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Monday, March 19, 2012

MY COUSIN VINNY




It is hard to believe by looking at this photo, but my little boy Vinny is 6 months old now on his way to being Howard Huge, and when I saw this going on in the front yard it reminded me of what I spent the whole weekend doing. I have been tortured by one inconsistency in one of my short term trading approaches. I have literally gone back and forth with it for 3 years trying to get a consistent read on exactly how to handle one particular aspect of it. I finally decided I was going to take the rat by the tail and get my arms around this issue. Vinny felt compelled to do the same thing with that pesky hose in the front yard which now is full of holes. On the other hand I was trying to patch some holes.

Here is the dilemma, look at the chart below.




My dilemma over the past several years has been, where in the hell do you enter these trades when you have pullbacks against an established trend? I have concocted one goofy indicator after another trying to get me a leg up on this, and none of them have really worked. I love these guys who post charts like this with lines drawn and just make it look like you would never lose just playing these flag or whatever you want to call these patterns. If you look closely at most of these corrections, there were several instances of a prior low going just to have the price continue to rally against the trend. Each and every one of these was tricky in terms of determining where you would short the market. It is always easy after the fact to draw in these lines, but it is another matter entirely to trade them live as real traders know.

I do have other tools I use that help me ferret out many of these fakes which I don't show here, but the net net of this is, reading the price patterns is still quite a challenge. You can read book after book talking about magic patterns and how they help to enter trades. It seems everyone has a different spin on this. My spin is that it is all hog wash. One of my favorite takes on this is "reversal bars have correctly predicted 5000 of the last 37 major tops." I hope you get this. In other words they are wrong most of the time.  Here is the same chart with reversal bars for sells highlighted in red. You can see for yourself that this is barely a 50/50 proposition.




I could label many other bar patterns that supposedly are magic and you would see the same thing, some work some don't. I have systematically tested just about every type of bar you can imagine and have found no edges at all to any of them. Studying collections of bars is another matter in that it is almost impossible to program them correctly. Even if I could I would not bother taking the time to do it. The solution to this dilemma is one of two approaches. First, you either enter at the market on a pullback with a Williams %R type of approach, and carry a stop at the dollar amount you are willing to risk. This will work until you either have a deep pullback or the trend changes. In those two instances obviously you will get stopped out for a loss. The second approach, which is the one I prefer, is to wait until you see the trend reasserting itself and sell on weakness.

This approach is somewhat of an art, but I think you can see from looking at the first Coffee chart where those instances are. I developed something somewhat mechanical to take the subjectivity out of this but that is hardly necessary. The net of it is that I will wait for the momentum to obviously turn back in my favor before entering the trades. It is up to you exactly how you approach this, but I would suggest that just waiting for the first low to get taken out on a pullback in a downtrend is not enough evidence to be consistent trading these little flag patterns.

In the mean time back at the ranch, the up trend in equities and most things for that matter continues. We just slowly creep day after day. This is a very difficult move to trade so be careful and be patient. You have to wait these things out some times. Do not try to impose your will or opinions against a move like this, trading cemeteries are full of people who tried that trick.

I do plan on launching my web site soon where for a pretty small fee you will have access if you wish, to more specific things like the research above I mentioned. I plan on pricing this very low to attract people to it.

Good Trading











5 comments:

PJ Whiteley said...

I will be interested in joining your new website. I like reading your journal.

John M said...

With stuff like that, I think you just have to use a bunch of different time frames, 5 or 6 of your favorite technical indicators--some fast, some slow--look for abc's and count waves...it just takes a bunch of things that you weigh and juggle onscreen and in your head.

I know you know that. I don't think there is a holy grail for this; one indicator that will give you consistently accurate signals. Not that it wouldn't be fun to try and figure one out. Might even work for a while. It just seems like it could be a little bit like trying to figure out how to turn lead into gold, when it's actually easier and faster to just buy some gold...or even mine it.

Chris Johnston said...

John with all due respect we completely disagree on this one. I think what you have mentioned there is where most traders go wrong. When you make things that complicated they are bound to go wrong on you. This will be something I write about a great deal once my newsletter is started again. I have very strong feelings on this topic and they grew out of frustrating trading periods in my life.

Anonymous said...

Chris
On the coffee chart you already have the trendlines drawn, why wouldn't you just sell a close below the break of the trendline.
For confirmation if needed you cousl use something as simple as a close below a 10 SMA. (20 sma takes too long). I use that close above or below the 10 SMA with CCI crossing the zero line all the time.
Don in Virginia

Chris Johnston said...

can you honestly tell me as the bars rolled out that you would have waited for some to pass and drawn those lines in the exact same place? I doubt it.

There are many ways to approach it, if you want to use moving averages you certainly can, I don't use them since I know from testing every combination I could every think of they don't work very well except in a perfect trend like that one