just theDecember  contracts  shows  quite  varied  results  and  a  generally  loweroverall  profit  level.  The  peak  at  an  MAE  stop  of  only  16  ticks  may  reflectthe  quiet  trading  in  the  early  months  of  the  contract  when  ranges  aren’tnearly  t~hose   of  the  active  contract.
102  Testing
Summary  103
TABLE  4.1
COMPARING  ANALYTICAL  CONTRACTS.
Perpetual  Contract
Winning  MAE  peaksbelow a stop of  .15
Losing MAE peaksbetween  .16  and  .30
Largest  MAE  for  awinner is 2.1
Largest MAE for ais  2.1loser 
MonthlyContracts
Winning  MAE  peaksbelow a stop of  .15
Losing MAE peaksbetween  .16   and  .30
Largest MAE for awinner is 1.05
Largest MAE for aloser 
is  over  2.1
December  Contracts
Winning  MAE  peaksbelow a stop of  ,15
Losing MAE peaksbetween  .16   and  .30
Largest MAE for awinner  is  .9
Largest MAE for aloser   is  over  2.25
Because  the  only  operational  tool  at  hand  is  a  stop,  what  couldthat  have  done  for  you?  A  tight  16-tick  stop  trading  Crude  wouldhave  been  trouble.  It  lowers  your  overall  profitability  but  it  keepsyou  in the  game.  If  dropping  ten  years’  profit  in  one  year  (abouttwo-thirds  of  original  capital  in  this  example)  would  knock  youout, even this too-tight stop would serve.
Going  to  a  stop  at  .31   is  better-it  nearly  doubles  overall  profita-bility  while  still  keeping  you  in  the  game.  Going  to  .46   bumpsthings up another 30% and still keeps you in the game. I stress thisto remind you that we can’t win if we can’t play. We can’t play if weever  lose  big.  The  problem  in  the  past  has  been  finding  stops  thataren’t too close and aren’t too far. Now we have a tool for placingstops  experientially.
Looking  at  the  yearly  profitability  charts,  I  see  all  the  action  on
the charts in the first four columns. Sometimes (e.g., 1989 and 1990),there doesn’t seem to be much difference where your stop would be,but in most years, trading these rules, the most change in profitabil-ity comes from stop levels below  .46.  I speculated earlier that, givenour  trending  trading  rules,  the  noise  level  in  Crude  probably  oscil-lates below .46.  Most tradables have some noise band like this.
Bottom  Line
By inspecting the experience with different trading vehicles (perpet-ual,  monthly,  or  December  contracts),  I’d  opt  to  trade  the  month-
lies.  Most  traders  would  want  to  be  in  the  most  active  contract  toget the fastest fills with the lowest slippage. Although the MAE dis-tributions  are  similar  for  all  three  approaches,  using  the  monthlycontracts  gives  the  smoothest  distributions,  suggesting  more  under-lying  consistency.  To  cap  it  off,  it’s  simply  30%  more  profitable  totrade  the  monthlies,  and  either  the  .31  or the  .46   MAE  stop  is  wellwithin  the  2%  of  capital  guideline.  I’d  choose  the  .31   level  becauseat  that  level  I  have  the  choice  of  trading  two  contracts  instead  ofone while staying under my 5600 loss limit.
Our  campaign  of  trading  is  off  with  a  profitable  set  of  underly-ing  trading  rules  and  a  loss  level  lower  than  the  limit  of  $600  pertrade,  as  shown  in  Table  4.2.
S U M M A R Y
Is it worth it to know where, given our trading  rules  our stop shouldbe?  The  answer  is  definitely  yes.  We  shouldn’t  trade  without  it.
Is  it  worth  it  to  know  what  trading  vehicle  (contract)  to  use  foranalysis and engagement? You bet: sooner or later we must take offand we’d better be on the right flight when we go.
Is it a lot of work to determine which contract to use? Yes.This chapter has shown what homework is necessary when usingmaximum  adverse  excursion  by  testing  for  the  best  stop  level  usingperpetual,  monthly,  and  December  contracts  for  trading.  We  foundthe  system  could  be  profitable  overall  despite  a  low  win-loss  ratioand  it  could  be  more  profitable  with  effectively  placed  stops  whentrading  the  most  active  month  of  the  Crude  contract.
TABLE  4.2 CAMPAIGN TRADING PROFITABILITYNEW  YORK  LIGHT  CRUDE.  1984-1994.
Mode
Trend
Rule
stop  Level
Profit/Loss
Two moving averages
.31
3,600
L
5Piling  On:Exploiting  the  Trend
After  the  initial  probe  and  entry,  the  main  campaign  gets  underway.  Although  the  battle  ebbs  and  flows,  if  we  find  the  enemy  re-treating  we  double  our  efforts.  So  it  goes  in  trading:  as  the  tradesmove along our line of advance. we look for places to commit addi-tional  resources.
Are  we  mindful  that  at  some  point  the  advance  must  end?  Ofcourse! At some point we will add another position to our trendingtrade and find out that the trend is no longer with us. Should we tryto avoid this’? No! Unless you are so prescient as to pick all topsand  bottoms,  you  are  going  to  take  a  loss  at  the  end  of  a  trend.What’s more, your trending campaign will be filled with little losses,some  more  significant  than  others.  It’s  up  to  you  as  the  general  tounderstand  what  stage  you  are  in,  but  here  I  suggest  some  tech-niques  for  managing  the  campaign  as  you  participate  in  a  trend.
SITUATION
Assuming  the  initial  trade  wasn’t  stopped  out  promptly,  we’re  in  atrend  mode  with  an  underlying  position  long  or  short.  Just  being  in
106
Piling  On:  Exploiting  the  Trend
What’s  Chem   What’s  Dear?
107
a  trend  trade  is  the  first  indication  of  the  trend.  Many  of  thesetrades  (about  two-thirds  of  them  in  this  system)  will  go  bad,  beingfalse  signals  of  a  trend.  The  other  third  will  go  along  more  or  lesswell.  Assuming  the  trending  trade  continues,  the  question  for  thecampaign  strategist  is  how  to  consolidate  and  then  extend  thethrust that is under way.
That thrust is the advance in equity, not the advance of the trad-able. It’s easy to stop at this point and think only of the trade that’son:  “How’s  it  doing?  Are  we  up?”  This  is  not  the  campaigner’spoint  of  view.  In  campaign  trading,  you  think,  “I’ve  got  a  tradethat appears, to date, to be good. If it turns out to be an extendedmove, which is the best thing possible, how can I prepare to exploitit fully? How can I build my equity most efficiently using this possi-ble trend?’
The  campaigner’s  approach  is  a  far  more  complicated  question
than “Are we up’?” It deals with
1. the likely rate of advance or decline2. the likely duration of the advance or decline3.  the  opportunities  for  add-on  trades4.  the  opportunities  for  countertrades
A campaigner expects tactical reversals even during a successfulunderlying  trend  trade.  It’s  rare  that  an  exchange-traded  securitygoes straight up or down for an extended period of time given un-certainty,  profit  taking,  and  other  possible  factors.  Although  theseretreats  will  be  a  setback  for  the  original  position,  the  campaignerwill use firm, objective rules to assess whether each retreat is a re-versal  or  an  opportunity  to  add  another  position.
WHAT’S  CHEAP,  WHAT’S  DEAR?
For the sake of simplicity, let’s use an advance as an example.
If prices were going up, we would want to buy when things werecheap; if prices were going down, we’d sell when things were rich.
From a campaign standpoint, any of a number of ideas could beemployed to gauge what’s rich and what’s cheap: retracement lev-els,  detrended  ranges,  Elliott  waves,  swings,  channels  and  manyothers. For example, if you decide a 4% retracement in an  uptrendis  a  good  trading  level,  you  could  place  an  additional  long  asstraightforwardly  as  a  commander  would  throw  reserves  into  theline as it sags under attack. As it happens, averages give an excel-lent  indication  of  cheap  or  rich  if  you  recall  the  skimming  idea.
In this idea, we specifically picked averages that tended to skimalong  the  bottoms  of  advances  and  the  tops  of  declines.  We  didthis  visually  (though  more  sophisticated  techniques  were  available),and now it’s time to exploit that behavior. For this job, averages arehandier than trend lines because the rate of advance or decline au-tomatically drives the average up or down at the appropriate slope.With  drawn  trend  lines,  we  must  initially  guess  what  the  slope  ofthe  trend  line  should  be.  Addicted  chartists  can  still  use  trend  linesin  the  manner  I’m  about  to  describe,  but  they’ll  work  harder  forless 
result.
Recall  our  having  a  longer  moving  average,  intended  to  capturecyclical  content  up  to  60  days,  and  a  shorter  average  to  capturenear-term activity. Because the longer average reacts more slowly, itdetermines when we enter trend trades. Because it lags above or be-low the trend, it is also our lower or upper boundary for the trend,though  we  should  keep  in  mind  that  prices  need  only  stay  flat  forthe  average  to  catch  up  with  them.  If  the  average  is  our  lowerboundary  during  an  advance,  prices  will  be  relatively  cheap  whenthey  touch  this  average.  At  that  point,  we’ll  buy  more.  If  we  hadentered a downtrend and prices rose to touch the long average, theywould  be  relatively  rich  (relative  to  the  prices  in  the  trend)  andtherefore  a  good  sell.  Figure  5.1  shows  how  the  moving  averagewould 
the  OEX  for  1995’s  advance.
look  on 
Looking  at  the  OEX,  note  that  additional  positions  are  addedwhen prices react to the longer average. An easy rule is to put in abuy  stop  at  the  estimated  value  of  the  average  for  the  day,  a  value  thatcan  be  extrapolated  fairly  closely  from  previous  values  of  the  average.Note  that  these  new  positions  from  touching  the  longer  averageare  not  day-trades  but  additions  to  our  underlying  trend  position.
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Piling  On:  Exploiting  the  Trend
What’s  Cheap,  What’s  Dear?
109
If  the  short-term  average  has  turned  downward,  kicking  us  out  ofour  underlying  long  while  the  long  average  continues  to  rise,  thesetouch points are only setups, places where we expect the opportu-nity to reenter. Ideally, we are long and looking to get longer whenprices react to the longer average. We have the opportunity to addpositions at favorable prices.
Just as a longer average like the traditional 21 days was used inFigure  5.1,  a  shorter  average  (5  days)  may  be  used  as  well.  Byblowing  up  the  March-June  segment  we  can  see  many  more  trad-ing  activities.  Every  time  the  prices  touch  the  five-day  average  wehave  an  intraday  trading  opportunity,  an  opportunity  that  veryoccasionally  turns  into  an  additional  trend  position  when  the  mar-ket  rockets  away  from  the  average  in  our  direction.  Figure  5.2
FIGURE  5.1 OEX,  1995.  ADD-ON  TRADES  USING  21-DAY  SIMPLEMOVING AVERAGE.  Form  fitted  for  discussion,  the  21.day  and  5.daymoving  averages  skim  along  the  bottom  of  the  OEX  advance  in  1995,One  campaign  tactic  is  to  add  to  an  advancing  or  declining  trend  tradeby using moving averages  tq define cheap or rich entry   points.
FIGURE  5.2 OEX,  1995.  DAY-TRADING  OPPORTUNITIES.  ADD-ONTRADES  USING  5-DAY  SIMPLE  MOVING  AVERAGE.  A  shorter  averagedesigned to skim the bottoms or tops of advances or declines defines thelower  boundary  of  the  1995  advance  in  the  OEX.  Traders  enter  on  a  buystop set at the average’s estimated value and exit at the close or a setprofit  level.
shows one form-fitted example from the 1995 bull market in equi-ties.  These  are  day  trades,  though.  They  exit  on  the  close  of  theday of entry.
lntraday  Trades
From a campaigner’s point of view, these daily skirmishes should bea  way  of  building  capital  and  probing  for  weakness.  Sometimes,when you send out a patrol in the form of a day-trade, you’re aim-ing to get out of action at the end of the day, and you get your wish:a  quick,  small  profit.  Sometimes  you  run  into  an  opposing  patroland you’re lucky to disengage without casualty. Once in a while, the
110
Piling  On:  Exploiting  the  Trend
What’s  Cheap,  What’s  Dear?
1 1 1
opposition comes at you in force just as you step out, steamrollingyour  trade  and  turning  it  into  a  loss.  Whatever  happens,  it’s  thelosses we’re worried about. How big a loss does it take to convinceus  that  our  little  day-trade  is  running  into  major  opposition?
For  example,  using  Figure  5.2,  we  go  long  as  the  price  driftsdown during the day to touch the short moving average’s value. Weexpect that the moving average’s value will act as a value referencepoint-support-and  that  the  close,  where  we’ll  exit,  will  be  higher.If that works  out: fine. If not, we’re looking at adverse price move-ment,  We  must  cut  that  off  somewhere  and  then  let  prices  declinefurther  until  they  reach  the  longer  average,  at  which  point  we  haveanother  decision  point.  Therefore,  as  prices  break  below  the  five-day average, we’ll have a loss when we stop out; that’s the cost oftrading. We want to keep those costs low, though.
Whether  approaching  probing  day-trades  or  position-buildingtrades,  the  important  thing  is  not  the  entry  rules  that  any  imagina-tive trader could dream up. The first thing to do is look at the ad-verse  price  movement  for  each  specific  rule  just  as  we  did  for  thebasic trend trade.
For each entry that follows the rules for entry and exit, we mea-sure  the  adverse  price  movement  to  see  how  bad  things  get.  Thenwe plot the distribution of adverse movements and see if there is adistinct difference between winners and losers. In other words, forfhis  disfinct   class   of  trades’   we  analyze  the  results  of  our  decision  inthe same manner we analyzed the results of our trend decision. Wewant  a  qualitative  picture  of  those  results,  a  picture  we  can  use  tocut off our losses efficiently and effectively.
Applying  these  two  exploitations  to  Crude  oil  on  a  monthly  ba-sis for ten years generates a lot of trades. Let’s take a look at theMAE  distributions  and  the  distributions  of  profit  versus  stop  levels
’  I  highlight  these  words  for  the  statisticians  among  us  and  those  concerned  withthe  number  of  ruler  used  to generate  out   sample  distributions.  I  argue  that  theseadd-on  trades  are  independent  of  the  underlying  trend  trade  and  that  they  need tobe  analyzed  and  financed  independently.
I  do  not  advocate  adding  trades  by  financing  them  with  profits  from  the  under-
lying trend trade,  the  practice  oft   ~“pyramiding.!
for New York Light Crude. First we’ll do it for the position-build-ing  trades,  then  for  the  probing  day-trades.  If  there  is  a  distinctdifference  in  the  behavior  of  winning  and  losing  trades,  we’ll  haveprofits  from  (1)  the  underlying  trade,  (2)  the  add-on  positiontrades, and (3) the day-trades in trend.
Probing  Day  Trades
One  form  of  add-on  trading  uses  the  pricing  that  touches  theshort-term average. In this case, we know we’re going to take morelosses  than  if  we  traded  prices  touching  the  longer  average.  Afterall, every time the price went to the longer average’s value, it had tofirst go  through  the  shorter  average’s  value,  generating  a  loss.  Theadverse  excursion  information  we  generate  should  tell  us  if  there’sany  distinction  in  our  winning  and  losing  trades  when  we  trade  offthe short-term average and whether there is a logical place to put astop  based  on  experience.
To  show  that  the  experience  with  this  different  set  of  tradingrules  is  consistent,  I’m  showing  all  ten  years’  graphs  (see  Figures5.3  through  5.13).  This  is  to  demonstrate  again  that  the  phenome-non  of  distinct  differences  in  distributions  of  losing  trades  versusthose of winning trades exists and also to show you the variety andfailures  of  this  type  of  analysis.  After,  all  nothing  is  perfectly  con-sistent, and as you’ll see, the market throws a lot of different condi-tions at us.
The trading rule used for these charts was that (1) an underlyingtrend trade was under way, (2) a buy or sell stop was placed at theday’s projected value for the shorter average (12 days), and (3) thetrade was closed at the end of the day.
Before  showing  the  charts  for  other  years,  it’s  worth  looking  atthe  MAE  chart  and  profitability  charts  for  1984  (Figure  5.3).  TheMAE  chart  has  a  very  sharp  distinction  between  winners  andlosers:  there  are  no  winners  at  all  with  an  adverse  price  movementduring  the  trade  of  more  than  sixteen  ticks,  or  .16.   Losers  havelarger  adverse  pricing,  and  one  of  the  adverse  movements  is  asmuch as 105 ticks, or over $1,000. Whether your stop could be exe-
112
Piling  On:  Exploiting  the  Trend
What’s  Cheap,  What’s  Dear?
113
FIGURE  5.3
FIGURE  5.3  (Continued)
WINNERS  AND  LOSERS,  1984  ADD-ON  TRADES  FROM  SHORTMOVING AVERAGE. Even on the short-term trades, winners simplydon’t  have  that  much  adverse  excursion.  They  can  be  traded  here  with  astop of only 16 ticks, perhaps less.
PROFITABILITY,  1984  ADD-ON  TRADES.  This  chart  deserves  somethought.  How  could  a  stop  of  .31  have  been  more   profitable  than  a  stopof  .16 if using .31  allowed  additional  losers.  See  the  text  for  the  answer.
I-!
-04  
.OL 1
EQUITY  LINES  FOR  VARIOUS  STOP,  1984  ADD-ON  TRADES.  Thestop of  .31   shows  the  greatest  profitability  not  from  greater  gains  butlesser 
losses.
cuted in a market moving that far in a single day is certainly a ques-tion,  but  there’s  no  protection  at  all  without  the  stop  that  mighthave prevented that sort of loss.
Still, the 1984 profitability graph shows that a stop of  .31  is moreprofitable than a stop of  ,16   even  though  no  winners  at  all  had  anMAE  greater  than  .16.   How  can  that  be?  Well,  what  if  a  tradeclosed at a loss of  .03  (3 ticks) but had an MAE of 20 ticks‘? Withno stop, the equity line just goes down 3 ticks. With a stop of  .16.the stop is hit and the equity line goes down 16 ticks. With a stop of.31,  it goes down again just 3 ticks because the stop is not hit.
In 1984, this happened repeatedly: the closer stop caused more,larger  losses  than  a  more  distant  stop,  as  stops  have  been  definedhere.  In  other  words,  a  stop  too  close  converts  some  small  losersinto  somewhat  bigger  losers.  The  effect  of  this  must  constantly  bebalanced  against  the  benefit  of  the  elimination  of  the  huge  losers.The  more  conservative  among  us  can  still  stop  out  profitably  at.16.   A  more  aggressive  analyst  can  analyze  the  volatility  that’sshowing  large  MAE  with  small  losses  on  the  close  to  decide  ifreaching  for  the  extra  profit  is  consistently  worthwhile.  For  a  clue,let’s  look  at  1985  (Figure  5.4)  and  1986  (Figure  5.5).
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Piling  On:  Exploiting  the  Trend
FIGURE  5.4
What’s  Cheap,  What’s  Dear?
115
FIGURE  5.4 
(Continued)
WINNERS  AND  LOSERS,  1985  ADD-ON  TRADES  FROM  SHORTAVERAGE. 1985’s distribution of losers again peaks in the .31  bin whilewinners peak in the first bin. The consistency of this distinction isalways  checked  first  to  see  if  a  new  trading  scheme  is  viable,
EQUITY  LINES  FOR  VARIOUS  STOPS,  1985  SHORT-TERM  AVERAGEADD-ON TRADES.  1985 did not have a horrendous loss to deal with  SDits  equity  line  is  smoother.
FIGURE  5.5
PROFITABILITY,  1985  SHORT-TERM  ADD-ON  TRADES.  As  in  1984,the  trader  must  choose  between  a  very   safe  but  lower  level  ofprofitability  with  a  close  C.16)   stop,  or  a  higher  risk  and  higher  rewardwith  a  stop  at  .31.
WINNERS  AND  LOSERS,  1986  ADD-ON  TRADES  FROM  SHORTMOVING  AVERAGE.  1986  offered  many  day-trades  off the  short-termaverage.  The  four  winners  with  large  adverse  movements  and  the  loadof  losers  give  a  very  jagged  profit  graph.
116
Piling  On:  Exploiting  the  Trend
What’s  Cheap,  What’s  Dear?
117
FIGURE  5.5  (Continued)
FIGURE  5.6
PROFITABILITY,  1986  SHORT-TERM  ADD-ON  TRADES.  The  ideal  stoplevel  for  this  book’s  example--.31-takes  the  biggest  hit  in  1986.Market  perversity  dictates  that  no  one  solution  will  be  ideal  for  allperiods.  Given  the  relative  consistency  of  the  other  stop  levels,  the  lowvalue at  .31  is  probably  a  random  event.
WINNERS  AND  LOSERS,  1987  ADD-ON  TRADES  FROM  SHORTMOVING AVERAGE.  1987  shows  a  good  distinction  between  winnersand  losers,  with  winners  having  very  little  adverse  excursion.Profitability grows as stops are widened to  .3.
EQUITY  LINES  FOR  VARIOUS  STOPS,  1986  SHORT-TERM  AVERAGEADD-ON 
TRADES.
PROFITABILITY,  1987  SHORT-TERM  ADD-ON  TRADES.
118
Piline  On:  Exoloitiw   the  Trend
What’s  Cheap,  What’s  Dear?
119
FIGURE  5.6  (Continued)
FIGURE  5.7  (Continued)
c
~~~~~.aggf~~e:asanpsI___----_NI
EQUITY  LINES  FOR  VARIOUS  STOPS,  1987  SHORT-TERM  ADD-ONTRADES.
PROFITABILITY,  1988  SHORT-TERM  ADD-ON  TRADES.
FIGURE  5.7
WINNERS  AND  LOSERS,  1988  ADD-ON  TRADES  FROM  SHORTMOVING AVERAGE. 1988 typifies one attractive feature of add-on day-trades:  a  high  percentage  of  winners.
EQUITY  LINES  FOR  VARIOUS  STOPS,  1988  SHORT-TERM  ADD-ONTRADES. Stops at .3  give the 1988 trades enough room to flourish,apparently  just  outside  the  noise  range  of  the  data  that  year.  Losers  hadmuch 
larger  adverse  excursions.
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Piling  On:  Exploiting  the  Trend
FIGURE  5.8
What’s  Cheap,  What’s  Dear?
1 2 1
FIGURE  5.8  (Continued)
WINNERS  AND  LOSERS,  1989  ADD-ON  TRADES  FROM  SHORTMOVING  AVERAGE.  A stop at  .16  might be tempting based on the MAEchart,  but  the  profitability  chart  shows  the  .3  level  is  as  good  as  inprevious  years  and  significantly  more   profitable.
EQUITY  LINES  FOR  VARIOUS  STOPS,  1989  SHORT-TERM  ADD-ONT R A D E S .
FIGURE  5.9
PROFITABILITY,  1989  SHORT-TERM  ADD-ON  TRADES.
WINNERS  AND  LOSERS,  1990  ADD-ON  TRADES  FROM  SHORTMOVING AVERAGE.  1990 MAE. This is a unique graph: the distributionof winners extends its tail as far as that of the losers. For  more  on theresults from the tumultuous years of 1990 and 1991, see the 1990profitability  and  equity  charts  and  Figure  5.10.
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Piling  On:  Exploiting  the  Trend
FIGURE  5.9  (Continued)