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Issue No. 61 – January 16, 2006 Prescott, Arizona Systems@WiserTrader.com
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1.0 Trading
Once the concept of the trading template is mastered, it becomes easier to develop a trading system of your own.
1.1 Trading Templates
A template is a procedure for applying technical indicators to trading stocks and options that have been selected by a filtering process. Each template exists for a specific technical formation and, together with a filtering process, forms the major portion of a trading system. Usually the simpler templates are, the easier they are to use. Simple templates have three parts, (1) recognition of a technical chart formation, (2) a trigger indicator that signals the condition for a trade and (3) a confirmation indicator that signals the timing for a trade. One type of trading system that makes the concept of templates easy to understand is that of a trend following system. The technical chart formation used in a trend following system is, as you might guess, trend identification. The acronym TTC is used to identify a trend-trigger-confirmation trading template. The key to understanding the use of a template is that its three components are applied sequentially because not all three components are likely to occur at the same time. This particularly applies to the trigger and confirmation. One will notice how the filter and the components of a template fit together to form a unified logical whole.
For a trend following system, growth-momentum stocks are selected using objective criteria to maximize the likelihood they will increase in price. To this end, the Cooper filtering criteria has been discussed frequently in this newsletter and is found on the website. This filter uses the fact that stocks selected are (a) the fastest rising stocks in the NASDAQ and NYSE, (b) are near their 52 week highs, (c) have superior earnings growth and (d) are in a leading industry. This filter sharply reduces the number of stocks under consideration. Selection of stocks priced at a minimum of $50 further guarantees that only top quality stocks are being considered.
© 2005 Desert Mountain Systems, LLC. Members of wisertrader.com are neither licensed brokers nor licensed advisors. Trades discussed represent recommendations made by the editor for the wisertrader.com portfolio. The newsletter and web site are for information only and should not be considered as personal advice. While it is believed that the posted information is factual, mistakes can be made in transcription. Investors should trade stocks only after verifying all information and consulting with a licensed broker or adviser. Desert Mountain Systems markets third party trading systems but has no other affiliation with trading system companies.
Once a group of stocks has been identified, each stock is checked to see if it meets trend requirements. A refinement of the Cooper trend screen is to require that the 30 or 40 day simple moving average (SMA) has a prescribed minimum slope of say, 5% over a 4 week period or 0.25% from day to day. Alexander Elder defines an uptrend based on two successive MACD histogram bars increasing in height. When one’s trading time frame is a few days, a weekly MACD histogram is used. When the trading time frame is weeks, a monthly MACD histogram is used. Almost any trend identification system can be used as long as it matches the trading time frame and style of one’s trading. If the trend screening criterion is not met, the stock is eliminated for current consideration.
For stocks that passed the trend test, now is a most import screen that protects the trader from a basic fallacy of human nature. We are naturally attracted to rising prices and our first impulse is to buy a stock just because it is in an uptrend. But even when stocks are trending they tend to oscillate, within a range, on either side of a mean tendency. If we buy on the high side of a range, it makes us nervous when the stock moves toward the lower side of the range. Although it is still trending in the same direction, it is painful to experience such movement and it may force us out of the stock, only to watch it move upward again. For this situation we use an oscillating trigger to buy the stock when it is rising from the lower portion of the range. The 5 period slow stochastic and the 10 period Williams %R indicators are good for triggering a buy. Either oscillator indicates a buy trigger when it reaches an extreme oversold condition. The slow stochastic triggers a buy condition when it reaches a value of 20 or less and then begins to rise. The Williams %R triggers a buy condition when it reaches a value of -80. These two are not the only oscillating triggers that can be used. Both can be easily applied to stock charts, along with simple moving averages of any composition at Bigcharts.com.
But wait! Just because we have a trend and a trigger, it does not mean that it its time to trade. We need confirmation that it is time to trade by seeing the stock, and indeed the major averages, moving in the proper direction. Unless there is an exceptional news release, the majority of a stock’s price movement can be attributed to recent and current movement of the major averages. Remember that this is a trend following system and crowd psychology plays an important role. We want to trade with the market trend as much as possible. One Cooper confirmation waits for the stock price to rise above its 7 day SMA. When used with the Williams %R it is called a TTC-A template. Another Cooper confirmation waits for the fast MACD line to cross above the slow MACD line. When used with the slow stochastic it is called a TTC-B template. Alexander Elder’s confirmation waits for the price to move above the previous closing price on whatever time scale one is trading. His method is named the Triple Screen template. Remember that the confirmation comes sequentially after the trigger. Once the confirmation occurs, the trigger oscillator is most likely no longer in an oversold condition.
All of these templates rely on the concepts of trend, trigger and confirmation. Notice how the three elements, along with the filter, logically reinforce one another. Each template is simple and taken as a whole, quite elegant. These are just a few of the many templates in existence. Each of the 63 technical formations found in The Encyclopedia of Chart Patterns by Bulkowski has a trading template for buying, as well as, for selling. The logistics of combining elements of a trading system can vary widely in terms of ease of use, cost and speed. The 3 step sequential process of a using a template automatically reduces the number of stocks being considered for actual trades. After trading a dozen or so times with a standard template, it becomes apparent how it should be adjusted to fit your trading personality.
2.0 Market Analysis
The market again finds itself at the beginning of another earnings season. It is typically choppy for the first three weeks of earnings season without much direction. Expectations are for earnings to be up about 13% over the previous year but with lowered projections further earnings in 2006. Precious metals and energy can expect a near term rise due to geopolitical concerns and colder weather. This implies a flat to downward bias for the broader market.
Key industry ETF’s in Table 2A are Biotech and Semiconductors which confirm the NASDAQ. Transportation confirms the Dow Jones Industrial Average according to Dow Theory. Banking and Financials are confirming indicators for the S&P 500. Gold and Real Estate are respective indicators for the inverse health of the currency (inflation) and the capacity for consumer spending.
Table 2A
Indices, Key Industry ETF’s and Sector SPDR’s
|
|
1 month |
1 wk ago |
2 wks ago |
3 wks ago |
4 wks ago |
|
Dow Jones Industrials |
0.8% |
0.0% |
2.3% |
-1.5% |
0.1% |
|
NASDAQ |
2.9% |
0.5% |
4.5% |
-2.0% |
-0.1% |
|
S & P 500 |
1.6% |
0.2% |
3.0% |
-1.6% |
0.1% |
|
Russell 2000 |
3.7% |
1.3% |
3.9% |
-1.9% |
0.5% |
|
GLD, GOLD |
10.7% |
3.2% |
4.1% |
2.9% |
0.1% |
|
RKH, Banking |
-0.8% |
-0.7% |
2.2% |
-2.3% |
0.0% |
|
IYT, Transportation |
-0.5% |
-1.7% |
0.2% |
-1.7% |
2.7% |
|
SMH, Semiconductors |
3.8% |
-0.5% |
8.2% |
-3.1% |
-0.6% |
|
BBH, Biotechnology |
-0.6% |
-1.4% |
0.5% |
-2.0% |
2.3% |
|
IYR, Real Estate |
1.7% |
-0.1% |
4.8% |
-1.8% |
-1.1% |
|
OIH, Oil |
9.2% |
1.7% |
8.7% |
-2.5% |
1.4% |
|
XLE, Energy |
6.6% |
1.9% |
6.3% |
-1.8% |
0.4% |
|
XLU, Utilities |
-0.3% |
0.1% |
2.5% |
-1.4% |
-1.5% |
|
XLB, Materials |
2.6% |
-2.6% |
3.7% |
-0.8% |
2.4% |
|
XLI, Industrial |
-0.2% |
-0.5% |
1.1% |
-1.3% |
0.5% |
|
XLK, Technology |
2.6% |
0.6% |
5.3% |
-2.3% |
-0.8% |
|
XLV, Healthcare |
2.4% |
-0.3% |
2.6% |
-1.8% |
1.9% |
|
XLF, Financials |
1.7% |
0.2% |
2.5% |
-1.6% |
0.7% |
|
XLP, Consumer Staples |
-1.3% |
-0.1% |
0.9% |
-1.6% |
-0.5% |
|
XLY, Consumer Discretionary |
0.4% |
0.7% |
2.1% |
-1.3% |
-1.0% |
