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A Adaptive techniques adaptive intraday breakout system, 748749 adaptive momentum calculations dynamic momentum index, 747748 trend-adjusted oscillator, 747 variable-length stochastic technique, 746747 adaptive process, 749750 development example, 749750 adaptive trend calculations alternate choices for varying the trend period, 739740 correlation coefficient, r 2, 739740 Chandes Variable Index Dynamic Average, 736 comparison, 741 Kaufmans Adaptive Moving Average. See Kaufmans Adaptive Moving Average making momentum calculations adaptive, 740 Master Trading Formula, 745746 McGinley Dynamics, 742 MESA Adaptive Moving Average, 737739 overview, 731 Parabolic Time/Price System, 742745 programming adaptive RSI, 740741 considering adaptive methods, 750751 overview, 731 Advanced techniques chaotic patterns and market behavior, 826827 conditional entropy, 827829 expert systems. See Expert systems fractals. See Fractals fuzzy logic. See Fuzzy logic genetic algorithms. See Genetic algorithms

measuring volatility. See Volatility, measuring neural networks. See Neural networks overview, 791, 845846 price-volume distribution, 811812 trade selection Bierovics On-Balance True Range, 810811 overview, 810 predicting volatility with trading ranges, 810 trends and noise, 812815 Anti-Martingales, 957958 Arbitrage butterfly spreads, 536537 institutional arbitrage finding representative subset of an index, 527 overview, 525 program trading, 525526 intercrop spreads, 534536 intermarket index spreads, 528530 creating a ratio chart, 529530 overview, 520521 pairs trading, 530 pricing of futures contracts Class B arbitrage, 525 crossrate matrix evaluation, 523525 interest rate parity, 522523 overview, 521 storable commodities, 521522 product spreads crack spread, 533534 overview, 531532 reverse crack, 534 soybean crush, 532533 single stock futures and underlying stock, 527528 stock and futures relationships, 531

CO

PY

RI

GH

TE

MA

TE

RI

AL

1157

1158

INDEX

ARIMA (Autoregressive Integrated Moving Average) estimation: determining the coefficients, 240241 forecast results, 241 Kalman filters, 243 overview, 237239 specification, 239240 trading strategies, 241243 countertrend indicator, 242 following the trend, 242 slope, 242243 use of highs and lows, 242 Arithmetic mean, 1920, 26 Arms Index, 504 Artificial intelligence, 696697. See also Pattern recognition, computer-based Asprays Demand Oscillator, 495496 Astrology, financial Jupiter-Saturn cycle, 613616 major physical events lunar eclipses, 624625 lunar phases, 619623 overview, 616618 solar eclipses, 623624 overview, 612613 Average, 1922, 2627 Average Directional Movement Index, 10151017 B Bands and channels changing price objectives with channels, 114115 moving channels, 145146 time-based trend systems Bollinger bands, 294295, 299 compromise between reliability and delay, 298299 overview, 292293 rules for using bands, 295297 timing the order, 297298 volatility sensitive bands, 293294 Bar chart Dow Theory. See Dow Theory long-term more reliable than short-term trends, 122123 multiple signals, 123 overview, 6364 pattern failures, 123125

price objectives for common elements of profit objectives, 113 overview, 112113 profit targets for consolidation areas and channels, 113115 targeting profits after tops and bottoms calculating profit target, 115116 head-and-shoulders price objective, 116 overview, 115 profit targets after bottom formation, 116 rule of seven, 117118 triangles and flags, 116117 testing your skill, 125126 trends easier to spot in retrospect, 122 Bayes theorem, 4950 Bear spread, 553554 Bear trap, 124125 Behavioral techniques Commitment of Traders Report. See Commitment of Traders Report Elliotts wave principle. See Elliotts wave principle event trading. See Event trading Fibonacci and human behavior, 587590 financial astrology. See Astrology, financial Fischers Golden Section Compass System, 603606 Ganns approach to time and space geometric angles, 608, 611612 hexagon chart, 608 overview, 606607 time and price, 607 measuring the news market selectivity, 566 media indicators, 566567 overview, 561563 ranking and measuring, 562565 trading on the news, 565566 opinion and contrary opinion Commitment of Traders Sentiment Index, 584585 contrary opinion, 581584 Dogs of the Dow, 585586 lesson from put-call ratios, 585 overview, 581 Small Dogs of the Dow, 585586 watching big block transactions, 586 overview, 561 price target constructions using Fibonacci ratio, 601

Index

1159

Benchmarks, 881882 Bias, 17, 873 Bierovics On-Balance True Range, 810811 Bollinger bands, 294295, 754755 Bolton-Tremblay approach, 503504 Bottoms and tops double and triple tops and bottoms, 100104 danger of trading, 104 extended rectangle bottom, 105106 head-and-shoulders formation, 108110 trading rules for, 110 overview, 97 rounded tops and bottoms, 106108 V-bottoms, 100 V-tops, 97100 wedge top and bottom patterns, 108 Breadth. See Volume, open interest, and breadth Breakaway gap, 8283 Bullish Consensus, 582583 Bull spread, 553554 Bull trap, 124125 Butterfly spreads, 536537 Buy and sell signals, 288292 C Candlestick charts overview, 118120 pivot points and candle charts, 121122 quantifying candle formations, 121 Caps, 8788 Central tendency, measures of, 25 Chandes Variable Index Dynamic Average, 736 Channels. See Bands and channels Charting basics accumulation and distributionbottoms and tops double and triple tops and bottoms, 100104 danger of trading, 104 extended rectangle bottom, 105106 head-and-shoulders formation, 108110 trading rules for, 110 overview, 97 rounded tops and bottoms, 106108 V-bottoms, 100 V-tops, 97100 wedge top and bottom patterns, 108 bar chart. See Bar chart

candlestick charts, implied strategies in, 118122 chart formations overview, 73 trend in retrospect, 7374 chart trading, basic concepts in major and minor formations, 96 market noise, 9697 continuation patterns flags, 94 overview, 92 pennants, 9495 run days, 96 triangles, 9293 wedges, 95 episodic patterns, 111112 finding consistent patterns causes of chart patterns, 6062 overview, 60 major price moves and trends, 6263 one-day patterns gaps, 8284 inside days, 9092 island reversals, 8688 key reversal days, 8990 outside days, 9091 overview, 82, 92 reversal days, 8890 spikes, 8586 wide-ranging days, 9091 overview, 5960 price objectives for bar-charting. See Bar chart, price objectives for price pattern evolution, 126127 systems and techniques. See Charting systems and techniques trendlines confirming new trend direction, 7778 creating channel with, 8081 identifying direction from consolidation patterns, 7980 overview, 74 position of closing price of bar, 76 redrawing, 7475 resistances becomes support and support becomes resistance, 77 rules for using, 77 support and resistance lines, 7576 as support or resistance lines, 77 trading rules for horizontal support and resistance levels, 7879

1160

INDEX

Charting systems and techniques action and reaction Fibonacci ratios, 135136 overview, 134135 percentage retracements, 138142 Trident Commodity-Trading System, 136138 Tubbs Law of Proportion, 136 basic principles of charting. See Charting basics channel breakout, 142145 combining techniques, 147 complex patterns, 147150 DeMarks Sequential, 148150 Dunnigan and the Thrust Method One-Way Formula, 131132 overview, 129130 Square Root Theory, 132 Thrust Method, 130131 moving channels, 145146 Nofris congestion-phase system, 132134 outside days with an outside close, 134 overview, 129 study of, 150152 Chi-square test, 10391042 Class B arbitrage, 525 Cleaning data, 937938 Commitment of Traders Report creating oscillator for COT numbers, 579580 trading signals, 580 overview, 576579 Commitment of Traders Sentiment Index, 584585 Commodex method of combining elements, 968970 Commodity Selection Index, 1013, 1017 Computer, use and abuse of acquiring data, 937938 cleaning the data, 937938 combining standard techniques into a system, 938939 expectations, 943944 it should work, but it doesnt, 941 isolating problems, 942943 maybe it does in theory, 944946 transparent or complex solutions, 942 vertical or integrated solutions, 941942 looking into the past, 940 overview, 936937

paper trading, 940941 programming a new idea, 939940 simple or complex?, 944 start slowly, 946 winner in disguise, 944 Confidence bands, 223224, 244245 Contingent probability, 45 Continuation patterns flags, 94 overview, 92 pennants, 9495 run days, 96 triangles, 9293 wedges, 95 Continuous forecasting, 132 Contrary opinion, 581584 Correlation coefficient, r 2, 220, 246247, 739740 Crack spread, 533534 Cups, 8788 Cycle analysis cycle basics Kondratieff wave, 450, 452 observing the cycle, 448450 cattle cycle, 448449 overview, 448 Swiss Franc cycle, 450 overview, 447448 terminology, 452453 cycle channel index, 478480 maximum entropy finding the cycle using Hilbert Transform, 473476 Fisher Transform, 476478 overview, 471 using phase angle, 472473 Ehlers lateral shift in thinking, 472473 overview, 447 phasing, 480482 uncovering the cycle enhancing the cycle: removing the trend using triangular weighting, 453454 Fourier analysis. See Fourier analysis overview, 453 trigonometric price analysis, 454461 two-frequency trigonometric regression, 461463 D Data and averaging, 17 bias in data, 17

Index

1161

data that is no longer useful, 18 economic data, 17 how much data is enough? law of averages, 16 quality of data used, 18 safety first, 19 sample error, 1718 Davis and Thiel system tests, 901 Day trading applicability of trading techniques choosing length of intraday bar, 712713 moving averages, 711712 uneven price bars, 712 overview, 706707 point-and-figure for short-term trading, 709710 time of day patterns, 707709 trading in wrong time zone, 709 impact of transaction costs estimating slippage costs, 704706 liquidity markets with trading limits, 704 mean-reverting strategies, 703 missed orders, 703704 overview, 702 overview, 700702 liquidity, 702704 overview, 699700 trading using price patterns intraday breakout systems overview, 720 opening range breakout breakout ranges based on time, 722724 filtering opening range breakout, 727 Fishers opening range breakout, 724727 overview, 720721 Raschke trades Crabel, 722 overview, 713 special set-up patterns for stocks day trades following wide-ranging bar, 728 overview, 728 reversal bar set-up, 729 support and resistance, 713715 Taylor trading technique, 715720 practical approach to trading Taylor, 719720 Taylors 3-day trading method, 718719

Demand. See Supply and demand DeMarks projected ranges, 629630 DeMarks Sequential, 148150 Dispersion, 27 Diversification and portfolio allocation classic portfolio allocation calculations, 10481050 spreadsheet approach, 1050 diversification, 10441048 Kaufmans genetic algorithm solution to portfolio allocation. See Kaufmans genetic algorithm solution to portfolio allocation overview, 10431044 portfolio allocation using Excels Solver, 1050, 10521053 test interval for portfolio allocation, 1082 Dogs of the Dow, 585586 Donchians 5- and 20-day moving average system, 336337 Donchians Four-Week Rule, 202203 Double tops and bottoms. See Bottoms and tops Dow Theory basic tenets 1. Averages discount everything (except acts of God), 65 2. Three trend classifications: primary, secondary, and minor day-to-day fluctuations bear market phases, 69 bull and bear market formation (monthly or weekly prices), 6668 bull market phases, 68 minor trends (using daily prices), 70 overview, 66 secondary trends (secondary reactions using weekly or daily prices), 6970 3. Principle of confirmation, 70 4. Volume goes with the trend, 70 5. Only closing prices are used, 70 6. The trend persists, 71 futures markets and, 72 interpreting todays S&P using, 7172 overview, 6465 Dunnigan and the Thrust Method One-Way Formula, 131132 overview, 129130 Square Root Theory, 132 Thrust Method, 130131

1162

INDEX

E Elders Triple-Screen trading system, 781783 Elliotts wave principle automating Elliotts wave analysis, 596600 fitting the market to the patterns, 593 overview, 590592, 600601 sideways markets, 593 supercycle, 596 trading Elliott, 595596 use of Fibonacci series, 594595 Entropy conditional entropy, 827829 maximum finding the cycle using Hilbert Transform, 473476 Fisher Transform, 476478 overview, 471 using phase angle, 472473 Ehlers lateral shift in thinking, 472473 Equity trends, 10281029, 10311032 Event-driven trends constructing swing chart using a swing filter. See Swing filter, constructing a swing chart using N-day breakout (rolling breakout). See N-day breakout overview, 153 point-and-figure charting. See point-and-figure charting swing trading, 153155 Event lag, trading, 571 Event trading key government reports, 570571 market reactions to reports, 568569 measuring an event, 569570 overview, 567568 presidential election cycle, 574576 Raschke approach, 574 results of event studies, 571574 reaction to unemployment reports, 573 trading reaction of treasuries to economic reports, 574 trading the event lag, 571 Exhaustion gap, 83 Expert systems description, 815816 forward chaining, 816817 technical expert system, 817818 Exponential curves, 228229

Exponential smoothing. See entry under Time-based trend calculations Extended rectangle bottom, 105106 F Fat tail, 286287 Fibonacci ratio, 135136, 783 Elliotts use of, 594595 human behavior, 587590 price target constructions using, 601 Fischers Golden Section Compass System filtering highs and lows, 606 overview, 603 price goals, 605606 time-goal days, 604 Fishers opening range breakout, 724727 Following Adaptive Moving Average, 737 Forecasting and following comparing errors of different time intervals, 253 error analysis, 251253 forecast error and risk of trend trading, 255 least-squares model, 251 limiting forecast to direction, 253254 overview, 249250 using error analysis for trading, 255 Fourier analysis overview, 464 spectral analysis, 464465 using a fast transform program, 468469 using Excels Fourier analysis, 469471 weighting factors, 466468 Fractals fractal dimension, 824825 overview, 824 using fractal efficiency, 825826 Frequency distributions, 2325 Fuzzy logic candlestick example, 821824 common approach to fuzzy solutions, 820821 description, 818819 fuzzy reasoning, 819 G Gambling techniquesthe theory of runs anti-Martingales, 957958 complex Martingales, 961962 delayed countertrend entry into a run, 962963 Martingales, 955957

Index

1163

overview, 954955 trading with overview, 958 system trading, 960961 trading daily sequences, 958, 960 Genetic algorithms converging on a solution, 844 fitness, 841 initial chromosome pool, 840841 massive testing, 874876 mating, 843 mutation, 843844 overview, 838 portfolio allocation with. See Kaufmans genetic algorithm solution to portfolio allocation propagation, 841842 representation, 839840 simulated performance, 844 Geometric mean, 2021, 26 Golden Compass. See Fischers Golden Section Compass System Golden rectangle, 601 Government reports, 570571 H Harmonic mean, 2122, 26 Head-and-shoulders formation, 108110 Herrick Payoff Index, 381382, 490 Hirsch stock market strategy, 443 Hochheimer system tests, 903917 Holiday effect for stocks, 437, 442 I Indices constructing an index, 41 cross-market and weighted index, 43 leveraged long or short index funds, 4142 overview, 4041 Institutional arbitrage, 525527 Intraday breakout systems, 720 Intraday volatility and volume, 801802 J January effect for stocks, 443 Joint probability, 45 Jupiter-Saturn cycle, 613616 K Kalman filters, 243 Kaufman on stops, 10051006

Kaufmans Adaptive Moving Average choice of volatility, 734 description, 731733 programming, 735 small moves in one direction, 734 time period for ER, 733734 trading with, 735 Kaufmans genetic algorithm solution to portfolio allocation constraining diversification, 1060 genetic algorithm solution, 10601082 modern portfolio theory, 10541055 objective function and target risk level, 10571058 optimal portfolio, 10581059 overview, 1054 portfolio constraints, 1059 special case for active trading, 10551057 Kaufmans strategy selection indicator, 10201022 Keltners Minor Trend Rule, 163164 Kondratieff wave, 450, 452 Krauszs multiple time frames, 783786 Kurtosis, 3233 L Least-squares method, 212214, 226227, 236237, 251 Leverage overview, 10001001 reserves, 10011002 Linear correlation computer programs to find correlations, 222223 correlation adjustments when using a time series, 223 forecasting using regression, 223224 confidence bands, 223224 overview, 220222 Linear regression calculating best straight-line fit corn explained by soybeans, 214217 gold and Barrick Gold Corporation, 218219 method of least squares, 212214 overview, 212 explaining, not predicting, 212 overview, 211212 programming and spreadsheet tools, 220

1164

INDEX

Liquidity day trading markets with trading limits, 704 mean-reverting strategies, 703 missed orders, 703704 overview, 702 risk control, 988990 Livermore system, 158160 failed reversal, 159160 Logarithmic curves, 228229 Lunar eclipses, 624625 Lunar phases, 619623 M Marginal probability, 45 Market Facilitation Index, 513514 Market Profile, Steidlmayers. See Steidlmayers Market Profile Market Sentiment Index, 582 Markov chains, 4649 Martingales and anti-Martingales, 955958, 961962 Master Trading Formula, 745746 Maxwell system tests, 902903 McClellan Oscillator, 504 McGinley Dynamics, 742 Media indicators, 566567 Median, 25, 27 Merrills intraday patterns, 632633 MESA Adaptive Moving Average, 737739 Mode, 2526, 30 Modeling human behavior, 837838. See also Behavioral techniques Momentum and oscillators double-smoothed momentum adding volume to momentum, 379380 double-smoothed stochastics, 377 forecast oscillator, 378379 Herrick Payoff Index, 381382 oscillator to distinguish between trending and sideways markets, 379 scaling by a percentage or volatility, 380 TRIX, 378 True Strength Index, 376377 volume, 382 volume-weighted RSI, 380381 hybrid momentum techniques combining a trend and an oscillator Cambridge Hook, 389 Directional Parabolic System, 388389 moving average projected crossovers, 387

momentum characteristics of, 349351 as the difference between price and trend, 352 high-momentum trading, 357358 identifying and fading price extremes, 354357 moving average convergence/divergence (MACD), 358360 overview, 348349 as a percentage: rate of change, 351 profit targets for fading extreme moves, 357 timing an entry, 353 as a trend indicator, 353354 momentum divergence example using momentum peaks, 391392 identifying divergence using a computer program, 394399 overview, 389391 slope divergence, 399401 trading rules for divergence, 392394 oscillators overview, 360361 relative strength index, 361364 Relative Vigor Index, 375 stochastics, 364369 Williams oscillators AD oscillator, 369373 %R method, 373 Ultimate Oscillator, 374375 overview, 347348, 401 velocity and acceleration finding velocity and acceleration of different techniques, 384385 overview, 382384 quick calculation, 386 using to identify a sideways market, 385386 Monte Carlo sampling, 876877 Month-end effect for stocks, 442 Mother of Adaptive Moving Averages index, 737 Moving average. See entry under Time-based trend calculations MPTDI (Major Price Trend Directional Indicator), 300301 Multiple time frames Elders Triple-Screen trading system, 781783

Index

1165

Krauszs multiple time frames description, 783784 laws of multiple time frames, 784786 perspective on the three time frames, 786 overview, 779 Prings KST System, 786789 tuning two time frames to work together, 779781 Multivariate approximations generalized multivariate solution, 235236 least-squares sinusoidal, 236237 overview, 231234 selecting data for an S&P model, 234235 N N-day breakout (rolling breakout) applied to stocks, 205207 avoiding problems programming the weekly breakout, 205 Donchians Four-Week Rule, 202203 modified for the final three months, 203 modifying, 203204 overview, 200202 testing, 204205 Negative Volume Index, 495 Net momentum oscillator, 364 Neural networks artificial, 831833 modeling human behavior, 837838 overview, 830, 838 reducing number of decision levels and neurons, 837 selecting and preprocessing the inputs, 833834 selecting the output, 834 terminology, 830 training example, 835837 training process, 834835 News, measuring market selectivity, 566 media indicators, 566567 overview, 561563 ranking and measuring, 562565 trading on the news, 565566 Nofris congestion-phase system, 132134 Noise, 812815 O October effect for stocks, 444445 On-Balance Volume, 491494 Opening range breakout

breakout ranges based on time, 722724 filtering opening range breakout, 727 Fishers opening range breakout, 724727 overview, 720721 Raschke trades Crabel, 722 Open interest. See Volume, open interest, and breadth Opinion and contrary opinion Commitment of Traders Sentiment Index, 584585 contrary opinion, 581584 Dogs of the Dow, 585586 lesson from put-call ratios, 585 overview, 581 Small Dogs of the Dow, 585586 watching big block transactions, 586 Optimal f, 10331036 Oscillators momentum and. See Momentum and oscillators overview, 360361 relative strength index, 361364 Relative Vigor Index, 375 stochastics, 364369 trend-adjusted, 747 Williams oscillators AD oscillator, 369373 %R method, 373 Ultimate Oscillator, 374375 Overfitting, 848 P Pairs trading, 530 Paper trading, 940941 Parabolic Time/Price System, 742745 Pattern recognition computer-based artificial intelligence methods, 696697 overview, 691, 693695 repeated patterns, 695696 opening gaps and intraday patterns cotton, 663 crude oil, 660, 665 do individual stocks show unique gap patterns?, 665668 Eurobund, 659 Eurodollars, 657, 665 gap study program, 668670 German DAX, 656, 664665 gold, 661 Nasdaq 100, 655

1166

INDEX

Pattern recognition (continued) overview, 651 simple gap trading method for stocks, 668669, 671 close-to-close gaps, 671 soybeans, 662 S&P 500, 654 U.S. 10-year notes, 658, 665 overview, 627629 projecting daily highs and lows comparing the two ranges, 630 DeMarks projected ranges, 629630 overview, 629 pivot technique, 629 time of day intraday highs and lows crude oil and soybeans, 647 Euro/U.S. dollar, 648 overview, 645 programming, 651653 S&P 500, 645646 using for trading, 649651 U.S. 30-year bonds, 646647 Merrills intraday patterns, 632633 overview, 630 patterns in agricultural futures overview, 637638 programming time patterns, 639 refining patterns for trading, 638639 relating opening direction to last bar of prior day, 643645 trading habits form lasting patterns, 631 Tubbs intraday patterns, 631632 updating intraday time patterns, 19972003 comparing new and old, 636 interest rate patterns, 636 overview, 633 S&P and Nasdaq patterns, 633636 weekday, weekend, and reversal patterns combining weekend and weekday patterns, 683, 685686 daily sequences heating oil, 672673 Nasdaq, Intel, and Amazon.com, 673675 S&P, Microsoft, and GE, 676 10-year notes, Euros, and gold, 676, 678679 holidays, 686, 690

reversal patterns, 690 program for, 690693 trading weekday patterns, 679 weekday pattern program, 680682 weekday patterns, 671672 weekend patterns, 682683 program for, 686689 Percentage smoothing, 269 Pivot points, 87, 266267 Point-and-figure charting box size, 172174, 186187 comparing performance at different price levels, 199200 formations, 169171 indexing and log scale, 196 overview, 165167 plotting prices using, 167169 price objectives horizontal count, 182184 overview, 182 vertical count, 184186 recent applications, 200 rescaling, 187189 scaling by constant rate, 190194 selecting trades, 200 stock dividends and splits, 196197 studies, 171172 Trade Station Point-and-Figure System, 194196 trading risk, 176177 trading techniques, 177181 alternate treatment of reversals, 181 take it and run!, 180181 trendlines, 171 using percentages, 196 variable-scale solution, 197198 volatility patterns, 175176 Point-and-figure testing, 887889 Portfolio allocation. See Diversification and portfolio allocation Positive Volume Index, 495 Practical considerations cleaning the data, 937938 computers. See Computer, use and abuse of gambling techniquesthe theory of runs. See Gambling techniquesthe theory of runs overview, 935 price shocks. See Price shocks

Index

1167

selective trading diverse building blocks, 964 filtering out losing trades, 963964 overview, 963 silver and Nasdaqtoo good to be true, 975977 similarity of systematic trading signals, 977981 system trade-offs, 964965 combining trends and trading ranges, 970971 Commodex method of combining elements, 968970 mean-reverting systems, 966 trade-offs, 966968 trend-following systems, 965966 trading limits and disconnected markets changing the rules, 975 frequency of limit moves, 972974 overview, 972 similar to price shocks, 975 use and abuse of the computer. See Computer, use and abuse of Presidential election cycle, 574576 Price and Volume Trend, 495 Price distribution systems measuring distribution overview, 753754 problems in using moving standard deviations, 754756 standard deviation bands, 754 overview, 753 price distributions frequency distributions, 760763 adjusting for inflation, 762 medians and means, 762763 structural changes, 762 long-term, 759760 patterns of market groups, 760 overview, 759 short-term distributions, 763764 trading system based on kurtosis and skew, 767771 program code, 769771 using skewness to identify a trend, 765767 Steidlmayers Market Profile. See Steidlmayers Market Profile use of price distributions and patterns to anticipate moves overview, 756

zone analysis, 756758 applying a moving average distribution, 758 non-random patterns, 757 zones for forecasting range and risk control, 758759 Price shocks crisis management, 952954 fooling yourself with hindsight, 947951 identifying, 951952 money moves the markets, not fundamentals, 947 overview, 946947 realistic distributions and, 997998 Prings KST System, 786789 Probability Bayes theorem, 4950 contingent probability, 45 joint probability, 45 laws of, 44 marginal probability, 45 Markov chains, 4649 overview, 4344 Probability density function, 476477 Programming, computer, 939940. See also Computer, use and abuse of Puppies, 585 Q Quadratic mean, 21 R Random walk theory, 57 Raschkes first cross, 306307 Regression analysis ARIMA (Autoregressive Integrated Moving Average). See ARIMA basic trading signals using a linear regression model adding confidence bands, 244245 adding R2, 246247 overview, 243244 using linear regression slope, 245246 components of a time series, 209210 evaluation of two-variable techniques, 229231 direct relationships, 230231 linear correlation. See Linear correlation linear regression. See Linear regression measuring market strength, 247248 multivariate approximations

1168

INDEX

Regression analysis (continued) generalized multivariate solution, 235236 least-squares sinusoidal, 236237 overview, 231234 selecting data for an S&P model, 234235 nonlinear approximations for two variables, 224226 overview, 209 price data characteristics, 210211 calculation period selection, 211 second-order least squares, 226227 transforming nonlinear to linear, 228229 Relative strength index, 361364 Relative Vigor Index, 375 Reversal patterns, 690693 Richard Arms equivolume, 490 Risk control, 356357 comparing expected and actual results binomial probability, 10371038 2 (chi-square) test, 10391042 overview, 10361037 compounding a position adding equal amounts, 10261207 adding equal size, 1026 comparison of compounding methods, 1028 maximum compounding, 10271028 overview, 10251026 reflecting pyramid, 1028 at a slower rate-the upright pyramid, 1026 equity trends, 10281029, 10311032 trading on, 1032 individual trade risk overview, 1002 risk on initial positions, 1003 stops. See Stops investing and reinvesting: optimal f finding optimal f, 10341036 observations of optimal f, 1036 overview, 1033, 1036 risk assessment, 10331034 leverage overview, 10001001 reserves, 10011002 liquidity, 988990 measuring return and risk its not the markets, its the money, 9991000 largest loss, 993 naive performance criteria, 991 overview, 990

potential risk, 993994 risk characteristics of systems, 998999 select a trading model, 990 Sharpe ratio, 991992 Ulcer Index, 993994 value at risk, 995998 mistaking luck for skill, 983984 overview, 983 probability of success and ruin, 10221025 ranking markets for selection commodity selection index, 1013 directional movement Average Directional Movement Index, 10151017 Commodity Selection Index, 1017 directional indicator and true directional movement, 1015 optimizing, 10171020 overview, 10131015 Kaufmans strategy selection indicator, 10201022 overview, 10121013 risk aversion common sense, 988 the efficient frontier, 987 overview, 984985 risk preference, 986 Rolling breakout. See N-day breakout Runaway gap, 83 S Sample error, 1718 Scatter diagrams, 867869 Seasonality calculating basic calculation components, 406411 comparison using different methods, 423425 effects of a few volatile years, 411 method of link relatives, 416418 moving average method, 418423 overview, 405406 program to create a table of monthly price changes, 411412 removing the trend, 415416 seasonal volatility, 425 Winters method, 423 yearly averages, 412415 common sense and seasonality being too specific about targets, 445446 overview, 445

Index

1169

recognizing nonseasonal years and external factors, 446 a consistent factor, 404 overview, 210, 403 pattern of, 404405 seasonal filters overview, 428430 seasonality for trading, 432, 434435 seasonal studies and key dates, 435437 updating bull, bear, and nonseasonal market patterns, 432 years with similar characteristics, 430432 stock market and Hirsch strategy, 443 holiday effect for stocks, 437, 442 January effect, 443 month-end effect, 442 overview, 437 risk of September and October, 444445 weather sensitivity measuring, 427428 overview, 426 Second-order least squares, 226227 Selective trading diverse building blocks, 964 filtering out losing trades, 963964 overview, 963 Sell signals, 288292 Sensitivity testing, 885 September effect for stocks, 444445 Sharpe ratio, 991992 Sibbetts Demand Index, 503 Significance, testing of, 17 Skewness, 2932 Small Dogs of the Dow, 585586 Solar eclipses, 623624 Soybean crush, 532533 Spectral analysis, 464465 Spreads and arbitrage arbitrage. See Arbitrage carrying charges carrying charge spread, 540 implied interest rates, 538539 limited-risk spread, 539 overview, 537538 changing spread relationships gold/silver and platinum/gold ratios, 541543 intramarket and intermarket financial spreads, 543544 TED spread, 544 overview, 540

dynamics of futures intramarket spreads, 515517 intermarket spreads description, 544547 increased spread risk, 547 trending or mean reverting?, 547 leverage in spreads, 559560 overview, 515 risk reduction in spreads, 520 spread and arbitrage relationships, 519 spread in stocks globallization, 517519 overview, 517 technical analysis of spreads historical comparisons, 548551 metal ratios, 558 overview, 548 relative levels using an oscillator, 552 relative spread opportunities, 551552 spread ratios, 556558 trend analysis of spreads bull and bear spreads, 553554 creating a spread to protect an outright position, 555 exceptions to the rules, 555 legging in and legging out of a spread, 554555 overview, 552553 reverse response to trending markets, 555 volatility and spread ratios, 555556 volatile spreads, 559 Standard deviation, 2728, 753, 804 standard deviation moving average, 262 standard deviation stop, 1005 Standard error, 3436 Statistical arbitrage, 530 Steidlmayers Market Profile construction, 773774 description, 771773, 778 quantifying the value area, 777 Time/Price Opportunities, 774775 trending markets, 777778 typical patterns, 775 what are buyers and sellers doing?, 775777 Stochastic techniques oscillators, 364369, 377 variable-length, 746747

1170

INDEX

Stops Kaufman on stops, 10051006 managing risk with and without, 1012 market noise and the frequency of stops, 1006 overview, 1004 risk protection or false hope?, 1006 standard deviation stop, 1005 stop-loss can conflict with trading strategy, 1007 testing over ten years, 10071011 total losses are constant, 10061007 trailing stop, 10041005 Students t-test, 3536, 886887 Supercycle, 596 Supply and demand building a model, 5558 cobweb charts, 54 demand, 5052 elasticity of, 52 equilibrium, 5354 overview, 50 supply, 5253 elasticity of, 53 Swing filter, constructing a swing chart using finding swing high and low points using Excel, 163 Keltners Minor Trend Rule, 163164 Livermore System, 158160 overview, 155156 percentage swings, 160 programming swing high and low points, 160163 rules for trading a swing method, 157158 swing philosophy, 158 System disconnect during a crisis, 953954 System testing anatomy of an optimization, 922925 arriving at valid test results common sense versus statistics, 879880 performance criteria benchmarks, 881882 measuring test results, 882885 overview, 881 sensitivity testing, 885 reading between the lines, 885 searching for robustness, 880881 Student t-test, 886887 systems that work in only one market, 885886 changing the strategy rules, 878 comparing results of two systems, 889895

comprehensive studies classic tests Davis and Thiel, 901 Hochheimer, 903917 Maxwell, 902903 overview, 901 overview, 900 expectations, 849850 getting big picture through testing, 918920 identifying the parameters distribution of values to be tested, 851852 overview, 850851 ranking test parameters, 852 test size, 851 types of test variables, 852853 massive testing genetic algorithms, 874876 Monte Carlo sampling, 876877 overview, 874 overview, 847849, 933934 plan for robustness overview, 926 realistic assumptions, 926927 robustness, 928933 targeted test results, 927928 point-and-figure testing, 887889 price shocks, 920922 profiting from the worst results, 895898 retesting procedure, 898900 searching for the optimal result mathematical optimization, 858860 overview, 858 test continuity, 860 selecting test data description, 853856 problems with adjusted data series, 856 synthetic data, 857858 which data series is best?, 856 step-forward testing and out-of-sample data, 871874 visualizing and interpreting test results averaging the results, 870871 overview, 861 seeing continuity in test results, 861864 standardizing test results, 870 two-parameter tests, 864869 T Taylor trading technique, 715720 Technical analysis, 1 Testing. See System testing

Index

1171

Thrust Oscillator, 505 Tick volume, 484 Tick Volume Indicator, 496 Time-based trend calculations drop-off effect, 269 exponential smoothing common form, 270272 comparison of exponential smoothing methods, 272276 double smoothing, 276278 of price changes, 277278 overview, 269270 smoothing and restoring the lag, 272 forecasting and following comparing errors of different time intervals, 253 error analysis, 251253 forecast error and risk of trend trading, 255 least-squares model, 251 limiting forecast to direction, 253254 overview, 249250 using error analysis for trading, 255 geometric moving average, 267268 moving average comparison of moving average methods, 264 overview, 255257 pivot-point weighting, 266267 triangular weighting, 264, 266 types of accumulative average, 258 plotting lags and leads, 262263 reset accumulative average, 258 standard deviation moving average, 262 truncated moving average, 259 weighted moving average, 259261 weighting by groups, 261 user-friendly software, 257 what do you average?, 257258 overview, 249 relating exponential and standard moving averages best approximation of smoothing constants, 283 description, 278284 estimating residual impact, 283284 Time-based trend systems applications of single trends master trading formula, 305306

MPTDI (Major Price Trend Directional Indicator), 300301 overview, 299300 parabolic time/price system, 304305 Raschkes first cross, 306307 10-day moving average rule, 302 triple exponential smoothing, 302304 volatility system, 301302 bands and channels Bollinger bands, 294295, 299 compromise between reliability and delay, 298299 overview, 292293 rules for using bands, 295297 timing the order, 297298 volatility sensitive bands, 293294 basic buy and sell signals anticipating trend signal, 289290 based only on trendline, 289 based on price crossings, 288289 overview, 288 profile of simple moving-average system, 290292 comparison of major trend systems different risk profiles breakout systems, 309, 312 linear regression, 312 moving averages and exponential smoothing, 309 different trend philosophies, 309 expectations, 313 frequency of trades, 312 impact of transaction costs, 320 overview, 307308 programming the six systems spreadsheet code, 330332 TradeStation EasyLanguage code, 320329 return patterns in other markets, 317 robust testing, 313314 similar systems give similar results, 313 trading rules, 307 varying speed of trend, 307 viewing results by frequency of trades, 317 which system is best?, 314317 different risk profiles, 316 swing and point-and-figure results, 316317 comprehensive studies, 337

1172

INDEX

Time-based trend systems (continued) living with a trend-following philosophy anticipating a trend change, 346 dilemma of two-trend system, 346 overview, 344 take your losses and let your profits run, 345 using other reasons to exit a trend trade, 345 more than two trends, 337 moving average sequences: signal progression, 341343 overview, 285 selecting right moving average, 337341 selecting trend speed, 338339 two trendlines, techniques using Donchians 5- and 20-day moving average system, 336337 overview, 332, 335336 why trend systems work fat tail, 286287 overview, 285 time intervals, market maturity, and trends, 285286 Time of day. See entry under Pattern recognition Tops. See Bottoms and tops Trade Station Point-and-Figure System, 194196 Trading range, 81 Trading systems and methods adaptive techniques. See Adaptive techniques advanced techniques. See Advanced techniques arbitrage. See Arbitrage basic concepts of. See Trading systems and methods, basic concepts charting. See Charting basics; Charting systems and techniques computers. See Computer, use and abuse of cycle analysis. See Cycle analysis day trading. See Day trading diversification and portfolio allocation. See Diversification and portfolio allocation event-driven trends. See Event-driven trends event trading. See Event trading introduction. See Trading systems and methods, introduction to momentum and oscillators. See Momentum and oscillators pattern recognition. See Pattern recognition

practical considerations. See Practical considerations price distribution systems. See Price distribution systems regression analysis. See Regression analysis risk control. See Risk control seasonality. See Seasonality spreads and arbitrage. See Spreads and arbitrage system testing. See System testing time-based trend calculations. See Time-based trend calculations time-based trend systems. See Time-based trend systems volatility. See Volatility, measuring volume, open interest, and breadth. See Volume, open interest, and breadth Trading systems and methods, basic concepts average, 1922 arithmetic mean, 1920 characteristic of, 2627 geometric mean, 2021 harmonic mean, 2122 quadratic mean, 21 data and averaging, 17 bias in data, 17 data that is no longer useful, 18 economic data, 17 how much data is enough? law of averages, 16 quality of data used, 18 safety first, 19 sample error, 1718 dispersion, skewness, and kurtosis choosing between frequency distribution and standard deviation, 3334 dispersion, 27 kurtosis, 3233 mean deviation, 27 probability of achieving a return, 2829 skewness, 2932 standard deviation, 2728 standard error, 3436 variance, 27 indices constructing an index, 41 cross-market and weighted index, 43 leveraged long or short index funds, 4142 overview, 4041 U.S. dollar index, 43

Index

1173

overview, 1516 price distribution frequency distributions, 2325 median and mode, 2526 overview, 22 probability. See Probability standardizing returns and risk annualizing risk, 3940 calculating returns, 3738 calculating risk, 3839 downside risk, 40 indexing returns, 38 overview, 3637 supply and demand. See Supply and demand Trading systems and methods, introduction to background material, 79 convergence of trading styles in stocks and futures, 23 fundamentals versus technicals, 34 notation used in this book, 14 objectives of this book, 1011 professionals versus amateurs, 46 profile of a trading system changing markets and system longevity, 1112 choice of data, 12 choosing analysis method, 13 diversification, 12 order entry, 14 performance monitoring and feedback, 14 risk control, 1314 testing, 13 time frame, 1213 trade selection, 13 random walk theory, 57 research skills, 910 technical analysis, expanding role of, 12 Transformations, 31 Treasuries trading reaction to economic reports, 574 Trend-following systems, 965966 Trendlines. See Charting basics, trendlines Trends and noise, 812815 Trident Commodity-Trading System, 136138 Trigonometric price analysis, 454461 Triple tops and bottoms. See Bottoms and tops TRIX, 378 True Strength Index, 376377 Tubbs intraday patterns, 631632

Tubbs Law of Proportion, 136 Two-frequency trigonometric regression, 461463 U Ulcer Index, 993994 Ultimate Oscillator, 374375 Unemployment reports, 573 Universal Clock, 615 Upside/Downside Radio, 504 U.S. dollar index, 43 V Variance, 27 V-bottoms, 100 VIX trading system, 802 Volatility, measuring creating your own filters, 807809 interpreting volatility using VIX, 799801 forecasting tomorrows trading range, 800801 intraday volatility and volume, 801802 overview, 791792 practical volatility measures, 796798 ratio measurements, 798799 trade selection using volatility constructing a volatility filter, 804 entry filter results, 804805 filter or delay?, 803 high volatility exits, 805806 overview, 803 transforming components instead of price determining base price, 792793 example of lognormal calculation, 796 overview, 792 time interval, 793796 VIX trading system, 802 volatility system, 802803 Volatility, predicting with trading ranges, 810 Volume Accumulator, 494 Volume, open interest, and breadth breadth indicators Arms Index, 504 Bolton-Tremblay approach, 503504 comparing, 505506 McClellan Oscillator, 504 overview, 502, 505506 Schultz approach, 504 separating advancing from declining volume, 503

1174

INDEX

Volume, open interest, and breadth (continued) Sibbetts Demand Index, 503 Thrust Oscillator, 505 Upside/Downside Radio, 504 filtering low volume overview, 512 removing low-volume periods, 512513 removing volume associated with small price moves, 513 integrated probability model, 509510 interpreting volume and breadth systematically advance-decline system, 508 identifying a volume spike, 506507 moving average approaches, 507508 overview, 506 intraday volume patterns, 510512 Market Facilitation Index, 513514 overview, 483 special case for futures volume, 483484 tick volume, 484 standard interpretation exceptions, 489490 Herrick Payoff Index, 490 overview, 487488 Richard Arms equivolume, 490 volume and open interest, 488489 volume is a predictor of volatility, 490 variations from normal patterns drop in volume, 486487 variance in volume, 485486 volume spikes, 486

W intraday pattern, 485 volume indicators Asprays Demand Oscillator, 495496 Negative Volume Index, 495 On-Balance Volume, 491494 overview, 490491 Positive Volume Index, 495 Price and Volume Trend, 495 programming Spreadsheet code, 497498 Tick Volume Indicator, 496 TradeStations EasyLanguage code, 499502 variable moving averages for volume, 496497 Volume Accumulator, 494 volume momentum and percentage change, 491 volume oscillator, 491 V-tops, 97100 W Weather sensitivity, 426428 Weekday, weekend, and reversal patterns. See entry under Pattern recognition Weighted average, 17, 19 White noise, 812 Wilders Swing Index System, 164165 Williams oscillators, 369375 X X-11 seasonal adjustment method, 421423

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