Nasdaq 100 Index
buy signal), the price bars turn green lists the performance
and an up arrow is displayed. (The statistics of this trad- 30- D- W System From 12/22/2000 14:00
entire bar is colored green even though ing system over the MACD System to 4/5/2001 14:30
this action takes place at the close of the test period. Figure 5 Gross Profit 2,730.22
bar.) When the MACD histogram drops (p. 48) shows the
Gross Loss -832.94
into negative territory (a sell signal), the trade-by-trade sum-
Net 1,897.28
bars are colored red and a down arrow is mary. This system
displayed. appears to be quite Total Trades 47.00
For each trade we will measure the successful but, again, Total Winning Trades 24.00
profit or loss as well as the MFE. For the test period is too Total Losing Trades 23.00
example, at point A in Figure 1, the short to draw any rea-
Percent Profitable 51.06
MACD histogram went positive on the sonable conclusions.
close at a price of 1,656.54. At point B the However, for our pur- Largest Winning Trade 266.83
MACD histogram signaled a short posi- poses, the first part of Largest Losing Trade -89.81
tion on the close at a price of 1,673.62, for our proposed solution Average Winning Trade 113.76
a 17.07-point profit. The peak price (there are positive Average Losing Trade -36.21
while in the trade was 1,749.29, for a trade outcomes) has
Ratio Average Win/Average Loss 3.14
MFE of 92.75 points. been met. Let’s now
Average Trade 75.81
Ideally, we would like to have our ini- add in the MFE analy-
tial test period include a trend and some sis for each trade. Max. Consecutive Winners 4.00
sideways price movement so we see how One way to Max. Consecutive Profit 909.41
the strategy performs in different market approach this analysis Max. Consecutive Losers 5.00
environments. Figure 3 (top right) is a is to step through each
Max. Consecutive Draw Down -253.96
daily chart showing the period of the his- trade on the screen
torical data base on a daily bar basis. We one bar at a time and Source: MetaStock Professional
can see January was a rising trend while continued on p. 5

ACTIVE TRADER • July 2001 • 4

After four consecutive winners at the beginning of the test period, the
system suffered six losing trades in a row.
MACD System log the information into Excel for fur-
Date Time Position Price P&L P&L Accum. ther analysis. This may seem like a lot of
12/28/2000 12:00 short 2435.17 0.00 work — it is — but the returns from
1/3/2001 9:30 long 2,187.07 248.09 248.09 your investment of time and energy are
1/4/2001 13:30 short 2,453.9 266.82 514.92
You gain a number of insights com-
1/8/2001 14:30 long 2,281.54 172.35 687.28 pared to asking the computer to do the
1/12/2001 9:00 short 2,503.66 222.11 909.40 work for you. First, you will feel more
1/12/2001 9:30 long 2,548.94 - 45.28 864.12 comfortable with the trading approach
1/12/2001 11:00 short 2,513.52 - 35.41 828.70 and have more confidence, because in a
1/17/2001 8:30 long 2,599.27 - 85.75 742.95 sense, you experience each trade. You
1/17/2001 14:00 short 2,566.45 - 32.82 710.13 will see the good times and the bad, so
you will not feel uneasy when your
1/18/2001 11:30 long 2,621.14 - 54.68 655.44
strategy experiences a predictable
1/19/2001 11:00 short 2,657.67 36.53 691.97 drawdown.
1/23/2001 10:00 long 2,659.16 - 1.49 690.48 Second, you will quickly realize if
1/24/2001 12:00 short 2,716.47 57.31 747.79 you have a rule that does not make
1/26/2001 12:00 long 2,618.14 98.33 846.12 sense, or a market situation for which
1/30/2001 13:00 short 2,669.74 51.60 897.72 you don’t know the appropriate action.
1/31/2001 9:00 long 2,713.19 - 43.44 854.27 Finally, you will bring to bear your own
intuitive skills for refining your tech-
1/31/2001 10:30 short 2,685.15 - 28.04 826.23
nique. None of this happens when you
2/1/2001 14:30 long 2,607.17 77.98 904.21 ask the computer to do the work.
2/2/2001 9:00 short 2,564.07 - 43.09 861.11 However, once we have the data we will
2/5/2001 13:30 long 2,451.03 113.04 974.15 use Excel to analyze the results.
2/7/2001 8:30 short 2,434.82 - 16.20 957.95 Figure 6 (opposite page, top) displays
2/7/2001 14:30 long 2,409.66 25.16 983.11 the MFE results as a histogram, arrang-
ing each trade by order of the size of its
2/8/2001 14:00 short 2,364.79 - 44.86 938.24
MFE. The minimum value was zero,
2/12/2001 9:00 long 2,293.92 70.87 1,009.11
and the maximum was 359.86 points,
2/13/2001 13:30 short 2,263.73 - 30.18 978.92 which happened to be the second trade
2/14/2001 13:00 long 2,284.74 - 21.01 957.91 in the test period.
2/15/2001 14:30 short 2,367.09 82.35 1,040.26 Figure 7 (opposite page, middle) sorts
2/21/2001 10:00 long 2,108.95 258.14 1,298.40 the MFEs of long and short positions.
2/21/2001 14:30 short 2,058.54 - 50.40 1,247.99 The majority of long signals cluster from
100 and below (with the exception of
2/22/2001 12:00 long 2,068.31 - 9.77 1,238.22
two large values, which are trades from
2/23/2001 9:00 short 1,979.44 - 88.87 1,149.35
early January). The MFEs of the short
2/23/2001 13:30 long 1,986.52 - 7.08 1,142.27 positions tend to steadily increase. Both
2/27/2001 9:30 short 2,021.37 34.85 1,177.12 of these observations make sense, con-
3/1/2001 13:30 long 1,877.52 143.85 1,320.97 sidering the market was in a downtrend
3/5/2001 8:30 short 1,905.67 28.15 1,349.12 more than two thirds of the test period.
3/6/2001 8:30 long 1995.48 - 89.80 1,259.31 It appears that these trading signals
are a valid approach because of the
3/6/2001 14:30 short 1,976.31 - 19.16 1,240.14
overall profitability. In addition, the
3/12/2001 13:00 long 1,748.33 227.98 1,468.12 MFE outcomes indicate we can identify
3/15/2001 13:00 short 1,736.44 - 11.89 1,456.23 a profitable target level for most trades.
3/19/2001 9:00 long 1,656.54 79.89 1,536.13 Now, how should we establish a target?
3/20/2001 13:30 short 1,673.62 17.07 1,553.21 Let’s return to Figure 6, which shows
3/22/2001 10:30 long 1,616.02 57.60 1,610.81 the MFE of all of the trades ordered by
3/26/2001 11:30 short 1,708.56 92.54 1,703.35 size. We can use a target based on what-
ever we choose from this graph, increas-
3/27/2001 10:00 long 1,734.15 - 25.59 1,677.76
ing or decreasing the size of the target
3/27/2001 13:30 short 1,715.33 - 18.82 1,658.94 based on the likelihood of hitting the tar-
3/30/2001 10:30 long 1,554.82 160.51 1,819.45 get. For example, let’s say we choose 50
4/2/2001 12:00 short 1,525.61 - 29.20 1,790.24 points as our target price. This value was
4/4/2001 10:00 long 1,418.57 107.04 1,897.28 exceeded more than 33 times, or 68 per-
Last Pos. Value 1,519.09 1,997.80 cent of the time. Let’s see how we can
alter our previous rules using this target.
Source: MetaStock Professional

5 • July 2001 • ACTIVE TRADER

This chart shows that the MFEs for the trades in the test ranged from zero
We will use both target and trend-fol- to 350-plus points.
lowing exits for each trade. We will take 400
half our profit at a target of 50 points MFE histogram
and hold the remainder of the trade 350
until the MACD histogram reverses
again. Figure 8 (bottom, right) shows
the equity line for the original trend-fol- 250
lowing positions, along with the equity
line using the additional target exit. (We
are only interested in the performance 150
of adding the targeting scheme; the
additional necessary capital is not an 100
issue here.) 50
Of course, this additional step added
more money, but more importantly, 0
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46
notice how the original equity line sys- Trades
tem peaked at trade 4 and did not sur-
pass this level until trade 19. By com-
parison, the targeting scheme version FIGURE 7 MFE SORTED BY SIZE AND POSITION
passed the previous high at trade 13. The upper curve represents the short sale positions. The lower curve repre -
Also, the original equity line from trade sents the long positions. On average, the long positions are smaller because
19 to 26 was flat, while the targeting the market was in a downtrend for the majority of the test period.
scheme version continued to add prof-
its. Most trend-following methods tend 400
to have lengthy periods of flat or nega-
tive equity growth, and the target
scheme counters this drawback. 300

Step 5: Drawing conclusions from the
testing. Based on this testing we can 200
conclude that the MFE approach is an
appropriate method for determining Short positions
profit targets. You can use the MFE to 100
create targets that suit your risk toler- Long positions
ance by using larger or smaller values
depending on how active you want to 0
1 3 5 7 9 11 13 15 17 19 21 23
be. Other MFE measurements may be
used for targets, such as percentage
price movement or a ratio based on the FIGURE 8 EQUITY CURVES
current average true range. Also
remember that other issues must be The bottom curve shows the performance of the original system. The top
addressed when designing a system or curve shows the performance with the addition of a 50-point profit target.
strategy, such as slippage and commis- The target continues to add profits to the system while the original
sions, risk and required capital. trend-following technique is in a flat period.
Granted, this targeting method is
based on hindsight. So, the first step 2,900
would be to test the approach on differ-
ent (and more) historical data and see if 2,400
the performance holds up. This is called Target plus
“out-of-sample” testing, and is a very trend-following positions
necessary step if you wish to draw reli- 1,400
able conclusions from your testing.
Finally, as with all technical trading 900 Trend-following
methods, past profitable performance positions
does not guarantee future profits, but if 400
you take the time to do this type of
work you will gain both experience and -100
2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48
develop profitable techniques. Ý

ACTIVE TRADER • July 2001 • 6

TRADING & Investing


Where can you find high-potential stocks in a battered market? Adding technical
signals to basic fundamental analysis can allow you to identify value stocks poised
to move.

D traders had one mantra: High tech is the place to

be. In reaction to the phenomenal bull market,
traders quickly adapted to techniques that meas-
ured momentum, be it price, earnings or sales momentum.
The goal was to hop on the backs of stocks that showed
acceleration of any kind, whether it was price- or fundamental-
based. Capital flowed to the leaders in the high-tech industry
uring the latter part of the 1990s, successful stock
because the growth rates using the aforementioned measure-
ments were so high. The risk, though, was great. If there was
any hint of slowdown in the acceleration of a company’s busi-
ness — not even anything as serious as an actual loss — your
position was hammered in a wink of an eye.
In the first quarter of 2000, a slowdown engulfed the entire
high-tech sector, and these stocks
FIGURE 1 S&P BARRA GROWTH INDEX — measured both individually
and by the Nasdaq Composite —
This index represents the stocks within the S&P 500 with price-to-book ratios greater lost more than 50 percent of their
than the average price-to-book ratio in the S&P 500 index. value over the subsequent 12
months. Once seemingly invinci-
S&P 500 (Barra Growth), weekly ble market leaders such as Cisco
Systems (CSCO), Sun Micro-
950 systems (SUNW) and Yahoo
900 (YHOO), among others, plum-
That’s been the headline news.
800 But away from the front page,
750 everything isn’t falling apart. In
700 fact, a new theme appears to be
shaping up in the market: under-
650 valued companies. We’ll explore
600 techniques for identifying un-
550 dervalued companies and meth-
ods for trading them.
Figures 1 through 3 illustrate the
changes that have taken place in
300 the market in 2000 and early
250 2001. Figure 1 (left) is the S&P
500 Barra Growth index and
1996 1997 1998 1999 2000 2001
Figure 2 (opposite page) is the
Source: MetaStock, Equis International ( S&P 500 Barra Value index.

7 • August 2001 • ACTIVE TRADER

The growth index is a capitaliza-
This index represents the stocks within the S&P 500 with price-to-book ratios lower
tion-weighted index of the com-
than the average price-to-book ratio in the S&P 500 index.
mon stocks within the S&P 500
index with price-to-book ratios 690
S&P 500 (Barra Value), weekly 680
higher than the index average (the 670
book value of a stock is the net 650
worth of the company divided by 630
the number of outstanding shares). 620
The value index is a capitaliza- 600
tion-weighted index of the com- 580
mon stocks within the S&P 500 560
index with price-to-book ratios 540
lower than the index average. 530
Figure 1 shows that growth stocks 510
fell precipitously beginning in the 490
first quarter of 2000, while value 470
stocks, shown in Figure 2, moved 450
to new highs over the same period. 440
Figure 3 (bottom right) provides 420
a clearer picture of the relation- 400
ships between these two indices. 380
Here we see the growth and value 360
indices using a logarithmic scale, 350
which measures how the indices 330
performed on a percentage basis.
You can see that the two tracked in 1996 1997 1998 1999 2000 2001
close fashion from 1996 until the Source: MetaStock, Equis International (
middle of 1998, at which point
growth stocks took off (A). Then, in FIGURE 3 S&P 500 BARRA GROWTH VS. VALUE INDEX
2000, the relative strength compari-
son traced out a double top and The relative performance of growth and value stocks. The top chart shows a
growth stocks fell relative to the double top formed on a relative strength basis, a bearish sign for growth stocks.
value stocks.
Whether or not this current trend Double top 1.60
will continue is difficult to know. 1.50
However, because it is in place it 1.45
warrants bringing a value-oriented 1.35
approach to your trading and 1.30
investing. The following approach 1.20
shows how to identify value stocks 1.15
and how to determine when to A 1.10
Growth stocks accelerate 1.05
commit capital to them. 1.00

Traditionally, value is defined by 900

comparing various “fundamentals” 800
to the price of a stock — for exam- Growth
ple, price earnings (P/E) ratio, 600
book value, sales ratio and so on.
A value-oriented technique dic- 500
tates that investments should only 400
be made in companies whose ratios
are at historical low values. The
logic is that such a company has
fallen out of favor with Wall Street,
1996 1997 1998 1999 2000 2001
(as reflected by the low value
Source: MetaStock, Equis International (
continued on p. 9

ACTIVE TRADER • August 2001 • 8

Market timing: ECO

T he Ergodic Candlestick Oscillator (ECO) is detailed in CSI) and a short-term EMA (generally five days for the CSI).
William Blau’s book, Momentum, Direction, and

two other concepts must first be

explained: “double smoothing” and
The next step is the calculation of the Candlestick
Divergence (1995, John Wiley & Sons). To calculate it, Indicator. The CSI is a ratio of the double-smoothed differ-


the Candlestick Indicator (CSI).
Blau uses exponential moving Even though RNWK opened on a gap-down, the CSI continued to rise and the
averages (EMAs) extensively in his MACD remained flat.
calculations. In an effort to create
smooth signals while minimizing Real Networks (RNWK), daily 8.16
price lag, Blau used a double-
smoothing technique — that is, he
applied an EMA to the raw price 7.48
data, and then performed a second
smoothing of the first EMA using an A
additional EMA. Blau uses the stan- 7.16
dard formula for an EMA, which takes CSI rises 7.00
Ergodic Candlestick Oscillator
a price observation, such as the
close, and multiplies it by a con-
stant, called the alpha (a), which, in 5.7
the following formula, represents
the lookback period used for a simple
moving average: -19.61
MACD is flat
MACD .05
a = 2/(n+1)
n = the lookback period for -.11
a simple moving average
2/22/2001 2/23/2001 2/26/2001
In other words, the exponential Source: Fibonacci Trader (
smoothing constant (a) to approxi-
mate a 20-day simple moving aver- CHART 2 PENETRATING THE SIGNAL LINE
age would be .095 (2/[n+1]).
The ECO crossing above and below the signal line generates buy and sell signals,
The adjusted closing price using 1-
respectively. In this case, the ECO signal occurred eight bars before the MACD
alpha is added to yesterday’s EMA
value, which has been multiplied by
alpha. Here is the formula for the Real Networks (RNWK), daily 8.16
EMA = (1-a)P + a(EMA (t-1)) 7.48
p = price
EMA (t-1) = yesterday’s EMA 7.16

Ergodic Candlestick Oscillator 7.-00

The double-smoothed closing
price series (EMA Double) uses the 18.36
EMA of the closing price: 5.7

EMA Double =
(1-a) EMA + a(EMA Double(t-1)) A -19.61
ECO crosses above the signal line
where MACD .05
EMA Double(t-1) =
yesterday’s EMA value
Blau uses the notation B MACD crosses above the signal line
EMA(EMA(P,r),s) to indicate a long- 2/22/2001 2/23/2001 2/26/2001
term EMA (generally 26 days for the Source: Fibonacci Trader (

9 • August 2001 • ACTIVE TRADER

ratios), but that its management team will respond to pressure
from shareholders and take steps to improve earnings. The
price of the stock will ultimately rise as management improves
ence between the open and close of each price bar and a
its business practices.
double-smoothed difference between each bar’s high and
There are a number of value-oriented techniques; the one we
will look at uses historical dividend yields as a basis for value.
Value Trend Analysis is a company that publishes
CSI = 100(Ema(Ema (close-open,r),s)/
Investment Quality Trends (IQ Trends), a value-oriented
(Ema(Ema (high-low,r),s)
appraisal of stocks. It uses individual historical dividend yield
analysis of each stock from the company’s approved list of 350
The CSI measures momentum based on how each bar
“Blue Chips” to determine when a stock is undervalued (i.e.,
closes relative to the range for the bar. Closes at the
has a historical high dividend yield), in a rising trend, overval-
upper end of each bar’s range and above the opening
ued or in a declining trend. IQ Trends uses the following
price indicate strength and positive CSI raw values.
requirements to qualify stocks as blue chips:
Closes at the lower end of each bar and below the open-
• The dividend has been raised five times in the last 12 years.
ing price indicate weakness.
• The company carries a Standard and Poor’s Quality rank-
A trend in either direction will have persistent read-
ing of “A.”
ings. The double-smoothing technique will create a
• The company has at least 5 million shares outstanding.
smooth indicator line that rises if the market is in an
• At least 80 institutional investors hold the stock.
uptrend and falls if prices are in a downtrend.
• There have been at least 25 years of uninterrupted dividends.
Intraday traders will value this indicator because the
calculation does not reference the pre- continued on p. 11
vious bars’ closes. Consequently, any
large price gap — such as a gap open or FIGURE 4 IQ TRENDS CHART
gap close — will not cause this indicator
to fluctuate dramatically. IQ Trends measures an individual company’s undervalued and overvalued
For example, Chart 1 is a 15-minute levels based on historical yields.
chart of Real Networks (RNWK). The
upper histogram chart is a 26-period CSI
and the lower histogram chart is the 12- Wachovia Banc Corp. (WB) Mid January 2001
26-period moving average convergence- Regional bank throughout N & S Carolina and Georgia
Dividend Price
divergence (MACD) indicator (see 6.5
Indicator Insight, Active Trader, July 6.0
2001, p. 88). Notice that at point A, 5.5

there is a gap-down opening, but the 5.0

Overvalued yield line
MACD, which looks at the market on a 65

close-to-close basis, remains virtually 4.0 60

flat. On the other hand, the CSI contin- 3.5 Undervalued yield line 50
ues to rise from the previous day’s read- 3.0

ing because the majority of the 15- 42

minute bars are closing near their 2.5 38

respective highs, indicating strength.
The ECO is a plot of two lines. The 2.0 30
primary is the ECO, which uses the CSI Earnings trend line 26
with an additional smoothing by a five- 24
1.5 22
period EMA, and the addition of a “sig- Dividend trend line 20
nal line,” which is a five-period moving 18
average of the ECO (similar to the
default nine-period moving average sig- 1.0 15
nal line of the MACD). .90
Basic buy and sell signals occur when .80 12
the ECO crosses above and below its sig- .70
nal line, respectively. Chart 2 compares
the ECO (upper histogram) and the 24

MACD (lower histogram). As a short- 16 16

term bottom was forming, the ECO 8 8

crossed above its signal line eight bars

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
before the MACD. Ern.1.94 2.13 2.14 2.51 2.83 3.13 3.50 3.81 3.96 4.45 4.97 4.60
Div. 0.70 0.82 0.92 1.00 1.11 1.23 1.38 1.52 1.68 1.86 2.06 2.28
Source: Investment Quality Trends (

ACTIVE TRADER • August 2001 • 10

Bank of America has traded into undervalued territory a number of times, offering
trade opportunities at points A, B and D (confirmed by the ECO crossovers). is an excerpt from the newsletter
that illustrates the price chart,
Bank of America (BAC), weekly 68.00 dividend yield bands and other
attributes of the company,
64.00 including earnings trend.
These companies are certainly
less volatile than the typical
56.00 Nasdaq stock. While the list of
B1 blue chip stocks may not be the
A1 52.00 most exciting, they do offer
opportunities for traders and
D1 investors alike.
Undervalued price=45 44.00 The technique to be discussed
may be primarily of interest to
40.00 investors or longer-term traders,
but since shorter-term traders
also improve their chances of
Ergodic candlestick oscillator 32.00 success by identifying stocks
and sectors most likely to move,
it will also provide valuable
B -4.68
information for them. Consider
D -12.35 this technique as one of a num-
-20.03 ber of trading strategies you
7/5/99 10/4/99 1/3/00 4/3/00 7/3/00 10/2/00 1/1/01 could employ. In other words,
Source: Fibonacci Trader ( diversify not only into different
markets, but among different
techniques as well.
S&P 500/Barra Growth and S&P 500/Barra Value Indices

I n 1992, Standard and Poor’s (S&P) and Barra worked in partnership to produce As our first criterion, we will
growth and value subsets of S&P’s equity indices. The S&P 500/Barra Growth and begin with a list of undervalued
S&P500/Barra Value Indices separate fast-growing companies from slower growing, stocks — those that have fallen
or undervalued, companies, based upon a price-to-book value calculation (the price of in price and reached their high
the stock divided by the “book value,” or net worth of the company). historical dividend yield. How-
The price-to-book ratio captures one of the fundamental differences between com- ever, we are faced with one
panies classified as value companies or growth companies: Growth companies tend to problem: By putting capital into
have higher price-to-book ratios than value companies. Also, price-to-book ratios tend undervalued companies, we risk
to be more stable over time compared to alternative measures such as the price-to- the possibility that the stock
earnings ratio, historical earnings growth rates or return on equity. Consequently, the price may languish, trading
growth and value indices experience relatively low turnover. sideways for a considerable
Companies in the growth index have higher market caps, on average, than those in the amount of time.
value index. As a result, there are many more companies in the value index than the However, use of technical
growth index. As of this writing, the Growth Index had 125 companies while the Value analysis allows you to spot situa-
Index listed 375 companies. More information can be found at the Standard & Poor’s Web tions that indicate price action is
site ( or and beginning to move into an
Barra’s Web site ( uptrend. A good tool for this is
called the Ergodic Candlestick
Oscillator (ECO), developed by
• The earnings have improved in at least seven of the last 12 William Blau. In the charts that
years. follow, we will plot the ECO as a histogram and the signal line
as a dot. For more information, see “Market timing: ECO,” p. 9.
In mid-January 2001, IQ Trends listed 30 companies as Our plan is to look for stocks from IQ Trends’ undervalued
undervalued, 89 in rising trends, 116 overvalued and 114 in list and then use the ECO to determine which ones are in an
declining trends. Many of the companies listed have been uptrend. The trend turns up when the ECO histogram is in
around most of the past century and are household names, negative territory and rises to the point that the signal line is
such as JP Morgan Chase and Eastman Kodak. Figure 4 (p. 97) not within the histogram. Our work will be with weekly charts.

11 • August 2001 • ACTIVE TRADER

This company reached undervalued territory for a three-month period before an
uptrend began, as signaled by the ECO (point A). first quarter of 2000, BAC traded
below 45. At point A, the ECO
Dillards Inc. (DDS), weekly histogram rose above the signal
line. On this bar, BAC closed at
50. BAC then moved above 60, a
18.00 gain of more than 20 percent. In
late June 2000, BAC again
16.00 dropped into undervalued terri-
tory, and the ECO flashed a buy
signal (point B) with a closing
price of 52.50. The stock then
advanced to 57.63 for a 5-point
Undervalued price=11 A1 12.00 gain. At point C, BAC again
dropped to below the underval-
10.00 ued level. However, notice that
during the short two-week rally,
the ECO never gave a buy signal.
Ergodic Candlestick Oscillator BAC again fell back into under-
valued territory at point D, and
-5.89 the ECO gave a buy signal at a
price of 46.13. The stock rallied
nearly 10 points after that. In
A -25.54 regard to taking profits, you can
1/3/00 2/7/00 3/6/00 4/3/00 5/1/00 6/5/00 7/3/00 8/7/00 9/4/00 10/2/00 11/6/00 12/4/00 1/1/01 2/5/01
use a trailing stop or a hard
Source: Fibonacci Trader (
money target, or take partial prof-
its at a combination of the two.
Figure 6 (top left) is Dillards
Heinz traded into undervalued territory twice last year. Each buy signal was followed Inc. (DDS). The undervalued
by a greater than 10-point gain. price for DDS is 11, or a yield of
1.5 percent. DDS reached this
price in October 2000, and the
H.J. Heinz (HNZ), weekly
ECO gave a buy signal that same
month (point A) at a price of
10.88. In mid-May 2001, the stock
traded above 18.
Our final example, Figure 7
44.00 (bottom left), is HJ Heinz (HNZ).
The undervalued price is 35, or a
40.00 yield of 4.5 percent. HNZ
reached 35 twice in 2000. The
first time, (point A) was in the
Undervalued price=35 A1 36.00
first quarter. The ECO gave a buy
signal at 33.59, and the stock
advanced to 45.94. The second
signal came in September 2000.
28.00 The ECO flashed a new uptrend
Ergodic Candlestick Oscillator
4.74 at a price of 38.94. In May 2001,
the stock traded as high as 48.
A -26.93 Will the price/earnings ratio
1/4/99 4/5/99 7/5/99 10/4/99 1/3/00 4/3/00 7/3/00 10/2/00 1/1/01
compression continue in the
Source: Fibonacci Trader ( Nasdaq stocks? Will value stocks
be the market for this decade? No
Figure 5 (opposite page) shows Bank of America (BAC). one knows, but broadening your methods to position yourself
According to the January IQ Trend, BAC was undervalued at a for whatever happens is a good step to take. That way, you can
price of 45 (giving it a dividend yield of 5 percent). During the take advantage of the current theme driving the market.Ý

ACTIVE TRADER • August 2001 • 12

Gauging typical price behavior
Regardless of what kind of trader you are or what approach you use,
knowing the typical price behavior for the markets you trade is essential.
Here’s how to do it.


W hen it comes to the price behavior of a par-

ticular stock or market, many traders
think of broad con-
cepts like a tenden-
cy to trend, or relatively high or low
volatility compared to other markets.
While such characteristics are useful
for generalizing market behavior, more
a spreadsheet such as Excel, can be applied to any market or
individual stock you trade.


From March 30 to mid-June, the QQQs displayed a wide range of price behav -
ior: an extended uptrend, short-term uptrends, a sideways trading range and
short-term downtrends.
specific, statistical measures of price
action are better for actual trading, espe- Nasdaq 100 Tracking Stock (QQQ), daily
cially for short-term traders who are 50.00
more dependent on the quality of their
entries and exits than long-term traders.
The simplest statistics can provide a
great deal of insight into a stock’s behav-
ior. For instance, knowing the average 45.00
difference between the open and low for
days the market closes up would be use-
ful for improving your trade entries and 42.50
stop placement. This is just one example
of the kind of information that can be 40.00
gleaned from analyzing price action bar-
We will look at some unique ways to 37.50
observe market behavior and then show
how to use this information in your trad- 35.00
ing. First, we’ll walk through some sim-
ple observations of market behavior April May June
using the QQQs, the exchange-traded 2 9 16 23 1 7 14 21 29 1 11
fund that tracks the Nasdaq 100 index. Source: CQGNet
The same analysis, which can be done in

13 • October 2001 • ACTIVE TRADER

TRADING Strategies


A histogram of the daily ranges of the QQQs for the period
in Figure 1 shows the typical daily range is approximately
$2. The blue line is a three-period moving average of the
The principle price behavior characteristics we’ll look at daily ranges and the red line is a 10-period moving average.
are the daily range, the close-to-close range and the differ-
ences between days that close up vs. those that close down.
For clarity, we will start by analyzing small amounts of data
and then expand our analysis. 8
The first price behavior characteristic to analyze is the typ-
ical daily range. Figure 1 (opposite page) shows a daily 5
chart of the QQQs from March 30 to the middle of June, a 4
period that encompassed up, down and sideways price
Figure 2 (right, top) shows the daily range (high minus 2
low) for each bar in the period in Figure 1. The blue line is 1
a three-period moving average (MA) of the daily ranges
and the red line is a 10-period MAof the ranges. Both MAs
reveal the typical daily range is approximately $2, the jump Price bars
at bar 13 notwithstanding. Source: Excel

The second characteristic is the difference between closing FIGURE 3 CLOSE-TO-CLOSE CHANGES
prices on a day-to-day basis. Figure 3 (right, bottom) shows The absolute value between closing prices indicates the
the absolute values of close-to-close price changes over the closing differences tend to be between $1 and $1.50, except
for the earlier observations. The blue line is the three-period
moving average of the bar-to-bar closing price differences
The simplest of statistics and the red line is the 10-period moving average.

can provide a great deal Points


of insight into a stock’s 4.5


behavior. 3.5
same period. As would normally be the case, the differ- 2.0
ences in closing prices are, on average, less than the daily
ranges (and the same volatility spike occurs at bar 13). As
in Figure 2, the blue line is a three-period MA and the red 1.0
line is the 10-period MA. Here, the averages tend to be .5
between $1 and $1.50, except for the early observations in 0
the example. Price bars
To delve further into this aspect of the QQQs’ price Source: Excel
continued on p. 15

ACTIVE TRADER • October 2001 • 14

behavior, we’ll display this data in a for-
mat that makes it easier to see how the In this chart the daily bars are adjusted so the opening price is zero. The high of
the high, low and close relate to the each bar represents the difference between the high and the open; the low of
open. Figure 4 (right) shows each of the each bar represents the difference between the open and the low; and the hash
daily open-high-low-close bars adjusted mark on each bar represents the difference between the close and the open.
so the opening price is zero. The high of Points
each bar represents the difference 8.0
between the high and the open; the low 7.0
of each bar is the difference between the 6.5
open and the low, and the dash on each 5.5
bar is the difference between the close 5.0
and the open. 4.0
The next step is to create two versions 3.5
of this chart to analyze the difference 2.5
between bars that closed up from the 1.5
previous close and those that closed 1.0
down from the previous close. Figure 5 0
(below) shows only bars that closed up -.5
from the previous day’s close. Figure 6 -1.5
(p. 62) shows those bars that closed -2.0
down from the previous day’s close. -3.0
Figure 5 reveals that, of days that -3.5
closed higher than the previous day,
Price bars
approximately one-third of the bars’
lows were less than 50 cents below the Source: Excel
open, one-third were between 50 cents
and $1 below the open, and one-third were between $1 and closed down for the day, but above the opening price — a price
$1.50 below the open. Interestingly, a number of the bars from pattern often referred to as a reversal day.
the final third closed below the open but made highs that were These charts reflect a bias for the low or the high depending
approximately 50 cents above the open for the day. on if the market closes up or down for the day. On up-closing
Figure 6 shows when the market closed down, the highs days, the majority of the daily ranges are above the opening
tended to range between 50 cents and $1 above the open. The price (with the highs often reaching $2 or more above the open-
bar with the highest high (nearly $2 above the opening price) ing), while the lows are often between 50 cents and $1 below
the open. The opposite is true for down-
Only the bars from Figure 4 that closed up from the previous day’s close are
shown here. Approximately a third of the bars had lows near 50 cents below
the open, a third were between 50 cents and $1 below the open, and a third Now we’ll expand this kind of simple
were between $1 and $1.50 below the open. statistical analysis to cover the period
Points from June 22, 1999, to June 13, 2001 (500
3.5 days). During this period, the market
3.0 $7.28 closed up 254 days, closed down 238
2.5 days and closed unchanged eight days.
2.0 Figure 7 (p. 62) sorts the daily ranges
in 50-cent increments. (The 50-cent col-
umn shows the number of days with
ranges up to and including 50 cents and
so on.) There were zero days with a daily
0 range of 50 cents or less; 13 days with
-.5 ranges of 51 cents to $1; 63 days with
-1.0 ranges of $1.01 to $1.50; and 72 days with
-1.5 ranges of $1.51 to $2. The daily range was
-2.0 greater than $10 just seven days. The typ-
-2.5 ical daily range was around $2, similar to
-3.0 the results for the shorter period exam-
-3.5 ined in Figure 2.
Approaching the data from the oppo-
Price bars site direction provides another perspec-
Source: Excel continued on p. 16

15 • October 2001 • ACTIVE TRADER

with a difference of up to +/-50 cents; 92
On days the market closed lower than the previous close, the highs tended to
days closed with a difference between
range between 50 cents and $1 above the open. The bar with the highest high
+/-51 cents and +/-$1; 66 closed with a
(nearly $2 above the opening price) closed above the opening price despite
difference between +/-$1.01 and +/-
closing lower than the previous close.
$1.50; and 54 closed with a difference
Points between +/-$1.51 and +/-$2.
3.5 Only 182, or 36.4 percent, of the 500
3.0 days the QQQs closed by more than +/-
2.5 $2 from the previous close. The data
2.0 indicates that although 70 percent of the
1.5 time the QQQs have a daily range
greater than $2, only 36 percent of the
time will they close more than $2 (high-
er or lower) from the previous day’s
-1.5 As noted, 254 of the 500 days closed
-2.0 higher than the previous day. Figure 9
-2.5 (p. 64) shows that for these days (using
-3.0 absolute values for the difference
-3.5 between the open and the low) the open-
ing price was equal to the low of the day
Price bars five times; the difference between the
Source: Excel open and the low was 50 cents or less 77
times; and the difference between the
tive. For example, out of the 500 days, how many days did the open and the low was 51 cents to $1 73 times, which means the
QQQs have a range greater than $2? It turns out that there were market was down as much as 51 cents to $1 before reversing to
352, or 70.4 percent of the total days. close up on the day. On only 32 days, or 12.5 percent of the
Figure 8 (below, right) is a similar breakdown of the typical time, did the market fall by more than $2 and still close up for
difference in closing prices, expressed as absolute values. Eight the day.
days were unchanged from the previous close; 98 days closed Of the 238 days the market closed down, the open and the
continued on p. 17


There were zero days with a daily range of 50 cents or less;
13 days with ranges greater than 50 cents up to and includ - There were eight unchanged closing prices; 98 that closed
ing $1; 63 occurrences with ranges greater than $1 up to between unchanged and +/-50 cents; 92 that closed greater
and including $1.50; and 72 days where the daily range was than 50 cents and up to $1; 66 that closed greater than $1
greater than $1.50 up to and including $2. The daily range and up to $1.50, and 54 that closed greater than $1.50 and
was greater than $2 approximately 70 percent of the time. up to $2.
Price bars Price bars
80 72 120
70 63 98
100 92
60 55 57

50 80 66
36 38 54 52
40 60
30 22 20
19 40 32
20 13 24 22
8 15
10 5 7 3 5 7 20 8 10
0 0 0 1 0 5 5 7 4
1 2 0 1 1 1

Range Range
Source: Excel Source: Excel

16 • October 2001 • ACTIVE TRADER

high were the same only 10 times (see Figure 10, below,
right). The market reached a high of between one cent to 50 Analyzing the absolute values of the differences between
cents before turning down 84 times, and was up between 51 the open and the low for days the market closed higher
cents to $1 65 times before reversing. reveals that only five times was the opening price equal to
Figures 9 and 10 reveal there were some volatile days in the low, and 77 times the difference between the open and
this period, in that five times the QQQs were down more the low was 50 cents or less. The market recovered from
than $4.50 and still closed up, and three times were up more being down between 51 cents and $1 before reversing to
than $4.50 and then closed down. close up for the day 73 times.
Price bars
These price behavior characteristics provide practical trad- 77
80 73
ing guidelines for systematic and discretionary traders alike
— regardless of other analytical approaches they use. 70
For example, if you trade intraday bars and came into the 60 50
trading day with a trade that was up $2 for the day, you 50
should consider taking some partial profits because
although the QQQs exceed a $2 range 70 percent of the time, 40
they close +/-$2 from the previous close only 36 percent of 30
the time. As a result, the statistics suggest the market is like- 20 13
ly to turn against this position by the close. 5
2 3
10 2 0 0 1 1
Or, perhaps your analysis indicates the QQQs have a
good chance to rally, but the market starts the day with an 0
early sell-off, trading down from the opening price. The sta-
tistics from Figure 9 (which showed the QQQs were down
as much as 51 cents to $1 before reversing to close up on the Source: Excel
day 73 times) suggest opportunity is there when the market

To understand any market, On days the market closed down, the open was equal to the
high only 10 times. The market turned down after reaching
a high between one cent to 50 cents 84 times. The market
you must measure was up between 51 cents and $1 65 times before reversing.
Price bars
and classify its behavior 100
in terms of probabilities. 80
is down $1. 50 38
If you are developing a short-term systematic approach
based upon indicators, you can substitute a hard-money
30 18
stop based on typical behavior of the market instead of
waiting for an indicator to give a signal at the close. 20 10 9
4 3 1 3 1
For example, when reviewing your test results you might 10 0 1 0 1 0
uncover that if your system was long and the indicator sig- 0
nals a reversal point that causes losses greater than $3 at the
close, you could substitute a hard-money exit rule based on Range
the statistics that show the market rarely recovers after it Source: Excel
has moved a certain amount intraday. In addition, knowing
the market’s typical behavior can help you better decide To understand any market, you must measure and classify its
how much capital to risk on any one trade. behavior in terms of probabilities. You can combine these sta-
tistics with other analytical techniques and build sound trading
methods based on concrete price behavior characteristics.
In his book Trading in the Zone: Master the Market with This kind of analysis reveals each market has typical behav-
Confidence, Discipline and a Winning Attitude, trader and author ior patterns, as well as the potential to — on any given day —
Mark Douglas writes, “The best traders treat trading like a trade outside of its typical pattern. That is a fact of life in trad-
numbers game, similar to the way in which casinos and pro- ing, but by using simple statistics, you’ll be better equipped to
fessional gamblers approach gambling.” trade effectively. Ý

17 • October 2001 • ACTIVE TRADER

TRADING Strategies


Technical and fundamental
analysis don’t have to be
mutually exclusive.
This trading approach
finds stocks with top
fundamentals and buys
them in uptrends when
they pull back.


W ith more than 10,000

stocks to choose from,
traders need to ensure
they are in the ones
that are moving. No one can afford to sit
in markets that are going nowhere.
Money goes where opportunities lie, characteristics is Investor’s Business Daily Of the five, the earnings per share rating
and traders and investors often define (IBD), a newspaper that publishes a and the relative strength rating receive
opportunity and commit capital based weekly list of stocks with top fundamen- the most weight.
on either technical conditions, such as tals. While IBD does not provide the pre- Earnings Per Share (EPS) Rating:
high price momentum, or fundamental cise criteria of the screening process used Compares the last two quarters and the
characteristics, such as strong earnings to identify these stocks, they rank high last three to five years of earnings
growth. in IBD’s SmartSelect Ratings. growth and stability to that of all other
However, there’s no reason funda- companies. A 90 rating indicates that a
mentals and technicals cannot comple- Get SmartSelect company’s earnings growth outper-
ment each other. In fact, you can All IBD screens and ratings are based formed 90 percent of all other companies
improve your chances of success by upon a proprietary stock database. For in the database.
focusing on stocks with both good tech- example, its relative strength ratings com- Relative Price Strength (RS) Rating: A
nical and fundamental characteristics. pare an individual stock’s price perform- stock’s relative price change in the last
After all, a company’s ability to deliver ance to the IBD stock database, not to the 12 months vs. all other stocks.
persistent positive business performance S&P 500 or a particular sector, as is the Industry Group Relative Price
should translate into a chart with an case with other services. Here is a brief Strength Rating: Compares a stock’s
upward, zigzagging price pattern — explanation of the IBD rankings, known industry price performance in the last
perfect for the nimble trader. as the SmartSelect Ratings: six months to 196 other industries. Top
One easy place to get a list of stocks SmartSelect Composite Rating: Com- industries rate A+, the worst rate E.
with strong technical and fundamental bines all five IBD SmartSelect Ratings. Sales + Profit Margins + ROE Rating:A

18 • July 2002 • ACTIVE TRADER

Money goes where opportunities lie, and
result, traders need an indicator that
traders and investors often define opportunity identifies relative low and high points in
a market. Bollinger Bands fill this role in
and commit capital based on either technical the strategy.
Bollinger Bands are price envelopes
conditions, such as high price momentum, consisting of lines plotted two standard
deviations above and below a moving
or fundamental characteristics, such average (MA), typically a 20-period MA.
Most of a market’s fluctuations will fall

as strong earnings growth. between the bands, so when price reach-

es or exceeds one of the bands, the mar-
ket, by definition, is at a relatively high
company’s recent sales growth, profit each day’s volume weighted by the clos- or low level. (For more information on
margin and return on equity (ROE) are ing price relative to the day’s range. The Bollinger Bands, see the Active Trader
combined and graded from A to E. denominator is the total volume over the Interview with John Bollinger in the
Accumulation-Distribution Rating: A 21-day period. The CMF formula (in January 2001 issue.)
price and volume formula determines if MetaStock language) is: For example, when a market is at the
a stock is under accumulation (buying) lower Bollinger Band, it is nearing an
or distribution (selling) in the last 13 CMF = sum((((C-L)-(H-L)) / (H-L)) * extreme downside level relative to its
weeks. A grade of A indicates heavy V, 21) / sum(V, 21) recent price history. If price is at the
buying and a grade of E reflects heavy upper Bollinger Band, it is reaching an
selling. where extreme upside level based on recent
Each week IBD singles out approxi- H = daily high price history. An important caveat is that
mately 20 to 30 stocks with top funda- L = daily low a simple tag of the upper or lower band
mentals. These stocks are highlighted in C = daily close does not guarantee price will reverse. A
yellow in the NYSE and Nasdaq Main V = volume strongly uptrending stock will persist-
Tables. They provide a starting point for ently tag the upper band, while a stock
identifying solid trading opportunities. (Traders using eSignal 7.0 can find the in a strong downtrend will repeatedly
The next step is to use specific technical custom formula for the CMF at hit the lower band.
criteria to narrow the list further and In this case, the Bollinger Bands will
ultimately signal trades. be set to a lookback period of 10 days
The strategy that will be outlined in Positive CMF values indicate the instead of the conventional 20 days.
the following sections will focus on stock is closing near the upper end of its
stocks with strong fundamentals, and daily range on higher volume, a sign of Trade rules
will operate exclusively from the long persistent buying. Negative CMF read- The strategy is designed to go long on
side of the market. ings reflect the opposite. short-term countertrend moves that
As long as the CMF is positive, the punctuate the longer-term uptrend. The
Blending in the trend: market is considered to be in an uptrend. rules for the strategy are:
Chaikin Money Flow The advantage of this indicator is its 1. Identify those IBD top
IBD performs its screening of top funda- focus on volume relative to how the fundamental stocks that also have
mental stocks on a weekly basis. This market closes each day. A stock could be positive CMF readings. These
means it is possible for a stock to switch down on the day because of selling pres- stocks also must be trading
from uptrend to downtrend based on sure throughout the broader market, but above $20.
some event that won’t be picked up by strong stocks should nevertheless tend 2. Wait for price to tag the lower
this screening process. (Later, we’ll look to close near their highs despite overall Bollinger Band.
at an example of a company that stayed market weakness. 3. Go long if the stock trades 5 cents
on the top fundamental stocks list for two At this point we have created a list of above the high of the daily bar
weeks despite losing almost 30 percent of fundamentally strong stocks and chosen that hit the lower Bollinger band.
its value.) Accordingly, it is necessary to a tool that defines when they are in If price does not trade 5 cents
consult a technical trend indicator to uptrends. Now we must decide the best above the high of the tag bar, then
identify those stocks that are in uptrends. way to enter trades. go long 5 cents above the high of
Chaikin’s Money Flow (CMF) will be the next bar.
used to determine the trend for the trad- Buying low and selling high 4. Place a stop loss 5 cents below the
ing approach we will outline. The CMF Today’s market requires a trader to buy low of the entry bar.
is a ratio of weighted volume relative to low and sell high, which is very different 5. Take profits if the stock moves
total volume over a 21-day period. from a few years ago when a trader one dollar in your favor.
The numerator is the 21-day sum of could buy high and sell higher. As a continued on p. 20

ACTIVE TRADER • July 2002 • 19

The stock tagged the lower Bollinger Band on Feb. 7 while the CMF was not go long.) Occasionally the CMF will
positive. A long trade was entered on Feb. 8 when the stock moved 5 cents momentarily edge into negative territo-
above the Feb. 7 high. The price target was hit the next day. Later in the ry when the price is at a lower extreme.
month another setup formed and the entry and exit occurred on the same day. Do not enter the market after the second
bar. Stocks also must be trading above
Price Alliance Gaming Corp (ALLY), daily $20 because the one-dollar move
35.00 required for the profit target is less like-
ly to occur in lower-priced stocks.

32.50 Trade examples

Sell The following trades are taken from
some of the 17 top fundamental Nasdaq
30.00 stocks highlighted by IBD on Feb. 2,
2002. When trading this strategy, you
can use the list for trading during the
Buy Buy
27.50 month, checking each week to make
Chaikin Money Flow 0.25 sure your stocks remain on the list.
Figure 1 (top left) shows Alliance
Gaming Corp (ALLY), one of the top
fundamental stocks as of Feb. 1, 2002.
0 The entry criteria were met on Feb. 8:
The previous bar had tagged the lower
28 4 11 19 25 4 Bollinger Band, the CMF was positive,
February March
and the stock traded above the high of
Source: eSignal 7.0 the tag bar ($29.85). On Feb. 11, the stock
reached a high of $31.44, exceeding the
If the CMF is not positive on the bar negative on the first bar that tags the one-dollar profit target.
that tagged the lower Bollinger Band but lower Bollinger Band, we cannot use the Then on Feb. 20, the stock touched the
turns positive on the next bar, use the high of that bar; if the CMF is negative on lower Bollinger Band a second time and
high of the second bar. (If the CMF is the bar following the tag bar, we still can- the CMF was positive. The next day we
went long 5 cents above the previous
day’s high of $29.67. The stock rallied to
FIGURE 2 DELAYED ENTRY $30.95 the same day.
On Feb. 5 the stock hit the lower band, but no trade was entered because the Figure 2 (bottom left) shows Nvidia
CMF was negative. The next day the CMF turned positive, but price did not Corp. (NVDA). In early February, the
trade above the previous high, again denying entry. On Feb. 8 the stock stock tagged the lower band but the
tagged the lower band but the CMF was negative. However, the next day (Feb. CMF was negative at the time. The CMF
12) the CMF turned positive and a long trade was triggered when the stock turned positive on the next bar, but the
exceeded the Feb. 11 high by 5 cents. stock did not trade above the high of this
bar; no trade was entered. On Feb. 8 the
Price Nvidia Corp (NVDA), daily 70.00 stock tagged the lower band once more,
Sell but the CMF had turned negative again;
65.00 no trade. The next day the CMF turned
positive and we went long on Feb. 12
when the stock pushed above the Feb. 11
high of 61.00 by 5 cents. The stock
No entry reached 63.35 the same day, fulfilling the
55.00 price target. Later in the month, the CMF
was negative when the stock tagged the
50.00 lower band (the stock was in a visible
downtrend at this point) and no trade
was entered.
Chaikin Money Flow
In Figure 3 (opposite page, top), price
tagged the lower band on Feb. 7, but did
not trade above the high of the tag bar
on Feb. 8. As a result, the Feb. 8 high
(57.75), plus 5 cents, became the refer-
28 4 11 19 25 4 ence point to enter a trade on Feb. 11. We
February March
went long on Feb. 11, and the stock hit
Source: eSignal 7.0 59.96 that day (more than a $2 move),

20 • July 2002 • ACTIVE TRADER

fulfilling the profit target. Also notice tunities for nimble traders. You simply a departure point for further testing, and
that in this case, the low was equal to the need a solid set of procedures for defin- can be modified to suit your own person-
previous day’s low, so the position was ing entry, risk and profit-taking. al risk tolerance and profit goals.Ý
not stopped out. The set described here that incorpo-
On Feb. 20 price tagged the lower rates the CMF and Bollinger Bands can be
band but the market fell for two more
days. Another tag occurred on Feb. 22, FIGURE 3 TAKE PROFITS WHEN YOU CAN
and the high of the day was 52.50. On
Feb. 25 the stock rallied above the trigger The trade on Feb. 25 illustrates that, regardless of your entry price, it’s wise
level, and on Feb. 26 it made a high of to exit at the $1 profit target. On the same day the trade was entered, price
53.57. (If you experienced slippage on eventually dropped below the bar’s low of $51.50, which would have resulted
your entry, you may have had to wait for in a loss larger than $1.
the full one-dollar profit.) Price Panera Bread Co. (PNRA), daily
This example shows why you should 65.00
take the profit at the target level, despite
your entry price: The same day the stock Sell
dropped below the entry bar’s low of Buy 60.00
51.50, which would have resulted in a
loss of more than $1.
Buy 55.00
The rest of the story
Earlier we mentioned that just because a
stock is on the top fundamentals list 50.00
doesn’t mean it’s in an uptrend at the
time. This final example is from January Chaikin Money Flow
2002, and it shows how market partici-
pants can turn on a stock with a
On Jan. 2, one company on the top
fundamental list was Dynacq Interna- 28 4 11 19 25 4
tional (DYII). Figure 4 (bottom right) February March
shows the stock steadily climbed from a Source: eSignal 7.0
low of 11.00 in September 2001 to 29.25
on Jan. 7; its PE pushed above 35. In
SmartSelect Composite Rating: 98
A stock can get crushed despite having top fundamentals. Two days after
Earnings Per Share Rating: 99
a positive earnings announcement, a published article raised concerns
Relative Price Strength Rating: 95
regarding accounting practices at the company, and the stock closed down
Industry Group Relative Price Strength
nearly 28 percent.
Rating: B+
Sales + Profit Margins + ROE Rating: A Price Dynacq International (DYII), daily Negative
Accumulation/Distribution Rating: B article

However, two days after announcing

earnings of 17 cents per share (vs. ana- 20.00
lysts’ expectations of 14 cents per share)
on Monday, Jan. 14, an article was pub- 15.00
lished questioning the company’s ac-
counting practices. The stock closed 10.00
down nearly 7.00 — a 28-percent loss.
However, Dynacq was still listed as a top
fundamental stock as of Jan. 25 because Chaikin Money Flow
the IBD screenings do not take into 0.25
account sudden changes in investor per-
ception. 0

Fundamental screening, -0.25

28 1 8 15 22 29 5 12 19 26 3 10 17 24 31 7 14 22 28 4
technical trading October November December January 2002 February
The stocks highlighted as having top
fundamentals by IBD offer many oppor- Source: eSignal 7.0

ACTIVE TRADER • July 2002 • 21

TRADING Strategies

22 • September 2002 • ACTIVE TRADER

Getting to know a market means
understanding the odds associated
with the price moves it typically makes.
A handful of simple calculations can put
these probabilities at your fingertips.


here will always be a select group of traders who know just

when the market is hitting its low for the day, enter a long posi-
tion and get out near the high. These traders share a keen, intu-
itive sense of price direction.
Is such talent mandatory for trading success? Not at all. Those of us without
an innate feel for the markets can perform simple analysis that allows us to
understand the typical price behavior of our favorite stocks and futures. We can
then incorporate this valuable information into our strategies.
We’ll look at some unique ways to observe and quantify market behavior,
and illustrate how to use this information in actual trading. The instrument
we will analyze is the S&P500 index tracking stock (SPY), but you can per-
form the same analysis on any market.
The goal in examining the price data is to find patterns in the daily
ranges, close-to-close ranges, and the relationship between the open and the
low (for days the market closes up) or the open and the high (for days the mar-
ket closes down). Analyzing simple price patterns makes it possible to deter-
mine the odds that different kinds of price moves will occur.
As a result, the characteristics revealed in this analysis can be used to tailor
trading strategies to the realities of the markets you trade, resulting in more dis-
ciplined and probability-based trading — in essence, a mechanical way of
achieving a measure of the “intuition” enjoyed by that select group of traders.
continued on p. 24

ACTIVE TRADER • September 2002 • 23

The initial test period for SPY contained both uptrending and downtrending conditions. trading days of data (late
February to mid-May 2002)
118.00 in SPY. The stock switches
S&P 500 index tracking stock (SPY), daily
from uptrend to downtrend
117.00 and back again.
Figure 2 (left, bottom)
shows the daily range (high
115.00 minus low) of each bar from
Figure 1. The blue line is a
114.00 three-bar moving average of
the daily ranges and the red
113.00 line is a 10-bar moving aver-
age. Comparing this chart to
112.00 Figure 1 reveals the highest
volatility occurred when
SPY was bottoming out in
110.00 May. Although there is not
enough data to draw a firm
109.00 conclusion, this does sup-
port the trading adage that
108.00 market turning points —
especially bottoms — are
107.00 more volatile than trending
periods in terms of daily
trading ranges.
105.00 Therefore, if some of your
March April May other indicators were hint-
25 1 11 18 25 1 8 15 22 29 1 6 13 20
ing at a top or bottom (such
Source: CQGNet as a divergence between
price and an oscillator), you
Daily range functions as a basic measure of volatility could refer to these simple moving aver-
The first aspect of price behavior to con- — the larger the range, the higher the ages of the daily range as one more con-
sider is the average daily range, which volatility. Figure 1 (above) shows 60 firmation of a pending reversal.
In addition, the daily
FIGURE 2 DAILY RANGE range information is vital
for intraday traders — those
Arranging the ranges (high-low) of the days in the test period highlights the market’s who close out all open posi-
volatility characteristics. The high-volatility area corresponds to the May bottom. tions by the end of each
trading session. By knowing
3.0 the current average range
High-volatility area you can set targets based on
Three-bar moving average how much the market you
trade typically moves in a
10-bar moving average day. Also, intraday traders
2.0 must be able to identify
markets with enough intra-
1.5 day volatility to make them
worthwhile to trade.

1.0 Close-to-close range

The second measure we’ll
0.5 analyze is the difference
between closing prices on a
day-to-day basis. We will use
absolute values (i.e., all posi-
tive numbers) of the close-to-
Day close price moves to make
Source: Excel, data by eSignal the analysis comparable for

24 • September 2002 • ACTIVE TRADER


up and down markets. Measuring the distance between closing prices provides a second perspective on market
Figure 3 (right) shows the volatility. Close-to-close moves reflect price gaps between bars.
difference between closes
for the bars in Figure 1, with 4.5
three- and 10-bar moving
averages. Note that there is
an outlier (an extreme read- 3.5
ing) at data point 48 — a
closing difference of $3.91. 3.0
This reading is much larger 2.5
than the same bar from
Figure 2 because of the low 2.0
close on May 7 and a gap-
up opening and high close
on May 8. Although a larger 1.0
price gap occurred a few
bars later, the close-to-close 0.5
move was not as exaggerat-
ed because the bar before
the gap closed near its high.
Some traders may want Day
to use average “true range” Source: Excel, data by eSignal
(the greatest absolute differ-
ence between today’s high financial press never says the market
and today’s low, today’s high and yes- closed up today twice the average true A different perspective
terday’s close, or today’s low and yester- range, but they do comment on closing A different way of viewing this price
day’s close) for this calculation. differences — e.g., today was the highest information is shown in Figure 4 (left).
However, by choosing close-to-close and close in three weeks, or at one point the The price data is adjusted so that each
high-minus-low ranges, you have statis- stock was down $6 from yesterday’s bar’s opening price is zero, the high is
tical references to know when market close, and so on. With historical num- the net gain from the open, the low is the
activity is significant relative to what bers in hand you can put price action in net decline from the open, and the close
many other people in the market are perspective and separate facts from is the difference from the open. This per-
talking and thinking about. After all, the hyperbole. spective highlights how much the mar-
ket moved above or below
the open on a given day.
FIGURE 4 ADJUSTING THE DATA The next step is to segre-
gate the bars in Figure 4 in
This graph shows the daily ranges plotted with the opening price at zero. This highlights
terms of days the market
how far above or below the open the market moved and where it closed on different days.
closed up from the previous
3.0 close (Figure 5, p. 26) and
days the market closed
down from the previous
2.0 close (Figure 6, p. 26). This
1.5 analysis will reveal whether
1.0 the market has any observ-
0.5 able tendencies on up-clos-
ing or down-closing days.
During this 60-day peri-
-0.5 od, the market closed up 28
-1.0 bars and down 32 bars.
-1.5 (Keep in mind that some
-2.0 bars closed below the open
but above the previous close
or above the open but below
-3.0 the previous close.) As you
Day might expect, the bulk of the
intraday price movement is
Source: Excel, data by eSignal continued on p. 26

ACTIVE TRADER • September 2002 • 25

These are the days from Figure 4 that closed up from the previous close. Isolating these above the zero axis (i.e.,
days allows you to identify any characteristics specific to up-closing days. higher than the open) on up-
closing days and below the
3.5 zero axis (i.e., lower than the
3.0 open) for down-closing
2.5 days.
2.0 There were four instances
1.5 where price was up more
1.0 than $1 above the open and
0.5 closed down (that is, closed
0 below the previous close),
-0.5 and five instances where the
-1.0 price was down $1 or more
-1.5 from the open and closed
-2.0 up. In addition, there were
-2.5 13 instances (46 percent) in
-3.0 Figure 5 where the price was
-3.5 50 cents or more below the
open, and still rallied to
Day close up for the day.
Source: Excel, data by eSignal On the other hand, SPY
moved more than 50 cents
above the open and closed

Those of us without an innate feel down for the day only nine times in 32
observations (28 percent). Also note that
SPYmade no unusual surges or declines
for the markets can perform simple during this period. However, there are
only 60 bars of data, so a longer-term
analysis that allows us to understand view would be required before reading
too much into these statistics.

the typical price behavior of the Getting more in depth

To get a more reliable picture of the
instruments we trade. price behavior in this market, we will
expand the data period to
500 daily price bars (May
FIGURE 6 DOWN-DAY ANALYSIS 25, 2000, to May 24, 2002)
and perform more sophisti-
Isolating the down-closing days helps highlight the price behavior of these bars.
cated analysis. During this
3.5 period, the market closed
3.0 above the previous close
2.5 245 times and below it 255
2.0 times. The average daily
1.5 range was $1.68, which is in
1.0 line with the data from
0.5 Figure 2.
0 Figure 7 (opposite page)
-0.5 analyzes the data by group-
-1.0 ing the daily ranges by size
-1.5 in 50-cent increments (i.e., a
-2.0 penny to 50 cents, 51 cents
-2.5 to $1, $1.01 to $1.50, etc.)
-3.0 and counting the number of
days that fell into each
group. The daily range was
Day $1 or less on 17 days, $1.01
to $1.50 on 118 days, and
Source: Excel, data by eSignal
$1.51 to $2 on 135 days (the

26 • September 2002 • ACTIVE TRADER

low of the day.
Breaking down the daily ranges into 50-cent increments is the first step toward determin -
Also, you can use this
ing the probabilities of different kinds of price moves. The daily range for SPY most often
information to decide
fell between 1.5 and 2.99.
where to place a stop if you
140 started the day with an
135 open long position. In this
case, if you are holding
120 118
positions overnight with
the goal of catching a one-
100 to three-day price swing,
you cannot place your stop
25 cents or less below the
80 open if you are long. Doing
so is inviting the market to
60 57 stop you out, because SPY
traded less than 25 cents
away from the open only 25
40 percent of the time. In other
words, the odds you will be
stopped out are 75 percent.
20 17
8 9 Here’s another scenario:
0 0 3 2 1 0 1 0 1 If you are an intraday trad-
0 er and your system is flash-
ing a buy signal when price
Daily range ($) is down $1.50 from the
open (remember just slight-
Source: Excel, data by eSignal ly more than 5 percent of
the time the SPY traded
highest total). where between a penny and 25 cents higher after being down $1.50 from the
Reading the chart from right to left, below the open and closed up for the open) you may want to pass on the
the SPY traded in a range greater than day, while the market traded between 51 trade.
$2.50 on 128 days (only 25.6 percent of cents and $1 below the low and still Now let’s look at the statistics for
the time). The most extreme reading for closed up for the day 66 times. The mar- down-closing days. Figure 10 (p. 29)
a daily range, between $8 and $8.50, ket traded more than $1.50 below the examines the difference between the
occurred when the Fed cut interest rates open and still closed up for the day bare- open and the high on days the market
on Jan. 3, 2001. ly more than 5 percent of the time. (Keep closed down from its previous close. The
Figure 8 (p. 28) sorts the close-to-close in mind the open can be up or down for open and the high were the same 16
price moves. The average closing change the day, and the close is compared to the days, and there were 67 days when the
was $1.27. The largest number of close-
to-close ranges was less than 50 cents.
The highest closing difference was
between $6.01 and $6.50. The SPYclosed
Analyzing basic price relationships makes
with a change greater than $2.50 only 12
percent of the time. it possible to determine the odds that
Highs and lows analysis different price moves will occur.
Figures 9 and 10 break down the data
into days the close was up from the pre-
vious close and days the close was down previous close. In other words, the mar- market opened, traded up between a
from the previous close, respectively. ket could open up $1, trade $2 down penny and 25 cents, and then declined.
The data is divided into 25-cent incre- from the open and finish 50 cents up This analysis can help determine
ments. from the previous close for the day.) where to place a buy stop if short from
Figure 9 (p. 28) compares the This data tells us a few things about the day before. First, it appears that
(absolute) difference between the open trading a long position. First, unless because of the bear market, stops can be
and the low on days the market closed there is incredibly positive news, there’s placed close to the open: The SPYtraded
up from its previous close. On eight no need to go long on the open, because less than 25 cents above the open while
occasions, the open was the low. Fifty- the market closed up only eight times (3 still closing down 32 percent of the time.
three times the market traded some- percent) on days the open was also the continued on p. 28

ACTIVE TRADER • September 2002 • 27

(Keep in mind, though, The majority of close-to-close moves were between 50 cents and $1.99 (the first three
that’s not enough room bars). This information, along with that from Figure 7, gives you an indication of the
because there’s a 68-percent size price move you can expect over different periods.
chance of being stopped
out. Nonetheless, this 140
shows the effect of the bear
market: The market traded
up more than 75 cents and 113
still closed down only 46
percent of the time. 100 95
If you are an intraday
trader and your system is
flashing a sell signal when 80
price is up $1 from the open,
remember that the SPY 60 53
traded $1 higher and still 46
closed down only 32 per-
cent of the time over the 40
past year. However, as is the 25
case with all these statistics, 20 15
32 percent is simply a num- 8
5 2 2
ber, and it should not be 0 1 1 0
used as the sole basis of a 0
trade; it should complement
some other form of techni- Close-to-close move ($)
cal analysis and preferably a
Source: Excel, data by eSignal
back-tested strategy.
This type of analysis can
be incorporated with other technical sig- other aspects of money-management. tial profits once the market hits the aver-
nals to set profit targets and improve For example, you could plan to take par- age daily range.
Finally, Figure 10 shows
there were two occurrences
Measuring how far the market drops below the low and then closes above the previous than $5 above the open on
close indicates the odds of a higher close fall significantly when the down move is more down-closing days. These
than 1.99 points. two occurrences were in
September 2001 when the
70 SPY opened sharply lower,
recovered from the
extremely weak opening
price, but still closed down
53 for the day (more than
50 $5.75 once and $1.43 the
other time).
35 Putting the numbers
33 to work
30 Compiling the information
from this analysis gives
20 you a comprehensive and
20 17 detailed picture of a mar-
ket. The characteristics
10 8 such analysis reveals about
4 a market can be of great
2 2 2 2 1
0 0 help in determining logical
stop levels and profit tar-
gets, especially for short-
Open-to-low move ($) term and intraday traders
as mentioned earlier. In
Source: Excel, data by eSignal
continued on p.29

28 • September 2002 • ACTIVE TRADER

addition, some of the num- Similar to Figure 9, this graph organizes open-to-high moves on days the market
bers highlight the impact closes below the previous close.
of the bear market, and one
number is somewhat sur- 70
Despite the bear market 60
of the last two years, the
number of up closes to
down closes is not that dif- 50
ferent (245 vs. 255).
Obviously, if we measured
40 37
the net difference in clos-
ing prices, the results 32
would be greater for down 30
days. 23
Another bear market
phenomenon is there were 16
only eight up-closing days
for which the open was the 10
low price; for down-clos- 3 2 1 2 1 1
ing days the open was the 0 0 1 1 0 0
high price 16 times. In
addition, a hump is evi-
dent at the 26- to 50-cent Open-to-low move ($)
point in Figure 9, while
Source: Excel, data by eSignal

Figure 10 shows a steadily declining they are now. Gauging the typical price
The data tells us series of lower highs. In other words, movement gives you a set of practical
even though the market did close up for references for what is high and what is
that unless there’s the day, there was enough selling pres-
sure to push prices well below the open,
low in the markets you trade, so you
don’t have to guess. And anytime you

incredibly positive which places the peak in Figure 9 to the

right compared to Figure 10. Both these
can bring descriptive analysis that
matches real-world experience, you
phenomena could be attributed to the improve your chances for success.
news, there’s no bear market. By incorporating typical price behav-
Analyzing a bull market period of ior analysis into your decision-making
need to go long SPY similar length might make the differ-
ences between bull and bear markets
process, you move away from trading
decisions based upon greed and fear

on the open, more evident, and would possibly

enable you to identify a bull market or a
and move toward objective, probability-
based trading.
bear market earlier than some other You will also develop a big-picture
because the market technique, such as the rising or falling view of your trading, because you will
200-day moving average. For example, a know the characteristics of the markets
closed up only eight shift in the peaks for the high-low analy-
sis in Figures 9 and 10 could be subtle
you trade and how and why your
approach works, and that any one trade
evidence of a change in the underlying can occur outside the typical behavior of
times (3 percent) trend. Another idea is to track the num- the market.
ber of occurrences when the open is Both steps — reducing emotion and
on days the open either the low or the high of the day. looking at trades as a group of decisions
rather than isolated events — lead to
more effective trading.Ý
was also the low of From subjective to objective
High and low are usually relative terms
in trading, because markets almost
the day. always trade higher or lower than where

29 • September 2002 • ACTIVE TRADER

TRADING Strategies

BULL vs. BEAR: The details matter

Market pundits often quip bull markets are different than bear markets.
But other than one goes up and the other goes down, what does the distinction
really mean? This comparison of bull- and bear-market characteristics provides
concrete statistics upon which to base upside and downside trading strategies.


T here’s no doubt traders

unwilling to sell short are at a
disadvantage in a bear mar-
ket. But even traders who
aren’t biased against short-selling some-
times operate under the misconception
that bear markets and down moves are
simply inversions of bull markets and up
moves. As a result, they think trading
from the short side is just a matter of
reversing the rules of a long-side strategy. depth analysis of the markets you trade, skewed because of the bear market con-
This is only true in the broadest sense, compare their bull and bear characteris- ditions that prevailed during this period.
however, because bull and bear markets tics, and design and implement your To see if the results were different dur-
have notable differences. One oft-repeat- trading strategies accordingly. ing a bullish phase, the same analysis
ed example is that sell-offs tend to be was performed on daily SPY price data
sharper and quicker than rallies (more Research refresher from June 1, 1998, to May 23, 2000. At the
on this later). But there’s still more to “Familiarity breeds profitability” (Active beginning of this bull period the SPY
profiting on the short side than just tak- Trader, September 2002, p. 38) discussed closed at $109.53; the last close was
ing profits more quickly than you would the typical price behavior of the S&P 500 $138.00.
on a long trade. As noted in “Losing depository receipts (SPY) using daily We’ll compare the results of the two
your shorts” (Active Trader, September open-high-low-close bars, with the goal periods, which we’ll refer to as “bear”
2002, p. 56), even when the prevailing of identifying characteristics that could and “bull” market results, respectively.
trend is down, it’s often more difficult to serve as the basis for trading strategies. Figure 1 (opposite page, top) shows the
make consistent money selling short Analysis of the two years from May prevailing downtrend of the bear market
than it would be going long if the condi- 25, 2000, to May 24, 2002 (which began period and Figure 2 (opposite page, bot-
tions were reversed. with a closing price of $140.25 and fin- tom) shows the uptrending conditions
To improve your short-selling acu- ished with a closing price of $108.69), that characterized the bull market period.
men, it’s a good idea to perform in- suggested some of the test results were continued on p. 32

30 • November 2002 • ACTIVE TRADER

From May 25, 2000, to May 24, 2002, the S&P tracking stock fell 22.5 percent. Even so, this period was punctuated by
substantial counter-rallies.
S&P Index Trust (SPY), daily












July Aug. Sept. Oct. Nov. Dec. 2001 Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 2002 Feb. Mar. Apr. May

Source: eSignal


The S&P tracking stock gained 26 percent from June 1, 1998, to May 23, 2000. Comparing the typical price behavior of
this period to that of the subsequent bear period, it’s possible to determine if and how trading strategies should be
adjusted for up- and downtrending conditions.
S&P Index Trust (SPY), daily












July Aug. Sept. Oct. Nov. Dec. 1999 Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 2000 Feb. Mar. Apr. May

Source: eSignal

ACTIVE TRADER • November 2002 • 31

We’ll begin by compar-
The majority of close-to-close moves were between 1 cent and $1.50 (the first three ing the differences in daily
bars). This information, along with that from Figure 5, gives an indication of the size closing prices for the two
price move you can expect over different periods of time. periods.

140 Differences from

120 Figure 3 (left) shows the
113 distribution of absolute val-
ues for the day-to-day
100 95 changes in closing prices
during the bear market
80 period. Figure 4 (bottom
left) provides the same
information from the bull
60 53 market period.
46 The bear period close-to-
40 close changes peak in the
$0.01 to $0.50 range, while
the bull market peak is the
20 15 $0.51 to $1.00 range. The
8 average change during the
5 2 2
0 1 1 0 bear market period was
$1.27, vs. $1.39 during the
bull period.
Close-to-close move ($) Apparently, when there
Source: Excel, data by eSignal is greed involved, traders
are willing to continue to
pay up until the close.
Interestingly, the close-to-close price moves in the bull period are similar to those of the bear market falls faster than
bear period, except that in this case the most moves were in the $0.51 to $1 range. a bull market rises, but in
this case, it appears people
140 don’t like to carry short
positions overnight, so
117 there may be a tendency to
113 cover short positions going
into the close despite a pre-
100 vailing bear market.
88 Figures 5 (opposite page,
top) and 6 (opposite page,
bottom) compare the daily
62 ranges (high minus low) of
60 the two periods. The similar-
ities between the two charts
are somewhat surprising.
The one difference is the bull
market did have one day
16 with a range between $0.01
8 7 and $0.50. But despite the
5 4 2
1 0 1 1 1 1 large upswing and down-
swing, the typical daily
ranges did not vary.
Close-to-close move ($) Figures 7 and 8 (p. 34) are
the open-to-low moves for
Source: Excel, data by eSignal
days the SPY closed up.

32 • November 2002 • ACTIVE TRADER

Here, the difference
between the bear market Breaking down the daily ranges into 50-cent increments indicates, along with the close-to-
and the bull market is more close moves, how much the market is likely to move from day to day. The daily range for
apparent. First, there were SPY usually fell between $1.01 and $2.50 in the bear market period.
only eight days during the
bear market for which the 140
open was the low for the
day, whereas the bull mar- 120 118
ket had 24 days.
Next, the difference 103
between the open and the 100
low during the bear market
peaked in the $0.26 to $0.50 80
range; during the bull mar-
ket it peaked between $0.01
and $0.25. This indicates 60 57
traders aggressively buy
right after the open in a bull 40
market, thereby supporting 30
prices, while during bear
markets they engage in 20 17 17
more selling that drives the 8 9
0 0 3 2 1
low further down from the 0 1 0 1
opening before prices rally
to close up on the day.
Daily range ($)
Figures 9 and 10 (p. 35)
are the open-to-high moves Source: Excel, data by eSignal
for days the SPY closed
down. Again, the difference
between the two periods is FIGURE 6 BULL MARKET DAILY RANGES
visible. There were 16 days There is virtually no difference in the daily ranges for the bear and bull markets, which
during the bear period for is somewhat surprising.
which the open was the
high for the day, compared 160
to just six for the bull peri-
od. In other words, during 140 135
a bull market price still
tends to advance after the 120 118
open, even on days that
eventually close down. 100
The bear market open-to-
high difference peak was 67
days for the range between
$0.01 and $0.25. The bull 58
market numbers, on the 60
other hand, were shifted to
the left, peaking at 53 40
occurrences for the $0.51 to
$0.75 range. Again, it is not 20 16 16
surprising that during a 8 9
0 1 3 2 1 0 0 0 1
bull market buyers would 0
try to push prices higher
even when the market ulti-
mately closed down on any Daily range ($)
one day. Source: Excel, data by eSignal
continued on p. 34

ACTIVE TRADER • November 2002 • 33

This summary of how far the market drops below the low and then closes above the
previous close indicates the odds of a higher close fall noticeably when the down move is
more than 50 cents.

What’s it all mean?
66 It is clear that entry, risk
management and profit-
60 taking tactics need to take
53 into account the market
trend, bear or bull. A trader
cannot use the same buy
setup and risk points that
40 were effective during the
35 bull market run because
the behavior of the market
changes during bear phas-
es. Consequently, it’s pru-
20 17 dent to spend time devel-
oping a sound trend indi-
cator, and then design
trade setups based on the
2 2 2 2 1 trend.
0 0
0 Many new traders get
into trouble by ignoring
these realities. Here’s how
Open-to-low move ($) the typical trader learning
Source: Excel, data by eSignal curve might progress: First
you learn you have to cut
your losses and let your
The bull market had most of its open-low moves for up days in the $0.01 to $0.25 range, oped your trading tech-
as opposed to $0.26 to $0.50 for the bear market. This indicates traders are more likely nique during the 1990s bull
to support prices in a bull market. market, you could have
designed a viable system
55 that used tight stops
50 because, as Figure 8 shows,
50 in the bull period SPY typ-
45 ically traded down in the
42 42 neighborhood of only $0.25
40 to $0.75 from the opening
36 price, and still closed up.
35 33
However, if you failed to
30 recognize the market’s per-
sonality change during a
25 downtrend, you may have
20 18 bought after the open
(when the market was
15 showing initial weakness),
and felt confident if the
10 8
market subsequently
5 5
5 3 2
moved into positive terri-
1 1 tory. But during a down-
0 0 0 0 0 0
trend (characterized by
persistent down closes), it
Open-to-low move ($) is unlikely the market will
climb well into positive ter-
Source: Excel, data by eSignal
ritory, as Figure 9 shows:

34 • November 2002 • ACTIVE TRADER

This graph organizes open-to-high moves on days the market closed below the
previous close. In the bear market period, the most notable concentration of days had
There were only 67 peak open-to-high moves of less than 50 cents.
opportunities, and the high 70
was less than $0.25 above 67
the open. If you consistent-
ly tried to buy post-opening 60
weakness in this kind of 54
environment, you would 50
slowly bleed all of your
capital by taking small loss
after small loss. 40 37
The trend is your friend
if you know how to take
advantage of it by using
these kinds of market 23
observations. If your indi- 20
cator signals the trend is 14
down, you can use the typ-
ical bear-market behavior
as a starting point for deter- 3 2 2
1 0 0 1 1 0 0 1 1
mining entry and exit rules 0
— e.g., going short the SPY
if the market is up $0.25 to
Open-to-high move ($)
$0.50 from the open, with
your stop a little higher Source: Excel, data by eSignal
than $1 above the open.
Develop separate rules for
uptrend market phases.
When SPY was down for the day, the open was the high only six times, and the market
No getting around often rallied as much as a dollar before closing lower. This shows, in a bull market,
the work price still tends to advance on down days.
You may be thinking:
Rules, rules, rules. Isn‘t 60
there an art to trading? Yes 53
and no. Intuitively oriented
traders probably have a 50
kind of mental spreadsheet, 44 45
and the profits to prove it.
If your profits are not
meeting your expectations,
take the time to quantify 31
the markets, as well as your
trading approach. You will
quickly see the relationship 20
between your actions and
the market’s, the results of 14
this coming in the form of a 10 9
8 8
series of losing or profitable 6
trades.Ý 2 2 1 1
1 0 0 0 0 0 0

Open-to-high move ($)

Source: Excel, data by eSignal

ACTIVE TRADER • November 2002 • 35

RISK Control and MONEY Management

Equity curve
Your system has given you four losing trades in a row.
Should you take the next signal, or move to the sidelines?
Here are some thoughts on how to determine when to
stay out of the market and when to jump back in.


A, B and C mark those periods when the equity line dropped
below its moving average, an indication that profitability is in
a downtrend and the system’s signals should not be executed.


Equity line


or traders not blessed with exceptional

market intuition, the best chance of sus- $25,000
tained profitability is to trade a system — a
B 10-period
set of fixed procedures to ensure they act
moving average
on market opportunities consistently and effectively. $20,000
In addition to entry and exit rules, though, a trading
system also must have a risk-management component A
that guards against losing a large sum of money on $15,000
any one trade.
Trade number
The mental challenge of following a system is giv-
ing up control of your trading. On the one hand, Source: Excel
you’re faced with the possibility of going broke
because your system suffers a drawdown that is longer and Watching the equity line
deeper than its hypothetical drawdowns in historical testing or One way to manage the trade-or-not-trade dilemma is to cal-
paper trading. On the other hand, there is the risk of missing culate a moving average of your system’s equity line (the run-
trade opportunities if you do not follow your system to the let- ning total of its dollar gains and losses) to determine when to
ter, even when it is in an extreme drawdown. act on its trade signals. When the equity line is above its mov-
When should you continue to trade a system, and when ing average, profitability is in an “uptrend,” the system is mak-
should you stop taking its signals? The following ideas are ing money and you continue to take each trade (see Figure 1,
techniques based on analyzing past system returns that above).
attempt to balance the fear of losing money with the fear of If the system begins to struggle, the equity line will drop
missing trading opportunities. below its moving average, at which point you simply log

36 • February 2003 • ACTIVE TRADER

The moving average approach (represented by the adjusted
equity line) gave up $3,500 in profits, but it also decreased the
original equity line’s worst drawdown from $2,653 to $1,720.

$40,000 Window on profitability

A second approach is to track the percentage of prof-
itable trades within a certain moving window — say,
$35,000 the most recent 10 trades. As long as the percentage of
Equity line profitable trades in this window is above a certain
threshold (e.g., 50 percent), continue to trade. If the
$30,000 percentage of profitable trades drops below the
C threshold, you would log the trades but not execute
them. Then, track the system and resume trading
$25,000 when it returns to profitability by moving back above
Adjusted the percentage threshold.
B equity line
$20,000 How they stack up
We’ll apply these two approaches to a two-year hypo -
A thetical track record for a 10-year T-note futures (TY)
$15,000 trading system. The system is momentum-based and
Trade number uses a preset profit target of 10⁄32 for two contracts and a
Source: Excel trailing stop for a third contract. (The target and stop
levels were determined using maximum favorable
excursion and maximum adverse excursion analysis.
FIGURE 3 WINDOW OF PROFITABILITY For more information on these techniques, see “On
target trading,” Active Trader, July 2001, p. 44, and
The moving window approach (taking trades only when 50
“Taking the guesswork out of stop orders,” Active
percent or more of the past 10 trades have been winners)
Trader, October 2001, p. 94. All the necessary analysis
decreased profitability, but it did not decrease the drawdown,
can be done using an Excel spreadsheet.)
as the moving average technique did.
Figure 1 shows the system’s equity line and its 10-
day moving average during 1999. (The equity value
was adjusted to reflect a starting point of $20,000, and
the track record begins in 1998 so the 10-period mov-
ing average is current at the start of the year.) Using
the rule of not taking signals when the equity line
Equity line
drops below the moving average results in three peri-
ods when you would have stopped trading, labeled A,
B and C. (The first losing trade that causes the equity
line to drop below the moving average is a real trade,
but the next trade would be a paper trade only.)
Figure 2 (top) shows the original equity line along
equity line with the new equity line representing the performance
of those trades executed when the original equity line
is above its 10-period moving average. The new,
50% adjusted equity line has flat periods that occur when
A B 10-trade profitability window the modified system is not being traded.
$15,000 0
The moving average technique reduced the sys-
Trade number tem’s profit by about $3,500, but it also decreased the
Source: Excel original equity line’s worst drawdown (refer to B in
Figure 1) from $2,653 to $1,720. This is a more-than-
trades on paper — do not execute them in the market. You con- acceptable compromise for traders who are willing to forego
tinue to track the logged signals and their impact on the equi- some profit in return for the ability to limit risk to a level they
ty line and its moving average. When the trading system are comfortable with.
begins to generate profits again, the equity line will cross back Figure 3 (bottom) uses a 10-trade moving window and a 50-
above the moving average, at which point you resume execut- percent profitability threshold, which means as long as five or
ing trades in the market. continued on p. 38

ACTIVE TRADER • February 2003 • 37

more of the past 10 trades are profitable, the system’s Using the moving average filter was more successful in
signals should be executed. If four or fewer of the past 2000 than it was in 1999, even though the adjusted equity line
10 trades are profitable, the trades are merely tracked suffered through a prolonged drawdown.
on paper.
There are only two periods, A and B, during which $40,000
the percentage of profitable trades dropped below 50
percent. Like the moving average approach, the mov-
ing window technique sacrificed profits, and for the $35,000
same reason — lag. However, the moving window did
not offset this reduction by shrinking the drawdown Equity line
as well. That’s not the end of the story, though. $30,000
Moving forward one year, Figure 4 (top) shows the B
hypothetical returns for the year 2000. At the begin-
ning of the chart, the original equity line is above the $25,000
10-period moving average, which means the original A Adjusted
and adjusted equity lines are identical. At point A, the equity line
original equity line drops below the 10-period moving $20,000
average, so the next trade (point B) is only logged on 10-period moving average
the books. Unfortunately (in terms of trading the mod-
ified system), it is a very profitable signal, and it push- $15,000
es the original equity line back above the 10-period
Trade number
moving average.
However, the next trade is a loss, so the system Source: Excel
again moves to the sidelines. The difference in prof-
itability at the end of the year was less than $2,000, but
the maximum drawdown for the original equity line FIGURE 5 MOVING WINDOW: YEAR 2000
was $4,592, while that of the adjusted equity line was The moving window technique that underperformed in 1999
only $2,692. This was certainly an improvement over outperformed in 2000, reducing the system’s drawdown and
the 1999 example, but the modified system still had a increasing profitability by the end of the year.
lengthy drawdown: It took another 30 trades before
the adjusted equity line was able to move above its $40,000
previous equity peak at trade 14.
Figure 5 (bottom) shows the year 2000 results of
equity line
using the 10-period moving window with the 50-per- $35,000
cent threshold. The original system had more than 50-
percent profitability for the most recent 10 trades until
point A. After that, only paper trading was permitted. $30,000
Real trading resumed at point B when the percent of
Equity line
profitable trades got back to the 50-percent threshold.
This time, the moving-window technique dramati- $25,000
cally reduced the system’s drawdown — only $1,756
vs. $4,592. By avoiding this drawdown, the money
management technique actually outperformed the $20,000 100%
original system by $500 by the end of the year. B 50%
A 10-trade profitability window
Drawdowns and market conditions $15,000 0
What was happening in the market that resulted in
such a severe series of losing trades? Figure 6 (oppo- Trade number

site page) is a daily chart of the continuous 10-year T- Source: Excel

note futures contract. The system struggled during the
middle of the year when the T-note was in a nearly two-month ly tying a trading system to the price action of a market. In
trading range before it embarked on a trend. The profit targets other words, you should know what kind of price behavior
that are typically met during a trending market were not being your system is relying upon to capture profits. (In this way, the
reached during the trading range, so the system was taking system’s profitability itself becomes an indicator of the type of
losses. market environment you are in.)
One lesson from this experience is the importance of logical-

38 • February 2003 • ACTIVE TRADER


Because of the congested market conditions that prevailed for a good portion
of the test period, the system’s profit targets were not met as often as they
would be in a trend environment. This underscores the importance of under -
standing the price behavior your system relies on to generate profits.
Stick to the rules
Having a rule that tells you when your 10-year T-note continuous futures (TY), daily
system is failing to perform permits you 93,000
to move to the sidelines based on logic
and discipline, rather than fear. The
more you can remove emotion from 92,000
trading, the higher your chances of
long-term success.
For the techniques outlined here, the
choices of a 10-period moving average
and a 10-trade moving window with a
50-percent threshold were arbitrary.
Other parameters may work better or 90,000
worse, and should be explored fully
before trading.
Finally, this study highlights the 89,000
value of developing a trading method
and documenting all of its trades —
both historically and in real time. Doing 88,000
so allows you to perform the kind of
analysis described here to manage your April May June July August Sept.
money in a more scientific fashion. Ý
3 10 24 1 8 15 22 1 12 19 26 3 17 24 1 14 21 1
Source: CQGNet

ACTIVE TRADER • February 2003 • 39

TRADING Strategies

Narrow-range bars and inside

bars represent short-term
volatility lows out of which
price can move sharply. This

shots strategy uses a simple volatility

measurement to determine
where to enter trades to
capitalize on this behavior.


The bars at A, B and C are all relatively narrow-range bars that represent
short-term consolidations. Applying specific entry rules allows you to take
advantage of moves out of the consolidation when volatility increases.




n the late 1980s, Tobey Crabel 77.50

published a series of articles
detailing various short-term price 75.00
patterns for futures trading. The B
patterns were designed to detect short-
term volatility changes — that is, a mar- 72.50
ket would move into a short-term con-
solidation, and then break out of it. A 70.00
Two of Crabel’s patterns will be cov-
ered here. The first is an inside day that
is smaller than the previous four days
(IDnr4) and the second is a day whose
range is less than that of the previous six
29 1 5 12 19 26
days (NR7). An NR7 day does not have
to be an inside day. Source: CQGNet
Figure 1 (right) contains examples of
these price patterns (in a stock rather than Analyzing IBM daily bar data from
a futures contract). Bar Ais an IDnr4: It is Oct. 1, 2001, to Nov. 15, 2002, revealed that Trading the patterns
an inside day and its range is smaller than 15 IDnr4 and 44 NR7 days occurred over Crabel recommended trading these pat-
the ranges of the previous four days. Bar this 286-trading day period. This means terns the next day using an entry strate-
B is an NR7 day. In this case, the day’s these patterns are somewhat rare. gy based on the opening price and a pre-
range is smaller than the previous six However, many trading opportunities set value called the “stretch.” He had
days’ ranges. Finally, bar C qualifies as present themselves if you look for these two versions of the strategy — one
both an IDnr4 and an NR7 day. patterns across a number of stocks. called the opening range breakout (ORB)

40 • April 2003 • ACTIVE TRADER

and the second the opening range break-
out preference (ORBP).
The stretch value is the 10-day aver-
age of the difference between the open The “stretch” is an amount added to a bar’s opening price to determine the
and the low or high, whichever is small- entry point and stop level, respectively.
er. For example, if the open was 79.50,
the high was 80.33 and the low was
77.98, you would use the difference
between the open and the high (0.83) vs.
the open and the low (1.52). Figure 2 $1.00
(top) shows the stretch range for IBM
over the last year: from an extreme of
just under $1 to just over $0.20, with the
average just over $0.50.
The entry strategy using ORB is to $0.60
place a buy stop just above the opening
price plus the stretch amount, and place $0.40
a sell stop just below the opening price
minus the stretch amount. The first stop
triggered is the trade, and the other auto- $0.20
matically becomes the protective stop.
If other technical indicators provide $0.00
evidence of a strong trend, then use the
ORBP: Place the entry stop in anticipa- Day
tion of the trend continuing. For exam-
ple, if the stock is in an uptrend, enter
only a buy stop above the opening price
plus the stretch amount. If filled, place FIGURE 3 FACTORING IN THE TREND
the protective stop below the stretch
Whether a market is in a trend (defined here by a 30-day EMA) dictates the
subtracted from the open.
trade entry technique that is used.
Time is of the essence
According to Crabel, the earlier in the IBM (IBM), daily
trading session the entry stop is hit the
more likely the trade will be profitable at
the close. A trend triggered quickly in 80.00
the session could rack up a substantial
profit by the close and should be held for 77.50
a possible two- to three-day run.
Once filled (and if the market is
exhibiting a strong trend early), then 75.00
move the protective stop to breakeven. If
you are not filled early in the session, 72.50
reduce the size of the position as time
passes through the day. Any positions
A 70.00
filled near the close are suspect. In this
30-day EMA
case, you may have only a small unreal-
ized profit, and probably should not 67.50
hold the trade overnight.
Rules in action 29 1 5 12 19 26
Figure 3 (bottom) is Figure 1 with the
Source: CQGNet
continued on p. 42

ACTIVE TRADER • April 2003 • 41

addition of a 30-day exponential moving The long-entry stop was 76.98, which taking, you would have been stopped
average (EMA). Bar A is the IDnr4 day. was hit later in the morning. The stock out at 81.48 (using the stretch the follow-
Considering the market moved above closed at 79.35 for a profit of 2.37 that ing day to determine the stop-loss).
the previous resistance level at 72.50 in day, not including slippage. This open
the act of confirming a double bottom profit warranted holding the position Profit targets
pattern, and the 30-day EMA was rising overnight. One way to take partial profits is to use a
and provided a support level, it’s logical The next day, the stretch is used as a percentage of the 10-day moving aver-
to conclude the stock is in an uptrend. trailing stop, based on the opening price age of the daily ranges as a target. Figure
Accordingly, we want to use the ORBP (79.35). The stretch had increased to 0.53, 4 (left) compares the 10-day average of
guidelines. making the stop level 78.82 (79.35-.53), the daily ranges compared to the stretch
At this time, the stretch was 0.49. The which was not hit. The next day, the amounts. The average daily range is
next day IBM opened at 71.55, so the stock opened at 81.56. Subtracting the 2.55, but it ranges from just above 1.50 to
just over 3.50. A reasonable target is 66-
FIGURE 4 DETERMINING LOGICAL TARGETS percent of the current 10-day moving
average, just to be sure to put away some
To increase the odds of profitability, you can take partial profits when price partial profits when you have the
moves in your direction by 66 percent of the 10-day average daily range. chance.
For example, at the bar after A in
Figure 3, the current 10-day moving
10-day MA of the daily ranges average of the range was 2.78. Assuming
3.5 that once you are stopped into the long
position you are confident the low at
3.0 71.19 is in place for the day, add 66 per-
cent of 2.78 (1.85) to 71.19 for a target of
2.5 73.04. This would have given you partial
profits of 0.98 on this day before slip-
2.0 page, which offsets the loss taken had
you held the position at the close.
1.5 Stretch In addition, had you traded against
1.0 the trend after the bar C trigger, you
would have been short at 81.37. The 10-
0.5 day moving average of the daily ranges
had increased to 3.06, so the target
0 would have been the high of 82.33 – 2.04
= 80.31 (3.06 * 0.666 = 2.04), which would
Day have been reached.
Finally, once in a trade, consider mov-
ing your stop to breakeven if the market
entry stop price was 72.04 (71.55 + 0.49) stretch (0.53) sets a new stop at 81.03, the has reached a point that represents 50
and the stop loss was 71.06 (71.55 – 0.49). approximate level at which the trade percent of the 10-day average of the
That day IBM climbed as high as 73.78, would have been stopped out. daily range.
fell as low as 71.19, and closed at 71.90. Bar C is the combination IDnr4 and
In this situation, when there is no profit NR7 bar. Still trading from the long side, Be a specialist
at the close, you should take the loss (in the market opened the next day at 81.90. Avery important aspect of applying this
this case, 14 cents plus any slippage). Adding the current stretch of 0.53 creat- kind of pattern-based technique is your
Bar B is the NR7 bar. The market is ed an entry stop of 82.43. But because the ability to execute trades with as little
clearly in an uptrend, and the prudent high was 82.00 on this day, no long trade slippage as possible. Identifying these
thing to do is trade with the trend, again was executed. types of price patterns, and combining
following the ORBPguidelines. After the As an example of what would happen them with rules for entering, managing
NR7 day, the stock opened at 76.50; the taking the trade against the trend, sub- risk and taking profits in various mar-
stretch was 0.48. In this case, the stock tracting 0.53 from the opening of 81.90 kets amounts to specializing. And spe-
made a low of 75.98 (0.52 below the would have put you short at 81.37. The cialization is as popular and profitable
open) in the first few minutes, which stock closed at 81.00, which would have an endeavor in trading as it is in other
would have triggered a short sale if we resulted in a small profit if you exited at disciplines.Ý
did not use the ORBP rule to trade with the close. If you stayed short, however,
the trend. expecting some follow-through profit

42 • April 2003 • ACTIVE TRADER

TRADING Strategies

What goes UP must come DOWN

The balance of up volume and down volume can tell you
a lot about the market’s bias during the trading day.

Here we detail a unique volume-based

indicator and ideas for using it in the markets.

hen analyzing the ume (total volume in stocks that are
broad market, many down for the day) can provide addition-
traders consult vol- al insight into market behavior.
ume to confirm price Typically, if up volume is greater than
moves. Total volume is most often the down volume, the market will be up on
subject of this analysis, but comparisons the day, and vice versa. Figure 1 (left)
of up volume (total volume in stocks shows an example of the relationship
that are up on the day) and down vol- between daily up and down volume.
The top half of the chart is the S&P
500, and the bottom is the difference
between up volume and down vol-
Up volume reflects how much trading is occurring in stocks that are trading up for ume. When the S&P closed up, the
the day; down volume is the opposite. This bottom part of the chart plots up volume difference between up volume and
minus down volume. Up volume was usually higher on days the market closed up, down volume was positive; on days
and vice versa. the market closed down, the differ-
ence was negative.
S&P 500 (SPX), five-minute 950.00

925.00 General volume characteristics

The battle between up volume and
down volume is similar to a car race
875.00 in which one car is running at top
speed and the other is sputtering
along. When traders and investors are
825.00 very bullish, they are buying more —
or more aggressively — than they are
selling. Up volume is greater relative
775.00 to down volume, and the market
advances. If traders and investors are
Up volume - down volume 15,000
bearish, the opposite is true. During
10,000 periods when buyers and sellers are
5,000 balanced, the up and down volume
0 statistics will be closely matched and
a trading range will unfold.
-5,000 An intraday view of two days —
-10,000 one where the bulls dominate and
Nov. Dec.
one where the bears are in charge —
7 14 21 28 1 4 11 18 25 2
offers additional perspective on the
Source: CQGNet
interplay of up and down volume.

43 • May 2003 • ACTIVE TRADER

On an bullish day for the S&P 500 index, up volume (left) increased at a much greater
rate than down volume (right).
NYSE advancing volume, C 1.0B
NYSE down volume, five-minute
800M 800M
(All of the following charts feature
five-minute bars.) 600M 600M
Figure 2 (top) shows three charts for
Nov. 1, 2002. The upper left is up vol- 400M D 400M
ume, the upper right is down volume
200M 200M
and the S&P 500 is on the bottom.
Points Aand B represent the previous Nov. 0 Nov. 0
(Oct. 31) close, a day on which down 1-8:30 10:30 12:30 1-14:30 1-8:30 10:30 12:30 1-14:30
volume was approximately 200 mil-
S&P 500 (SPX), five-minute
lion more than up volume, and the
S&P closed down just less than five
points. 895.00
On the Nov. 1 close (points C and
D), however, up volume was more 890.00
than 1 billion shares and down vol-
ume was less than 400 million shares. 885.00
It’s no surprise, then, the S&P 500
was up more than 15 points on the
day. The steady rise and steeper angle 1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30
of ascent of the up-volume line rela-
Source: CQGNet
tive to the down-volume line is an
indication of solid buying power.
Figure 3 (bottom) shows the differ- FIGURE 3 MOVIN’ ON UP
ence between up volume and down As the S&P gradually moved up, so did the difference between up volume and down
volume compared to the S&P 500 on volume.
Nov. 1. When the opening bell rang,
the S&P 500 was down from the pre- Up volume - down volume
vious close and the difference
between up volume and down vol-
ume was negative. At point A, the B
difference bottomed and climbed into
positive territory just as the S&P 500
moved into positive territory.
Also, notice that while the volume
difference made a new high at point B, A
the S&Pdid not make a new high until
a short time later. Not all stocks S&P 500 (SPX), five-minute
included in the calculation of the vol- 900.00
ume statistics are in the S&P500. Here, C
up volume was continuing to climb at 895.00
a faster pace than down volume, indi-
cating the broad market was still ris- 890.00
ing. The S&P 500 soon followed. 885.00
Figure 4 (p. 32) is more interesting.
The top half of the chart shows the ratio 880.00
(rather than the difference) of up vol- Nov.
ume to down volume. There appears to 1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30
be a greater correlation between this Source: CQGNet
calculation and the index, as the peaks
and troughs of the two series are close- day, like a simple moving average. Also,
ly aligned. The ratio of up-to-down vol- Designing an indicator because both up volume and down vol-
ume runs nearly 2-to-1 for most of the day. The primary challenge of developing an ume climb all day, it may be advanta-
There are two components to the ratio indicator is to have up volume and geous to calculate the rate of change of
— up volume and down volume. The next down volume start each day at zero. To these values; acceleration or deceleration
step is to analyze the individual compo- accomplish this, the indicator must be in the rate of change might forewarn, or
nents to see if an indicator can be created. quick to drop values from the previous continued on p. 45

ACTIVE TRADER • May 2003 • 44

Instead of subtracting down volume from up volume, the top part of this chart shows up
volume divided by down volume. Like Figure 3, the line steadily climbs throughout the action in the lookback period. One
day. However, this calculation tracks the S&P more faithfully than the subtraction formula. such measurement can be derived
Up volume/down volume ratio
from linear regression.
3 A linear regression line is a “best-
fit” straight line plotted through data
points. If the data points are zig-zag-
2 ging upwards, a best-fit line drawn
through the points would be rising or
have a positive slope. If the data
1 points are zig-zagging downwards,
the best-fit line would have a negative
slope. If the data points were zig-zag-
ging sideways, the best-fit line would
S&P 500 (SPX), five-minute be horizontal — that is, its slope
900.00 would be zero. (For more information
on regression lines, see “The next-bar
890.00 The top of Figure 5 (bottom) shows
up volume, and below it is an indica-
885.00 tor that tracks the slope of a best-fit
linear regression line of the up volume
880.00 using a five-period lookback. (The
Nov. first five readings are ignored because
1-8:309:00 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30
they include the previous day’s val-
Source: CQGNet
ues.) The market began on a negative
note, but up volume was climbing
FIGURE 5 THE UP-VOLUME SLOPE LINE from the early part of the day, and the
Below the up-volume line (top) is a line reflecting the slope of a five-day linear slope indicator started just above zero.
regression line at each bar. A linear regression (or “best-fit”) line incorporates all A little after 9:30 a.m. CT, the slope
data points of a lookback period. The slope sunk to (or below) the zero line at the indicator shot above +250, indicating a
same time price made intraday pullbacks. large increase in buying.
At points A and B the slope line
Up volume 1.0 B dropped near zero and below zero at
750M point C. These low readings coincid-
500M ed very closely with the S&P’s pull-
200M backs within the day’s uptrend. More
0 importantly, the slope line was above
zero almost the entire day and consis-
Ignore these readings Up-volume slope
250 tently had readings at or above +250.
Figure 6 (opposite page, top) is like
A B C Figure 5 except it shows down vol-
-250 ume. At point A, the slope was just
S&P 500 (SPX), five-minute over +150, much higher than the up
volume reading for the same period
in Figure 5. With down volume dom-
895.00 inating the early market, the S&P 500
was down in the first hour of trading.
890.00 The peak at A coincided with the bot-
tom in the S&P, and when the market
began to advance, the slope line
880.00 dropped to nearly -100 (point B). This
Nov. is where the up volume advanced
1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30 above +250 in Figure 5.
Source: CQGNet This change represented a real shift
toward up volume, and the fact the
at least confirm, the current price trend. However, this isn’t necessarily the best up-volume slope line had a higher intra-
The most common way to measure measurement, because it ignores the day peak than the down-volume slope
rate of change is to compare the current prices between the current and the old- line suggested an uptrend was in the
value to the value x prices ago — for est in the lookback period. A better cal - wings. For most of the day, the down-
example, five bars, 10 bars, etc. culation would incorporate all the price volume slope line stayed between -100

45 • May 2003 • ACTIVE TRADER

The slope indicator for down volume peaked at the same points the up-volume slope
to +100, except for one excursion to line made temporary bottoms in Figure 5.
+200 at point D. This coincided with
Down volume
the worst sell-off of the day. 750M
Figure 7 (bottom) shows how the
up volume, down volume battle
plays out on a down day. The top part 250M
of the chart plots the up volume
divided by the down volume. The Down-volume slope
Ignore these readings D 200
trading day started with the up-vol- C
A 100
ume/down-volume ratio above 40 0
percent, a number that fell to 20 per- -100
cent by the end of the session.
The top portion of Figure 8 (p. 47) S&P 500 (SPX), five-minute
contains the up volume, with its 900.00
slope line. The market opened down
but the slope line bounced back to 895.00
just below +75 at point A. For the bet-
ter part of the day the slope stayed at
relatively low levels as the market 885.00
worked its way down. This con-
firmed the lack of buying. The only 880.00
decent rally came at point B, when Nov.
the slope moved back to +75. 1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30
Figure 9 (p. 34) shows the down Source: CQGNet
volume with its slope line for the same
day. The slope line quickly moved FIGURE 7 ON A DOWN DAY
above +100 and hovered near this The up-volume/down-volume ratio (top) on a day the S&P declined essentially mimics
level for most of the day until surging the downtrend in the index.
higher toward the end of the day.
Although these are only two exam- Up volume/down volume ratio .500
ples of trending days, in both situa-
tions the slope line provided a good .400
indication of the dominant market
force. Strong uptrending days have .300
up-volume/down-volume ratios of
2-to-1 (200) or higher. Downtrending
days are accompanied by up-vol- .200
ume/down-volume ratios of less
than 1-to-2 (50). On non-trending
days, the ratio tends to be much clos- S&P 500 (SPX), five-minute
er to 1-to-1 (100). 910.00

Market context 905.00

What sets the stage for an uptrending
or downtrending day? Most often, 900.00
some news event will push people’s
psyches in one direction or the other.
The catalyst can be expected news,
such as economic releases, or
unplanned, such as a group of ana- 9-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 9-14:30
lysts simultaneously making com- Source: CQGNet
ments early in the morning.
Therefore, a quick check of the morn- volume/down-volume is 50 or less after extended run, or a breakout of support
ing volume statistics can often give an the first hour of trading, the sellers will and resistance. On days such as these,
indication of what kind of day to expect. likely be in control all day, barring some check the slope indicator early in the day
If the news was good and the up-vol- other news that reverses the crowd’s and see whether up or down volume is
ume/down-volume ratio is 200 or high- mentality. more dominant. If the up slope line hits
er, expect a market that will wind its way Sometimes the market action may be +200 and down slope line only rises to
upward. more technical in nature — for example, +50, higher highs are likely. On the other
On the other hand, if up- the result of profit-taking after an continued on p. 47

ACTIVE TRADER • May 2003 • 46

Short-lived intraday rallies are accompanied by peaks in the up-volume slope line. level peaks, and the up-volume slope
line peaks shortly after. At the same
Up volume 400M time, the down-volume will trough
300M and begin to rise, and the down-vol-
200M ume slope line will turn up. Watching
the differences between the two
Up-volume slope slopes can highlight volume changes,
B 100 and in turn, market shifts.
50 Figure 10 (opposite page, top) is
another chart of Nov. 1. The top part of
the chart plots the difference between
the up-volume slope line and the
S&P 500 (SPX), five-minute down-volume slope line. (Remember
A 910.00 the first five readings are ignored
because they incorporate the previous
905.00 day’s readings.) A horizontal line is
B placed at +50, a level chosen (instead of
900.00 zero) because the difference between
the two slopes may not cross zero.
Recall that just after 9:30 CT on this
day, the up-volume level crossed
above the down volume level (see
9-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 9-14:30 Figure 3), and the up-volume/down-
Source: CQGNet volume ratio was close to 2-to-1 (see
Figure 4). Both developments are
signs of an emerging uptrend.
FIGURE 9 DOWN-VOLUME SLOPE ON A DOWN DAY Let’s develop some hypothetical
The slope of down volume remained steadily above the zero line and shot up at the trading rules:
end of the day when the index declined. 1. A buy signal occurs when the
slope-difference line turns up after it
Down volume 1.0B has fallen below 50.
750M 2. The risk point is just below the
500M low of the entry bar.
250M 3. Take a profit when the slope-dif-
Down-volume slope ference line crosses above 50, and
then back below 50.
Each letter in Figure 10 marks an
0 entry; the exits are marked on the
appropriate price bar. There are a
S&P 500 (SPX), five-minute number of good entry and exit points,
910.00 with some losing trades occurring
during congestion (see points C and
905.00 D). Trade E was stopped out because
the market traded below the low of
the entry bar. However, because the
slope-difference line was below the
+50 line, the trade was re-entered.
Another idea is to experiment with a
higher exit threshold, such as a rise
9-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 9-14:30 above and a drop below 200.
Source: CQGNet Figure 11 (opposite page, bottom)
shows a downtrending day. In this
hand, if slope for the down volume indicators can help decipher intraday instance, we placed a horizontal line at the
climbs to +150, and the up volume drops price action: the difference between the -50 level of the chart showing the differ-
to –60, the bears are in control. up-volume slope line and the down-vol - ence between the two slopes. For a down-
ume slope line. An uptrending day pro- trending market (i.e., the difference
Taking another step vides the first example. between the up volume and down volume
During obvious trend days, another cal- The concept here is the short-term is negative, and the up-volume/down-
culation involving the volume slope market trend peaks as the up-volume volume ratio is 50 percent or less), go short

47 • May 2003 • ACTIVE TRADER

when the slope-difference line is above The difference between the slope of the up-volume line and the slope of the
-50 and turns down. The risk point is down-volume line captures many of the market’s intraday turns. Trades that were
just above the high of the entry bar, so entered are marked by letters, with the exits noted.
take profits if the slope-difference line
crosses back above -50. Slope difference 600
The first trade (point A) was a loser,
but the next trade was profitable 400
despite a lower entry point than the
previous trade. Trade C was caught in 200
some sideways market movement. F
You would not re-enter after this trade Exit 0
A Exit C D Exit
because the slope-difference line was B
below -50, not above. Trade D had a -200
nice open profit, but the majority was
given back, and trade E was a good S&P 500 (SPX), five-minute
run down until the close. 900.00
These signals could be improved by Exit
calculating the typical price move fol- Exit 895.00
lowing an entry, using maximum D F
B Exit E Re-enter 890.00
favorable excursion (MFE) analysis to A Exit Exit
set targets. Exit

The ups and downs 880.00

of the market Nov.
Intraday up- and down-volume sta- 1-8:30 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 1-14:30
tistics offer insight into the dynamics Source: CQGNet
of buying and selling pressure. When
the up- and down-volume numbers
are nearly the same throughout the FIGURE 11 TRADING ON A DOWN DAY
day, the market tends to trade back When the trend is down, the slope differential can be used to signal trade
and forth — the case on most trading opportunities. Moves above and below the -50 line are the initial triggers.
days. However, there are days when
the market makes significant moves, Slope difference 200
and the intraday volume numbers 100
can help identify trade opportunities. E
Remember, there is usually some Exit C D Exit 0
event that causes people to favor one -100
side of the market on a given day. In
the first hour or two, you can deter- -200
mine if up or down volume is domi- -300
nating by looking at the raw difference
between the two, the ratio or by using
slope analysis. However, trending S&P 500 (SPX), five-minute
conditions do not develop every day, Exit 907.50
which is why intraday traders have 905.00
mostly good days and bad days and, A Exit Exit 902.50
only occasionally, great days. Exit E
D 900.00
The concept of tracking the intra-
day volume statistics presented here 897.50
is the groundwork for further C
research. Traders could use the slope-
difference line of the up volume and
down volume as the basis for a sys- 9-8:30 9:00 9:30 10:00 10:30 11:00 11:30 12:00 12:30 13:00 13:30 14:00 9-14:30
tem, or elements for either entry and Source: CQGNet
exit strategies within other systems.
Finally, on those days with a bullish bears will take charge when the up vol- down-volume stocks) or selling a rally
bias, watch for the down volume indica- ume slows. This may seem counter-intu- (after a short-term rise in the number of
tor to show signs that its ascent is wan- itive, but it will have you thinking about up-volume stocks).Ý
ing. The market will typically rally from buying in an uptrend (after a pullback
that point. Likewise, on bearish days, the driven by an advance in the number of

ACTIVE TRADER • May 2003 • 48

Do markets have intraday
price characteristics
short-term traders can
use to improve their

We crunch some numbers

to find out when the
market is moving and
when it’s snoozing.


V olatility, although often as-

sociated negatively with
choppy, uncertain market
conditions, is essential for
traders: The market has to go somewhere
to make a position profitable. What
traders wish for is not low-volatility con-
ditions; on the contrary, they prefer high
volatility occurring in the direction of
their positions.
The degree of volatility is especially
crucial for intraday traders because they
try to capture short-term price move-
ment; they do not have the luxury or
desire to hold a position overnight. For
such traders, knowing when the most
volatile periods occur during the trad-
ing day would be a valuable piece of
information — if there were a consistent
pattern to that volatility. Traders could
then focus on those periods with the
most promise of price movement and
avoid those less likely to offer tradable

Gathering the evidence

We will determine if different times of

49 • August 2003 • ACTIVE TRADER


The largest average 10-minute range (4.46 points) was the 9 a.m. period,
which corresponds to when many economic reports are released.
the trading day exhibit noticeable
volatility characteristics by analyzing
10-minute price bars in the S&P 500 E- Time 8:30 8:40 8:50 9:00 9:10 9:20
Mini futures (ES) between 8:30 a.m. and
3:10 p.m. CT, from Jan. 2 to March 31, Average range 3.62 3.68 3.60 4.46 3.54 3.32
2003. This daily trading period coincides
with normal market hours at the New
York Stock Exchange (NYSE) plus 10
minutes (we will see if anything interest-
ing occurs in the futures after the NYSE The 9:20 periods are plotted as a line and the 12:20 periods are plotted
closes). The total historical analysis peri- as a histogram. There were only six times (less than 10 percent of all
od encompassed uptrends, downtrends occurrences) that the 12:20 period had a larger range than the 9:20 period
and sideways price movement. the same day.
The total number of price bars over
these 61 trading days is 2,440 — forty 8.00
10-minute bars per day. The narrowest
price-bar range was .50 points and the
largest was 15.00 points. (We are not 6.00
concerned with direction, just the ranges 5.00
of the 10-minute bars throughout the
trading day.) 4.00

Intraday time patterns
Figure 1 (opposite page) shows the aver- 2.00
age ranges for each 10-minute trading 1.00
period in the trading day, beginning
with the bar that opens at 8:30 a.m. and 0.00
the final bar that opens at 3 p.m. The Day
most volatile time of the day is the first
Source: Excel; data from CQGNet
hour of trading, when the 10-minute
average ranges noticeably exceed those
during the rest of the day as traders dis- FIGURE 3 2:20 PERIOD VS. THE 12:20 PERIOD
count overnight events.
Here the 2:20 period (plotted as a line) is compared to the 12:20 period
Table 1 (top) lists the average values
(plotted as a histogram). The 12:20 range was larger than the 2:20 range 15
for the first hour, and shows the largest
times (25 percent of all occurrences) the same day.
average 10-minute range (4.46 points) is
the period beginning at 9 a.m., which is 10.00
likely because so many economic
reports are released at that time.
Referring back to Figure 1, the average 8.00
ranges taper down to less than 2 points 7.00
at 12:10 p.m., climb again as the market 6.00
nears the close, and finally drop off in 5.00
the final few bars. It is safe to assume the
combination of a lack of news and the
lunch hour plays a role in the declining
volatility during the middle of the trad- 2.00
ing day in Chicago. 1.00
This initial analysis suggests the best 0.00
trade opportunities are early in the trad-
ing day. After all, markets are all about
continued on p. 51 Source: Excel; data from CQGNet

ACTIVE TRADER • August 2003 • 50

The difference between the average and median ranges shows almost all of the
values are positive, indicating there is a positive skew to the data.




0.30 price discovery, and the process is in full

force as traders adjust to the release of
economic numbers and individual sto-
0.10 ries driving particular companies and
market groups. As the trading passes
0.00 the mid-point of the session, traders
who may have held onto losing posi-
tions likely will be forced out when
volatility increases as the market nears
Time the close, while traders on the right side
Source: Excel; data from CQGNet of the day’s trend may see better profits
with a little patience.
FIGURE 5 RANKING THE RANGES For a more direct comparison of high-
volatility and low-volatility periods,
The ranges span 0.50 to 14.75. The most common range value is 2.00, with Figure 2 (p. 50) shows the 10-minute
313 occurrences. The number of occurrences of 2.00 or larger is 1,702, or 69.8 ranges for all the 9:20 a.m. periods (the
percent. blue line) and the 10-minute ranges for
all the 12:20 p.m. periods (the his-
togram) over the 61-day analysis period.
300 There were only six times (just less than
10 percent) that a 12:20 p.m. 10-minute
250 range was larger than the 9:20 a.m. peri-
od 10-minute range for the same day.
The average range for the 12:20 p.m.
150 period was 1.99, and the number of
times the range was 2 points or larger
100 was 32 (52 percent). The 9:20 a.m. period
50 was 2 points or larger 55 times (90 per-
0 Figure 3 (p. 50) compares the 2:20
p.m. periods (the blue line) to the 12:20
Range p.m. periods (the histogram). The 12:20
Source: Excel; data from CQGNet p.m. range was larger than the 2:20 p.m.
range on only 15 days, or 25 percent of
FIGURE 6 LARGEST RANGES the time. However, the range of the 2:20
bar was 2 points or greater 48 times (79
This chart shows both time and size of 10-minute ranges that were 6.25
points or more. Twenty-three of the 32 occurrences, or 72 percent, occurred
Figure 3 also shows that one 2.20 p.m.
before 10 a.m., with nine occurring during the 9 a.m. bar.
bar had a range of 9 points. Because of
16.00 its abnormally high range, this repre-
sents an “outlier” — a statistical anom-
14.00 aly. To counter the disproportionate
12.00 effect an outlier can have when calculat-
ing an average, some statisticians use
the median value instead. The median is
8.00 the center point, or middle, observation
in a data set, with the data arranged
from the lowest to the highest value.
4.00 Because there are 61 observations (trad-
ing days) in the analysis period, the
median will be the value 30 places
0.00 below the maximum range and 30
places above the minimum range for
Time any of the 10-minute periods.
Source: Excel; data from CQGNet
51 • August 2003 • ACTIVE TRADER
Here are the average ranges for each 10-minute period, beginning with the
bar that opens at 8:30 a.m. and the final bar that opens at 3 p.m. Again, the
best trade opportunities are in the morning when volatility is the highest.



Comparing the 0.15

averages to the
medians, almost all

the values are


positive, indicating Source: Excel; data from CQGNet


there is a positive In QQQ, the opening 10-minute bar and the 9 a.m. bar had average ranges of
19 cents.
skew to the data.
Time 8:30 8:40 8:50 9:00 9:10 9:20

Figure 4 (opposite page, top) charts Average range 0.19 0.18 0.17 0.19 0.17 0.15
the difference between the median and
average values for all the 10-minute
periods. Almost all the values are posi- FIGURE 8 AVERAGE MINUS THE MEDIAN, QQQ
tive, indicating there is a positive skew
Most of the differences between the averages and the medians are positive
to the data — which means the ranges
indicating a tendency for the ranges to be larger than the mid-point of the data.
tend to be larger than the median range.
Interestingly, the 12:20 p.m. and 12:30 0.0300
p.m. periods have negative values, again
highlighting how the market slows 0.0250
down during the noon hour. (The 2:40 0.0200
p.m. hour has a negative difference, as
How common is a 9-point range for a 0.0100
10-minute bar? Figure 5 (opposite page, 0.0050
middle) sorts the ranges by size, from
the smallest (.50) to the largest (14.75)
and the number of occurrences. The -0.0050
most common range is 2 points (313 -0.0100
occurrences). The number of ranges 2
points or larger is 1,702 (69.8 percent).
There were only two 10-minute ranges Time
of 9 points. Source: Excel; data from CQGNet
Figure 6 (opposite page, bottom) plots
the time and size of 10-minute ranges Nasdaq 100 index-tracking stock (QQQ). the average ranges exceeded those of the
that were 6.25 points or larger (there The narrowest range was 3 cents, and remainder of the day. Table 2 (middle)
were 32 such occurrences). Twenty-three the largest was 63 cents. Figure 7 (top) lists the average values for each 10-
(72 percent) occurred before 10 a.m., shows the average ranges for each 10- minute period in the first hour.
with the most (nine) occurring during minute period throughout the trading Figure 8 (bottom) plots the difference
the 9 a.m. bar. day. between the average ranges and the
As was the case with the S&P E-Mini median ranges for each 10-minute period.
Analyzing a second market: QQQ futures, the most volatile time of the day Again, almost all the differences are posi-
Let’s review the same period for the is the first hour of trading, during which continued on p. 53

ACTIVE TRADER • August 2003 • 52


The individual 10-minute ranges for the 9:20 period are plotted as a line and
the 12:20 periods are plotted as a histogram. There are only three occurrences
when the 12:20 period had a larger range than the 9:20 period.


tive, suggesting the ranges tend to be, on

average, larger than the median range.
Figure 9 (top) shows the individual
10-minute ranges from all the 9:20 a.m.
periods (the line) and all the 12:20 p.m.
periods (the histogram). In this case, the 0.30
12:20 p.m. period had a larger range
than the 9:10 a.m. period on only three 0.20
days. The QQQ had one 10-minute bar
from this period with a range of 50 cents 0.10
on one day. Now, let’s look at how the
sizes of the ranges rank over the total 0.00
analysis period. Day
Figure 10 (middle) shows the size of
Source: Excel; data from CQGNet
the 10-minute bar ranges and the num-
ber of times each occurred. The most
common range was 9 cents (271 occur- FIGURE 10 RANGE RANK, QQQ
rences). In fact, more than 72 percent of The most common range was 9 cents, with 271 occurrences. Over 72 percent
the 10-minute bars had a range of 9 of the 10-minute bars had ranges of 9 cents or higher.
cents or higher. Using only the ranges
greater than 25 cents (there were 49), 300
Figure 11 (bottom) plots the ranges vs.
the time of the day. Again, most of the 250
occurrences are in the morning, with 40
of the 49 (82 percent) outliers occurring 200
before 10 a.m., and 10 of those in the 9
a.m. bar. 150

Another piece, 100

not the whole puzzle
This study says nothing about the way 50
the ranges unfold. The fact that the
average for the 9:20 a.m. bar is slightly 0
larger than the 9:40 a.m. bar says noth-
ing about the relationship between Range
these two bars. Having said that, the Source: Excel; data from CQGNet
best volatility opportunities (for traders
with the proper skills) occur primarily FIGURE 11 LARGEST RANGES, QQQ
during the early part of the trading day;
they taper off toward noon, and then The majority of the exceptionally large occurrences are in the morning with 40 of
rise again. In addition, there is a slight the 49 (82 percent) occurring before 10 a.m. Ten of those are in the 9 a.m. bar.
tendency for the occasional large move
within the individual periods, which .6
also offers the trader a better-than-aver-
age opportunity.
If you analyzed an intraday trading .4
approach without incorporating a refer-
ence to time patterns, you might devel- .3
op target and risks points that are not as
logical or useful because of unforeseen
changes in volatility. Those traders not .1
following equities or their counterpart
futures contracts should perform the 0
same analysis on their favorite mar-
Source: Excel; data from CQGNet

53 • August 2003 • ACTIVE TRADER

TRADING Strategies

Trends, consolidations and

Traders often monitor total volume, or up volume
and down volume. This analysis studies
the price action that follows days with high
T he best trade opportunities
arise when a market is
trending in a certain direc-
tion, but markets alternate
between these desirable trending phases
and hard-to-trade congestion phases.
Given this reality, a tool that high-
levels of unchanged volume. lights congestion would make it easier
to position oneself to take advantage of
the next trend phase. An “internal” indi-
BY THOM HARTLE cator that helps in this regard is the vol-
ume of unchanged stocks trading on the
The NYSE breaks down the total vol-
The highest unchanged volume reading corresponded to a market pause that ume into up volume (the volume of
preceded a substantial run up. stocks trading above the previous day’s
close), down volume (the volume of
S&P 500 index (SPX), daily stocks trading below the previous day’s
close) and unchanged volume (the vol-
ume of stocks unchanged from the pre-
vious day’s close).
There are two issues to explore here:
First, can a high unchanged volume
975.00 reading be attributed to a high number
C of stocks in a directionless mode?
B Second, what happens the following
day respective to a high unchanged vol-
950.00 ume day’s high or low? Does the market
trend after a high unchanged volume
We investigate these issues regarding
NYSE unchanged volume statistics via
the S&P 500 because of the popularity
of its index-tracking stock (SPY) and the
High unchanged volume E-Mini S&P futures contract (ES).
Unchanged volume
40 mil.
The volume message
The insight volume offers is that it
directly reflects the degree to which
30 mil. traders and investors are committing
money to the market or liquidating posi-
20 mil. tions.
Here are a few unchanged volume
statistics from recent market history.
10 mil. From June 1, 2002, to June 2, 2003 (252
days), the lowest unchanged volume
reading (just over 1 million shares)
12 19 27 2 9
occurred on July 5, 2002. The highest
reading was 58.3 million shares on
Source: eSignal
September 20, 2002. Sorting the data

54 • October 2003 • ACTIVE TRADER

This table shows how much the S&P 500 index exceeded the previous bar’s high
or low after a day with unchanged volume of 24.1 million shares or more.

The high is exceeded
from low to high values and looking at
the top 25 percent of the unchanged vol- -5
ume results in 63 observations, with the -10
lowest unchanged volume reading of
this group just over 24.1 million shares -15
The low is exceeded
and the highest 58.3 million. Now let’s -20
look at the market action following a
high unchanged volume reading.
Figure 1 (opposite page) shows the
S&P 500 cash index and the unchanged
volume level at each day’s close. May For the most part, higher unchanged volume levels were followed by bigger
23, 2003, (bar A) was an inside day and moves above the previous high.
the unchanged volume was just under
39 million shares. This reading was the 30
12th highest reading during the obser- The high is exceeded
vation period. The following day, the 25
S&P 500 index traded below the low of
bar A by 0.09 points, but the market then 20
rallied and the index made a high 17.56
points above the May 23 high.
The day after bar B’s unchanged vol-
ume reading of 25.6 million, the market
traded 2.69 points higher than bar B’s
high, then reversed and traded below its
low by 3.89 points. Bar C had an
unchanged volume reading of 31.8 mil-
lion, and the index traded 13.73 points Lower Unchanged volume Higher
above the previous day’s high before
reversing and closing near the open.
Finally, on bar D the unchanged volume
was 32.5 million, and the next bar vio- FIGURE 4 DEGREE OF MOVEMENT — DOWN MOVES
lated the bar D low by just 0.84 points Unlike the higher unchanged volume/up move relationship shown in Figure 3,
before turning up. this table shows little correlation between unchanged volume levels and down
Two of the four examples had sizable moves the next day.
moves, one traded both above and
below the previous day range, and two 20
made slight down moves before revers- The low is exceeded
ing to the up side. Were there any notice-
able patterns here?
Of the 63 observations with 14
unchanged volume of 24.1 million 12
shares or more, there were only three 10
times the following day was an inside 8
day. Of the 60 remaining examples, only
five took out both the previous day’s
high and low, forming outside bars. 4
Figure 2 (top, right) shows how much 2
the following day’s low or high exceed- 0
ed the previous day’s low or high when Lower Unchanged volume Higher
continued on p. 56

ACTIVE TRADER • October 2003 • 55

The day after this high-unchanged volume day was an up day, one of two
days that interrupted a downtrend. was -10.13 points.
Another aspect of this data to consid-
S&P 500 index (SPX), daily er is the relationship between the
1,075.00 unchanged volume level and the degree
of the following day’s price movement.
Figure 3 (p. 55) shows how the previous
1,050.00 day’s high was exceeded according to
the level of unchanged volume, from the
lowest to the highest. There is a slight
1,025.00 bias in that the lower unchanged volume
levels appear to have slightly lower
extremes, with the exception of the sec-
1,000.00 ond example from the left, which fol-
lowed the last day of the year, a day typ-
ically with low volume because of the
Figure 4 (p. 55) is similar to Figure 3,
26.7 million shares unchanged
except that it displays the amount by
which the previous low was broken.
950.00 There is no correlation between the size
of the penetration and the unchanged
3 10 17 24
June volume level.
Finally, is there any correlation to the
Source: eSignal trend of the market? Analyzing some of
the largest moves suggests the prevailing
FIGURE 6 DOWN MOVE IN UPTREND trend does not exert much influence. For
example, Figure 5 (top) shows the S&P
The day after this high-unchanged volume day moved lower, but the market
rose more than 27 points after the June 14,
turned back up the next day.
2002, unchanged reading of 26.7 million
shares while the market was in a down-
S&P 500 index (SPX), daily trend. On March 28, 2003, the unchanged
volume reading was 24.8 million shares
and the following day the S&P dropped
875.00 17 points below the previous day’s low
(see Figure 6, left). However, another
look at Figure 1 shows two up days fol-
lowing high unchanged volume readings
850.00 in an uptrending market.

Potential applications
24.8 million shares unchanged The patterns following high unchanged
825.00 volume readings can help clue you in to
different opportunities or risks by
revealing the typical behavior following
certain price bars.
For example, this analysis suggests if
today’s high is approximately 15 or
more points above the high of yester-
10 17 24 31 day’s high unchanged volume day, the
likelihood of higher prices becomes
Source: eSignal more remote. Similarly, a low that
exceeds the high unchanged volume
the previous day’s unchanged volume points. For days when the previous day’s low by more than 10 points on the
exceeded 24.1 million shares. Of the unchanged volume was greater than downside is a low-probability situation
higher highs, 12 were 10 or more S&P 24.1 million shares and the low was for a short trade. Ý
points higher, with six exceeding 20 exceeded, the market fell more than 10
points. The average difference was 9.14 points 11 times. The average difference

56 • October 2003 • ACTIVE TRADER

TRADING Strategies

The TELLTALE spread

Analyzing the relationship between BY THOM HARTLE

the E-Mini Nasdaq 100 and the E-Mini

S&P 500 can indicate when the broad rend analysis of the stock market can take several
forms: measuring an index’s percentage change
market is making a genuine move over a period of time, comparing the index to a
moving average and so on. Furthermore, some
or when it’s faking people out. traders refer to tools such as the number of advancing stocks
relative to declining stocks and volume to determine a particu-
lar trend’s strength or weakness.
Spread analysis, or measuring the
TABLE 1 S&P 500 COMPOSITION price difference (or ratio) between two
The S&P 500 consists of the 500 largest publicly traded companies measured stock indices, is another way to gauge
by market cap. It is designed to reflect the broader market. the robustness of a move in the stock
market. By identifying the typical rela-
Top stocks Top groups tionship between two indices and recog-
nizing when that relationship deviates
General Electric 3.19% Financials 20.50% from its pattern, you can determine the
Microsoft Corp. 3.06% Information technology 16.20% trend and identify potential reversals.
Pfizer, Inc. 3.00% Health care 14.80% Also, although this approach is general-
ly longer term, you can track the
Exxon Mobil Corp. 2.67% Consumer staples 11.70% Nasdaq-S&P spread on an intraday basis
Wal-Mart Stores 2.62% Consumer discretionary 11.10% to insure you are on the right side of
intraday trends.
Citigroup Inc. 2.45% Industrials 10.40%
This study analyzes the relationship
Johnson & Johnson 1.71% Energy 5.80% between two of the most popular stock
American International Group 1.60% Telecom services 3.90% indices, the S&P 500 (SPX) and the
Nasdaq 100 (NDX), which also underlie
IBM 1.59% Utilities 3.00%
the two most popular equity index
Intel Corp. 1.51% Materials 2.70% futures contracts, the S&P 500 E-Mini
(ES) and the Nasdaq 100 E-Mini (NQ),
Source: Standard & Poor’s 6/30/03 traded at the Chicago Mercantile

57 • November 2003 • ACTIVE TRADER


The Nasdaq 100 is comprised of the 100 largest companies trading on the
Nasdaq (financial companies are excluded), based on market cap. The index
is heavily weighted with technology stocks.
Top stocks Top groups
1. Microsoft Corp. 10.15% 1. Computer & office equipment 28.39%
2. Intel Corp. 5.10% 2. Computer software/services 28.01%
3. Cisco Systems Inc. 4.49% 3. Telecommunications 11.69%
4. Amgen Inc. 4.28% 4. Biotechnology 11.45%
5. QUALCOMM Incorporated 3.65% 5. Retail/wholesale trade 9.86%
6. Dell Computer Corp. 3.24% 6. Health care 4.51%
7. Comcast Corporation 3.07% 7. Services 3.16%
8. Oracle Corp. 2.82% 8. Manufacturing 1.94%
9. eBay Inc. 2.65% 9. Transportation 0.99%
10. Nextel 2.48%
Communications, Inc.

Source: 6/30/03


Calculating the difference between the Nasdaq 100 E-Mini

futures (top) and the S&P 500 E-Mini futures (middle) results
in a spread chart (bottom) that shows when one index is
outperforming the other.

Exchange (CME). We’ll use the spread between the

Nasdaq E-Mini (NQ), weekly
S&P and Nasdaq 100 futures contracts in this analysis.
We’ll begin by looking at a longer-term use of the
Nasdaq-S&P spread before shortening the time hori-
zon and examining ways to identify intraday trend 1,250
Finding the market leader:
S&P safe haven vs. Nasdaq growth
The S&P 500 is a capitalization-weighted index of com-
panies with market caps (stock price multiplied by S&P 500 E-Mini (ES), weekly
number of shares outstanding) in excess of $3 billion. Divergence between
The larger a company’s market capitalization, the more S&P 500 and Nasdaq 100 1,000
its stock price affects the index value.
The S&P 500 is designed to reflect the risk and return
characteristics of the broader, large-cap market. Table 1 800
(opposite page) shows the top individual holdings and
the group breakdown of the S&P 500. NQ-ES spread, weekly
The Nasdaq 100 is comprised of the 100 largest busi- 300
nesses, excluding financial companies, traded on the
Nasdaq stock market exchange. The index uses a “mod- 200
ified capitalization-weighted” approach, by which
stocks are weighted with a proprietary algorithm when- Rising spread
ever any stock represents more than 24 percent of the is bullish 100
index’s total market value, and/or the combined weight
of all stocks with weightings of at least 4.5 percent 0
exceeds 48 percent of the index’s total market value. April July October 2003 April July
Table 2 (above) is a recent list of the top Nasdaq 100 Source: CQG, Inc.
continued on p. 59

ACTIVE TRADER • November 2003 • 58

A bullish stock market is reflected
by an uptrending Nasdaq 100-S&P 500 spread.
A bearish market is characterized by a downtrending spread.

individual stock holdings and a breakdown of its most heavily cent), followed by information technology (16.20 percent). In
represented groups. terms of growth stocks, the technology industry offers far more
The Nasdaq 100 contains a much higher percentage of tech- opportunities than the financial services industry.
nology stocks than the S&P. Table 2 shows the computer and Microsoft (MSFT) is the most heavily weighted individual
holding in the Nasdaq 100 and the second most heav-
ily weighted in the S&P 500. Because it accounts for a
FIGURE 2 HIGHLIGHTING LEADERSHIP large enough percentage in both indices, MSFT has a
relatively muted effect on the spread between the two.
The growth-oriented Nasdaq 100 tends to lead the S&P to the Because of its large technology component, in an
upside as well as the downside. When it doesn’t, as was the expanding economy the Nasdaq 100 should lead (i.e.,
case at points C and F, this lack of leadership can result in rise at a faster rate than) the S&P 500 when the overall
trend weakness in the overall market. market is moving higher because more money man-
agers and investors will be attracted to the potential of
G growth stocks. On the other hand, in a declining eco-
1,300 nomic environment, financial services companies offer
1,250 a safe haven for money (plus, many financial compa-
nies pay dividends). That will tend to pull money
1,200 away from Nasdaq stocks and into S&P stocks. As a
A result, the Nasdaq 100 should lead the S&P when the
market is moving lower, as well.
1,100 In other words, a bullish stock market is reflected by
Nasdaq E-Mini (NQ), daily
an uptrending Nasdaq 100-S&P 500 spread (the
H Nasdaq 100 price minus the S&P 500 price). A bearish
E 1,000 stock market will be characterized by a downtrending
Nasdaq 100-S&P 500 spread.
B 950
Weekly perspective
S&P 500 E-Mini (ES), daily
900 Figure 1 (p. 35) shows the Nasdaq 100-S&P 500 rela-
tionship from the fourth quarter of 2002 into the sec-
300 ond quarter of 2003. The top and middle charts show
New high the Nasdaq 100 E-Mini and S&P 500 E-mini futures,
275 respectively, while the bottom panel shows the spread
between the two.
250 Both the Nasdaq 100 and the S&P 500 futures con-
tracts reached new lows in October 2002. However,
C 225 during the fourth quarter of 2002, the Nasdaq 100
embarked on a substantial rally, bettering its July 2002
NQ-ES spread, daily 200 high; the S&P 500, however, was unable to surpass its
21 1 12 19 27 2 9 16 23 1 14 21 28 1 summer (August) high. The Nasdaq-S&P spread
May June July Aug. jumped sharply higher, reflecting the Nasdaq 100’s
more accelerated rally. Both markets peaked in
Source: CQG, Inc.
December 2002 and moved downward until February.
The Nasdaq-S&P spread made a slightly lower low
office equipment industry group comprises 28.39 percent of in January, just below its December low. As the S&P 500 moved
the Nasdaq 100, followed by the computer software/services lower, the spread started to climb again, reflecting the Nasdaq
group at 28.01 percent. 100’s outperformance relative to the S&P 500. The Nasdaq 100
The top group in the S&P 500 is financial stocks (20.50 per- made the second low of a double bottom in March 2003, at

59 • November 2003 • ACTIVE TRADER

which point both markets rallied into June. The developing wider margin (approximately 1.28 percent vs. .87 percent,
based on closing prices on May 6 and May 15). The spread (see
spread relationship signaled this period of strength in the over-
all market: The spread bottomed in October and began form- line C) was flat between these two peaks, indicating the
ing a series of higher highs and higher lows, indicating a bull-Nasdaq 100 was no longer outperforming the S&P. This situa-
tion was followed by a short correction into the week
of May 19.
FIGURE 3 INTRADAY INSIGHT Moving forward, the Nasdaq 100 peaked in early
June while the S&P 500 peaked in mid-June. This
Although intraday price data is more volatile than daily or divergence, indicated by the declining spread (line F),
weekly data, the Nasdaq-S&P spread relationship reflects the was part of another correction that lasted until the end
same dynamics. Here, the spread (bottom) pushed above its of the month.
downtrendline before the Nasdaq or S&P futures did. In July, the Nasdaq 100 surged to new highs, while
the S&P 500 made a lower high. This divergence pre-
Nasdaq E-Mini (NQ), 30-minute 1,250 ceded a correction in the broader market.
T1 (Interestingly, though, the spread itself surged to new
highs, which reflects leadership on the part of the
Nasdaq and should be a longer-term bullish sign.)
The spread does not necessarily indicate a correc-
1,200 tion is complete; it does not wave a red flag.
Nonetheless, there is value in being alerted to condi-
Support tions that signal a potential correction.

S&P 500 E-Mini (ES), 30-minute Intraday applications

T1 990 On a very short-term basis, the Nasdaq-S&P spread
980 can help keep you on the right side of intraday trends.
The same basic guideline holds, in that the Nasdaq 100
970 should lead the way, both up and down.
Although simple trend analysis, such as drawing
trendlines, can help to spot changes, intraday spread
NQ-ES spread, 30-minute charts, like individual markets, are very volatile. For
250 example, during the latter part of June 2003, the stock
T1 market was moving sideways.
240 On July 1, the market broke key support levels, but
the spread did not break its equivalent level. As the
230 market began to recover, and moved back up through
the previous broken support level, the spread broke
the down trendline shown in Figure 3 (left). The
Support Nasdaq 100 and the S&P 500 did not break their trend-
25 26 27 30 1 2-8:30 lines until later in the session.
Source: CQG, Inc. Majority rules
Analyzing the Nasdaq 100-S&P 500 spread relation-
ship reflects the idea that if the majority of stocks are
ish market environment based on the better performance of the not rising — or, if the market-leading stocks are lagging the
Nasdaq 100 relative to the S&P 500. broader market — the trend may lack staying power.
The spread between the Nasdaq 100 and the S&P 500 can
Divergence on the daily time frame function as a gauge of how healthy or weak the overall market
In addition to gauging the relative strength of the indices when is. If one of the major indices is not keeping pace, the spread
they are moving in the same direction, divergence between the will fail to make new highs or lows. In those situations, watch
Nasdaq 100 and S&P 500 on the daily time frame can signal for a trend change. 
potential market corrections. Figure 2 (opposite page) is a daily
chart of the E-Mini Nasdaq 100, E-Mini S&P 500 and the spread
between the two.
Line A shows the Nasdaq 100 rising to slightly higher highs For other articles by Thom Hartle, visit the Active Trader online store
in May while the S&P 500 surpassed its early May highs by a at

ACTIVE TRADER • November 2003 • 60

TRADING Strategies

Choosing the proper

Intraday traders can use time frames ranging anywhere
from one minute to more than an hour. Is there a way
to find the most appropriate time frame given your
trading approach? Read on to find out.


T raders typically incorporate several tools and con-

cepts, such as price patterns, indicators, money
management, and entry and exit strategies in a
trading plan. But how much consideration do
they give time frame?
For example, people who trade on an intraday basis might
gravitate to five-minute bars without giving the matter too
you execute trades. This usually means defining trend direc-
tion on a longer-term time frame and executing trades in that
same direction using setups on a shorter-term time frame — a
“multiple time frame” approach.
To illustrate this process, we will begin by identifying sup-
port and resistance levels with a basic chart pattern. To that
end, we need to consider how support and resistance levels
much thought. Five minutes just seems like a reasonably com- occur.
pact, easy-to-reference time frame. But is there really any
advantage to five-minute bars over two-minute bars, 10- What makes a support or resistance level?
minute bars or any other time frame? Support is often characterized as a price level at which buyers
The answer depends on the time frame you use to define the repeatedly come
trend, which should be different from the time frame on which into the market
The pivot low and pivot high shown
FIGURE 1 WHERE THE VOLUME IS here represent the evaporation of
buying and selling at low and high
The highest and lowest prices for a given day tend to have the lowest volume.
price levels illustrated in Figure 1.
Pivot high
1029.25 2
1028.75 Sell signal is a 1 3
1027.75 move below the
1027.25 low of bar 2 or
1026.75 the close of bar 3.
1020.25 Buy signal is a
1019.25 move above the
1018.75 high of bar 2 or
1018.25 the close of bar 3.
1 3
5.00K 10.00K 15.00K 20.00K 25.00K 30.00K Pivot low
Volume 2
Source: eSignal Source: Fibonacci Trader

61 • December 2003 • ACTIVE TRADER

Although only three are labeled, this five-minute chart contained 32 pivot
highs and lows.
and hold up prices; one theory is large S&P E-Mini (ES), five-minute
institutional traders scoop up cheap 1,030.0
securities or contracts when they drop to 2A
a certain level. Resistance is considered 1
the opposite — a level at which sellers 1,028.0
offer large numbers or size into the mar-
ket, checking a rally.
However, Figure 1 (opposite page, far
left) tells a different story, in terms of how
the high and low for a trading day are
typically set. It shows how many con-
tracts traded at different price levels in
the September E-Mini S&P 500 futures 3
contract on Sept. 5, 2003. It doesn’t show 1,022.5
12 1,022.0
when the market traded at a particular
price, only the total volume that occurred
at each price level that day. Notice the
highest and lowest prices for the day are 1,020.0
the levels with the lowest volume.
Figure 1 suggests the market stopped
going up because increasingly higher 123
prices eventually failed to attract enough
buyers willing to pay for the contract at
those levels. Volume decreased as price 1,016.0
9/5/03 9/8/03
advanced to the top of the day’s range,
which means the market stopped going Source: Fibonacci Trader
up because it ran out of buyers.
Similarly, the low for the day occurs because at some point pivot lows and one pivot high have been labeled. Point A is the
falling prices fail to attract additional selling — i.e., the market pivot high for the day and point B is the pivot low.
stopped falling in Figure 1 because there were no more sellers. Here’s the problem of using five-minute bars: If you look at
This process repeats throughout the day, with the market often a daily chart and conclude the trend is up, and you want to go
making several new intraday highs or lows. The ultimate high long, what are your chances of spotting the intraday pivot low
and low prices can occur at any time during the day. that represents the lowest low of the day — the most favorable
How does this behavior manifest itself on a standard price entry point?
chart? Figure 2 (opposite page) shows two examples of a three- Obviously, you need to reduce the number of intraday pivot
bar pattern called a “pivot,” in which price makes its final highs and lows to improve your odds. Using a longer-term
move into new territory (a higher high or lower low) on bar 2 intraday time frame would accomplish this. Figure 4 (p. 63)
and reverses direction to form bar 3 (making a lower high or shows a 30-minute chart. Now there are just three pivot lows
higher low). The first example in Figure 2 is a pivot low and the and two pivot highs. (In this example, bar 1 of the first pivot
second is a pivot high. low is using the low of the previous day’s final bar.) In the
Based on the conclusions about support and resistance from middle of the chart, it appears the large spike-down bar would
Figure 1, the ultimate high or low reached in bar 2 and the sub- be bar 2 of a pivot low (these bars are marked A, B and C), but
sequent retracement of bar 3 in a pivot pattern is the result of there is no overlap between bar A and bar C. The pivot concept
price exhaustion in that direction. With the completion of bar is based on the idea that a market is not attracting sellers near
3, the pivot high or low is in place. An early warning a pivot is the pivot low area. In this case, the fact that bar B sold off so
forming is the violation of bar 2’s high (for a pivot low) or bar sharply and bar C did not retrace enough to overlap with bar
2’s low (for a pivot high). A is a sign bar C is just a correction of bar B, and not the begin-
Once a pivot low or high is in place, the market has estab- ning of a reversal. (If the first bar gaps lower, as it did here, it
lished support or resistance at that price level. means the trading occurred in the evening Globex session, so
the previous day’s bar would be bar 1.)
The daily pivot
Depending on the intraday time frame, any number of pivot Five bars a day keeps the guessing away
lows and highs can form throughout the trading day. However, Moving to an even longer-term time frame, Figure 5 (p. 63)
only one pivot high can be the high for the day and only one shows an 81-minute bar chart that divides each day into five
pivot low can be the low for the day. price bars. Now, only two pivot lows and one pivot high
For example, Figure 3 (above) shows a five-minute chart of appear.
the September 2003 E-Mini S&P500 futures. There are 16 pivot Because a pivot high or low pattern consists of three bars,
highs and 16 pivot lows in this chart; to avoid clutter, only two continued on p. 63

ACTIVE TRADER • December 2003 • 62


Increasing the time frame to 30-minute bars reduces the number of pivot
highs and lows. breaking the day into five 81-minute
bars increases the chances of identifying
S&P E-Mini (ES), 30-minute
1,030.0 the ultimate high or low for the day. If
2 3 we were using five-minute bars, the
chances of identifying the ultimate high
1 1,028.0 or low during the day would be remote
1 because of the high number of pivot
lows and highs.
1,026.0 The choice of 81-minute bars is most
appropriate for trading if you are fol-
lowing the trend on the daily time frame
1,024.0 (a multiple time frame approach). For
3 2 example, if the daily trend was defined
A 3 as up based on the market closing above
1 1,022.0 a rising 20-day moving average, you
could enter on pivot lows on the 81-
minute bar time frame.
Multiple time frames
C 1
In Figure 6 (opposite page), the daily
B 3 1,018.0 range is plotted as boxes that “encapsu-
2 late” the five 81-minute bars for each
day, along with a 20-day moving aver-
1,016.0 age (plotted as a “step” line). In essence,
9/5/03 9/8/03 the encapsulation rectangles are like
Source: Fibonacci Trader transparent daily bars that allow you to
see the intraday action on the 81-minute
At point A, the daily bars form a pivot
Using 81-minute bars divides a trading day into five bars, reducing the num - low (labeled 1, 2 and 3); bar 2 temporar-
ber of pivot highs and lows to one each. ily penetrates the 20-day moving aver-
age. The combination of the rising mov-
S&P E-Mini (ES), 81-minute ing average and the formation of a pivot
2 1,030.0 low on the daily time frame signals an
uptrend. Trades can be based on the for-
mation of pivot lows on the 81-minute
1 3 1,028.0 time frame, entering on the close of bar
3 (or on a move above bar 2’s high) of an
intraday pivot, and risking a move to
1,026.0 the low of the entry bar.
1 However, if this represents too much
3 risk and you prefer to trade shorter-term
1,024.0 price bars, you can work backwards to set
up a similar multiple time frame analysis
on the time frame of your choosing.
1,022.0 Let’s use five-minute bars as an exam-
2 ple. Using the same approach of five bars
of the short-term time frame per one bar
of the longer-term time frame, you would
use 25-minute bars to define the trend
and look for pivot lows and highs on the
five-minute bars to enter trades. (Using
1 1,018.0
25-minute bars does leave one unaccom-
2 panied five-minute bar at the end of the
trading day, however.)
9/5/03 9/8/03 Figure 7 (opposite page) shows five-
minute bars encapsulated on a 25-
Source: Fibonacci Trader
minute basis. Each red rectangle repre-

63 • December 2003 • ACTIVE TRADER


Here, 81-minute bars are “encapsulated” by rectangles that function as

transparent daily bars allowing one to see the price action of two distinct
sents a 25-minute bar and pivot lows time frames.
and highs on the 25-minute bars will be
used to define the trend. The first 25-
S&P E-Mini (ES), 81-minute
minute bar of the day gaps down, but
still qualifies as bar 2 of a pivot low. A 1,030.0
pivot low is established when the mar-
ket trades above the high of the 25-
minute pivot bar 2, which signals a low 1,022.5
on the longer-term time frame and a ris- 1,020.0
ing trend.
At this point, you would look for a
pivot low on the five-minute bars to go Pivot low
long. Again, you can buy as the market 1,010.0
moves above the bar-2 high of the five- Encapsulation
minute pivot low, with a stop at or near
the low of the entry bar.
In this example the market did 1,000.0
advance until it formed a 25-minute bar
Pivot low
pivot high, after which it tumbled hard,
forming only three five-minute pivot
highs (two of which are contained in the 3 990.0
same 25-minute encapsulated bar) dur-
ing the decline. These three pivot highs 1 Pivot low
were the better trade setups — everyone
Moving average 2
wants to catch this kind of sharp decline A 980.0
— but such opportunities are rare. 8/25/03 9/2/03 9/8/03
Another 25-minute pivot low formed Source: Fibonacci Trader
after the sharp decline, signaling the
trend was turning back up, and a num- FIGURE 7 BACK TO THE FIVE-MINUTE TIME FRAME
ber of pivot lows formed on the five-
minute bars. Using the approach from Figure 6, the five-minute bars here are encapsulat -
ed by the 25-minute range, which is the time frame that defines the trend.
Don’t put the cart before
the horse S&P E-Mini (ES), five-minute
Many traders select a time frame and 1,030.0
2 3
struggle to make their trading fit that
Trend is down
time frame, rather than first deciding
how they want to trade and then pick- 1 1,028.0
ing an appropriate time frame. When
selecting a time frame on which to trade,
1 1,026.0
make your decision based on a multiple
time frame perspective. 3 Pivot high
In this case, dividing a longer-term 1 2
(daily) time frame into five shorter-term
(81-minute) periods and using a three- 3
bar pivot pattern to define trends and 1,022.5
support and resistance provided the 2 Pivot low 1,022.0
framework for a simple trading ap-
Trend is up
proach. Trading in the direction of the
trend of the longer-term time frame and 1,020.0
using chart patterns or indicators on the
shorter-term time frame for entry sig- 1
3 1,018.0
nals should increase your success. Ý
2 Pivot low
Encapsulation is a patented trademark of Trend is up
Robert Krausz. 1,016.0
9/5/03 9/8/03
Source: Fibonacci Trader

ACTIVE TRADER • December 2003 • 64

TRADING Strategies

The method trader

The trading world is filled with truisms and generalities, but there are no
magical indicators or secret recipes when it comes to trading well. Profitable
trading is grounded in a process — how you approach your trading approach.


65 • April 2004 • ACTIVE TRADER

Knowledge is experience,
and the essence of experience is self-reliance.
— T.H. White, The Once and Future King

W hen in comes to consistently profitable trading, there are many roads

leading to the promised land, but as the saying goes, “Many are called,
but few are chosen.”
New and struggling traders are always looking for something — an elusive insight or
technique — that will put everything into focus and allow them to excel. Like virtually
any other profession, though, the answer is not some bit of mysterious knowledge or a
perfect trading tool. Proficiency boils down to three steps: Specialization, preparation
and execution.
This should not come as a surprise. For example, when we need medical attention for
an out-of-the-ordinary problem, we seek a physician who specializes in the field of med-
icine specific to our affliction. The physician will prescribe a set of procedures, be they
medicinal, surgical or otherwise, that have shown a high probability of success in cur-
ing the disease or treating the symptoms we have presented to them.
We rightfully expect when a physician prescribes a course of treatment he or she has
the proper knowledge, training and skills to do so; and that the treatment is not
unproven or experimental, unless we agree to it. Unfortunately, we do not set the same
high standards for ourselves when we attempt to make money in the markets.
Think about what so many traders and investors do — place a trade based on the lat-
est news event, after reading a newspaper article, or seeing something on television.
Compare this to a visit to your doctor’s office. What would you think if your doctor, if
asked for details about the medication he was prescribing, could not provide any infor-
mation regarding its efficacy because it was something new he’d just seen on TV the
night before?
Part of the problem is trading does not have the relatively uniform education, training
and regulation that are the norm in most other professions. But that is not the primary
issue. The reality is traders, because they are in an essentially individual and entrepre-
neurial business, have to take responsibility for everything they do. And the most criti-
cal responsibility is knowing the probabilities associated with every trade they make.
Many people believe the key to making money is finding the perfect indicator or pat-
tern. This is not the case. The key is knowing the probabilities of what the market will
do in the aftermath of any price pattern or indicator, and having set procedures to make
the most of that knowledge.
To do that, you have to work through a great deal of material to find techniques that
fit your needs. It’s the trading equivalent of putting yourself through medical school and
settling on your specialty.

Determining your expertise

It takes a considerable amount of research before you can make an informed decision
about your area of specialization. It is only after having acquired a broad background
continued on p. 67

ACTIVE TRADER • April 2004 • 66

FIGURE 1 TESTABLE TRADE SETUP that you can narrow your focus and select techniques that
The trade setup shown here — whether or not it turns out to fit your risk-reward temperament. This balance is an impor-
have merit — has an advantage over many trading ideas tant issue to consider as you work your way through vari-
because it has specific, quantifiable attributes that can be ous trading approaches.
tested. (The pivot low is labeled “1, 2, 3.”) Your tolerance for risk and goals for reward will impact
the markets you trade and the time frame on which you
Nasdaq 100 index-tracking trade them. There is no “correct” time frame to trade; the
stock (QQQ), 30-minute 38.40 goal is to find the one you are most comfortable with.
Upper Bollinger Band Consider the differences between day traders and posi-
38.30 tion traders. Day traders most likely cannot cope with
overnight risk and want to be flat at the end of every trad-
38.20 ing session, starting each day fresh. They do not like to see
big profits turn into small profits — or worse, losses —
because of overnight events.
38.00 Position traders are more likely to consider intraday price
action as meaningless noise — the product of the random
37.90 nature of the market. They are more at ease holding posi-
tions and attempting to capture longer-term trends and less
37.80 comfortable taking multiple positions during a trading day.
1 Lower Bollinger Band Regardless of the time frame, as you study various trad-
3 ing concepts, market tendencies and patterns, you will
37.60 begin to identify some that appear to have consistently
Tagged the lower favorable outcomes. In other words, you will recognize cer-
Bollinger Band 37.50 tain aspects of market behavior and think, “I’ve seen this
Rising long-term
happen before, and the market always seems to rally.” Now
moving average
37.40 you’re onto something.
1/15/04 1/16/04
For example, you might be studying a technique that com-
Source: Fibonacci Trader bines indicators and price patterns. Perhaps, you’ve deter-
mined if the market is in an uptrend (based on a set moving
FIGURE 2 GANN LINE NO.1 average value) and price tags the lower 10-day Bollinger
Band and forms a pivot low (a three-bar support pattern),
When considering a trading technique, you should always ask there is a tendency for the market to rally (see Figure 1, top).
yourself if it can be converted into precise, testable rules. Your goal is to determine the precise probabilities of this ten-
This Gann-based technique would not pass the test. dency and determine whether it merits trading.
38.50 There is a subtle but important point to absorb here. This
Nasdaq 100 index-tracking 2
3 Pivot high pattern has specific attributes that can be defined and test-
stock (QQQ), 30-minute 1 38.40 ed (in the preparation phase). This is not always the case
with “setups” traders use. There is no lack of vague and
Entire bar above 1x1 line
38.30 ambiguous trading concepts and rules: “Look for a break-
out of a tight consolidation,” “Buy when a very large bar
38.20 forms and prices closes near the low,” and so on. But with-
out precise definitions of what constitutes a “tight consoli-
38.10 dation,” a “very large bar” and “near the low,” there is no
way to identify past examples of these patterns and deter-
38.00 mine the odds of what will happen after them. And without
that information, how can you trade?
In Figure 2 (left) for example, an upward 1x1 “Gann line”
Trend reversal (which is a 45-degree trendline that is supposed to represent
price moving in equilibrium with time) is drawn off a pivot
1 low (a three-bar support pattern consisting of a low with a
3 higher low on either side). A trader might have a rule that if
37.60 an entire bar’s range is above the upward 1x1 Gann line
(signaling a rapidly rising trend), it indicates the trend may
37.50 be vulnerable to a reversal. Then, if a pivot high (the oppo-
1/15/04 1/16/04 site of a pivot low) forms, go short if the market breaks the
rising 1x1 line.
Source: Fibonacci Trader
However, a 1x1 Gann line reflects a price-to-time ratio —

67 • April 2004 • ACTIVE TRADER

The key to making money is knowing the probabilities of what
the market will do in the aftermath of any signal generated by
a price pattern or indicator.
e.g., one point or price movement per one time unit — and this MAE is the difference between the entry price and the posi-
ratio can change simply on the basis of how a chart is con- tion’s largest open loss. With this information, you can deter-
structed. Figure 3 (right) is the same price chart, but drawn on mine the typical outcomes of your trade setups.
a different scale. There are subtle but critical differences Figure 4 (p. 32) shows an Excel spreadsheet containing the
between this chart and Figure 2 — most significantly, the break information for a sample trading approach. The first two
of the 1x1 line occurs at different points on the two charts columns contain the date and time, the next four contain the
because of their different price scales. setup’s indicator values, and the next four show the open,
As a result, depending on how your software plots charts, high, low and close prices.
different signals would occur using the same trading “rules.” The next column is used to enter the trade number (in the
(The solution in this case would be an additional rule that row of the bar on which the trade occurred). You could also log
requires the price-to-time ratio to always be a fixed number. this number on the appropriate bar on a chart, either a printed
This way, every chart will always create the same signals.) So, or electronic version. The setup for this trade, which is based
while working through a technique, you must always ask on a set of rules that indicate a purchase on the close of the bar,
yourself if it is something that can be converted to precise, is labeled L-1.
testable rules. The next two columns contain the MFE and MAE for the
An example of a testable one-bar pattern is: Today’s high is
the highest high of the past 10 bars and is at least 1.5 percent FIGURE 3 GANN LINE NO. 2: SAME “SETUP,” DIFFERENT
above yesterday’s high, today’s low is below yesterday’s low, RESULT
and today’s close is in the lowest 10 percent of the bar.
The ability to convert market patterns into precise defini- Because the Gann line is inconsistent and can change
tions, which in turn can be translated into trade setups and depending on how a chart is constructed, the same price
procedures, enables you to test their outcomes and determine action shown in Figure 2 produces different results here sim -
their value. This determination is the goal of the preparation ply because the chart is drawn using a different scale.
Nasdaq 100 index-tracking stock (QQQ), 30-minute
Preparation: Beyond “system testing” 38.60
Pivot high
Testing trade setups is hardly a new idea, and there are
numerous software programs that expedite the process of Entire bar above 1x1 line 2
designing and implementing trading systems. Sometimes, 1 38.40
however, a great deal of computer power can be a bad thing. Trend
We can miss opportunities if we rely on standard system- reversal
testing programs to do all our analysis. Many new traders 38.20
essentially take a trading idea and “ask” the computer to
check it out. If the summary test statistics — net profit, maxi-
mum drawdown, etc. — indicate poor performance, a trader 38.00
will likely toss out the idea.
However, if the testing had been a little more hands on —
for example, incorporating direct observation of the outcome 37.80
of trades on charts and extending the performance analysis 1
beyond the confines of a typical analysis program — then, 3
after a little tweaking, a successful trading approach might 37.60
emerge after all.
All it takes to perform valuable analysis is a spreadsheet
such as Excel. First, print out a series of charts with the signals
1/15/04 1/16/04
that are the basis for your potential trades. Next, import the
same data into Excel, or at least the date, time (if intraday), Source: Fibonacci Trader
open, high, low and close. Then you can set up columns to log
various trade setups, such as “Setup 1-buy,” “Setup 2-buy,” trade. For example, trade number 35 occurred on the close of
“Exit 1,” “Exit 2,” etc. the 12:00 bar. The position reached its maximum open profit of
Most importantly, you can create a column for the maximum 18 cents on the 14:30 bar; this value is entered on the same row
favorable excursion (MFE) and maximum adverse excursion as the trade number in the MFE column. The trade reached its
(MAE) for each trade. The MFE is the difference between the largest open loss of -6 cents on the next bar, and this MAE
setup’s entry price and the position’s largest open profit; the continued on p. 69

ACTIVE TRADER • April 2004 • 68

Spreadsheet analysis allows you to perform a great deal of hands-on analysis. This example
shows the trade date and time, indicator values, price data, trade number, setup, MFE and None of this analysis can be
MAE values, profit or loss, and reason for exit. After compiling this information for all your completed until you have spe-
trades, you can then sort the data and perform in-depth analysis that reveals key informa - cialized on a trade approach
tion about profit targets, stop levels and other aspects of a strategy. and have converted it into pre-
cise entry and exit rules. But
once you have completed these
first two steps — specialization
and preparation — you will
have a very clear understand-
ing of the nature of your strate-
gy. You might discover it is not
as good as it initially appeared,
and avoid rushing into the
market and losing money. Also,
by manually working through
the charts and logging the
information in a spreadsheet,
you have the opportunity to
discover a slight variation on
your original idea that may be
an improvement. This is less
likely to occur if you let the
computer do all of the work.
Source: Excel “Pattern probabilities” (op-
posite page) illustrates another
way to use a spreadsheet to
value is entered in the same row in the MAE column. measure the probabilities of trade setups and determine their
Because the trailing stop was not hit and positions are not value.
held overnight, the trade was exited at the close. Use the same Finally, all this work is an excellent way to develop good
line for key information about each trade (the highlighted skills for trading when the market is actually open. It is similar
rows). This will help later when you want to sort the data by to a basketball player spending hours in the gym shooting
trade number. The final two columns contain the trade’s profit nothing but foul shots so he is confident and behaves auto-
or loss (P/L) and the reason for the exit. matically during the pressure of a real game.
The other three trades were based on a different setup (L-2) Once you have tested your ideas and identified high-proba-
and two of them were stopped out using a trailing stop. The bility targets from the entry setups and risk points for manag-
last trade shown was exited on the close. ing the trade, you are ready for the execution phase.
Anatural question is how many trade examples are necessary
to draw meaningful conclusions about a trade setup. But the Implementing the strategy
more important issue is different types of market conditions. At this point, you have a collection of procedures to follow and
First, you should review a setup using price data that has can trade objectively and consistently. You have moved away
uptrends, downtrends, trend reversals and trading ranges. from trading by the seat of your pants, jumping from one tech-
Avoid testing in a period dominated by one price direction. That nique to the next and wondering why you experience incon-
said, gathering information on at least 100 trades is a good start. sistent results using a patchwork collection of strategies.
At this point you can begin to do some interesting work. For With this framework you no longer have to concern yourself
example, you can copy all the trades and paste their values in with forecasting the markets; simply follow your tested proce-
another spreadsheet page and sort the data different ways. For continued on p. 70
example, you could sort by trade number, then by MFE to see if
there is a price target value that has a high probability of being hit
on a regular basis. In Figure 4, the MFE was more than 10 cents for Additional research
three of the trades. If you had 100 trade examples, you might find The MFE and MAE analysis concept is from John Sweeney’s
the market was making a favorable move of 10 cents at least 60 book, Campaign Trading: Tactics and Strategies to Exploit
percent of the time. If the corresponding MAE is low — meaning, the Markets (1996, John Wiley & Sons).
the trade isn’t going against you more than it is going in your
favor — then you have a potentially viable trade idea. Trading in the Zone by Mark Douglas (2001, Prentice Hall
Similarly, you could sort by MAE and determine at what point Press) is a good source of information on the value of
you should abandon a trade because a majority of trades that hit thinking and trading in probabilities.
a particular MAE level do not recover to be winners. Other ideas “On-target trading,” Active Trader, July 2001, p. 44.
to consider are sorting trades by the type of setup or time of day
“Taking the guesswork out of stop orders,” Active Trader,
to determine if there is a particular time that works best for a par-
October 2001, p. 58.
ticular setup.

69 • April 2004 • ACTIVE TRADER

dures. This will relieve you of the psychological pressure of The three steps outlined here — specialization, preparation
being right or wrong on any one trade. You will be trading based and execution — reflect the same basic process that carries peo-
on probabilities that have been proven over dozens of trades. ple in a wide range of disciplines from the novice to profes-
But that doesn’t mean the work is over. sional stage. Moving from broad-based approaches to special-
ized techniques that are converted to procedures with proba-
Going forward bility-based outcomes puts you in a position to succeed.
It is important to continue to update your spreadsheet with It takes a lot of work, but the end result is having the skills
real-time trades. Markets change, and if you begin to see to be consistent, regardless of the trading approach you use.Ý
results that are inconsistent with your original analysis, you
can spot this before it becomes a real problem.

Pattern probabilities

A nother way to use a spreadsheet is to determine the

probabilities of a price pattern before you even
design specific rules for trading it.
Figure 5 (below) shows an excerpt from a spreadsheet that
shows several statistics — the average price move, median
These conditions are shown in the formula bar (for cell F22) as:

1. (C22-C21)/C21>0.01
2. E22<E21
3. (E22-D22)/(C22-D22)<0.10
price move, the maximum price move and the minimum price
move — in the three days following the completion of a price Each condition is preceded by the “IF” function, and the
pattern. “1,0” at the end of the argument indicates that if all the con-
To perform this kind of analysis, you must first import the ditions are true, “1” will be entered in the appropriate cell in
open-high-low-close price data for the period you wish to test the F column; if even one of the conditions is false, “0” will
(the “open” column is hidden here). The period here spans be entered. By dragging this formula to fill all the cells in col-
May 31, 2000, to Dec. 13, 2000; many of the rows are hidden umn F, each bar that fulfills the pattern criteria will be
to conserve space. flagged with a 1. (Alternately, if you have programmed the
Column F contains the pattern’s conditions. In Excel, it is pattern conditions into your analysis software, you will be
easy to string together several “If” conditions that describe aable to automatically include this information when you
offload the price data to the spreadsheet.)
pattern. In this case, the pattern is a bar with three conditions:
Columns G-O contain the close-to-close price moves, MAE
1. The high must be at least one percent above the previous and MFE values for the three days after each pattern occur-
high; rence. Dragging the formulas makes calculating the numbers
2. The close must be below the previous close; for the sheet a very simple process. This analysis could be car-
3. The close must be in the bottom 10 percent of the price ried out for as many days as you wish. Also shown is the total
bar. number of patterns that occurred.
For example, row 22 holds the data for
FIGURE 5 BASIC PATTERN TEST the Oct. 24, 2000, pattern and shows the
market dropped 1.89 percent the day
Column F contains the pattern criteria. The remaining columns show the after the pattern (day 1), had an MFE of
closing price differences, and MFE and MAE values for qualifying price bars. .69 percent and an MAE of -2.40 percent.
By the close of day 2, however, the mar-
ket had risen 1.57 percent, and so on.
The summary statistics at the bottom
allow you to judge the probabilities of
the raw pattern signal. These are only
examples of the kinds of statistics you
could include. Others are the percentage
of positive and negative returns at each
time interval, a separate breakdown of
positive returns and negative returns,
and so on.
If a pattern’s probabilities are favor-
able, you can then proceed to developing
and testing trading rules to maximize the
pattern’s potential.

Source: Excel — Active Trader Staff

70 • April 2004 • ACTIVE TRADER

TRADING Strategies


and the QQQ
One way to gauge how the market
might move is to analyze its
characteristics when it’s going nowhere.


The price of the Nasdaq 100 index-tracking stock is nchanged volume is the volume of stocks with
shown here with the level of unchanged volume below. prices that are unchanged from the previous
day’s close. It is one of three components of the
Nasdaq 100 index-tracking stock (QQQ), daily total trading volume provided by the New York
A B Stock Exchange and the Nasdaq. The other two are up volume,
which is the total volume of those stocks currently up on the
C 38.50 day, and down volume, which is the total volume for stocks
down on the day.
“Trend, consolidations and unchanged volume” (Active
38.00 Trader, October 2003, p. 44) analyzed the NYSE unchanged vol-
ume to see if it highlighted trading opportunities in the S&P
500. The research showed high unchanged volume readings
corresponded to the market being in a balanced state, or what
E 37.50 typically takes the form of a congestion period. Seasoned
F traders know trends emerge from such periods, and if the mar-
ket as a whole is congested at the close of one day, it is worth-
37.00 while to anticipate a trending day the next day.
D Because of its popularity, the price action of the Nasdaq 100
index-tracking stock (QQQ) and the unchanged volume of the
Nasdaq Exchange will be the focus of this analysis.

Choosing a measuring stick

Nasdaq unchanged volume E The first step in the analysis is to determine what constitutes a
100 mil.
F high unchanged volume reading. We looked at 500 daily read-
D 75 mil. ings of the unchanged volume for the Nasdaq beginning on
A 50 mil. March 25, 2002, and ending on March 17, 2004. The lowest was
C G 6.2 million (Feb. 6, 2004) and the highest was 269.6 million
25 mil. shares (July 24, 2002).
By sorting the values from lowest to highest it was possible
20 26 Feb. 2 9 to determine the highest 25 percent of unchanged volume
readings were above 35.01 million shares. Let’s look at some
Source: CQGNet Inc. high unchanged readings and the price action in the Nasdaq

71 • July 2004 • ACTIVE TRADER

100 index-tracking stock the next day to FIGURE 2 PUSHING ABOVE THE HIGH, BELOW THE LOW
see if there are any useful patterns. This diagram shows how far the QQQ rallied above the highs and fell below
the lows of days with 35 million or more shares of unchanged volume.
Sizing up the market
Figure 1 shows the price for QQQ in the 2.00
top window and the closing value for The high is exceeded
Nasdaq unchanged volume in the bot- 1.50
tom window between Jan. 20 and Feb. 9,
2004. Bars A, B and C each had consecu-
tive unchanged volume readings
exceeding 35 million shares.
Bar A was a day the open, high, low 0.50
and close were all below the previous
day’s respective open, high, low and 0.00
close. It would be easy to conclude from
the price action that Bar A was a weak
day relative to the previous day’s price
action. However, the high unchanged
volume reading indicated the selling -1.00
was not widespread for the broad mar- The low is exceeded
ket. -1.50
Bar B climbed 3 cents above bar A’s
high, then reversed to close below the Sources for this and following figures: charts — Excel; data — CQGNet
previous day, although the low was
above the previous day’s low. However, FIGURE 3 UPSIDE FOLLOW-THROUGH
the unchanged volume was again above The rising regression line reflects the increased upside price movement as
the 35-million-share threshold. Over the the unchanged volume level increases.
next two days the market traded up and
then down, with low unchanged vol- 1.8
ume readings that indicated broad mar- The high is exceeded
ket participation. The unchanged vol-
ume readings here did not portend 1.4
much besides the days’ ranges expand-
ing after the high unchanged readings. 1.2
Bar D was the second of two big
down days, and while the market closed 1.0
near its low, the high unchanged vol- 0.8
ume reading indicated the broad market
recovered more than the QQQ. 0.6
Following a higher opening the next
day, the QQQ fell an additional 35 cents 0.4
below the previous day’s low before
recovering and closing higher on the
day. 0.0
Bar E was an outside day (a bar with Lowest Highest
a higher high and lower low than the Unchanged volume
continued on p. 73

ACTIVE TRADER • July 2004 • 72

As was the case when the high was exceeded, the higher the unchanged vol -
ume, the more the QQQ followed through on moves below the low.
The low is exceeded
previous bar), followed by bar F, an
1.0 inside day (a bar with a lower high and
higher low than the previous bar). Both
0.8 days had very high unchanged volume
readings. The next day, the QQQ
gapped down on the open and closed at
its low.
Bar G was an inside day, and the next
0.4 day, when the market broke above bar
G’s high, the rally continued an addi-
0.2 tional 57 cents.

0.0 What does it mean?

Lowest Highest In this example there were two clusters
Unchanged volume of high unchanged-volume days, one of
which (bars E and F) preceded a good
FIGURE 5 MOVES ABOVE THE PREVIOUS HIGH follow-through day. There also were
two, single, high unchanged-volume
After a high unchanged-volume day, the QQQ exceeded that day’s high by 7 days (bars D and G), both of which were
cents or more 75 percent of the time. followed by bars that exceeded the low
1.8 and high by 35 cents and 57 cents,
It appears if the high or low of a bar
1.4 with high unchanged volume is violat-
ed, some follow-through price action
can occur. Let’s look at the data and see
1.0 what the typical price action is follow-
ing a high unchanged-volume reading.
Of the 500 days, using the top 25 per-
0.6 cent of unchanged-volume readings as
the cutoff, there were 125 days that
0.4 exceeded 35 million shares of unchanged
0.2 volume. Of those 125 days, the next day
was an inside day 10 times and an out-
0.0 side day 21 times. Figure 2 (p. 72) dis-
plays the price moves for those days the
high was exceeded and those the low
FIGURE 6 MOVES BELOW THE PREVIOUS LOW was exceeded. (We calculated the differ-
ence between the two highs or two lows;
The QQQ fell 16 cents or more 75 percent of the time after breaking below inside days were excluded.)
the low of a day with high unchanged volume. The average for the days the high was
1.4 broken was a 32-cent move above the
previous high. If the previous day’s low
1.2 was broken, the average move was 36
cents below the previous day’s low. If
1.0 the outside days are removed, the aver-
age move for those days that push
0.8 above the previous day’s high climbs to
36 cents. The average break below the
0.6 previous day’s low increases to 43 cents.
Figure 3 (p. 72) sorts the upside fol-
0.4 low-through moves according to the
unchanged volume levels (from lowest
0.2 to highest) to see if there is any correla-
tion between the level of unchanged
0.0 volume and the follow-through move-
ment when the high is broken. Notice

73 • July 2004 • ACTIVE TRADER

the regression line rises slightly from left
to right, indicating there is a slight bias
for the amount of upside price action as
the unchanged volume climbs.
Figure 4 tells a similar story regarding
what happens when the low is penetrat-
ed. Again, the regression line rises (at a
slightly higher rate compared to the
price action when the high is broken),
indicating a correlation between high
unchanged volume and follow-through
in the direction of the breakout the next
day. The fact the average break when the
low is violated is more than the average
price move when the high is broken (and
the slightly higher rate as the unchanged
volume level climbs) reflects how mar-
kets tend to fall faster than they rise.
Figure 5 shows the price moves
beyond the previous day’s high sorted
from lowest to highest. For those days
the high was violated, the high was 7
cents or more (up to $1.64) above the
previous day’s high 75 percent of the
Figure 6 sorts the drop below the pre-
vious day’s low from lowest to highest
for days following bars with unchanged
volume of 35 million or more. When the
low was broken the market fell 16 cents
or more (up to $1.21) 75 percent of the
time — again, more evidence of how
quickly markets can drop.

Trading implications
One thing that stands out is the opportu-
nity for short-selling traders: A break
below the previous day’s low following
a day with unchanged volume of 35 mil-
lion or more resulted in at least 16 cents
follow-through 75 percent of the time.
Day traders should pay special atten-
tion to those days that follow high
unchanged-volume days because there
were only 10 inside days out of 125.
Therefore, you can expect the high or
low of a day with high unchanged vol-
ume to be violated the next day. You can
use your favorite setups to take advan-
tage of this if the market opens within
the previous day’s range.
This research should be kept up to
date, as market volatility can change.
These numbers could be very different a
year from now.Ý

For information on the author see p. 10.

ACTIVE TRADER • July 2004 • 74