mind, look at Figure 9.3, which shows a 15-minute bar chart of the September Bonds in1989. The major trend moves were adequately captured by this technique.Figure 9.4 again shows Bonds, this time in April 1998, and again you see how the penetration ofshort-term high and low points enables a trader to be in phase with most of the trend moves for a 10-daytime period.You can use this technique two ways. Some traders may simply buy long and sell short on thesechanges in trend. That's a basic simplistic way to use this technique. A more educated approach would beto take buy/sell signals when confirmed by TDW, TDM, secondary data, and so on, thus filtering our tradeswith something other than wiggles and waggles on a chart.Finally, we may use this indication of trend to tell us we can buy on pullbacks, and sell on rallies inunison with the underlying trend. If our indication of trend is positive, and there has been a reversal to theupside, then we can take buy signals from short-term measures or techniques.
Figure 9.3 T-Bonds (1 5-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 9.4 T-Bonds (15-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
The Three-Bar High/Low SystemAt one point in my career, I had over 30 consecutive winning trades using this next short-termtrading strategy. You will first have to calculate a 3-bar moving average of the high and a 3-bar movingaverage of the lows. (Each bar represents the time period displayed on your chart. Use 5-minute charts forlots of signal, or 15-minute charts if you want a little less hectic trading career.) This is automatically doneon all quote machines, although "in the old days" 1 did it by hand. You can have the old days!The strategy is to buy at the price of the 3-bar moving average of the lows-if the trend is positive,according to the swing point trend identification technique-and take profits at the 3-bar moving average ofthe highs.Sell signals are just the opposite. This means you will sell short at the 3-bar moving average of thehighs and take profits at the 3-bar moving average of the lows. It is downright foolish to do this unless thereis a reason to take only short sales. Our reason might well be that our swing point reversal system has told usthe trend is down. Then, and only then, sell the high and cover at the lows.Now let's try to make some order out of all this. Figure 9.5 shows the addition of the 3-bar movingaverages and the swing lines. I have marked the
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Figure 9.5 T-Bonds (15-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 9.6 T-Bonds (1 5-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
138points where trend changes; we switch from buying the lows to shorting the highs following these reversals.The 3-bar high and low entry points are also shown. The game goes like this; trend reversal up so we buythe 3-bar low line and take profits at the 3-bar high and await a pullback to the 3-bar low. If the 3-bar lowwould create a trend reversal for selling, however, pass on the trade. Sells are just the opposite; await a trendreversal down, then sell all the 3-bar highs and take profits at the 3-bar lows.Figure 9.6 has all the trend reversals marked off, so you can begin paper trading by looking for the buyand sell entries and exits. I suggest you walk through this chart to get a sense of how one can trade this veryshort-term approach. Note these are 15-minute bars, but the concept will work on 5minute to 60-minute barsas well.
A New Indicator for Short-Term Traders ... Will-SpreadMarkets move for real reasons, not because of technical whirling dervishes. Things happen in lifebecause there are consequences to actions. Charts do not move the markets. Markets move the charts. Inkeeping with that, I also think short-term swings occur because of some external factor. Price never ralliesbecause it is rallying, the rally is the symptom of a cause. Detect that cause and we are several light yearsahead of the average short-term or day trader.One of my favorite causative indicators is my Will-Spread index, a measure of the flow of pricebetween the primary market we are trading and a secondary market that influences the primary. As youknow, Bonds influence stocks, and Gold influences Bonds; Will-Spread allows us to spot the inner workingsof these market relationships. The index is constructed or calculated by first dividing the price of the marketwe are trading, the primary market, by the secondary market and multiplying by 100. This creates a spreadbetween the two markets allowing a basic comparison of market interaction.For short-term trading on 15-minute bar charts in particular, and most other time frames as well, I thencreate a 5-period exponential of the spread and subtract that from a 20-period exponential of the spread. Byso doing, we can see when one market is heating up over another and get a better sense of these inner-marketinfluences. Granted, this is not a perfect system, but the only perfect approach to day trading I have everseen are those myriad of ads in commodity magazines and newspapers. You can absolutely trust me on this:those are 90 percent hype and 10 percent substance. If anyone really had such an outstanding system, he orshe could make 100 times more money trading without the hassle of having to deal with the public. Inaddition, the tax advantages of trading are gargantuan compared with hawking systems. I have
139yet to see a totally mechanical day trading system that consistently makes money. Day trading is an artform that must be based on good concepts to be successful.
An Actual ExampleFigure 9.7 shows a 30-minute bar chart of the June 1998 Treasury Bonds. Will-Spread, based onthe spread between Gold and Bonds, is the index at the bottom of the chart. Our trading strategy should beto look for market rallies whenever this index moves from negative territory, below the zero line, to aboveit into positive land. A sell is just the opposite; when the index has been positive and then falls below thezero line, it is probably time to sell.I do not use this index as a be-all, know-all system. I use it as a tool to keep me in correct alignmentwith the true trend of the market I am trading. In this case, we are looking at Bonds versus Gold. Onceprice goes from being negative to positive, I will most always wait for one more thing to happen.I want the very next trading bar to rally above the high of the bar that switched the index from negative topositive. I am looking for final confirmation that the trend is still alive.
Figure 9.7 T-Bonds (30-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
140I am not nearly as comfortable without this confirmation taking place. An exception can be made ifother technical gauges such as trendlines or positive oscillator readings are appearing on your chart orscreen. You can take such trades, but there is no better proof of a market's ability to rally than taking out thehigh or falling below the low when a crossing from positive to negative has taken place.Let's start with the May 8, 1998 chart. The first 30-minute bar saw a big down move resulting in anegative crossing, but the following bar did not fall below that bar's low so no entry. Finally on the 13:50bar, we would have sold short as the index was negative and we traded below the prior bar's low. Our entrywould have been 120 7/32.Will-Spread stays negative all that day as well as the next, finally turning positive on May 12 on the9:50 bar. Now comes the acid test ... will the rally continue? And it does as the 10:20 bar trades at 119 14/32netting us a gain of 25 ticks or $750 per contract.We are now long at 119 14/32 and looking for a negative crossing to go short. The first break belowzero occurs on May 14 on the 12:50 bar. Again, we wait for confirmation, but none comes on the next bar.We now wait for that bar's low to be violated. Our "trailing" stop to exit and reverse is finally elected whenthe 14:20 bar trades down to 120 4/32. Our net gain is 20 ticks or just a little over $600 per contract.We steel our nerves for the short trade and await a new development, a penetration of Will-Spread backinto the positive zone. This does not take place until the 8:50 bar on May 18. The rally continues with afull-fledged buy at 120 14/32 on that day. We lost money on the short, in fact, our net loss was 10 ticks or$312.50.Could we have prevented this loss? Sure, in retrospect as Monday morning quarterbacks, but blindlyfollowing the rules, you would have taken the hit. When this happens, and it most certainly will, I takeconsolation in the following statement:Casinos do not win on every roll of the dice either.We did end the day with a 5-tick profit or about $150 to help lick our wounds and offset the loss, andthe next trade (remember, traders fight wars not battles) would have made $500 per contract.An astute trader may have exited the short position on the second bar of trading when it took out theprevious bar's high. Reasons? Will-Spread was quickly approaching the zero line. We should limit losses,and price had a volatility breakout at 120 5/32 for a net loss of just 1 tick or $32.50 plus commissions. Youmay not have chosen to exit, but that would have been my choice on the strength of the action ofWill-Spread in conjunction with the breakout of the trading range. As I said, this is a thinking person'sbusiness.
141If you were in a quandary about what to do, you could have looked at a 5- or 15-minute chart onMay 18. There you would have noticed both time frames giving a clear-cut penetration of Will-Spread tothe upside suggesting the best course of action would have been-at the very least-to pitch your shortposition.
Will-Spread and the S&P 500 Stock IndexThis same idea works quite well in helping us catch short-term swings in the various stock indexcontracts such as the New York Stock Exchange, Dow Jones, Value Line, the Mini S&P as well as theS&P 500 full-size contract.Although Gold makes the world of Bonds go around, it does not have as strong an impact on stocks.As you now know, however, interest rates do; so I suggest you use either T-Bills or Bonds in yourWill-Spread setup. Using 30minute bar charts, I am employing the difference between a 3-period and15period exponential average. Admittedly, this is a lot of work to do by hand, but the better quote softwaresuch as Omega's Trade Station and Genesis Data have now built my indicator into their programs.Instead of just randomly choosing time periods to present to you to illustrate the value of Will-SpreadI am first going to show you "The Anatomy of a Crash," by highlighting the biggest crash of all times, the1987 debacle, as well as the 1997 and 1998 waterfall slides.
The Crash of 1987Here it is in all its glory; the largest stock market decline in the history of the world! A decline thatchanged lives and fortunes, a decline of such disastrous proportions lawyers were still suing for damagesfrom the drop 5 years later. Even now, books are written claiming to know why it took place or explain itaway. Academics have suggested many ways to prevent the damages of such speculative busts in thefuture. Big deal, I say; it was predictable-then-not now, with Will-Spread (see Figure 9.8). This amazingindex dipped into the negative zone on October 14 at 311.50 staying short all the way through the debacletelling its followers the bottom was not yet in sight. Interest rates vis-a-vis T-Bills were not supportive ofthe market and without that confirmation we should not look for any buy signals. Indeed, just about anybuying, other than the absolute low, would have proven costly.The exit or first crossing back into positive territory came on October 20, 1987, with the S&P bloodiedand battered at 219.50, a profit of $46,000 per contract. The margin at the time was only $2,500 (Figures
1429.9 and 9. 10).
Figure 9.8 S&P 500 Index (30-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Figure 9.9 S&P 500 Index (30-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
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Figure 9.10 S&P 500 Index (30-minute bars). Graphed by the "Navigator"(Genesis Financial Data Services).
Although Will-Spread can stand on its own, it can be used in conjunction with other known facts aboutthe market. As just one example, you have read about a huge bias for stocks to rally at the first of everymonth, especially in February, March, May, July, September, October, and November. Thus one possibleshort-term strategy you could employ at the start of every month would be to take Will-Spread buy signalswhen the positive crossings occur, with special focus on the previously named months. Here is a recap of allsuch signals for 1997 starting with January. Stay with me as I "walk" and talk you through what happenedand what you could realistically could have done using this combination of ingredients.January1997. Will- Spread did its thing crossing on January 2, 1997, with an entry at 744.70, stayingpositive until the negative crossing on January 6, by then the S&P rallied to 752.00 with a profit of 7.30points!February1997. On January 29, the first-of-the-month rally was clearly indicated by a positive crossingat a price of 774.60 with an exit two days later on the close of January 31 as Will-Spread had begun todeteriorate. We know this is a 2- to 3-day bias, so let's take the 13.90 profit at the end of our time windowunless the index is particularly bullish.
144March 1997. We did not get an entry until March 3 at 792.90. This was not much of a trade, but tookout 1. 10 points profit with a crossing on March 4 when the S&P was trading at 794.00.April 1997. Oh, I just love Will-Spread. A conventional month-end trader would have bought andlost money. But, you and I are smarter, we do not trade just technical and seasonal stuff alone, we knowinner-market relationships provide meaningful insights into what is going on. That is why we bypassed thetrade. Will-Spread did not give a buy until April 7, way outside the hot zone.May 1997. We could see the month-end rally coming on April 28 when a bullish signal was given at772.40 with an exit on May 1, 1997 at 800.50. This was a quick and explosive trade for an amazing 28.10points profit!June 1997. Here comes our first losing trade: a buy was given on May 28 with a positive crossing thatwent negative just a few bars later at 851.20. I would have pitched this trade the same day at 849.00 for aloss of 2.3 points. But, the hot zone of month-end/start was still there, so when Will-Spread turned positiveon May 30, there was no reason not to take the trade; we were still in the time zone. Entry price was 844.70with an exit on June 2 at 848.00 making up the loss on our first shot at the trade.July 1997. Well, we are given another lesson in humility, going long on a positive crossing on June 30at 896 with an exit the same day, a 6.0 point loss at 890! Wow, that was quick and ugly. But just like the endof june, we see another positive crossing on July 1, so we go long at 898. Our strategy is simple, wait for anegative crossing or two days in the trade. We wait. Will-Spread crosses to the downside just a few hourslater at 897.80 for a .20 loss. Another crossing comes late in the day on July 1, so we reenter at 900.25 andhold until our sell on july 7 at 927.55, netting 21.10 points in july.August 1997. Along comes the first of the month, but Will-Spread is tracking in the negative area so wehave no trade. Again, our filter has kept us out of what appeared on the surface to be bullish. As the timeapproached, we could see the fundamentals were not there to justify the trade.September 1997. More humility. There is a clear-cut crossing on August 29 with an equally clear-cutexit and loss the same day at 902.55 for our biggest loss of the year of 3.20 points.
145But we stick with it, taking the buy signal on September 2 at 912.50 and watch a very powerful rallyunfold lasting until September 3 when we close out the trade at 928.90, again recouping our earlier loss.That was close, but the combination of the time influence and inner market influence coupled to keep us inthe black, with this 15.50 point gain +1295.October 1997. We had to wait until the first of the month when a crossing took place forewarningus a rally was on the way. There was an additional chance to buy again as Will-Spread dipped into negativefor one bar, but with no follow-through for a sell and an immediate upturn on October 2 at 965.30, givinganother positive crossing until time ran out with a negative crossing. The rally stopped, for us at least, at968.75, a 3.45 point gain.November 1997. This was almost too easy. The crossing came on October 31 at 919.00 with anequally clear exit at 947 for a very profitable trade of 28.0 points. This is how I wish it worked everymonth!December 1997. Another storybook trade with a positive crossing on the first of the month at962.50 and an exit on December 2 at 973.20. It was, as old Blue Eyes used to sing, a "very good year," 13total trades with 10 winners. More importantly, the net profits of 99.70 points, or $24,925, illustrate thevalidity of combining fundamentals with time influences. The time influence is always there, but without avalid underpinning-the stage being set on a fundamental basis-I will pass, thank you. There are too manygood trading opportunities where we can get such high odds that there is no reason to go slumming fortrades just because there is one element "that may work." The more the merrier, that is my adage!
Chapter 10
Special Short-TermSituations
History does repeat itself, just not with precision.
It is time to develop a checklist of possible short-term trading opportunities, we can accept or rejecteach month. You can do this yourself by gleaning out of my trading opportunities that appeal to you. Togive you a feel for doing this, I devote this chapter to setting up specific trades you should be looking foreach month. These trades are based on times of the month and holidayThe time-of-the-month trade is hardly a new idea. As noted earlier the concept has been known foryears. Here are my improvements and adaptions to a long-standing market truism: stock prices rally aroundthe first of the month. The light I shed on this play was to find out that Bond prices experience this samemonthly uplift as demonstrated earlier. We will develop a winning strategy based on these insights.
Month-End Trading in Stock IndexesThere are now several vehicles speculators can use to catch these savings. The S&P 500 stock indexhas been the kingpin of trading stock market moves but lately, the lower margin S&P minicontract has been
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Figure 10.1 S&P 500 buying first day of each month.grabbing smaller investors' attention. The newcomer in this group, though, is the Dow Jones 30 index, afutures contract that mimics the world-famous Dow Jones Average. I expect this to become an even moreimportant index to trade in the future.The strategies discussed here are based on the S&P 500 for one simple reason; we have more databecause this stock index began trading in 1982, the Dow 30 in 1997. But, the strategies can be applied to allthe stock indices; just alter your stop based on margin, contract size, and current volatility.I went back to 1982 and tested buying the S&P 500 index on the open of the first trade day of everymonth with an exit on the first profitable opening. The stop I chose was only $1,500, but was not used on theday of entry; however, after the entry day it was in place at all times. There have been 129 trades making anet gain of $73,437, about $7,000 a year for trading only once a month. The numbers of this system areexcellent; the accuracy is 85 percent, average profit per trade (that's net gain, winners minus losers, dividedby total trades). Drawdown came in at $3,325, less than 5 percent of total gains. This is good stuff (seeFigure 10.1).
Target MonthsIf you are getting the hang of this game, you may have already asked yourself if some months dobetter than others. The answer is yes, as the following printouts show. The story they tell is that the worstmonths, in the past 16 years, have been January, February, and October. These should be your target monthsto avoid or be cautious of seasonal trading. I suggest you study the month-by-month recaps presented inTable 10.1.
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Making It BetterAlthough some of our speculative competitors are aware of this repetitive pattern, most do notconsistently take advantage of it nor have they figured out about skipping some months. That is a bigimprovement, but we can do even better.How? By only taking these first-of-the-month trades when Bonds are in an uptrend. As I demonstratedearlier, an uptrend in Bonds is conducive to stock market rallies. A pretty good rule, and easy to follow, is toonly buy on the first of a month, any month-if Bonds have closed higher the day prior to our anticipatedentry than 30 days ago. This is evidence Bonds should be supportive of a stock market rally.
Month-End Trading in the Bond MarketNext, let's look at buying the first trading day of every month in the Bonds, as we did in the S&P500. The results are quite profitable based on the rules of using an $1,100 stop and exiting on the firstprofitable opening. This approach to trading comes close to 70 percent accuracy and has a very large averageprofit per trade considering that we are in for only one day on average (see Figure 10.2).We can dramatically improve these results by simply by-passing the poorer performing months which,as shown in Table 10.2, are January, February, April, and October, with December being a question mark.
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Figure 10.2 Bonds buying first day of each month.
As mentioned, the month-end up move in stocks has been written about for years; all I have done isfigure out how to better qualify trades for this time period. Until now, the tendency for Bonds to rally at thissame time has been known by only a few of my students. My research and actual trading over the yearsshow this is also an excellent time for short-term swing moves in Bonds and Bills.Figures 10.3 and 10.4 should give you an overall view of this technique's strength. Figure 10.3 showsthe growth in an account that would have
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Figure 10.3 End-of-month T-Bonds system (U.S. T-Bonds day session 1983-1996).
Figure 10.4 End-of-month S&P 500 (1983-1996).
152bought one contract of T-Bonds on the third to the last trading day of each month and held for six tradingsessions, exiting at that time or taking a loss of $1,500 with a protective stop. This chart, from one of theBond market's best students Mike Stock, offers convincing proof of the phenomenon. The same opportunitypresents itself in the S&P 500 as well as Figure 10.4 shows.
Getting SpecificThe rally usually begins in Bonds prior to the first of the month as evidenced by the next set ofprintouts. Figure 10.5 shows the results of buying Bonds on the opening of TDM 18 with a $1,500 stop andexiting on the close 3 days after entry. The 139 trades, since 1986 netted $34,875 with a comfortable averageprofit per trade of $2 50. This is tradeable, despite the $8,62 5 drawdown.We can do better, however, by bringing a subset of the trend of the Gold market to filter out bad ormarginal trades. As described in the works of such major contributors to our understanding of the markets asMarty Zweig or John Murphy (whose books are must reading), Gold exerts a great impact on Bonds. WhenGold is in an uptrend, it acts as an impediment to Bond market rallies, conversely, when Gold is in adowntrend, Bonds are more apt to rally.Figure 10.6 reveals the power of filtering trades with Gold. In this case, trades were taken at the sametime period with the same stop and exit as before. The difference is that trades were only taken if Gold wasin a downtrend (i.e., the close of Gold on the day prior to entry was less than 24 days ago).
Figure 10.5 Buying bonds on TDM 18.
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Figure 10.6 Bond TDM 18 buy signals backed by gold.Although total profits dip $2,000, the accuracy slightly increases while our "all important" averageprofit per trade jumps up over $100 per trade and drawdown improves substantially by being cut almost inhalf!
Better and BetterWe can do even better than the preceding results by delaying our entry until TDM 22. There are a lotless trades as the Figure 10.7 shows, only 50, but a
Figure 10.7 Bond TDM 22 buy signals.
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Figure 10.8 Bond TDM 22 buy signals backed by gold.higher accuracy, 76 percent, an amazing $496 average profit per trade, and very livable drawdown of a littleover $4,500.I know, I know, you want to know what happens when we back this trading opportunity with the trendof Gold. Well, Figure 10.8 shows the answers and they are very impressive, $20,156 of profits. Again, thetrend criteria is that Gold close lower than 24 days ago, same stop and exit as in the previous results.Although our drawdown has a major improvement, crashing all the way down to $1,500, the accuracyskyrockets to 89 percent and average profit literally zooms to $719 per trade.This is an exceptional trading opportunity; the problem is not many months have a TDM 22, but whenthey do, I will be buying. Check out the string of winners with the Gold filter, 17 winners in a row, whereaswithout the filter, we only had 5 winners in a row.
A Time to Sell as WellBonds have also dipped around mid-month most of the time, as Figure 10.9 reveals. The rules calledfor selling on the open of TDM 12 with our usual 3-day exit and $1,400 stop. From 1986 to the middle of1998, this dip has been profitable to trade 76 percent of the time with an average profit per trade of $133 onthe 152 trades. Drawdown is acceptable at $6,093, but larger than the ideal ratio of profits to drawdown.Ideally, drawdown should be no more than 15 percent of the profits of $20,281. In this case, the drawdownwas 20 percent profits. So, although we are certainly onto something here, I would like a shot at making itbetter.
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Figure 10.9 Bond sells TDM 12.
Whereas traditional commodity market analysts would try to filter this trading opportunity withtechnical "junk" like the trend, oscillators, or momentum flows, I would rather go back to what matters;fundamental relationships, that of Gold to Bonds. After all, charts and oscillators do not move the market,underlying conditions do.In addition to now having a real way to trade this mid-month dip, we are also able to again see thepower of fundamentals in Figure 10.10. The trade entry and exit rules are exactly as in the previous clip, theonly difference-and what a difference it makes-is that trades were only taken when Gold had closed greater
Figure 10.10 Bond sells TDM backed by gold.
156than the close 10 days ago. In other words, Gold was in an uptrend, which suggests to us that sell signalsshould be more effective in this monetary environment. The average profit per trade more than doubles,profits get bumped up $6,000, accuracy goes from 76 percent to 78 percent, no big deal, but our drawdownto profit percentage is just about halved from 20.9 percent to 11 percent. Perhaps best of all the averageprofit per trade jumps to $359 from $133.Here we have a very tradable opportunity. All one need do is have the patience to wait for themid-month time periods when Gold has been in an uptrend: that is the fundamental setup that created theseresults.Patience seems to be the one commodity commodity traders have in short supply. Most people mustlike to trade for the heck of it, I guess. I want to wager or speculate only when I have a distinct advantage inthe game. If it is not there you know where I will be ... on the sidelines . where I belong. I hope you will bethere with me!
Chapter 11
When to Get Out of Your Trades
Never begin anything until-you have reflected upon the end of it
I have three rules for you to follow to get out of your trades:1. Always use a dollar stop on all trades so in the event all else fall,. you will have protection.2. Use my, "bailout" profit-taking technique developed with the help of Ralph Vince. The basic rule is toexit on the first profitable opening if the profit is only one tick, take it.This works best for the S&P; for slower moving markets I will delay the bailout a day or two to givethe market time to grow