435
Figure 6.2 Buying on the opening Monday.
87winning trades out of a total 758. Thus the average profit per trade is $125 with 57 percent accuracy. Bondsmake money buying on Tuesday opening plus 70 percent of Monday's range with $28,812 profits and 53percent accuracy netting $86 a trade which is a little small, but a better exit technique will radically changethis number (see Figure 6.3). The long and short of all this data is that a simple filter, TDW, enables us todo what the professors say is impossible ... beat the market.To recap, stocks have a proven proclivity to rally on Mondays, Bonds on Tuesdays and virtually allthe grains on Wednesday. To arrive at this opinion, we examined grain prices as far back as 1968 (30 yearsof data), Bonds to 1977 (21 years of data), and the S&P since they began trading in 1982 (17 years). Inshort, we rolled the dice enough to draw some reliable conclusions and observed enough data to determinethere are biases; price is not solely motivated by a drunken sailor's random walk through the pages of theWall Street Journal.From this research, we have a leg up on other traders, an advantage in the game, and a window ofopportunity to focus on when trading. It is not how often you trade that makes you a winner, after all anyfool can trade every day of the week. Old punters like myself know it is how often you don't trade, howselective you are, that will lead to a successful career.Astute traders are probably already asking the next question I will now answer, "If there is a bias tothe TDW could there be a bias to the Trading Day of the Month?"The answer is yes, and here comes the proof. The following results were arrived at by buying/sellingon the opening of the trading day of the month
Figure 6.3 Using a better exit technique.
88shown and exited with either a $2,500 stop in the S&P 500 or $1,500 in the Bonds or on the close the thirdday after entry.The entry day was not the calendar date but the trading day of the month (TDM). A month can have 22trading days, but because of holidays, weekends, and the like, we don't always get 22 days. Our entry rule isto buy or sell on the open of the TDM shown. This means you will have to count how many trading dayshave taken place so far this month to set up the trade.This concept, TDM, is akin to seasonal influences. Most other authors and students of market activityhave focused on calendar days but that approach has inherent problems; if the computer spits out that the15th calendar day is the best for a buy, yet this year the 15th is a Saturday and the day before is a holiday,just when do we take action? On Wednesday, Thursday, or the following Monday? TDM eliminates thisquestion, giving us focus on a specific tradable day.I do not trade these days as exclusively, or should I say, inclusively, as TDWs. I use TDMs as setups,leading indicators of when to take what type of action. I may or may not take a TDM trade, I reservejudgment for that specific trade when that time rolls around. I will want to see what else is going on becausethis is a thinking person's game that deals in reality, not a robotic virtual reality experience. My researchshows that all markets have TDM setup periods where the odds of a rally or decline are definitely tipped inour favor. If you trade markets other than the ones discussed in this book, you should get a computer, orprogrammer, to provide you with this information on your trading vehicles.Indeed, there is a time to sow and a time to reap each week and each month of the year. Some times arebetter than others, but only a very inexperienced trader would blindly take such trades. My strategy is to finda bias such as TDW and TDM and then couple it with another bias to load or stack the deck in my favor.Should you and I play cards, for money, trust me to come with a marked and stacked deck, which is exactlyhow I want to trade; with as many odds in my favor as possible. If the scales are not heavily unbalanced inmy favor, why trade? There are plenty of trades every year that are stacked deck trades, I will wait for themto materialize.Enough said. Tables 6.6 and 6.7 show the best TDMs for Bonds and the S&P 500, respectively.These results are actually staggering. By following some very simple rules, $211,910 of profits couldbe had from trading Bonds just 6 days a month, and $387,320 from trading the S&P a mere 7 days permonth. The S&P results reflect no stop on entry day, but a $2,000 stop after entry day, whereas the Bondsused a $1,500 stop starting on entry day.Although you may not want to blindly follow these trade dates, we certainly want to be awake andaware around these pivotal trading periods because we have a definite advantage in the game-we know whenstrong rallies are most likely to take place.
89Table 6.6Best TDMs for S&P 500 1982-1998
Table 6.7Best TDM's for T-Bonds 1977-1998
Monthly Road MapsTo give you a better feel of how prices usually move during each month of the year, Figure 6.4 shows adaily chart that reflects how price changes on each TDM. Again, these are general outlines of what price hasdone in the past. Like road maps, price may, or may not follow the same pattern this Year and this month.Usually though, these price formats will be followed. Figure 6.4 charts T-Bonds for 1998; underneath theprice activity is a line that reflects the daily movement during each month. No one should expect price tofollow this index exactly, but, it generally follows the ups and downs. This index shown was created on datafrom the past and extended out into 1998. As you can see, the January peak came on schedule as did the Maylows, June rally, and late July pullback.Is this a fluke? Could be, so let's look at another TDM road map, this time for the S&P 500, againcreated on data ending in 1996, and then look at how prices moved in 1998 (see Figure 6.5). Although not aperfect representation, the similarity is remarkable and some excellent "stacked deck" trading time periodsdid appear in the future as the past suggested they might.
90The best example is the major stock market slide that started in July 1998, right on schedule, congruentwith the TDM road map. This index is one of the tools I used to get all my stock subscribers out of themarket in
Figure 6.4 Day T-Bonds (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 6.5 S&P 500 Index (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
91June 1998.I do not believe the past precisely predicts the future. My view is that the past is an indication of whatis likely to happen in the future, thus it is a general guideline, an outline or bias we can and should takeinto consideration. It is time to think about what we should be doing on this day, this month, this year.I am closing this chapter with an actual example from my own trading in 1998. Based on a system Iuse for trading Bonds, I was short a little over 300 contracts of Bonds where the arrows are marked onFigure 6.6. This was not a very good place to be short; price moved against my position to the tune ofalmost $250,000. I was emotionally fraught as my automatic dollar stop was close at hand calling for me toexit and take my licking at 122 22/32nds.Had I not known of this map or pattern I would have been stopped out. But, knowing of the pattern ofweakness usually starting on the 12th TDM, I chose to not only raise my stop to the 122 21/3 2nd area butalso went short on the 2/19 in hopes the TDM influence would come to play as it usually does. Fortunately,the market "knew what to do" and declined from that point until February 24 when my system called forgoing long. I still took a loss on
Figure 6.6 Day T-Bonds (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
92the initial trade, but far less than the one I would have taken had I not known of this market bias.Admittedly, the market could have moved higher; the possibility of being wrong never takes a vacation,which is why I still used a stop. I just slightly altered it based on the information at hand. This is a thinkingbusiness. Always has been, always will be, which is why I am interested in teaching the elements that canlead to successful trading. One of the vital elements I have used with a good degree of success is theTDM/TDW concept. I am not really certain who first came up with this idea-Sheldon Knight, one of thenicest guys and best researchers in the commodities business, or myself. But I think I have relied the most onthe technique.Several of my trading friends reject the TDW concept and insist there is no difference from one day ofthe week to the other. I violently disagree; it is my first building block in determining what I will dotomorrow. The data in this chapter indicate the existence of bias on certain days of the week. It is my job asa trader to maximize this opportunity.
Chapter 7
Patterns to Profit
My evidence that there is method to the madness of market
Chartists have believed that certain patterns or formations on their charts can predict market behavior.For the most part, this crowd has looked at long-term patterns of market activity. Serious students of suchphenomena should start with the Edwards and Magee classic, Technical Trends.In the 1930s, Richard Wyckoff, Owen Taylor Gartley-. and George Seaman (my favorite), spent agreat deal of time on these long-term patterns in an attempt to build a systematic approach to trading. In the1950s Richard Dunnigan took a big step forward by focusing on price patterns of 10 to 15 days while theolder crowd was still looking at 30- to 60-day price patterns.As mentioned, these same price patterns con be found in any activity. Flip a coin, chart it, and you willsee the same formation, found on a Pork Belly or Corn chart' This has turned some analysts price structureanalysis and for good reason; enerally speaking, these do not forecast or tell us much about the future. Thismay be because there is no predictable ability in chart formations, or the time period studied is not
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94correct. W. L. Linden, writing in Forbes magazine, found that economic forecasts made by leadingeconomists have consistently been incorrect at virtually every major turning point since the 1970s. Achilling thought here is that the study included forecasts done by Townsend-Greenspan-the latter name isthat of the man who became head of the Federal Reserve System (the world's most powerful privatecorporation), Alan Greenspan.The only ray of hope to be found in the article is the statement that these forecasts were correct in onlya short time frame. This makes sense; it is far easier to forecast the next 5 minutes of your life than the next5 years. AS time progresses, more variables, more change, comes into play. Hence forecasts stumble in theunknown dark, black holes of the future altering what was once known or thought to be the path ofrighteousness.I guess this may explain why I have actually made money (for many years I might add), trading off ofpatterns. The patterns I have used are for calling very short-term market fluctuations of from 1 to 5 days.There may be some grand scheme of things, some master pattern of all major market highs and lows. If so, ithas never been revealed to me, but certainly there are many short-term market patterns that give you a big-in some cases, I would go so far as saying huge-advantage in the game.
The Common ElementFirst, I need to prove that patterns can and do work or at least bring an advantage to the table, a cowfor us to milk. Then I can tell you why I think these patterns do work, what the method to the madness is,what my working premise to these patterns to profits is all about.Let's start with a basic pattern using the S&P 500, a broadly traded market. What we know is that 50percent of the time this market should close up for the day, 50 percent of the time down for the day. Whatwill happen tomorrow on any given day is supposed to be a coin flip, if we don't consider TDW.Patterns can change all that rather dramatically.We begin by establishing a basic parameter. What happens if we buy the S&P 500 every day and exiton the next close with a $3,2 50 stop? From July 1982 through February 1998, there were 2,064 trades with52 percent accuracy and an average profit per trade of $134.Now we add our first pattern, what if we only buy tomorrow if today closed down? In this case, therewere 1,334 trades with the same 52 percent accuracy, but the average profit per trade escalated to $212.Finally, if our pattern consists of three consecutive down closes, the accuracy jumps to 58 percent to 248trades and the average profit per trade skyrockets to $353 Could it be there is something to this pattern stuff?
95Let's mock up a simple pattern to see what happens tomorrow if the following conditions exist: First,we want today's price to be greater than the close 30 days ago so we are in some sort of up trend. Next, wewould like to have seen a slight pullback against the uptrend so we will want today's close lower than theclose 9 days ago. If that condition exists, we will buy on the open tomorrow and exit on the next day'sclose. If the market is really random, 52 percent of such trades should make money (not 50% becauseduring the time period of the study there had been an overall trend bias to rally best evidenced by the factthat the initial study showed higher closes 52% of the time).The facts of the matter are far different. This meek little pattern produced 354 trades with 57 percentaccuracy and an average profit of $421 a trade. Accuracy jumps from 52 percent to 57 percent and theaverage profit per trade increases almost fourfold! Hold on to your hat, it gets better.If we combine a pattern with our trade-day-of-the-week concept and take these pattern trades on justMonday, the accuracy goes to 59 percent and average profit to $672. I rest my case; patterns and days ofthe week can be a helpful trading tool or advantage for the short-term trader.The best patterns I have found have a common element tying them together patterns that representextreme market emotions reliably set up trades for price swings in the opposite direction.In other words, what the public "sees" on their charts as being negative is most often apt to be positivefor short-term market moves and vice versa. A case in point is an outside day with a down close. The day'shigh is greater than the previous day's high and the low is lower than the previous day's low and the close isbelow the previous day's low. This looks bad, like the sky is indeed falling in. In fact, the books I have readsay this is an excellent sell s ignal, that such a wild swing is a sign of a market reversal in favor of thedirection of the close, in this case down.Whoever writes these books does not spend much time looking at price charts! As Figure 7.1 of theDollar Index shows, this can be a very bullish pattern or market configuration.Reality is far different than conjecture as a quick computer test shows and reveals the power of one ofmy favorite short-term patterns. It does not take much to prove the validity of patterns or to check to seewhat is really going on. Given this outside day pattern I have noticed, there is a final filter, or event that canhappen to further influence the pattern tomorrow. This event is the direction of tomorrow's opening, asshown in Figure 7.2. If, in the S&P 500 index, tomorrow opens lower than the outside day's down close andwe buy on the next day's opening, we find 109 occurrences with 85 percent accuracy making $52,062 and$477 a trade.
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Figure 7.1 U.S. Dollar (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 7.2 A bullish pattern.
97If we buy on any day but Thursday, a day we know tends to see selling pressures spilling over intoFriday, we make a little less, $50,037 but bump our average profit per trade up to $555 and increaseaccuracy to 86 percent with drawdown going from $8,000 to $6,000. These results use a $2,000 stop toexit or the first profitable opening exit rule.We can use this same pattern for setting up trading opportunities in the Bond market as well. Thispattern is so powerful that it can be used in all markets as a stand-alone trading formation, butstacked-deck Larry still prefers to have additional confirmation to make certain I use only the best of thebest trades. Figure 7.4 shows the results of taking all outside day down closes followed by a loweropening the next day in Bonds. To get out of the trade, we will take a $1,500 loss or exit on the firstprofitable opening. Few traders realize that such a mechanical approach to trading can be so good, wescore an 82 percent accuracy and $212 average profit per trade on the 57 occurrences since 1990.Can we make this a better performing pattern? You bet. Got any ideas how? You should by now, infact, you are probably wondering whether the pattern is better on some days of the week than others. It is.If we take the trade on any day but Thursday, just as in the previous S&P results, we skyrocket theaccuracy to 90 percent and make $17,245 on 41 trades for an average profit per trade of $420 (see Figure7.5). Folks, it doesn't get much better than this.
Figure 7.3 Using the first profitable opening exit rule.
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Figure 7.4 All outside day down closes.
The problem is these outside day patterns do not occur as often as we would like! The next time yousee an outside day with a down close lower than the previous day, don't get scared, get ready to buy!Time for another bullish looking pattern in the S&P 500. We will now look for any day that closesabove the previous day's high and is preceded by two consecutive up closes, making it the third up day in arow (see Figure 7.5). Such seemingly strong showings of strength have been known to lure the public intobuying.
Figure 7.5 Trade on any day but Thursday.
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Figure 7.6 A close that is above the day's high.For example, checking this pattern from 1986 to 1998 in the S&P 500, there were 25 occurrences ofthis pattern on Tuesday setting up sells for Wednesday. Of these, 19 were winners, netting $21,487. In theBond market, the same pattern set up 28 trades on Thursday, to sell on Friday, making $13,303 whichchallenges the random walk professors with a thoughtprovoking 89 percent accuracy. The Bond test was ondata from 1989 to August 1998! A $1,500 stop was used in Bonds, $2,000 in the S&P 500.For both markets, we used the simple bailout exit I will teach later. There are several major short-termpatterns like this that I take advantage of in my trading. The search is on each day to see what the currentpattern foretells. I have some stock patterns that I have used for years, but am always on the lookout for newones.
The Questions to AskPatterns work. I know. I have cataloged hundreds of them over the years and suggest you do thesame starting with the ones I am providing here. It is best to think about why these patterns work. What dothey represent? Can I find the pattern at work in all markets? Does the trading day of the week matter?
100Those are my stock questions, but the underlying germ of truth I am looking for is some visualpattern that emotionally sucks the public into buying or selling at just the wrong time ... for them ... and righttime for me. Understanding emotions as reflected on charts is the key to "chart reading." "Trader Rick," arecent seminar attendee, E-mailed me this note as I was writing this section. Read it to understand what tolook for and reflect on yourself at the same time:Would you like yet another story that proves you should not be an emotional trader? Well here goes,you'll find it interesting.Last weekend I decided to place a buy stop in May Copper at 77.80, first thing Monday morning.Shortly after Copper opened I called my broker (unfortunately my regular broker does not come in untilaround 8 A.M.) and asked, "What's Copper called this morning?" He replied, "I don't follow Copper, I reallydon't know, I'd have to look it up. . ." (Oh brother, never mind)."OK," I said, "what's the last price?" and was told it was trading at 77.00 down from 77.90, this toldme price had already gone above my stop so I thought I'd wait for a pullback.I called back later, price was at 77.30. Again, I did nothing. Why you ask? I really don't know, except Ithought I'd "watch the market" to see what 1 should do. The funny thing is I now know if it went higher Iwould have waited for a pullback, if it went lower I would have been afraid to buy. Up or down would scareme out, and that's just what happened! What would I have "seen" anyway, handwriting from God?Later in the day I called back, now Copper was at 80.30. "Damn ... OK, buy one at the market." Now Iknew Copper was really hot, and buying it violated everything you had taught us that weekend. Butsomething, almost a mysterious force, "pushed" me into the trade. I bought pretty much at the high of theday, because I was upset I bad not gotten in earlier.The very next day Copper began a pullback, fortunately it eventually went higher, but it cost me $500.Dumb, dumb, dumb. Haven't I learned anything yet? Yeah, I have, it's simply this, Plan your trades and don'tdeviate, don't let emotions push your over the cliff at just the wrong time.Rick's comments kind of reminded me of fishing, how I'll toss a worm in and wiggle it just a little, nobite, then a little more, still no bites, then just a little twitch and ... Blam! I've hooked a nice fish. The marketseems to hook us just like a fish with those little wiggles until we just can't resist and fall for it; hook, line,and sinker. The problem is that this is not catch and release, it is bite and lose, no more "forced feedingfrenzies" for me! The next time old man greed taps you on the shoulder or your hear an emotional call luringyou to the bait ... don't bite!
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My Smash Day PatternsThe siren song of greed is what keeps the public on the losing side of the ledger in this business. Thatis bad for them but good for us if we can figure out what it is that gets them to bite, what sucks them intowrong decisions. One such "event" is what I have labeled smash day reversals. These are days where themarket has a major break, up or down, this violent action pulls the public in to the foray.There are two types of smash days. The first is pretty obvious. A "smash day buy setup" consists of aday that closes lower than the previous day's low, a "naked close" is what Joe Stowell, who's got a greateye for charts, calls these. Such days may take out the previous 3 to 8 days' lows as well. To the chartist,the public, or professional technical analyst, this looks like a breakout to the downside, thus the extremeselling brings them to the table.Sometimes they are right, but usually dead wrong if the market immediately reverses itself.A smash day sell setup is just the opposite (see Figure 7.7). Here what you will be looking for is a daythat closes above the prior day's high and most likely "breaks" out to the upside to close above a tradingrange. This is the twitching worm that causes the public to leap before they look. The illustration showshow this usually looks. What you have here are the buy and sell setups.
Figure 7.7 A smash day sell setup.
102As mentioned, sometimes this is a valid break. However, if the very next day price moves opposite thesmash day and trades above the high of a down close smash day you have great buy signal. By the sametoken, a smash day up, one of those strong closes above the prior day's high, alerts us to sell signal if thevery next day price trades to the smash day's low.The phenomenon is that there is an immediate reversal the very next day, which means the public(sellers on the down close, buyers on the up close) are now in a world of hurt; their envisioned breakout hasfailed! They swallowed the hook, again, and now price responds with a reversal giving us an excellent entry.That is the pattern and the rationale, the reason it should work. I am a firm believer that when what "shouldhappen in the market doesn't" we have powerful evidence to take a trade in alignment with the newinformation.I have selected a few examples of this pattern at work (Figures 7.8 and 7.9). Once we review the othertype of smash day reversal, I will explain how I use this pattern.My second smash day reversal (Figure 7.10) is a bit more difficult to identify but works on the sameprinciple of the market not following through on one day's action and reversing the very next day. Thepattern you will be looking for, to establish a buy setup, will be a day that has an up close, not a naked downclose. But, and this is the key or secret to the pattern, the day's close will be in the lower 25 percent of the upday's range and will also be closing below the opening of the day in the very best patterns. I call this a"hidden smash day" because of the up close.
Figure 7.8 Smash day pattern at work.
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Figure 7.9 Another smash day pattern example.
What has happened on these days is that price has either opened much higher and then closed up forthe day but way off the highs, or opened a little higher, rallied way up and then failed to hold the day'sgains. Sure, it closed up a little for the day but way below the high. The buyers got smashed, in eitherpattern, and chartists will now come in looking for the kill.Only to be killed themselves-if the next day-price rallies back and takes out this smash day high. Againwe see the pattern of a market failure immediately reversed the very next day. This is a most bullish set of
Figure 7.10 A hidden smash day buy.
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Figure 7.11 A hidden smash day sell.
events and calls for going long-if the stage has been set for a rally by our background tools such asTDW TDMMarket relationships, overbought/oversold, and trend.A hidden smash day sell is just the opposite. Look for a down close that is in the upper 25 percent of the day'srange and above the open of the day. Our entry comes when price falls below the hidden smash day's low thevery next day indicating the rally has failed. A quick look at Figure 7.11 should establish what this patternlooks like.
How to Use Smash Day PatternsThere are two ways to use these patterns. Let's first look at the pattern in sharp up and downtrends,trends you wish You were in or where you want to add a position. In such tight trend up moves theappearance of a smash down day, hidden or not, sets up our buy for the following day and is precise evidencethe trend is intact and ready for traders to have another go at it. another race to the sun.In a downtrend, the reverse situation will be found to produce excellent indications of when to getback aboard the decline. Here you will be looking for either the naked up close day or a down day thatcloses in the top of its range. If the very next day prices smash below that day's low. it is time to get short.
105The examples shown here should help you understand the importance of this technique.The other way I like to use these smash day setups is to look for a market that has been in a choppy tradingrange. I then note a smash day and act accordingly once the high or low of the smash day is penetrated. Mythinking is that we will probably see a breakout of the congestion if the smash day is immediately reversed.Such action is suggestive of a market that moved to where all the stops were, and elected all the "breakoutbabies" who had orders there. The breakout is a magnet for the public to take action and they do. What killsthem is the immediate reversal the very next day. They cannot believe their “Iuck" and decide to hold ondespite the reversal; a few days later, they pitch their positions adding fuel to the move we hooked up withthanks to the smash day pattern.Confucius must have been a chartist when he said that one picture (one chart) is worth a thousand words. Ihave marked off examples of the smash day pattern in trading ranges for your study. These appear as Figures7.12 through 7.17.
Figure 7.12 Comex Silver (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 7.17 CBT Wheat (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Specialists' TrapHere is a pattern that uses the smash day idea in yet another fashion. This idea comes fromRichard Wyckoff who authored a course on stock trading in the 1930s. I have a good degree of affinity forwork, because in 1966 and 1967, I worked right across from the library in Carmel, California, whereWyckoff wrote much of the material that in later years he donated to the library. As fate would have it, Istumbled on his donation on my lunch hour one day and there after broke bread with his writings for the nextyear.The Wyckoff concept is that markets are "manipulated" perhaps not by a manipulator, as you wouldthink, but more by a collective consciousness, the great anamorphic "them" or "they." This group of"them," Wycoff teaches, moves the market to draw the public into the game at the wrong times. Thespecialists on the floor of the New York Stock Exchange, who keep book on stocks, have often been accusedof "running" and rigging prices to trap the public, hence my, term "specialists' trap," but I do not assign any,manipulation to them, only to a much more cosmic notion of price movement. I know specialists: one, BillAbhrams, has been a friend for 15 vears and has convincingly proven to me they do not rig stock prices.
109The selling "trap" consists of a nice uptrending market that moves sideways in a box or congestion for 5 to10 days, then breaks out to the upside with a naked close above the entire trading range. The true low of thebreakout day then becomes a critical point. If it is broken below, or taken out in the next 1 to 3 days, there isa great probability the upside breakout was false