itable trading.
COMMON SETUPS
Many traders confuse setups with triggers. A setup is an indication that agiven market is developing a pattern that could or should lead to action.While there are many patterns in the markets, there are only a handful thatare reliable. The sad fact is that most traders follow patterns that are notreliable. Ask yourself the following questions about the methods you arecurrently using:
(cid:2)(cid:2)
How often has the pattern or method you are using been correct?Is the pattern completely objective and speciﬁc, or does it require youto make a judgment call?
9
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Does the pattern have speciﬁc entry and exit rules?Does the pattern or method give you an idea of risk and/or reward?
If your answer to any one of these is no, then I respectfully submit thatyou are either losing money with the pattern or if you are making moneywith it your luck will not last.
The performance statistics of some commonly used trading tools mightinterest and disappoint you. For example, the daily reversal signal is oneof the most widely followed price patterns and it comes in two forms—upand down—deﬁned as follows:
(cid:2)
(cid:2)
Daily reversal up. The market drops below the previous daily low andcloses above the previous daily close as shown in the simple examplein Figure 2.1.Daily reversal down. The market goes above the previous daily high andcloses below the previous daily close as shown in the simple examplein Figure 2.2.
I programmed these two patterns on the computer for the S&P 500futures. The computer examined all the instances of these two patternsfrom 1982 to 2004 and then I asked the following question:
How often after this pattern could a proﬁt have been achieved the nextday if a position was taken on the close of trading on the day of thereversal?
Figure 2.3 shows the results.
S-200507: Soybeans CBT (Pit) Jul 2005 (Daily bars)
Simple reversal up
06/16/05
06/30/05
07/15/05
FIGURE 2.1 Simple reversal up.Source: Courtesy of www.GenesisFT.com.
www.GenesisFT.com
07/12/2005 = 682
2 (-6
∧
∧
0) 755∧0750∧0745∧0740∧0735∧0730∧0725∧0720∧0715∧0710∧0705∧0700∧0695∧0690∧0685∧0682∧0680∧0675∧0670∧0665∧0660∧0655∧0650∧0
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LC-055: Live Cattle (Pit) Cont 1st (Daily bars)
www.GenesisFT.com07/12/2005 = 78.400 (+0.325)
Simple reversal down
11
82.6
82.4
82.2
82
81.8
81.6
81.4
81.2
81
80.8
80.6
80.4
80.2
80
79.8
79.6
79.4
79.2
79
78.8
78.6
78.400
78.2
78
06/16/05
06/30/05
07/15/05
FIGURE 2.2 Simple reversal down.Source: Courtesy of www.GenesisFT.com.
OverallTotal Net Profit:
Total Trades:
Average Trade:
Avg #of Bars in Trade:Avg #of Trades per Year:Max Closed-out Drawdown:
Account Size Required:Open Equity:Current Streak:
Winning Trades
Total Winners:Gross Profit:Average Win:Largest Win:
Largest Drawdown in Win:Avg Drawdown in Win:Avg Run Up in Win:Avg Run Down in Win:Most Consec Wins:Avg # of Consec Wins:Avg # of Bars in Wins:
$39,250589$673,9325.4−$91,325$108,668
$01 Losses
447$578,200
$1,294$14,675−$3,375−$863$1,740−$863505.203.66
Profit Factor ($Wins/$Losses):
Winning Percentage:Payout Ratio (Avg Win/Loss):
Z-Score (W/L Predictability):Percent in the Market:Max Intraday Drawdown:
Return Pct:Kelly Ratio:Optimal f:
Losing TradesTotal Losers:
Gross Loss:Average Loss:
Largest Loss:Largest Peak in Loss:Avg Peak in Loss:Avg Run Up in Loss:Avg Run Down in Loss:Most Consec Losses:Avg # of Consec Losses:Avg # of Bars in Losses:
1.0775.9%0.34−4.939.5%−$91,35036.1%
0.05150.13
142−$538,950−$3,795−$15,025$10,788
$508$508−$3,79551.634.77
FIGURE 2.3 Results of a simple reversal-up buy strategy.
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OverallTotal Net Profit:Total Trades:
Average Trade:
Avg #of Bars in Trade:Avg #of Trades per Year:Max Closed-out Drawdown:Account Size Required:Open Equity:Current Streak:
Winning Trades
Total Winners:Gross Profit:Average Win:Largest Win:Largest Drawdown in Win:Avg Drawdown in Win:Avg Run Up in Win:Avg Run Down in Win:Most Consec Wins:Avg # of Consec Wins:Avg # of Bars in Wins:
−$15,175550  $284.7523.7−$97,875$115,218
$01 Wins
385$582,775
$1,514$21,225−$3,438−$949$2,242−$949283.474.11
Profit Factor ($Wins/$Losses):
Winning Percentage:Payout Ratio (Avg Win/Loss):
Z-Score (W/L Predictability):Percent in the Market:Max Intraday Drawdown:Return Pct:Kelly Ratio:Optimal f:
0.9770.0%0.42−1.144.6%−$97,900−13.2%−0.0182−0.02
Losing TradesTotal Losers:Gross Loss:Average Loss:
Largest Loss:Largest Peak in Loss:Avg Peak in Loss:Avg Run Up in Loss:Avg Run Down in Loss:Most Consec Losses:Avg # of Consec Losses:Avg # of Bars in Losses:
165−$597,950−$3,624−$6,700$8,725
$555$555−$3,62461.506.26
FIGURE 2.4 Results of a simple reversal-down sell strategy.
Look closely at the results and don’t let yourself get fooled by the 75.9percent winning trades. As you can see, the average trade made $67 afterdeducting $25 for slippage and commission. Note also that this methodwould have resulted in over $91,000 in draw down*, enough to wipe out mosttraders accounts. At best this is a marginal system. This record representedonly the buy reversals.
The sell reversal historical record is shown in Figure 2.4.The other statistics contained in Figures 2.2 through 2.4 are not
relevant to this course∗
As you can see, this approach revealed a 70 percent accuracy; but theproﬁts were abysmal. Never ask what the percentage accuracy of a tradingmethod is. This statistic is meaningless without knowledge of whether themethod is proﬁtable! In spite of the poor performance, the accuracy isimpressive and there must be a way to take advantage of the pattern. Thereis a way, and that way is simple. All we need to do is to add a trigger to themethod.
∗Draw down: The maximum dollar amount of successive losses.
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ADDING A TRIGGER
What if we added a trigger to each of these patterns? Would that perhapsmake them more accurate and proﬁtable? I took the simple reversal patternsand added one more variable as a trigger.
Buy Reversal
The buy-reversal pattern can be expressed as low of day 2 is lower than lowof day 1; close of day 2 is higher than close of day 1 and close of day 3 islower than the low of day 2, then buy on the close of day 3 and take proﬁton ﬁrst proﬁtable opening. You can see from the chart shown in Figure 2.5that this pattern is counterintuitive. In other words, it is not what you wouldexpect to see as a buy signal. It “looks like” it should be a sell rather than abuy. One of the key things I want to impress upon you is that you must thinkdifferently than most traders. You must rid yourself of common thinkingunless you want common results!
Table 2.1 shows the historical performance of this pattern.Do you see a signiﬁcant difference? Which pattern would you rather
trade?
Sell Reversal
The sell-reversal pattern can be expressed as high of day 2 is higher thanhigh of day 1; close of day 2 is lower than close of day 1 and close of day 3
SP-067: S&P 500 Index (Pit) Cadj Liq (Daily bars)
www.GenesisFT.com
07/15/2005 = 1231.2 (-0.5) 1238
Reversal up
Exit on firstprofitableopening.
Low below lowof previousday
Buy on closebelow low ofreversal day.
06/07/05
06/21/05
07/06/05
07/20/05
FIGURE 2.5 Reversal Pattern with Trigger.Source: Courtesy of www.GenesisFT.com.
1236
1234
12321231.21230
1228
1226
1224
1222
1220
1218
1216
1214
1212
1210
1208
1206
1204
1202
1200
1198
1196
1194
1192
1190
11881186
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TABLE 2.1 Results of Buy Reversal with Trigger
Summary—Long Trades Report
Name: Jake’s Reversal Trades NewSymbol: SP-067
OverallTotal Net Proﬁt:
Total Trades:Average Trade:
$79,513
Proﬁt Factor
101$787
($Wins/$Losses):Winning Percentage:Payout Ratio (Avg.
Win/Loss):
5.134.4
Avg. No. of Bars in Trade:Avg. No. of Trades per Year:Max Closed-out Drawdown: −$16,075 Max. Intraday Drawdown:$35,593Account Size Required:$0Open Equity:7 WinsCurrent Streak:
Return Percentage:Kelly Ratio:Optimal f:
Z-Score (W/L Predictability):Percent in the Market:
Winning TradesTotal Winners:Gross Proﬁt:Average Win:Largest Win:Largest Drawdown in Win:Avg. Drawdown in Win:Avg. Run Up in Win:Avg. Run Down in Win:Most Consec Wins:Avg. No. of Consec Wins:
92$132,363$1,439$9,900−$5,600−$1,384$1,879−$1,3842510.22
Losing TradesTotal Losers:Gross Loss:Average Loss:Largest Loss:Largest Peak in Loss:Avg. Peak in Loss:Avg. Run-up in Loss:Avg. Run-down in Loss:Most Consecutive Losses:Avg. No. of Consecutive
Losses:
2.50
91.1%0.25
0.18.8%−$18,275223.4%0.54720.61
9−$52,850−$5,872−$7,400$2,175$782$782−$5,87221.13
Avg. No. of Bars in Wins:
5.29
Avg. No. of Bars in Losses:
3.44
is higher than high of day 2, then sell on close of day 3 and take proﬁt onﬁrst proﬁtable opening. Again, note that this is not what you would expect.But does it work as well as the buy pattern in the previous section? Take
a look at the performance history of this pattern as shown in Table 2.2.
As you can see, the sell pattern has been correct nearly 90 percent of thetime—but it fails to make money. Is that a problem? No! If the buy patternworks we will use it. Because the sell pattern does not work, we avoid it.
It is all about knowing what works by adding a trigger and follow-through to a basic setup. In other words, it is about knowing what worksbefore you put money on it. Ask yourself some important questions. Do you
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TABLE 2.2 Results of Reversal-down Pattern with TriggerSummary—Short Trades Report
Name: Jake’s Reversal Trades NewSymbol: SP-067
OverallTotal Net Proﬁt:
Total Trades:Average Trade:
$338
Proﬁt Factor
115$3
($Wins/$Losses):Winning Percentage:Payout Ratio (Avg.
Win/Loss):
1.00
87.8%0.14
Avg. No. of Bars in Trade:Avg. No. of Trades per
9.415.0
Z-Score (W/L Predictability):Percent in the Market:
0.018.4%
Year:
Max. Closed-outDrawdown:
−$29,450 Max. Intraday Drawdown:
−$32,450
Account Size Required:Open Equity:Current Streak:
$49,768$02 Wins
Return Percentage:Kelly Ratio:Optimal f:
0.7%0.00260.00
Winning TradesTotal Winners:Gross Proﬁt:Average Win:Largest Win:Largest Drawdown in Win:Avg. Drawdown in Win:Avg. Run-up in Win:Avg. Run-down in Win:Most Consecutive Wins:Avg. No. of Consecutive
Wins:
Losing TradesTotal Losers:
101$114,488 Gross Loss:$1,134$11,000−$7,275−$1,300$1,535−$1,300357.77
Average Loss:Largest Loss:Largest Peak in Loss:Avg. Peak in Loss:Avg. Run-up in Loss:Avg. Run-down in Loss:Most Consecutive Losses:Avg. No. of Consecutive
Losses:
14−$114,150−$8,154−$8,950$1,850$497$497−$8,15421.17
Avg. No. of Bars in Wins:
7.57
Avg. No. of Bars in Losses:
22.64
use methods like the Elliott Wave, Gann, or Fibonacci? Do you know if theywork?
ADDING A FOLLOW-THROUGH
Now let us take the ﬁrst reversal pattern (the buy pattern) and add a fewfollow-through alternatives. In other words, we vary the stop-loss and theexit. The results shown in this section’s tables use two different stop-losses
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TABLE 2.3 Reversal-up Pattern with Trigger and $2,500 Stop-loss
Summary—Long Trades Report
Name: Jake’s Reversal Trades New $2,500 stop-loss Exit on First
Proﬁtable Opening
Symbol: SP-067
OverallTotal Net Proﬁt:
Total Trades:Average Trade:
$38,138
Proﬁt Factor
105$363
($Wins/$Losses):Winning Percentage:Payout Ratio (Avg
Win/Loss):
1.55
74.3%0.54
Avg. No. of Bars in Trade:Avg. No. of Trades per
3.774.5
Z-Score (W/L Predictability):Percent in the Market:
0.46.8%
Year:
Max. Closed-outDrawdown:
−$17,450 Max Intraday Drawdown:
−$17,475
Account Size Required:Open Equity:Current Streak:
$34,793$01 Losses
Return Percentage:Kelly Ratio:Optimal f:
Winning TradesTotal Winners:Gross Proﬁt:Average Win:Largest Win:Largest Drawdown in Win:Avg. Drawdown in Win:Avg. Run-up in Win:Avg Run-down in Win:Most Consecutive Wins:Avg. No. of Consecutive
Wins:
78$107,413$1,377$9,350−$2,338−$743$1,788−$743173.71
Losing TradesTotal Losers:Gross Loss:Average Loss:Largest Loss:Largest Peak in Loss:Avg. Peak in Loss:Avg. Run-up in Loss:Avg. Run-down in Loss:Most Consective Losses:Avg. No. of Consecutive
Losses:
109.6%0.26380.26
27−$69,275−$2,566−$3,250$3,400$254$254−$2,56641.29
Avg. No. of Bars in Wins:
4.01
Avg. No. of Bars in Losses:
3.07
and exit methods. As you can see, follow-through in the form of a stop-lossand exit method can make a big difference.
Using a stop-loss of $2,500 with exit on the ﬁrst proﬁtable opening
makes the results much less impressive, as you can see in Table 2.3.
Now let’s change the exit method and the stop-loss to exit on the thirdproﬁtable CLOSE with a $4900 stop-loss. Table 2.4 shows the results. Notethat these examples are not recommended as trading strategies. They aremerely included as illustrations.
As you can see, follow-through (also know as exit strategy) can make
a major difference.
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TABLE 2.4 Another Variation on Follow-through
Summary—Long Trades Report
Name: Jake’s Reversal Trades New $4900 stop-loss with exit on 3rd
proﬁtable close
Symbol: SP-067
OverallTotal Net Proﬁt:
Total Trades:Average Trade:
$94,113
Proﬁt Factor
102$923
($Wins/$Losses):Winning Percentage:Payout Ratio (Avg.
Win/Loss):
Avg. No. of Bars in Trade:Avg. No. of Trades per
5.224.4
Z-Score (W/L Predictability):Percent in the Market:
2.27
85.3%0.39
−0.49.1%
Year:
Max. Closed-outDrawdown:
−$17,900 Max. Intraday Drawdown:
−$18,225
Account Size Required:Open Equity:Current Streak:
$35,543$03 Wins
Return Percentage:Kelly Ratio:Optimal f:
Winning TradesTotal Winners:Gross Proﬁt:Average Win:Largest Win:Largest Drawdown in Win:Avg. Drawdown in Win:Avg. Run-up in Win:Avg. Run-down in Win:Most Consecutive Wins:Avg. No. of Consecutive
Wins:
87$167,988$1,931$15,150−$4,850−$1,482$2,644−$1,482256.69
Losing TradesTotal Losers:Gross Loss:Average Loss:Largest Loss:Largest Peak in Loss:Avg. Peak in Loss:Avg. Run-up in Loss:Avg. Run-down in Loss:Most Consecutive Losses:Avg. No. of Consecutive
Losses:
−264.8%0.47780.39
15−$73,875−$4,925−$4,925$3,400$970$970−$4,92521.25
Avg. No. of Bars in Wins:
5.52
Avg. No. of Bars in Losses:
3.47
S-T-F: THE COMPLETE APPROACH
To trade proﬁtably you need to use a complete approach. Here are theelements of that approach:
(cid:2)(cid:2)(cid:2)(cid:2)
Speciﬁc entry and exit rules.100 percent objective follow-through.Statistical performance history.No interpretation needed.
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Independent of any fundamentals or analysis.Capable of being completely computerized and analyzed.
This gives you a complete package that, in my view, places you way
ahead of the vast majority of traders.
REVIEW
In this lesson, you learned a speciﬁc example of how we move through thesetup, trigger, and follow-through method using a simple pattern. While thepattern in and of itself is not proﬁtable, adding a trigger improves its ac-curacy and adding a follow-through method further improves the potentialproﬁts.
Now that you have seen an example of how we can take some commonly(but incorrectly) used setups and turn them into proﬁtable methods, you’reready to move onto the ﬁrst of ﬁve methods you will learn in this course.Lesson 3 introduces you to the ﬁrst of these methods: the seasonal setup.Once you know how to ﬁnd and evaluate the seasonal setups, we look atseasonal triggers and follow-through methods.
LESSON 2 QUIZ
Instructions: Circle the correct answers.
1. Most patterns in the markets:
A. Make money.B. Lose money.C. Are used for hedging.
D. Are based on weather.
2. A reversal up pattern occurs when:
A. Traders quit for the day because the market goes limit up.
B. A winning trade becomes a losing trade because a trader has become
too emotional.
C. A losing trade is closed out at the stop-loss on a Tuesday.D. The low of day 2 is lower than the low of day 1 and the close of day 2
is higher than the close of day 1.
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3. A reversal down pattern occurs when:
A. The high of day 2 is higher than the high of day 1 and the close of
day 2 is lower than the close of day 1.
B. Traders quit for the day because the market goes limit down.
C. A losing trade becomes a winning trade because a trader has devel-
oped a new trading method.
D. A losing trade is closed out at the stop-loss on a Friday.
4. Common thinking in trading:
A. Gets common results.
B. Will help you be successful.C. Is a good method to use.D. Uses exponential moving averages to get good results.
5. It is best to think differently than most traders:
A. Because most traders think the same way.B. Because different thinkers get better results.C. Because common thinking gets common results.D. All of the above.
6. Looking only at the percentage accuracy of a trading method:
A. Is the correct thing to do.B. Is the method used by professional traders.C. Can help you discover excellent trading methods.D. None of the above.
7. Choose all that apply: The following are aspects of a total approach to
trading:
A. Speciﬁc entry and exit rules.B. 100 percent objective follow-through.C. Statistical performance history.D. No interpretation needed.
8. Proper structure of every trade consists of:
A. Having the right newsletter(s).B. Discussing every trade with your broker before you enter.C. Using the right systems.D. Setup, trigger, and follow-through.
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L E S S O N 3, D A Y 3
Seasonality andHigh-OddsSeasonal Setups
INTRODUCTION
One of the most enduring and reliable patterns in the markets is seasonality.While some people believe that seasonality is a function of weather or theseasons, this is not entirely true. Seasonality is the tendency for marketsto move in certain directions during certain times of the year. These movesare caused by factors such as weather, harvest, planting, inventory buildup,holiday closing of mines, buying of building supplies prior to the build-ing season, quarterly mutual fund portfolio adjustment, summer demandfor meat, holiday demand for pork and poultry, summer unemployment in-creases, and a host of other variables. The reason or reasons for a seasonalmove can be obvious—or they may not. While some traders care about the“why” of market moves, I do not. I am only interested in the fact that manymoves are predictable to varying degrees of accuracy. Seasonals are foundin virtually all data including commodities and stocks.
“Mine is not to reason why . . . mine is but to sell and buy.” It makes nodifference to me what causes markets to move as long as I can ﬁnd reliablesetups with a solid history of predictability. I suggest that you do the same.Note that I am not opposed to the use of fundamentals (i.e., the study ofeconomic conditions that cause moves). I believe, however, that setups andtiming are more important and that we do not need to know the causes ofmoves if our setups and triggers are valid.
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TYPES OF SEASONALS
There are ﬁve basic types of seasonals:
1. Monthly seasonal patterns in the cash markets. These patterns give usa big picture idea of what has happened in the markets over a long periodof time.
2. Weekly seasonal patterns in commodities, stocks, and cash markets.
These give us a shorter term, week-to-week idea of price changes.
3. Daily seasonal futures patterns. These tell us the exact starting and
ending dates of moves in stocks and futures.
4. Preholiday seasonals patterns. These patterns tend to occur with a high
probability prior to major holidays.
5. Seasonal patterns in spread and ratio relationships. These patternsshow how different months and/or markets have moved relative to eachother.
The information derived from each of the above seasonal patterns givesus different information. My goal is to direct you to the most proﬁtable andconsistent of these patterns.
SEASONALS ARE SETUPS
As noted in Lesson 1, seasonals are setups that must be triggered. In Lesson1, I cited a crude oil seasonal setup that had an exceptionally high probabilityof repetition. I have found over 1 million seasonal setups with accuraciesfrom 75 percent to 100 percent