ears. One doji is important to consider, and may cause you totighten your stops. Two dojis should always cause you to tightenyour stops. The added weight of the reversal bar (open higher -close lower) is cause to liquidate the position. Take your profitswhile they are still there. On the reversal day, the bears have won.The likelihood of a trend change is extremely high at that point,especially when preceded by the two doji bars.
There will be times when this action turns out, with hindsight,to be incorrect. However, most of the time it will prove to havebeen the right thing to do.
 
| treat each position on its own merit. If | have been able tocover costs, take a small profit, and am still in the position fromearlier in the trend, | will be trailing a stop on a different basis.
My objective for the earlier positions is to be stopped outbecause prices have touched a curve fitted moving average or acurve fitted volatility study. At times it may be both.
| have studied the markets over many years, and havesimultaneously used differing trailing stop methods for differententries. That way I've been able to test and compare how eachworks. All the while, I'm earning money while | find out.
ED H DAILY W5,2.4
 
Suppose I were trailing natural support pointstops in this market when it made its firstnajor correction. If I try to curve fit the shyvolatility study to the trend, I run into aproblem. The correction is of sufficientmagnitude to disrupt my trend line. yet
                     
My natural support point stop wouldhave kept me safe, but in order to
curve fit a study for maintaining afuture trailing stop, I wouldneed to use a moving average.
T+ Disruption inthe volatilitystudy makes itinpossible tocurve fit thestudy for futureuse.
 
Nou DEC JAN
219| could have used any number of different combinations ofmoving averages. The one I've shown on the next chart is a 25 barmoving average of the close, offset, or moved forward in time by 5
bars.ED H DAILY
 
This offset moving average of theclose vould have easily
contained prices all the way touhere I ran out of prices to jshou you,
                     
This is one uay to extractthe most profit from atrending market. ¢
It would not matteruhether this { Kevere a Cocoa
38 minutechart, or aS minuteS&P chart.
The truthvorks in
all tinepe ul
\natant cnldal Mulihuy
JUN JUL AUG SEP OCT NOU DEC JAN
 
n25F596159688
The stop is trailed by placing conit just on the outside of the 3555noving average. Once you haveestablished a position and are 9548satisfied vith the profits 9925you've taken so far, you may 9518uish to use this kind of a 9495trailing stop. 9488
This kind of stop would have aesaved you from being stopped
out at tvo natural support 9435points. I’ve pointed them out 9428vith the arrous. 9485
9398Even so, using natural support 9375
points would have made you 9368plenty of money in this market.
9345You don’t need any fancy soft- 9338ware or a computer to use 9315natural support and resistance 9389points. 9285927892559248
These moving averages can also be computed by hand. It's achore to get them set up, but once you do, you can easily maintainthem in tabular form from day to day. It's simply a matter ofdropping the oldest day and adding the latest day.
220
 
 
Before the advent of computers and daytrading, | kept suchstudies by manually entering the figures each day. Naturally, unless| wanted to work myself very hard, | was able to monitor only a fewmarkets.
Then along came Messrs. DiNapoli and Damusis with theirsoftware for the Epson computer, running under CP/M. What a joy!| was ecstatic, freed forever from the drudgery of doing all thesethings with a high intensity of labor. | am now able to do inmoments what took hours of my evenings to do.
Then | visited Joe DiNapoli on a trip | made to California to bewith my parents. Wonder of wonders, he had live data. | wasflabbergasted. | knew the big brokerage houses had such things onmain-frame computers, but here was this thing called CQG, and itwas displaying charts with live data.
This was my awakening. | had been an almost total recluse. |had traded privately and secretly for so long, | had forgotten therewas another world out there.
Now, through the marvel of the computer, | am able to sharewith others the many things | learned over the years.
I think I've shown enough of the Eurodollar trade that you canget a pretty good idea of how the Study can be used to filter Rosshooks.
It's time now to move onto something else.
In the chapter that follows, | will be showing you how to usey bands to screen and filter your trades.
 
vola
There is a market for everyone. There is a suitable time-framefor everyone. There are studies that suit the tastes of everyone whotrades.
The next study, if it suits your temperament, may be all youneed to become a winner. This study is taken from real lifeexperiences of more than one trader. A lot of money has been madeusing the concept. See if it fits your style of trading.
221Chapter 14
Envelope Filtering
| have long been an advocate of the use of envelopes andenvelope breakouts in my trading. With the advent of the computer,it has become very easy to do this type of work, live, and with avariability that more correctly reflects market action.
This chapter and a later one will show two entirely differentconcepts for using envelopes with the Ross hook.
Let me show you a picture. See if you can figure out how touse Ross hooks with the accompanying studies. We'll start out withthe five minute oil chart | showed in the previous chapter.
CL2G.5 MIN
 
191?
r 19141911
1988
1985
1982
| 18991896
I 1893I 18981887
188418811878187518721869186618631868185718541651184818451842
 
 
The study shown on the chart is the Keltner Channel. Theinformation | have on this study states, "The Keltner Channel isbased on volatility expressed as a bar's range. A channel is createdon both sides of a moving average. The average true range of eachbar is multiplied by a constant, and then added and subtracted fromthe moving average to create the channel on each side of the
moving average."
The center line is an exponential moving average, in this case a39 bar exponential moving average of volatility.
Formula: Center Line: XMAC = (AV * (N-1) + Price) /NAv Range: Av Range = (Range * (N-1) + High - Low) /NChannel: Upper = XMAC + Range * C
Channel: Lower = XMAC - Range * C
Parameters:1st: N = Number of bars in the exponential
average.2nd: C = Multiplier constant, | used 1.618
Typically, you buy when prices penetrate the upper channel,and sell when prices penetrate the lower channel.
It doesn't make much difference if you use a simple movingaverage of the close in place of an exponential moving average.Therefore, if you wanted to do this by hand, simply maintain a 39bar simple moving average of the close, and also maintain a simplemoving average of volatility (the difference between the high and the
low each day).
 
The upper channel would be created by adding the movingaverage of volatility times 1.618 to the moving average of the close.
The lower channel would be created by subtracting the movingaverage of volatility times 1.618 from the moving average of the
close.
  
| wish | had more information to pass on to you, but the above,is all | know about the Keltner Channel. Most importantly, it's all 1
need to know.
223If you recall, Ross hooks occur only in trending markets. Tothe best of our ability, we want to filter out anything that looks likea hook if it is not occurring in a trending market.
  
The Keltner Channel (KC) can be used to do precisely that job.By using a 39 bar Keltner Channel we are forced to trade with thelong term trend.
We take hook trades only when they occur outside thechannel, or if the taking out of a hook would position your tradeoutside the channel.
We want to be sure that the market is indeed trending, so wemust see the trend begin while it is still in the channel, if we areanticipating a breakout from the channel. If prices are alreadyoutside the channel we will filter them with the Study.
  
The Keltner Channel! is such that when a market is movingsideways for awhile, the entire sideways move may be outside thechannel. We want to avoid trading "pointy" places when a market ismoving sideways outside the channe’ be showing examples ofthis. At that time, we will use the Study to filter our trades.
 
We want to use the KC as a filter for trading the Ross hook.We trade only the hooks in the direction of the trend on the side ofthe channel that corresponds to that direction. We trade long ifprices are above the channel. We trade short if prices are below thechannel.
. We ignore anything that looks like a hook if the trade will occurinside the channel. This is the price we pay to accomplish not overtrading, and making sure we are with the long term trend.
 
The market does not need to make a 1-2-3 high or low prior totaking hooks outside the channel.
We can also trade breakouts of 1-2-3's, if the number 2 point
is outside the channel or a takeout of the number 2 point will takeus out of the channel.
224
 
However, we do want to use our discipline of identifying whenwe are in congestion, and when we are in a trend. All the rules fortrading the Ross hook are still in effect. The channel is there solelyfor the purpose of telling us when we are in a trend.
 
 
 
At times the market begins to congest while it is still outsidethe KC. At that time we have two options. The first option is towait for the KC to catch up to the congestion area before weresume taking hooks outside the channel. The second option is tofilter those trades with an appropriate version of the Study.
Our discipline must be exacting in following the rules I've justlaid down.
trading. We will add the Study to screen out some of the trades wemight otherwise have taken. As you will see, this is a veryconservative method of trading.
The name of this kind of trading is patience. It is not unheardof to have to wait for more than a week, trading a five minute S&Pchart, for prices to begin to move out of the channel.
With these considerations in mind, let's look at the five minuteCrude Oil chart, followed by a number of other charts showing thisconcept. All of the charts shown occurred within a three dayperiod. There are plenty of markets and opportunities to trade.
225
Because we want to be very careful, we will add a filter to this |CL G.5 MIN6 1917
19111985
 
8 iL 12
9 181875 C- 1880 U- 24 X= 86 Y- 82
12 1 2O- 1877 H- 1982 L-
There are three Ross hooks on the chart. See if you can spotthem. The first was tradable and resulted in a loss. The secondwas not tradable because of a gap opening on the following day.The third was tradable and made a sizable move for a sizable profit.
Now, where do you put the stop? Take a look. I'm going tomove the chart back in time to where the first trade took place.
226
          
CL G.5 MIN 1862 18681985
198218991856189319981887188418811878187518721869
n 1866< us lever 1863
a185?185418511848184518421839183618331838
     
113:58 O- 1863 H- 1863 L- 1856 C- 1857 U- 15 -K- 1862 Y- 1874 Z- 1866
You could have used the Volatility Stop Study. On the chartabove, the point of the hook was at 1861. Had you entered thetrade at 1860 (shown in the upper right corner of the chart), yourstop would have been at 1862 (shown to the right of center at the
top of the chart).
One arrow shows the Volatility Stop price level. As you cansee, immediately upon completion of a price bar the study is updatedand extended forward to where the next price bar begins. Anotherarrow is shown at the level of the entry into the market.
227The trade resulted in a loss of two ticks.
Now let's look at the next trade.
CL G.5 MIN 1874 1882
    
haba bes
18331838
 
tall i mt lu
289 1811:25 O- 1877 H- 1682 L- 1875 C- 1888 V- 24 = X- 1874 ¥- 1867 2- 1858
  
. We have had a swing up from the bottom of the channel to ahigh that made a number 2 point, a correction to a number 3 point,and a Rh. If we take out the Rh, we want to be long.
a A lias pent
  
Note that the earlier 1-2-3 did not give us a number 2 pointoutside the channel.
228
     
CL G.5 MIN 1988
 
 
& 6 fo & &
18)198:
1818186:18
18571818
184518:
   
it 12 t 2 89 18 11 1211:48 O- 1879 H- 1898 L- 1878 C- 1888 U- 31 + X- 1881 Y- 1868 2- 18
A maximum of 32 points could have been made if we exitedon the top tick. That's not likely. But what would the results of thisseries of trades have been?
Trading three contracts at $25 a round turn including fees, wewould have lost $60 + costs of $75 on the first trade, for a loss of
$135.CL G.5 NIN
      
 
mht11 12 1
  
11:48 0- 1879 H- 1898 L- 1878 C- 1888 Y-
  
18
 
1968
i31
1882191?1914191119881985198218991856189318981887188418811878187518721869186618631868185?18541851184818451842
X- 1881 ¥- 1868 2- 1858
On our winning trade, we would have costs of $75. We wouldcash one contract after eight ticks to cover costs, and then wouldhave pulled our stop to breakeven on the remaining two contracts.At that point, we are ahead of costs for this trade by $5. Beingconservative, we could have trailed a 50% stop which would neverhave been hit. The two remaining contracts could have made as
much as $320 net for each one.
230
 
Was this a sensational trade? No. But it was very typical ofwhat happens when you trade hooks using the Keltner Channel as a
filtering envelope.
 
Next, we will look at some other markets in other time framesshowing this same channel concept.
BPH.S MIN 18566 K39,1.618
h bel yt <
Honeys m tue
     
This is a perfect example of a congestion takingplace entirely outside the channel. Unless themarket begins to trend, or reenters the channeland then breaks out, we do not trade this kind
of market, unless...
iil
2. 68 3 18 il 12 1 2?
...we filter the trade our regular way with the Study. In otherwords, when prices are entirely out of the channel, we do not usethe channel. At that point we are being told one of two things: 1.
   
,
18688
18585
19578
18555
18548
18525
18518
19495184881846518458184351842818485183981837518368183451833819315193881828518278182551824818225
The market is going sideways ona 39 period basis. 2. The market
is trending outside the channel on a 39 period basis.
2316C G.5 MIN K39,1.618 |3828
No problems trading the dountrend outside %
the channel. If prices would form a 1-2-3
CL G.5 MIN1962
Here is our old friend Crude Oil on a different day. We didn’t do so vell this 1959day. Lost on a breakout of the nunber tuo point, and barely covered costs on 1956
        
 
 
a breakout of the Rh. We don’t aluays vin! 1953 = 35;= here, ue could take a breakout of the nunber1958 * 2 point as it comes out of the channel. 3828194? e 311944 311941 : 311938 £ 35121935 311932 3581929 <sell \ 3581926 | if « =ie tt 4 3581528 sell4)||t {| 3s! i 1 lly’ 3041911 - 1 we 1iy 1 | tout sett->i] tlh I 368I i Notice that prices are ‘straddling’ the oe 3488I channel in a large congestion. The 348handling of this type of situation will 1895 348be covered in another section. You will 1856see several of these’straddles’ in the 1893 xecharts ahead. 1898 ome1887 od
   
ly il
illllltihii
12 1
When I'm daytrading, | will make no more than three attempts On some of the Charts, | am marking many of the possibleat a market. That means three attempts at a single market. Usually, entry signals that could be considered. That doesn't mean that | or
I'll make no further attempts for the rest of the day in that market. z you would take every one of them. Each has to be considered inlight of a great many other things that may be going on. But if you |
2 wanted to intensively trade a particular market, you would take allthe signals presented. To do it, you must maintain tight control overyour trading. You must insist on low commissions, good fills, andplace tight stops. You also need an awesome amount of self
discipline.
 
 
232 233
 Notice that placing stops below natural support points would
           
          
   
            
JY H.5 MIN: 8084 have held in every case. Notice also, that placing a stop just belowfar er pir dy sabe tesa ar gg oko need nt oe 8288 the upper channel line would have easily held this trend.encounter stair-stepping markets. Notice, there is an 8876 JY 4.5 MINuptrend as sho by the channel lines. ore This next one vould have been tough to trade unless you know how anY Rh La 8064 to trade a stair—stepping market. Watch closely, you often 8076Rh uy encounter stair-stepping markets. Notice, there is ani 1 } t 8868 uptrend as shoun by the charmel lines. 8872buy i rN 856 80682 priser | 8052 Yeh kebuy 8864| yz ents Rh I 8868| as eats ‘yy Ba?| it hall tl aS bal gas| hie ft 8836 8048t i 8832 80442 id 8828 88408824 = 88368828 e 88328016 2 88286012 2 88246888 : 88288084 ¢ 88168088 a 88127996 = 6887992 = 80847988 ¥ 80087984 = 7996ill 7392i 79887984
   
 
18 11 12 1 ?
The fourth, fifth, and sixth trades were also successful
The first area I've labeled as a 1-2-3, may not actually haveaccording to stop placement.
been a 1-2-3 low. That's not important, because what we're reallyinterested in is the "pointy" place I've marked as number 2. We
want to buy a breakout of the number 2. A daytrader could have garnered quite a few points out of the
Japanese Yen on this day when it seemed to do so little overall.
. The second and third trades come as the result of 1-2-3's, oneis a possible loser, the other is okay. | suppose it all depends uponwhere you place your stop.
A position trader, looking at a similar daily chart, would havedone just as well, except that it would have taken a lot longer.
235
wineries id d ORIN:
234         
The next chart is of the S&P. It shows how you have to be BO H DAILYatient.p oe ute concerned vith here is ae e congestion straddliSP H.5 MIN the channel. Ue vould vant to 2198Here ue see a nost difficult chart to trade. The S&P can be fabulous 42165 filter our trades with the Study. 2175when it trends intraday. Here ve see one of those horrible congest ions 42158 2168that make the Swinute look like it usually does on a daily chart, Here 42135 2145the S&P is not so fabulous. At tines, it can go many days looking as 42128 2138it does on this chart. 42185 211542858 218842875 208542868 207842845 205542838 . 204842815 . 282542888 2018< 41985 1995| 41978 1988419554194841925 1935
         
192819851898
There is really only one trade 41918that could have been taken, and it vas 41895a loser by any standard. I’ve marked it on 41989
 
the chart. After that, the market ventinto and stayed in congestion. ieee a41835 184541828 liteetretteliin srnsseliretaatl lil41885 SEP Oct NOU JAN
 
hi
Because of the incredible disorder, trades coming out of thecongestion must be filtered using the Study. We'll be looking at afew more of these chaotic charts, along with trending charts, andthen see how the congested ones may be traded in relation to theKeltner channel. Be patient, | have only a few more charts to showyou.
18 11 12 1 2 3
236 237
1965 {1958|
 WH DAILY K39,1.618
    
 
Here we have a trend that is almost entirely
out of the channel. All we do here is trade ft |
this using normal hooks and a filter such as i lI tt
cel. /
| iitiy all
“eeu tharcathitgyslll illite‘SEP oct NOU DEC JANCC H DAILY k39,1.618
Pay attention to the large congestionarea that straddles the channel.
 
I will show how to handle this type
ttt shes s if |;
 
 
 
 
SB H DAILY K39,1.618
  
abtutoudtatdutaot leat
“hay ‘JUN SUL ‘AUG SEP Oct NOU DEC JAN
 
SB H.S MIN
I put this one in because it uas so
interesting. Sugar was in a hurry
to get from one congestion to theth, next.
   
ullttasastt16 11
239BO H DAILY
This straddle is the opposite of one ve looked at earlier.It is hanging onto the bottom side of the channel.
  
This is enough looking. Vhatdo we do about such tradingsituations?
The easiest and safest answer is to simply stay out of themarket when you see a congestion area. In practice, this might bethe best way to handle the situation.
But knowing how most traders are, even if they stay out incongestion, they want to know how to get in or whether to get inwhen prices come out of the channel.
So, let's revisit some of these congested channel straddles tosee how they may have been traded.
240
 
 
# H DAILY2-11
The question is,do we take a breakoutof the nunber 2 point tombrvod since It 15 out 2295of the channel?
    
   
Nov DEC
 
en mL
pointing the 2@55ong MAY 3a25
1995cniennnees ts)anne nennnnnn=193519851875
*
 
AUG =—sSEP OCT Nov DEC
There is somewhat of a judgment call on this chart. If priceswere to take out the number 2 point K might very well cross D. ButI'd like to see it have a bit more room in which to turn around.
241Question: Should ve go short if prices
 
    
take out the Rh?SEP OT NOU DEC12-24BO H DAILYMi fp tt A NAP nenee eeAnsuer: Yes!The Study is58 going theright vay -downta wee eenenene-ee2B----------=-4-}-H- Lydd nh tt naapfennabpan---- == os
 
DEC
SEP NOU
242
I'll go through two trading decisions for trades from the Sugar
     
   
 
               
  
2235 monstrosity | showed a few charts back. I've decreased the number2285 of bars shown in the chart for purposes of increased clarity.2175214s Sm Dari This trade was Question: Should ve take a 99taken lo breakout of the Rh? seaus De trade, |ere2085 oun) ae2855 8968822025 9681995 8541965 8401935 826a1285 The trades that1975 were filtered ou 798ere not making{fie BPOPED any 784crossing would 778
      
have been
       
2235 SE os
SB H DAILY nos2285 m SN TOS OE, 11!21752145 pnnnnennnnnnenennnnealts2085 Answer? Not 2682055 Because the Study g<42025 is below the 25% 348
level.
1995 8261965 pan nap nnn fname nn nfm nnn ant hbo pina cba panna bag nnnn nnn al21935 wo 2981985 « 7941875 ma
JUL AUG SEP oct Nou
243SB H DAILYQuestion: Shot
ld. we Sey to buy 938924918896882868854848926812798
h 784778
ul.a breakout of the
 
 
      
moved away from D 954a crossing wouldalmost surely have 949inthe right aisin the night direc- g2¢
Sph i N ene. Sew.
BBO NS prmmn nnn nnn nnn pe pncad nnn nn dfn nb Ee fom fiagothetical bar 79%and see what would 794happen.
778
AUG SEP OCT HOU DEC
But, the crossover would have to take place below the 75level, which it never did.
This trade, if it had been taken, turned out to be a moneymaker and resulted in the December high.
 
| guess we still haven't found the Holy Grai
244
 
 
 
cc H DAILY These 3 are attemptedbreakouts of the RRh. 136!1344
‘tt : I ! 1328
wid 1312
   
         
12961280126412481232121612081184
<-Yes, if break-1168out occurs,
FEB
   
=ou=f=
   
 
OCT NOU DECCC H DAILY
 
“s==“ananorgensPAT EER
1312a Y = 1296 |
This style of trading can prove to be very interesting regardlessof time