futures showing a bottoming or accumulation phase priorto a rally.
Accumulation/DistributionTheory
What I have just described for you is the theory of accumulationand distribution. The theory has face validity and is certainly easyto understand. The difficult part is finding methods, indicators,and/or technical trading systems that will allow traders to takeadvantage of the hypothetical constructs. One such indicator is theadvance/decline (A/D) oscillator originally developed by LarryWilliams and James J. Waters in 1972. Their article entitled“Measuring Market Momentum” in the October 1972 issue ofCommodities Magazine introduced their A/D oscillator.
The purpose of the oscillator was to detect changes in the bal-ance of power from buyers to sellers and vice versa. Calculation ofthe A/D oscillator is a relatively simple matter. A thorough expla-nation and critical evaluation of the A/D oscillator can be foundAccumulation Distribution Oscillator Derivative 159
in The New Commodity Trading Systems and Methods.* The A/D
o oscillator is also available in preprogrammed form on many of thepopular software analysis systems such as CQG (CommodityQuote Graphics). The formula for calculating A/D can beobtained either in the original Williams and Waters article or theKaufman book cited above.
Using the A/D Oscillator
There are several potential applications of the A/D oscillator forposition and day trading. They range from the artistic and inter-pretive to the mechanical and objective. Since this book is notabout art but about the quasi-science of technical analysis, I willrefrain from a discussion of the artistic application of the A/Doscillator. While my application may not be as scientific as onewould like, my efforts are in the correct direction. One method Ihave worked with extensively is to buy and sell based on A/Doscillator crosses above and below the zero line. The construc-tion of the oscillator suggests that when the A/D value is abovezero, the market is under accumulation, or the bulls are in con-trol.
Conversely, when the A/D value is below zero the bears are incontrol of the market. Theoretically, when the A/D crosses fromplus to minus, a market crosses from bullish to bearish and viceversa. Figures 13-4 through 13-6 support the argument, eachshowing the A/D oscillator and market trend. Note how the A/Doscillator has the uncanny ability to remain negative for a lengthyperiod of time as prices continue to decline or positive for alengthy period of time as prices continue to rally. That’s the goodnews about the A/D oscillator. The bad news is that these areideal situations that do not occur as frequently as we would like.All too often markets move higher and higher while the A/D is innegative ground and vice versa. Such situations not only confusethe trader into thinking that the theory is incorrect, but they arealso costly, since they produce losses. Yet another limitation of theA/D and, indeed, of all oscillators, is that they can frequently
*Perry Kaufman, The New Commodity Trading Systems and Methods, Wiley, NewYork, 1987, pp. 102-106.fi : ryt :! Mn, abby‘| f Md ‘eet ut
 
Figure 13-4. Daily February 1998 gold futures showing negative A/D reading for over 6months of a bear trend.
 
Figure 13-5. Daily March 1998 yen futures showing negative A/D reading for over 6 monthsof a bear trend.HeLa] steer?
 
Accumulation Distribution Oscillator Derivative 161
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Figure 13-6. Daily March 1998 silver futures showing positive reading in A/D and a sus-
tained bull trend.
move back and forth above and below the zero line numeroustimes before a sustained trend emerges. Traders who buy and sellon such frequent crosses above and below the zero line will suffernumerous repeated losses, not to mention the cost of commissionsand slippage.
As an example, of this limitation, consider Figure 13-7. Thisfigure shows March 1998 coffee futures with an A/D oscillatorthat remains negative until the top of the market in December1997. After the oscillator crosses into positive ground, the markettops and declines sharply. How can such a severe limitation beovercome? The approach I suggest is to use a derivative of theA/D line that will generate signals when the A/D line crossesabove and below its first derivative. In this case the derivativewill be a moving average of the A/D line as explained in the nextsection.162
 
Chapter Thirteen
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Figure 13-7. The A/D oscillator crosses into positive ground at the top of a move afterremaining negative throughout a large rally from the October/November lows.
The Advance/DeclineDerivative (ADD)
The term derivative means exactly what it says. The first derivativeof any value is a new value that is derived from the initial value.If, for example, I have a 24-day moving average as my originalvalue, and then I calculate a 20-day moving average of the 24-daymoving average, then the 20-day moving average is the first deriv-ative of the 24-day moving average. If I calculate a moving aver-age of the A/D oscillator, then the moving average I calculate istermed the first derivative of the A/D line, since it is derived fromthe A/D value. One purpose of calculating a derivative is tosmooth the values of the original data. Our purpose is to do this aswell as to use the derivative value and the A/D value in order togenerate signals that will help overcome the limitations of theA/D oscillator when used alone (as cited earlier).Accumulation Distribution Oscillator Derivative 163
Beginning with the A/D values we will calculate a moving aver-age of the A/D and plot both lines on the same chart against price.We will use the crossover points of the two values as our buy andsell points for day trading. As an example, consider Figure 13-8. Itshows the A/D oscillator with a 28-period simple moving averageof the A/D oscillator. I have marked the lines accordingly. Thechart does not include the underlying market. It merely shows thetwo lines as well as the points at which they cross over one anoth-er. My method buys and sells when crossovers occur. But note thatthere are several additional rules for buying and selling oncrossovers; these will be explained shortly. For the time being,please examine my notes in Figure 13-8. Now examine 13-9. Itshows the same chart with the actual market prices above it. I havemarked the crossover points on the A/D and price chart for illus-tration.
 
Figure 13-8. A/D Line and 28-period simple MA of A/D line. Note crossovers marked “X.”164 = Chapter Thirteen
 
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Figure 13-9. A/D oscillator and its moving average plotted against price.
ADD Signals
In order to use the ADD for day trading (or position trading), wemust have a set of rules for entry and exit. These rules are as fol-lows:
= Compute the A/D values.
= Compute a simple 28-period moving average of the A/D values.
= A buy signal occurs when the A/D line crosses above its movingaverage after being below it.
® A sell signal occurs when the A/D line crosses below its movingaverage after being above it.
® In order for a signal to be valid, the crossover must remain ineffect for at least two postings of the values. This is done inorder to avoid whipsaw moves.
= All trades are exited at the end of the day session—win, lose, ordraw.Accumulation Distribution Oscillator Derivative 165
= New trades can be entered the next day either on the openbased on the direction of the last signal or you can wait for anew signal.
Figures 13-10 through 13-15 illustrate the rules as applied above aswell as the buy and sell points on intraday price charts.
Caveats and Considerations
As presented here, the ADD method is objective but not entirelysystematic. In order to use it as a system, you will need to add arisk management stop loss and/or a trailing stop loss (if you pre-fer). This will make the method useful as a system. Naturally, youwill want to trade the ADD in active and volatile markets only.The ADD method also has potential for use in day trading volatilespreads.
ACC/DIST RIS 10 MINUTE | Een ___ © 197°7_CO¢
 
Figure 13-10. ADD buy and sell signals. 
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Figure 13-12. ADD buy and sell signals. 
               
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Figure 13-14. ADD buy and sell signals.
    
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Figure 13-15. ADD buy and sell signals.
Summary
The accumulation/distribution oscillator (A/D) is a powerfuloscillator that has considerable potential for use in day trading flatpositions as well as volatile spreads. This chapter discussed thebasic A/D oscillator and introduced the idea of the A/D deriva-tive (ADD) as a timing indicator or trend change method. Specificrules of application were presented. The ADD is a highly versatileindicator lending itself for use in all time frames. Traders interest-ed in using this approach are encouraged to research it more thor-oughly as a trading system with risk management rules beforeusing it extensively for day trading. As I have noted in this chap-ter, the ADD method is not offered as a system at this time. It ismerely a method that could be systematized by adding risk man-agement rules.The Importanceof Orders
Praise the Lord and pass the ammunition.LT. CMDR FORGY AT PEARL HARBOR
To the day trader (in fact to all traders), using the right price orderis just as important as using the right tool is to the mechanic orcarpenter. Using the right orders can spell the difference betweenprofits and losses. Using a market order when a stop or stop limitorder should have been used may result in a poor price fill thatwill cost you dollars. Since the bottom line is very important today traders, perhaps more important than to any other type oftrader other than a scalper (who is also a day trader), every ticksaved is indeed a tick earned. Orders should be specifically gearedto what you seek to achieve in terms of timing your trading sys-tem. Orders are designed to save you money, not to lose youmoney. They will help you reduce bad fills and avoid lost pointsor price skids. But to use price orders to your advantage, you mustbe familiar with the various types of orders and when they arebest used. You must also know what orders to avoid and when toavoid them.
169170 ~~ Chapter Fourteen
What You Should Knowabout Market Orders
Market orders must be avoided whenever possible. A marketorder is, as far as I’m concerned, a license to steal. Rarely will amarket order be filled at the exact price you are expecting.Typically, a market order will cost you one tick, at times two orthree. In S&P futures, a market order may cost you much morethan just a few ticks, although one or two ticks in a quiet market isnot unusual. If you lose two ticks on entry and two ticks on exit,the cost per trade will most assuredly add up. However, not usingmarket orders will cause you to risk not getting a position at all ornot being able to exit a position at all. Here are some guidelinesfor using market orders:
= Only use a market order when absolutely necessary. If you are usingan intraday oscillator-type signal that enters’ at the end of agiven time segment, then a market order is acceptable. If, how-ever, you can use a specific price order as opposed to a marketorder, this is preferable. It is not uncommon for markets to makea quick move following a signal, but very often the marketreturns to its original entry price fairly soon, and a price orderwould have been sufficient. You can save a great deal of moneythis way.
If you are riding a fairly large profit and wish to exit a positionquickly because your indicators have turned, then it is worthgiving some of the profit back just to make sure you are out ofyour position.
Avoid market-on-close (MOC) orders. All too often such orders areeven more of a license to steal, since they can be filled at almostany price during the last minute of trading. An MOC order inthin markets is a certain invitation to trouble. Many traders jok-ingly refer to MOCs as “murder-on-close” orders, since fills areoften so poor.
= Never use market orders with spreads. You are far better off usingspecific spread levels for entry and exit, or you may use specificprice orders in each market individually to “leg” into or out ofthe spread. Considerable slippage is the rule in spread marketorders. Unfortunately, the only orders you can use in spreadsare market orders or price orders. Of the two types, price ordersare clearly preferable.The Importance of Orders 171
Market-If-Touched (MIT) Orders
An MIT order to buy is always placed below the market, and anMIT order to sell is placed above the market. An MIT orderbecomes a market order when hit. Therefore, if you have an MITorder to buy at 4150, this order will become a market order assoon as a trade occurs at 4150. The pit broker holding this orderwill immediately buy at the market. You could get filled at anyprice; however, you will usually be filled at or near your order, attimes better than your price and at times worse. This is the chanceyou take when using such an order. An MIT order is used whenyou have a specific price level in mind for entry and you do notwish to take the chance of not being filled. Ordinarily such ordersare used for selling at resistance above the market or for buying atsupport below the market.The day trader who is using the support and resistance methodsdescribed in this book may use MIT orders; however, do note that© such orders can cost you a few ticks. MITs are, however, excellentorders to use when trading support and resistance levels.Remember that such orders are not accepted by all exchanges norare they accepted at all times. Under certain market conditionsMIT orders may be refused at the discretion either of the pit bro-ker or of the exchange.
Fill-or-Kill (FOK) Orders
A fill-or-kill order is given at a specific price with the understand-ing that the pit broker will attempt to fill your order three times insuccession at the requested price. Hence, if you have an FOKorder to sell at 4550, the broker who gets your order will offer at4550 three times. If there is no fill, the broker will immediatelycancel, or “kill,” your order, and the kill will be reported back toyou. The advantage of this order is that you will be able to place itat a specific price, and you will get very quick feedback as towhether it has been filled. And that’s important!
Be aware, however, that not all exchanges or brokers acceptFOK orders. Under certain market conditions such orders may berefused. Some brokers will become irritated if you use too manyFOK orders that go unfilled, since it takes time and person powerto place these orders. Discount brokers may be especially unhap-py if you use too many FOK orders.172 ~~ Chapter Fourteen
Stop Orders
Finally, do not place your orders too far from the market, orthey will not get filled. This will be even more aggravating foryour broker. If you plan to use FOK orders, then please use ordersthat are very close to the current price. If you abuse these orders,you will frustrate your broker and you will lose the respect of theorder takers.
FOK orders are useful in virtually all situations where entry atthe market should be avoided but where there is a need to estab-lish or liquidate a position. Remember that using an FOK orderdoes not guarantee a price fill; it merely guarantees that you willbe filled at your price or better or not at all.
Stop orders are placed either above or below the market. Theseorders are especially good for exiting positions when they goagainst you or for entering markets on breakouts. The problemwith stop orders is that you will not necessarily be filled at yourprice in a fast market. Frequently many sharp and sudden movesin the currencies, T-bond futures, or S&P futures will result in con-siderable slippage of buy-and-sell stop orders. The best way toavoid this is to use a stop limit order, described below.
Stop Limit Orders
A stop limit order is a stop order with a price limit on it. The rea-son for using such an order is to allow more flexibility in obtain-ing a fill. Therefore, when you place a buy stop limit order at 6450with a limit of 6465, this means that you will accept a fill withinthese limits inclusive. The good part of such an order is that it per-mits the floor broker more leeway in filling you and thereforeimproves the odds that you will be filled. Such an order protectsyou from too much slippage. Stop limit orders should be usedmore often, although few traders actually use them.
Good-Till-Canceled Orders
A good-till-canceled order does exactly what its name suggests. Itis an order that will remain in the market until canceled or filled.This order is also called an open order. Typically all open orders areseneregmeerenemenenmenctemerec tnt se mane ne en
The Importance of Orders 173
canceled by your broker at the end of each calendar month andmust be reinstated. In practice, day traders have no need for GTCor open orders, since their work is done at the end of each day.
One Cancels the Other (OCO)
This is an order qualifier. It allows a trader to have two ordersentered simultaneously with the cancellation of one contingentupon the fulfillment of the other. In other words, when one of theorders is filled, the other will be canceled. This is a good way ofbracketing markets for either of two possible outcomes. As in thecase of several other orders noted previously, some exchanges dcnot accept such orders.
Using Orders to Your Advantage
Now that you've read about the different types of orders, here aresome suggestions regarding their use. The purpose of learninghow to use price orders to your advantage is obvious. Profitableday trading depends on making every penny and every pointcount. You must be consistent and frugal in everything you doHere is a list of dos and don'ts with respect to orders:
= Try to avoid using market orders unless absolutely necessary. Marketorders cost you ticks. If you lose a few ticks getting in and a fewticks getting out, then you have lost good money, often unneces-sarily. There are many good alternatives to market orders. Someof them have been discussed previously; others will be dis-cussed later.
= Don’t use MOC orders. They will cost you ticks, and ticks add upA few ticks here, a few ticks there—pretty soon it adds up to rea.money. If you must use such an order, then you are probablybetter off selling at the market several minutes before the closethan in giving your broker an MOC order. Again, as far as Irconcerned an MOC is, most often, a license to steal.
= Use stop limit orders instead of stop orders. In most cases you wilbe filled. If you are concerned about being filled, put a one- 01two-tick limit on your order.
a Fill-or-kill orders can be used to your advantage in several ways. 11you need to exit or enter a trade and you don’t want to wait tc174
Chapter Fourteen
find out if you’ve been filled, then use an FOK order. You'll getquick feedback, and you'll probably save money. If you’ve neverused such orders before, then get your feet wet.
Use FOK orders to test a market. One good way to see how strongor weak a market may be is to use an FOK order. Here’s what Imean: Let’s say that June S&P futures are trading between406.50 and 406.90. You had a buy signal at 406.50. Trading vol-ume is light. Following the buy signal, prices moved quickly to406.90, and you didn’t want to chase the market. You are con-cerned that the signal might not work this time, because themarket fell back quickly to the original breakout price of 406.50.You are therefore hesitant to buy. What to do?
Test the market by placing an FOK order to go long at 406.45or 406.40, knowing that this is below the recent range of trades.Your order goes in and you watch the tape. It reads 406.55 whenyou enter your order. The ticks then go as follows: 406.55 . . .406.50 . . . 406.53 .. . 406.50... 406.50. . . 406.45B (your bid)...406.45. You are filled at your bid price. What does this meanabout the character of the market? Most likely this indicates amarket that is weak. You were filled at a low bid, and thismeans that there are willing sellers. This characterizes a weakmarket.
However, consider the same scenario with a different out-come. You enter your bid at 406.45 FOK. The tape reads 406.55when you enter your order. The ticks then go as follows: 406.55 .. 406.50... 406.55... 406.50... 406.50... 406.55... 436.55...406.60... 406.65... 406.60... 406.55... 406.60... 406.65...406.70 .. . 406.75 . . . and so on. The market never even comesclose to your bid, and the order is returned killed. What doesthis mean? It indicates a market with good demand. It suggeststhat you had better get on board quickly. You may even want touse a market order to do so.
MIT orders are acceptable but not always efficient. They are good fortrading within a support/resistance channel, but they will costyou ticks.
OCO orders, where accepted, are very helpful. They will help youbracket the market with different strategies and should be usedwherever needed.
Specify first open only. Some New York markets have staggeredopenings. In these markets each contract month is opened indi-The Importance of Orders 175
vidually in chronological order, traded for a few minutes, andthen closed so that another month may be opened. Once theprocess has been completed, all months are opened again at thesame time. The same procedure is used for closing. Should youneed to get into one of these markets on the open, specify thatyou want your order good for the first open only. All too oftenthe second opening price is distinctly different from the firstopen. This can cost you money.
Insist on prompt reporting of order fills. It is absolutely necessaryfor you to know when you've been filled and when you’venot been filled. You must be strict with your broker indemanding fills back as soon as possible. Do not accept excus-es, particularly in currencies, T-bonds, S&P futures, and petro-leum futures, where flash fills are easily given. A flash fill isone for which you may remain on hold as your order is hand-signaled to the pit. Although there will be some conditions inwhich delays are understandable, such delays are anathemato the day trader and must be avoided whenever and wherev-er possible.
Know which exchanges will accept certain orders. The rules changefrom time to time and from one market condition to another. Ifyou don’t know the rules, find them out. The ChicagoMercantile and IMM will accept almost all orders almost all thetime. The Chicago Board of Trade is a stickler for accepting onlycertain types of orders—it does not accept MITs. Some NewYork markets have restrictions as well. Orange juice is one of themost notorious markets, but then you probably don’t want toand shouldn’t day trade OJ.
Find out how your broker places your orders. Does he or she call thefloor? Are your orders put on a wire for execution? Does yourbroker need to call someone, who will call someone else, whowill then call someone else? This all takes time. Day traderscan’t afford the time for such delays. Ask your broker for his orher procedures and deal only with those brokers who can getyou the fastest fills. Anything else will cost you money no mat-ter how low the commission rate. Don’t be penny-wise andpound-foolish.
Globex (24-hour) trading requires even more discretion in order place-ment. Be very careful. Learn the rules and learn to deal with thelack of liquidity.176
Chapter Fourteen
a If trading futures options, use price orders all the time. A marketorder in options will frequently bring you shockingly badresults due to the poor liquidity. Always use price orders infutures options!
Learn how to place orders. Make sure your terminology is correct,make certain you mean what you say, and make sure you listento the order as it is repeated back to you. You are liable for yourorders. Errors will cost you.
Don’t beat around the bush. When you place your orders, speakquickly, decisively, and clearly.
Keep a written record of your orders. Even if you trade only onemarket, once a day, keep a written record that includes the mar-ket, whether you bought or sold, the type of order, the quantity,the price at which you were filled, your order number (as givento you by the order taker), and the time you placed the order.Don’t fail to note all the above. It will save you a great deal ofmoney in the long run.
Report all errors immediately. The longer you wait to report anerror, the smaller the odds of having it rectified.
Always check out at the end of the day, especially if you have traded agreat deal. By check out I mean make certain you have received allyour fills and that you have closed out all your trades. Manybrokerage firms will send you a preliminary run at the end ofthe day via modem. Print out the run and check it against yourorder sheet. Report all errors immediately!
Check your order sheet before market closing to. make certainyou have taken the necessary steps to close out positions. Themore you trade and the larger your positions, the more impor-tant this will be.
These are just a few suggestions that will help you master thepragmatic end-of-day trading. Don’t ever discount the importanceof proper order placement and consistent procedures. The wrongorder in the wrong market can cost you plenty. I know. I’ve madeall these mistakes at one time or another, and I don’t want you tohave to repeat them. Learn it from me the easy way—don’t learn itthe hard way by losing money.Summary
The Importance of Orders 177
Too many traders are either ignorant of, or uninformed about, theimportance of orders. The day trader must make the most of eachtrade. Therefore, saving a tick here and a tick there can eventuallyadd up to a considerable sum of money. Although the day traderwill most often use market orders, there are numerous situationsin which other types of orders are either preferable or dictated bythe nature of the system that is being used. This chapter definedthe various types of orders, indicating when they are best usedand under what conditions certain orders might be better or worsethan others.]
The Psychologyof Day Trading
He bears the seed of ruin in himself.MATTHEW ARNOLD
Day trading is, at the same time, less psychologically demandingand more psychologically demanding than position trading. Onthe one hand, day trading requires more discipline and self-con-trol than does position trading; on the other hand, there is a cer-tain peace of mind that comes with the knowledge that you are“clean and clear” at the end of the day. When people have askedme why I prefer day trading to position trading, I quickly replythat “T like to sleep at night.” While this may seem at first blush tcbe a flippant response, there is much truth to it. The good newsabout day trading is that it permits the trader to walk away fromthe markets at day’s end knowing that there is nothing that canhappen overnight to affect his or her account balance other than atotal economic collapse or bankruptcy of the firm that carries theaccount.
Position traders, however, will argue that by limiting one’s trad-ing to the time frame of 1 day, potentially significant profit oppor-tunities are lost. And this may very well be the case. But tradingopportunities are very much like paying taxes—it’s not what youmake, it’s what you keep that’s important. Note also that there isnothing to prevent a day trader from being a position trader as well
179180 Chapter Fifteen
(although I advise you to separate these methods of trading by hav-ing a different account for each). In the long run, the choice is anindividual matter that must be made on the basis of several distinctand equally important variables. These are reviewed below.
Patience, Impatience, and
Temperament
If everyone in the world had the same personality, life would beterribly boring. The fact that we all have different perceptions ofreality, in some cases, radically different perceptions, is the essenceof creativity and the backbone of diversity. Perception and person-ality are to a large extent responsible for the existence of the secu-rities and commodity markets. Different traders interpreting thesame information in different ways is what makes for opinions,and opinions move markets.
Some traders are patient, methodical, premeditated, focused,and organized. They have the ability—whether inherited,acquired, or a combination of both—to sit and analyze markets, toenter orders, to wait patiently for their orders to be filled, and tohold a position as dictated by their system(s). Such traders aremore suited to trade for longer periods of time. Hence, they havechosen position trading as their preferred method. Provided theycan remain disciplined and organized, they will fare well asfutures traders in the long run.
Other traders are anxious. They have limited patience, limitedtolerance, and limited organizational skills. They react quickly andprefer to enter and exit their trades based on very short-termchanges in market trends. Provided such individuals can remaindisciplined and committed to a particular system or method, theycan do well as futures traders in the long run and perhaps even inthe short run. But in order to achieve even the slightest degree ofconsistent success, the day trader will need to follow a set or rulesthat may, at times, run contrary to his or her impetuous nature.
A third category of traders is positioned somewhere within theextremes of the position trader and the day trader. I term this cate-gory the “short-term trader.” In most cases the short-term traderwill hold a position for several days but rarely for only 1 day(unless a trade is closed out at a stop loss). I have already dis-cussed the topic of short-term trading in my book Short-TermTrading in Futures.The Psychology of Day Trading 181
Personality Traits of theSuccessful Day Trader
 
Your personality could very well be the key to whether you suc-ceed or fail as a day trader. While you may make light of myclaim, I urge you to take me seriously. If you have never day trad-ed before and if you think that trader psychology has little to dowith success as a day trader, then you have a lot to learn. My goalin writing this book is to help you avoid reinventing the wheel.Please take me seriously.
What are the psychological traits that contribute to success asaday trader? Based on my extensive experiences as a trader and asan observer of other day traders, I consider the following traits toeither facilitate success as a day trader and/or to contribute to it:
=