FuturesTechs Blog

With this article I will introduce Point and Figure charts: how to understand them, and how to recognise some simple patterns. My main source will be Jeremy du Plessis’ The Definitive Guide to Point and Figure, which you might be interested to purchase from the Global Investor Bookshop (in association with FuturesTechs).

Point and Figure is a very old method of charting price action, which originated when traders were simply recording the prices as they saw them happen: 14.50, 14.55, 14.60, 14.55, etc.

This gradually evolved to the point where traders were filling out boxes on a graph corresponding to price levels which the market had crossed, moving to the right each time that the price retraced over an old price level. Eventually, we got the modern Point and Figure chart.

Here’s the most recent NASDAQ chart:

As indicated, the X’s are drawn when the price has increased, while the O’s are drawn whenever the price has decreased.

In the example above the intervals used are just a point wide (the “box sixe”), meaning that we change from X to O (or O to X) and move to the next column whenever the price moves by just a point in the opposite direction to the previous move.

That makes this a very short-term chart, of course. With one-point reversals happening all the time, a couple of hours’ trading will quickly fill up the chart.

The two ways we can make it longer-term are:

• Increase the box size
• increase the reversal size

Increasing the box size should be obvious enough; instead of recording 1-point movements, we’ll record 10-point movements, for example. Here’s the first chart modified in this way:

These boxes stretch back a couple of weeks now, instead of a couple of hours.

Now let’s change the reversal size, the size of the reversal which needs to take place before we change between x’s and o’s and move into the next column. This is measured in terms of boxes, and is set to 3 in the below chart:

The above chart stretches back a couple of days. For a bigger picture view combining both changes, we could require 3-box reversals for 10-point boxes, i.e. requiring 30-points reversals before changing direction on the chart. The below chart represents the price action of a year:

One thing you might have noticed at this point is that we don’t really have a proper time axis. That’s true. While it’s true that time is progressing as we move from left to right on the chart, it’s not doing so on a constant basis. The chart only moves right when we get a sufficiently large change in direction (as defined by our parameters). The chart only changes when the price does. So, instead of being a traditional time vs. price chart, Point and Figure is instead an original way of drawing the price action.

We’re going to look at some patterns now, focusing on charts with 3-box reversal sizes. Any box reversal size can be used, and some care should generally be taken to choose the one that leads to the most favourable chart for the desired timeframe.

That said, we usually don’t like to use 1-box reversals. Charts look very different with 1-box reversals, being of a much shorter timeframe and with very different-looking patterns. Much of the difference is related to the fact that a 1-box reversal chart can have columns with just a single entry of , i.e. when we get two reversals in quick succession.

Check out the Difference between the CAC futures charts below. The top is a 10 x 1 (10 points, 1-box reversal) chart, while the bottom is 10 x 3.

Besides being of a much shorter timeframe in the same space, we can see that the one on the top does indeed have many columns with just a single X or O.

The advantage of sticking with reversal sizes of 2, 3 and more, is that we get to take advantage of the resulting asymmetric filter. The chart is biased to ignore movements in the opposite direction to the prevailing trend that do not satisfy the box size criterion. While a move of, say, 10 points in the prevailing trend will be charted, a move in the other direction won’t be plotted until it reached, say, 30 point.

So let’s have a look at some simple patterns.

The double-top buy is seen when the price reverses off a high, then comes back and breaks through it on the second attempt. It’s an awkward name since the Double Top bearish reversal pattern in mainstream bar/candlestick analysis, but the context is usually clear enough. Here’s an example of it in an uptrend:

Equally, the double-bottom sell occurs when we get the creation of a lower low:

These can be reversal or continuation patterns, depending on the previous trend. As continuation patterns, they tend to be a little more reliable (in accordance with the general principle that trends have a universal tendency to continue!)

In a similar vein to the above, we can have triple-top buy and triple-bottom sell signals. Indeed, we can have any number of tests before the breakout, with all manner of compound patterns.

The first of these buy signals comes after a failed attempt by the bulls to break through the previous highs (indeed, the correction causes a failed reversal triple-bottom sell signal. Our bias is to trade with the prevailing trend, so hopefully we would not have seized on that false signal):

In our next post on this topic, I’ll cover a selection of more advanced patterns and have a look at the price targets we can derive from them.

For now, this has been an introduction to Point and Figure charting. If you have any questions or comments, please don’t hesitate to get in touch. To subscribe to our daily technical analysis of the futures and FX markets, please sign up for a free trial.

Graham Neary MSTA (graham@futurestechs.co.uk)

One of the premises of tecnical analysis is that price patterns tend to repeat themselves. But what are these patterns? Today, we’re going to lookat reversal patterns, i.e. where a change of trend is indicated.

Perhaps the most famous of these is the Head and Shoulders pattern.

Here is the Dow weekly candlestick chart, showing how this topped out in 2007.

The general picture behind the Head and Shoulders is as follows: we start off with an uptrend, which proceeds as normal creating higher highs and higher lows.

The initial warning sign is a failure to create a higher high. This is the top of the “Right Shoulder” on the above chart.

Our technique then is to connect the two most recent lows. This isn’t a proper trendline (which should really connect three points) but instead is the “Neckline” of what is still only a potential Head and Shoulders pattern.

The Head and Shoulders pattern is completed by the break through the Neckline. Sometimes, the bulls will have a go at recapturing it, just as they did in the case of the Dow. What really strengthens the bear story, and is something you can look for, is if the broken Neckline then turns resistance. This happened with the Dow, making this a textbook case of the Head and Shoulders pattern.

Note that the Neckline was broken briefly on the retest; the danger of getting a false signal in this way is limited by placing certain conditions on what sort of a break is required. For example, demanding two consecutive closes above the Neckline (the “Two Day Rule”) would have prevented us from getting whipsawed by thinking that the Head and Shoulders pattern was being negated.

The above chart shows the standard method for constructing measuring targets with the Head and Shoulders pattern. Find the height of the head and then target that distance below the Neckline, measuring from where it broke (so we would target the red horizantal line in the above case).

The Inverse Head and Shoulders is based on the same idea, reversing a downtrend. Here’s Light Sweet Crude Oil changing direction in this way in 2007. Observe the broken Neckline providing support twice:

Now let’s look at Double Tops and Double Bottoms. The Double Top is formed when, in an uptrend, we run into resistance twice at the same level. We then fall through the intermediate low, completing the pattern and providing a sell signal. The broken Neckline can turn resistance, as it did with the DAX futures between 2007 and 2008; see the weekly candles chart below

Here’s an example of a Double Bottom, this time on a bar chart. It’s Vodafone at the bottom of the bear market in 2009, finding support at the same level twice, then beating the intermediate high and continuing the move.

In this case, our measuring target would be similarly calculated as with the Head and Shoulders patterns, i.e. the height of the pattern projected from the breakdown point. In this case, it’s 123.60 plus 12.40, i.e. 136.00.

Here’s an example of a Spike, or V-Reversal.

The Spike is really just the name for a market which reverses direction without giving any proper clue in tertms of hte preceding pattern that this was likely. This is the market turning “on a dime”, and the most difficult to trade.

The only clue at the top of the above chart that Wheat was turning was the “Harami Cross” candlestick pattern at the top (that’s the Doji contained within the range of the long green candle). When a Spike happens, our only recourse is to short-term signals such as candlesticks.

Finally, here’s a Saucer Bottom in Corn futures (the Saucer Top is the equivalent reversal of an uptrend). This is the opposite to the Spike, the price very gradually changing direction.

As technicians we much prefer to see a Saucer Bottom or Top than a V Reversal, with the slow move giving us lots of time to change skew.

Volume

One thing we haven’t mentioned much so far in this article is the role of volume in all of these patterns. Volume - the level of trading activity taking place over any period - is an essential component of technical analysis and an important part of pattern recognition.

The general principle is that volume accompanies movements with the trend. In terms of trend reversals, then, we should see the volume faltering during those final movements with the old trend, and eventually picking up as the new trend takes over.

In the case of the Head and Shoulders pattern, for example, volume should be weakest during the Third Shoulder, as enthusiasm for the dying bull market begins to evaporate.

A distinction can be made here between tops and bottoms. It is generally recognised that volume is not so important for tops as it for bottoms: at tops, market can “fall of their own weight” with buyers simply failing to show up, and volume not increasing.

Bottoms, on the other hand, generally involve mass participation, with active buyer enthusiasm being the main driving force behind the move.

Variations

There are several variations on the patterns mentioned here, in particular the Complex Head and Shoulders, the Triple Top and Triple Bottom. The Triple Top and Triple Bottom are fairly self-explanatory, while the Complex Head and Shoulders generally involves multiple shoulders on one or both sides of the Head.

The principles of volume analysis and the measuring techniques for these patterns are much the same as for the patterns already described here.

Conclusion

These patterns, without being infallible, help us to map out major changes in trend. They are generally medium and long-term patterns, with their significance and measuring targets in proportion to their size.

We incorporate these patterns into our daily analysis of the futures and FX markets. If you would like to sign up for a trial of our services, click here. For a free trial, click here.

Graham Neary MSTA (graham@futurestechs.co.uk)

Whether you are Spread Betting, trading CFD’s, or trading DMA Futures, you need an edge.

Trading is tough, and managing your emotions is one of the toughest things you will have to learn in order to make a success of trading for a living.

The human brain is wired up all wrong for trading, in fact.

By nature we will take a profit too early (GREED kicks in and we snaffle up the winnings on the table), whereas if a trade goes into the red we won’t get out. Instead we’ll start to cross our fingers and hope that it comes back. As the trade goes further into the red pride gets in the way even more, and we allow the situation to get even worse. We FEAR booking a loss, and seeing that loss crystallise on our account, so we sit tight even more (or even worse we add to the losing position), waiting for it to come back (actually HOPING it will come back), except it probably won’t.

“The first cut is the cheapest” is a phrase commonly used by Professional Traders. When I go into my professional clients’ trading rooms I see stickers on traders’ screens with phrases like “get out of bad trades” and “run the winners”.

To become a successful trader you need to rewire your brain almost, and teach yourself to have the DISCIPLINE to get out of bad trades early on, and run the good trades as long as possible.

How can you do this? By using the charts.

You can use Technical Analysis to:

• Trade in the direction of the trend.
• Look for buying or selling opportunities
• Set clear targets and stops, preferably with a decent risk/reward (ie put on trades knowing where you’re going to get out, and knowing that the possible loss will always be much less than the potential profit)
• Trade at the important technical levels, and not in “no mans land”.

All of this will help you to manage your emotions. Only the very best traders in the world can ELIMINATE emotion. Most of us will have to content ourselves with finding a way of REDUCING the emotional side of things in order to help us make better trading decisions.

If you’re a novice at trading and/or technical analysis you will need some help with this, and FuturesTechs can provide you with the levels to trade around, as well as offering market leading guidance and analysis on a daily basis.

Professional Traders have been using our service for years as an essential part of their daily routine.

YOU now have the chance to enjoy the same advice on a daily basis.

Click here to subscribe (your maximum commitment only has to be 1 month, or £57.50)

Or if you’ve never seen our service before, click here to request a no obligation Free Trial.

Have a good week,

Yours,

The FuturesTechs Team

Ichimoku Charts are a tool many traders swear by, and which we may occasionally use as an ingredient in our daily analysis. This article explains the basics.

The main source I’m using will be “Ichimoku Charts” by Nicole Elliott, an excellent book which you can purchase from the Global Investor Bookshop by clicking here.

Part I: Construction

We start with the humble Japanese candlestick chart, the type that you will see on our reports every day. Replete with patterns, it is the building block of Ichimoku. Note that we generally only use daily charts for Ichimoku, although that’s more a product of convention than for any other reason.

Next, we add some special moving averages, with periods nine and twenty-six. These don’t use the close, as would normally be used in the West, but the “mid-price”, i.e. the price halfway between the high and the low of the period in question.

This mid-price is used to calculate each of the Ichimoku lines (except one) and is a convention passed on by the Japanese.  Similarly, the choice of 26 for the longer moving average is based on the length of the standard Japanese business month.

Now for some terminology: the nine-day moving average is called Tenkan-sen (the “Conversion Line”) while the twenty-six-day moving average is Kijun-sen (the “Base Line”). We can use these like we would any other pair of moving averages (see the previous blog tutorial).

Next, we add the defining feature of Ichimoku charts: the cloud. Here’s the complete picture:

The pink line at the top of the shaded cloud area in the centre of this chart is called Senkou Span A (”Leading Span A”), and is calculated as the average of the two special moving averages we had already added to the chart. As the average of two moving averages, it is thus a kind of weighted moving average, giving greater emphasis to the recent prices.

The other line forming the cloud is called Senkou Span B and is the average of the highest price of the last 52 days and the lowest price of the last 52 days. Since we aren’t necessarily expanding the 52-period range all the time, this regularly stays constant day-to-day (you can see how it has flat periods in the above chart).

Both of these lines are plotted 26 days ahead of the market. This means that for the current day, the positions of these lines are calculated using the data available 26 days ago. In other words, the current price is compared with what the weighted moving average and the longer-period range were 26 days ago, not what they are now.

Note also that the prices used here are the Japanese “midpoint” prices, not the close as might be expected in Western technical analysis.

The observant will notice that apart from the moving averages and the cloud lines, there is another line included in the chart above. This is the brown line (colours may vary) which is at the top of the chart during the middle of the pictured timeframe, and is the Chikou Span (”Lagging Span”). It is simply the daily close, plotted at a delay of 26 periods - hence why it “lags”. Each candle’s close, therefore, is plotted against the candle 26 days previously. Note that the Chikou Span is the only line in the Ichimoku chart which uses the closing price in its calculation.

Part II: Analysis

We can take Ichimoku Analysis to almost any level of depth, but the key ideas are as follows:

A. Moving Averages

These are used like the ordinary moving averages are used in traditional Western analysis: as support and resistance levels, getting a bullish message if the price is above the moving averages, or bearish if it is below. Also check for bullish/bearish crossover signals as the averages change position (see the previous blog article). A bullish crossover signal is stronger if it is seen above the cloud, while a bearish crossover signal is stronger if it happens below.

B. Ichimoku Cloud

We are bullish when the price is above the cloud, bearish when it is below.

We also use the cloud lines (Senkou Spans A and B)  as support/resistance levels, getting reversal signals when they are broken.

The width of the cloud doesn’t really matter, except insofar as a thicker cloud means that it will take longer for us to reverse skew by a breakout through the opposite side.

On a related note, the colour of the cloud doesn’t really matter either - it just tells us which line of the cloud is on top. In the above chart, red means that Senkou Span A is on top, while blue means that Senkou Span B is on top.

The Dow chart above would have had us thinking bear thoughts first of all as the price dipped below the cloud. Since it didn’t manage to get a close below it, however, we probably wouldn’t have sided with the bulls outright, still waiting for a clean move away from it. When the price soon rallied back above it, we could then have taken an outright bullish skew.

Hopefully, this skew would have been maintained for most of the period shown above. Of course, the candlesticks did give bearish reversal warnings at various points, and there were a couple of short-term corrections. The solution might be to use the candlestick patterns for specific short-term entry and exit points, while using Ichimoku for an insight into the big picture. For those who are investing for the medium to long term, they might ignore the short-term candlestick patterns completely, or use them merely to make small adjustments to their positions or as a minor piece of evidence relative to the longer-term Ichimoku cloud.

The lessons from this are familiar: use more than one indicator, be flexible, and always act appropriately with respect to your investment or trading timeframe.

C. Chikou Span

This last piece of the jigsaw is simply the close mapped 26 days previously. With this, we can check if the recent close is above or below the candle of 26 days ago, and use that as another piece of evidence.

The Chilkou Span is quite easily recognisable, no matter what colour it is on your chart, since it is just the line chart at a lag. We can see it spike upwards in the above when this market broke to the upside in September. It’s not complicated, of course, but simply knowing where you are in relation to the price last month is a useful piece of the jigsaw. It’s bullish if the Chikou Span is above the candle of 26 days ago, or bearish if it’s below the candle 26 days ago, and we get bullish and bearish signals as they change position.

Part III: Conclusion

We’ve explained Ichimoku charts in a nutshell. The cloud is the most important, and the most unique feature, with two lines: Senkou Span A, a moving average which gives greater weight to the more recent prices, and Senkou Span B, the midpoint of a long-term range. We’ll tend to be bullish above the cloud, and bearish below it. We’ll also monitor the action of two special moving averages and the lagged closing price (Chikou Span). There are a host of signals to watch out for, and our conviction to buy or sell is strongest when all of the signals are aligned.

For a more detailed exposition of Ichimoku Charts, see “Ichimoku Charts” by Nicole Elliott. To read the daily technical analysis we produce at FuturesTechs, sign up for a free trial.

Graham Neary MSTA (graham@futurestechs.co.uk)

The FTSE has been making some noises to the downside of late, finally coming to the party on our pullback skew.

Our regular readers will know that ever since we found resistance around 4500 over most of May we have been mooting the idea of a pullback. Will this take us back to or even through the March lows? You need to subscribe to FuturesTechs to have access to our views on questions like this. As a taster for those of you who, for some strange reason, don’t subscribe,  here’s today’s FTSE Futures commentary and chart.

To get this sort of thing every day you need to become a FuturesTechs member. We offer generous discounts for 6 or 12 month memberships. Click here to join up.

Clients are enjoying the extra levels we now provide on our levels sheets, which have padded out the offering for all asset classes; Commodities, leading UK Stocks, and Forex now enjoy extra coverage for FuturesTechs members.

Clive recently spoke at the SII “Risk Forum” on a pnel discussion on the outlook for the next 6-12 months. Again our clients had access to the slides for this presentation, giving bigger picture insight on the technical outlook for Equities, Commodities and Bonds.

Clive was recently asked to do an interview by Malcolm Prior, author of several best selling books on Spread Betting. Malcolm published this interview on his website, Spread Betting Central. Click here to read this.

We are also considering rolling out Twitter updates for FuturesTechs members so they can get updates on anything new, either in the markets, or on the website. Please let us know your thoughts on this by clicking here.

As part of our continued efforts to explain the major technical indicators to our clients, what follows is a simple explanation of the Stochastics momentum indicators often used in our analysis.

Originally devised by George C. Lane in the 1950s, the Stochastic oscillator is one of the easiest indicators to interpret. It tells us where the price sits in relation to its recent trading range, in a fixed 0 – 100 range and using different degrees of smoothing to provide some stability. Coming in a few different versions, their interpretation rests on the sensible assumption that price pressure is on the upper end of the range in an uptrend, and on the lower end in a downtrend.

Before we create a Stochastic oscillator, we need to decide what time parameter to use. Ten periods is our preferred choice for our daily charts, capturing the range of the previous two weeks.

The simplest one, the Fast Stochastic, has two lines: %K and %D, calculated as follows:

•    %K = [close – low (N-range)]/[high(N-range) – low(N-range)]
•    %D = SMA (%K)

So %K is the position of the most recent close in the range of the last N days; if the close was the low, we get 0, while if the close was the high, we get 100. And %D is the simple moving average of this series (we also need to choose a period for this moving average; typically, we use 3).

Fig 1. Fast Stochastics

It’s always helpful for an indicator to be bounded in a constant range, such as this is between 0 and 100. For one thing, we don’t need to worry about long-run matters like inflation: you’d get a similar pattern for an uptrend in the Dow whether you were looking at it in 1950 or 2000, without any need to rescale it. This means we can easily look for recurring patterns in a market over a period of decades.

It also means that we can easily use the indicator for intermarket analysis. Since the oscillator is bounded as it is, the patterns have the same size regardless of whether you’re watching a stock that trades for £1.00, £20.00 or £50.00, a currency pair or an interest rate future!

Getting back to the main topic, the only major problem with the Fast Stochastic is the lack of smoothing. Note how jagged the %K (blue) line is in the FTSE Index chart above. It reaches extreme readings quite frequently, jumping about and making it hard to interpret.

The solution is easy: we use the smoother red line of the Fast Stochastic as our blue %K line instead, and then average it and use the new average as our new red line! So the new red line is the average of the average of the old blue line (simple, isn’t it?!) And this is how we construct the “Slow Stochastic”.

Fast Stochastic:

• %K = position in N-range
• %D = SMA (%K)

Slow Stochastic:

• %K = %D (Fast Stochastic)
• %D = SMA (%D (Fast Stochastic))

Fig 2. Fast Stochastics vs. Slow Stochastics

We can compare the different Stochastics in the chart above. Observe that the slower red line in the Fast Stochastic is identical to the faster blue line in the Slow Stochastic.

Now we can see the advantage of the Slow Stochastics: they don’t reach the overbought/oversold levels so easily, meaning that we are whipsawed less frequently.

What are these overbought and oversold levels? Generally, we consider anything above 80 to be overbought, and anything below 20 to be oversold.

This system of lines provides a bunch of easily observed buy/sell signals. The simplest of these is simply to take a buy signal when % K crosses the slower % D line from below and a sell signal when it crosses from above. However, this generally happens much too frequently to provide useful signals.

The solution most commonly used is to wait until the slower %D line makes it into one of the extreme overbought/oversold regions, and only use crossovers which occur there. This gives us fewer false signals, with those we do get more likely to be at genuine market turning points.

Another technique, which Stochastics have in common with other indicators, is divergence: when the oscillator moves in the opposite direction to price. This is a warning sign that a trend is running out of momentum. So, for example, if we have an uptrend on the price chart with a sequence of higher highs being formed, but the Stochastics are forming a sequence of lower lows, then we can say that the uptrend is losing momentum and that we will give extra weight to any argument that a reversal is underway. The chart below illustrates one of those divergence scenarios with a resultant sell-off.

Fig 3. Divergence of Price and Slow Stochastics

As with other oscillators, the biggest danger when using it is to assume that a reversal is imminent simply because it is at an extreme measurement. This isn’t necessarily true! Price pressure will remain on the upper end of the range, and hence the Stochastic will stay at elevated levels, for as long as the market is trending.

Fig 4. Sustained “overbought” Stochastics measurement.

In the Soybeans futures market recently, for example, the Slow Stochastics remained in the overbought region from May 6th to June 11th. Why wait for a reversal through all of time, instead of just running with the trend? The Stochastic crossover signal is an excellent counter-trend signal, but that’s not much use when the market just keeps on trending.

This would have been a better market to trade with the Stochastics:

Fig 5. Ranging market with useful Stochastic signals.

We weren’t so strict as to wait for the %D (red) line to get into overbought/oversold territory before we accepted a signal, but most of them worked pretty well. The two signals in red font weren’t successful (we were mostly flat after the red buy signal, and the market rallied after the red sell signal), but six of the eight crossovers were followed by decent moves in the direction of the signal.

The lesson: always adapt your indicators to the market you’re trading, and remember that even when it appears to be working, no signal is infallible!

Graham Neary MSTA (graham@futurestechs.co.uk)

The MACD indicator is one of the most popular tools in technical analysis, and it’s another tool that we occasionally use in our reports.

Developed by Gerard Appel in the 1960s, the basic idea of MACD histogram is to follow the trend in the market under consideration, with a special hybrid of two different moving averages.

We take two exponential moving averages (typically with periods 12 and 26) and subtract the slower (26 period) from the faster (12 periods) to get the “MACD line”, given in blue in the chart below.

Observe that in this market the faster (brown) moving average is always higher than the slower (pink) moving average, so that the MACD line is always positive.

When the moving averages are closest together, MACD is at its lowest level. As the moving averages get further apart, MACD rises accordingly. And since the faster (brown, 12-day) moving average is always greater than the slower (blue, 26-day) moving average, MACD – the latter subtracted from the former - is always greater than zero.

So what’s the red line beside the MACD line? That’s the Trigger or Signal line, and is the 9-period exponential moving average of the MACD line. That makes it the average of a difference between two averages!

The red line provides us with a handy way to interpret MACD, providing easily recognised buy and sell signals. For example, a trader could take a buy signal whenever the MACD line crosses the signal line from below, or a sell signal whenever it crosses from above. This is really just a more advanced version of taking buy and sell signals whenever moving averages of different periods intersect with each other.

To help isolate the distance between MACD and the signal line, some people plot this distance as a histogram along with the line, like this:

With the histogram in place, we can spot the buy and sell signals whenever it crosses from positive to negative, or vice versa. We can also get early warnings of the signal as we watch the histogram reach highs and lows. When it reaches a high, and starts declining, we know that the sell signal is getting closer; when it forms a low, and starts rising, we know that a buy signal is imminent.

Another way to use MACD is to look for any divergence it has with the price action. This helps us to identify situations where a trend is running out steam – where the price is continuing to move in the direction of the trend, but without the conviction it had before. This principle provides us with early clues of a reversal.

Above is an example of a reversing bull market where the price reached a higher high, but the falling MACD line hinted that all was not well.

As a word of warning, here’s an example of a ranging market where the choppiness means that getting useful buy or sell signals is impossible. In this case we’ve placed the Buy and Sell signals on the days after MACD and the trigger actually intersected, to give a more realistic “worst case” scenario, where we don’t get to execute our trade until the signal is confirmed on a closing basis. As you can see, the results aren’t impressive:

As with everything else, the MACD is not a cure-all. As a trend-following indicator though, it is certainly a useful tool and helps to place any market in a bullish/bearish context, as well as providing us with interesting signals. Whether we are looking for specific crossover trade signals, or just watching how elevated or depressed the MACD line is to tell us how bullish or bearish the market is, it’s something that’s worth keeping an eye on in a wide variety of situations.

Some principles to bear in mind here and with indicators in general:

1. Parameters can be adjusted to take into account the particular market you’re trading. If the market you’re in is alternating trend too fast for the MACD to provide profitable signals, adjust the time parameters down to make it more responsive.
2. Indicators are always of secondary importance to the price action itself: that means simple support and resistance levels, trendlines, etc.
3. All technical tools can and should be used in conjunction with each other. If the MACD signal agrees with each of your other tools of analysis, then you could be onto a winner. But if MACD is telling you one thing, and a candlestick pattern is telling you another, then think twice! (this is a whole subject in itself which we’ll have a go at covering in later blogs).

Graham Neary MSTA (graham@futurestechs.co.uk)

We always welcome feedback from clients and free trialists here at FuturesTechs, so we can strive to provide the best possible service to aid your trading decisions.

I thought I’d use the Blog to answer publicly a few questions we have been asked of late, so here goes with one:

Dear Clive,

Re buying Technical Analysis, I always find myself thinking the same question: “If it were that easy/obvious……’we’ve been bullish almost right from the start of the recovery’……….’gearing up for a sell-off’…… why do analysts like yourself not just make loads of money trading futures or spreadbetting?

If I found it that easy/made so much money I wouldn’t bother selling my levels…

Regards,

RJ

This is a question I’m often asked, especially at Seminars. People are, quite rightly, confused that I appear to be so well equipped to trade the markets, yet I don’t.

I think there are several reasons why I don’t trade, so let’s try and go through a couple.

1. It could be argued that YOU wouldn’t want me trading, because then I would be skewing my comments and ideas around my own position. If the market was clearly going down but I’d been caught with a long position I might be trying to talk it up, convinced that my position was right, and the market was wrong. The problem with this is that the market’s never wrong! But I am a human being, so I am subject to emotions just like you, and fear of cutting a wrong or losing position is one of the most powerful (negative) emotions in trading. The flip side to this argument is also pretty valid, though. The idea that an analyst should be able to trade their views put their money where their mouth is has merit, sure. The problem I’ve found with this is that good analysts generally don’t make good traders. I’ll come back to this notion in point 4.

2. I don’t have time. I run a growing company that’s trying to reach out to all sorts of traders, through seminars, increasing product breadth, and finding new delivery methods to take the product to a wider audience. Not only that but the day-to-day analysis takes a good chunk of time each day as well, starting nice and early at 5.30am each morning (although I’m not on my own, it must be said!). So I don’t feel I have the proper amount of time to devote to trading. I don’t think this is something you can do properly with 20 minutes work a day, and if you believe in those ads that tell you this then maybe you should think about the old “if it sounds too good to be true, then it probably is” rule.

3. I haven’t made (consistent) money before as a trader. I have had a go at trading a few times. In 2001 I worked in a Trading Room in the City for a year. It was a “Prop” room with a bunch of short term traders doing “high frequency” trading. These guys were happy to make a tick on a trade, and did at least 50 trades a day. Whenever I had a position on in the Bund Futures that was more than 5 ticks onside the rest of the guys couldn’t believe I was still in the trade. I wanted to run it for another 10 or 20 ticks, but found myself taking the smaller profit. In other words I allowed what was going on around me to affect my trading decisions - Bad mistake. The other problem was that my trading was fitted around writing the analysis. I would write the analysis from 5.30am to 8am, then trade until 10.30am, the write the analysis from 10.30am ‘til midday, then start trading again. - Oh dear! The result? I broke even, so lost money over the course of a year, when taking into account expenses like the cost of the desk and the professional trading software.

Then in 2005 I put some money into an account to have a go at trading UK Equity CFDs, all the while continuing with my daily analysis, as well as providing stock tips for a CFD firm. I lost most of my stake because I was long of a bunch of stocks one week in a nasty bear move, when my FuturesTechs FTSE report was as bearish as it could be… So I was bearish in my view, but bullish in my positions. Pretty dumb, huh?!

I closed this account down, deciding that trading wasn’t for me, which brings me on to my final point, because so far, re-reading what I’ve wrote, it sounds like a bunch of lame excuses. There is a much more important reason why I’m not a trader.

The main reason I don’t trade?

4. I don’t enjoy it, or maybe I’m just not cut out for it. I am an emotionally highly charged person. I am extremely passionate about what I do. I am also extremely self-critical. I hate it when I get the market wrong when I’m writing about them, and I’m 10 times worse when I’m trading. I turn into a total pain in the butt, and my wife likes me even less than usual! During the two stints when I was trading I found my mood swings to be unpredictable, I found my home life was affected; snapping at the kids, and finding a quiet corner of the house to have a sulk when my P&L wasn’t going the way I wanted to. I don’t like being this person. While I care passionately about the markets, about Technical Analysis, and the FuturesTechs product, I don’t wish to jeopardise things that are far more important.

So my own personal journey of discovery has led me to make the firm decision that trading’s not for me, and that I am far better cut out to analyse the markets, and continue to aid real traders (who can manage their emotions!!) to trade the markets using Technical Analysis, one of the most powerful tools available to anyone who wishes to make a success of trading.

I’m happy to admit that I’m not a good trader then, which is possibly why I’m doing okay as an analyst, because there is a school of thought that a good trader will never be a good analyst, and vice-versa, just because we’re all “wired up” differently.

Next time I’m going to talk about some more technical stuff; we’ve had a few questions from readers about gaps, and how to trade them.

In the meantime if you are a FuturesTechs member and have any questions that you think would be suitable for a “public” answer then feel free to ask away!! (Click here).

If you wish to have a look at our service please click here to request a free trial.

‘Sell in May and go away, come again on St. Leger’s Day’, or so the ancient wisdom goes. According to convention, investors do well by exiting the stock markets during the quiet summer months, only returning in mid-September.

Not satisfied with old wives’ tales here at FuturesTechs Towers, we decided to do a little bit of empirical research and find out for ourselves if this had worked in years gone by.

In order to spice it up a little bit, and to add some “timing” to the whole affair, we also decided to consider the amendment offered by another technician (the excellent and well-respected Axel Rudolph at Dow Jones): “Sell in May and go away, come again on St. Leger’s Day so long as there is a Stochastic crossover sell signal.” Ooh-err!

The results?

It turns out that this rule hasn’t been too bad at all, looking back for the last 20 years.

We put the start of the summer period as the day of the first Stochastic crossover sell signal in May or, if there was none, as May 31^st. The end of the summer was defined as the day of the St. Leger Stakes, the horse racing meet in Doncaster that’s been running since the 18^th century, and which is always held in mid-September. We use the Slow Stochastic indicator with the typical parameters.

So here’s a simple comparison: the returns for each of the last twenty years (blue) versus the annualised returns for each summer (red):

Fig 1.

The chart shows that the red series was quite a bit lower than the blue series on a couple of occasions (1992, 1998, 2001, 2002, for example), meaning that summer returns were much worse than the annual returns in each of those years. And we also see that the years in which the summer significantly outperformed the year as a whole weren’t very common.

So now let’s compare the same annual returns versus the returns achieved by sitting out during the summer period (selling in May and coming back in September). The annual returns are in blue again, with the returns from the “Sell in May” strategy in purple:

Fig 2.

This shows that the returns from sitting out for the summer months were better than for the year as a whole in 1990, 1992, 1998, 2001, 2002, 2006, 2007 and 2008.

What’s also going on here, though, is that the returns from summer were greater than zero for 11 of the 20 years in question, so that for each of these years you were better off staying invested rather than sitting out. Even if the summer returns weren’t that great, they were better than the zero gained by doing nothing for that time.

In general, though, the records show that there has been some good success in leaving the fray for summer, as illustrated by this summary:

1989-2008                          Average Returns

Annual                                      6.03%

Summer (annualised)          -1.03%

Sell in May Strategy                7.39%

The average return for each of the past 20 years has been 6.03% but, by employing the Sell in May strategy, the average return rises to 7.38%. The average of the annualised returns for the summers has actually been negative.

Now let’s look at the suggested amendment to the rule, and use the Stochastic sell signal. We find that when you only sell out in the years when there was a sell signal, the strategy does improve a little. This is illustrated by Figure 3, where we simply stayed invested for the years when there was no signal:

Fig 3.

Waiting for a Stochastic sell signal meant that you would still have been protected from summer losses in 1990, 1992, 2001, 2002, 2006, 2007 and 2008 (you would have suffered pretty big losses last year anyway, of course). This strategy performed worse than simply staying invested for the year in 1989, 1991, 1993, 1995, 1997 and 2005. The average return from this strategy, however, is still an improvement on simply selling out (which was already an improvement on staying invested):

1989-2008                                  Average Return

Annual                                             6.03%

Sell in May                                      7.39%

Sell Signal Strategy                      7.49%

Looking exclusively at the years when there was a sell signal, the worst return (except for 2008) was -3%! Some people might consider this to be good value risk management, even if it means missing out on some growth during good years

Our summary box looking only at the years with a sell signal helps to prove how the rule made a big difference:

Sell Signal Years                     Average Return

Annual                                              5.75%

Summer (annualised)                  -3.64%

Sell in May Strategy                         8.01%

This isn’t a very formal analysis, of course, but could be worth thinking about. In terms of this year, we had a Stochastic sell signal for the FTSE on the 13^th of this month (the vertical line on the chart below).

Fig 4: Stochastic sell signal for the FTSE-100 index, 13^th May 2009

The market has gained a little more since the signal, but anybody who thinks that the rally is probably over now might take encouragement from the historical record of weak summer trading. That would make this an opportunity to get out, only coming back for race day in Doncaster next autumn.

Graham Neary (graham@futurestechs.co.uk)

We included the RSI and Parabolic SAR indicators in the new levels sheet available in our Members Area, so thought that it would be worthwhile to briefly introduce them to anyone who might not be familiar with how they worked or how to use them.

Fig 1: The New Levels Sheet. (Click to enlarge)

RSI (Relative Strength Index)

One of the most popular oscillators, the Relative Strength Index was first introduced by J. Welles Wilder in his popular, now-classic book, “New Concepts in Technical Trading Systems” (Trend Research, 1978).

The calculation might not look intuitive, but it really isn’t too complicated:

where RS is the “Relative Strength” of up days versus down days over the period being used (typically fourteen).

As originally calculated by Welles Wilder, the strength of up days is calculated as follows: for each day, “Up” is recorded as: the difference between the close and the prior close if there was on increase, or as zero if there wasn’t. “Down” is recorded similarly: the size of the difference between the close and prior close (always a positive number) if it decreased, or zero if it didn’t. The exponential moving averages of “Up” and “Down” are calculated, with the EMA of “Up” then divided by EMA of “Down” to give us the Relative Strength.

RSI is bounded in the range 0-100, and the use of the exponential moving averages makes it reasonably smooth, solving two issues which often arise with oscillators (for example: the simple Momentum indicator - the difference between latest close price and the price n periods ago - is neither smooth nor bounded, making for volatile swings which can’t be compared across markets).

The key takeaways from RSI are:

The ideas that hold true for oscillators in general hold true with the RSI. The oscillator will frequently turn around before the price does – for example, a price still rising that is accompanied by a falling RSI produces a bearish divergence between price and oscillator, a major warning that the up trend is running out of steam (see Fig 2 below).

Fig 2: NASDAQ Futures, September 1999 – May 2000. Divergence between price and RSI at the height of the bubble. (Click to enlarge)

It’s worth reinforcing that extreme RSI readings do not by themselves constitute buy or sell signals. For example, the most that a high RSI, even one above 70, can indicate is that if the market is ranging, it is now due for a correction. The sell signal won’t actually be produced until RSI starts declining back toward neutral levels, and if the market is trending instead of ranging, then it could stay at elevated levels for extended periods of time. As with any indicator, trader discretion is advised.

When looking at our levels sheets, simply checking whether the RSI is above or below 50 tells you something about the internal strength of that market. Additionally, we highlight the figure in yellow if it is in one of the extreme overbought/ oversold zones. A cluster of extreme overbought/oversold markets in the same sector of our equities, commodities or Forex sheets provides interesting information about general market trends, while also helping us to identify specific opportunities.

Parabolic SAR

Another invention by Welles Wilder, the Parabolic Stop-and-Reverse is designed as a trailing stop system with a difference. Originally called the Parabolic Time/Price System, the stop is calculated as function of price and time.

The SAR alternates between providing stops for shorts and longs, switching as soon as a stop is activated. In the chart above, the blue marks are the stops for shorts, with the red marks the stops for longs. As you can see, this system is “always in”, meaning that it always indicates an uptrend or a downtrend (depending on which type of stop was the last one to be activated), so that somebody who focused exclusively on it would always have a position in the market. This makes it unsuitable for ranging markets, where a trader using it would be constantly whipsawed (see Fig 3 below).

Figure 3: NASDAQ Futures, January - May 2009. Whipsawed until mid-February, and then helpfully following the trends. (Click to enlarge)

The stop is calculated by:

Today’s SAR = (Yesterday’s SAR) + (Acceleration Factor)*(Yesterday’s Extreme Price – Yesterday’s SAR),

where yesterday’s extreme price is the high in a downtrend, or the low in an uptrend, and the Acceleration Factor is a fraction which increases incrementally each day up to a maximum value, providing the distinctive parabolic shape (this is the part of the formula incorporating time).

The recommended use of the Parabolic SAR is as a stop in a trending market where other, primary tools of analysis have originally motivated the trade. The stops which it provides won’t rush to the price action too quickly at the start of a serious move, thus giving it some initial time in which to develop. However, the increasing “Acceleration Factor” means that it will pick up speed when it isn’t activated, until it races quickly towards the price. This means that when the trend does eventually lose momentum, it will quickly catch up with the price and close out the trade.

Our levels sheets provide the SAR stop in green if it’s the stop in an uptrend, or in red if it’s the stop in a downtrend. Again, simply browsing which sectors are predominantly in uptrends or downtrends according to the SAR provides useful information, even if you aren’t using the stops in trading a specific market.

A Note on Parameters

Note that as with all indicators, the parameters of the RSI and the Parabolic SAR can be tailored to suit the individual markets under consideration. Our levels sheets use the most commonly used parameters for each indicator (14 periods for the RSI, an acceleration factor of .02*(t) up to a maximum of .2 for the Para SAR), for the same reason that we look at 10, 20 and 50-day moving averages: besides being reasonable parameters to use most of the time in their own right, they are the parameters that a majority of people automatically use anyway, and therefore gain technical significance purely on that basis.

Other Indicators, Other Markets?

The levels sheets are there to assist our members and if there are particular indicators and/or markets which you would like to receive automated levels for, please let us know and we’ll do our best to include them. While automated indicators and levels are never going to be a trader’s panacea, when incorporated into an overall strategy they are a key ingredient of successful trading.

Graham Neary (graham@futurestechs.co.uk)