Errors of Judgment a Trader Can Make

BarroMetrics Views: Errors of Judgment a Trader Can Make

In the chapter I am writing for Wiley, I am writing about how Barros Swings help define the trend of trader’s timeframe and how the Swings help answer the question: continuation or change?

If you think about it, there are three types of errors a trader can make:

  1. Failing to correctly define the current trend, it’s structure and whether the trend is likely to continue or change.
  2. Entering too early or too late. Both subject the trader to financial stress.
  3. Incorrect position sizing.

For me, making sure I am correct about the trend and its possible continuation is the most important. And in this regard, Barros Swings have proven invaluable.

Let’s take the AUDUSD, for example,

Figure 1 shows the 18-day swing (monthly trend). Assuming one applies the traditional Barros Swings Theory, then the price action after the Upthrust Sell Change in Trend Signal has been ‘sloppy’ (see chart for what I mean).

The impulse move prior to the change in trend signal was normal in terms of magnitude and duration. One of the advantages of Barros Swings Theory is the ease with each we can calculate the stats for impulse and corrective moves.

So, the question is can the higher time frames shed light on the AUDUSD’s current direction and duration.

The 13-week (quarterly trend) shows a breakout and a correction where although the line has turned down, the swing low is not the low point of the correction. I have stated the implications of this event in the chart. Usually we’ll see at least a re-test of the primary low (.9536).

So what the 13-week swing is saying is the current sideways, choppy price activity is  not over until we see a retest of .9370 to .9536. Acceptance above the upside maximum extension (1.0619)  would negate this scenario.

This is why I love the Barros Swings. It allows me to formulate scenarios with benchmarks. The benchmarks allow me to define the probability of success and risk.

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FIGURE 1 18-day Swing

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FIGURE 2 13-week Swing

Evaluating Trading Systems

BarroMetrics Views: Evaluating Trading Systems

I am constantly amazed how gullible we are – how we want to believe in unrealistic claims and how willing we are to put our hard earned on the line in the pursuit of our fantasies.

So I am writing this blog in the hope it will help someone avoid a burnout. The system here I have taken from Collective2 who evaluate public systems for free.

Suppose you received the ad that said:

  • Winning Trades: 94%
  • Total return on a $10,000.00: $52,350
  • Expectancy Return per trade: $523.50

And you also received the chart in Figure 1.

Looks good right? Where do I sign up!

But if instead of signing up, you investigated and found that the avg$loss was $18,206 compared with an average daily profit of $1,719. Would alarm bells sound?

It would for me. Given that imbalance between the Avg$loss and Avg$Win, you would only need to small reduction in win rate and this system would fall into negative – and it could be quite a large negative.

Figure 1 shows the system description and comments from those who have traded the system. Why such a dichtomy in the comments. Figure 2 provides a possible explanation. The favourable comments started trading within the blue rectangle, and the unfavavourable in the red. That’s the problem with this sort of system – risk management appears to be missing.

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FIGURE 1 Comments

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Figure 2 Hypothetical Equity Curve

Constructing a Ray Wave Count

BarroMetrics Views: Constructing a Ray Wave Count

Jordan, a new Ray Wave student, asked me for a step-by-step process to construct a Ray Wave Count.  The charts provide the visual process, the text the written one.

  1. Step 1: Place Barros Swings up to the First Higher Timeframe. In Figure 1, the Black represents the 75-period swing, the Red represents the 18-period swing and the Blue represents the 5-period swing.
  2. Once the swings are in, get a visual feel for the magnitude of the corrective structures.
  3. Step 2: Work out the magnitude of the corrective waves. If you are using MA6, use the ‘Time-Price Label Tool”.
  4. You are looking for categories of corrective waves within 20% of one another. In Figure 2, there are three – the 172 +/- 20% (black rectangle), the 127 +/- 20% (blue rectangle) and the 72 +/- 20% (orange rectangle).
  5. Step 3: Label and identify the ‘make or break’ level for the current corrective structure. The ‘make or break’ level is the farthest level a correction can go without exceeding the bounds of symmetry i.e. exceeding the 20% maximum. In this case for the category of (0), the price is .9320. Acceptance below .9320 suggests a correction of the 172 category is in the works.
  6. Since wave (2) is complex, wave (4) is expected to be simple. Normally a simple correction will retrace between 40% to 62% but in this case, a 40% retracement would exceed the 20%. So, we’d expect the boundaries of the correction to be between the 33.33% level (minimum correction), .9335 and, the ‘make or break’ (.9320) (the maximum correction).
  7. Step 4 draws in the possible wave 4 channel and summarizes the action.

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FIGURE 1: Step 1

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FIGURE 2: Step2

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FIGURE 3: Step 3

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FIGURE 4: Step 4

What A Difference A Day Makes

BarroMetrics Views: What A Difference A Day Makes

On Wednesday, the papers were filled with doom and gloom and filled with stories about the ‘certainty’ of a double dip recession. Today we are told that figures yesterday in the US and China have negated the ‘double dip’ at least for the moment.

If ever there was a day that demonstrated why I use technicals to trade (supported by Pete Steidlmayers’ classification of fundamentals as context), it was yesterday.  The technicals have been suggesting that we would be seeing a rally, so yesterday’s price action comes as no surprise. By the way, this is not hindsight bias:  since August 24, the free daily update on the S&P has been giving reasons why a rally was on the cards.

In the same way,  the call for inflation is premature.

In my view, despite all the talk of quantitative easing, inflation won’t be a problem until the ‘easing’ hits Main Street. It won’t hit Main Street until the banks see fit to start lending again. How will we know that the banks are starting to lend? By keeping an eye on the St Louis Adjusted Monetary Base chart.

Figures 1 & 2 show the same picture; Figure 1 is  seasonally adjusted while Figure 2 is the raw data. We should have  two to three months lead time from the time the AMB starts to fall (i.e. banks start to lend) to the time the CPI starts to climb. When that happens, we can expect to see pressure on US rates and weakness in the US$ as the word ‘stagflation’ starts to make the rounds.

This brings me to the final item for tonight: when can we expect a  Stock Market to hit a high? I can’t even begin to guess but I am interested to see whether the Kress Cycles will prove correct. I spoke about these in Stock Market Cycles 2. The last Kress cycle that is yet to form a high is the 6-year due Sept/Oct 2011.

I read about Kress Cycles in Cliff Droke’s “Stock Market Cycles“.  The other night I rang Bud Kress and I have to say I was impressed with his sincerity. I am looking forward to seeing how his work plays out for my trading.

Usual Disclaimer: I receive no benefit of any kind for sales of Stock Market  Cycles or Kress’ work. I pass on the information as items I find interesting; and hopefully, useful in my quest for a positive expectancy return.

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FIGURE 1: St Louis BASE Seasonally Adjusted

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FIGURE 2: St Louis BASE Raw

The Nature of Price Action

BarrosViews: The Nature of Price Action

I was listening to an interview of S James Gates Jr. During the interview he said (more or less): “Many believe science is about truth; that is a misconception. Science is about providing the best possible explanation of what we observe”. The assumption is the explanation is based on the current state of our knowledge. As our knowledge increases and is refined so too does our explanation vary and change.

This ideas resonates strongly with me. It is an apt, fundamental explanation of how I trade the markets. I carry in my head a model of how the market (price action) behaves. I call this model the Tubbs Model after Frank Tubbs, not because he created it (he probably did not) but because I first saw it in his Tubbs’ Stock Market Correspondence Lessons.

Figure 1 shows the model. It is my believe that, so far as trading strategy is concerned, everything we need to know is contained in the model. The model itself is based on a number of critical ideas that found their best expression in Pete Steidlmayer’s Market Profile:

  1. That the market is  an auction process. This means that under normal conditions, we seek to sell highs and buy lows; and under exceptional circumstances, we buy new highs, sell new lows. This means that the market must go too high to have gone high enough and too low to have gone low enough.
  2. That the main purpose of the market is to be efficient. And the best expression of efficiency is the bell curve. The bell curve in the markets is found in congestion. Thus the main purpose of the market is  to seek congestion.
  3. The second purpose of  the market is to facilitate trade i.e. the market will do what is necessary to generate the maximum participation. Hence the relationship between volume, range and direction provides a reasonable indication whether a market is likely to continue or change its current direction.
  4. Finally, it is the context i.e. the current dominant structure that defines and gives meaning to the patterns we seek to exploit for profit. For example, in a sideways market, a lack of volume and range in the middle of congestion is different to a lack of volume and range in upmoves in an uptrend that has been in place for sometime.

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FIGURE 1 Tubbs Model

Insights from Wyckoff and The Profile

BarroMetrics Views: Insights from Wyckoff and The Profile

It’s been a week for mail. The offer of ‘free coaching’ from the attendees from the Intensive Training Seminar brought a ton of mail. This was closely matched by questions regarding the Wyckoff and the Profile.

Time prevents me from answering the questions individually. I think the best way to proceed is to provide what I consider the essential principles of each theory.

WYCKOFF

Outlining is easy to do for  Wyckoff because he sets them out in his work:

  • The Law of Supply and Demand: why does a market go up? Because there are more buyers than sellers. Why does a market go down? Because there are more sellers than buyers.
  • The Law of Cause and Effect: “The effect realized by a cause will be in direct proportion to that cause. Consequently to get an important move,…there must be an important cause…. that takes time…to develop” (Introduction to Wyckoff Method of Stock Market Analysis [Stock Market Institute])
  • The Law of Effort vs Result: “In terms of the law of effort versus result….It is the volume that produces….the result. …When the amount of effort and the extent of the result are not in harmony, something is wrong”. (Introduction to Wyckoff Method of Stock Market Analysis [Stock Market Institute])

For me these principles were reflected and developed in Pete Steidlmayer’s Market Profile.

MARKET PROFILE

  1. “The market is an auction process” The principle augments Wyckoff’s ‘Law of Supply and Demand’.  Understanding that the market is an auction was critical to my success. I agree with Brett Steenbarger that technical analysis starts with pattern recognition; but for me, how the patterns come about is just as important, if not more so. Thus in a sideways market, we have a Primary Buy and Primary Sell Zone. The zones reflect rejection areas (or as Tom Alexander calls them “unfair” prices). Knowing why the zones are termed rejection zones, and knowing how the zones come about, allow us to create scenarios around what may be happening when prices are not rejected. (See tonight’s post on the Forum-Twitter service).
  2. Peter felt that price action had four stages: a) A directional move (what I call an Initial Price Movement) b) Start of Development c) Development d) End of Development and start of new Initial Price Movement). When a new Initial Price Movement began after a normal development, the Law of Cause and Effect applies. But if we see smaller than normal development, we should see a larger than expected move. (It took me ages to reconcile this with The Law of Cause and Effect’. I found the resolution had to do with context).
  3. The purpose of the market is to facilitate trade. This is similar to The Law of Effort vs Result. Market Delta‘s software has been the significant improvement for this principle. Note that Peter had several versions of the purpose of the market. “Facilitation of Trade” was the first and in my view the best of the formulations.

You’ll see these ideas in operation each time I analyze a market.

A Blogger’s Paradise

BarroMetrics Views: A Blogger’s Paradise

I started this blog to help readers of Nature of Trends (NOT) understand my ideas and to gain greater insight on how I applied the concept.  Of course, my objective has expanded over time. Nevertheless,  my original aim is still the main one.

Now, I don’t always find it easy to write a daily blog – sometimes ideas are hard to come by. But sometimes, the market provides an opportunity I can only describe as a ‘blogger’s paradise’. Last night, the S&P provided such an opportunity.  Let me start the blog by explaining to the non-readers of NOT that the foundations of my plan’s technical approach are:

  • A variation of the Elliott Wave, an objective version, I call the Ray Wave
  • The ideas and principles of Richard Wyckoff.
  • Pete Steidlmayer’s Market Profile. And while Pete Steidlmayer would probably not agree, I see his Market Profile as an extension of Wyckoff’s ideas.
  • One of the common elements of Wyckoff and the Profile are the concepts and strategies around the relationship of price direction, price range and volume. Market Delta has added a dimension to the analysis by classifying real-time volume as being buyer or seller control.
  • To these ideas I have added the Barros Swing and
  • Finally you have traditional technical analysis (Edwards and McGee patterns) and traditional candlestick principles

That completes the elements of my approach. Let’s now turn to the S&P.

The first pattern I want to show you is found in Figure 1: the monthly chart of the S&P. This is the pattern that is controlling current price action and is a pattern is that Peter Steidlmayer called a ‘313 Outside’. The elements of the Pattern are:

  •  A sideways market (313)
  • The breach of an extreme in the direction of the original direction move (trend) and
  • Failure to follow through on the break.
  • This calls for a move to at least the Primary Sell Zone.

In Figure 1 the prior 12-M Barros Swing trend (Yearly Trend) was up. At 666.80, the S&P took out the low at 768.65 but failed to continue South. Instead we saw the S&P return into congestion. This price action provides a highly probable move to the Primary Sell Zone at 1577 to 1476.

More tomorrow

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FIGURE 1 12-Month S&P

The Frank Tubbs Model

BarroMetrics Views:  The Tubbs Model

In the 1920’s Frank Tubbs wrote his much respected Tubbs’ Stock Market Correspondence Lessons. His model of price action remains as valid today as when he wrote it. Figure 1 shows the model.  When trading, I start an analysis by asking:

  • What is the trend of the trader’s timeframe?
  • Is it likely to continue or change?
  • If continuation, where are we in the Tubbs Model, in particular are we seeing as directional move or correction? If correction, is it a simple or complex structure?
  • If change in trend, what change in trend pattern is the instrument exhibiting?

Now if the markets weren’t fractal, a trader’s life would be so much easier. The problem is they are. This means we need a tool to distinguish between timeframes – because a correction in the proximate higher timeframe usually means an attempted change in trend in its next lower timeframe. The principle is important in our trading to prevent whipsaws and to enter at optimum levels. Figure 2 shows the principle in action.

We see an uptrend in the AUDUSD from the October 2008 lows. I define an uptrend as a sequence of higher swing highs and higher swing lows. The red lines represent the 18-day swing (monthly trend) and the blue lines represent the 5-day swing (weekly trend) I have highlighted with green rectangles the corrections in the 5-day which broke their lows but resumed their uptrends. The rectangles labeled with numbers are those that turned the 18-day line down. Each ‘breach of lows’ constituted an 18-day buying opportunity.

We then see (Figure 3) the equivalent of the 13-week line turn down to .8065 from the .9400 high. But instead of breaking down, we see 13-week support (MIDAS, Fibo 38.2%, and 13-week corrective stats) hold.  Had we sold because of the 18day change in trend, the area .8250 to 8065 was an important one. The break back above .8600 was a warning/signal of a 13-week resumption of the uptrend and  for me acceptance above 50% of the 13-week range was the final pattern that signaled the resumption of the 13-week uptrend. This last pattern I read in Don Vodopich’s ‘Profit with Precision Timing’ (1984) [The book is out of print]. I still use the pattern today.

Throughout this up move, using the Tubbs Model and asking the questions I raised in the second paragraph would have helped you stay with the uptrend.

What’s the target for this move?

Figure  4 is a long-term chart of the AUDUSD from 1914. The chart suggests we are currently forming a sideways pattern between .9850 to .6074. The target for this move would be the Primary Sell Zone .9850 to .9378 with the probable target being between .9567 to .9739.

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FIGURE 1  Tubbs Model

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FIGURE 2  18-day and 5-day

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FIGURE 3 13-week Equivalent

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FIgure 4 Long-term AUDUSD

Chart through the courtesy of The Chart Store

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Figure 5 12-Month Swing

Strategy & Discipline

 

Woody Allen once said a stockbroker is someone who invests  your money until it is all gone. We are conditioned to think an investment is safe and sensible but it is often not the case.   The wise man is an investor who shuns wild speculation and abhors foolish gambling.

What  about a trader? To some extent, he  also shuns gambling but he is a speculator.  All successful traders have one common, yet very important ingredient in their trading methodologies: a game plan.

During World War II–the invasion of Britain was planned but never executed, while the Battle of Britain was executed, but never planned.  In the same way, many traders and investors go through their short investing lives planning trades they never execute and executing trades they never plan.

Success often follows the wise trader/investor who identifies an effective strategy and has the discipline necessary to carry it out.

The basic elements of a trading plan should provide the reason for logically entering and exiting a position, whether it proves profitable or not. Once a position is entered, the price can only take three paths: rise, fall or remain unchanged .

 Trading plans may be mental or written, but written plans are best.

 Other factors to log in a written trading plan include:

·         Reasons for entry into the position

·         Note the actual price of entry into the market, and how it compares with your planned entry price.

·         Note the stop-loss price level and the liquidation plan once the market is entered.  Also  the minimum profit objective and does it correspond with the risk involved in the trade.

·         The trader should check his record of closed profits and losses, to ensure that results generally parallel the plan’s expectations regarding profit or loss.

My mentor Ray Barros has a Risk Management Excel sheet for his students to plan before executing a trade.

All successful traders do their planning before executing their trades in some ways, and the results of the plan should  be parallel  with the objective and risks parameters. The trader should have a plan form that is complete for every trade, and a strong  discipline so that there is no significant  variation within his control between the actual and possible events.

Therein lies the path to making a successful  trade with  a strategy and discipline to execute the strategy, with the probability of winning the trade on his side.

 

Idkit

Ag Moderator

How to Draw Angles of Ascent

BarroMetrics Views: How to Draw Angles of Ascent

Peter  said: ” I follow the principle but can’t figure out how you calculate the angle measurements – can you possibly elaborate how you calculate them.”

Pete, thank you for your question.

At first brush, the answer seems simple enough. The 12:00 is straight up, so 12:15 would be 90%. Since we are looking at 12:05, 12:10 etc i.e. a circle, 12:05 would be 30% (360/12) and 12:10 would be 60%.

But on reflection there is a problem: the problem is the angle of ascent will depend on the scale of the chart.

So I reviewed what I do using Market-Analyst 6. Here’s the process – not exactly rocket science but I do get a good feel for the strength of a trend and the likelihood of continuation.

  1.  Figure 01. After charting the instrument, I check the scale range by unclicking the auto range.  In this case, for the Nifty it’s 3147.90
  2. Figure 02. I select from Gann Tools, the Gann Angles.
  3. Figure 03.  I place the Gann Angles on the chart.
  4. Figure 04. I then shift the decimal point of the price unit two or three places so that the angles reflect the data. In this case, I shifted the decimal point 3 places to 3.147. (Figure 06 shows what the angles would look like if I shifted it only two places).  I use 1×2 for the 60 degrees and 2×1 of the 30.
  5. Figure 05 shows the Gann Angles in degrees.  The angles I drew represent 63.75 and 26.25 degrees (green lines; the red line is the 1×1 = 45 degrees) – so they are a little off. But by drawing it in this way, I get a pretty good idea of the angle of ascent in the context of the scale of the chart.

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FIGURE 01

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FIGURE 02

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FIGURE 03

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FIGURE 04

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FIGURE 05

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FIGURE 06