ov(V,100,S),-2) AND Ref(CI,-1)/Ref(CI,-D1-1)<1 AND(P12 AND T12)If you don’t have FVE in your indicators list then you should create a custom indicatornamed FVE with the following code:
Appendix C
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PERIOD:= Input(“PERIOD FOR FVE”,5,80,22);COEF:=Input(“COEF FOR CUTOFF”,0,2,.1);H1:=If(H>0,H,Mov(H,5,S));L1:=If(L>0,L,Mov(L,5,S));INTRA:=Log(H1)-Log(L1);VINTRA:=Stdev(INTRA,PERIOD);INTER:=Log(Typical())-Log(Ref(Typical(),-1));VINTER:=Stdev(INTER,PERIOD);CUTOFF:=COEF* (VINTER+VINTRA)* C;MF:=C-(H+L)/2+Typical()-Ref(Typical(),-1);FVE:= Sum(If(MF>CUTOFF, +V, If(MF <-CUTOFF,-V,0)),PERIOD)/(Mov(V,PERIOD,S)+1)/PERIOD* 100;FVE
Target FormulaIn my article published in the June 2007 issue of Technical Analysis of STOCKS& COMMODITIES, I derived statistically the following formula for calculating theaverage price objective of rectangle formations:Target = 2.3h .8where target = the breakout price objective in points or dollars which is the verticaldistance measured from the formation upper boundary trendline to the first short termtop. If this is measured on the chart with a ruler then the preferences should be setto display the chart in arithmetic and not logarithmic scale; h = rectangle height inpoints or dollars.In the following example the target was exceeded by only $0.6 or 0.7 %. On 18May 2007 Royal Dutch Shell Plc. (RDS.A) broke out from a 9-month rectangle andnever looked back until it peaked on 9 July 2007 at $85.34.Rectangle height h = 71.87 (upper rectangle boundary) − 63.28 (lower boundary) =8.59Substituting for h in the above formula we get:Breakout = 2.3∗ (8.59).8 = 2.3∗ 5.59 = 12.85and therefore the predicted target price is 71.87+12.85 = 84.72 vs. the actual breakoutprice of 85.34.
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Exit RulesOf course nothing is certain in the stock market and potential rectangles can sometimes fail to reach the expected profit target or breakouts fail to follow through andreverse direction to enter below the rectangle upper boundary.My research on rectangles (presented in my article in the June 2007 issue ofTechnical Analysis of STOCKS & COMMODITIES) was used to derive the followingconditions to close long positions detected by the exploration formula above:• Profit target: The stock reaches the profit target according to the formula calculatedin Column B of the exploration) or 55 % whichever comes first.• Inactivity stop: The stock fails to reach the profit target in 95 calendar days (65trading days).• Stop loss: The price crosses below the rectangle upper boundary (calculated inColumn C of the exploration).
Glossary
Advance-decline lineOne of the most widely used indicators to measure the breadth of the stock market. Tocalculate the A/D line the number of declining issues is subtracted from the number ofadvancing issues each day and the net total is added to the previous cumulative total.American Depository Receipts (ADRs)ADRs are negotiable receipts for the securities of a foreign company which are keptin the vaults of an American bank, allowing Americans to trade foreign securities inthe United States.ArbitrageThe simultaneous buying and selling of assets in different markets or in derivativeforms, taking advantage of the price difference.Artificial neural networksNonlinear statistical modeling tools that can be used to model complex relationshipsbetween inputs and outputs or to find patterns in data.AutocorrelationCorrelation between values of a series and others from the same series separated bya given interval.Average True Range (ATR)The True Range indicator was first introduced by J. Welles Wilder in his book, NewConcepts in Technical Trading Systems (see Bibliography). Wilder defined the truerange to be the greatest of the following for each period:• The distance from today’s high to today’s low.• The distance from yesterday’s close to today’s high.• The distance from yesterday’s close to today’s low.
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The Average True Range is simply the average of the true ranges over the past xperiods.Black boxA proprietary trading system whose rules are password protected and not disclosed.Bollinger BandsDeveloped by John Bollinger, this indicator plots trading bands two standard deviations above and below a 20-day moving average.Central Limit TheoremThis theorem states that as the number of cases in the sample increases, the distributionof the data approaches normality.Correlation coefficientThe correlation coefficient indicates the strength and direction of a linear relationshipbetween two variables. A correlation coefficient of 1 (or −1) indicates a perfect linearrelationship. A correlation coefficient of zero indicates that there is no straight linerelationship between the two variables.CovarianceCovariance is the measure of how much two random variables change together. Thecovariance is calculated by taking the cross product of the deviations from the mean,and then dividing by the number of observations.CoverPurchasing back a contract or a stock sold earlier to profit from a price decline.Chaos TheoryDescribes the behavior of nonlinear systems. In the stock market, Chaos Theory seeksto forecast the future path of stock prices, using non parametric methods.DrawdownThe reduction in account equity from a previous high as a result of a trade loss or aseries of losses.Efficient Market TheoryThe Efficient Market Theory states that at any given time, security prices fully reflectall available information.Exchange-traded funds (ETFs)Investment funds that can be bought and sold as a package on an exchange. Typically,ETFs try to replicate a stock market index such as the S&P 500 (e.g. SPY) or a marketsector such as energy or technology, or a commodity such as gold or crude oil.
Glossary
373
Exponential moving averageAn exponential (or exponentially weighted) moving average places more weighton the most recent closing prices by applying weighting factors which decreaseexponentially. It is calculated by applying a percentage of today’s closing price toyesterday’s moving average value. The formula for calculating EMA is:EMA = (Today’s closing price* k) + (Yesterday’s EMA* (1 − k)), where k =2/(n + 1); n = no. of periods.Finite Volume Element Indicator (FVE)This indicator was developed by Markos Katsanos and introduced in the April 2003issue of Technical Analysis of STOCKS & COMMODITIES magazine. It was modifiedfor volatility in the September 2003 issue of the magazine. FVE is a money flowindicator but with two important differences from existing money flow indicators:1. It resolves contradictions between intraday money flow indicators (such asChaikin’s money flow) and inter-day money flow indicators (like Granville’s OnBalance Volume) by taking into account both intra- and inter-day price action.2. Unlike other money flow indicators which add or subtract all volume even if thesecurity closed just 1 cent higher than the previous close, FVE uses a volatilitythreshold to exclude the volume on days of minimal price changes.The FVE provides three types of signals:1. The strongest signal is divergence between price and the indicator. Divergencecan provide leading signals of breakouts or warnings of impending corrections.The classic method for detecting divergence is for FVE to make lower highs whileprice makes higher highs (negative divergence). An alternative method is to drawthe linear regression line on both charts, and compare the slopes. A logical buysignal would be for the FVE, diverging from price, to rise sharply and make aseries of higher highs and/or higher lows.2. The most obvious and coincident signal is the slope of the FVE line. An upwardslope indicates that the bulls are in control and the opposite for downward slope.This indicator level is a unique and very important property of FVE. Valuesabove zero are bullish and indicate accumulation while values below zero indicatedistribution. FVE crossing the zero line indicates that the short to intermediatebalance of power is changing from the bulls to the bears or vice versa.3. The best scenario is when a stock is in the process of building a base, and the FVEdiverges from price and rises to cross the zero line from below, at a sharp angle.Conversely the crossing of the zero line from above is a bearish signal to liquidatepositions or initiate a short trade.Genetic algorithmThis is an alternative method to the “brute force” approach that seeks to solveoptimization problems using the methods of evolution, or survival of the fittest.
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Hidden neuronsUsed to connect the input and output layer of a neural network. They are built duringthe learning process and use weighting transform functions to serve as connectors.Historic volatilityMeasures how much a security price has fluctuated over a period of time in thepast; usually calculated by taking the standard deviation of price changes over a timeperiod.Historical dataA series of past intraday or daily market prices.Kolmogorov-Smirnov normality testThe Kolmogorov-Smirnov test can be used to test that a variable is normally distributed by comparing the observed distribution function with a specified theoreticalnormal distribution.KurtosisDescriptive measure of the sharpness of the peak of a frequency-distribution curve.LagThe time difference or shift between one value of a time series and a previous valueof the same time series.Least-squares methodFitting a line or curve to data so as to minimize the sum of the squares of thedifferences between the observed values and the estimated values.Linear regression lineA statistical technique for fitting a straight line to a set of data points using the leastsquares method.Market breadthInternal market statistics which are calculated by counting stocks that meet certaincriteria. The “Percentage of stocks above their 40-day moving average” for example,counts the number of stocks currently trading above their 40-day price moving averageand then plots this as a percentage. So if the daily value of this statistic is 70, youknow that 70 % of the stocks on the NYSE are above their 40-day MA.Maximum adverse excursionThe most equity lost intraday by any single position.MomentumThe change of today’s price from some fixed number of days in the past.
Glossary
375
Momentum indicatorA technical analysis indicator showing the distance the current close is relativeto the recent x-period high/low range. Momentum indicators are useful for predicting overbought or oversold conditions, and possible turning points within themarket.Money flowA technical indicator that incorporates volume and price action to measure buying orselling pressure.Monte Carlo SimulationA procedure used to repeatedly analyze a system by rearranging the trades randomly(hence the name).Moving average crossover systemOne of the most popular trading systems. A dual moving average crossover systemgenerates a buy signal when the shorter of two moving averages exceeds the longerone; a sell signal is generated when the shorter moving average falls below the longermoving average.Moving average convergence/divergence (MACD)The MACD is a trend-following momentum indicator that shows the relationshipbetween two moving averages and is calculated by subtracting the value of the26-period exponential moving average from the 12-period exponential moving average. A 9-period dotted exponential moving average (the “signal line”) is usuallydisplayed on top of the MACD indicator line. The MACD was developed by GeraldAppel, publisher of Systems and Forecasts.MulticollinearityA case of multiple regression in which the predictor variables are themselves highlycorrelated with result of two variables explaining the same portion of variationwhereas either would be sufficient.Multiple linear regressionLinear regression where more than one predictor variable is involved.Neural networksSee Artificial neural networks.Normal distributionA probability distribution for a continuous random variable that forms a symmetricalbell-shaped curve around the mean.
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NormalizedA price series adjusted so that the data vary within a prescribed standard range(usually between 0 and 100).Null hypothesisThe hypothesis that an observed difference (as between the means of two samples)is due to chance alone and not due to a fundamental cause.On-balance volume (OBV)This is a money flow indicator developed by Joe Granville. It seeks to show if volumeis flowing into or out of a security and is calculated by adding today’s volume to acumulative total when the security’s price closes up, and subtracting the day’s volumewhen the security’s price closes down.OscillatorAn indicator used to identify oversold or overbought levels.Out-of-sample dataPrice data that haven’t been used in developing or optimizing a mechanical system.Over-fitting or curve-fittingOptimizing the parameters of a trading model to return the highest profit over thehistorical data. An absurd and false model may fit perfectly if the model has enoughcomplexity by comparison to the amount of data available. Over-fitting is generallyrecognized to be a violation of Occam’s razor principle.Pairs tradingTaking a long position and a short position at the same time on two stocks in the samesector, creating a hedge.Pessimistic rate of returnA statistic that adjusts the usual wins/loss statistic to estimate the worst return fromtrading results by reducing the number of wins by the square root of the actual numberand increasing the number of losses by the square root of the actual number of losses.PipThe smallest price increment of change in a currency. The last digit after the decimalpoint of the exchange rate is a pip: for example, in a EUR/USD exchange rate quote,a change from 1.4715 to 1.4716 is one pip.PyramidA technique of adding additional positions to a winning trade based on a certaincriteria as the trend grows.
Glossary
377
Random walkTheory that stock daily price changes are random and there is no sequential correlationbetween prices from one day to the next. Many believers of the random walk theorybelieve that it is impossible to outperform the market consistently without takingadditional risk.RangeThe difference between the high and low price during a given period.Rate of changeCalculates the n period price change of a security expressed as a percentage accordingto the following formula:(Ctoday − Cn)/Cn ∗ 100where Ctoday and Cn are the closing prices today and n days ago respectively.Relative strengthA price comparison of two securities. It is calculated by taking the ratio of theirprices.Risk-adjusted returnIt is calculated by dividing the annualized rate of return on equity by the standarddeviation of equity changes.Shapiro-Wilk’s testThe Shapiro-Wilk’s W test is used in testing for normality. If the W statistic issignificant, then the hypothesis that the distribution is normal should be rejected.Sharpe ratioThis is a measure of the mean excess return per unit of risk and describes how muchexcess return you are receiving for the extra volatility of trade results and is calculatedaccording to the following simple formula:SR = (r − R)/σwhere r is the asset return, R is the return on a benchmark asset, such as US T-bills,and σ is the standard deviation of the excess return.S&P e-miniElectronically traded, smaller-sized ($50 times the S&P 500) contracts of the Standard& Poor’s 500 index.Standard deviationA widely-used statistical concept indicating the spread of the data set around themean, equal to the square root of the sum of squares of the deviations from the
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arithmetic mean according to the following formula:σ = sqrt

(xi..n − µ)2

where: µ = arithmetic mean of the series.Sterling ratio methodAnother measure of risk/return given by:S R = R (%)/(D (%) + 10 %)where R = three-year average annual return; D = three-year average maximumannual drawdown.Stochastics oscillatorAn overbought/oversold momentum indicator that compares where a security’s priceclosed relative to its trading range over the last x-time periods. The formula for the%K parameter of the Stochastic is:(today’s close − x period lowest close)/(x period highest − x period lowest)Values of %K are then transformed into a range between zero and 100 and smoothedby their three-period moving average.Stock index futuresA futures contract that uses a market index as the underlying instrument. The deliveryis usually in cash.RTradesimA MetaStock plug-in used for portfolio back-testing of a large number of stocks.More information is available at http://www.compuvision.com.au/.
Trailing stopA stop-loss order that follows the prevailing price trend. The stop attempts to exit atthe price that would value the position at the highest profit over the historical periodless the trailing value.T-testThis analysis is used when comparing the means of two groups to assess whether onegroup is statistically different than the other.
Glossary
379
Volume Flow Indicator (VFI)The VFI is a money flow indicator based on the popular On Balance Volume (OBV)but with three very important modifications:• Positive readings indicate a bullish state and negative ones a bearish state.• The calculation is based on the day’s mean instead of the closing price.• A threshold is introduced to eliminate the volume on minimal price changes andanother threshold to trim excessive volume.The VFI was first introduced by Markos Katsanos in the June 2004 issue of TechnicalAnalysis of STOCKS & COMMODITIES. A simplified interpretation of the VFI isthat values above zero indicate a bullish state and the crossing of the zero line is thetrigger or buy signal.R
METASTOCK FUNCTIONSI thought it would be helpful to include the MetaStock functions used in this book, forthe benefit of the readers who are not familiar with the MetaStock formula language.ABS(DATA ARRAY)Calculates the absolute value of the data array.ADX(PERIODS)Calculates Wilder’s Average Directional Movement indicator.ALERT()The alert function is used in conjunction with other functions to extend a true signalfor a specified number of periods. The following example illustrates the use of thealert() function:Buy: STOCH(10,3)>MOV(STOCH(10,3),4,S)) ANDALERT(CROSS(STOCH(10,3),20),3)If these were entered as the Enter Long rule, the system would enter a long positionwhen the stochastic was greater than its moving average and had crossed over 20 atany time over the previous three time periods.ATR(PERIODS)Calculates the Average True Range indicator (see also Glossary).BBANDTOP(DATA ARRAY, PERIODS, METHOD, DEVIATIONS )Calculates the top Bollinger Band of DATA ARRAY using METHOD calculationmethod and shifted upward DEVIATION standard deviations. Example:
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BBANDTOP(C, 10, S, 2 ) calculates the top Bollinger Band 2 standard deviationsfrom the 10-day simple moving average.BBANDBOT(DATA ARRAY, PERIODS, METHOD, DEVIATIONS )Similar to the above. It calculates the bottom band.CC is the closing price of the base security on test.CI(PERIODS)This calculates the Congestion Index (a custom indicator described in Chapter 9).CORREL(DATA ARRAY, DATA ARRAY, PERIODS, SHIFT)Calculates the correlation between two data arrays over PERIODS time periods, aftershifting the second data array to the right SHIFT periods. Example:The formula CORREL(SEC1, SEC2, 30, 0) calculates the 30-day correlationbetween securities SEC1 and SEC2.CROSS(DATA ARRAY 1, DATA ARRAY 2)Returns 1 or “true” when DATA ARRAY 1 crosses above DATA ARRAY 2. Example:CROSS(C, MOV(C,10,E)) is true when the closing price crosses over its 10-dayexponential moving average.FML(“FORMULA NAME”)Calculates the value of a custom formula. The formula can be referenced using theFORMULA NAME in quotes. Example:FML(“FVE”) calculates the value of the custom formula FVE using the defaultperiod of 22 days.HThis is today’s extreme high price of the base security on test.HHV(DATA ARRAY, PERIODS)Calculates the highest value in the DATA ARRAY over the preceding PERIODS(PERIODS includes the current day). Example:The formula “HHV(C, 5)” returns the highest closing price over the preceding fiveperiods.HOUR()On an intraday test, returns the number of hours that have passed during the day usinga 24-hour clock. For example, if the current time is 14:15:20, the hour() function willreturn “14”.
Glossary
381
LThis is today’s extreme low price of the base security on test.LINREGSLOPE(DATA ARRAY, PERIODS)Calculates the slope of the linear regression line.LLV(DATA ARRAY, PERIODS)Calculates the lowest value in the DATA ARRAY over the preceding PERIODS(PERIODS includes the current day). Example:The formula “LLV(C, 5)” returns the lowest closing price over the preceding fivedays.MACD()Calculates the MACD indicator (for more information on the MACD see also theGlossary).MOV( DATA ARRAY, PERIODS, METHOD)Calculates a PERIODS moving average of DATA ARRAY using METHOD calculation method. Valid methods are:EXPONENTIAL, SIMPLE, TIMESERIES, TRIANGULAR, WEIGHTED,VARIABLE, AND VOLUMEADJUSTED (these can be abbreviated as E, S, T,TRI, W, VAR, and VOL). Example:The formula “MOV( C, 30, E)” returns the value of a 30-period exponential movingaverage of the closing prices.SAR(STEP, MAXIMUM)Calculates the predefined Parabolic SAR indicator (for a description of the parabolicsee also the Glossary and Chapter 17). Example:SAR(0.02, 0.20) calculates the parabolic function using an acceleration factor of0.02 and a maximum value of 0.2.STDEV(DATA ARRAY, PERIODS)Calculates the standard deviation of a data array for PERIODS days. Example:STDEV(C, 21) calculates the one month (21 trading day) standard deviation of theclosing price of the security on test.STOCH(%K PERIODS, %K SLOWING)Calculates the stochastic oscillator. Example:The formula “STOCH(10, 3)” returns the value of the 3-day moving average of a10-period stochastic.
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ABBREVIATIONSADXAMEXAORDATGATRAUDCACCACFCICMECRBDAXDJ-30DJIADXYEMAESESTXETFEUREXFDAXFOREXFTSEGLDGLOBEXGSCIHUIIMOLRSLSEMAMACDN225NQNYMEXNYSEOIXPredRJ/CRBRSS&P 500SDSECSPX
Wilder’s Average Directional IndexAmerican Stock and Options ExchangeAustralian All Ordinaries IndexAthens General Stock IndexAverage True RangeAustralian DollarFrench Stock Market IndexCAC 40 FuturesCongestion IndexChicago Mercantile ExchangeCommodity Research Bureau IndexGerman Stock Exchange IndexDow Jones Industrial AverageDow Jones Industrial AverageDollar IndexExponential moving averageStandard & Poor 500 e-mini futuresEuro Stoxx 50 IndexExchange Traded FundEuropean Derivatives ExchangeDAX Index FuturesForeign ExchangeLondon Stock Exchange FTSE-100 IndexGold ETFCME electronic trading system for futuresThe Goldman Sachs Commodity IndexAMEX’s Gold BUGS IndexIntermarket Momentum OscillatorLinear regression slopeLondon Stock ExchangeMoving averageMoving Average Convergence/DivergenceTokyo Stock Exchange Nikkei 225 IndexNasdaq 100 futuresNew York Mercantile ExchangeNew York Stock ExchangeCBOE Oil IndexPredictedReuters/Jefferies CRB IndexRelative StrengthStandard & Poor 500Standard deviationSecurityStandard & Poor 500
Glossary
StDevTNXTSXVHFVIXXAUXOIYMZZN
383
Standard deviation10-year Treasury Note yieldS&P/TSX Composite Canadian Stock IndexVertical horizontal filterThe CBOE Volatility IndexPhiladelphia Gold & Silver SectorAMEX Oil IndexDow Jones Industrial Average e-mini futuresZ-Score or FTSE futures10-year Treasury Note E-CBOT futures
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