<s> AIQ Opening BellMonthly
IN THIS ISSUE
V OL . 6
Feature
INTERVIEW
An Interview with "StreetSmarts" Author LindaBradford Raschke ............... 1
LINDA BRADFORD RASCHKE ONSHORT TERM TRADING STRATEGIES
S ec t i o n sData Maintenance ............... 6Using AIQ Reports .............. 7Market Review ..................... 8
The Opening Bell Monthlyis a publication ofAIQ SystemsDavid Vomund, Chief AnalystP.O. Box 7530Incline Village, Nevada 89452
I SSUE 8
By David Vomund
T
his month we are pleased topresent an interview with LindaBradford Raschke. Linda isPresident of LBRGroup, a firm specializing in trading and commercial hedging. She is featured in Jack Schwagersbook The NewMarket Wizardsand coauthoredthe best sellingbook StreetSmarts - HighProbability ShortTerm TradingStrategies.
A UGUST 1997
DV: Thanks for joining us for thisinterview. In your book Street Smartsyou give several strategies for short termtraders. Do you think that anyone cantrade short term or are certain personalitytraits required to be a successful short termtrader?
LBR: Anybody who wantsto can be a successful short termtrader. In terms ofpersonality, youeither want totrade or you dont.People who like totrade tend to beLinda will bemore activea keynotetraders. These arespeaker at AIQsthe people who doLake Tahoewell in the marseminar schedkets. Severaluled Septemberstudies of FCM25 thru 27 . Her(Futures Commisspeech is enLinda Bradford Raschkesion Merchant)titled, Back toaccountshaveshownthat the mostthe Future - Modern Applications ofsuccessfultradersarethose with theClassic Timing Techniques. She willhighestactivitylevels.Even the bestexamine which systems and techniquesintermediateterminvestorswho usehave withstood the test of time, intrendfollowingsystemsconstantlyaddition to using sector analysis in yourmassage and adjust their positions. Alloverall timing.the people I know who are able toInterview continued on page 2
®
AIQ Opening BellINTERVIEW continued . . .support themselves by trading tendto be very active. But in the mostrecent stock market environment, onehas obviously been able to do well bygood old fashioned investing!DV: How much is your ownjudgment a factor in your trading?
Holy Grail PatternBuy rules (sells are reversed)1. The 14-period ADX must initially be greater than 30 and rising. Thisis the value to the right of TradingExperts ADX/R indicator.2. Look for a retracement in price to the 20 period exponential movingaverage. This will usually be accompanied by a turndown in theADX.
LBR: I have found that I dobetter using discretion as opposed to3. When the price touches the 20 period moving average, put a buytrading a system. There are a fewstop above the high of the previous bar.select systems that I trade becausethey force me to place a trade that I4. Once filled, enter a protective sell stop at the newly formed swingmight otherwise feel far too uncomlow. Trail stops as profits grow.fortable with using my own discretion. These systems serve as theThey might examine what theytrader has losing steaks. How do youtrigger. Many of the patterns disperceivetobefundamentaldataandtreat these losing streaks and do you evercussed in Street Smarts actually have athenmakeevaluationjudgments.Forget the urge to change your strategymechanical entry or trigger to make itwhen they occur?easier for people to trade. Thesystem keeps them from failing toLBR: Consistency speaks inpull the trigger. For example, it isreference to following a specificThe worst thing you can do in methodology. Unfortunately,helpful to have buy stops restingterms of market timing is to buy most methods dont always workin the market which will automatically take you into the trade,in the middle of a trading range. in all market conditions andbut then you must manage themarket conditions never persistEither buy new highs, or buytrade in terms of how the marketforever. What happens is that thepullbacks, but dont put yourresponds.minute you become discouragedcapital to work in the middle of with a particular methodologyDV: In Street Smarts you sayand abandon it, market condithat the single most important secreta trading range.tions change and the systemis this: Listen to the markets and dobegins to work again. You endnot impose your will upon them.up exiting every methodology atCan you expand on this?example, they may think the marketits low draw down on its equity curveLBR: It simply means not lettingis too high so they go short. On theso you are always one step out ofyour positions speak for you. A lot of other side of every trade is somebodysync. If you are always switchingpeople get into scenario building.who is equally convinced that it isstrategies, you are probably justgoing in the opposite direction. Wholeaving the one that is ready to kickin.PLEASE SEND CORRESPONDENCE TO: is right? The market is. The marketis going to do what it wants regardAs for losing streaks  a losingless of your convictions.Opening Bell Monthlystreak for most professionals is moreG.R. Barbor, EditorIf you pay attention to what thethan likely to be characterized by aP.O. Box 7530market is saying rather than forcingIncline Village, NV 89452flat period instead of huge losses.your will on the market, it will giveThere is absolutely no reason in thisAIQ Opening Bell Monthly does notyou subtle clues as to what it is goingbusiness for small losses to becomeintend to make trading recommendations,to do. For example, moves often start big losses. Unless you are following anor do we publish, keep or claim any trackin either direction with an impulserecords. It is designed as a serious tool totrend following system which getsand a thrust. It may be a rangeaid investors in their trading decisionswhipsawed during consolidations,through the use of AIQ software and anexpansion, an increase in standardlosing streaks come from sloppyincreased familiarity with technicaldeviation, a breakaway gap, or even a habits, trader error, or stubbornness.indicators and trading strategies. AIQfailure to make a lower low. There isreserves the right to use or edit submisI have never been tempted toalways a message but you are notsions.changemy style because I feel thatgoing to pick it up unless you have anmypatternsand strategies dontFor subscription information, phoneopen mind.1-800-332-2999 or 1-702-831-2999.change. The market is very basic DV: You say consistency is ayou buy pullbacks in a trending issue,© 1993-1997, AIQ Systemsnecessity for successful trading, but every you buy divergences, or you buy
2
AUGUST 1997
AIQ Opening BellINTERVIEW continued . . .breakouts from congestion areas.Likewise on the sell side. Thesethings dont change over time.
Figure 1
DV: How important is markettiming in your analysis?LBR: Very important. It helpsdetermine how much you want torisk and it helps determine the degreeof follow through. If your timing issuch that you are hopping on boardright when there is an increase inmomentum, then you have greatlyincreased the probability of followthrough in your direction. Likewise,if you are not in a period of highmomentum, then you may want tobuy on a pullback or at the lower endof a trading range to minimize yourrisk. The worst thing you can do interms of market timing is to buy inthe middle of a trading range. Eitherbuy new highs, or buy pullbacks, butdont put your capital to work in themiddle of a trading range.DV: AIQ users are primarily equitytraders rather than futures or commodities traders. Do you trade stocks or areyou primarily a futures trader?LBR: I trade stocks as well.People dont appreciate that smallinvestors have much more flexibility,especially in stocks, than institutional
investors. Small investors dont haveto move as much size, they donthave to justify their decision makingprocess to stockholders, and theydont have to show that they are 95%invested long at the end of thequarter. Institutional investorsalways have a different type ofpsychological gun to their heads.
Figure 2
DV: One of the easiest patterns tofind that is listed in your book is the HolyGrail (preceding page). Can you explainthis pattern and give us a few examples?LBR: This pattern uses WellesWilders ADX (Average DirectionalIndex), which measures the strengthof a trend over a period of time. Thestronger the trend, the higher theADX reading. This pattern takesadvantage of the fact that the oddsare very high that when a securitymakes a new momentum high andpulls back, it will retest its recenthigh. Therefore, any pullback from anew momentum high can be bought.Most people hesitate to buy pullbacksbecause a top may be in place. Withthis pattern, the odds that a top is inplace is probably only 5% to 10%. Ifyou look at stocks that have participated in the markets advance in thelast two or three months, youll seethe majority of them have had HolyGrail patterns.The 20 period exponentialmoving average often acts as supportfor stocks. Recently, Chevron (CHV)provided a good example. With theHoly Grail pattern, we want the stockto fall back to a 20 day movingInterview continued on page 4
AUGUST 1997
3
AIQ Opening BellINTERVIEW continued . . .average after its ADX indicator hasmoved to a value above 30.
DV: TradingExpert has a Price Gapreport which makes it easier to spot theThree-Day Unfilled Gap Reversal pattern(see description next page). Can you give
gap
When you research this pattern,you should also look at cases when itfails. A good example is Eaton Corp.(ETN). The stock had a huge thrustup and pulled back nicely to the 20period moving average. The ADXindicator was quite high. But in thelast five days (July 1 to July 8) therewas little movement in the stock (seeFigure 2). You havent lost anymoney but you havent made anymoney either. Today (July 8), thestock was down when the Dow madea new high. This is a case wherethere is no reason to be in this trade.Dont give it the benefit of the doubt.
ï
A good example of a Holy Grailbuy is Cincinnati Milacron (CMZ) onJune 23 and 24 (see Figure 1). CMZtouched the moving average and thencontinued to rally to a new high.Another example can be seen inAmerican Express (AXP). AXPtouched the moving average on July1, rose the next day, and then jumped7 points the following day.
Figure 3
us some examples of this pattern?LBR: Gaps are a classic tool intechnical analysis. There are differenttypes of gaps such as breakaway gapsor exhaustion gaps which come at theextremes. The Three Day UnfilledGap Reversal signals periods wherethe security has exhausted itself and areversal is close at hand. A lot of
Figure 4
stocks had beautiful buy setups inApril of this year. If you look atChrysler (C) you will see a perfectexample (Figure 3). On April 11,Chrysler gapped down (see arrow).Two trading days later, the April 11high point was surpassed. Otherexamples can be seen in Sears (S) andGeneral Motors (GM). These areclassic examples of trades that wouldstill be winners as the market hasnever looked back.A more recent example isWorldcom Inc. (WCOM), whichgapped down on June 6 with the buysignal coming on June 10. In thiscase, the gap might have been causedby news, creating a false shake-out.On the sell side, Amoco Corp. (AN)just filled a gap yesterday (July 7).DV: Another strategy that onlyuses price analysis is a pattern you callthe Wolfe Wave (see description nextpage). Can you give us some examples?LBR: Ill give you several examples because once you study thischart pattern you will automaticallyget a magically trained eye and willbe able to immediately recognize thepattern. Keep in mind that when youlook at this pattern you are seeingaccumulation or distribution. In the
4
AUGUST 1997
AIQ Opening BellINTERVIEW continued . . .last two months, weve been in a verystrong upward move. There aremany examples of Wolfe Wave buysin April and May and now fewer areappearing as the market moveshigher.
Figure 5
A good example is ComputerSciences Corp (CSC) during April(see Figure 4). Wave 1 was on April2, wave 2 on April 8, wave 3 on April22, and wave 4 on April 24. The buycame on April 28. Interestingly, therewas also a Wolfe Wave buy on July 1but that is more readily seen usinghourly data. Another example isBristol Myers Squibb (BMY) whichgave a buy on April 14 (see Figure 5).Yet another example is Disney (DIS)which also gave a buy on April 14.Since the overall market is so strong,the stocks have rallied past their
Three-Day Unfilled Gap Reversals1. Today the security gaps lower and does not fill the gap.2. Over the next three trading sessions, have in place a buy stop onetick above the high of the gap-down day.3. If filled, place a protective sell stop at the low of the gap-down day.4. Protect any accrued profits with a trailing stop.5. If not filled after three trading sessions, cancel the initial buy stop.
Wolfe Wave Construction1. Wave 2 is the top of a bar chart.2. Wave 3 is the bottom of the first decline after wave 2.3. Wave 1 is then the bottom prior to the wave 2 top. Point 3 must belower than point 1.4. Wave 4 is the top of wave 3. Wave 4 should be higher than the wave1 bottom.5. A trend line is drawn from point 1 to point 3. The extension of thisline projects to the anticipated reversal point which we call wave 5.This is the entry point for a ride to the target line (1 to 4).6. The price objective of this pattern is from a trendline drawn frompoints 1 to 4. The initial stop is placed just beneath the newly formedreversal at point 5. It can then be quickly moved to break-even.Note: You cannot begin looking for the Wolfe Wave until points 1, 2, 3,and 4 have been formed.
target prices.You have to train your eye for sellsignals as well. An example on thesell side is Ralston Purina (RAL). InFigure 6 (next page), the pattern onthe sell side is simply a reverse of thebuy side. RAL gave a sell on June 13and the stock fell right to its target.Another example on the sell sideis International Game Technology(IGT), which gave a sell on June 20.Digital Equipment (DEC) also gave asell on June 20 but has since movedsideways. Here is a case where youhave to manage your trade. The besttrades work very well and there is nodoubt that they are working. Whenthe security starts to chop back andforth, like DEC, then you have tolisten to the market rather thanimpose your will upon it. DEC issaying it does not want to go down.These patterns also work withweekly data. Kroger (KR) is anexample of a weekly chart that lookslike it is forming a top.DV: Lets talk a little aboutstop strategies. Obviously you keep thempretty tight.LBR: Different patterns haveInterview continued on page 6
AUGUST 1997
5
AIQ Opening BellINTERVIEW continued . . .different stops. Most often, Ill getout if the market fails to do what Ithought it would do. The bestpatterns give you instant feedback.How tight a stop you use depends onhow aggressive or conservative youare. If a trade feels uncomfortable, Isometimes find it easiest to place anorder to exit the market on close.This takes away the psychologicalanguish of trying to time the exit.
Figure 6
DV: It is nice to be able to sleep atnight! Thanks for the interview and welook forward to seeing you at our AIQseminar in September. nStreet Smarts - High ProbabilityShort Term Trading Strategies can bepurchased by calling OceanviewFinancial Research at 800-797-2584.AIQ users will receive a 20% discountoff the book's regular price of $175.
STOCK DATA MAINTENANCEThe following table shows past and future stock splits and large dividends:Stock
Ticker
Split/Div. Approx. Date
Stock
Ticker
Split/Div. Approx. Date
Torchmark Corp.
TMK
2:1
08/04/97
Benchmark Elect.
BHE
2:1
08/18/97
Wesbanco Inc.
WSBC
3:2
08/04/97
Encore Wire Corp.
WIRE
3:2
08/19/97
Roper Inds.
ROP
2:1
08/04/97
Micrel Inc.
MCRL
2:1
08/20/97
Solectron Corp.
SLR
2:1
08/05/97
Tekelec
TKLC
2:1
08/25/97
Walgreen Co.
WAG
2:1
08/11/97
Plexus Corp.
PLXS
2:1
08/26/97
Dekalb Genetic
DKB
2:1
08/11/97
Level One Comm.
LEVL
3:2
08/27/97
Diamond Offshore Drill. DO
2:1
08/15/97
AES Corp.
AES
2:1
08/29/97
Oracle Systems
ORCL
3:2
08/18/97
Keane Inc.
KEA
2:1
09/01/97
Supreme Intl
SUPI
3:2
08/18/97
Yahoo! Inc.
YHOO
3:2
09/01/97
Trading Suspended:
Verifone Inc. (VFI), Oshkosh BGosh Inc. (GOSHB), Great Western Finl (GWF), Portland General (PGN),Fibreboard Corp (FBD), Tambrands (TMB)Name/Ticker Changes:Pride Petroleum Services (PRDE) to Pride Intl (PRDE), Fed Home Loan Mtg Corp (FRE) to Freddie Mac (FRE)CWM Mortgage Holdings (CWM) to INMC Mortgage Holdings (NDE), Proffitts Inc. (PRST) to Proffitts Inc. (PFT)Ambac Inc. (ABK) to Ambac Financial Group Inc. (ABK), Winton Finl (WFCO) to Winton Finl (WFI)Stryker Corp (STRY) to Stryker Corp (SYK), Glendale Federal Bank (GLN) to Golden State Bancorp (GSB)
6
AUGUST 1997
AIQ Opening BellUSING AIQ REPORTS
REDUCING THE RISK OF RELATIVE STRENGTHINVESTINGtional Movement Index and theBy David Vomund
I
DAVID VOMUND
n this years April and July issuesof the Opening Bell, we reportedon several studies that wereperformed using the RelativeStrength report. These studiesrevealed that results of buying intostrength are impressive, but also therisks are high. As relative strengthinvestors know, a small correction inthe Dow can turn into a bear marketfor high relative strength stocks,especially for small company stocks.What goes up fast can come downfaster. In this final article on relativestrength investing, well look at waysto reduce the risk of high relativestrength investing.
Using Market TimingThe most obvious way to reducerisk is to not be invested duringcorrections. Incorporating AIQs
market timing model, as reported inthe April 1997 Opening Bell, accomplishes this.A creative technique discussed byIan Woodward at last years LakeTahoe seminar is to create an index ofhigh relative strength stocks and thenuse the index to help identify whenrelative strength investing is turningout of favor. The theory is that whenthe market leaders turn sour, themarket will soon follow.As an example, I ran the RelativeStrength-Strong report on April 15,the day of the last AIQ buy signal. Agroup was created using the top tenstocks on the report (see Figure 7).When this group begins to breakdown, market risk is high andrelative strength investing is out offavor. Depending on your timeframe, a breakdown can be as quickas a drop below the 28 day movingaverage. A less sensitive techniquewould be to require both the Direc-
Figure 7
Positive Volume Index to turnnegative (DMI below zero and P-Volbelow its signal line).
Incorporating Fundamental AnalysisA second method of reducing therisk of relative strength investing is toincorporate some form of fundamental analysis. A few of these techniques were discussed in our interview with James OShaughnessy,which appeared in the May 1997Opening Bell. To lower risk, he willlimit his relative strength screeningsto stocks with a PE ratio of less than40. A further screening discussedwas to only buy high relative strengthstocks with a price to sales ratiobelow 1.5.By combining fundamentalanalysis with relative strengthinvesting, the war story stocks likeMicron Technology or Iomega wontbe purchased at the top.Additional Screening ReportsA final method of lowering therisk of relative strength investing is torun an additional screening report onthe high relative strength stocks.Since volume is not a factor in relativestrength analysis, it makes sense torun a report like Price VolumeDivergence or Persistence of MoneyFlow on the stocks that appear nearthe top of the Relative Strengthreport.Instead of combining a volumereport with the Relative StrengthStrong report, weve chosen to usethe Point & Figure Breakout report.The Point & Figure Breakout reportlists stocks that have undergone asideways consolidation followed by abreak above the consolidation.The stocks that appear near thetop of the Relative Strength-Strongreport are usually risky because theyUsing AIQ Reports continued on page 8
AUGUST 1997
7
AIQ Opening BellUSING AIQ REPORTS continued . . .have been so strong that there are noclear support levels near the theircurrent prices. By requiring that thehigh relative strength stocks alsoappear on the Point & FigureBreakout report, we get a list ofstrong stocks that have recentlybroken above a consolidation pattern.In order to screen the stocksusing this technique, well first runthe Relative Strength-Strong reportand create a list of the stocks thatappear near the top of the report.Well then run the Point & FigureBreakout report on this newly createdlist. The result will be high relativestrength stocks with recent Point &Figure breakouts.As an example, we ran theRelative Strength-Strong report onthe S&P 500 stocks on July 1. Wewanted the stocks that were on thefirst page of the Long Term section ofthis report to be eligible for purchase.In order to create a list of the stocksthat appear on the first page of thereport, we designated the print rangeof the Relative Strength-Strong reportto 2 pages (one page for the ShortTerm section, one page for the LongTerm section). To change the printsetting, go to the Reports applicationand choose the Settings command onthe menu bar. Go to Report Criteria,then Daily Stock Criteria. Highlightthe Relative Strength-Strong reportand indicate 2 pages in the PrintRange setting, which is found in thelower right corner.
After thereport is generated, single clickon a ticker in theLong Termsection and thenchoose the BuildList icon on thetoolbar. Thiswill create a listof the top stocksfrom the LongTerm section ofthe RelativeStrength report.We nextwant to run thePoint & FigureBreakout reporton this newly created list. Onceagain, in Reports go to Settings, thenGlobal Criteria, and Daily GlobalCriteria. Next to the Stock choice,select the newly created list (thedefault name is reports). Then runthe Point & Figure Breakout report onthis newly created list.In our July 1 example, only onestock, Intl Business Machines (IBM),met both criteria  a strong stockthat recently broke above a consolidation pattern. Its relative strength ishigh as it has increased about 80% inthe last year. The report places moreweighting to the price activity in thelast three months, a time periodwhere IBM rose about 35%. Although IBMs relative strength washigh, it did just break above a short
MARKET REVIEW
T
he market continued its advance in July with the S&P 500,Russell 2000, and Nasdaq at alltime highs at month end.July was a month in whichmarket timing signals differeddepending on your source ofmarket data. Using Dial/Data orWSJ data, the market timing modelfully participated in the advance asno sell signals were given. Withthis data, the model remained onthe March 21 buy signal and a
8
continuation buy signal wasregistered on July 30, the sixthstraight upside signal. However,with Telescan or Interactive Data,sell signals were registered near theend of July. Signals sometimesdiffer with Telescan because theyuse actual high and low Dow pricesinstead of theoretical values.Interactive Data's signals are almostalways in line with Dial/Data. Thesell seen near the end of July is arare exception. n--D.V.
Figure 8
term consolidation pattern. This ismost easily seen on IBMs Point &Figure chart (see Figure 8).Notice that in May and June, IBMrallied to about $92 but in each casesellers came in and the stock fell (Xsrepresent rallies, Os representdeclines). It wasnt until the lastcolumn of Xs that IBM was able tobreak above the $92 level. This level,which acted as resistance, nowbecomes support (as does the lowpoint in the previous column of Os).We can see that this two-part screening process will find stocks that haveperformed well but have recentlytaken a breather.
In ConclusionIn our series of articles on relativestrength investing, weve seen somefantastic results of using the RelativeStrength-Strong report. If performance was based just on returns,more people would be buying intostrength. However, risk is an important part of overall performance andthe risk of relative strength investingis high.Weve seen that there are ways tolower risk such as incorporatingmarket timing, performing fundamental analysis, or running additional screening techniques on thehigh relative strength stocks. n
AUGUST 1997
<|end|>