definitive trend or price reversal tooccur; and then I act on that signal and carry a position until the marketdemonstrates a loss in momentum, the time to exit the trade. The keys towinning are the ability to practice patience and wait for the setup to develop and the discipline to act on the trigger. Mostly, it is the ability to exita losing trade as the signals dictate, not to hang onto the loser. So whenusing a system, you will know and understand that the mechanics are never100 percent right and that you will have a certain number of trades that donot work out. Once you come to grips with that fact, it will be easier to embrace your losses rather than become emotionally wrangled when theyoccur. Hopefully, you can learn from a trader with long-term positive experiences. Good advice will get you ahead more quickly than if you have tolearn everything on your own, and it will help you avoid costly mistakes.Take my advice: Learn a system, back-test it to see the strengths and weakness of the method, and then trade on these testable signals.
SEASONAL STOCK SYSTEMJeff Hirsch and his father, Yale, who publish Stock Trader’s Almanac(Wiley, 2004, 2005), reveal many top-notch statistical studies based on past
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historic price action. Many of their strategies are based on seasonal factorsthat help stock pickers time the markets. One of the methods they promoteis using a simple MACD developed by Gerald Appel to better time entriesand exits during the best six-month period for stocks, which starts in October. Once a market bottoms out and develops in an uptrend, the MACDindicator triggers confirmation that a price reversal is underway. TheMACD signals help traders time their entries. However, as we uncovered inprior chapters, it is a lagging indicator. With that said, I believe what canmake that buying program or system more effective is to add and apply aweekly and/or monthly pivot point study. This may give a trader an edge byadding another dimensional element that combines the seasonal factor fortiming with targeting a price level from pivot points. Using this approachcan help light the path to a trading system that a trader can back-test on hisor her own through software such as Genesis.
HISTORY LESSONSI want to combine the lessons on how to choose the right pivot point support and resistance numbers with how those values relate to the market direction number. This can help you determine if the market has departedtoo far from the mean or too far from what I call the “fair value” of the market. Start by examining the past price history. Once you see where the market was and how far the market has moved in a given length of time (paceof price change), you can possibly determine the realm of reality of wherea target level of support may be located. You can use this information to determine if a market is significantly overbought or, as we will show in thisexample, oversold and ripe for a buying opportunity. When a market is significantly oversold, the conditions exist for a consolidation phase and a reversal of trend, especially when we have a seasonal condition. Thisconcept applies in commodities, stocks, and foreign exchange (forex) markets as well.Let’s take a look at how the bottom formed in the stock market in October 2005 as we review and expand on the Stock Trader’s Almanac MACDsignal. Figure 11.1 is my sheet from the week ending October 14. We usethis sheet as a quick reference so I can see what the past week’s high, low,and close were. The pivot point is displayed in the far right column. We seethat in the prior week, the high in Standard & Poor’s (S&P) was 1239. Thepivot point is 1208, and the pivot point moving average is 1220.58 (rounddown to 1220.50). The indication is that the market is bearish, so we wouldlook at the Bearish Target column and see 1155. Here is where back-testingsoftware may help you determine what the largest price range is in a given
284FIGURE 11.1Used with permission of www.nationalfutures.com.
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week in the S&P on a historic basis. Why is that relevant? Because I wantto know if 1155 is an unrealstic number to hit if the market was at 1239 andthe standard range was 40 points. From the prior week’s high to the projected bearish S-2 target low, that would be an 84.00-point price decline.Not unheard of but not realistic, at least not in one week’s trading period.At the very least, we need to see how the market reacts at the S-1 target support number, 1177.50, labeled as the Target Key Number, which is the S-1pivot number.On further examination, we see the market closed the week ending10/07/2005 at 1200. So sometime in the following week, I want to heightenmy awareness or program a system to alert me to when or if the marketreaches that level and if a buy signal exists at or near 1177.50, such as if ahammer or doji is present within five points above or below that level. Afterall, we have a decent sample of statistics that reveal that these two candlepatterns form at or near the lows in e-mini–S&Ps a high percentage of thetime on an intraday 15-minute period.The low was made on 10/13/2005 at 1172; it closed that day back abovethe pivot support at 1178.25. The next session formed a high close doji(HCD). Using the HCD pattern and trading by the rules, you would havebought at 1189.75; and your risk was a stop on a close below the doji low,which was at 1172. The most pressure you took on a futures position tradewas from your entry price to the lowest low on a pull-back was when itretested the low at 1174, which is 16 points. The stop-close-only order wasthe correct risk mechanism for this position trade. Using a seasonal factorcombined with pivot point analysis helped traders pinpoint both the timeand the price of a particular market; and in using historical seasonal information, traders would possibly want to employ a longer-term risk-andreward strategy. Even if you are a one-day or swing trader, seasonal factorscan help identify the side of the market to be on, like in a bullish environment to look to buy breaks. My point is that if you are a position trader,your risks and reward objectives should be greater than those of a daytrader. Here we have a trading opportunity based on several factors. All weneed to do now is select a strategy.
WHICH STRATEGY TO SELECT?If buying the futures markets seemed too risky, you at least have a situationwhere you can explore longer-term low-risk/high-reward options strategies such as S&P call options. That was my recommendation in my weeklynewsletter. You could apply this analysis to buy Standard & Poor’s Depositary Receipts (SPDRs), Diamonds, Nasdaq QQQs, or options on those
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
exchange traded funds. That is one reason why I spent time going overthose products in Chapter 1. Seriously, if you are just a day trader in futures or forex or simply a stock trader, diversification is a trader’s bestfriend. Anyone who is after profits and making money can apply thesetechniques. To any investment vehicle, a trading system can be programmed to alert you when dojis form near pivots support or resistancelevels. Moving average crossover features using various parameter settingscan also be applied. This form of market analysis is adaptable and very versatile for integrating in a trading system.
WHAT ABOUT THE MACD?Pivot point analysis enhances what Stock Trader’s Almanac reveals. Looking at the chart again in Figure 11.2, you see how the MACD indicator gavea buy signal triggered by the zero-line crossover and a moving averagecrossover on October 24. This was generated on the close at 1202.25. Not
FIGURE 11.2Used with permission of esignal.com.
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knowing the risk you want to take with the MACD seasonal buy signal, ifyou bought at that price at that time, the most pressure you took on thetrade was 22 points, slightly more than the high close doji trigger signal.Also the MACD signal came a bit later. This is why all traders can use pivotpoint support and resistance analysis to help time trades better with bothelements, time and price.I went over how to use the pivot point as a moving average in Chapter6. In Figure 11.3, I took the liberty of highlighting the pivot point to illustratethe slope (or direction) of the moving average. Once the market hits thepivot support, the market moves in a consolidation phase; but the pivotpoint average is sloping higher, indicating a bullish bias. Granted, you always want to see immediate results as a trader; but using the seasonal factors identified by Stock Trader’s Almanac combined with pivot pointsupport targets and a pivot point moving average component gives you amuch better timed entry and method to identify a trend reversal.One more advantage of incorporating the pivot point average is that asthe market finally blasts off, the moving average component generates asell signal and the histogram makes a negative zero-line cross. However,
Pivot point moving averageslopes higher.
Pivot point moving averageslopes higher.
FIGURE 11.3Used with permission of esignal.com.
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
that is the opposite of what prices are showing from the candle patterns, aswe do not see a succession of lower closing lows. In addition, the pivotpoint moving average is sloping higher, once again indicating a bullish bias.From a systems programmer looking for a defined set of rules, when youdevelop your own system, it is important to make sure that your set of criteria or the series of conditions that exist all need to be in sync, such as allmust be generating sell signals, before making your entry or exit triggers.In Figure 11.4, the Genesis Software has my algorithms programmedwith variations of what was covered in this book to show you how youcan develop your own personal “black box” system. As this illustrates,for my day trading program, I use both the 5-minute and the 15-minuteperiods with the e-mini–S&P, the Chicago Board of Trade (CBOT)mini-Dow, 30-year Treasury bonds, euro currency, and the spot forexBritish pound. Except for in this figure, the one chart that is second fromthe right is a 5-minute chart on bonds; and under it is a 15-minute chart onthe euro currency.I use this system to help confirm buy and sell signals, as indicated withthe arrows. When we are at the projected support targets, which the software indicates by green support lines, arrows appear, indicating to go long.The chart on the left is the e-mini–S&P; the 5-minute is on top and the 15minute is beneath it. See how arrows point up simultaneously, which indicates a buy signal, especially as the market is near support. The chartsecond from the left is the mini-Dow with the 5-minute on top and the 15minute beneath it. The 5-minute time period generates a buy signal againstthe pivot point support targets simultaneously with the e-mini–S&P. Thiscorroborates the buy signal, as it has developed in both markets. It is alsoconfirmed in the 15-minute chart beneath it.
WHAT IS THE BEST DAY TRADING CONFIRMATIONTRIGGER TO PROGRAM?The most reliable trading signal is when the 5-minute time period triggersa buy when the 15-minute time period is also in a buy mode; in other words,the best signals are when the 5-minute period is in sync with the 15-minutetime period in a pivot point moving average crossover system. We see thisoccur as it applies to day trading the spot forex British pound as the chartin Figure 11.4 shows. Look on the right-hand side of the chart; in the upperright-hand corner is the 5-minute period, and directly below it is the 15minute chart. See how the 5-minute generates the sell signal first, as it isagainst the projected pivot point resistance targets; and the 15-minute chartbeneath it confirms that sell signal. This is exactly what we want to see—a
289
FIGURE 11.4Used with permission of www.GenesisFT.com.
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
sell signal triggered against resistance; and the higher time period, such asthe 15-minute component to the 5-minute sell signal, confirming that action.
SHOW ME THE PROOFAs a systems trader, once you have set your variables or your best selectedset of rules or criteria and have defined the parameters such as time periods, then you can go and back-test the method. I want to show you that anysystem worth following needs to show sizable profits with reasonable risks.No system is 100 percent accurate, at least none that I know of in reality. Ifone existed, I would believe through the laws of probabilities that it wasdue for a breakdown. There are several categories on which you want tofocus that will enlighten you as to the true validity of the methods. Inessence, back-testing allows you to closely examine your system’s inefficiencies so you can correct the flaws. Looking at the back-test results willalso help you understand when to increase position sizes, when to avoidtrading, and how to facilitate improvements.You want to see if the reasons you make decisions to execute a tradeconsistently generate more profits when you are right than losses when thesystem or trade fails. If less than 70 percent of trades result in winningtrades, you want the winners to outgain the losses. It makes no sense tohave a 70 percent winning system that generates more losses than winnersand longer holding periods. Imagine what that will do to your psyche, not tomention your trading account.It is important that you understand what elements trigger a trade whenthe transaction is entered or exited. This helps in determining another wayto account for slippage. For example, if the system generates buy and sellsignals on the close or on the next open, if this is a day trading program,then there may be less chance for price gaps. However, if the system executes based on the closing price or on the next open, such as what we havedisclosed in the high close doji pattern or the low close doji pattern, then onovernight positions you may experience poor entry or exits. With thatknowledge, you can change your program to include the next availableopen, which would include night sessions.Let me clarify what the night session is for various trading vehicles. Aswe know, there is no official close in spot foreign currencies. Therefore,you need to assign a daily close and then an open. In Chapter 1, I revealedthat I use the New York Bank settlement of 5 P.M. (ET) and use the open asthe next five-minute interval. As for futures, different exchanges on whichvarious markets trade have specific official closes and reopens for theirafter-hours trading markets. The Chicago Mercantile Exchange (CME) has
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GLOBEX, the CBOT has the e-CBOT, and the New Mercantile Exchange(NYMEX) started using the CME’s electronic trading platform in June 2006.The partnership between the CME and the NYMEX begins a 10-year dealthat allows the NYMEX to use the CME’s GLOBEX platform to electronically trade both energy and metal futures and options. This promises to givebetter access to traders worldwide for those specific markets.If you are reading this book, I assume that you already know the various market hours; but if not, visit www.nationalfutures.com, where theyare listed under Trading Tools, which has the current margin requirements,contract specifications, and trading hours listed. In Table 11.1, I have a description of the categories that are important in helping to determine a system’s validity.In Table 11.2, we have results from a pivot point moving averagesystem I developed with the help of Pete Kilman at Genesis. It is what Icall the “Defcon” day traders’ program system. As I stated before, this isnot 100 percent accurate. I do not know of any system that is; but it is a
TABLE 11.1
Determining a System’s Validity
Total net profitPayout ratioAvgerage number ofbars for winnersWin percentKelly ratio
Largest win
Largest loss
Average win tradeAverage losing tradeReturn percent
This number tells you how much the system madeafter slippage, commissions, fees, and losses.This tells you based on a profit/loss the percent thatwinners outpace losers.This category shows what the average time period wasbefore the trade was offset in order to establish aprofit.This figure shows how many winners versus loserswere generated.A math calculation used to derive the number ofcontracts to trade in relation to the ratio of winningtrades to losing trades.This figure shows the largest single winning trade. Welook at this number to see if profits on a single tradeare larger than 20 percent of the overall net profit. If itis, it indicates the trade signals may be invalid.This category helps traders identify if single losses arebigger than winners so they can implement a betterrisk management approach.This shows what to expect on the average-sizewinning trade.This shows what the average-size loss is.This is the percent of profit on the initial size startingaccount.
292TABLE 11.2
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
E-mini–S&P All Trades, from 01/08/2003 to 01/10/2006
Total net profit:Total trades:Average trade:Average # of bars in trade:Average # of trades per year:Max closed-out drawdown:Account size required:Open equity:Total winners:Gross profit:Average win:Largest win:Largest drawdown in win:Average drawdown in win:Average run-up in win:Average run-down in win:Most consecutive wins:Average number ofconsecutive wins:Average number of bars in wins:
$39,538258$15378.8985.7–$4,063$7,913$100164$76,963$469$2,100–$1,663–$271$708–$27192.6076.68
Profit factor ($wins/$losses):Winning percentage:Payout ratio (average win/loss):Z–score (W/L predictability):Percent in the market:Maximum intraday drawdown:Return percent:Kelly ratio:Total losers:Gross loss:Average loss:Largest loss:Largest peak in loss:Average peak in loss:Average run-up in loss:Average run-down in loss:Most consecutive losses:Average number ofconsecutive losses:Average number of bars in losses:
2.0663.6%1.180.874.4%–$4,350499.7%0.326694–$37,425–$398–$1,825$1,938$276$276–$71671.4982.73
fairly reliable and robust system with a 63.6 percent overall win ratio inthe e-mini–S&P 500 futures. The sample testing period was conductedduring open outcry session only, from 9:30 A.M. (ET) until 4:15 P.M. (ET).There were no stops or loss parameters; this was simply a reversal system,which means we were always in the market and out on the close of business. The trades were all done on just one single contract; so we did nothave a money management position scale-up program designed, whichmeans we did not increase lot size as profits accrued. This system is basedon pivot point analysis and the principles outlined in this book; the tradingsignals were based on a 15-minute time period, and the testing period wasthree years.All trade signals were taken from 01/08/2003 to 01/10/2006. This timeperiod was one of the most active trading times in recent decates, so I feelthis was a good sample period to back-test. A starting account was set upwith $10,000, taking one contract per signal. A $50 commission and slippagewere assigned per trade. Generally, the electronic commission rates are aslow as 3.50 and as high as 25, depending on which brokerage firm was used;so again this was an adequate figure to use. With those variables, the systemgenerated close to a 500 percent return. As we examine the system closer,we see it generated 258 trades, of which only 164 were winners. That meanswe must have bigger winners than losers, and we do. The average win is$469, compared to $398 per loss on average. The neat feature in this system
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or with this sample back-test model is that the largest drawdown in wins is1,663. This is the kind of information that will give you a statistical edge intrading. You now know that you have a system that generates buy and sellsignals with a 64 percent win ratio. This information should help you stayemotionally grounded by achieving two things: (1) not getting too upsetwhen losses occur; (2) not overpositioning yourself in trades if and whenyou have a win streak with more than eight or nine consecutive trades.Most people lose big as they see their systems or methods generate hugeprofits many times in a row. They get this feeling that their trading is invincible or impervious to losers. And then, wham, that’s when a drawdown period occurs! Generally, it is at this point that a trader goes from trading 10contracts to 50 contracts. All it takes is one bad trade, and you have wipedaway your trading profits or, worse, your entire trading account.
MONEY MANAGEMENT IS THE KEY TO SUCCESSUsing the Defcon trading system, we started with a trading account balanceof $10,000. The overnight initial speculative margin for the CME’s emini–S&P, as of 2/15/2006 was $3,938 per contract. Therefore, with tradingjust one contract, we had committed 39 percent of our trading capital at anyone time. Since our account starts with $10,000 and the system only generates less than two trades per week, we need to define when it is apropriateto increase our lot sizes. Aha! This is a novel idea and is what truly helpstraders get wealthy—knowing when to fold, hold, or add on.If you look at Figure 11.5, you see a chart with an equity curve showingsome pretty good gains with an occasional bump in the road. Recoverableas it is, a drawdown in profits occurs. Using system analysis can help youdetermine most consecutive wins and losses and what the largest loss is.Armed with that information, you can now go on to trading like a truemegastar professional fund manager—or simply a downright happycamper. Why? Because that information will help you determine the nextlevel of profits you have to build in order to increase your lot size. If you donot manage your money properly and double or quadruple your positionsize before doubling your account size, you could be in for a rude awakening. As you can see, the maximum drawdown experienced is –4,062.50 on11/10/2004. If that was the day you decided to mistakenly increase your lotsize, it may have potentially wiped your account out.In Table 11.2, observe that the largest loss is $1,825. By increasing yourlot size prematurely or or by having an imbalance to largest loss in relationship to account balance, such as having four or more contracts on atany one time, you could wipe out not only your gains but also the majorityof your account. Using statistics and mathematical formulas is what will
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CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 11.5Used with permission of www.GenesisFT.com.
give you an edge in the markets, from both a business stance and an emotional stance. You will be better prepared, and that should help make you abetter trader.In conclusion, one of the greatest values of data derived from back-testing a system is that it will reveal hidden intricacies about the system. Simply having a rudimentary knowledge of placing stop-loss orders is not thedefinition of knowing sound money management techniques. You must expand your knowledge in managing your money properly by either under- oroverleveraging your trading capital. We went over a seasonal trading strategy that Stock Trader’s Almanac uses in the equity markets using theMACD indicator. I showed you how you can optimize that method by introducing the use of pivot point analysis. With the ability of back-testing astrategy, we can back-test this theory on our own; and more important, wecan learn if our system or trading method has a seasonal factor that performs best or worst at certain times of the year. Then, you can also determine, based on your equity size, the number of positions you should haveon while maintaining a proper risk/reward ratio.
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WHEN IS THE BEST TIME TO TRADE?Remember I stated in Chapter 1 that traders need to ask more questions?Well, the more you learn, the more you know what to ask. As a systemstrader, asking how a system performs during different times of the year isa novel idea, especially as seasonal forces can impact a market. Ask questions such as, “When is the best or the worst time to trade?” From a simpleyet elegant standpoint, the answer for day traders in equities is lunchtime.This is substantiated by volume levels generally declining during that timeframe. Forex traders note that trading activity is light from 10 P.M. (ET)until 1:30 A.M. (ET), as we discussed in Chapter 1. What about on a weeklyor monthly basis? When does our system perform best?By tracking trading performance, as shown in Table 11.3, from a historical perspective, we can form an opinion of when the system is at peakperformance or when the market we are trading is in sync with seasonalfactors. There is never a guarantee that past performance is indicative of future results, but we can and do benefit from studying history. Without adoubt, I do not want to go on a major tangent here; but we are trading in anew frontier environment. The new age of technology has more peopletrading online, and more people are more computer savvy. We have an intricate globalization of our economy. Trading partners with China and evenIndia is not like what we had just five years ago. So with that perspective,my opinion is that looking at seasonal tendencies of a market starting from2000 up through 2005 would not be a huge statistical event, but it would bemore relevant than a testing period in 1990 through 1995. With that in mind,we ran a test, as the results show in Figure 11.6, to see which months perform best with the “Defcon III model.”Using the Genesis Software product and asking the right questions(e.g., When is the best time to trade?), I can get a reasonable answer. In fact,I wanted to know which months are the best and which months are theworst in which to trade. Using the Genesis Software, I can run back tests tosee what the performance from a seasonal perspective with the Defconsystem looks like on a monthly performance basis. Using a test period overthe past three years, I am able to conclude that April is a month to avoidtrading! Based on a three-year average, this is the month that consistentlydelivers drawdowns. With that statistical information, I have a slight edgein the market, as it relates with my system. I can make a decision either tolower my contract sizes or to avoid trading entirely. Figure 11.7 shows theyearly breakdown of the compiled results.The more statistics I have, the better prepared I am; and with thatknowledge, I have stacked the odds in my favor. This is the ultimate in trading tools and system designs: being able to identify opportunity and discover the weakest link in my chain of trading system. Table 11.4 dissects
296TABLE 11.3
By Month Report
Jan 28, 2006 21:25:39Name: John Person Defcon IIISymbol: ES1-067Statistic to chart Profit, Position selection, All trades, From date 01/08/2003, To date 01/10/2006.
Month
Trades
JanuaryFebruaryMarchAprilMayJuneJulyAugustSeptemberOctoberNovemberDecember
272221191921231921202323
WinPct
WinAvg
LossAvg
RunUp
RunDown
P/L
P/F
AverageTrade
C/L
MaxLoss
Profit
AverageBars
66.67%68.18%66.67%57.89%78.95%66.67%65.22%63.16%47.62%65.00%47.83%69.57%
$488$408$690$414$418$371$453$502$376$476$508$502
–$369–$273–$732–$609–$256–$393–$117–$516–$267–$554–$413–$300
$734$597$1,075$656$649$575$697$720$630$669$733$736
–$635–$754–$1,113–$922–$619–$946–$309–$782–$545–$946–$647–$536
1.321.490.940.681.630.953.860.971.410.861.231.67
2.643.201.890.936.111.897.241.671.281.601.133.83
$202$191$216–$17$276$117$254$127$39$116$28$258
122214226332
–$1,175–$650–$1,475–$1,825–$500–$1,413–$338–$1,325–$1,375–$1,750–$1,313–$650
$5,450$4,213$4,538–$325$5,238$2,450$5,850$2,413$825$2,313$638$5,938
65.7068.0087.9591.3787.7986.3870.22100.2190.2962.4575.3970.43
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FIGURE 11.6Used with permission of www.GenesisFT.com.
FIGURE 11.7Used with permission of www.GenesisFT.com.
297
298
TABLE 11.4
Monthly History Report
Used with permission of www.GenesisFT.com