<s> Campaign  TradingTactics  and  Strategies  toExploit  the  Markets
John  Sweeney
JOHN  WILEY  &  SONS,  INC.New  York  l  Chichester  l  Brisbane  l  Toronto  l  Singapore
This  book  is  dedicated  to  the  folks  who  provided  the  educationI  didn’t  get  in  business  school:  Jack  Hutson,   Jake   Bernstein,Bruce  Babcock,  Chf   Sherry,  John  Ehlers,   Larry   MacMillan,Martin  Pring,   Ned  Davis,  and  Thorn  Hurtle.  Each  providedsomepracticalpiece   of  the  market  puzzle.  Thanks!
This  text  is  printed  on  acid-free paper.
Copyright  0  1996  by  John  SweeneyPublished  by  John  Wiley&Sons,  Inc.
All  rights  reserved.  Published  simultaneously  in  Canada,
Reproduction  or  translation  of  any  part   of  this  work   beyondthat  permitted  by  Section  107   or  108  of  the  1976  UnjtedStates  Copyright  Act  without  the  permission  of  the  copyrightowner  is  unlawful.  Requests  for  permission  or  furtherinformation  should   be  addressed John  Wiley  &  Sons,  Inc.
to  the  permissions  Department,
This  publication  is  designed  to  provide  accurate  and  authoritativeinformation  in  regard  to  the  subject  matta  covered.  It  is  soldwith  the  understanding  that  the  publisher  is  not  engaged  inrendering  legal,  accounting,  or  other  professional  services  Iflegal  advise  or  other  expert   assistance  is  required,  the  servicesof  a  competent  pmfewianal
  person  should  be  sought.
Sweeney,  John.
Campaign  trading  :  tactics  &  strategies  to  exploit  the  markets  i
by  John  Sweeney.
cn--(Wiley   finance  editions)index.
P.Includes ISBN  0-471-14150-X  (alk.  paper)1. Program trading (Securities) 2. Investment analysis. 3. Stock
exchangesData   prcxessing.   4.  Commodity  exchangeesDataprocessing.  I.   Title.  II.  Series.HG4515.5.S93  332.6’028tic20
1996
96.7807
Printed  in  the  United  States  of  America
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I
Contents
List  of  Illustrations
x i
Introduction  xvii
Stops  xviiMore  Markets  More  TradesPreparing  to  Campaign  xviiiInnovation  xixNinety-Nine  Percent  Perspiration  xx
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1  Campaigning 
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Introduction The  Big  Picture  3Basics  5Campaigning  13Classic  Stages  15Anomalies  22Summary  23
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viii  Contents
Trading the Trend
27
Trends  27Trading  Rules  38Exemplary  Trading  39Summary  39
Handling  the  Bad  News
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How Bad Does It Get?The  Argument  from  ExperienceExemplary  Trading  61Campaign  Wrap-Up  63
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T e s t i n g   6 5
Your  Personal  Experience  66Scientific Process 6768In Sample or Out of Sample69Details  of  Specific  ContractsDetails of New York Light CrudeSummary  103
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Piling  On:  Exploiting  the  Trend
105
Situation  105What’s  Cheap,  What’s  Dear?Summary  Profitability  133Summary  135
106
Reversing  Bad  Trades
137
The  Idea  138Trading  Rules  141Results  141Inspection  142Profitability  of  Reversing  149summary  150
Switching Modes: Trading Ranges
153
Recognizing  Ranging  154Range  Trading  MAE  160
Contents  ix
Results  163Summary  171
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Reversing Out of Ranges
173
Reality  174Results  178Summary  183
9  Minimum  Favorable  Excursion
185
How  Little  Do  Trades  Go  Our  Way?Finding Winners and Minimizing LosersGray  Areas  193Favorable  Excursion  197Campaigning  202
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10  Shifting  the  Odds:  Using  Options
205
Rationale  for  Using  OptionsSetting Up to Use OptionsSkipping  Stops  Using  OptionsTrading  222
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11  Conclusion  to  Campaign  Trading
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Seeing  the  Market  224Campaign  Tactics  224Old  Hands  225
Appendix:  Trading  Charts
227
Index
243
Illustrations
The  Whole  Campaign  41.1Exemplary  MESA  Analysis1.21.3  CRB  MESA  Spectrum  IOTrending  or  Ranging?  141.4Campaign  Trading  141.5Action  in  Crude  161.6Broadening  Range  231.7
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2.12.22.32.42.52.62.72.8
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Trend  to  Flat  TrendPersistence  29Pivot  Points  31Drawing  Trend  LinesRegression  33Cycle  Trend  Line  34GM’s   Averages  35Exemplary  Crude  37
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xii  Illustrations
illustrations  xiii
2.92.10
Weekly  Crude  38Trading  Two  Moving  Averages,  1984-1994
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Price  Excursion  443.13.2 What  Is  MAE?  45Summary  Chart  533.3Smeared  543.4Quarter-Size  Bins  553.5Net Profit vs. Stop Level3.6CrudeMAE   5 83.7Profitability  603.8TheGood   6 23.93.10 TheUgly   6 2
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Profitability of Short Average Add-On Trades 1984-1994
1994  Add-On  Trades  127
5.135.14 MAE  for  Add-On  Trades  1295.155.16 MAE  for  Position  Add-Ons  1315.17 Profit  from  Position  Add-Ons  1325.18 Countertrading  134
6.16.26.36.46.56.66.76.8
141
Profitability  since  Inception  139MAE  Using  Monthly  ContractsReversal  MAE  142Categories  of  Reversal  TradesReversal  Logic  145Profitability  vs.  Days  in  TradeDays from Beginning or End of Underlying Trend TradeDays  in  Trade  vs.  Days  before  Trade
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4.14.24.34.44.54.64.74.84.94.10
5.15.25.35.45.55.65.75.85.95.105.115.12
December  Crude  71Daily  Range  72Perpetual  Ranges  73Volatility  in the December ContractMonthly  Contracts  with  Rollover,  1984-1994Monthly  Crude  MAE  87Monthly  Profitability  87MAE  and  Profitability  December  ContractsDecember Crude MAE,  1984-1994Profitability  vs.  MAE  Using  December  Contracts,  1984-1994
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OEX,  1995  108OEX, 1995 Day-Trading Opportunities1984  Add-On  Trades1 IO1985  Add-On  Trades  1141986Add-On   Trades  1151987  Add-On  Trades  1171988  Add-On  Trades1181989  Add-On  Trades  1201990  Add-On  Trades  1211991  Add-On  Trades  I231992  Add-On  Trades  1241993  Add-On  Trades  126
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Picking  Out  Ranges  155Simple  Definition  of  RangingRanging  Model  158Broadening  Formation  159Range  Whipsaw  160Reversing Out of Range TradingDays  in  Trend  162Establishing  a  Range  163Ranging  Example  164
7.17.27.37.47.57.67.77.87.97.10 Ranging  MAE  1647.11 Detailed  MAE  Breakdown  1657.12 Profitability  vs.  MAE  Stops  1667.13 Profit  over  Time  1677.14 Range  Trading  at  .3  Stop  Level  1677.15 Trading  Ranges  1687.16 Breaking  Out  of  Ranges  1697.17 Days  in  Range  170
8.18.28.3
Reversing  Out  of  Range  Trading  174Exemplary  Reverse  Trade  175A  Disastrous  Reversal  176
xiv  Illustrations
l8ustrations   xv
1986 2311987  2321988 2331989  2341990 2351991  2361992  2371993 2381994  239
A.3A.4A.5A.6A.7A.8A.9A.10A.11A.12 Weekly  240A.13 Monthly  241
Days  in  Trade  1768.4Favorable  Excursion  1778.5Favorable  Excursion  vs.  Range  Size8.6Reversing  Profit  Distribution1798.7Total  Profit/Loss  vs.  Size  of  Win/Loss8.8Reversing  MAE 18 18.98.10 Profit  vs.  MAE  on  Reversing8.11 Cumulative  Profitability  182
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9.1 Moving  Up  Stops  187Hitting  the  Stop  1889.2Defining  MaxFE  1899.39.4 Measuring Favorable ExcursionBad Trades Going Good9.5Sharp  Distinction  1929.6Overlapping  Distributions  1929.7Some  Favorable  Movement  1949.8Less  Favorable  Movement  1949.99.10 Losers  All  195Losers  Hit  Stops  1969.11Protective Stop at .39.129.13 Days  in  Trade  198199Losers’  Daily  Gain  or  Loss9.149.15 Reversal  Winners’  Profit  by  Day9.16 Reversals  without  Outliers  2019.17 Close Up: Winners by Day202
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10.1 Long  the  Underlying  21110.2 Long  the  Option  21210.3 Less  Profit  21310.4 Stop  vs.  Option  21310.5 Values  at  Opening  21410.6 After One-Third of Option’s Life10.7 Almost  at  Expiration  216
215
A.1A.2
1984  2291985  230
Introduction
Up until now, you didn’t really know where to put your stops. Youdidn’t  know  when  to  get  out  or  to  reverse.  You  might  have  hadsome  gut  feeling  for  it,  perhaps  some  support  or  resistance  levelson the chart, or perhaps a money management stop or a parabolicbeing crossed, or maybe you just got a signal in the other direction,but aside from reversing, these were and are vague.
What sense did it make to put your stop at the level every othertrader  was  watching?  Where  did  that  dollar  limit  or  percentage  ofcapital  limit  on  losses  come  from,  truly?  If  you  investigated.  youfound  that  the  foundations  of  these  practices-if  you  could  findany-were  weak.  Nevertheless,  the  trading  maxim  was  “Cut  yourlosses!”  How  to  do  it?
STOPS
Here  are  some  answers:
1.  If  you  look  at  the  market’s  price  behavior  from  the  point  ofentry  of  your  trading  rules,  there  should  be  some  regularity.2. One of those points of regularity is that good trades don’t govery  far  against  you.  Measured  properly,  the  difference  be-
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Introduction
Introduction 
xix
tween  good trades and bad trades tells you where to put yourstops.
3.  Knowing  where  to  put  your  stops  quantifies  your  loss  levels,w-hich  in  turn  gives  you  the  amount  of  capital  you  need  totrade according to the rules you’re considering.
4.  Knowing  the  losses  you  should  be  taking,  you  have  rulesagainst which to measure your performance. If you’re manag-ing  other  traders,  you  have  standards  for  their  performance.
MORE  MARKETS,  MORE  TRADES
Furthermore,  this  technique  works  not  just  for  trend  trades  butalso  for  trades  in  all  phases  of  the  market:  trades  into  a  range,trades against the trend, and trades reversing other trades. In otherwords, the technique makes it possible to trade no matter what themarket is doing.
Trading  all  the  time  is  a  new  ball  game.  You  may  have  severaltypes  of  trades  at  the  same  time.  The  number  of  contracts  orblocks  of  stock  may  vary  by  type  of  trade.  The  instruments  them-selves  may  vary  as  options  or  other  derivatives  are  used.  Perhapsyou’re trading more than one market. and each market has its ownset of effective rules and loss levels. In other words, you’re runninga  complex  but  necessarily  coordinated  trading  campaign,
PREPARING  TO  CAMPAIGN
Running  a  trading  campaign  is  not  like  executing  a  single  tradingrule over and over, and this book doesn’t describe running a cam-paign  Instead,  this  book  shows  by  example  how  to  build  the  basefor  campaigning:  the  measurement  techniques  to  use,  how  to  testtrading rules for effectiveness, and how to pick the types of tradesyou will use in future campaigns. Think of this book as an exampleof  preparing  a  campaign  of  trading.
INNOVATION
I believe the unique argument’ here is that we should try to captureour  experience  in  the  market  with  observational  statistics  (notparametric statistics).’ We are still in the observational stage of de-veloping a theory of market behavior, but that doesn’t stop us fromusing  our  observations  to  quantify  old  saws  like  “cut  your  lossesshort,”  “let  your  profits  run,” and  so  forth.  If  nothing  else,  ourcomputer  power  allows  the  efficient  gathering  of  data  in  volumesunimaginable  even  a  decade  ago.  That’s  experience  in  digital  for-mat.  What  we  make  of  this  experience  depends  on  our  analyticalconstructs.  I  believe  I  can  show  at  least  one  method  of  analysis  ofour  experience  in  the  markets  that  gives  us  quantitative  guides  toour  future  conduct.
The  counterargument  is  that  markets  don’t  behave  consistently,and  therefore,  our  experience  of  markets  cannot  be  consistent.  Inthis  view,  the  multitude  of  random  events  stimulating  the  marketmakes  its  behavior  unpredictable.  If  it’s  unpredictable.  how  is  itpossible to characterize it and. hopefully> exploit that characteriza-tion?
I don’t argue that I can predict tomorrow’s market (and I don’tdeny  it  either!),  only  that  given  my  view  of  the  market  (or  yourview or any other consistent view--even, perhaps. a random view),it may be possible to describe the market’s behavior  chardcteristi-tally  and,  for  practical  purposes,  exploit  the  most  likely  behavior.allowing always for being wrong.
’  Unique  in  1982.  Although  there  hasn’t  been  much  response  to  my  articles  1”Stocks  and  Commodities  magazine,  good  analysts  started  to  publish  work  alongthis line in 1994 and 1995. Also, it could  be argued that Art Merrill’s work estimat-ing  the  value  of  indicators  at  di&ent  confidence  levels  is  in  this  line  of  thought.Ed Gotthelf’s 19505 observations on how far trades carry is also experiential.’  Nonparametric  statistics  are  used  to  describe  phenomena  that  do  not  hax  nor-mal  relative  frequency  distributions.  Pammetric  statistics  are  used  CO   describe  phe-ncmena   whose  characteristics  can  be  described  with  normal  distributions  (amongother  assumptions).  These  descriptions  can  use  formulae  filled  with  parameters,values  that  determine  the  shape  of  the  distributions.
xx 
Introduction
NINETY-NINE  PERCENT  PERSPIRATION
In  1982,  seeking  to  deal  with  losses,  I  first  hit  on  the  differing  be-havior  of  winning  and  losing  trades.  1  published  that  material  in1985  and  again  in  1991  and  1992.  In  the  era  of  “rocket  science,”  mydown-in-the-mud techniques didn’t give me much pride, but I grad-ually gained respect for their practicality. These days, the growth ofarcane  technique  is  unbridled.  and  I  commend  the  exploration.Sooner or later, though, it all must actually work in a market wherepricing is determined instant by instant by, in some cases, two peo-ple  screaming  at  each  other.  This  perspective  reminds  us  that  fearand  greed,  possessed  by  every  investor,  every  trader,  and  everyspeculator,  still  drive  the  prices  we  seek  to  predict  and  drive  themepisodically, not randomly. Lots can go wrong. A certain caution, acertain  humility,  and  a  certain  respect  for  the  difficult  job  of  ex-ploiting changes in price is in order.
CAMPAIGN  TRADING
I----
1Campaigning
INTRODUCTION
This  is  a  book  for  speculative  traders,  retail  or  commercial,  notniche  traders  or  arbitrageurs.  Speculative  traders  may  be  tradingfrom an intensive knowledge of their market or merely from the ac-tion.  Their  horizon  is  usually  short,  but  in  some  industries  (coppercomes  to  mind)  may  extend  to  four  or  five  years.  Speculativetraders  aim  to  profit  from  price  fluctuation,  not  hedging.  It  followsthat the more fluctuation they may exploit, the better their chances.In  the  trading  books  of  the  early  part  of  the  century,  writerswould  grandly  refer  to  a  campaign  of  trading,  a  series  of  battlesand  skirmishes  to  accumulate  and  eventually  distribute  a  position,long or short, Today, while large operators still assemble and disas-semble  large  outright  positions,  grand  campaigning  may  be  hin-dered  by  the  capacity  of  the  markets.  Many,  if  not  most,  moneymanagers  are  locked  into  quarterly  comparisons  of  performancethat prevent a longer view and focus on managing many issues. Thefield  of  play  for  the  smaller  speculator  therefore  is  not  often  occu-pied by predatory competitors seeking to destroy him.
Smaller speculative traders can use their advantage on executionto  fully  exploit  market  swings.  They  can  nimbly  add  positions  onthe way up or down, bail out at the peak or bottom, reverse or go
1
2  Campaigning
The  Bie Picture 3
into  trading  range  mode  until  another  trend  is  established.  More-over, they can add positions on pullbacks, as well as fade the trendduring excesses of the advance or decline-times when you must beparticularly  nimble.  The  result  is  more  profit  opportunities  thatarise  from  more  comprehensively  exploiting  market  movement.
That  said,  it’s  not  possible  to  constantly  be  right  on  a  movingmarket.  Most  objective  trading  schemes  are  tied  to  one  mode:trending  behavior.  That’s  because  the  most  spectacular  gains  ap-pear to come from catching a big ride. Surely, you must sit througha lot of small moves that don’t turn into trends, but you plan to bethere when the big one shows up. You hope that the move will bebig enough to cover all the losses and indecisive trades.
To take full advantage of the market’s movements, to extract allthe  energy  available  in  the  tide  of  the  price  cycle  (ultimately  thebusiness cycle), we need to employ the tactics of today and the nextthree  weeks  while  keeping  in  mind  the  strategy  for  the  next  sixmonths  to  a  year  and  the  grand  swing  over  the  next  four  or  fiveyears. This book emphasizes that task up to about six months.
The key to this is determining which mode we’re in and employ-ing  an  objective  trading  strategy  for  that  mode.  Being  objectivemeans  we  know  for  each  tactic  in  each  strategy  what  winningtrades or losing trades look like, and therefore how much capital touse and where to cut our losses. Oddly, just about any trading rulethat objectively specifies an entry and exit serves our purpose.
Once we  heave   objective  means  of  defining  trade  modes,  takingtrades,  and  managing  losses,  we  should  trade  all  the  time,  not  juston a single trading rule. A strong set of rules should allow us to beactive  in  all  market  phases.  I  refer  to  this  continuous  activity  as  acampaign, a concerted effort to build capital.
Finally, I hope to keep things simple. This isn’t the book for ex-otic  definitions  of  trend  or  piles  of  theoretical  mathematics,  be-cause the state of the art doesn’t support such approaches. 1 hopemost traders will be able to follow my argument by first looking atthe  pictures,  then  reading  the  text  Footnotes  will  lead  to  other  ref-erences,  sources:  and  products.  I’ll  achieve  my  purpose  here  if  Ishow a comprehensive view of recording and exploiting market be-havior.
THE  BIG  PICTURE
What if we could extract from the market every bit of profit that itsfluctuations allow? We’d be pretty excited, right? Even if we couldget to half of it, we’d be pumped up. After all, the market is con-stantly moving somewhere, but we all know how difficult it is to bethere and be right. Few of us have the agility or the market sense toconstantly  and  consistently  ride  the  waves  and  wavelets   in  the  rightdirection,
Yet what we ask isn’t crazy. We  should be working toward thatgoal,  even  if  we  can’t  make  it.’  Instead,  what  typically  happens  isthat we lock into a single mode of trading or a single trading “sys-tem,”  typically  a  trend-following  mechanism.  If  there’s  no  trendingor the trend we seek isn’t behaving the way our system likes to seethings, we’re in for trouble. If we do get headed in the right direc-tion  and  at  the  right  time,  we  don’t  have  a  way  to  fully  exploit  theadvance or decline we’re riding. How do we know when to add po-sitions and when to take them off?
Then,  when  we  reach  the  end  of  the  trend-what  to  do?  Mostsystems  (all  the  ones  I’ve  seen)  just  bail  out  and  wait  for  anothersetup like the one they are programmed to see. There’s no thoughtof  reversing  into  the  countertrend,  no  plan  to  exploit  a  hiatus  at  anew level. Most so-called trading systems are one-note affairs.
This  single-minded  approach  may  have  some  virtue,  but  it  limitsus  when  we  most  need  to  make  hay-when  things  are  going  right.We know we’re going to have the numerous small losses-we needto make a ton when there are fish in the water. A one-note tradingrule  doesn’t  do  it  no  matter  how  many  setups,  triggers,  and  filterswe tack onto it. That’s just going for the perfect entry, the unreach-able Valhalla of retail traders.
Instead,  see  the  whole  picture  (see  Figure  1.1)  not just the  up-trend.  Look  at  the  basing,  the  trend,  the  reversal,  and  the  ranging,which are not, as we know, the only possible sequence. Instead of a
’  To  get  a  taste  of  this,  check  the  “perfect  indicator”  in  MetaStock   for  Windowsand  DOS  by  Equis   International.  The  indicator  is  used  as  a  reference,  not  a  trad-ing  signal.
4  Campaigning
A
Price
Ranging
THE WHOLE CAMPAIGN. Instead of looking just for
FIGURE  1.1trends,  plan  for  an  entire  campaign  of  trades,  some   exploiting  rangingand  some  exploiting  trending.
single  tactical  fight  over  a  single  entry  and  exit  on  the  trend,  con-sider  a  whole  campaign  of  tactical  conflicts  beginning  with  quietskirmishing  during  a  basing  period,  skirmishing  that  builds  andbuilds  until  it  erupts  in  a  breakout  and  we  commit  greater  andgreater  amounts  of  capital.  Even  within  this  battle-uptrend  ordowntrend-there  are  entries  and  exits  and  more  skirmishes,  untilwe sense, through heavy contact and diminishing advances, that thetrend  is  ending.
Our campaign strategy shifts to exiting the positions we’ve accu-mulated,  not  in  a  spasmodic  ejection,  but  carefully,  concedingground  while  considering  the  possibility  of  a  complete  reversal  oftrend-and  our  position.  Or  perhaps  ground  gained  will  be  heldand  we  can  go  into  defensive  positions,  hacking  back  and  fortharound  support  and  resistance,  holding  a  ridgeline,  in  combatterm%   with  aggressive  patrolling  and  probing  assaults.
The  combat  terminology  isn’t  meant  to  indicate  that  we  analyzeor think in these terms but only to suggest the overall picture. Ob-viously,  there’s  plenty  of  colorful  but  unquantifiable  verbiage  we I want you to campaign usingcould use to describe these  concepts.
Basics  5
objective,  quantifiable tools. This book will illustrate how to cam-paign using New York Light Crude as an example.
BASICS
A  young  basketball  player  is  fascinated  with  The  Shot.  He  doesn’tthink  about  the  footwork  he  needs  to  get  to  the  shot.  He’s  notaware  of  position  on  the  court  or  even  body  position  in  the  con-stant  tactical  encounters  at  each  end  of  the  court.  These  funda-mentals  can  make  for  easy  buckets  or,  alternatively,  the  continualneed  to  pull