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Post by TradingForGod on Aug 21, 2004 11:38:02 GMT -5
Arguably the biggest questions facing the economy right now are how high energy prices will go, and how chronically high prices will affect the rate of economic expansion. I am no economist. I am just a technical trader. So I will leave it to the deep thinkers to wrestle with the macro-economic uncertainties of the relationship between oil prices and economic growth. But I will try to wrestle, and wrestle is the word, with the question of how high energy prices might go. But first a little history. From its low just over $10 in late 1998, West Texas Intermediate (WTI), the US benchmark crude type, has almost quintupled in value. There aren’t a lot of things that increase in value five-fold in less than six years. But that’s sometimes the nature of commodities markets. Demand goes up or supply goes down or both, and price has to compensate. In the 1973 Arab Oil Embargo, crude went up in % terms much faster than today. In the lead up to the Gulf War, prices more than doubled in just three months. And on the downside, the Saudi netback pricing policy in the mid-80s cut oil prices by 2/3 in four months. What makes this rally unique is that there has been no real “supply shock” to cause it. Certainly Iraq is producing well below its maximum capacity, but that’s no different than when crude was trading $20/bbl. But something is sure different. For the entire decade of the 1990s, crude oil traded at an average price of about $19/bbl. Yes, there were spikes like the Gulf War and big dips like the 1998 price collapse (remember sub-$1 gasoline?). But if you looked at a VERY long term moving average, it was pretty much flat at about $19. Prices spent as much time above the average as below it. But since the turn of the century (isn’t it hard to think of that as a recent event…I still think of that as from the 1800s to the 1900s…I guess I really am old), there has been a radical shift. World energy prices have been in an unprecedented uptrend. The long-term MA that was flat for a decade is pointed sharply higher now. Even in the absence of a “see change event” (the Iraq War does NOT count), prices have been in an unremitting, though choppy, uptrend for six years. This rally seems to have been caused by the growing realization that there has been a fundamental tightening of the overall supply/demand balance for energy. The weekly chart below shows just the most recent leg of this uptrend. Going back to late 2001, crude prices fell to $17 from a high of almost $38 just a year earlier. And that peak was a low of $10 just two years before that, so the seeds of this high volatility were planted years ago. Prices rallied to $40/bbl in early 2003, with a $15 increase coming in the three months leading up to the Iraq War. When it became apparent that the Iraqi oil fields were safe, prices collapsed dramatically, at one point falling $10 in a week. Now THAT’S volatility. After about six months of choppy, sideways price action, crude started to really rally in Sep’03. It was at about $27 then, and within nine months it was $15 higher at over $42, what was then a new all-time high. A number of technical analysts, myself included, called for a reversal lower at that point because there was a severe momentum divergence on the daily chart and the daily MAs had flattened out. Plus, the speculative “funds” were very long energy then and had spent almost a month with no net appreciation. They took the opportunity to take profits and prices fell back almost $7 in a little over a month. You probably remember gas prices falling a little right before the 4th of July. From there, prices have rallied at ever increasing speed. This week, crude for September delivery expired at almost $48 after briefly trading up to 49.40 early on Friday. The chart below shows that this is right at the top of a parallel channel off the ’01 and ’03 lows. In addition, it is also right at the “normal” swing target from the big rally last year (dashed blue line). Crude oil has achieved pretty much every conceivable target, and then some. The rally over the last two months has taken on the characteristics of a “blow off top” with panic buying evident. These types of rallies almost always end with an explosive crescendo and are followed by an equally implosive collapse. So am I saying the top is in? Not at all. It MIGHT be. It certainly COULD be. But trying to call the top of a runaway market is one of the toughest things a technical trader can try to do. Right now all I can do is point out things to look to give clues the reversal is upon is. The first will be a violation of SOME moving average support. You can see from the chart above that prices are well above even the fastest MA. This is true of the daily chart as well. The 7-week MA (orange line) should be at about 44.60 next week. A weekly close below there would be the first in two months and could trigger a big sell off. Note how in early 2003 a close below this MA immediately preceded a huge collapse in crude prices. I am really going to be watching for this. Another thing I am watching is the net long position of the “spec” traders. The Commodity Futures Trading Commission (CFTC) puts out a weekly Commitment of Traders report that shows long and short positions divided by Commercial and Non-Commercial traders. While these categories are very broad, in general the Non-Commercials are thought to be more speculative traders rather than companies hedging a physical position to satisfy a business need. For instance, an oil company selling crude to lock in a profit on their oil production would be a hedger, a “Commercial” trader. A hedge fund who is long crude oil just because they think it is bullish would be a speculative trader, a “Non-Commercial.” Anyway, back in June before the $7 sell off, the specs were very long energy futures. Right now, with oil prices $7 higher that back then they are only about ½ as long. It seems that the specs are using this most recent rally to reduce there long exposure. Back in 1998 as oil prices pushed down to $10 the same thing happened. The specs had been very short, but as prices made their last dip they got out of most of their positions. This behavior could be a sign of an impending reversal too. Also, oil issues like Exxon/Mobil, Chevron/Texaco, etc. are all well off their recent highs even as crude prices have continued to climb. Is the market smart enough to begin discounting future oil company earnings because it believes oil prices are about to head lower? This is something to watch as well. But frankly, unless there is some “event” like peace breaking out in the Middle East, I think we are at least a week away from any kind of major reversal. The moving average structure is still too bullish and the ADX trend indicator is too strong. We may not go much higher from here (though we might), but I think prices have to spend a little more time in this general area before they have a chance to stage a meaningful reversal. The trend is your friend, and right now the trend is decidedly up. The next time we talk about energy, I will look at a much shorter term view as we try to hone in on a reversal set-up. Blessings to you all, TFG
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Post by TradingForGod on Aug 20, 2004 19:28:08 GMT -5
Last week's low on the Nasdaq was 1751. That's the number to beat to the downside. Hopefully it won't happen, but watch for it just the same.
May we all be blessed to be a blessing!
TFG
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Post by TradingForGod on Aug 20, 2004 19:28:08 GMT -5
Last week's low on the Nasdaq was 1751. That's the number to beat to the downside. Hopefully it won't happen, but watch for it just the same.
May we all be blessed to be a blessing!
TFG
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Post by TradingForGod on Aug 19, 2004 8:32:47 GMT -5
Hi everyone, Today begins our ongoing discussion of real markets in semi-real time. Again, let me state that the analysis and opinions expressed here are my own. They are provided for your information only. Trade wisely. We’re going to look at the Nasdaq index today. I am going to reference most, if not all, of the indicators and patterns discussed in the “basics” series. If something doesn’t make sense here, please go back and read those topics. If you still have a question, please feel free to ask. I have shown the weekly chart below. It’s quite “busy” but it contains a lot of information. I’ll try to go over it thoroughly. The Nasdaq bottomed in late 2002 and then rallied straight up thought the end of January. This rally slightly exceeded the minor bounce high back in Jan’02, and this caused some people to think that the market was really getting ready for a big push higher. However, each successive high came with a bigger and bigger momentum divergence, which as we discussed yesterday warned of an impending reversal. By late Jan the market had just run out of steam. Notice how the rally up from the lows fit the Elliott 5-wave pattern for an impulsive move. I have highlighted the swings in yellow. Since the peak, the Nasdaq has fallen in an ABC corrective pattern, also highlighted in yellow. The “B” wave was very choppy and irregular, which isn’t uncommon. The A and C waves were almost exactly equal in length. The low last week touched support at the uptrend line off the ’02 and ’03 lows and hit the 38% (Fibonacci) retracement of the whole rally. Those important supports were within just a few points of each other. It’s not surprising that the Nasdaq held there and reversed. Shorts from above and dip buyers all stepped in at the same time. The big question now is…was that it for the sell-off? Unfortunately, it’s too early to say for sure. All we can say now is that the sell off stopped where it needed to in order to prevent a much bigger drop. Here are some things to consider. First, the Nasdaq has only fallen to the MINIMUM retracement level normally seen in a correction, 38%. It is more normal to see corrections of 50% of even 62% unless the market is really bullish. For the Nasdaq those levels are 1630 and 1507 respectively. Weekly momentum is still very negative, and there is no sign of a momentum divergence on the downside yet. Markets can reverse without that though. MA structure is very negative as well with the 7-week MA (orange line) below the 20-week MA (yellow line) which is below the 40-week MA (blue line). The ADX trend indicator is rising and is above 20 right now indicating that a weekly DOWN trend is trying to get organized. About the only really positive thing here is that the weekly stochastics are trying to turn up from very oversold levels. That should be good for at least a decent corrective bounce, even if prices ultimately fall again. Putting it all together, it looks to me like the Nasdaq is getting ready for AT LEAST a bounce to 1905, the 38% (Fibonacci) retracement of the sell off from late January. The rally could wind up being much larger than that. That’s the minimum expectation. The 62% retracement of the sell-off is up at 1999. A close above there more than likely sets the stage for a much larger, longer term rally that could ultimately drive the Nasdaq a 1000 points higher, similar to the rally that started in 2002. How will I know this point-of –view is wrong? If the Nasdaq closes below last week's low, it STRONGLY suggests that the sell-off is going to push another 120-240 points lower. That sounds terrible, I know, but remember that would only make this a “normal” pull-back from the highs. That said, you probably wouldn’t want to be fully invested if it happens. How the market performs on this push higher could well determine the course of price activity for months to come. Watch the key numbers shown above for clues. Next time, we’ll look at the crude oil market since it’s been such a big concern to everyone with respect to the impact on the economy. God bless. TFG
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Post by TradingForGod on Aug 19, 2004 8:32:47 GMT -5
Hi everyone, Today begins our ongoing discussion of real markets in semi-real time. Again, let me state that the analysis and opinions expressed here are my own. They are provided for your information only. Trade wisely. We’re going to look at the Nasdaq index today. I am going to reference most, if not all, of the indicators and patterns discussed in the “basics” series. If something doesn’t make sense here, please go back and read those topics. If you still have a question, please feel free to ask. I have shown the weekly chart below. It’s quite “busy” but it contains a lot of information. I’ll try to go over it thoroughly. The Nasdaq bottomed in late 2002 and then rallied straight up thought the end of January. This rally slightly exceeded the minor bounce high back in Jan’02, and this caused some people to think that the market was really getting ready for a big push higher. However, each successive high came with a bigger and bigger momentum divergence, which as we discussed yesterday warned of an impending reversal. By late Jan the market had just run out of steam. Notice how the rally up from the lows fit the Elliott 5-wave pattern for an impulsive move. I have highlighted the swings in yellow. Since the peak, the Nasdaq has fallen in an ABC corrective pattern, also highlighted in yellow. The “B” wave was very choppy and irregular, which isn’t uncommon. The A and C waves were almost exactly equal in length. The low last week touched support at the uptrend line off the ’02 and ’03 lows and hit the 38% (Fibonacci) retracement of the whole rally. Those important supports were within just a few points of each other. It’s not surprising that the Nasdaq held there and reversed. Shorts from above and dip buyers all stepped in at the same time. The big question now is…was that it for the sell-off? Unfortunately, it’s too early to say for sure. All we can say now is that the sell off stopped where it needed to in order to prevent a much bigger drop. Here are some things to consider. First, the Nasdaq has only fallen to the MINIMUM retracement level normally seen in a correction, 38%. It is more normal to see corrections of 50% of even 62% unless the market is really bullish. For the Nasdaq those levels are 1630 and 1507 respectively. Weekly momentum is still very negative, and there is no sign of a momentum divergence on the downside yet. Markets can reverse without that though. MA structure is very negative as well with the 7-week MA (orange line) below the 20-week MA (yellow line) which is below the 40-week MA (blue line). The ADX trend indicator is rising and is above 20 right now indicating that a weekly DOWN trend is trying to get organized. About the only really positive thing here is that the weekly stochastics are trying to turn up from very oversold levels. That should be good for at least a decent corrective bounce, even if prices ultimately fall again. Putting it all together, it looks to me like the Nasdaq is getting ready for AT LEAST a bounce to 1905, the 38% (Fibonacci) retracement of the sell off from late January. The rally could wind up being much larger than that. That’s the minimum expectation. The 62% retracement of the sell-off is up at 1999. A close above there more than likely sets the stage for a much larger, longer term rally that could ultimately drive the Nasdaq a 1000 points higher, similar to the rally that started in 2002. How will I know this point-of –view is wrong? If the Nasdaq closes below last week's low, it STRONGLY suggests that the sell-off is going to push another 120-240 points lower. That sounds terrible, I know, but remember that would only make this a “normal” pull-back from the highs. That said, you probably wouldn’t want to be fully invested if it happens. How the market performs on this push higher could well determine the course of price activity for months to come. Watch the key numbers shown above for clues. Next time, we’ll look at the crude oil market since it’s been such a big concern to everyone with respect to the impact on the economy. God bless. TFG
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Post by TradingForGod on Aug 18, 2004 10:23:13 GMT -5
This is the last in our series on the fundamentals of technical analysis. We have previously discussed the early development of the “art” (candlestick charting), pattern recognition (Elliott Wave), the mystery of Fibonacci numbers, determining trending and non-trending markets and a few ideas for how to trade them, and how to identify and trading congesting markets. Today we’ll focus on a couple of momentum indicators that help to refine entry and exit points. I use the Moving Average Convergence/Divergence (MACD) and the Slow Stochastics (SSto). The MACD indicator, developed by Gerald Appel, measures the relative strength or weakness of a market by comparing the difference between two moving averages of different lengths with the recent average of those differences. Most software packages subtract the 12 period MA from the 26 period MA and then compare that value to the average of the last 9 observations. This “average of the averages” is referred to as the Signal Line. Let’s assume the market is bullish. The theory is that as prices rise the shorter term MA will rise faster than the longer term MA. In other words the MAs will “diverge”. As this difference gets larger it moves away from the average of the differences too. It’s sort of like watching your cars speedometer. If you are driving at a constant rate of speed the car is moving, but the speedometer stays in one place. But if you press down on the accelerator, not only are you moving but you begin moving faster. The MACD works the same way. Theoretically, if the market is rising at a constant rate over a long period of time, the distance between the MAs will stay constant and the average of the differences will be constant too. So the MACD would read zero even though the market is still moving high. It is just not ACCELERATING higher. I hope that makes sense. When prices begin to stall out, the shorter term MA begins to flatten out faster than the longer term MA does, so they begin to “converge”. As this happens the difference between the current difference and the Signal Line starts to fall. Basically the market is decelerating, kind of like the way a car does as you move toward a traffic light. You are still moving forward (prices still rising), but you have the foot on the brakes. In the literature about this indicator it talks about buying the market when the current difference crosses the Signal Line and selling when it crosses below that. Personally I have never found that to work. Unless the market is in a MEGA trend, you end up buying too late in the trend and selling out well after the trend has peaked. I have come to use the MACD primarily as an early warning indicator to alert me to possible reversals. Let’s think about the car example again. Have you ever seen a car go from 55 MPH into reverse? No, because it would tear the transmission apart. The car has to stop before it can reverse. And is has to slow down (decelerate) before it can stop. SO, I look for times when prices are still rallying but the MACD is falling to alert me to potential trend reversals. These are called “momentum divergences”, and as time goes on you will see me mention them a lot. They can be extremely powerful reversal indicators that can save you lots of money by getting you out of trades much closer to the top. However, the fact that prices are making new highs on lower momentum doesn’t necessarily mean the market is about to reverse. It just means it could reverse. It’s like a tornado watch alert. It doesn’t mean that a tornado is out there, just that conditions are favorable for one. The second indicator I use as a momentum oscillator is the SSto. This indicator, developed by George Lane, measures the relative strength or weakness of the market in a much different way. The math is pretty complicated, but basically it compares the difference between the closing price and the low of a bar with the difference between the high and low of the bar. In theory, when the market is moving up, the close will generally be high in the range of trading activity of the day. The market generally finishes near the high. In downtrends, the reverse is true. The SSto makes use of this fact and calculates a running average of these differences. The higher recent closes are relative to the recent ranges, the higher the SSto indicator lines. There are two indicator lines called %K and %D. The %D line is just a moving average of the %K line. They both range between 0 and 100. The conventional trading strategy for SSto is to sell the market when it gets “overbought” (lines above 80) and buy the market when it gets “oversold” (lines below 20). This strategy DOES NOT WORK. Every study I have seen for stochastics alone show that this is a loser. The main reason is that when the market is trending the SSto can be overbought or oversold for a long time. You can get run over trying to catch the turn. I use stochastics as a confirming indicator for trades I am otherwise considering. For instance, let’s say I want to buy a dip after a big rally. I will wait for the stochastics to begin to turn higher from the “oversold” area to take the trade. When combined with other indicators, SSto can really help in timing trades more effectively. In addition, like the MACD, it can also be used to look for momentum divergences to signal trend reversals. The MSFT chart below shows the MACD (yellow histogram in the middle) and the SSto (at the bottom). You can clearly see how they oscillate with the ups and downs of price. The main thing I want to point out is the huge momentum divergence around the mid-July high. As I said earlier, all that traders would have been able to see at that time was a potential reversal warning. But as it turned out, in this particular case there really was a tornado outside. So that’s it. That’s most of what I use in my technical assessments. I do some additional pattern recognition work (bull flags, pennants, etc) and some trailing stop criteria, but we will talk about that as we go along. Starting tomorrow, I will be doing periodic technical updates about the stock market and any other things that look interesting. I am open to your thoughts and suggestions about topics to pursue. I look forward to hearing from you. Read Eccl. 2:26. May we all be men and women who please God. Blessings, TFG
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Post by TradingForGod on Aug 18, 2004 10:23:13 GMT -5
This is the last in our series on the fundamentals of technical analysis. We have previously discussed the early development of the “art” (candlestick charting), pattern recognition (Elliott Wave), the mystery of Fibonacci numbers, determining trending and non-trending markets and a few ideas for how to trade them, and how to identify and trading congesting markets. Today we’ll focus on a couple of momentum indicators that help to refine entry and exit points. I use the Moving Average Convergence/Divergence (MACD) and the Slow Stochastics (SSto). The MACD indicator, developed by Gerald Appel, measures the relative strength or weakness of a market by comparing the difference between two moving averages of different lengths with the recent average of those differences. Most software packages subtract the 12 period MA from the 26 period MA and then compare that value to the average of the last 9 observations. This “average of the averages” is referred to as the Signal Line. Let’s assume the market is bullish. The theory is that as prices rise the shorter term MA will rise faster than the longer term MA. In other words the MAs will “diverge”. As this difference gets larger it moves away from the average of the differences too. It’s sort of like watching your cars speedometer. If you are driving at a constant rate of speed the car is moving, but the speedometer stays in one place. But if you press down on the accelerator, not only are you moving but you begin moving faster. The MACD works the same way. Theoretically, if the market is rising at a constant rate over a long period of time, the distance between the MAs will stay constant and the average of the differences will be constant too. So the MACD would read zero even though the market is still moving high. It is just not ACCELERATING higher. I hope that makes sense. When prices begin to stall out, the shorter term MA begins to flatten out faster than the longer term MA does, so they begin to “converge”. As this happens the difference between the current difference and the Signal Line starts to fall. Basically the market is decelerating, kind of like the way a car does as you move toward a traffic light. You are still moving forward (prices still rising), but you have the foot on the brakes. In the literature about this indicator it talks about buying the market when the current difference crosses the Signal Line and selling when it crosses below that. Personally I have never found that to work. Unless the market is in a MEGA trend, you end up buying too late in the trend and selling out well after the trend has peaked. I have come to use the MACD primarily as an early warning indicator to alert me to possible reversals. Let’s think about the car example again. Have you ever seen a car go from 55 MPH into reverse? No, because it would tear the transmission apart. The car has to stop before it can reverse. And is has to slow down (decelerate) before it can stop. SO, I look for times when prices are still rallying but the MACD is falling to alert me to potential trend reversals. These are called “momentum divergences”, and as time goes on you will see me mention them a lot. They can be extremely powerful reversal indicators that can save you lots of money by getting you out of trades much closer to the top. However, the fact that prices are making new highs on lower momentum doesn’t necessarily mean the market is about to reverse. It just means it could reverse. It’s like a tornado watch alert. It doesn’t mean that a tornado is out there, just that conditions are favorable for one. The second indicator I use as a momentum oscillator is the SSto. This indicator, developed by George Lane, measures the relative strength or weakness of the market in a much different way. The math is pretty complicated, but basically it compares the difference between the closing price and the low of a bar with the difference between the high and low of the bar. In theory, when the market is moving up, the close will generally be high in the range of trading activity of the day. The market generally finishes near the high. In downtrends, the reverse is true. The SSto makes use of this fact and calculates a running average of these differences. The higher recent closes are relative to the recent ranges, the higher the SSto indicator lines. There are two indicator lines called %K and %D. The %D line is just a moving average of the %K line. They both range between 0 and 100. The conventional trading strategy for SSto is to sell the market when it gets “overbought” (lines above 80) and buy the market when it gets “oversold” (lines below 20). This strategy DOES NOT WORK. Every study I have seen for stochastics alone show that this is a loser. The main reason is that when the market is trending the SSto can be overbought or oversold for a long time. You can get run over trying to catch the turn. I use stochastics as a confirming indicator for trades I am otherwise considering. For instance, let’s say I want to buy a dip after a big rally. I will wait for the stochastics to begin to turn higher from the “oversold” area to take the trade. When combined with other indicators, SSto can really help in timing trades more effectively. In addition, like the MACD, it can also be used to look for momentum divergences to signal trend reversals. The MSFT chart below shows the MACD (yellow histogram in the middle) and the SSto (at the bottom). You can clearly see how they oscillate with the ups and downs of price. The main thing I want to point out is the huge momentum divergence around the mid-July high. As I said earlier, all that traders would have been able to see at that time was a potential reversal warning. But as it turned out, in this particular case there really was a tornado outside. So that’s it. That’s most of what I use in my technical assessments. I do some additional pattern recognition work (bull flags, pennants, etc) and some trailing stop criteria, but we will talk about that as we go along. Starting tomorrow, I will be doing periodic technical updates about the stock market and any other things that look interesting. I am open to your thoughts and suggestions about topics to pursue. I look forward to hearing from you. Read Eccl. 2:26. May we all be men and women who please God. Blessings, TFG
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Post by TradingForGod on Aug 17, 2004 10:02:39 GMT -5
Last time we looked at how to identify a trending market and some basic strategies for how to trade in that environment. Today we are going to look at what to do, or NOT do, when the market is in congestion. As I said last time, commodities are in congestion between 75%-80% of the time by some estimates. Even though stocks trend much more often, it’s still a good idea to know how to identify congesting markets and how to trade them effectively. To review, the way I determine whether a market is trending or not is to look at the moving averages (MAs) and the Average Directional Index (ADX). If the 3 MAs are all sloping the same way, chances are the market is trending. If the ADX is positively sloped and between 20 and 40, the market is trending and the trend is strengthening. If the ADX is positively sloped but below 20, a trend MAY be forming. If the ADX is negatively sloped from high numbers, an existing trend is in danger of reversing. And if the ADX is below 20 with a flat or negative slope there is no discernible trend. As I said last time, most traders place trades assuming the market is going to continue in the direction of the recent price action. That obviously implies that they expect the “trend” to continue. However, if the market is not trending per the criteria described above this type of strategy usually results in traders getting “chopped up”, meaning they wind up buying the highs and selling the lows multiple times as the market moves around the average more or less randomly. If this discussion does nothing other than help you stay away from markets like that, then hopefully that will help improve your trading performance and result in higher average returns. It will also keep you from tying up precious capital on stocks that are not going anywhere. However, for the bold and the brave, there are ways to trade non-trending markets that can profit from an ABSENSE of trend. To discuss that though, I first need to talk about another indicator that I use, the Bollinger Bands. Bollinger Bands get their name from John Bollinger, who popularized them. You probably have seen him on CNBC or other financial shows. You would think that because it is named after him, the Bollinger Bands must be something really special, but there is nothing exotic about this indicator. It simply uses basic statistics to graph “volatility bands” around the price action. Let me explain. In statistics there is a function called the “standard deviation”. The formula for it is not really important here, but the meaning of it is. The standard deviation (StD) measures the degree of dispersion or spread in a data set. The more spread out the data is, the higher the “volatility”, the larger the StD. If you take a set of data and perform this function on it, assuming a large enough data sample and a “normal distribution” of the data, about 2/3 of all the data will fall in a range one StD above and below the average of that data. For instance, let’s say that the average price of some stock over a period of time is $25, and the standard deviation of that stock is $3. That means that statistically 67% of the time prices will be between $22 and $28. Simple enough, right? Also, statistically about 95% of the data will be within two StD of the average. And about 99.5% of all the data will be within 3 StD of the average. The Bollinger Band (BB) indicator makes use of these statistics to establish an expected range of price action around a mean (average). The default conditions in most software are 20 periods for the data considered and two standard deviations. I have done a little optimization work that suggests a longer averaging period and tighter StD criteria are a little better, but for our purposes we are going to use the basic indicator criteria here. To calculate the BB we first calculate the 20-period MA and the StD deviation of the closes over that same time. Again, the software will do this. We just have to look at the results. The BB indicator graphs the average of the data and “boundary lines” two StD above and below the average. Based on statistics, 95% of all the data should fall within the upper and lower bands. As time passes we get a new MA with each period and the StD changes as we consider just the last 20 closes for the calculation. As the dispersion, the volatility increases and decreases over time, the width of the bands increase and decrease to compensate so that theoretically 95% of the data stays within the bands whether the volatility is high or low. So how can you use BBs to trade? Well first, and MOST importantly, all BB trades are counter to the recent price action. In other words, you sell strength and buy dips. That is the opposite of trend trading in which the entries are always in the direction of the prevailing trend. That means you only use this tactic when you are sure the market is NOT trending. The basic strategy when trading in congestion is to wait until prices are at the outer bounds of recent price action (i.e. at the BBs) and trade counter to the movement looking for prices to return to at least the mean. I generally liquidate BB trades when they reach the mean because most of the gain will have been achieved by then. If prices continue to move to the opposite BB, I may have given up some potential gain but by then I am looking to set a trade in the opposite direction anyway. That trading style is a personal preference though. Some people wait for prices to move toward the opposite band before liquidating. Let’s look at MSFT (below) to see how BBs work. I have included the ADX again so we can see when the market is trending. Starting back in March, note how MSFT rode right down the lower band as it trended strongly lower. That’s one of the biggest things to watch about trading against the BBs…if the market is trending you will get run over. Even though most of the price action was above the lower BB, it was falling so rapidly that any sale would have resulted in a loss if held more that just a few hours. So watch the ADX. If it indicates a trending market, don’t use a congestion-bases strategy (again, duh). Prices rallied up to the upper BB in early April while the downtrend was eroding. This provided an ideal short entry because it was against the upper BB while a downtrend (albeit a weakening one) was still in place. So you were trading against the short term price action, but IN the direction of the prevailing trend. This one was an almost lay down hand. Prices fell into the mean (yellow line) for a good exit opportunity. The market traded sideway with little opportunity for over a month before beginning to rally again in early June. Note that as prices rallied, the ADX turned up from very low levels. You might have tried to trade against the upper BB for a few days in mid-June, and could even have made some decent money intra-day. But the rising ADX would have negated any selling ideas by 6/14, and in fact the MA work would have suggested going long instead. Note how the BB served as resistance all the way up into late June, but the band was steeply rising. That’s another thing to watch for. BB trades almost always work better when the band you are trading against is flat. If it is sloping in the direction opposite the trade you are considering, beware. The bands gave a great buying opportunity in early July similar to the sale in early April. MSFT fell back to the lower band while the uptrend was still in place, though weakening. In fact, you would have had two or three chances to buy at the lower band (note it was flat) and sell into the MA. The explosive top on 7/21 was too volatile to trade, but the narrow range the next day MIGHT have been a short. I don’t think I would have had the guts to try it though because of the ADX was still over 20. Since then prices have dropped as MSFT has detrended. It gave a buying opportunity on 8/6, but did not rally high enough to sell out at the mean. Even though ADX is not showing a trend yet, MA structure is bearish now, so having a long on at this point is problematic. So chances are a BB trade from last week would have been scratched a couple of days ago. So there you have it. That’s the congestion trading strategy. You can also use the BBs as a profit taking point on trend-based trades. As we have pointed out, prices generally stall for some kind of pull-back end in a trending environment. But you would want to replace any positions quickly in strong trends. Only really aggressive, short-term traders should attempt this type of position management. Tomorrow, we’ll complete the series on the basics by looking at two oscillators that I use to try to figure out when the market is “overbought” and “oversold”. After that, we’ll be looking at actual markets. Yippee! May all your trades be winners. God Bless. TFG
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Post by TradingForGod on Aug 17, 2004 10:02:39 GMT -5
Last time we looked at how to identify a trending market and some basic strategies for how to trade in that environment. Today we are going to look at what to do, or NOT do, when the market is in congestion. As I said last time, commodities are in congestion between 75%-80% of the time by some estimates. Even though stocks trend much more often, it’s still a good idea to know how to identify congesting markets and how to trade them effectively. To review, the way I determine whether a market is trending or not is to look at the moving averages (MAs) and the Average Directional Index (ADX). If the 3 MAs are all sloping the same way, chances are the market is trending. If the ADX is positively sloped and between 20 and 40, the market is trending and the trend is strengthening. If the ADX is positively sloped but below 20, a trend MAY be forming. If the ADX is negatively sloped from high numbers, an existing trend is in danger of reversing. And if the ADX is below 20 with a flat or negative slope there is no discernible trend. As I said last time, most traders place trades assuming the market is going to continue in the direction of the recent price action. That obviously implies that they expect the “trend” to continue. However, if the market is not trending per the criteria described above this type of strategy usually results in traders getting “chopped up”, meaning they wind up buying the highs and selling the lows multiple times as the market moves around the average more or less randomly. If this discussion does nothing other than help you stay away from markets like that, then hopefully that will help improve your trading performance and result in higher average returns. It will also keep you from tying up precious capital on stocks that are not going anywhere. However, for the bold and the brave, there are ways to trade non-trending markets that can profit from an ABSENSE of trend. To discuss that though, I first need to talk about another indicator that I use, the Bollinger Bands. Bollinger Bands get their name from John Bollinger, who popularized them. You probably have seen him on CNBC or other financial shows. You would think that because it is named after him, the Bollinger Bands must be something really special, but there is nothing exotic about this indicator. It simply uses basic statistics to graph “volatility bands” around the price action. Let me explain. In statistics there is a function called the “standard deviation”. The formula for it is not really important here, but the meaning of it is. The standard deviation (StD) measures the degree of dispersion or spread in a data set. The more spread out the data is, the higher the “volatility”, the larger the StD. If you take a set of data and perform this function on it, assuming a large enough data sample and a “normal distribution” of the data, about 2/3 of all the data will fall in a range one StD above and below the average of that data. For instance, let’s say that the average price of some stock over a period of time is $25, and the standard deviation of that stock is $3. That means that statistically 67% of the time prices will be between $22 and $28. Simple enough, right? Also, statistically about 95% of the data will be within two StD of the average. And about 99.5% of all the data will be within 3 StD of the average. The Bollinger Band (BB) indicator makes use of these statistics to establish an expected range of price action around a mean (average). The default conditions in most software are 20 periods for the data considered and two standard deviations. I have done a little optimization work that suggests a longer averaging period and tighter StD criteria are a little better, but for our purposes we are going to use the basic indicator criteria here. To calculate the BB we first calculate the 20-period MA and the StD deviation of the closes over that same time. Again, the software will do this. We just have to look at the results. The BB indicator graphs the average of the data and “boundary lines” two StD above and below the average. Based on statistics, 95% of all the data should fall within the upper and lower bands. As time passes we get a new MA with each period and the StD changes as we consider just the last 20 closes for the calculation. As the dispersion, the volatility increases and decreases over time, the width of the bands increase and decrease to compensate so that theoretically 95% of the data stays within the bands whether the volatility is high or low. So how can you use BBs to trade? Well first, and MOST importantly, all BB trades are counter to the recent price action. In other words, you sell strength and buy dips. That is the opposite of trend trading in which the entries are always in the direction of the prevailing trend. That means you only use this tactic when you are sure the market is NOT trending. The basic strategy when trading in congestion is to wait until prices are at the outer bounds of recent price action (i.e. at the BBs) and trade counter to the movement looking for prices to return to at least the mean. I generally liquidate BB trades when they reach the mean because most of the gain will have been achieved by then. If prices continue to move to the opposite BB, I may have given up some potential gain but by then I am looking to set a trade in the opposite direction anyway. That trading style is a personal preference though. Some people wait for prices to move toward the opposite band before liquidating. Let’s look at MSFT (below) to see how BBs work. I have included the ADX again so we can see when the market is trending. Starting back in March, note how MSFT rode right down the lower band as it trended strongly lower. That’s one of the biggest things to watch about trading against the BBs…if the market is trending you will get run over. Even though most of the price action was above the lower BB, it was falling so rapidly that any sale would have resulted in a loss if held more that just a few hours. So watch the ADX. If it indicates a trending market, don’t use a congestion-bases strategy (again, duh). Prices rallied up to the upper BB in early April while the downtrend was eroding. This provided an ideal short entry because it was against the upper BB while a downtrend (albeit a weakening one) was still in place. So you were trading against the short term price action, but IN the direction of the prevailing trend. This one was an almost lay down hand. Prices fell into the mean (yellow line) for a good exit opportunity. The market traded sideway with little opportunity for over a month before beginning to rally again in early June. Note that as prices rallied, the ADX turned up from very low levels. You might have tried to trade against the upper BB for a few days in mid-June, and could even have made some decent money intra-day. But the rising ADX would have negated any selling ideas by 6/14, and in fact the MA work would have suggested going long instead. Note how the BB served as resistance all the way up into late June, but the band was steeply rising. That’s another thing to watch for. BB trades almost always work better when the band you are trading against is flat. If it is sloping in the direction opposite the trade you are considering, beware. The bands gave a great buying opportunity in early July similar to the sale in early April. MSFT fell back to the lower band while the uptrend was still in place, though weakening. In fact, you would have had two or three chances to buy at the lower band (note it was flat) and sell into the MA. The explosive top on 7/21 was too volatile to trade, but the narrow range the next day MIGHT have been a short. I don’t think I would have had the guts to try it though because of the ADX was still over 20. Since then prices have dropped as MSFT has detrended. It gave a buying opportunity on 8/6, but did not rally high enough to sell out at the mean. Even though ADX is not showing a trend yet, MA structure is bearish now, so having a long on at this point is problematic. So chances are a BB trade from last week would have been scratched a couple of days ago. So there you have it. That’s the congestion trading strategy. You can also use the BBs as a profit taking point on trend-based trades. As we have pointed out, prices generally stall for some kind of pull-back end in a trending environment. But you would want to replace any positions quickly in strong trends. Only really aggressive, short-term traders should attempt this type of position management. Tomorrow, we’ll complete the series on the basics by looking at two oscillators that I use to try to figure out when the market is “overbought” and “oversold”. After that, we’ll be looking at actual markets. Yippee! May all your trades be winners. God Bless. TFG
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Post by TradingForGod on Aug 15, 2004 20:28:34 GMT -5
Hi Everyone! Today we’re going to talk about the most basic question to ask before you begin trading…is the market trending? I know that seems almost ridiculously simple, but the answer to this question radically affects how you should trade a given instrument. If the market is trending, you should only trade in the direction of the trend unless you are taking profits (duh!). If the market is NOT trending, then it’s pretty likely that prices will revert to the mean of recent price action and you should trade COUNTER to the short term movements at the edges of the recent price action unless one of the following is true: a) other technical indicators strongly suggest a break-out is imminent b) you have specific, non-technical, knowledge that support an imminent break-out I know that most of you are primarily stock traders, and I suspect that you trade from the long side most of the time. My background is in commodities trading where it’s as easy to go short as it is to go long. As a result, I have developed a “neutral bias” with respect to market price action. It has been my experience, however, that equity traders generally have a “bullish bias” since that is the way that they are going to make money, from the long side. This tendency was only exacerbated in the 80s and 90s when the equity market was uni-directionally higher. Most stock traders, even seasoned professionals, trading in early 2000 had never lived through a real bear market. That’s why most pundits on CNBC were saying “buy value” as the Nasdaq fell 78% from the highs. Of course, there are the aggressive shorters in the equity markets too. They look for stocks they feel are overvalued and then sell short. You see many of those folks on message boards “bashing” a particular stock they have shorted. There are few real “neutral” players out there. That has always fascinated me, since in commodities trending markets are the exception rather than the rule. I saw an article a long time ago that said commodity markets are technically trending only 20%-25% of the time. Stocks, especially over the last 25 years, trend much more often. However, if you go back to the 1970s the market was basically flat for a decade. If you were looking to “buy and hold” back then you had better have been doing it for the dividend! We want to use technical analysis to filter out any biases we have about the market so that we can objectively evaluate the current market conditions for the instrument that we are wanting to trade, whether that’s an individual stock, a stock index futures, crude oil, or pork bellies. So how do we do that as it relates to the question of trend? There are several ways to chose from but I use two: moving averages (MAs), and the average directional index (ADX). Moving averages are perhaps the most widely known technical tool. I think they are the oldest math-based indicators. People calculated and graphed them by hand long before computers made it easy. The calculation is very simple. The closes of the last “n” periods are added together and then divided by the number of periods. As each new period occurs, the first period in the series is dropped off so that only the n most recent periods are considered. There are a lot of different ways to use moving averages. Some people use only one and consider the market trending when the MA is sloped positively or negatively by a certain amount. Some people use two MAs of different periods and buy or sell when one MA crosses the other. The benefit of these types of systems is that they give signals pretty quickly, so you can get into a trade fairly early. The downside is that they give quite a few “false” signals resulting in a high percentage of losing trades, especially in choppy markets. I use a three MA system to help quantify the strength of a trend. By using three MAs I can get PARTIALLY into a trade when the shortest term MA indicates a trend MIGHT be forming, but it helps me wait to build a position until the longer term MAs suggest that’s the right thing to do. Plus, once the trend is going, I can use the shorter term MAs as trailing stops to partially exit a position if the market begins to reverse. More on that as time goes on. There are probably as many different MA systems as there are traders. A lot of work has been done back-testing data to try to come up with the “optimum” periods to use for the averaging. I have tried to do that myself. What I have found is that the “best” settings change over time, so optimizing a system so that it works well over all time frames is really hard. As a result, I am still using the basic system I have used for over 10 years. I use the 7, 20, and 40 periods for my fast, medium, and slow MAs. Why those particular settings? Well, believe it or not I use them because 7 is the number of completion in the Bible, there are 20 trading days in a lunar cycle, and the flood and Jesus’ time in the desert lasted 40 days. That’s kind of weird, I know. But heh, I’m a Christian. What can I say? Plus, it seems to work pretty well. Whatever MA system you use to evaluate the market, consistent application is the key. As to how to interpret the data, if all the MAs are very close to one another with small slopes in different directions, the market is clearly not trending. If the 7-day MA is above the 20-day MA, but below the 40-day MA, the market MIGHT be starting an uptrend, but it is not certain so trade small. If the 7-day MA is above the 20-day MA which is above the 40-day MA the market is probably trending. The other main way I evaluate trend is the ADX. This indicator, developed by Welles Wilder, measures the STRENGTH of a trend, not its direction. You have to use other means like MAs or visual observation for that. The math behind the indicator is a little complex, so I’m not going to explain it here. It’s not really necessary anyway. You don’t have to know how a carburetor works to drive a car. For our purposes, we’ll just talk about the basic interpretation rules. If the ADX is below 20, especially if the line has a negative slope, the market is considered non-trending. If the ADX is between 20 and 40 with a rising slope the market is trending and the trend is strengthening. If the slope begins to turn lower, especially if the ADX is above 40, the trend is in danger of failing. Beware of a correction at that point. So let’s look at our friend the MSFT chart to see how to apply the criteria we discussed above. From April through mid-May, MSFT was correcting from the big sell off earlier in the year. Notice how the 40-day MA (blue line) acted as resistance for several weeks in April as the ADX was falling rapidly from high numbers (downtrend eroding). The big gap higher in late April was not sustained because it just completed the correction higher off the lows. The market consolidated in a narrow range through May and early June as the ADX continued below 20 (non-trending). In early June prices began to rise, and MA structure and ADX quickly moved into bullish configuration. Notice how the 7-day MA (orange line) acted as support all the way up until the first part of July. On that dip, the 40-day MA held as support, but note how the ADX was declining from high levels. This indicated that the uptrend was weakening. The big gap higher in late July occurred in the context of this weakening trend and resulted in a “two-day island reversal formation”. Early this month, MSFT consolidated around the MAs that were all clustered together. On August 4th it closed slightly below the 40-day MA, doing so for the first time in over two months. The very next day it fell sharply. The 7-day MA now seems to be acting as resistance and the 20-day MA just crossed below the 40-day MA putting the MAs into the most bearish configuration. The ADX is still “non-trending” however, with a reading less than 20. If that indicator begins to rise, I’d look for MSFT’s weakness to accelerate. That’s how I use these two indicators in tandem. So that’s the basics of determining a trending market with a little bit of strategy for trading it. Next time we’ll talk about how to trade non-trending market using volatility bands. May all your trades be winners! Blessings, TFG
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Post by TradingForGod on Aug 15, 2004 20:28:34 GMT -5
Hi Everyone! Today we’re going to talk about the most basic question to ask before you begin trading…is the market trending? I know that seems almost ridiculously simple, but the answer to this question radically affects how you should trade a given instrument. If the market is trending, you should only trade in the direction of the trend unless you are taking profits (duh!). If the market is NOT trending, then it’s pretty likely that prices will revert to the mean of recent price action and you should trade COUNTER to the short term movements at the edges of the recent price action unless one of the following is true: a) other technical indicators strongly suggest a break-out is imminent b) you have specific, non-technical, knowledge that support an imminent break-out I know that most of you are primarily stock traders, and I suspect that you trade from the long side most of the time. My background is in commodities trading where it’s as easy to go short as it is to go long. As a result, I have developed a “neutral bias” with respect to market price action. It has been my experience, however, that equity traders generally have a “bullish bias” since that is the way that they are going to make money, from the long side. This tendency was only exacerbated in the 80s and 90s when the equity market was uni-directionally higher. Most stock traders, even seasoned professionals, trading in early 2000 had never lived through a real bear market. That’s why most pundits on CNBC were saying “buy value” as the Nasdaq fell 78% from the highs. Of course, there are the aggressive shorters in the equity markets too. They look for stocks they feel are overvalued and then sell short. You see many of those folks on message boards “bashing” a particular stock they have shorted. There are few real “neutral” players out there. That has always fascinated me, since in commodities trending markets are the exception rather than the rule. I saw an article a long time ago that said commodity markets are technically trending only 20%-25% of the time. Stocks, especially over the last 25 years, trend much more often. However, if you go back to the 1970s the market was basically flat for a decade. If you were looking to “buy and hold” back then you had better have been doing it for the dividend! We want to use technical analysis to filter out any biases we have about the market so that we can objectively evaluate the current market conditions for the instrument that we are wanting to trade, whether that’s an individual stock, a stock index futures, crude oil, or pork bellies. So how do we do that as it relates to the question of trend? There are several ways to chose from but I use two: moving averages (MAs), and the average directional index (ADX). Moving averages are perhaps the most widely known technical tool. I think they are the oldest math-based indicators. People calculated and graphed them by hand long before computers made it easy. The calculation is very simple. The closes of the last “n” periods are added together and then divided by the number of periods. As each new period occurs, the first period in the series is dropped off so that only the n most recent periods are considered. There are a lot of different ways to use moving averages. Some people use only one and consider the market trending when the MA is sloped positively or negatively by a certain amount. Some people use two MAs of different periods and buy or sell when one MA crosses the other. The benefit of these types of systems is that they give signals pretty quickly, so you can get into a trade fairly early. The downside is that they give quite a few “false” signals resulting in a high percentage of losing trades, especially in choppy markets. I use a three MA system to help quantify the strength of a trend. By using three MAs I can get PARTIALLY into a trade when the shortest term MA indicates a trend MIGHT be forming, but it helps me wait to build a position until the longer term MAs suggest that’s the right thing to do. Plus, once the trend is going, I can use the shorter term MAs as trailing stops to partially exit a position if the market begins to reverse. More on that as time goes on. There are probably as many different MA systems as there are traders. A lot of work has been done back-testing data to try to come up with the “optimum” periods to use for the averaging. I have tried to do that myself. What I have found is that the “best” settings change over time, so optimizing a system so that it works well over all time frames is really hard. As a result, I am still using the basic system I have used for over 10 years. I use the 7, 20, and 40 periods for my fast, medium, and slow MAs. Why those particular settings? Well, believe it or not I use them because 7 is the number of completion in the Bible, there are 20 trading days in a lunar cycle, and the flood and Jesus’ time in the desert lasted 40 days. That’s kind of weird, I know. But heh, I’m a Christian. What can I say? Plus, it seems to work pretty well. Whatever MA system you use to evaluate the market, consistent application is the key. As to how to interpret the data, if all the MAs are very close to one another with small slopes in different directions, the market is clearly not trending. If the 7-day MA is above the 20-day MA, but below the 40-day MA, the market MIGHT be starting an uptrend, but it is not certain so trade small. If the 7-day MA is above the 20-day MA which is above the 40-day MA the market is probably trending. The other main way I evaluate trend is the ADX. This indicator, developed by Welles Wilder, measures the STRENGTH of a trend, not its direction. You have to use other means like MAs or visual observation for that. The math behind the indicator is a little complex, so I’m not going to explain it here. It’s not really necessary anyway. You don’t have to know how a carburetor works to drive a car. For our purposes, we’ll just talk about the basic interpretation rules. If the ADX is below 20, especially if the line has a negative slope, the market is considered non-trending. If the ADX is between 20 and 40 with a rising slope the market is trending and the trend is strengthening. If the slope begins to turn lower, especially if the ADX is above 40, the trend is in danger of failing. Beware of a correction at that point. So let’s look at our friend the MSFT chart to see how to apply the criteria we discussed above. From April through mid-May, MSFT was correcting from the big sell off earlier in the year. Notice how the 40-day MA (blue line) acted as resistance for several weeks in April as the ADX was falling rapidly from high numbers (downtrend eroding). The big gap higher in late April was not sustained because it just completed the correction higher off the lows. The market consolidated in a narrow range through May and early June as the ADX continued below 20 (non-trending). In early June prices began to rise, and MA structure and ADX quickly moved into bullish configuration. Notice how the 7-day MA (orange line) acted as support all the way up until the first part of July. On that dip, the 40-day MA held as support, but note how the ADX was declining from high levels. This indicated that the uptrend was weakening. The big gap higher in late July occurred in the context of this weakening trend and resulted in a “two-day island reversal formation”. Early this month, MSFT consolidated around the MAs that were all clustered together. On August 4th it closed slightly below the 40-day MA, doing so for the first time in over two months. The very next day it fell sharply. The 7-day MA now seems to be acting as resistance and the 20-day MA just crossed below the 40-day MA putting the MAs into the most bearish configuration. The ADX is still “non-trending” however, with a reading less than 20. If that indicator begins to rise, I’d look for MSFT’s weakness to accelerate. That’s how I use these two indicators in tandem. So that’s the basics of determining a trending market with a little bit of strategy for trading it. Next time we’ll talk about how to trade non-trending market using volatility bands. May all your trades be winners! Blessings, TFG
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Post by TradingForGod on Aug 23, 2004 5:43:21 GMT -5
To speakinggodsword:
I'm sorry this is confusing. It's kind of complex, for sure. You really don't need to know a whole lot about how the ratios are derived to be able to use them in trading though. The main number to remember are 38% and 62%. These are the Fibonacci retracement objectives to watch for on corrections.
As we go on and you see them used a few times, I bet that it will become a lot clearer. At least I hope so.
Blessings, TFG
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Post by TradingForGod on Aug 23, 2004 5:43:21 GMT -5
To speakinggodsword:
I'm sorry this is confusing. It's kind of complex, for sure. You really don't need to know a whole lot about how the ratios are derived to be able to use them in trading though. The main number to remember are 38% and 62%. These are the Fibonacci retracement objectives to watch for on corrections.
As we go on and you see them used a few times, I bet that it will become a lot clearer. At least I hope so.
Blessings, TFG
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Post by TradingForGod on Aug 13, 2004 13:02:17 GMT -5
Happy Friday the 13th everyone. Today, I thought we’d talk about one of the coolest things I have found in trading. It’s cool because it ties trading into the natural world and the creative order of things. It’s the Fibonacci series in mathematics. This mathematical series was popularized by a 13th century Italian mathematician named Leonardo Fibonacci. Thus the name…<br> The series is very easy to construct. Start with the first two number…1 and 2. Add them together to get 3. So far the series is 1, 2, 3. Now add the last two numbers in the series so far, 2 and 3. The series becomes 1, 2, 3, 5. Repeat. 3 + 5 = 8. And so on and so on. The series becomes 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. Pretty simple, huh? Okay here comes the interesting part. This series can go on forever, and as the number get larger the ration of the second to last number (n-1) to the last number (n) of the series converges to a non repeating decimal fraction approximated by 0.618. The ratio of the third to last number (n-2) to the last number (n) converges to a non-repeating decimal fraction approximated by 0.382. If you add these two numbers together you get exactly 1.0. Okay, that’s really not so interesting because the series is constructed by adding the last two numbers together to get the next number in the series. So by definition (n-2)/n + (n-1)/n = n/n = 1. That’s just simple algebra, BUT………<br> If you square 0.618 you get 0.382, the other ratio in the series that adds together to get exactly 1.0. There is no other mathematical series like that. And, if you take the reciprocal of this number, n/(n-1), you get 1.618…out to infinity. If you subtract 0.618…out to infinity from its reciprocal, 1.618…out to infinity, you get EXACTLY 1.0000000000000…..out to infinity. There is no other number like that! This is truly amazing. The ratio of n/(n-1), 1.618…, is called the Golden Ratio. What is amazing it, and the Fibonacci series, is that they show up in nature all over the place. The petals of lots of flowers arrange themselves in Fibonacci numbers. The angle of the spirals of a pine cone, and a conical sea shell, and a hurricane, and the arms of spiral galaxies are in the golden ratio. The ratio of the lengths of the bones in a human finger and hand are the Fibonacci series. This ratio is a thread that runs throughout creation. It’s all around us, and yet, we usually don’t see it. There are lots of resources on the web if you want to read more about it, but here is one link to look at for examples of Fibonacci series, and the Golden Ratio, in nature: www.world-mysteries.com/sci_17.htmOkay, so what does all this have to do with trading? Well, as I mentioned yesterday in the discussion about Elliott Wave, frequently when markets retrace they pull back in relation to the Fibonacci series. Let’s look at the same MSFT chart we looked at yesterday. (By the way, I just pick this at random, so this is not a “well-picked” example”). You can see that the rally from late March to late April pulled back into mid-May. They light blue dashed lines are a “Fibonacci retracement tool” on my technical analysis package. The dashed lines represent the 38.2% {(n-2)/n}, 50%, 61.8% {(n-1)/n}, and 78.6% {square root of (n-1)/n} retracements of the rally. Note that the pull back went to EXACTLY the 62% retracement! The advance from mid-May to July 1st pulled back into mid-July. This time, the pull-back just slightly exceeded the 38% retracement (red dashed lines). This doesn’t always work quite so “perfectly”, but I have seen it work more often than it doesn’t. So how would you use this in trading? I’ll just give one example. Let’s say that you were bullish MSFT after the explosive gap higher in late April. But you really don’t want to buy such great strength because you’re afraid of a big pull-back. You might buy only 10% of your expected position on the break-out. That way if prices do rally, at least you participate. But you wait on the balance and scale into the rest of your longs between the 38% and 62% retracements. That would have worked great in the May dip. But in the July dip you would have only gotten a small piece of the position on since the dip went only to the 38% retracement. How will you know when the pull-back is over and it’s time to buy your whole position? Ah, that’s a topic for another column! Two more things about Fibonacci ratios and trading. First, many times I have uses failures to hold retracement targets as an EXIT signal for a position. For instance, if you were long MSFT at the top and prices slipped below the 62% retracement of the rally from the mid-July low to the high on 7/21, that would be an exit signal for at least some length. It doesn’t mean that whole rally is done, though it might be, but it does mean that there is a deeper retracement coming that will give a better buying opportunity. Finally, I mentioned yesterday that the “3” wave usually extends in an impulsive move, exceeding the length of the “1” wave. Well, guess what? Many times that extension is the 1.618 of the “1” wave. Yeah, that’s right. It extends by the Golden Ratio. It doesn’t happen all the time, but it’s a great place to look to take profits if the market is going your way. I hope you are finding these columns helpful. I’ll pick it back up next Monday as we start a discussion of the various math-based indicators I look at. With the advent of cheap computing power, what was once impossibly difficult analysis has become easy. The problem is that it is SO easy that you can look at so many things it just confuses the issue. We’ll talk about five math-based indicators that I use to try to characterize the market. When combined with trendlines, Elliott Wave pattern recognition, and Fibonacci analysis, these tools are all I use. See, technical analysis isn’t so hard! Have a blessed week-end. TFG (TradingForGod)
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Post by TradingForGod on Aug 13, 2004 13:02:17 GMT -5
Happy Friday the 13th everyone. Today, I thought we’d talk about one of the coolest things I have found in trading. It’s cool because it ties trading into the natural world and the creative order of things. It’s the Fibonacci series in mathematics. This mathematical series was popularized by a 13th century Italian mathematician named Leonardo Fibonacci. Thus the name…<br> The series is very easy to construct. Start with the first two number…1 and 2. Add them together to get 3. So far the series is 1, 2, 3. Now add the last two numbers in the series so far, 2 and 3. The series becomes 1, 2, 3, 5. Repeat. 3 + 5 = 8. And so on and so on. The series becomes 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and so on. Pretty simple, huh? Okay here comes the interesting part. This series can go on forever, and as the number get larger the ration of the second to last number (n-1) to the last number (n) of the series converges to a non repeating decimal fraction approximated by 0.618. The ratio of the third to last number (n-2) to the last number (n) converges to a non-repeating decimal fraction approximated by 0.382. If you add these two numbers together you get exactly 1.0. Okay, that’s really not so interesting because the series is constructed by adding the last two numbers together to get the next number in the series. So by definition (n-2)/n + (n-1)/n = n/n = 1. That’s just simple algebra, BUT………<br> If you square 0.618 you get 0.382, the other ratio in the series that adds together to get exactly 1.0. There is no other mathematical series like that. And, if you take the reciprocal of this number, n/(n-1), you get 1.618…out to infinity. If you subtract 0.618…out to infinity from its reciprocal, 1.618…out to infinity, you get EXACTLY 1.0000000000000…..out to infinity. There is no other number like that! This is truly amazing. The ratio of n/(n-1), 1.618…, is called the Golden Ratio. What is amazing it, and the Fibonacci series, is that they show up in nature all over the place. The petals of lots of flowers arrange themselves in Fibonacci numbers. The angle of the spirals of a pine cone, and a conical sea shell, and a hurricane, and the arms of spiral galaxies are in the golden ratio. The ratio of the lengths of the bones in a human finger and hand are the Fibonacci series. This ratio is a thread that runs throughout creation. It’s all around us, and yet, we usually don’t see it. There are lots of resources on the web if you want to read more about it, but here is one link to look at for examples of Fibonacci series, and the Golden Ratio, in nature: www.world-mysteries.com/sci_17.htmOkay, so what does all this have to do with trading? Well, as I mentioned yesterday in the discussion about Elliott Wave, frequently when markets retrace they pull back in relation to the Fibonacci series. Let’s look at the same MSFT chart we looked at yesterday. (By the way, I just pick this at random, so this is not a “well-picked” example”). You can see that the rally from late March to late April pulled back into mid-May. They light blue dashed lines are a “Fibonacci retracement tool” on my technical analysis package. The dashed lines represent the 38.2% {(n-2)/n}, 50%, 61.8% {(n-1)/n}, and 78.6% {square root of (n-1)/n} retracements of the rally. Note that the pull back went to EXACTLY the 62% retracement! The advance from mid-May to July 1st pulled back into mid-July. This time, the pull-back just slightly exceeded the 38% retracement (red dashed lines). This doesn’t always work quite so “perfectly”, but I have seen it work more often than it doesn’t. So how would you use this in trading? I’ll just give one example. Let’s say that you were bullish MSFT after the explosive gap higher in late April. But you really don’t want to buy such great strength because you’re afraid of a big pull-back. You might buy only 10% of your expected position on the break-out. That way if prices do rally, at least you participate. But you wait on the balance and scale into the rest of your longs between the 38% and 62% retracements. That would have worked great in the May dip. But in the July dip you would have only gotten a small piece of the position on since the dip went only to the 38% retracement. How will you know when the pull-back is over and it’s time to buy your whole position? Ah, that’s a topic for another column! Two more things about Fibonacci ratios and trading. First, many times I have uses failures to hold retracement targets as an EXIT signal for a position. For instance, if you were long MSFT at the top and prices slipped below the 62% retracement of the rally from the mid-July low to the high on 7/21, that would be an exit signal for at least some length. It doesn’t mean that whole rally is done, though it might be, but it does mean that there is a deeper retracement coming that will give a better buying opportunity. Finally, I mentioned yesterday that the “3” wave usually extends in an impulsive move, exceeding the length of the “1” wave. Well, guess what? Many times that extension is the 1.618 of the “1” wave. Yeah, that’s right. It extends by the Golden Ratio. It doesn’t happen all the time, but it’s a great place to look to take profits if the market is going your way. I hope you are finding these columns helpful. I’ll pick it back up next Monday as we start a discussion of the various math-based indicators I look at. With the advent of cheap computing power, what was once impossibly difficult analysis has become easy. The problem is that it is SO easy that you can look at so many things it just confuses the issue. We’ll talk about five math-based indicators that I use to try to characterize the market. When combined with trendlines, Elliott Wave pattern recognition, and Fibonacci analysis, these tools are all I use. See, technical analysis isn’t so hard! Have a blessed week-end. TFG (TradingForGod)
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