le Hadady ofPasadena, California, deserves credit for popularizing his concepts ofbullish consensus, but I found his data useless to me as a day trader,since they reached me much too late. By the time I received the data,they were almost a week old.
175176 Chapter Nineteen
Although Earle did a wonderful job polling brokers, newsletter writ-ers, and other market professionals on their sentiment, the disseminationof his data was necessarily delayed due to the mechanical process ofinformation gathering. My inability to find prompt and accurate dailymarket sentiment led me, in 1987, along with several associates, to beginmy own program of daily sentiment collection. The daily sentiment indexwas designed to assess traders on a daily basis regarding their bullishmarket sentiment on all active futures markets. Since data collectionbegan, I have amassed a considerable historical database of daily marketsentiment which I have found to be extremely helpful in short-term andday trading.
Defining Sentiment
Perhaps the best place to begin is with a very brief but functional defini-tion of market sentiment. Stated very simply, market sentiment is a numer-ical assessment of the percentage of bullish or bearish opinions within agroup of individuals. In this case, the individuals whose opinions arepolled for my daily sentiment indicator (DSI) service are all presumed tobe traders and knowledgeable about the markets. They are assesseddaily by my staff, and the results of the assessment are available by 4:00p-m. Chicago time.
On the basis of these daily sentiment indicators, we can determine thedegree to which our sample of traders is bullish or bearish for each ofthe markets. Daily market sentiment, therefore, is a measure of how manytraders in percentage terms expect a given market to go up. Empirically, Ihave found that in most markets a daily sentiment reading of 90 percent orhigher very frequently indicates that the particular market will actually movelower over the next several days or that a significant top could develop over thenext several days. Due to the very short term nature of market sentiment,its use is specifically intended for determining short-term marketswings only. The DSI as I use it is nothing more than a short-term indicatorof market sentiment or emotion.
Now that we've examined what high DSI means, let’s take a look atlow DSI or sentiment. I’ve found that when market sentiment drops to avery low level, typically 15 percent or lower, this is often an indicationthat the particular market is likely to establish a low within the next dayor two. Frequently, markets with extremely high or low sentiment tendto make their turns very soon after the sentiment indicator has reachedits extreme level.Sentiment Reigns Supreme 177
The Daily Sentiment Index—Ideal forShort-Term Trading
Since human emotion is a very volatile aspect of the futures markets, itis subject to change dramatically from one day to the next. Whereas, themajority of our DSI sample may be extremely bullish today, they couldeasily reverse sentiment to extremely bearish the next day, given a dropin the market or an item of significant bearish news. Since daily sentimentis so volatile, its application must necessarily be of an extremely short-termduration.
Given the extreme sensitivity and responsiveness of daily sentiment,its application to short-term timing is ideal. Specifically, its use as a filterfor some of the intraday techniques I have discussed in this book issuperb. Consider the applications described below as important addi-tions to every day trader’s repertoire. First, however, spend a few min-utes reviewing the following example of DSI application.
A Brief Historical Overview
As you know, the last 5 years have been anything but tame in S&Pfutures. The market has survived two severe declines, one in 1987 andanother in 1990, making new all-time highs after each sharp decline. Thetrend has continued persistently higher with the exception of these twomajor corrections. The market has trekked doggedly higher, climbing awall of worry after worry, refusing to give in to bearish fundamentalafter bearish fundamental. There seems to be no individual fundamentalwhich will drive prices persistently lower.
Yet, my study of my DSI back to 1987 has revealed some extremelyinteresting results which I'd like to share with you. But before doing soa brief statement regarding the relationship between daily sentimentand price is in order.
Simply stated, high sentiment (i.e., about 90 percent bullish or higher)tends to signal tops, whereas low sentiment (i.e., about 15 percent orlower) tends to signal market bottoms. We’re not talking here aboutlong-term tops—we’re only talking about shorter-term tops and bot-toms, some lasting a few weeks, others a few days or less.
Sentiment is no more a perfect indicator than is any other market indi-cator. It has its shortcomings, but it also has its strong points, the mostimportant of which is that it tends to be a leading indicator rather than alagging indicator. Astute traders would rather have one reliable leading indica-tor than 1000 semireliable or questionable lagging indicators. It's one thing to178 Chapter Nineteen
know 2 days after the fact what should have been done. It’s far more meaningfulto know what must be done a day, 2 days, or even 2 hours ahead of time.
A DSI Day-Trading Application
As an example of how the DSI relates to short-term price swings in S&Pfutures, consider the listing in Figure 19-1. This list shows DSI readingsof 90 percent or more (top expected) and 10 percent or less (bottomexpected) by market, and the price change for the next several tradingsessions. Take a few minutes to evaluate this list. What are your conclu-sions about extreme DSI readings and short-term price swings?
Visualizing Market SentimentRelationships
Before delving into the applications of the DSI as a filter, let’s first exam-ine the ideal and actual relationships between DSI, price, tops, and bot-toms.
Figure 19-2 shows the ideal relationship between market sentimentand trend. As you can see, market sentiment tends to increase with anup trend and decrease with a down trend. In fact, market sentimentvery closely mimics trend in virtually every market. There are some sig-nificant instances, however, in which daily sentiment and trend differmarkedly.
These are, in particular, tops and bottoms. Figure 19-3 shows the idealrelationship between DSI, market tops, and market bottoms. Compareboth the ideal trend relationship from Figure 19-3 as well as the top andbottom relationship from Figure 19-3 with the actual charts shown inFigure 19-4 through 19-6. These charts are not exceptions. The fact isthat a significant number of important tops occur when the DSI is at 90percent or higher and that a significant number of bottoms occur whenthe DSI is at 15 percent or lower. This is an important market relation-ship which can be taken advantage of by the day trader. But how?
The Importance of Market Sentiment
As I've already noted, one of my favorite methods of finding potentiallyprofitable day trades is to use daily market sentiment as a filter.Typically, when daily market sentiment is very high, markets tend totop, and when daily market sentiment is very low, i.e., bearish, marketstend to bottom. In many cases, the highs and lows in market sentimentSentiment Reigns Supreme 179
 
Date DSI% Price Date Price Result
10/19/87 07 ~=—-201.50 10/23/87 253.00H + As muchas 5200 points to recovery high.
11/04/87 04 = 250.15 11/06/87 258.20H + About 800-point rally to next intradayhigh.
03/24/88 10 264.10 04/08/88 271.95H + Rallied about 700 points to intraday high.
03/25/88 09 257.75 04/08/88 271.95H + Great recovery of over 1400 points to thehigh.
07/12/88 09 269.35 07/15/88 273.70H + Smaller recovery but rallied over next3 days.
09/14/89 09 — 348.30 09/19/89 353.30H + Another small rally following lowsentiment.
11/03/89 10 339.40 11/17/89 344.20H + Gained about 480 points after low DSI.
11/06/89 05 = 333.40 11/17/89 344.20H + Over 1000-point gain in next few trading _sessions.
06/19/90 05 363.60 06/22/90 368.45H + About 400-point gain possible to nexthigh.
06/20/90 08 364.40 06/22/90 368.45H + Minor recovery to next high followinglow DSI.
07/23/90 06 357.80 07/26/90 360.35H + Another minor rally after low DSI.
08/16/90 09* 331.75 08/21/90 326.60H — Clearly a losing trade in spite of low DSI.
09/27/90 07 302.70 10/02/90 323.50H + This one more than made up for thelast one!
10/01/90 92 318.25 10/12/90 297.50L + Another beauty—dropped over 2000points.
10/09/90 07 = 305.75 10/22/90 318.65H + Followed by a great gain to the nextsmall top.
10/11/90 07 = 302.20 10/22/90 318.65H + Another day of low DSI confirmed a rally.
11/07/90 07 = 307.25 11/14/90 323.75H + Wow! Gained over 1600 points afterlow DSI.
01/14/91 06 316.85 01/17/91 339.50H + And yet another gain of about 2200 afterlow DSI.
02/04/91 92* 351.70 02/06/91 353.50L — This one was a small loser after ahigh DSI.
02/05/91 93* 355.60 02/06/91 353.50L — And this one lost as well in spite of93 percent DSI.
02/13/91 93 373.10 02/26/91 365.90L + But this one did well gaining about700 points.
02/27/91 93 372.30 03/19/91 368.00L + And this one did well too!
03/05/91 93 380.80 03/22/91 368.10L + Still another possible winner followinghigh DSI.
03/26/91 92 379.70 04/10/91 372.75L__+ Fell about 700 points after high DSI.
04/16/91 90 389.15 04/30/91 374.20L + This was great too—fell nearly 1500points.
04/17/91 92: 392.15 04/30/91 374.20L + A double whammy! Big drop after 2 days,high DSI.
05/15/91 07 369.65 05/31/91 391.00H + Scoreda major rally after very low DSI.
05/30/91 91 387.50 06/12/91 374.20L + Followed by a 1300 + drop from 91
 
percent DSI.
 
Figure 19-1. DSI extremes in S&P futures, 1982-1993.180 Chapter Nineteen
Date DSI% Price Date Price Result
06/12/91 05 374.20 06/14/91 382.90H + 5 percent DSI led to 800 + point rally tointraday high.
06/24/91 07 373.50 07/02/91 380.90H + Still another rally off low sentiment
07/31/91 92 388.40 08/06/91 385.20L + Not too big of a drop despite 92 percent
 
DSI.
08/16/91 10 386.85 09/03/91 398.60H + Great rally of about 1100 points from10 percent DSI.
08/19/91 08 378.85 09/03/91 398.60H + A double whammy after 2 days of lowDSI.
11/19/91 08 = 380.95 11/21/91 382.15H + Justa tiny recovery from low sentiment.
12/26/91 93* 407.25 01/02/92 413.80L — This was clearly a loser without a doubt.12/31/91 93 419.70 01/13/92 416.45L + Just a small drop after excessively highDSI
03/05/92 08 408.85 03/19/92 412.50H + Small rally from low DSI.04/08/92 08 395.25 04/16/92 417.30H + Fantastic rally from low DSI—over 2200oints!
05/04/92 94 416.50 05/15/92 410.00L + Dropped nicely after high DSI.
06/22/92 06 405.00 07/02/92 417.20H + And rallied over 1200 points from 6percent sentiment.
10/02/92 07 409.90 10/20/92 418.00H + Another good one following low DSI.
10/07/92 08 403.75 10/20/92 418.00H + Persistently low DSI led toa rally.
10/09/92 04 403.10 10/20/92 418.00H + Double whammy—maior rally—lowestDSI ever.
11/02/92 96 422.05 11/05/92 415.70L + Good drop after 96 percent DSI.
11/11/92 90 422.55 11/17/92 418.05L + Small drop from 90 percent DSI reading.
11/24/92 91* 428.10 12/01/92 428.70L - A small loser in spite of 91 percent DSI.
12/01/92 96 431.10 12/04/92 429.55L + A brief decline to the low in next few
days.
12/04/92 92 433.55 12/16/92 431.40L + And another brief decline to the intradaylow.
12/07/92 93 436.10 12/16/92 431.40L + But this one was quite good afterhigh DSI.
* = DSI trades that were clearly losers.
H = High of day
L = Low of day
+ = Market move in expected direction
— = Market failed to move in expected direction.Bold dates and DSI = High DSI readings.
Figure 19-1. DSI extremes in S&P futures, 1982-1993. (Continued)
correlate strongly with uncanny opportunities to enter markets atextreme lows for long positions or at extreme highs for short positions.Many traders consider S&P futures to be a contrary market. Tradingsystems which work well in most other markets seem to fall apart whenused in S&P futures. Market patterns which are known to be reliable inSentiment Reigns Supreme
100%
os!
0%
Figure 19-2, Ideal relationship between trend and DSI.
T = Top, B = Bottom
 
Figure 19-3. Ideal relationship: DSI, market tops, and market bottoms.
181182 = Chapter Nineteen
         
He
AN an APT A A Pee PA ahee LE a Ayee
Figure 19-5. Actual example of DSI versus price.Sentiment Reigns Supreme 183
 
Figure 19-6. (Continued)184
Chapter Nineteen
virtually all other markets are like strangers to S&P futures. Why doesthis happen? Although I’m not entirely sure, I do have my theories.Perhaps the most cogent reason is that the S&P futures market is ahybrid, representing both stocks and futures. The market is monitoredclosely by computers and money managers for imbalances.Furthermore, it is used heavily as a hedging vehicle by stock fund man-agers. Although it is a speculative market, it is affected by a host of vari-ables which do not affect most other markets.
Yet there is one variable which seems to work better in S&P futuresthan in any other market—and that’s daily market sentiment. BecauseS&P is such a liquid market (most of the time), because it is followed bystock and futures traders, because it is heavily traded by professionalsfrom all sectors of the financial arena, because it is the quintessentialspeculators market, and because it has a high dollar value per tick, it is amarket which is more sensitive to trader emotion than any other futuresmarket in existence today. And this is all very comforting to those of uswho enjoy having reliable indicators to assist us in our trading decisions.
= DSI with gap signals of both types. One of my favorite applications ofthe market sentiment as assessed by the DSI is with gap trades. It isnot uncommon for the best gap trades to occur in close proximity toextreme sentiment readings. As you can easily imagine, your bestodds for buy gap trades of both types is when sentiment is at or about15 percent or lower. Your best sell gap trades will occur when senti-ment is at about 90 percent or higher.
= MA channel and DSI are also an outstanding combination. When DSI isexcessively high, you can expect an MAC sell signal to develop on theintraday charts. In such cases you can feel relatively secure sellingagainst the MAH as well as the MAL and, of course, the midpoint ofthe channel. When DSI is excessively low you can expect an MAC buysignal to develop on the intraday charts. In such cases you can feelrelatively secure buying against the MAH as well as the MAL and, ofcourse, the midpoint of the channel.
Stochastic pop signals can also be filtered using DSI. I suggest caution if
you get an SP buy signal when sentiment is about 90 percent or high-
er or a sell SP sell signal when DSI is about 15 percent or lower. SPsignals seems to work best when DSI has not reached an extreme levelon either side.
« Critical time of day (CTOD) signals also appear to be related to DSI. 1 donot have any hard evidence to support this conjecture due to the lim-ited number of cases. It appears that when DSI is at a high extreme,CTOD sell signals will be more reliable. When DSI is at a low extreme,Sentiment Reigns Supreme 185
CTOD buy signals tend to work better. (See Chapter 20 for discussionof CTOD methods.)
= Oscillator signals, as discussed in a previous chapter, can also be filteredwith DSI. When DSI is too high, oscillator buy signals are apt to beunreliable whereas oscillator sell signals are more likely to work wellfor larger moves. Conversely, when DSI is too low, you should becareful about taking sell signals, since oscillator buy signals tend to bemore accurate and they tend to produce larger moves.
In the final analysis, market sentiment can be used as an excellent fil-ter for the many different day-trading methods and systems I’ve dis-cussed in this book. Daily market sentiment is subject to such wideswings because it is based on trader response, which is, in turn, basedon trader perception of market events. Trader perception is mediated byemotion. Hence, DSI is an excellent indicator of emotion. Since manylarge intraday price moves are based on emotion, DSI is an excellentmethod for determining markets which are in an emotional state suffi-ciently conducive to reliable intraday moves. That’s why I urge all daytraders to be aware of and to use daily market sentiment.
DSI Historical Data
I have been collecting daily market sentiment data since 1987. The his-torical database is sufficiently extensive now to allow for fairly intensiveresearch. Although I am constantly researching ways of using DSI datafor day trading as well as short-term and position trading, I do not haveall the answers with regard to using this powerful tool. For those whowish to do their own research (and I encourage this), I am making thehistorical data available at no charge whatsoever either in hard copyprintout or on computer disk. If you would like to obtain the data thensimply send me a blank disk along with a stamped, self-addressed enve-lope (about 3-0z postage). For a hard copy printout, send a stampedself-addressed envelope (about 7-oz postage). If you have questionsabout the data, please don’t hesitate to contact my office (MBHCommodity Advisors, Inc., P.O. Box 353, Winnetka, II. 60093). Iam gladto provide the historical data at no charge, since it will stimulate moreresearch on this valuable indicator.
Daily updates of the DSI are provided via hotline, fax, or computerbulletin board. There is a subscription fee for this service, since I dohave costs in gathering and disseminating the data daily.Critical Timeof Day (CTOD)
Perhaps one of the most interesting and intriguing day-trading methodsis what I call critical time of day (CTOD). This is a method I’ve been usingsince the late 1970s when I first developed it. It is both simple and easilyapplied, yet it is demanding inasmuch as it requires the trader to bepresent throughout the day, tracking prices every 5 minutes. This is whythe method may not be suitable for all traders.
The CTOD method has remained virtually unchanged since it wasdeveloped. This is a strong testimonial to its efficacy. ] caution you,however, to remember that CTOD is a method, it is not a system,although it is systematic and has the potential to be used as a system.CTOD is designed to spot intraday price moves based on the 5-minuteclosing price range during the first 2 hours of the trading day.
Basic CTOD Signals and Parameters
186
The basic methodology and operational procedures for using CTODmeasures are as follows:
= Plot the 5-minute closing prices for the first 2 hours of trading regard-less of market (see exceptions later on). By 5-minute closing prices, Imean the price at the end of every 5 minutes. The price used is the lastprice, not the intraday high or low price. When plotted according tothe rules, the 5-minute closing price plot for the first 2 hours of tradingwill look like Figure 20-1. See also Figure 20-2 for ideal buy-and-sellsignals the same day.
Remember this, it is important. Use the price at the end of each
5 minutes, not the high or low, but the last price each 5 minutes.
 Critical Time of Day (CTOD) 187
Buy on § Minute "close" above this price -
5 Minute"Closes"
~ Sell short on § Minute “close” below this price.
First Hour of ] Second Hour of | Third Hour of | fourth Hour ofTrading Trading Trading Trading
Figure 20-1. First 2 hours of closing prices—ideal example.
 
Buy on § Minute “close* above this prict5 Minute TO“Closes”
First Hour of | Second Hour of | Third Hour of | Fourth Hour ofTrading Trading Trading Tradin
Figure 20-2. CTOD buy-and-sell signals.
 188 = Chapter Twenty
= Once the first 2 hours of 5-minute closing price data have been gath-ered, the highest price will be used as a buying breakout point,whereas the lowest price will be used as a selling breakout point.
= An upper breakout and buy signal will occur when prices have had a5-minute “close” (i.e., plot) above the highest 5-minute closing plotestablished during the first 2 hours. You will then buy at the marketusing a 5-minute closing stop loss below the lowest closing 5-minuteplot of the first 2 hours.
= A lower breakout and sell signal will occur when prices have had a 5-minute close (i.e., plot) below the lowest 5-minute closing plot estab-lished during the first 2 hours. You will then sell at the market using a5-minute closing stop loss above the highest closing 5-minute plot ofthe first 2 hours.
= You will use a trailing stop loss which consists of a 5-minute closebelow the lowest 5-minute close of each previous hour for longs andabove the highest 5-minute close of the previous hour for short posi-tions.
«= As an alternative you can use a money management stop loss or astop loss based on other indicators discussed in this book (e.g., mov-ing averages or oscillators).
= You will exit positions either by the end of the day or by beingstopped out either at a loss or at your trailing stop loss.
Figures 20-3 through 20-5 illustrate some examples of buy-and-sell sig-nals using the 2-hour CTOD parameters.
Tips and Suggestions for Using CTOD
/ The CTOD method is best used in active markets which tend to makelarge moves during the day. Currently such markets are S&P futures,most currencies, and Treasury bonds. This can change, however, inas-much as markets currently not active will one day become active aswell as volatile. .
¥ Once you have established your position, be sure to use a trailing stoploss, or you may find your profit rapidly diminishing. The whole ideaof CTOD trading is to grab profits yet at the same time to give themarket you are trading sufficient room to continue its move.
/ Experiment with different time frames such as 1 hour, or 1% hours.Study the markets you are trading for unique characteristics whichallow short- or long-time windows to work better.Critical Time of Day (CTOD) 189
5 Minute“Closes”
First Hour ofTrading
Figure 20-3. A CTOD sell signal.
 
Buy on 5 Minute “close” above this price:5 Minute» ST“Closes”
" Seli short on § Minute “clase” Delow this price
 
First Hour of | Second Hour of | Third Hour of | Fourth Hour ofTrading Trading Trading Trading
 
Figure 20-4. A CTOD buy signal.190 Chapter Twenty
 
Figure 20-5. Another CTOD signal.
¥ Multiple units can offer you the best of possible worlds using CTOD.If, for example, you enter your initial position with two units, thenyou can close one out at a profit when the market either bulges ordrops sharply and hold the remaining unit according to the rules inthe event that a further move is coming.
Y Trailing stop losses can and do work with CTOD. Experiment withdifferent stop loss methods, in particular with those described in thisbook.
¥ Remember that CTOD can give two signals each day, a buy and a sell,or it may, on occasion give no signals whatsoever.Putting ItAll Together
Now that you've had an opportunity to review and study the many sys-tems, methods, and indicators I’ve presented in this book, the ultimateissue must be addressed, and that is, How do you put all of it together intoa profitable trading strategy? The question appears simple and straightfor-ward, but the answer is, unfortunately, not so simple. Because tradersdiffer so markedly in their expectations, abilities, and available time, itis not possible to state categorically that any one particular strategy ormethodology is more favorable or desirable than another. This is some-thing that the individual trader will need to address on his or her own. Iwill, nevertheless, give you some suggestions based on my experiences,hoping that they will be meaningful to you and that, perhaps you willfind them useful in day-trading futures profitably. Unfortunately, I canmake no guarantees, and even if I could, I would be prohibited fromdoing so by the existing regulatory agencies. I will, however, guaranteeyou the following:
If you learn and apply consistent trading rules and indicatorsto the markets on a day-trading basis, you will achieve
profitable results so long as you remain consistent, wellcapitalized, and willing to accept losses when they should, be accepted.
 
With this caveat in mind, I will now review some valuable sugges-tions based on my considerable experiences as a trader. Please note thatthis list is not necessarily in chronological order, nor is it in order ofimportance.
191192
Chapter Twenty-One
Before You Begin Day Trading. Perhaps you are already daytrading or trading for the short term. If this is the case, and if you arenot pleased with your results, then I suggest you stop what you aredoing and consider some of the suggestions and methods proposed inthis book. I think it is important for you to find trading techniques notonly which appeal to you from the standpoint of logic, but which alsoare consistent with your abilities as a trader. If, for example, you have afull-time job which does not allow you to follow the markets tick by tickor every 5 or 10 minutes within the day, then clearly many of the tech-niques in this book are not suitable for you. You would want to restrictyour trading possibly