The Educated Analyst Jul-Aug 2010

A Free Technical Analysis E Magazine for Traders of Financial Markets
Volume 2 Issue 4 JUL / AUG 2010
HOW DO YOU AVOID THE PITFALLS OF MARKET MANIPULATION?
Inside this issue...
Two examples of market manipulation at work and how to avoid being caught out by it. The power of Moving Averages in your trading system. Discover how Continuation Patterns can be one of the most profitable trading techniques of all. And much more...
www.EducatedAnalyst.com
CONTENTS
THE EDUCATED ANALYST
JUL / AUG 2010 - VOLUME 2 Issue 4
24 CONTINUATION PATTERNS
Continuing the series of articles by Peter Varcoe this issue we come to the business end of the identification process for what is undoubtedly, for many, one of the most profitable trading techniques of all.
4 SOMETHING STINKS IN THE U.S

Alan Oliver reviews the Bear Stearns options scandal, and the more recent traders accident event which cause the largest one day drop in US Market History. Alan then goes on to show you where you can go to escape this kind of market manipulation while continuing to employ Gann and Fibonacci techniques (video).
33 AN INTRODUCTION TO EXCHANGETRADED FUNDS (ETFS)

Mike Smith from Horizon Professionals reviews the nuts and bolts of Exchange Trade Funds as they become more popular with traders and investors for their versatility and which can gives you exposure with relative ease to markets and vehicles which maybe otherwise difficult or complicated to trade.
7 SOME OF THE MOST WIDELY TRADED

STOCKS ON ASX
With the current volatility in the Australian Stock market Dale Gilham reviews some of the biggest stocks in the Top 100 to see what they are doing and demonstrates how to apply some simple techniques and make comment on how the stocks have been unfolding.
39 EMOTIONAL STAGES OF A TRADE

The psychological states of traders rarely get a mention, yet these have an enormous impact on individual traders results. Chris Collingwood explorers why emotions influence our capacities to take in information, process it and make functional decisions.
12 Q&A RAY BARROS

In this new section of the Educated Analyst Matthew Humphreys from Market Analyst Software poses a series questions to Author, Trader and Market Educator Ray Barros.
The Educated Analyst is Changing! Beginning from September the Educated Analyst will no longer exist as a bi-monthly PDF publication. Instead we are converting to a blog style website which will begin with weekly article updates. The article styles and content will not change, and our focus will continue to be quality education for market traders. The change to a blog format will allow us to react to current events (such as the impact of the RSPT) much faster, and to include a wider variety of content such as videos, polls, user comments, etc. Once the site is ready we will email all of our existing subscribers with the details. We look forward to seeing you in September. The Educated Analyst Team
15 MOVING AVERAGES IN THEORY AND

PRACTICE
Despite many innovations in technical analysis over the years, the moving average in all of its forms remains one of the most powerful methods available for analysing, trading and profiting from financial market movements. In this article Asoka Selvarajah will review some of the systems which can be implemented using the granddaddy of TA indicators.
21 POETRY IN MOTION
This article is a follow on from Dawn Bolton-Smiths previous item LESSONS IN GEOMETRY. It is not so much about words but the pictures that the market provides and translates into charts, which at times can be pure geometry.
The Educated Analyst |
JUL /AUG 2010
EDITORIAL H
i and welcome to the latest edition of The Educated Analyst.
It always amuses me how we often have a recurring theme in the articles without any scripting from us. This time we have two articles that highlight some of the market manipulation that seems to be going on. Besides those given in the articles, another example in recent times is the manipulation of the silver market, where large players were allegedly manipulating the price by the sheer volume of contracts that they held. Many people will cry foul over this - and rightly so, where this is found to be happening it should be prosecuted. In reality though, I take a very pragmatic view on this, while I do not doubt that manipulation happens, I think it is something that has been happening for as long as we have had "Free" markets. From a purist Gann point of view, it could be said that the manipulation was necessary to have the market reach the required Gann levels........ but that is where my mind struggles too much with the paradox of "Does the market define the levels, or do the levels define the market". I think that that is a philosophical discussion to be had over a nice bottle of wine. Nevertheless, I do not think manipulation is a reason to stay away from a market. The more you study a market and get to know it, you will be able to successfully trade it no matter if the moves are "natural" or manipulated. In over fifteen years of being involved in the trading industry, the very best traders that I have met are always those that choose, study and test a market thoroughly. In some other news related a bit more closely to The Educated Analyst, this will be the last time that we present The Educated Analyst as a large PDF file like this. You see, many of the articles in this issue were actually received weeks ago, and STOP THE PRESSES! some of them were quite pertinent to what was happening in As an example of the important (and time the market at that time. Rather than make you wait for us to specific) information were hoping the new blog collate all the articles and build them into this PDF, we are format will make available to you, please click the going to release them as we receive them in a blog format. If image below to watch a short video presentation you are subscribed to The Educated Analyst, we'll let you know from Alan Oliver about the S&P500 Index. as soon as we have changed the website so that you can subscribe to that service via email or RSS. Well that's it from me, I trust that you enjoy the articles and that they give you some insights into the market that assist you with your trading. Stay safe with your trading and remember to protect your capital.
Mathew Verdouw
Editor The Educated Analyst.
Disclaimer: The Educated Analyst, its staff, officers and contributing authors cannot be held liable for trading decisions that you make as a consequence of education that you receive from the articles. Trading and Investing involves risk and has the potential for large financial losses. The content provided in The Educated Analyst is of a general nature and does not take your personal situation or financial objectives into consideration. You should consult with your broker or financial advisor before acting on any of the content in The Educated Analyst.
SOMETHING STINKS IN THE U.S

With Alan Oliver
ny trader who has been watching the markets actively in the last year or so could be excused for thinking that the US has a real corruption problem, and this has been highlighted on several occasions. Lets look at the two most recent examples of dubious behaviour. In March 2008, somebody unknown to market regulators and officials bought 1.7 million dollars of puts on Bear Stearns stock. If you havent traded options, this is a short trade with a time limit and a price that the market must drop below to have a winning trade. Nothing unrealistic or suspicious about the trade, but bear in mind the options had strike prices between 50% and 60% lower than the trading price. Again, perhaps a wild bet on market movements, but considering the size of the trade one would be forgiven for raising your eyebrows. But it gets better.
The options were due to expire in 9 days.. I dont trade options but I recognise a stupid trade when I see it. This was a ridiculous strategy unless you had some reason to suspect that Bear Stearns was not going to be saved like the other banks were. As it turns out, Bear Stearns was not afforded a rescue package like the others, and in 6 days this trade was worth $270 million dollars to the trader. Not bad for a weeks work. So who is this super trader with millions to risk on very doubtful trades? What was his strategy and how did he presume to know that one bank would not be saved when others were rescued? Well, we will never know because the SEC, the Securities and Exchange Commission charged with maintaining an orderly and fair trading market cant find the trader or the money. This must beggar belief to anyone that $270 million dollars can go missing or is untraceable. From my bank employee days I know this is untrue, so there is a definite stink brewing here. Now lets look at the latest fiasco. The US stock market had its largest single day down in history, falling over 1000 points in one day. Many stops would have been knocked out as the market fell temporarily; in fact it only took a couple of hours for the market to rally back up 700 points.
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And now, yes, you guessed it, the NYSE exchange doesnt know what caused it or how it happened. It was rumoured that a trader made a mistake entering an order, but this would have left a paper trail that could be confirmed. This now seems to have been ruled out. Now you know why I am imploring smaller, individual traders to trade currency markets on an intraday basis. From my previous articles you will know that I am a big believer in using both Gann and Fibonacci techniques in my trading. Gann in particular is probably most famous for his trading on commodities, and to a lesser extent equities, and as such many traders think that his techniques are only applicable to those markets. What I have found over years of study is that you can apply all the works of Gann to currencies just as you would to commodities or equities, sometimes it even works better. In fact I believe that where there is any "free market" that has enough liquidity, you can apply these techniques. I think the best way to explain this is to show you a video which demonstrates how I use both Fibonacci and Gann techniques in the analysis of the Euro to $US. This is one of the four weekly videos based on Market Analyst that I produce for people who buy my course. The first of the four is actually a free weekly video that anyone can sign up for on my website (www.tradingwithgods.com).
Best wishes to all, Alan Oliver.
About Alan Oliver Alan Oliver is a full time trader and private educator. Early in Alans career he worked for two major Australian banks where his interest in the markets began. After developing and successfully honing the skills of a full time trader, Alan left the workforce to trade full time which is what he has been doing ever since. Most recently Alan has written a book on his favourite subject of Fibonacci and the Golden Harmonic ratio. Alan has travelled extensively, been invited as a key speaker to many countries including: Australia, Hong Kong, Malaysia, Singapore, Thailand and China. Alan also runs a web site (named after his book) to assist traders www.tradingwithgods.com.
Something Stinks in the U.S
JULY/AUG 2010
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SOME OF THE MOST WIDELY TRADED STOCKS ON ASX MAY 10

With Dale Gilham
With the current volatility on the market we thought it would be a good time to look at some of the biggest stocks in the Top 100 to see what they are doing. Heavy selling has occurred across the broader market, and with it we have seen the price of stocks like CBA, AMP, BHP, TLS and WOW trade lower to test levels of support below, and in some cases the stocks have triggered signals to exit. Given this, we thought now would be an opportune time to apply some simple techniques and make comment on how the stocks have been unfolding. Commonwealth Bank Australia Since falling to a low in January 2009, CBA has risen around 149% in just sixty-four weeks. This rise is faster than any previous uptrend over the same period of time. Whilst it is always important to allow your profits to run, it is equally important to ensure that you are prepared for a change in trend. Remember what goes up fast will generally come back at a much faster rate than the prior rise. Given this, you need to know how you will manage your downside risk when conditions do change. CBA recently broke through resistance at around $56.00 to be trading just below the All Time High price for the share of $62.16 in November 2007. This is a strong level capable of turning or at least slowing the rise, and as expected, the stock formed a high close to this price at $60.00 on 21 Apr 10. As you can see, CBA has pulled back swiftly from that level to provide two consecutive weekly closes below the current uptrend line, and this week triggered a Gann swing exit. Given this, now is not the time to consider CBA. That said, if you already hold the stock you might consider selling to protect your capital against any further downside risk, in case the stock continues to fall through support at around $51.00 to the next level below at $46.00.
Source: Market Analyst 6 (www.Market-Analyst.com)
Some of the Most Widely Traded Stocks on ASX May 10
JULY/AUG 2010
AMP Ltd
AMP has never traded above its opening price, and is one of the worst performers in the ASX Top 20 over the past 10 years. It is therefore not a stock suitable for buy and hold, however it is a good trading stock that has more than doubled in price a number of times. During the past six months, whilst other financial stocks continued to rise, AMP has merely traded sideways below resistance at $7.00 causing it to also break below its uptrend line. Prior to the falls we have seen over the past few weeks, this sideways move could just have been a consolidation phase (as highlighted by the pennant pattern) prior to its next upward move. However, as AMP recently broke below the pattern and continued the decline this week to confirm a downtrend is in place, the risk of a further fall has increased. Given this, it is now possible to draw a downtrend line from the high in Oct 09. AMP has been in a battle against NAB for the opportunity to takeover AXA. As a general rule, the share price of the company doing the taking over is likely to fall, whilst the price of the company being taken over will rise. Therefore, if AMP is successful, the share price is likely to be held back for some time below the current downtrend line. That said, if AMP moves up to complete two consecutive closes above the downtrend line, it may be time to move it back onto your watch list.
BHP Billiton Following the long term low of $20.00 in November 2008, BHP worked its way up steadily to a recent significant high of $44.93 on 6 April 2010, before reversing and falling away to complete two consecutive weekly closes below the current uptrend line at the end of April. It is interesting to note that until January 2010, BHP enjoyed support from and traded above an uptrend line (dashed line) anchored from November 2008. However, in January BHP reversed from Point A and broke down through the uptrend line to find support at around $40.00 before continuing the uptrend to a new high at Point B. This move to a new high enabled a new uptrend line to be drawn (solid line). Historically BHP has resonated around particular levels of support / resistance; multiples of $8.00 being $32.00, $40.00 and $48.00, and also the half way points
JULY/AUG 2010
between these levels at $44.00 and $36.00. Two weeks ago BHP gapped down at the start of the week to close strongly below the $40.00 level, and is testing support just above the next level at $36.00. Given this, it is likely for BHP to slow the current decline close to this level. If you were using trend lines to manage your exit then you would be out of the trade. However, if you are using Gann swing or Dow Theory to manage your downside risk you would still be in the trade. Remember to set a stop loss to protect capital in case it continues to fall. If you are looking for an opportunity to take a position in BHP it is important to note that the weekly swing is still pointing down and therefore it has not proven the fall is over. Given this, it would be better to wait until the stock looks stronger technically, particularly as the next level of overhead resistance is not far away at around $40.00.
Telstra Following the All Time High of $9.20 in February 1999, TLS traded down to a low of $2.88 eleven years later in March 2010. This represents a loss in value of 69%, making it similar to AMP as one of the worst Top 20 stocks to buy and hold. However unlike AMP Telstra is not a trading stock. Although TLS has paid a huge dividend, this massive erosion of capital adds little support for the buy and hold approach advocated by many advisors. Marked on the monthly chart below are important price levels which have been calculated by taking specific Fibonacci and Gann percentage levels off Telstras $9.20 high. You can see that so far the price action has respected the levels at 38.2%, 50% and 61.8%, with these price divisions being support / resistance.
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In terms of where to from here for TLS, there is no indication so far that the long term decline is complete. Currently TLS is trading under a confirmed downtrend line on the monthly chart as shown. For me the stock would need to move up convincingly through this line to even indicate possible future support around $2.90. Given this, TLS is more likely to fall to around $2.30 (75% price division) before it is ready to turn up in a sustainable manner and be considered for purchase.
Woolworths (WOW) Following the All Time High (ATH) of $35.05 in December 2007, WOW fell away sharply as investors exited over the next seven months to create a significant low of $22.85 in July 2008 (Point A). Important levels of support / resistance are shown at $24.20, $26.60 and $29.20, indicating it has a natural price multiple around $2.50. It is also interesting to note that while in the grip of the GFC, the significant low at Point A occurred about nine months before most of the market bottomed in March 2009. Since then WOW has been caught up in a sideways trading band between $24.20 and $29.20, and in doing so has given investors a moderately volatile journey, with fluctuations ranging between + / 9.5%. Going forward, $29.20 is a very important resistance level and as such, until the stock breaks strongly above this level and out of the sideways move, I believe there are better opportunities elsewhere.
JULY/AUG 2010
About Dale Gilham Dale Gillham, founder and chief analyst of Wealth Within successfully trades $10s of millions on behalf of clients using his proven and audited investment strategy. His company also specialises in delivering Australias first and only nationally accredited Diploma and Advanced Diploma of Share Trading and Investment as well as the accredited Course in Contracts for Difference. For information about Wealth Within visit www.wealthwithin.com.au. AFSL No. 226347
JULY/AUG 2010
Q&A
WITH MATTHEW HUMPHREYS
Q&A IS A NEW REGULAR SEGMENT WEVE ADDED IN THE EDUCATED ANALYST WHERE WE POSE A SERIES OF QUESTIONS TO THE EXPERTS, TO LEARN FROM THEIR EXPERIENCE AND EXPAND OUR OWN HORIZONS. IN THIS EDITION WE TALK TO T RADER, AUTHOR AND MARKET EDUCATOR RAY BARROS.
Q. A.
How did you get into trading / investing? My father was the investment manager for his company and I gravitated to the stock market during the Poseidon Boom in Australia.
The Poseidon bubble was a stock market bubble in which the price of Australian mining shares soared in late 1969, then crashed in early 1970. It was triggered by the Poseidon NL company's discovery of a promising site for nickel mining in September 1969. In the late 1960s, nickel was in high demand due to the Vietnam War, but there was a shortage of supply due to industrial action against the major Canadian supplier Inco pushing the price of nickel to a peak of 7,000/ton. In September 1969, the mining company Poseidon NL made a major nickel discovery. Their shares had been trading at $0.80, but as information about the discovery was released, the price rose until it was trading at $12.30 on October 1. After this, very little further information came to light, but the price continued to climb due to speculation; at one point, a UK broker suggested a value of up to $382 a share. The price of Poseidon shares quickly became too high for many investors, so some investors turned to other nickel stocks, stocks in other mines near Windarra, and eventually other mining stocks in general. As the price of mining shares grew, numerous new companies were listed by promoters looking to cash in. Some of these new listings did not even have any mining leases, let alone viable mines. Many investors lost money on these shady listings, and this attracted substantial negative press. Thus the image of mining stocks was tainted, and the prices began to fall. Mining stocks peaked in January 1970, then immediately crashed. Poseidon shares peaked at an intraday high of $280 in February 1970, and fell rapidly thereafter. By the time Poseidon actually started producing nickel, the price of nickel had fallen. Also, the nickel ore was of a lower grade than originally thought, so extraction costs were higher. Profits from the mine were not sufficient to keep Poseidon afloat, and in 1976 it delisted.
Source: Wikipedia
Q. A.
How long have you been trading the markets? My first trade was 1969 (Australian Stock Market - Peerless Options). I became a full-time trader in 1980 when I sold my legal practice. My private hedge began in 1990. Were there any authors, market teachers that influenced your style of trading as you started? Richard Wyckoff and Pete Steidlmayer
Q. A.
Q. A.
What was one of the most common mistakes you made when you started trading the markets? All the common ones and some that were unique: Looking for certainty and the Holy Grail - Confusing Win Rate with Positive Expectancy - Overtrading in terms of Frequency and position size - Failing to predefine initial exit strategies (initial stops) - Trading without a Plan - Trading Without Risk Management Failing to keep a Psyche Journal and thus failing to learn from my mistakes......
Q. A.
Which exchanges do you prefer to trade and why? FX (major crosses including AUDUSD and USDCAD), S&P futures, 30-year Bonds, Crude Oil Futures, Gold Futures. At one point the basket offered diversification - not now but I do expect it will do so again in the future.
Q. A.
Are there any markets you wont trade and if so why? Thin markets like Orange Juice, Heng Seng because of the slippage.
Q. A.
What time frames do you aim for your trades (short term, mid-term, long term, combination of all 3?) I trade the monthly trend, the 18-day Barros Swing.
Q. A.
Do you utilise any fundamental analysis in your trading, or do you use Technical Analysis exclusively? I use Austrian economics to provide a context to my trading but my trading entries and exits are based on technical analysis.
Austrian School economists hold that the complexity of human behaviour makes mathematical modelling of an evolving market extremely difficult (or undecidable) and advocate a laissez faire approach to the economy. Austrian School economists advocate the strict enforcement of voluntary contractual agreements between economic agents, and hold that commercial transactions should be subject to the smallest possible imposition of forces they consider to be coercive. In particular, they advocate an extremely limited role for government and argue for the smallest possible amount of government intervention in the economy, especially in the area of money production (advocating instead a commodity-money system).
Q. A.
What is the most important lesson youve learned as a trader so far? 1. Success comes from the consistent execution of my trading and risk management plans. 2. The educational system by which traders learn to trade (similar to US Army pilots pre-1934) is partially responsible for the dismal success rate (8%) of traders. It needs revamping.
Q. A.
Do you utilise leveraged products such as CFDs? I trade FXC and Futures because they are the most cost effective way to trade. I do not trade stocks in bear markets.
Q. A.
Do you utilise any hedging products such as Options? No. Options are outside my realm of expertise.
Q. A.
Can you give the details of one of your best trades (setup, entry, exit, etc). On April 29 I said in my Forum Daily Free Service that I believed that the S&P had topped. I sold a full size position. The next day, the S&P pushed past minor resistance, so I covered 1/4 of my positions. I was expecting the market to head higher but on May 4, the S&P had a bearish-conviction bar down and I added to my shorts. By end of trading May 4, I had twice my normal position. I covered all my shorts on May 6.
Q. A.
With the debt problems in Europe, and the massive bail outs weve seen in Australia and across the globe, what effect do you think this will have on the markets (if any)? Add dark pools and quant trading, and you have the recipe for greater volatility. Success will depend on knowing when to stay away from the markets as much as knowing when to take part. This will be a function of our personality and trading methodology.
Dark Pool Liquidity is a term that refers to the trading volume created from institutional orders, which are unavailable to the public. The bulk of dark pool liquidity is represented by block trades facilitated away from the central exchanges.
Source: Investopedia.com
investopedia.com
Q. A.
If you had to pick 3 things no trader should be without, what would they be and why? 1) The beliefs that, a) money can be made from the markets b) I can make money from the markets c) I deserve to make money from the markets. 2) Honesty - to see what the market is telling us rather than fit the information to our preconceptions. 3) Integrity - to keep the promises we make to ourselves.
Q.
A.
The internet is flooded with claims market traders can see 1000s of percent profit each year which can be very misleading to those just starting out. What would you consider to be an achievable average return (p.a.) for people trading the markets? That is a difficult question because it depends on the trader and where he is in his stage of a trader's evolution. With low risk of ruin, probably around 15% to 20%.
Q.
A.
Do you recommend your book, The Nature of Trends, for novice traders or does it require some experience in the markets to be fully beneficial? What knowledge were you hoping to impart to your readers? The Nature Of Trends is aimed at the experienced trader. For most experienced traders, Nature of Trends brings a fresh perspective with a robust edge. If you are a novice, it will take effort to master the material. I am writing a new book with the target audience being the novice. In Nature Of Trends I was looking to provide an approach that was statistically sound and one which moved away from the normal set of Technical Analysis tools.
About The Nature of Trends

The Nature of trends draws on the latest developments in the neurology, psychology, game theory and complexity theory to construct a written trading plan with an edge. The books step by step approach will assist traders in their quest for investing and trading success. The Nature of Trends provides a template for a successful trading plan. It assists the trader to answer questions such as: What are the conditions for low-risk entry? What is the trend of my time frame? Once in a trade, how can risk be managed? This practical guide to identifying trends and determining their likelihood of continuing or changing is an essential tool for traders looking to achieve their financial goals. Click here to purchase.
About Ray Barros

Ray Barros is a professional trader, fund manager, author, and educator with over 30 years experience in the markets. Ray has appeared on Singapores Chanel News Asia, Bloomberg and CNBC and has been regularly featured in regional newspapers and publications like Sydney Morning Herald, Your Trading Edge Magazine, Business Times, and Smart Investor. The interviews have focused on his trading strategies as well as his opinions on market sentiment. They have also dealt with his track record, trading philosophy, how and why he got into trading, and what advice he would give to those wishing to become traders/investors. Ray can be contacted www.tradingsuccess.com through his website
MOVING AVERAGES
IN THEORY AND PRACTICE.
With Dr Asoka Selvarajah
Despite many innovations in technical analysis over the years, the moving average in all of its forms remains one of the most powerful methods available for analysing, trading and profiting from financial market movements. Moving averages can be put to a wide diversity of uses from assessing the major trend of the market within any timeframe, right through to detecting short-term overbought/oversold conditions. As a consequence, moving averages form a critical component in many high quality fixed rules trading systems. There has been a lot of innovation in moving averages over the years. However, the basic concept is that of smoothing out short-term price fluctuations in order to gain a better picture of the overall trend. The specific calculation for achieving this may differ according to the type of average used, but once this smoothing has been achieved, one or more such averages of different timeframes may then be compared with each other to gain additional information about market movements and resulting trading opportunities. Basic Moving Average Calculations The simple moving average is calculated by adding the prices (generally closing prices, but not necessarily) over n time periods, and then dividing by the number of time periods: Moving Average (n) = Price(1) +Price(2) +Price(3)+ +Price(n) __________________________________ n* This type of moving average is the most commonly used. It has this fact as its chief advantage, in so far as it forms a ready basis of comparison because so many players in the market use it. For example, a lot of people like to track the 200-day moving average because they know that many long-term players such as investment funds track its movements closely and follow it.
Other kinds of moving average have been created, usually with a view to correcting some perceived deficiency in the simple average. The weighted moving average gives more recent price action a progressively larger weighting than more distant price action at the beginning of the sequence. The notion is that more recent price action should be given greater consideration than prices that occurred further back in the past, particularly in the case of longer moving averages. Hence, if w(n) is the weight of Price (n) in period n, the calculation is: Weighted Moving Average (n) = w(1)*Price1 + w(2)*Price2+ . +w(n)*Price(n) ______________________________________ n*w(n) where w(n) is the sum of the individual weights. Usually, the weights used are linear; for example if the most recent price is Price1 and n=5, then we might use: w(1)=5, w(2)=4, w(3)=3, w(4)=2, w(5)=1. This gives the required heavier weighting to the most recent price, Price1, and correspondingly less weight in linearly reducing fashion to other prices in the sequence. Yet other kinds of moving average calculation exist. For example, the exponential moving average uses weights derived from an exponential sequence. Nevertheless, however these moving averages may be calculated, the purpose is ultimately the same. It is to smooth out noise and random fluctuations from the price series in order to give the best possible picture of the main trend in the timeframe being considered. From that point, this information may be used in conjunction with that from other moving averages or even other technical indicators altogether. How Moving Averages Are Used Although the calculations used to obtain moving averages may be somewhat intricate, their use is rather more simple and immediate. One may use a single moving average to both determine the general direction of the trend, as well to find support and resistance zones in exactly the same manner as you
Moving Averages
JULY/AUG 2010
would for a standard trend line. When price is above the single moving average and the latter is pointing upward, then this is a clear indication of an uptrend. Conversely when price is below the average and the latter is pointing down, then this is clear indication of a downtrend. However, note that since the moving average is a lagging indicator, it therefore indicates what the trend has been up to this point, but not necessarily into the future. Having said that, a skilful technical analyst can integrate the moving average analysis with other technical indicators to generate a high probability assessment of how prices are likely to move. The two moving average combination is probably the most commonly used because it is very effective as well as quick to interpret and understand. It also readily lends itself to being incorporated into fixed rules trading systems. With two moving averages, the shorter average tracks the shorter term trend while the longer average tracks the longer term trend. Consequently, when the shorter average crosses above or below the longer term average, this signifies a possible trend change. If the shorter average crosses below the longer term average, it means that the market may be commencing a short-term move to the downside, and vice-versa. This sort of crossover characteristic is commonly used in creating automated setup conditions. When it occurs, the market is setup for a new uptrend or downtrend according to the moving averages, and consequently the trader creates an entry condition to then exploit that
new situation. The simplest entry condition is no entry condition at all, i.e. one simply buys or sells when the two averages cross over. However, this sort of system is highly vulnerable to false moves, and consequently better trading systems generally employ a subsequent entry condition after the moving average setup has been triggered. Examples are (1) buy/sell signal on candles, (2) confirmations from oscillators such as RSI, (3) trend line breaks and so on. When the price action itself is included with the moving averages, even more useful information can be gleaned. If the price is above the shorter moving average which is itself above the longer moving average, we can infer that the market is in an unambiguous bullish condition, and one should be looking primarily for buying opportunities, or for chances to add to existing long positions. If the price is below the shorter moving average which is itself below the longer moving average, we infer that the market is unambiguously bearish. In this case, we are primarily looking for selling opportunities, or for chances to add to existing short trades.
However, when price is between the two moving averages, the interpretation becomes somewhat less obvious. Under this situation, the trader might not wish to initiate any trade at all but rather might wait until the situation resolves itself clearly into one of the two scenarios just described above. If the trader already holds an existing position and then this neutral scenario
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appears, this might be inferred as an opportunity to reduce the position (hopefully by taking profits) or else to close it completely in anticipation of a trend reversal. Of course, other forms of technical analysis would be used to decide which of these two possibilities should be favored. The trader might not necessarily do exactly the same thing under every such scenario, unless a fixed rules trading system is being used. With three moving averages, even more possibilities are introduced. In this case, the unambiguous bullish (bearish) situation is when the shortest moving average is above (below) the medium term moving average, which is itself above (below) the longest moving average. The next scenario is that the short average could cross below (above) the medium term average, but the latter might still remain above (below) the long moving average. This might be used by the trader as an early signal of trend change to at least exit the existing long or short. However, this kind of signal is also the most vulnerable to false breaks. Another possibility presented by the three moving averages is for the shortest average to cross below the medium term average, which itself crosses below the long average. This scenario is a high probability situation for definitely closing out existing positions because when both the short and medium-term averages cross below the long-term average, it means that it is highly likely that the main trend has changed. Although nothing is guaranteed, there is much less chance of a whipsaw when the middle average also confirms the signal from the short average. However, the price you pay for this is
that the signal takes that much longer to occur and hence you exit your existing position that much later.
Three moving average combinations are often used in fixed rules trading systems for the very reason that they allow for a wider variety of responses compared to a one or even two moving average combination. The number of variable parameters price plus the three moving averages is greater and becomes greater still if the system also includes other technical indicators such as oscillators. In fact, it is also possible to use four moving averages (and doubtless more besides). In this case, treating the four as two pairs can yield very good results. The analyst employs the two longer moving averages to determine the overall trend, using simple crossovers as previously explained. Once the trend is defined in this manner, the two shorter moving averages crossovers may then be used to determine entry and exit signals within the overall direction of the main trend. For example, taking the two longer term moving averages, if the shortest of this pair is above the longer, then the market is overall bullish. Given that this is the case, one then uses bullish crossovers of the two shorter term moving averages to enter long trends ONLY, and bearish crossovers to exit those long positions. Outright short positions are not
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entered until the pair of longer term averages cross into bear mode. When they do, only short trades are taken thereafter, again using the shorter moving average crossovers. Moving Averages Used As Oscillators Moving averages combinations may also be used to create oscillators. This may be done in a number of different ways. In the famous Moving Average Convergence Divergence (MACD) oscillator, the basic idea is to take the difference between 12-period and the 26-period exponential moving averages, which produces the first line of two in the oscillator. The second line, called the signal line, is calculated as the exponential equivalent of the 9-period moving average. Of course, all of these numbers can be varied. Traders then used the MACD by looking for (1) crossovers of the two lines, (2) crossings of the zero line, (3) overbought/oversold conditions indicated by the oscillator when compared to previous values of itself during past market extremes, (4) breaking of trend lines drawn upon the MACD line itself, (5) oscillator divergences.
Actually, moving averages are used in many more oscillators than just the MACD and can give value far in excess of their usual means of interpretation. Other Applications of Moving Averages In addition to all of the above, there are still more uses that moving averages may be put to. Many market participants like to follow certain moving averages on the basis that they know that these are popular and are keenly watched by other market participants. A good example of this is the 200-day simple moving average. Since this is a very long term moving average, it follows the long-term trend of any market, i.e. the investor timeframe. Hence, many investment and pension fund managers keep an eye on the market relative to the 200-day moving average. Closes below this average are deemed highly negative and may lead to liquidation of positions. Thus, a smart trader might also watch the same 200-day moving average to gain an idea of what the large players are likely to be thinking. The 200-day average often gives excellent support and resistance, partly as a result of a self-fulfilling prophecy in so far as so many big players watch this particular average and make decisions based upon it. One very popular application of moving averages is to project bands of a fixed percentage above and below the moving average to form a price envelope. The best known example of this is the Bollinger Band, which is structured to contain 95% of the price action within the boundaries of the bands. Hence, if the price penetrates the bands in either direction, the
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trader would either consider the market overbought/oversold and hence potentially ripe for a trade in the opposite direction, or else ready to make a breakout into a new directional move. Percentage price bands around a moving average need not be limited to just two alone. Some systems have a series of such bands projected around a single moving average. When used either alone or in conjunction with other technical indicators, such price envelopes can yield very useful information regarding the present and likely future condition of the market. Another application of moving averages attempts to overcome their chief limitation, which is the fact that they are lagging indicators. All technical software packages nowadays allow you to create a moving average based upon the usual historical data, and then displace it forward a fixed number of time periods. The Displaced Moving Average (DMA) creates an effect similar to projecting the moving average forward in time, rather like having tomorrows moving average value today. The most common use of the DMA is as a short-term trend indicator. One of the chief drawbacks to all moving averages is the difficult of knowing which time period moving average is optimal to use with which market, and also whether the analyst is better off looking at one, two or more moving averages combinations. To overcome these problems, Trading Systems expert Perry Kaufman invented the Adaptive Moving Average, which is commonly available in pretty well all technical analysis software programs. The Adaptive Moving Average is a single average which dynamically varies its own length, typically from a 2period to a 30-period average, according to the degree of volatility and directionality in the market. Hence, when the market is trending strongly with little volatility, the length of the average will decrease towards its minimum value. However, when the market trend eventually stalls and a trading range ensues, the Adaptive Moving Average will grow longer, tending towards its maximum value. The secret to using this indicator is NOT to look for crossovers between price and moving average, but
simply to consider the overall direction of the moving average itself. Hence, when the average points up, the trend is up, and when it points down, the trend is down. When the direction of the Adaptive Moving Average is horizontal, the market is in a trading range (at least within the overall timeframe daily, weekly, monthly in which the Adaptive Average has been calculated).Thus, you only need ONE moving average, not two or more, to very neatly determine the overall market trend. Closing Summary In conclusion, the moving average remains a very powerful technical tool. It gives the analyst/trader a large range of possible methods for determining overall market trend across different time frames, overbought/oversold conditions, trade entry/exit signals, and can often serve as excellent zones of support and resistance. Moving averages also form a critical part of many excellent rules-based technical trading systems. They are a crucial part of the arsenal of any serious technical analyst/trader and should be studied and researched in depth in order to gain all of the many benefits that they offer.
About Dr. Asoka Selvarajah Dr. Asoka Selvarajah is a former investment banker of 11 years experience, as well as a financial markets trader/researcher for many more. He worked as Technical Analyst for several major Wall Street firms and was a senior trading strategist for a multi-billion dollar investment fund in the UK. His work has been featured on Reuters and he has been interviewed by Technical Analysis Of Stocks & Commodities magazine. Dr Selvarajah offers readers of Educated Analyst his critical new report, The 7 Deadly Mistakes Of Online Trading, entirely free. Which of these deadly errors do you regularly make in your trading? Download your free report now at http://www.onlinetradingrebel.com/EA
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POETRY IN MOTION
With Dawn Bolton-Smith
This article is a follow on from the previous one LESSONS IN GEOMETRY. It is not so much about words but the pictures that the market provides and translates into charts, which at times can be pure geometry. The MARKET ANALYST 6 Software is a wonderful back up to some of the hand drawn charts of the various styles to help you trade with the trend. I consider the half hourly chart on the ASX 200 index as the most important one you should maintain. It is well worth the effort along with a 2 pt. P&F chart plotted at the same time as the price action. I do mine from MA 6 Tic data with 4 screens 2 charts of SPI & index and tic data below. It is making my life so much easier to follow these exciting and volatile markets intraday where attention to detail is so important. The previous article contained the illustration of the half hourly almost up to the April 2010 high of the then bull market. It provided some wonderful trends, especially using Gann square overlays. The current chart up to 20th May shows how quickly the bear can take hold again. The methodology which I have been teaching for years produces excellent results. This was described in detail in the last issue. The Directional Movement System has been outstanding in recent weeks, providing the crossover sell signals as the market topped, confirming a market to be traded from the short side. When the -DI crossovers the +DI you take the short trades. A trending ADX, usually at a low level as the new trend gets underway, is a measure of the strength of the trend and not the direction. A rising ADX is a trending market and this eventually provides a signal that the trend has run its course. Combined with a Parabolic Stop to take you out of the trade, an excellent exit level for a very profitable trade. It can rise to levels of +50 plus. I always caution against taking positions when the ADX is trending strongly.
My favourite combination after strong acceleration is simple crossover of 3/5 period moving averages. You need to follow DM on the various time frames to check for yourself how well it functions even on a 1 minute chart. I try to leave the fundamentals to others (mostly yesterdays news) and concentrate on the price trend. Boarding up the windows is not a bad idea. Investors who bought into the recent top area of the market have now joined the losers, having been lulled into a false sense of security mostly from press and radio comment. Whether we have just had a bear market rally off the March 2009 low, or a bull market is mostly irrelevant now. It paid to follow the charts technicals paved the way. If you are trading the stock market it is advisable to maintain charts which show the monthly, weekly, daily and half hourly trends. The BIG PICTURE is an important part of your analysis. Up to-date charts are an absolute necessity in this environment of increasing volatility. Getting in early in any trend offers the best rewards and the least risk. Money management, if not practiced, can to be a road to ruin especially in futures and derivatives. Dr. Mircea Dologa is most adamant about MM and preparation for trading. His book Volume III INTEGRATED PITCHFORK ANALYSIS should be in your library. I firmly believe he is the most knowledgeable person on the planet when it comes to technical indicators, which of course are available in MA 6. The Gann and Jenkins Tools are the ones to be using now to advantage, and also the Astro section. I believe Gann was 90% astrological. SPI traders continue to be at the mercy of SYCOM which mostly dictates the opening trend of our market. Their overnight ranges can be extraordinary. It is advisable to do technical work on the Overseas Bourses and particularly S&P 500, Nasdaq 100 and the Dow Jones the most quoted index on the globe. As I write this article without the benefit of action to come in Thursday
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night 20th May, my three trusty P&F charts show these indices to be just holding UPTRENDS. Counter trend rallies can come out of the blue and be sharp and nasty and the trader needs to be prepared, but overall it is important to trade the main trend. I view moving averages as one of the simplest forms of trading with the trend. Likewise the P&F charts shout when the others stutter. The opening and closing sessions of the SPI are worth plotting P&F charts, especially the session 4.004.30 pm which shows the number of contracts traded at the various price levels. This can give a lead for the next day or continuing into the overnight Sycom where the smart and informed money comes into the market. The late P&F can give reliable targets for what eventuates in Sycom. I put the overnight range as a red bar on my chart it can be very helpful. It is a daunting experience to be caught on the wrong side of any futures markets but using the right charts will assist in providing the trigger points. I recall Dr. Alexander Elder, author of TRADING FOR A LIVING, stating in one of his seminars that when he enters his dealing room, he always says a little prayer please dont let me be a loser to-day. I consider it a privilege to be associated with the MARKET ANALYST TEAM. All Australian and thoroughly professional at all levels, I especially value their excellent support team. On a personal note, I am eagerly awaiting a visit by Dr. Mircea Dologa from Paris as he has promised me more lessons with Gann and Jenkins Tools in MA 6. I hopefully will be able to report on these in a future article. On the occasion of my recent 80th birthday, David Fuller of Fullermoney (a P&F enthusiast & expert too) sent me an email with a hug, stating that if he ever meets Margaret Thatcher he will tell her she is the Dawn Bolton-Smith of politics! He did say that still learning at 80 or his more modest learning at 68, it is wonderful and what keeps the brain alert. Investment analysis is, or should be, a continuous learning curve until we run out of time. He concluded by saying just think how much more I will know at 100! There is a message in this for all traders coming from one of the best in the world. The various charts accompanying this article will provide the accurate information to copy deadline, and are
worth studying. The special P&F Chart on ASX 200 20 pt one box is the simplest, and at times provides the early and definitive signals particularly when there is a major change of trend. I used Gann 144 Square overlay on this chart and last week there was some important geometry, a set up which I had learnt from the late Phyllis Kahn i.e. when price is at a 45 degree angle juncture and is 2/3 in time (horizontal Axis) and 2/3 in price when this breaks, expect a MOMENTUM MOVE DOWN. This happened this week with the index at close 4316 on 7th May 2010 the row of 0s down for a 4320 plot. Our market has broken major support the bear cometh again! Looks simple in hindsight, but exciting if you noticed it with foresight. I suggest all serious traders keep this chart. If you would like a scanned copy which you could transfer to a sheet of chart paper, you could send me an email: dawnboltonsmith@optusnet.com. This chart will provide a valuable part of your roadmap for the future. By putting the plots on by hand, you have an awareness of the prevailing trend. It is the oldest form of charting in this day of sophisticated black box systems, and at times tends to outshine them. Chart No. (1) ASX 200 Half Hourly to 20/5/10
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heavyweights in the index. A sell signal from DM on 20th April at 42.80 +DI 29 DI 38, ADX 16. 20th May - 36.75 +DI 9 DI 36. ADX 49. Some nice signals there for day traders. So far a trouble free ride for the shorts and put options. The Resources Tax news at 39.53 the market was already in downtrend. A blue print of this methodology to protect and preserve capital. Good Trading. (2) ASX 200 Half Hourly a recent example of a Gann Square 144 overlay- pure Gann and Geometry from the 7th May low which provided a sizeable bounce in the market. Dawn Bolton-Smith
(3) ASX 200 20 Pt 1 box P&F to 20/5/10
About the Author Dawn Bolton-Smith is the matriarch of technical analysis in Australia, with a career spanning 43 years. A female pioneer of trading in Australia, Dawn successfully predicted the 1974 share crash and called the bottom of the market to within four points.
(4) BHP 5 minute chart from MA 6 screen dump (the printer does not do it justice). One of the big
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CONTINUATION PATTERNS
CONTINUED....
With Peter Varcoe
ow we are getting towards the business end of this identification process for what is undoubtedly, for many, one of the most profitable trading techniques of all. Why would I say that? Because, unlike many other techniques, continuation patterns work equally well whether going long or going short. Therefore, because the combined trending time going up plus going down is longer than the time they go sideways, the informed and practiced trader is presented with more pattern entry opportunities than many other entry techniques. During the Bull run from March 2003 to December 2007, there were approximately 10 pattern entry opportunities to every trend change opportunity. Now while this seems logical in hindsight, it wasnt until late 2005, early 2006 that it was realised that we were in the biggest Bull run, in Australia anyway, since the run into 1987. During November & December 2007, there were a large number of directional change (Trend Change) entries which presented themselves. Since December 2007, however these continuation patterns have also presented a large number of entry opportunities during the downward run, and have continued to do so since the market changed direction in March of 2009. At the risk of repeating myself, I think it important here to re-state a view I have long had, which is also backed by many successful traders Price is King Indicators are confirmation only. The share price itself will tell you everything you need to know about when to get in and when to get out too many people look for the latest, you beaut, you cant bend it indicator with a 100% success rate. Please do not fall into this trap, it is an easy one to fall into. Why is this? The answer is simple, the above described indicator means that we dont have to spend countless hours researching, testing, applying in real
time, before we get to make squillions from the market with very little effort. This is no more true than with continuation patterns. Price is what tells you whether it is a continuation pattern or retracement. Price tells you when to get in and when to get out. Now we have established that price is king, let us look at how we can utilise what we have covered so far what does a pattern actually tell us? It tells us which direction the price is expected to travel and gives us a minimum destination point or target for the price to reach. Research has shown that a continuation pattern, as discussed in this series of articles, has a probability of directional continuation of in excess of 80%, and once that direction has been confirmed, target probability in excess of 90%. In other words, once a correctly identified pattern has broken out in the expected direction, there is a 90% or greater probability that it will reach its target. This is very exciting news as we not only know the intended direction, but also the distance to be travelled, or in other words, the minimum expected profit from the transaction. This aids us enormously as it then tells us immediately, with a >=90% probability what reward to risk we are likely to achieve should we enter the transaction. Many of the novice traders amongst us are, at this stage wondering why we should be excited by this, as many are not aware of what good risk management strategies mean, or how they are an integral part of their survival as a trader. Let me digress for a moment. Reward: Risk If you were to risk $1.00 per share on a transaction ($1.00 being the difference between your entry figure and your Stop Loss otherwise known as Trade Risk per share) would you like to see a potential return of $1.00?
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Or would you like to see a potential return of $2.00 per share for each $1.00 risked? Or would you like to see a potential return of $3.00 per share for every $1.00 risked? Or would the potential return which you would like to see, be linked to whether company involved was a blue chip, midcap or speculative company? Personally I like to see a potential return as follows: Blue Chip Mid Cap Speculative 2:1 3:1 5:1
These guidelines have stood both myself, and my fellow students who followed them, in very good stead over the last 10years Thanks Rob. Getting back on track the target allows us to pre plan, with great accuracy, more so than directional change trades, our R:R and therefore confirm whether the trade is viable. Lets get more specific shall we? Pattern identification guidelines: All continuation patterns need to firstly be identified by the formation being a consolidation. After that we get more specific for each type of pattern.
The major advantage with continuation patterns in regard to risk management is that they immediately show you what you R:R (reward to risk ratio) is, therefore allowing greater flexibility in decision making. I will go into this in greater detail in later articles, but I was taught to take into consideration several risk management parameters by my mentor Rob Lennox (also a contributing author to Educated Analyst). I owe a great deal for all the extra time, effort and energy he put into me as I was a student under him learning, essentially, from scratch. The basic risk management parameters Rob taught then were, in combination: Capital Exposure how much capital exposed to a single trade. Capital Allocation how much capital exposed to BC MC S. 2% rule Max of 2% of capital exposed as a trade risk. Reward to Risk parameters.
Flag:
Ascending Descending
Triangle:
Ascending Symmetrical Descending
Pennants:
Ascending Symmetrical Descending
With flags, we need to be able to place a pair of parallel lines around the consolidation (we will call these momentum lines), with at least 2 touches on each of the lines. The upper momentum line needs to be very accurate to ensure highest probability factor. The lower momentum line can be a line of best fit, but it needs to have very little overlap and underlap, which will make more sense with a practical example. In the case of flags, the target is determined in the following way. The distance (price difference) between
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the beginning of the run into the consolidation to the peak of price action, is applied to the lowest point contained within the consolidation, and projected in the same direction as the run into the consolidation. This will make more sense when we delve into the practical examples and show you the targets in real time application. Market Analyst has a great tool to help determine these targets, and this is the Price Extensions tool under the Levels section in Tools. We shall start here with Flags: With a flag, we need to picture what a flag pole with a flag at the top looks like. There is a run upwards, with an object at the top which is rectangular, and stands out from the pole; I have drawn several examples of this in the following chart.
Because price action does not normally travel vertically or horizontally, we must adapt this vision to the reality of normal price action, so what we see in the next 3 examples are the reality of what we need to be able to read on our screens. With a flag formation, examples 2 & 3 are what we are expecting to see in the real world of charts. There is a decisive run upward, followed by a consolidation in the price action. Figures 2 & 3 demonstrate this. The consolidation can be either horizontal or in the opposite direction to the run into it. It CANNOT be in the same direction as some people mistakenly believe, and as is shown on the right side of the example. Let us go back to our definition. There is a decisive run upward followed by a consolidation plus the target is The distance (price difference) between the beginning of the run into the consolidation to the peak of price action, and is applied to the lowest point contained within the consolidation. The figure on the right side of the example does not have a consolidation it has a slow down in price direction. This normally precedes a change in direction, and is a dangerous piece of price action to trade. In addition, there is no way in which to determine the target if it was a flag, as there is no peak in price action yet until it changes direction. I have seen some people, with misinterpreted identification rules, use the illustration on the left only to fail and lose money in most instances - BEWARE THE EXAMPLE on the right.
On the left we see the shape we would actually expect to see with a real flag pole and a flag outside, in the real world, with a moderate wind blowing.
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We are going to look at a potential flag formation as it forms in real time, with real price bars, then we will apply the target identification to it and then determine whether it reached its target or not. Supercheap is the company we will look at in this illustration. We can see that Supercheap changed direction in June 2006, and then had a strong upward run, with a couple of pauses during that run. Is this pause another of what we saw earlier in August & September?? Time will tell. The first thing we need to look at is whether we can apply our parallel lines around the pause at the top of the upward run, and the current answer is yes we can.
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We can see here that there is a little under and overlap on the lower momentum line. This is acceptable for this formation. We can also see that the average ROM within the formation is lower than the average ROM during the run into the peak. What do we do with this chart now? If we believe this is actually a flag, we need to plot targets, determine risk management parameters and providing all is well, place a conditional order for entry should the price breakout next week.
First thing we need to do is apply our market noise parameters to determine entry and stop loss positions. We the need to calculate our Trade Risk per share, then determine the target level. The trade risk per share should be relative to the normal ROM of the share price being examined. In this case we are using an entry stop spread of around 5% or around $0.14. The run starts at $1.55 and goes through to $2.86 before consolidating, giving a pole of $1.31 in length. The lowest price inside the consolidation is $2.65, so when we apply $1.3 to the low, our target price becomes $3.96, which is off the top of the screen in this case. This shows us a very high R:R potential.
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this time the pattern is no longer viable within the same probabilities which we have come to expect. It may be as simple as us being too enthusiastic in the first place and identifying something which wasnt really there Desperation, self confidence, enthusiasm made us see things which werent there in the first place. I know that I have been guilty of this same thing in the past.
Using the vertical line function, we can see where the breakout, if it happens next week, will provide our entry. I do believe in calculating this exactly, as I have seen some very large discrepancies based on the use of cursors and assumption that the line was correctly drawn exactly where it should have been. In this case the entry, should it occur next week, will be approximately $2.84. As we can see in the next chart, our price penetrated the upper momentum line, but not the entry price. However we now have to relocate our upper and lower momentum lines to keep to our identification criteria, as shown below. Sometimes at this point we cannot get a parallel lower momentum line to work properly with minimal under & overlap. Should this be the case, be prepared to discard this as a trading pattern. Observation indicates that at
This week our entry price is approximately $2.83, with our stop around $2.70. So what does next week bring? More disappointment as our price action failed to hit our entry. Damn, this is getting frustrating isnt it?
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Or is it? For every week our price action does not hit our entry price, the entry price falls does it not? The question we need to ask here is, what has happened to our target price, has it fallen, or is it still the same? The fact is that the target has not changed, and every week that our entry price falls without being triggered is increasing the distance between our entry and the target, allowing us to expect a higher amount of profit is it not?
There is no need to worry yet, what happens next week????

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Hooray, our entry is triggered, we are in the trade and expecting to reach our target of $3.96 from our entry price of$2.82, which should show us a nice profit of $1.14 per share, thank you very much. Go you good thing gooooo. Let us jump a few weeks ahead to see what actually happens.
spend the time necessary to become very proficient in the use and application of these, and other techniques, will be in the best position to make large profits from these situations as they arise in the future. My own experience has shown that with patterns, when they are correctly identified, they usually reach their targets within 10 weeks. The normal profit seems to fall into the 17 22% range per transaction as an average. There is nothing wrong with these figures, and they are very good if you are able to consistently identify correctly continuation patterns in excess of 80% of the time. Let us also bear in mind, that even those patterns which do not reach their targets still give you an opportunity to make a profit. Imagine with Supercheap if it only reached $3.50 and then fell away, an effective trailing stop would have locked in some profit, albeit not as much as we ended up with, but still a good profit. Continuation patterns are a highly reliable, very profitable entry technique. Next time we will explore triangular patterns. These patterns have their own unique quirks, and we will explore these in detail. Until then may the markets go with you (thanks for that saying Rob), and have an awesome time. Pete
Supercheap reached its target in 10 weeks. We would have made $1.14 profit from a $2.83 entry or 40.28% profit from our entry price. This is not a normal profit to be expected from a pattern entry. Reality needs to step in here and bring us back to earth. This was a continuation pattern entry during what was to become the biggest Bull Run in living memory for most of us. These were exceptional circumstances and should not be expected to be repeated within the near future. Make no mistake, however, these sort of situations will repeat themselves. Markets have cycles, they have booms and busts, and those who do the work now, who are consistently accurate in their determinations, who
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About Peter Varcoe Peter started learning about trading with Wallstreet Group from Melbourne in 1999. He then joined the company to head up the Queensland Branch in March 2000. He left Wallstreet Group during 2002 and Joined Stock Market Investors Group to help with their program of educating Primary Producers, and for the next 2 years was educating Primary Producers in Victoria, Queensland and Western Australia. Peter joined Australian College of Financial Education as Senior Lecturer in 2005 and contracted to them for education, a position which he still holds today. Peters experience is mainly in shares and CFDs but Forex is filtering its way into his trading for future incorporation. He has done many thousands of hours work with patterns, in particular, flags, pennants, triangles and has developed some very specific, reliable techniques around these continuation entries. Peter heads up Aztec Trading & Training which is a subsidiary of WIN Financial Group incorporating WIN Financial Network and WIN Investors Club. Peter Varcoe can be contacted PeterV@WinFinancial.com.au. through his e-mail
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An introduction to
EXCHANGE-TRADED FUNDS (ETFs)

With Mike Smith
An exchange-traded fund, or ETF, is a basket of securities (forming a fund) that trades like shares on major stock exchanges. The securities that make up an ETF can be varied and may include such things as stocks, bonds, commodities, or currencies. An ETF may track the performance of a broad index, like the S&P 500, or it may track a specific countrys index or sector.
requirements of the fund. Some funds are made up of a basket of shares, but it is important to note that this may not necessarily be the case.
One of the major benefits of ETFs is the ability to trade options of the underlying ETF
Trading the underlying commodity via an ETF may be purer than trading a resource stock if you want exposure to the movement of that specific commodity
Other ETFs may have exposure to futures contracts, or currencies. This can be seen as an advantage, as the movement of a particular commodity future e.g. Oil, is often thought of as being Purer than oil or gold stocks which are of course exposed to different forces as well as the underlying commodity. Although ETF trading decisions in terms of entry and exit can be made from a technical perspective, it is essential that the trader does the appropriate due diligence in 3 key areas. Logically, it would be fair to say these are the first 3 golden rules of investing in ETFs and are to: a. Know the component parts that make up the
In practical terms, this gives the trader the opportunity to better meet their own investment purpose with exposure with relative ease to markets and vehicles which may be otherwise difficult or complicated to trade.
ETFs give the trader a relatively easier opportunity to trade vehicles and markets which may be otherwise difficult or more complex to trade
fund. b. Ensure a good correlation exists with the particular index or vehicle for which the trader wants exposure. c. Develop an understanding of the factors influencing a particular asset class for relevant funds e.g. commodities or currency ETFs. While an ETF as an investment vehicle may be similar to a mutual or managed fund, there are differences which make these particularly attractive to traders who wish to retain more control over their investing than would be standard with a mutual/managed fund.
The tradable value of the fund i.e. what you can buy or sell for, is defined as with any asset class by the market. In this case the pricing of an ETF reflects the total value of assets held within the fund and will alter during market hours as the value of its component parts changes. There are over 20 companies who offer ETFs. As part of the responsibility of the issuing company, the composition of the ETF must be defined as part of the
An Introduction to Exchange- Traded Funds (ETFs)
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The first and perhaps key difference is that an ETF trades during market hours like an individual stock and can be bought and sold continuously until market close. ETFs can also be sold short (dependent on your broker) unlike funds, but of major interest to many traders is that many (but not all) ETFs are Optionable (i.e. you have the capability to trade options strategies in that particular ETF). This provides the options savvy trader with the chance to use strategies they are already familiar with to access markets and vehicles that otherwise would require much in additional learning, account set-up and complexity. ETFs can be actively or passively managed dependent on the specific management objectives of the fund. In the former of course, the component parts of the fund may change more readily than that of its passive counterpart.
a. Index ETFs As the name suggests, the most common of ETF, the index ETF, tracks the specific chosen index of the fund to attempt to replicate the performance of that index. The index fund either holds the contents of the index or a representative sample of the securities in the index in its portfolio. An example of an index ETF would be (QQQQ), which tracks the NASDAQ 100 index. Some index ETFs invest 100% of their assets proportionately in the securities underlying an index, termed "replication". Other index ETFs use "representative sampling", investing 80% to 95% of their assets in the securities of an underlying index and investing the remaining 5% to 20% of their assets in other related asset classes, such as futures, option and swap contracts, and securities not in the underlying index. The final method occasionally used by a fund manager would be so called aggressive sampling where investment is in only a small number of the underlying securities. This would be used for index ETFs that invest in indexes with thousands of underlying securities. See also leveraged, bear/short ETFs and sizerelated ETFs in the later section for common variations particularly (though not exclusively) regarding the index ETF type. Examples:
Checking the sampling technique of the index fund will assist in deciding whether this ETF is the most suitable
Types of ETF Dow Jones DIA There are many different types of ETFs. As previously stated, this key advantage to the trader in terms of opportunities to trade markets that would otherwise be more difficult provides an exciting array of strategies dependent on the individual trader purpose. There are various ways of classifying the types of ETF. Some may be articulated perhaps a little differently than in other things you may have read. This does not really matter, however it is essential that you adhere to the first of the 3 golden rules that were outlined earlier. S&P500 SPY NASQAQ - QQQQ b. Commodity ETFs
Commodity ETFs invest in commodities, such as actual or futures in precious and non-precious metals and other commonly traded commodities. Commodity ETFs
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generally are viewed as index funds, but track nonsecurities indexes.
c. Bond ETFs Exchange-traded funds that invest in U.S. Government bonds are known as bond ETFs. There are specific points in an economic cycle where exposure to bond ETFs may be advantageous. They tend to do particularly well historically during uncertain economic times because traders pull their money out of the stock market and into U.S. Treasuries. Additionally, there may be benefits in terms of alternative asset exposure within a selfmanaged superannuation fund, again with relative ease. The use of options with bond ETFs may therefore offer opportunities irrespective of economic conditions. Examples: 10 year bonds TLT High yield bonds JNK
Checking the correlation between a commodity ETF/ETC and the actual underlying commodity is essential prior to making your investment decision
Exchange Traded Commodities (ETCs) which operate in exactly the same way as far as the trader is concerned as an ETF, are investment vehicles that track the performance of a single underlying commodity index, including total return indices based on a single commodity. ETCs trade just like shares, are simple and efficient and provide exposure to an ever-increasing range of commodities and commodity indices, including energy, metals, soft commodities and agriculture. Although there is usually a good correlation between a commodity ETF/ETC and the underlying commodity, it is important for a trader to recognise that there are often other factors that may affect the price of a commodity ETF that might not be immediately obvious. In the case of many commodity funds, they simply roll front-month futures contracts from month to month which may add additional expense in the rollover process. Having said this, there is little doubt that in the majority of situations the ETF will track the underlying commodity much closer than that of a commoditybased stock. Examples: Oil USO Gold GLD Agriculture DBA SLV Silver
Trading options on currency ETFs gives you exposure to movements in currency without having to learn how to trade Forex
d. Currency ETF or ETCs A currency ETF provides traders the ability to track the performance of various currencies throughout the world, such as the U.S. dollar, Japanese yen, British pound, or Euro. Also, there are some funds which expose the trader to a basket of currencies V the US dollar. There are many variations on this theme, including the ability to access long or short currency funds. As well as for general investment purposes, there may be distinct
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advantages to those involved in import/export or exposed to overseas investments as a hedge against adverse local currency movement. Examples:
options available over their stocks, and so offers this opportunity also to the ETF trader. Examples: China - FXI
UUP Dollar index (bullish) Brazil EWZ FXA AUS/USD Emerging markets - EEM FXE EUR/USD g. Other ETF Variations e. Sector ETFs A sector ETF holding represents a segment of an economic market. Common sectors include Basic Materials, Consumer Goods, Financial, Government, Health Care, Industrial Goods, Services, Technology, and Utilities. Commonly these are stocks representative of that sector. Again, investing in these may give you easy access to a recognised sector without the exposure to specific company risk. Examples: Financial XLF Gold stock GDX Materials XLB f. Country ETFs A country-specific ETF tracks the performance of the economies of an individual country. As the ETF availability grows, more countries are being added as well as grouping of countries e.g. emerging markets. Additionally, there are ETFs whose securities track a specific region such as Europe. The obvious advantages to traders are the exposure to countries which may otherwise be difficult to access (e.g. China), and of course many countries do not have exchange traded a. Large-cap (larger than $10 billion) b. Mid-cap (a range of $2 billion to $10 billion) c. Small-cap (a range between $300 million and $2 billion) d. Micro-cap (a range between $50 million to $300 million) ii. Leveraged ETFs There are three other variations on the ETF theme that are worth mentioning. These are size-specific, leveraged and short/bear market ETFs. They are commonly utilised, though not specifically, with some index ETFs. i. Size-specific ETF
A size-specific ETF is defined by the market capitalization of the individual holdings within the fund. There are 4 standard types of market cap classification, though these differ from country to country. In relation to the US markets the following is a common distinction:
This type of ETF provides traders with the prospect of amplifying their returns when the market responds in a specific direction. Traders must note that should that direction be against the desired one, the result will be magnified losses instead of gains.
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Again this provides some justification for looking at options, as the risk of such an adverse move is capped with many options strategies.
As with any leveraged market vehicle, leveraged ETFs can magnify losses as well as profits
iii.
Short or bear market ETFs
A short or bear market ETF is becoming a popular way for many traders to hedge their portfolio for downside risk in the markets, and returns the inverse or opposite of an underlying index. So in essence this may be useful in down trending markets that a specific fund is exposed to. Having said this are two reasons why a decision not to enter these may be taken. Firstly, there is a risk to the upside should the movement in the fund components occur. Secondly, the opportunity to enter options positions to either hedge or profit from downturn through the use of a Put Option, for example, may make these less popular and seen as unnecessary with some traders.
b. As with any traded option strategy, liquidity of the option NOT the liquidity of the underlying asset (in this case the ETF) is a vital consideration whether such is suitable to trade or not. c. Defining trader purpose should be your primary guide in selection of option strategy over your chosen ETF. d. The rules of any trading game are to have a plan, trade your plan and review your plan often. e. Covered Call options may be sold over an ETF in the same way as with holding stock. Delivery of the underlying ETF is required should the call be exercised. f. As with many options strategies most positions will be closed prior to expiry or exercise unless it is desired and it is likely that they will expire worthless. g. Option expiry is the same as for security options in most countries. h. Some care must be taken in ETFs with asset classes that trade over the 24 hour period e.g. forex, commodities as ETFs may only be traded in US market hours. In reality however, this is no different really to having some exposure to a resource stock where the underlying commodity over the 24 hour period may move whilst the resource stock is not tradable. Nevertheless it is an important consideration. Trader Requirements What you need: a. The required knowledge so that you have a good understanding of how equity markets work, ETFs and options over ETFs. b. Trading software with relevant ETF codes as it is these that will assist you in your entry and exit decision-making.
Trading short or bear ETFs may be less necessary if you are an options trader with the ability to trade Put Options
Using ETF Options A few key points about the options capabilities of ETFs: a. Not all ETFs are optionable.
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c. Broker accounts that not only allow ETF trading in the originating country but also the capability to trade options over the ETF. It is an advantage if trading across time-zones to have the ability to place conditional orders. d. A trading plan for every ETF option strategy you are choosing to trade. Summary ETFs offer the trader an incredible opportunity to invest in alternative trading ideas with ease of access and the same trading plan you would use for shares. Those who are able to trade options are presented with an awesome array of potential investment opportunities to not only profit from any market direction, but also to hedge a portfolio easily, or even a business or property portfolio. So the question is surely not why would you look at ETFs, but why wouldnt you??
Horizon Professional is a leading provider of meaningful wealth education. For those who attend our courses and use our products you will maximise your chances of creating a measurable difference in your knowledge, facilitating you to move towards your financial, and so lifestyle goals. Our educational programmes with a focus on using share market products as part of your overall wealth creation, and strategic alliances developed with other leading edge wealth creation companies, will provide you with the tools to make a difference to your life. Through our courses and products you will learn the POWER of our Lifestyle Objective Trading System that will accelerate turning your dreams into reality.
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EMOTIONAL STAGES OF A TRADE

with Chris Collingwood
hen we think about trader education, most peoples attention goes towards learning to use technical analysis or fundamentals, choosing sources of information and making sense of them with intent to identify potentially profitable positions. The media report changes in the markets and in some of the fundamentals that influence them. The psychological states of traders rarely get a mention, yet these have an enormous impact on individual traders results. Emotions influence our capacities to take in information, process it and make functional decisions, and the feedback for a trader is instant. We are not proposing that an alert, embodied, flow state will guarantee results by itself, but in combination with a good trading system and plan, it will contribute to effective decision making and hence, profits. To foster an understanding of the scale of problems many traders experience with trading emotions, we will outline below the different stages of a trade and events that can happen to induce emotional difficulty for traders. Stage 1 - Commencing a trade. When novice traders place a trade, there is often a mix of emotions. Excitement may be experienced about the potential for profit; fear about the potential for loss. Hesitation is often experienced if the trader is unsure about trading or about the position. These things can all happen at once or in sequence. Psychological research has identified this common thought process. Once a decision is made, whatever the subsequent result, people look for evidence that they have made the right decision after they have made it. Their perception of the probability of the identified outcome increases after the decision has been made. Once a trade is taken, novice traders often experience the decision as being the correct one.
Stage 2 - Option 1 - The trade goes into profit When a trade goes in the correct direction, novice traders experience a flush of excitement and joy. They were right and they begin hallucinating what they can or will do with the money they will make from the trade. They begin hoping and wishing for it to go higher. The higher and faster it goes up, the more excitement they feel. Stage 2 - Option 2 - The trade goes into loss Hopes are turned to dust as a great idea is smashed by an uncaring market. The emotions generated by this event can range from mild annoyance at the trade not going right, to fearful anxiety, to a complete inability to think. Stage 3 - Its time to get out. At the time to get out, traders can be experiencing a mix of emotions. If the trade went well they can extremely joyful. If they got out at a massive loss, they can be filled with panic and intense regret at staying in for so long. Often traders can feel that the market is against them personally. Doubt and self-reproach are common when exiting at a large loss. Stage 4 - Post trade emotions. The post trade emotions can vary depending on the outcome of the trade. They can vary from wild exuberance and ongoing joy if exiting at a large profit, to devastation and recrimination if exiting at a large loss. Regret is a very common post trade trading emotion. Traders often regret getting out if the stock goes on to higher prices. Alternatively, they can regret not getting out earlier if an exit signal was presented and not taken immediately.
Emotional Stages of a Trade
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The technical merits of the trade are rarely considered in the aftermath, nor how well the trade was executed. Yet these are essential considerations that support long term trading survival and success. You probably recognized some of these experiences from your own trading history. At times it may have seemed that you were the only one in the experience. However, everyone who has traded will have had some of these experiences. Key Understandings Since different emotions arise at different parts of a trade, its possible to predict the likelihood of their occurrence. The emotions that take place at different parts of a trade are occurring at that stage because, without being conscious of it, you have identified something important that is out of place. The natural response is strong sensation around the midline of the body, which may be called excitement when the anomaly is pleasing, or anxiety, regret (etc) when the anomaly is displeasing. For example, the emotion of regret for doing something that cost you money serves a purpose of letting you know not to do it again. The emotion of excitement for making a very good trade serves the purpose of rewarding you to do the behaviour again. In Summary: Trading Emotions are functional and they serve a purpose. Trading Emotions have repeatable structures and patterns. They are communications from your unconscious mind to protect and serve you. Knowing the patterns enables you to have choice about which emotions to have at what time. How to use this information Knowledge leads to choice and functional action. Knowing about yourself and how you respond to your environment allows you to engage the environment and respond to it as you choose, instead of repeating actions the way you were programmed from the past.
When you appreciate that you may experience different emotions at different stages of a trade, you will be able to notice when they are beginning and not allow them to cloud your judgment. Noticing your emotions can also serve as a trigger to focus you back on the technical aspects of your trade. After you exit a trade, it can be helpful to reflect on what emotions you were experiencing while entering or exiting the trade. This can assist you in preventing lossmaking trades in the future. When you know your emotions can affect your trading, you can learn to use them deliberately, to help you become a better trader and make your trading more profitable. Improving your trading can be assisted greatly by understanding your own emotional patterns and learning effective ways to improve or vary your emotional responses.
More about us:
Trading State Pty Ltd is a company committed to assisting traders to deal with the emotional aspects of trading and to improve their trading performance. We offer training courses and coaching in state management and emotional flexibility for traders. If you think you have had problems with the emotions of trading, you are not alone. Together we have over 30 years experience in assisting traders to achieve better performance in their trading and in trading ourselves. Whatever issue you have with your trading experience, we can assist you. For more information about us visit our website. Chris Collingwood Dip. TAS, BA (Psych), Grad. Cert. NLP, MAppSci. (Social Ecology) Chris has been working in designing and teaching accredited training courses and coaching for over 25 years. He has a particular passion for working with market traders in developing emotional choice about how they operate when making and executing trading decisions. Trained in psychology, his area of interest is in applied cognitive psychology for the study of expertise and expert performance. He first became interested in financial trading when he and his life partner were engaged to model the expertise of a well known trader. In addition to private one on one trader coaching, corporate clients have included National Westminster, Societe Generale Australia.
Emotional Stages of a Trade
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A Free Technical Analysis E Magazine for Traders of Financial Markets

Volume 2 Issue 4 JUL / AUG 2010

HOW DO YOU AVOID THE PITFALLS OF MARKET MANIPULATION?

Inside this issue...

4 SOMETHING STINKS IN THE U.S

33 AN INTRODUCTION TO EXCHANGETRADED FUNDS (ETFS)

7 SOME OF THE MOST WIDELY TRADED

39 EMOTIONAL STAGES OF A TRADE

12 Q&A RAY BARROS

15 MOVING AVERAGES IN THEORY AND

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SOMETHING STINKS IN THE U.S

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Something Stinks in the U.S

Best wishes to all, Alan Oliver.

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SOME OF THE MOST WIDELY TRADED STOCKS ON ASX MAY 10

The Educated Analyst |

Some of the Most Widely Traded Stocks on ASX May 10

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

Some of the Most Widely Traded Stocks on ASX May 10

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

Some of the Most Widely Traded Stocks on ASX May 10

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

Some of the Most Widely Traded Stocks on ASX May 10

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

Some of the Most Widely Traded Stocks on ASX May 10

About The Nature of Trends

About Ray Barros

The Educated Analyst |

The Educated Analyst |

The Educated Analyst |

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

The Educated Analyst |

The Educated Analyst |

The Educated Analyst |

(3) ASX 200 20 Pt 1 box P&F to 20/5/10

The Educated Analyst |

The Educated Analyst |

Continuation Patterns Continued

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Ascending Symmetrical Descending

Ascending Symmetrical Descending

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Continuation Patterns Continued

JULY /AUG 2010

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

Continuation Patterns Continued

JULY /AUG 2010

Source: Market Analyst 6 (www.Market-Analyst.com)

The Educated Analyst |

Continuation Patterns Continued

JULY /AUG 2010