percent of the day's range.The next line coming down the chart only deals with days that the distance from the open to theclose would have made a trader more than $500. At the point I have marked on this line, we see thatabout 42 percent of the time we closed above the open by an amount making $500 or more if we didnot take more than a 10 percent dip below the opening. Finally, the third and bottom line representsdays that closed with more than $1,000 of profits above the opening. These are the biggest range daysin the bond market.At the point marked, we see that 15 percent time, we get these huge blast-off days if there is a dipless than 10 percent.
Figure 2.15 Probability of dollar value of open to close versus (open-low)as percentage of yesterday's range-T-Bonds.
36BY the same token, there is an almost zero chance of getting a large blast-off close above the opening ifprice has dipped 70 percent to 80 percent below the opening.This is true of all three lines; again telling us the greater the price swings below the open, the less of achance we have of a positive open to close. This proves my rules:1.
Don't try to buy big dips below the open on expected up close days.
2.
If long and prices fall much below the open on expected big up close days, "get out."
3.
Don't try to sell big rallies above the opening on expected large down days.
4.
If short and prices rally much above opening on expected large down days, "get out."
Don't try to argue with these statistics, they are the laws of gravity controlling how stock andcommodity prices move. The tabulations shown here can be replicated in any freely traded market, thusrepresenting a universal truth of how, on average, trading transpires during any given day. Yes, you willoccasionally see large-range days that work both sides of the opening, but that is the exception, not the norm.The averages are against bucking this law. As a trader, I want as much going for me as I can. My winningtrades don't come from luck, they come from having the tables tilted in my favor.
Where the Trend Is with You-The Second Power Play Price PatternIs the market in an up- or downtrend? Will prices most likely go up or down from here? Indeed, is thereanything that might help us understand what is in store for future price activity? These are big questions, theanswers the uninformed and those unwilling to think and study, have failed to find since trading began.just as we have learned that, generally speaking, small ranges set up large ranges, there is anotherfundamental design to the way prices of stocks and commodities move across the march of time in anycountry, any time frame.Thus we begin your first lesson in understanding trend analysis in the marketplace. The basic principleis that as prices move from a low to a high there is a shift from where the close is in each day's range.Remember, it makes no difference whether we are using 5-minute, hourly, or weekly charts. The same ruleapplies.
37As a market low is made the close of the day, or time period, is right at or very close to the low of that day'srange. Then seemingly out of nowhere, a rally begins, and as this rally unfolds, there is a markedrelationship change. The change is that the further along this uptrend matures, the higher the close will be onthe daily bars. Figure 2.16 presents a stylized view of this relationship change.Markets bottom with price closing on the low of the daily range, while they top out when closes are ator near the high of the daily range.
The uninformed think "smart money" comes into the market with buying thus reversing the trend.Nothing could be further from the truth. As MY long-time friend Tom DeMark says, "Markets don'tbottom because of an influx of buyers, they bottom because there are no more sellers."We can look at this relationship of buyers to sellers at work on virtually every day or bar that takesplace. My operating rule, which I first wrote about in 1965, is that sellers in any time period are representedby the price swing from the high of the day to the close, while buying is represented by the close
Figure 2.16 The relationship changes as a rally occurs.
38minus the low. My point is that the distance price closes off the low tells us the power of the buyers, thedistance from the high to the close illustrates the impact sellers had on prices.This understanding came from the work I did in trying to understand the OBV (On Balance Volume) chartsJoe Miller and Don Southard were keeping at Dean Witter. Back then, traders, or just old duffers looking fora free cup of coffee and a place to chat, would sit around looking at the flow of prices on the ticker tape, atrade-by-trade display of each trade made during the day.There were two noteworthy old codgers, Jack and Murray, who appeared daily to dispense theirwisdom of the ages. Since they had been around longer than us, we hung on to their every word. Murray, theolder of the two, had been a board room marker boy during the crash of 1929 and frequently recounted howhe had marked down the price of the stock of Bank of America exactly 100 points on the first day of thecrash! You could just see young Murray at the boards, writing down, in chalk the last price B of A traded at,then erasing to replace that value with a lower one. Murray said the biggest price mark down was 23 pointsfrom one trade to the next!His story fit right in with the other oldsters' redundant favorite saying, which still rings in my ears.Jack would tell us at least once a day, "What you don't want to do is catch falling daggers," and then hewould add, "You wait until they stick in the floor and stop quivering, then and only then do you pick themup. That's the best lesson I've learned in over 50 years of watching people lose money."For short-term traders, I took this to mean that I should not try to buy market sell-offs, should not stand in theway of freight trains. I lost lots of money thinking I could tell when price had "bottomed" and would turnaround for the day. My early trading accounts are pretty convincing proof that I could not perform thatmagic.I eventually learned not to try to pick tops and bottoms, but it wasn't until years later that I fully understoodwhat was really going on in the market and how I could take advantage of this market truth. My accountbalance had convinced me of the folly of buying abject weakness but I did not know why. I do now.The next chart should make this lesson in speculation come alive for you, so you don't have to waste time ormoney learning the way I did. Figure 2.17 illustrates how prices traded during an actual market day inCoffee; on the right-hand side, the chart shows the way the bar for the full day appeared.Price opened, dipped to a low, rallied to make the high of the day, then got hit by selling until the close. Youhave been aware that every day there is a battle between buyers and sellers; now you know how and where tolook for the buyers and sellers. More importantly, you have learned about shifting
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Figure 2.17 Coffee (15-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
relationships: that the higher the close is on a bar the closer we are to a top, while the lower the close ison a bar, the closer we are to a bottom. Here are two of my rules:1.
Most all market highs can be found to occur at or shortly after a market closes right on the
high of the day.2.
Most all market lows can be found at or shortly after a market closes right on the low of the
day.Got it? Good, now let's look at actual examples of my theoretical concept at work. I will beginwith Figure 2.18, a chart of the Treasury Bond market from 1992. Look at the price turns, which arepretty easy to see, then focus on the terminal high and low days, at or just before, the end of each upand downswing. See it? There it is, the end of the uptrend could be foretold by the mere fact the dailycloses were near the highs of the day, the lows, or end of the downtrend, foretold by closes near the lowof the day.This is not an isolated occurrence, nor is it limited to daily charts, as the next few examples willshow. Figures 2.19 through 2.23 show, in sequence, a 15-minute chart of the S&P 500, then an hourlychart, a daily chart, a weekly chart, and finally a monthly chart. In each instance, you
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Figure 2.18 Day T-Bonds (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 2.19 S&P 500 Index (1 5-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 2.20 S&P 500 Index (60-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 2.21 S&P 500 Index (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 2.22 S&P 500 Index (weekly bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 2.23 S&P 500 Index (monthly bars). Graphed by the "Navigator"(Genesis Financial Data Services).
43will note these same repetitive phenomena. The closer the daily close is to the high of a bar, especially ifthere are several such bars together, the closer we are to a market high.Market lows, in all time frames are just the reverse: the closer the closes of the bars are to the low thenthe closer we are to a market upturn. This is market reality; this is how the world of speculation works,always has, always will.
Chapter 3The Real Secret to Short-Term Trading
The "secret" is the shorter your time frame of trading the less, money you will make.
Sad but true. Think about any investment you have ever been in. Did you make a killing in one day?And, if you were so lucky, how many times were you able to repeat it' Not many. That is because theuniversal rule of life. Of ain, is the same as the universal rule of speculation:It takes time for profits to grow.
Successful traders know that a market can only move so far in 1 minute that a market can movefurther in 5 minutes, even more in 60 minutes and a heck of a lot more in a day or a week. Losing traderswant to trade in a very short time frame and thus automatically limit their profit potential.By definition, they have limited their profits and kept an unlimited loss scenario. It is no wonder somany have done so poorly at this of short-term trading. They have boxed themselves into a no-win situatiounder the guise, often promoted by brokers or system sellers. That money can be made calling market highsand low’s during the day. The merit is bolstered with the seemingly rational statement that by tading withinjust one day and never holding anything overnight. you cannot be exposed to news or major changes; thusyou limit your risk.
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46That's flat-out wrong, for two reasons.First, your risk is under your control. The only control we have in this business is to set a stop-losspoint, a level at which we exit the trade, all trades. Yes, a market could gap beyond your stop the followingmorning, but that is a rare experience, and even then we are still able to limit our loss with our stop-loss andabsolute willingness to get out of losing trades. Losers hold on to losses, winners don't.Once you establish a position with stops, you can only lose about that much money. No matter when orhow you got into the trade, your stop limits your risk. Your risk is the same if you buy at an all-time newmarket high, or low.Not holding overnight limits the amount of time your investment has to grow. While sometimes themarket will open against you, if we are on the right track even more of the time the market will open in ourfavor.More importantly, by ending our trading at the end of the day, or worse yet at some artificial cutoffpoint such as a 5- or 10-minute chart, we have drastically limited the potential for profits. Remember I saidthe difference between losers and winners is losers hold on to their losses? Another difference is thatwinners hold onto their winning positions while losers get out "too early." It is almost as if losers can't standbeing in a winning trade. they are so damn happy to get a winner, they bail out of it far too early (usually, bygetting out during the day of entry).You will never make big money until you learn to hold on to your winners, and the longer you hold themore potential you have for making a profit. Successful farmers don't plant a crop and then dig it up everyfew minutes to see how it is doing. They let it germinate, let it grow. We traders could learn a great dealfrom this natural process of growth. Our success as traders is no different; it takes time to create winners.
It Is All about TimeWhat I have just told you is an absolute unequivocal investment truth. It takes time to make moneyregardless of the activity. Thus short-term traders, by very definition, are limiting their opportunities.The fallacy of day traders is their belief that they can actually call the short-term swings of the market,tell where price is going the vast majority of the time, predict the highs and lows as well as the precise timemarkets will top and bottom. Sorry to tell you this, folks, but it cannot be done with any consistency. It is aday trader's dream, a pipe dream at that.But don't give up hope, my years of market analysis and trading have revealed one fundamental truthabout market structure, which is the secret to making "short term" trading profitable.
47By now you understand that (1) short-term swings are very difficult to predict; (2) we must limitlosses; (3) as short-term traders, we will only do well when there is an explosive move in our favor; (4)time is an ally because we need time to create profits.To make significant money as short-term traders, we have to be able to sense how long the mostprofitable short-term swings usually last. This is not just a question of time, it is also one of price. Just asthere are no straight paths to heaven, price can only go straight up, or down, to a certain point. The questionI needed to answer was, What usually represents that balance of price and time? Note I said usually; manytimes, price swings will go further and take longer than you could ever imagine; and just as often, theyfalter and fizzle out just when you think you finally have outwitted the market.Keeping all this in mind, I am now going to reveal my biggest shortterm secret of trading to balancethe trade-offs of price and time swings. This secret consists of two components:1. We only make money on large-range days.2. Large-range days usually close at or near the high, if an up day, the low if a down day.I am willing to let the fancy dancing day traders figure out the machinations of interday swings. Idoubt they can do it, but even if they can, it is very hard, frustrating, and demanding work. Despite the twoold codgers' knowledge of tape reading and years of market wisdom, they had no more ability to correctlycall market moves from tape watching than any of the rest of us. We have gone from tape reading to quotemachines, but the game, or myth is the same, and so is the degree of difficulty. It is pressure city to sit infront of a quote machine for 7 hours a day battling, guessing, and being proven wrong more often than not.About twice 1 year, I get talked into bankrolling some hotshot trader who thinks he or she can profitfrom these short-term swings. Let's see, two traders a year for 35 years, that's 70 times I should havelearned the lesson I am teaching right here, right now. I just don't think it can be done. The only caveat Iwould put here is that it cannot be done with a system or mechanical approach. I have seen traders with a"feel" succeed at this, but that feel often deserts them and is something they cannot pass on to anotherperson. Therein my work is different: you or anyone can repeat what I do.I place my trade knowing only one of three types of days will develop: a small-range day that willproduce a small loss or gain; a day that reverses against my position; or a large-range day that, if I am onthe correct side, means I will finish the day very near the high of an up day or the low of a down day.Although no one can predict what will be the high or low of a large-range day, I can predict that such days
48will most often close at their extreme-thus there is no need to try to play any silly technical games ofwiggling and waggling buying and selling during the day.I can prove my point about large-range days with the following charts. Figures 3.1 through 3.6 showdifferent time periods of Copper, Cotton, Soybeans, Pork Bellies, Gold, and T-Bonds, a pretty wide diversityof markets. Carefully go through each chart, note the large-range days, and then notice where they openedand closed.In the vast majority of the large-range, up close days you should have noted that price opened near thelow of the day and closed near the high. The down close, large-range days reveal just the opposite tradingpattern; openings near the highs and closes near the low of the day.What this all means to short-term traders is that, to catch a winningtrade, the most profitable strategy is to hold to the close.I cannot emphasize this enough. The most profitable short-term trading strategy I know and use is toenter the trade, place my protective stop, then shut my eyes, hold my breath, quit looking at the market, andwait to get out on the close. Or later! If I am lucky enough to get a large-range day I will
Figure 3.1 High grade copper (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 3.2 Cotton #2 (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 3.3 Soybeans (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 3.4 Pork Bellies (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 3.5 Comex Gold (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 3.6 Day T-Bonds (daily bars). Graphed by the "Navigator"(Genesis Financial Data Services).have captured a major move that can pay off the small-range days. If I try to dance in and out, I willinvariably not make as much money as holding to the close. The truth is whenever I have tried fancydancing, I have had to pay the piper a stiff fee.To further prove this point, Figures 3.7 through 3.9 show the results of a simple little system for tradingthe S&P 500. The rule is simply to buy on the open every Monday if that open is lower than Friday's close.This is the start of short-term system building, so don't get enamored with the results or the system quite yet.My point here is to show you the tremendous advantage of knowing you can make more money if you holduntil the close.Figure 3.7 depicts what most short-term traders want to do, make about $500 a day trading so theresults reflect a stop of $3,000 (large, but that's what this volatile market requires) and an automatic $500profit. Although the accuracy is high at 59 percent, the speculator loses money ... $8,150 to be specific.The next set of data reflects all the same rules except a $1,000 target. This time we make money,$13,737, again on the same number of trades, 389, giving us a small average profit per trade of $35. I havededucted $50 for commissions (as all results shown in this book do). To make our $13,737, we were down$8,897 at one point, and had 55 percent winning trades.
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Figure 3.7 A trade with a $500 target.
Finally, we are able to turn the corner and make money by following my basic rule of holding until theclose and then exiting the position. What a difference, we actually clean up, banking $39,075 of profits,with a $100 average profit per trade, 3 times better than when taking an automatic $1,000 profit. Ourdrawdown, how much we had to lose during our worst run to make what we did, was less at $6,650; the$500 target trader had a $12,837 drawdown. The facts speak for themselves. Traders can argue all day longabout what works and what does not work, but what you have just seen settles
Figure 3.8 A trade with a $1,000 target.
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Figure 3.9 A trade that follows the basic rule: $100 profit per trade.the argument for me. It is sitting tight, not trading in and out that will make for profits.I hold to the close, at least, for an exit point. Until someone can do the impossible, call all short-termfluctuations, there will be no better strategy for a short-term trader, as you will capture the large-range dayswhere serious money is to be made. The only difference in the preceding results was how long the trade washeld: the shorter the holding period, the less opportunity for profits. Never forget that rule.There is even more money to be made holding over, past the close, but that should be true if what Isaid earlier is valid, that it takes time for profits to accrue. As we discuss individual markets, I will give youmore specific rules of how to further capitalize on this phenomenon of profitable trading.As final proof for my thesis, Figure 3. 10 shows the same system we just looked at, buying onMondays when the market opens below Friday's close. But this time, we are going to hold the position in thefirst example until the next close; that is, the first close after our entry day or until we are stopped out,whichever comes first. The product of this strategy nets $68,312, making an additional $30,000 andincreasing our net profit per trade by $7 1.Finally, look at Figure 3.11, which depicts holding for the close 6 days after entry or being stoppedout. Following this strategy proves my point and should cure you of the notion that big easy money can bemade catching small swings. We now make $71,600, almost doubling the exit on close results boosting ouraverage trade up to a now respectable $251. Remember, the only difference in these results is how long westayed in the trade, all the other rules are the same.
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Figure 3.10 Using timing to increase our profits.The legendary Jesse Livermore said it best, "It was never my thinking that did it for me, it was mysitting that made the big money. My sitting!"He added, "Men who can be right and sit tight are uncommon."What I am trying to get across to you is that catching the big swing (within the time frame you aretrading) is the only way I have been able to make millions of dollars trading. I finally figured out that I hadto let my profits run to be able to pay off the losses that are as natural to this game as breathing is to life.Losses will most absolutely come to you. That is a given,
Figure 3.11 The timing makes all the difference.
55it will happen, which gives rise to the obvious question, what can we do to offset these chunks out of ourrear end? There are only two ways to overcome this negative, we must either have a very low percentage oflosing trades and/or a substantially higher average profit than loss. Time, and time alone, will give yoularger profits, not thinking, not fancy dancing, not trying to buy and sell every top and bottom. That is afool's game. It is not a matter of opinion-it is provable, as the simple system presented in this chapter soclearly demonstrates.By now, you should have learned how the market moves, the three most dominant time cycles, and bedeveloping a sense, or feel, for the underlying order in what appears to be chaos. But most of all, youshould have learned to hold on to winners to the end of the time frame you are trading for. In my case, I'mtrading for 2-to 5-day swings. Whenever my greed factors have convinced me to take a quick profit-oroverstay my time period-I have paid dearly.
Chapter 4
Volatility BreakoutsThe Momentum Breakthrough
Necessity may, or may not, be the mother of nvention, but for sure it is the fatber of taking chances.
Momentum is one of the five concepts that can bring us short-term trading profits. It is what Newtonwas talking about when he said an object once Set in motion tends to stay in motion. So it is with stocksand commodities: once price starts to move, it will most likely keep going that direction. There are almostas many ways to measure momentum as there are traders. I will not delve into all of them, just the ones Ihave found to work, and the concept, I trade with. There are other approaches; any one with a fertile mindshould be able to go past where I have. Mathematicians, this is the chapter where you can bring all yourtechniques, concepts, and formulas to play. This is where you have a distinct advantage over those of uslimited to basic addition. multiplication, and subtraction.I doubt that anyone fully understood how the markets work until the mid-1980s. Sure, we knew abouttrend; about overbought and oversold markets; about a few patterns, seasonal influences, fundamentals,and the like But we really did not know what caused trend or, more correctly put. how it began and ended.
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58We do now and it is time for you to learn this fundamental truism of price structure and movement.Trends are set in motion by what I call "explosions of price activity." Succinctly, if price, in one hour,day, week, month (pick your time frame for trend identification) has an explosive move up, or down, themarket will continue in that direction until there is an equal or greater explosive move in the oppositedirection. This has come to be known as an expansion in volatility and verbally captured by the phrasecoined by Doug Brie "volatility breakout," based on my early 1980 work.It gets down to this, price has an explosive breakout, up or down, from a center point. That is what setsor establishes the trend. Thus we have two problems; first, what do we mean by an explosive breakout (howmuch of an up or down move), and second, from what point do we measure this expansion in price?Let's start with the beginning, what set of data should we use to measure the expansion?Since my working thesis is that we need a very quick explosion of price change I like to use daily rangevalues-the difference between the day's high and close. This value shows how volatile the market has beeneach and every day. It is when this volatility increases out of recent proportion that trends change.There are several ways of taking this measure. You might use the average range for the last Xnumber of days, various swing points, and the like. Bi and large though, I have found that using justyesterday's range as my cornparison of volatility works wonders. Let's say yesterday's range was 12 cents inWheat. If today's range exceeds that range by some percentage. the trend probably changed, at least that isthe way to wager. This would be a clear in dication price has had a new impetus driving it in a direction, andprice. Like any object once set in motion, tends to stay in the direction of that motion.It is really as simple as that, a pickup in range, substantially greater than yesterday's range implies achange in the current market direction.That also leads to the second problem: From what point do we measure the expansive move, up ordown? most traders think we should measure from today's closing price. That is typical thinking; we usuallycompare price change from close to close. But it is not the correct answer. I will get to that in a moment, butfirst let's consider points from which to measure this expansion: we could use the close, the average price ofthe current day, or perhaps today's high for a buy or today's low for a sell.Let's look at the very best results of several nonrelated commodities using a variety of points formeasuring the explosion. Table 4.1 shows buying tomorrow at a percentage of today's range added totoday's close. The data, listed in order, shows the commodity, percentage of range, dollar profit. accuracy,and average profit per trade.
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In this table I have even provided the best percent of the previous day's range to add to the close for abuy and to subtract for a sell. In this, and all data shown, no stop was used and you were always long short.This table shows only the best percent volatility add-ons for buys and subtracts for sells; and again inthe data for Table 4.1, we added the volatility factor or filter to the previous day's close. Using cattle as anexample, if price rallied 70 percent of the previous day's range above the close, we bought and sold short at50 percent of the day's range subtracted from the close.Next, look at buying tomorrow at a percentage of yesterday's range added to yesterday's high orsubtracting that same amount from yesterday's low for a sell signal (see Table 4.2).
60Although this concept makes money, again on the best-fit basis, it does not do as well as adding orsubtracting a value from the close. A simple way to compare the results is to determine the size of theaverage profit per trade. In the add-to-the-close method, it is $327 a trade and $313 for the add-to-the-highand subtract-from-the-low technique.The next set of data adds a percentage of today's range to tomorrow's open and buys there for a longentry or subtracts a percentage of today's range from the opening for a sell. The results appear in Table 4.3.A careful look at the data shows us the average profit per trade is higher at $389 and the accuracy isalso higher; five commodities in this test showed an accuracy of 50 percent or higher while none of them didin the first two tests.My conclusion is that the best point to add or subtract a volatility expansion value to is tomorrow'sopen. I have always traded this technique with the open, but in preparation for this book, I did the precedingtests to see whether my judgement was right and was pleased to see facts fit my intuitive conclusion.As short-term traders, we can use this concept to tell us there is a high probability of a further extensionof price we can capitalize on. I will not trade just because of such an entry but will use this as my entrytechnique when the time and conditions are correct.Of all the trend entry approaches I am aware, from moving averages to trendlines, oscillators to Ouijaboards, and fancy math to simple charts; I have never seen a more consistently profitable mechanical entrytechnique than volatility breakouts. It is the most consistent of all entries I have ever traded, researched orseen. Now let's look at some ways of using this basic concept.
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Simple Daily Range BreakoutsFrom the preceding we have learned that we should add our breakout value to tomorrow's opening.Now the questions begin; What's the best value?. There are several good ones, but the simplest is to taketoday's range adding a portion of it to tomorrow's opening. Just that simple approach has been a consistentmoneymaker since I first discovered it almost 20 years ago.It is now time to go a bit beyond these results and create a trading model that is actually tradable (i.e.,it makes money in an acceptable fashion). Figure 4.1 shows the result of buying and selling bonds on theopen every day at a distance of 100 percent of the previous day's range above the open for a buy and 100percent below the open for a sell.A protective stop of $1,500 or 50 percent of the previous day's range subtracted from