
In  this  chapter,  pushing  our  luck  further,  we  were  able  to  defineMAE stops for reversing out of the range as well, giving us anothersource  of  profit.  It  turned  out  that  for  the  first  time  in  this  analysis,the  MAE  was  greater  than  the  .31   we’d  used  in  all  the  previoustrading rules as shown in Table 8.  I, As a further result, with a capi-tal constraint of  $600  or so, we’d only be able to trade one contractusing  these  rules  unless  we’re  willing  to  accept  a  much  lower  esti-mated  profitability.
From  a  campaigner’s  point  of  view,  reversing  out  of  a  tradingrange  in  Crude  is  a  vital  tactic.  On  average,  three  of  these  rangeswill crop up every year, and once their levels are broken, there is astrong  possibility  of  a  strong  move.  The  profitability  level  isn’t  asbig  as  trend  trading  but  it’s  right  up  there  with  add-on  trading,building  a  trader’s  strength  and  trading  capacity.  It  kicks  oneinto  the  same  direction  as  trend  trading,  too,  perhaps  earlier  ifeverything  goes  exactly  right,  so  it’s  psychologically  advantageousas  well.
TABLE  8.1 CAMPAIGN  TRADING  PROFITABILITYNEW  YORK  LIGHT  CRUDE,  1984-1994
Mode
TrendTrendTrendTrendRangeRange
Rule
stop  Level
Two moving averagesAdd-on  day-tradesAdd-on  position  tradesRWCZrSal
Trade into rangeReverse out of range
.31.31.31.31.31.51
Profit/Loss(points)
3,6002,5006401,8275502,229
FIGURE  8.11 CUMULATIVE  PROFITABILITY.  Reversing becomesmore  steadily  profitable,  with  less  variability,  when  MAE  stops  are  used.Figure 8.10 reversing looks at this shape end-on.
range with  .6 or  .7,   but  beyond  that  we  may  be  looking  at  huge,uncontrollable  excursions  (gaps  in  pricing)  that  aren’t  worth  theexposure.
Taking  .5   as  the  cutoff  for  reversal  trades  out  of  a  range  gener-
ates a net trading profit of 2,229 trading points.
Trade  Behavior
I  enjoyed  analyzing  reversal  trades  in  Crude.  The  contract  oftenbreaks  cleanly  through  support  and  resistance,  at  least  as  it’sdefined here, and goes on to trending. As a result, often before thetrend trading starts, you’re already on-board the trend.
It’s worth noting that the reversal trade shouldn’t be ‘converted’to a trend trade once things are going well; it has its own separatecapitalization  and  loss  level  (Sl)  that  is  different  from  that  of  thetrend trade  (.31).   Trending  trades  will  kick  off  with  their  own  sig-nals and loss levels when both averages start moving in the same di-rection.
Minimum  FavorableExcursion
HOW LITTLE DO TRADES GO OUR WAY?
If  it  is  worth  knowing  how  bad  things  get  during  a  trade,  whatabout  looking  at  how  good  they  get?  Maximum  adverse  excursionmeasures how far against us both winners and losers go. What’s the[east  we can count on winners and losers goingfor  us?
For  purposes  of  analysis,  let’s  again  split  things  into  the  perfor-mances of winners and losers. For each category, we want to knowthe  maximum  amount  the  trade  went  for  us  before  ending.  Evenbefore looking at the results, we’d expect that losers wouldn’t showmuch  movement  in  our  favor  and  that  winners  would.  We  alreadyknow that winners don’t go very far against us and that losers do.Again,  we  won’t  check  chart  formations,  averages,  indicators,  oranything  but  the  actual  excursion  of  prices  from  the  point  of  entry.
Protective  Stops
Over the years, authors Edward Gotthelf, Tushar Chande, and my-self  have  explored  how  favorably  trades  move  eventually,  looking
185
186  Minimum  Favorable  Excursion
How  Little  Do  Trades  Go  Our  Way?
187
for guidelines to managing trades in place.’ This was usually to findgood  exits.  I’d  settle  for  something  less  at  this  juncture:  a  goodplace  to  raise  our  stops  from  the  MAE  point,  preferably  withoutgiving  up  profits  prematurely.
Even to achieve breakeven on a good number of losers would bea  major  achievement  because  it  could  alter  the  ratio  of  wins  andlosses  from  30:70   to:   say,  50:50,   increasing  profitability  in  theprocess.
Reversing trades in Crude are a good example to use for this be-cause, from Chapter 8, we have graphic evidence that reversals outof  ranges  have  a  good  percentage  of  winners  and  tend  to  go  onetrading  range  or  more  to  the  upside  when  they  succeed.  That  is,when  they  win,  they  go  somewhere.  How  far  do  they  go,  and  dothey  go  for  enough  to  let  us  put  a  stop  below  the  trade  at  somepoint,  rationally  cutting  off  winning  trades  that  turn  into  losers  latein  life?
What  would  the  impact  be  if  a  stop  were  placed  at,  say,breakeven once a trade had advanced as much as  .3  or  .6 or .9?  Inother words, can we profitably cut off the loss we’re going to takefrom  trades  that  are  to  become  losers  or  will  we  cut  off  too  manyeventual  winners?
Favorable  Price  Excursion
Figure  9.1  shows  the  basic  picture.  Initially,  prices  advance(whether we’re long or short) favorably. At some favorable excur-sion, we’re encouraged to move our stop up from the MAE level.How  far  do  we  move  it‘?  Of  course,  good  ideas  can  go  bad,  asdemonstrated in Figure 9.2.
’  Edward  B.  Gotthelf,  The  Commodex  System  (New  York:  Commodex  SystemsCorp.,  1974),   pg.  90  (originally  published  in  1959);  Tushar  Chande   and  StanleyKroll.  The New Technical Trader  (NW  York: John Wiley & Sons, Inc., 1994); JohnSweeney,  presentation  at  TAG  Conference;  Las  Vega%   Nev.,   1994;  also  JohnSweeney,  “Settlement,”  in  Techn;cal  Analysis~of  Rocks  and  Commodities  (Seattle:1991,  1992),  November  1991~September 1992.
FavorableExcursion
UnfavorableExcursion
Time
FIGURE  9.1 MOVING  UP  STOPS.  In  this  idealized  diagram,  measuredfrom entry, the trade initially goes in our favor but later retreats. Whereshould the protective stop be placed, if used at all!
Figures 9.1 and 9.2 are idealized, but should get the idea across.If we have a winner we’d move the stop up along with the advanc-ing  prices.  Familiar  methods  for  doing  this  include  using  trendlines,  parabolic  stops,  dynamic  moving  averages,  previous  resis-tance levels, and others. These methods are usually oriented towardexiting  a  trade  at  the  end  of  a  trend.  Here,  again,  I’m  looking  forsomething  more  limited:  to  prevent  an  initially  favorable  advancefrom  turning  into  a  loss.
The Best Yardstick?
What  is  the  best  measure  of  favorable  excursion?  Can  we  judgefrom  how  favorably  the  trade  has  gone  when  to  move  up  the  stop
188  Minimum  Favorable  Excursion
How  Little  Do  Trades  Co  Our  Way?
189
t
FavorableExcursion
Excursion
\
Go  Long
FIGURE  9.2 HITTING  THE  STOP.  Naturally,  if  things  can  go  well,  theycan go poorly. Here, the protective stop knocks out a much greaterurofit.
to breakeven? If so, how far is far enough? That is, given favorablemovement X,  what is  y for stop placement?
In this situation, the price closest to the proposed protective stopisn’t the maximum  favorable excursion  (MaxFE) (Figure  9.3)  butthe  minimum inan advance or the lowest high in a decline). Before going further, letme define minimum favorable excursion  (MinFE)  by example.
favorable  excursion  (the  distance 
the  highest 
low 
to 
Why  use  the  nearest  low  if  long  or  the  nearest  high  if  short?These are the best proxies for the chance of a protective stop beinghit. In Figure 9.4, an example taken from action in 1984 Crude, thereversal trade was made during the first bar, going long. The maxi-mum  favorable  excursion  for  the  next  ten  days  was  hit  that  sameday. The trade ended a winner on the last bar shown.
If we wanted to know where to set~a  protective stop, the first dayis  no  help  at  all  because  the  low  was  below  the  stop  and  the  high
:avorable ExcursiOn
AdvancingPrilXS
t
DecliningPriCGZS
Maximum Favorable Excursionin  a  decline.
t
FIGURE  9.3 DEFINING  MAXFE.  Within  the  time  frame  of  the  trade,MaxFE is the distance from the entry to the highest high in a longposition or the lowest low in a short position.
gave no clue. On the next two days, the lows were below the entrylevel and the highs, though above entry level, were below the maxi-mum favorable excursion. If we had tried to estimate the likely stoplevel, MaxFE would not have helped.
It wasn’t until the fourth day that there was any space at all be-tween  the  entry  level  and  the  low  of  the  day.  Still,  the  fourth  daywas  a  more  reasonable  place  to  think  of  moving  up  a  stop  ratherthan  the  first  couple  of  days.  Lows  act  as  a  conservative  minimumdistance  from  the  point  of  entry  (when  going  long)  even  thoughthere is still a role for the maximum favorable excursion.
190  Minimum  Favorable  Excursion
Finding  Winners  and  Minimizing  Losers
191
Advancing
DecliningPrices
c
t
Minimum Favorable ExcursionRising
W  Time
------__ MAE Stop Level
FIGURE  9.4 MEASURING FAVORABLE EXCURSION. From the pointof entry in a purchase, minimum favorable excursion is the differencebetween the highest low encountered and the entry price with aminimum of zero.
In  the  first  place,  there’s  necessarily  a  strong  relation  betweenthe  two,  as  shown  in  Figure  9.5.  However,  the  interesting  situa-tions are the eight times (clustered on the Y axis) when the MinFEwas zero and the MaxFE was positive. In all these cases, the rever-sal  was  a  loser  but  the  price  jump  outside  the  range  boundariestriggered  the  reversal.  In  terms  of  going  long,  the  high  establisheda  MaxFE,  but  the  lows,  if  there  was  more  than  one  day  to  thetrade, never went above entry. There are far too few cases to estab-lish  any  rules,  but  this  occurrence  raises  the  question  of  whichwould  be  the  better  proxy  for  moving  stops,  especially  when  theMinFE is zero.
BAD TRADES GOING GOOD. MinFE and MaxFE are
FIGURE  9.5strongly related (they are opposite ends of the same price bar) except incases where there is no minimum favorable excursion.
FINDING  WINNERS  AND  MINIMIZING  LOSERS
Is there an edge we can find here? Is there a point of favorable ex-cursion that, once reached, creates the fair likelihood that a protec-tive stop won’t be picked? Let’s look at the exemplary informationfor reversal trades.
Figure  9.6  shows  a  distinct  difference  between  the  minimum  fa-vorable  excursions  of  winners  and  losers.  The  losers’  minimum  fa-vorable  excursions  are  usually  less  than  .3.   Only  1  in  16  is  morethan  .3.  As expected, favorable excursions trail off to the right, andas hoped for, there is relatively little overlap between the two distri-butions  because  only  three  winners  had  MinFE  of  less  than  .6,whereas all the losers were bunched.
In  other  words,  just  as  winning  trades  don’t  go  very  far  againstus,  losing  trades  don’t  go  very  far  in  our  favor  if  we   measure   byA&FE.
What about maximum favorable excursions (MaxFE)? Given theclose relationship with MinFE, wouldn’t MaxFE serve just as well?Also, if we used MaxFE, could we get some guidance about thoseeight  trades  with  a  positive  MaxFE  and  no  MinFE?  Figure  9.7shows  the  distribution.
192  Minimum  Favorable  Excursion
Gray  Areas  193
tual winners and eventual losers while MaxFE  does not, at least us-ing these rules with Crude.
So, as a first cut, we’d use MinFE and look for a reversing tradewith a MinFE > .3  (or .6  to cover all the bases). There’d be no needto move up the stop protectively in this case because our experience(see Figure 9.6) indicates that this trade is likely to be a winner andwe don’t want to put that at risk with a closer stop.’
Of course, on the downside, if the reversing trade instead hit ourMAE stop, our trade management problem would be over:  we’d beout of the trade. It’s the gray area in between-where the trade hasnot  been  stopped  out  or  advanced  more  than  MinFE  >  .3-that  aprotective stop may have its place.
GRAY  AREAS
Do  losing  reversal  trades  give  us  a  chance  to  get  out  whole  or  atleast with less of a loss than the MAE stop? In other words, what isthe  distribution  of  the  movement  of  losing  trades  in  our  favor?  Forexample, in Figure 9.7, there was one trade that was 2.1 points inour favor at one time. To have that turn into a loss is very damaging.As  it  turns  out,  there  is  some  opportunity  on  virtually  everytrade when we look at MaxFE (see Figure 9.8). All but one losingtrade  had  some  favorable  excursion,  potentially  giving  us  someroom  to  move  up  a  protective  stop.  This  is  not  the  case  withMinFE,  as  shown  in  Figure  9.9.  With  MinFE,  some  losing  tradeshad  no  minimum  favorable  excursion  at  all,  indicating  that  therewas no room to move up a stop.
I’m  particularly  interested  in  the  trades  with  MinFE  <  .3-arange that includes those with none or zero  MinFE-and/or tradeswith MaxFE  >  0.  From  Figure  9.6,  these  trades  are  suspect:  untilthey achieve MinFE  >  .3,   they  could  be  losers,  which  will  cost  usthe MAE stop. Just eyeballing Figure 9.9, we can see that most arelikely losers. Can we cut them off early?
2  Especially  because  breakouts  often  lead  to  trends,  we  may  start  thinking  of  add-on trades for the reversal. These would be taken along the lines described in Chap-ter  5.
9
FIGURE  9.6 SHARP DISTINCTION. Minimum favorable excursionproduces clearly different distributions for winning trades and losingtrades. When reversing out of a range, a trade with a MinFE of morethan .3  is highly likely to be a winner.
This is a muddier picture. There is a lot of overlap between thesetwo  distributions,  One  of  the  losers  had  a  maximum  favorable  ex-cursion of around 2.1. Yet these trades are the same as those in theprevious  figure.  MinFE  provides  a  sharp  distinction  between  even-
il
FIGURE  9.7 OVERLAPPING DISTRIBUTIONS.  Measuring favorableexcursion  using  maximum winners and losers tough.
favorable  excursion  ~makes   distinguishing
1
194  Minimum  Favorable  Excursion
Crav  Areas  195
To  look  at  the  gray  area  more  closely,  let’s  plot  MaxFE  andMinFE  for  trades  where  MinFE  <  .3   and  MaxFE  >  0.  In  Figure9.10 every trade with a MinFE below  .3  was a loser. It even turnsout that my  .3  definition of a bin was coarse:  .16  would have done,though  that’s  vague  given  the  sparseness  of  the  data.  Still,  it’s  tan-talizing  that  even  .l  would  have  gotten  all  but  two  of  these  losingtrades.  It  holds  the  promise  that  a  trade  with  a  MinFE  >  .l  couldbe  allowed  to  run  confidently  while  those  less  than  .l  could  be  cutoff early on.
Unfortunately,  Figure  9.10  shows  no  neat  cutoff  point,  only  in-formation  for  the  trader  to  consider.  Figure  9.11  shows  that  mostof  these  losers-reversal  trades  with  some  maximum  favorable  ex-cursion-will  likely  get  stopped  by  the  MAE  stop.  After  all,  onlythree  of  them  didn’t  go  below  the  MAE  stop.  That  indicates,though  not  conclusively,  that  the  gray  area  is  a  very  small  part  ofour  trading  problem:  3  of  35  trades.  Moreover,  if  a  trade  doesn’thit the stop, it’s going to cost us less than the stop, which is some-thing we can bear.
SOME  FAVORABLE  MOVEMENT.  It  turns  out  that  even
FIGURE  9.8losing  trades  have  some  favorable  movement.  The  question  is  where  tocut it off without damaging winning trades.
.
FIGURE  9.9LESS  FAVORABLE  MOVEMENT.  Minimum  favorableexcursion  gives  a  sharper  cutoff  between  winners  and  losers  but  lessroom  to  move  up  a  protective  stop.
FIGURE  9.10LOSERS  ALL.  MinFE  versus  MaxFE  for  MinFE  <  .3.Looking at trades with MinFE less than .3, we find all were losers.Tantalizingly,  these  15  trades,  nearly  half  of  our  experience,  indicatethat losing trades rarely have MinFE  > .16 or even  .l
196  Minimum  Favorable  Excursion
Favorable  Excursion  197
LOSERS  HIT  STOPS.  Though  some  go  well 
FIGURE  9.11black,  there  appears  no  neat  point  at  which  trades  with  low  MinFE  andpositive  MaxFE  can  be  cut  off.
into  the
It  turns  out  in  Crude  that,  when  reversing,  experience  does  notsuggest a neat point to move up the protective stop. Keep in mindthat in these gray-area trades the MinFE does not go more than  .3above the entry (and half the time doesn’t even get that far!) whilethe MaxFE does move strongly in a favorable direction, You have asituation  with  very  long  bars.  So,  if  you  experience  a  high  MaxFEbut  the  low  doesn’t  rise  enough  to  generate  a  MinFE  greater  than.3 (or .l if you’re pressing your luck), you don’t have a clear-cut callto raise the protective stop.
If  you’d  settle  for  a  less  clear-cut  call,  an  artful  call,  I’d  suggestmoving  up  the  stop  to  breakeven  if  MaxFE  >  .3,   even  thoughMinFE  <  .3,   as  shown  in  Figure  9.12.  Although  .3   seems  to  keepcoming up, the graph itself suggests this level. Around  .4 there is anaccumulation  of  MaxFEs;  so,  though  the  information  is  sparse,there’s  the  potential  to  take  advantage.  In  effect,  the  rule  is  that  ifthe  trade  goes  up  as  much  as  .3   while  the  low  (in  a  long  trade)never gets above  .3  (or .16  to really push things), it’ll be closed outwhen  it  returns  to  breakeven.  Although  there  aren’t  enough  of
PROTECTIVE STOP AT .3. Reversal trades with MaxFE
FIGURE  9.12> .3  (but MinFE < .3) can be cut off early on with a stop at .3  over entry.This may put the occasional winner with a low MinFE at risk, thoughthat  didn’t  happen  in  this  period.
these  situations  to  justify  statistics,  inspection  shows  this  workedout favorably in all nine cases, reducing losses that would otherwisehave  been 
taken.
FAVORABLE  EXCURSION
When things go badly, we stop out, but what about when things gowell? Favorable price excursion has its behavioral characteristics aswe’ve just explored, and before leaving the subject I’d like to pointout  a  few  more  using  the  reversal  trades  as  examples.  I  haven’tfound  hard  and  fast  rules  using  this  information,  so  I  present  it  asadditional  information  you  can  accumulate  to  know  your  tradeablemore  thoroughly.  The  “looks”  I’ll  show  here  could  have  been  as-sembled  for  any  of  the  trading  modes  outlined  previously.  I  haveforborne  because  the  campaigner  will  not  get  a  firm  trading  rulefrom  it.
198  Minimum  Favorable  Excursion
Favorable  Excursion  199
lime  of  Trade
Normal  Advance  or  Decline
Winning  trades  very  commonly  persist  long  enough  to  generateprofits,  and  losing  trades  go  downhill  quickly.  The  advantage  tothis  behavior  is  that  you  quickly  learn  if  your  opinion  is  wrong  andhave  the  opportunity  to  reverse  as  we’ve  already  discussed.  An-other  advantage:  if  you  take  out  insurance  by  using  options,  youwon’t burn up much time premium in the four to ten days you needcoverage.
Taking  a  look  at  reversal  trades,  how  long  did  winners  persist
and losers survive?
As shown in Figure 9.13, winners generally last 20 days or more,which  reflects  the  trending  that  occurs  on  breakout  from  a  tradingrange. This persistence gives the breakout its status as a strong indi-cator  of  trending  activity.
It’s  more  practical  to  look  at  how  winners  advance  and  losersstruggle  along.  Although  each  trade  is  unique,  looking  at  thetrades  graphically  from  the  point  of  entry  makes  it  possible  to  seesome  commonality.  Starting  with  losers,  how  do  they  look  day  today?  Figure  9.14  shows  losing  reversal  trades  seen  from  the  pointof entry.
Looking at Figure 9.14 puts a picture to the old traders’ admoni-tion  that  if  it’s  not  going  your  way,  get  out.  Without  this  sort  ofpicture,  you  always  have  hope  that  things  will  eventually  go  yourway. With this picture, your trade’s fate may more probably be seen.
FIGURE  9.13 DAYS IN TRADE.  Winning and losing reversal trades.Winners, not surprisingly, last longer than losers when reversing from atrading range. Unusual here is the fair number of losers that last up to 15calendar days. (Days shown are calendar days, not trading days.)
LOSERS’  DAILY  GAIN  OR  LOSS.  Not  only  do  reversals
FIGURE  9.14out  of  ranges not go too far for  us  (on a closing basis), they take theirtime about doing it. Crude range reversals that end up losers may takeup to ten days.
200  Minimum  Favorable  Excursion
Favorable  Excursion  201
Two things strike me about Figure 9.14. First, nearly all the ex-cursion is between  .4  to -.4, implying that not only do losing Cruderange reversals not go too far for us but also they don’t go too faragainst us  until the last.  Thinking in terms of a long breakout (a re-versal  upward  out  of  a  range),  one  that  doesn’t  succeed  doesn’tseem  to  reverse  sharply  back  into  the  range  immediately.  Second,they  take  their  time  about  it,  meandering  about  the  reversal  level(which here was .3  above the range) for up to ten days. This adds tothe picture of Crude as a tradable that respects support and resis-tance because it appears that breaking out of the range by  .3  eitherholds  around  that  breakout  level  or  moves  upward  sharply,  butdoesn’t  immediately  or  randomly  move  back  into  the  range.  Sim-ply, a reversal out of a range is a relatively safe trade.
Figure 9.15 shows reversal winners. One extraordinary sequencedistorts  the  information  on  the  rest  so,  deleting  that,  we  get  Fig-ure  9.16.
I have eyeballed a channel of advance in Figure 9.16 to highlightthe general area that reversals out of ranges generally take. It’s al-ways caught my eye that, long or short: 1984 or 1994; high  volatil-
.2 T
FIGURE  9.15 REVERSAL  WINNERSPROFIT  BY  DAY.  Winning  tradesnaturally last longer than losers  and generally cluster along similar linesof advance under all the  vaious  conditions  oft  11 years of trading.
FIGURE  9.16 REVERSALS  WITHOUT  OUTLIERS.  Omitting  two  tradesthat advanced  very   sharply  shows  the  remainder  in  better  detail.  Thebulk  of  the  excursion  proceeds  along  a  relatively  consistent  pathway.
ity  or  low;  bonds,  futures,  or  stocks;  there  is  usually  some  consis-tency  in  the  market  behavior  when  measured  from  the  point  oftrading entry, and I see it again here.
Last, for easier comparison with the losers, see Figure 9.17.There could hardly be a greater contrast in the behavior of win-ners and losers than in Figures 9.17 and  9.14.3  For the trader whois  psychologically  unsure  the  middle  of  a  trade,  looking  at  thesecharts and comparing them to the trade he or she is in, can usuallyhelp to sort out the situation in a hurry.
I can’t reduce the practical effect of these observations to a rule.First,  the  idea  of  moving  up  stops,  particularly  on  winning  tradesduring the first ten days, puts winners at  risk!  winners may still beflogging  about  the  entry  level  during  that  period  and  could  be  pre-maturely  cut  off.  After  eight  to  ten  days,  they  could  be  reasonablymoved  up  along  the  lower  channel  of  Figure  9.17,  or  just  tobreakeven 
to  be  more  conservative.
1  Keep  in  mind  that  the  days  shown  in  these  charts  are  trading  days,  not  calend