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On the world's financial markets and stock exchanges. Part 8

On the world's financial markets and stock exchanges. Part 8

1. Introduction

To become a modern trader who uses a computer in his trading, you need to do three steps: choose the software, the computer and the data for analysis.

If you want to work on wood or metal, you will go to a tool shop and buy a set in a drawer. You will have to learn how to use these tools correctly in order to work intelligently and efficiently. In turn, technical analysis toolkits offer electronic means of processing market data.

The toolkit draws daily and weekly charts, divides the screen into several windows and builds price and indicator charts. A good toolkit has many popular indicators: average price movement indicator, channels, MACD, MACD histogram, stochastic, relative strength index and many more. It allows you to customise all the indicators. For example, at the touch of a button it allows you to go from 5-day to 9-day stochastics.

Modern computer programmes allow you to write your own indicator and add it to the system. In addition to ready-made indicators, you can have your own favourite formula. The software allows you to compare any two markets and find similarities between them. If you trade options, the program should definitely include an option valuation model. Sophisticated programs can check the profitability of trading.

As we mentioned before, technical analysis is divided into two methods:

  • Graphical - based on the analysis of price charts - plotting the change in price over a certain period of time.
  • Mathematical - a computer method of analysis using indicators.

 

2. The main groups of indicators and oscillators

 

Indicators allow you to find trends and the moments of their changes. They allow to better understand the balance of forces between bulls and bears. Indicators are more objective than drawn charts.

The problem with indicators is that they sometimes contradict each other. Some work better in a trend, others in a quiet market. Some are better at detecting pivot points, others are better at identifying trends.

Most amateurs look for a single indicator: the silver bullet that kills all doubts in the market. Others collect many indicators and try to average their signals. Either way, a careless beginner with a computer is like a teenager with a sports car and you should expect disaster. In case you set up for serious trading, you should know which indicators work best in strictly defined conditions. Before you use an indicator, you need to know what it measures and how it works. Only then will you be able to use their signals with confidence.

The main feature of oscillators is their ability to signal a market reversal. They are very useful when working in a channel. The main signal of oscillators is divergence.

The following points should be considered when using oscillators:

  • Intersection with zero line as a signal is weak and taken into account only if it doesn't contradict the main price trend;
  • Critical values of oscillators indicate only that the current price movement is too fast, and, therefore, a correction can be expected soon. It also follows, however, that the oscillator can reach the over-zone long before the end of the trend (if prices changed significantly at the beginning of the trend), and stay there for a long time as the trend develops further. Therefore, an especially strong signal occurs when the oscillator makes several oscillations in the over-zone and only then leaves it;
  • The divergence of the price chart and the oscillators (divergence). The price chart forms a new peak that is higher in absolute value than the previous one, but the oscillator does not confirm it. The divergence value itself does not influence the strength of the subsequent price change. The use of divergence is one of the most reliable methods of technical analysis;
  • It is useful to use trend lines, support and resistance on the oscillator charts. You will often see the classic figures of technical analysis, which may be of greater importance than on the price chart;
  • Overbought and oversold zones should be set individually, depending on the type of market and time frame on which the chart is plotted. Sometimes they can be 2-5% to filter out false signals;
  • The shorter is the oscillator period, the more frequently signals appear and their lag is less, respectively, the higher is the proportion of false signals. With oscillators with a larger period the number of signals decreases, the lag increases, but the reliability increases.

Indicators and oscillators can be divided into 3 major groups:

 

  • Trend-following - help to work in a trend and include Moving Averages (Moving Average), Envelopes, MACD, Bollinger Band, Parabolic, +/-DM indicators, ADX indicator;
  • Flatteners (channel) help to trade out of trend and are made up of: Stochastic oscillators, Momentum oscillators, ROC, CCI, RSI, MACD histogram;
  • Volume indicators analyse the dynamics of volume change, which is seen by analysing volume indicators and their interaction with the price chart.

 

Trend indicators work well when the market is on the move, but give dangerous signals if the market is standing still. Flat oscillators show pivot points in a stationary market, but give premature and dangerous signals when the market begins to move in a trend. Volume indicators give a better insight into the psychology of the masses. The secret of successful trading is to combine several indicators and oscillators from different groups, so that their negative qualities are mutually compensated, while the positive ones remain intact.

3. trend indicators and oscillators

3.1 Moving averages

Probably the most real money is made today by using moving averages (MA), rather than all other technical indicators put together. Because they can be used for any purpose, such as finding long-term monthly trends, setting stops for day trading, and much more. Moving averages have been the subject of more discussion in technical literature and other sources than any other technical study. One of the reasons they have become so popular is that when markets are trending, these simple little lines perform as well or even better than indicators requiring a doctorate for their calculation and interpretation.

Moving averages smooth out market fluctuations and short-term volatility, giving the trader a sense of where the market is heading. Equally important to know is what they do not do. They are trend following indicators in their purest form. They always show the direction of the trend, but they do not measure how strong or weak the trend is. Their function is to determine the direction of the trend and then smooth out or silence its volatility. Moving averages handle these important tasks simply and well.

There are so many different types and variations of moving averages, that it is meaningless to try to list them all. Most types were created in the 1970s, when moving averages were considered a very sophisticated and advanced technical analysis tool. Many talented and inventive technical analysts have spent much of their time coming up with new ways to use and improve on moving averages. The interest in them has been generously rewarded - the 1970s were the time of markets in a constant state of trend, and moving averages worked exceptionally well.

The disadvantage of moving averages is that the averages lag in relation to the rate of the value in question. Moving averages differ in the method of averaging.

There are three basic types of simple moving averages:

  • Simple Moving Average - Simple Moving Average (SMA);
  • Linear Weighted Moving Average (LWMA);
  • Smoothed Moving Average (SMMA);
  • Exponential Moving Average (EMA).

The only thing where moving averages of different types differ considerably from each other - is in different weight coefficients, which are assigned to the last data. In case of simple moving average, all prices of the time period in question are weighted equally. Exponential and Weighted Moving Averages give more weight to recent prices.

The most common method of interpreting a price moving average is to compare its movement to the movement of the price itself. When the instrument price rises above the Moving Average there is a signal to buy, when it falls below the indicator line - a signal to sell.

This trading system, which is based on the moving average, is not designed to provide entrance into the market right in its lowest point, and its exit right on the peak. It allows you to act according to the current trend: buy soon after the prices reach the bottom, and sell soon after the prices have reached their peak.

Moving averages may also be applied to indicators. That being said, interpretation of Moving Averages is similar to that of price moving averages: if the indicator rises above its Moving Average, it means that the upward movement of the indicator will continue, and if the indicator falls below its Moving Average, it means that its downward movement will continue.

The exponential moving average is recommended as the basic one for application.

The basic rules for the construction of an average are as follows:

  • The longer the time period, on which an average is built, the lower the order of the average should be selected (for daily charts, the order of 89 or less, for weekly charts - 21 or less), short averages can be used without restrictions;
  • the longer is an average, the less sensitive it is;
  • An average of a very small order gives a lot of false signals;
  • an average of a very high order is constantly late; an average with a higher order than usual is used in the case of a sideways trend

Insert an example from MT where you can adjust the type of moving average, select the number of days and the colour. And add a brief description of this figure.

 

3.1.1 Simple moving average

 

Simple Moving Average (SMA), is calculated by adding and averaging a set of numbers representing market action over a period of time. The calculation usually includes closing prices but can also be calculated from the peaks, troughs or average of all three. The oldest data point is discarded with the appearance of a new one, hence the average "slides" and follows the market. A line connecting the daily averages will smooth out recent market fluctuations.

Longer-term moving averages will smooth out any minor fluctuations, and only show longer-term trends. Short-term moving averages will show shorter-term trends to the detriment of longer-term trends. A smaller data set representing only more recent data will create a more sensitive line. A chart showing a 5-day moving average overlaps the same chart for a 50-day average, the 5-day average reflects the data much more accurately, following every small change in price. Short-term trends are easy to see, while trends made obvious by the 50-day average are much harder to identify.

Long-term and short-term moving averages each have their own uses and disadvantages. Although the 50-day moving average stays with the trend, it always stays away from real prices and changes direction much less frequently than prices. In practice, a trading system based on a moving average of this length will be slow to enter and exit the market. A slow entry misses a significant portion of the trend start and a slow exit sacrifices a large portion of the return. On the other hand, a 5-day moving average is quick to enter and exit, but is not in harmony with the underlying trend and is just as often on the wrong side of the market as it is on the right side.

Another interesting property of simple moving averages (and many other technical studies of this type) is that they are also affected by old prices, which are thrown out of the averaging as well as new ones. An unexpected turn in a moving average could mean that fresh prices have turned. It can also mean that fresh prices are behaving relatively neutrally, but significant prices have been thrown out of the other end of the data. This is not necessarily a bad thing. After all, the purpose of a moving average is to smooth the data. But one must be prepared for this effect. This phenomenon can sometimes explain what seems to be an inexplicable change in a moving average or other indicator.

For example, a 5-day moving average shows the average prices of the last 5 days, etc.

A simple, or arithmetic, moving average is calculated by summing up the closing prices of an instrument over a certain number of unit periods (for instance, 12 hours), and then dividing the sum by the number of periods. The formula for calculating a simple moving average:

 

SMA = SUM (CLOSE (i), N) / N

where:

SUM - amount;

CLOSE (i) - closing price of the current period;

N - number of calculation periods.

The main drawback of MA is that it reacts to one change of the rate twice: when it is received and when it is withdrawn from the calculation. MA has an inertia. The bigger n is, the smoother МА is formed, but the more its changes lag behind the price changes. Usually two or more moving averages are used, and one assesses not only what each of them shows, but also their location relative to each other.

3.1.2 Linear Weighted Moving Average

In a Weighted Moving Average - Weighted Moving Average (LWMA), the most recent data is given a higher weight, and the earlier data is given a lower weight. A Weighted Moving Average is calculated by multiplying each of the closing prices in the series in question by a certain weighting factor.

LWMA = SUM (CLOSE (i) * i, N) / SUM (i, N)

where:

SUM - sum;

CLOSE(i) - current closing price;

SUM (i, N) - sum of weights;

N - period of smoothing.

 

3.1.3 Smoothed moving average

The first value of smoothed moving average - Smoothed Moving Average (SMMA), is calculated as a simple moving average (SMA):

SUM1 = SUM (CLOSE (i), N)

SMMA1 = SUM1 / N

The second value is calculated according to the following formula:

SMMA (i) = (SUM1 - SMMA (i - 1) + CLOSE (i)) / N

Subsequent moving averages are calculated using the following formula

PREVSUM = SMMA (i-1) * N

SMMA (i) = (PREVSUM - SMMA (i - 1) + CLOSE (i)) / N

where:

SUM - sum;

SUM1 - sum of closing prices of N periods, counted from the previous bar

PREVSUM - the smoothed sum of the previous candle;

SMMA (i - 1) - smoothed moving average of the previous candlestick

SMMA (i) - smoothed moving average of the current candlestick (except the first one);

CLOSE (i) - current closing price;

N - period of smoothing.

As a result of arithmetic transformations the formula can be simplified:

SMMA (i) = (SMMA (i - 1) * (N - 1) + CLOSE (i)) / N

3.1.4 Exponential moving average

Like car builders who modify old models - traders modify already created indicators. Exponential Moving Average - Exponential Moving Average (EMA), gives more value to new data and reacts more clearly to current changes.

An exponentially smoothed moving average is determined by adding a certain fraction of the current closing price to the previous moving average. With exponentially smoothed moving averages, the latest closing price is given more weight. An exponential moving average will be of the following form:

 

EMA = (CLOSE (i) * P) + (EMA (i - 1) * (100 - P))

where:

CLOSE (i) - closing price of the current period;

EMA (i - 1) - value of the moving average of the previous period;

P - the share of using the price value.

 

The main advantage of EMA is that it includes all prices of the previous period, and not only the segment defined at period setting. At the same time, more weight is given to the later values.

What should be considered when choosing parameters of averaging? The main thing is to sense changes (change direction) and to filter changes, i.e. to refrain from abrupt changes.

Another interesting feature - the MA serves as support and resistance lines!

Hence the use of a combination of MAs of different orders. By comparing the position of the means of different orders, relative to each other, we assess the presence of a trend over large intervals. General rules of analysis:

  • find intersection points between the average and the price chart;
  • find intersection points of averages with each other;
  • analyse the position of averages in relation to a price chart (whether they are above or below the chart);
  • find points following the maximum or minimum of an average;
  • find the points of greatest divergence between the average and the price chart;
  • follow the direction of movement of an average.

 

3.1.5 Double Moving Averages

 

The most popular moving average systems use two moving averages. They usually consist of a longer moving average, which serves to define the trend, and a shorter moving average, which gives trade signals on the crossover with the longer-term average. The best known of these systems is Richard Donchian's 5-day/20-day system, which, by the way, is not a simple reversal system, but uses an elaborate set of filters.

The main signal of the double moving averages is a crossover. Buy when the shorter moving average crosses below the longer moving average, and sell when the opposite occurs. You can also use crossovers as trend reversal points and trade only in the direction of the marked trend, using other shorter term methods for entries and exits.

Most of the research we have seen and done has shown that a double moving average system is generally more profitable than other moving average combinations. Research also shows that all moving average systems have long periods of gains and losses, depending on the trendiness of the markets.

Interesting signals are given by a combination of 9-day and 14-day moving averages. The point of intersection of the two lines MA9 and MA14 is a signal of a change in trend. The disadvantage is the systematic lag in the signal. The advantage - it is easy to determine the trend direction, and you can also use them as support and resistance lines.

 

3.1.6 Triple moving averages

 

One of the most popular triple moving averages is the widely used 4-9-18 day moving average, popularised by R.K. Allen in the early 1970s. The third moving average opens up a large number of potential trading opportunities. In general, when the market has bottomed out, the main indication of a change in the trend is the crossover between the 4-day and the 18-day. The crossover between the 9-day and the 18-day is a confirmation signal. When the prices are at the peak, the crossing of the 4-day and the 9-day will be the preliminary signal of a possible change in the trend. The earnings at this point will help overcome the characteristic feature of moving average systems, which is the return of earnings. The trend reversal will only end when the 4-day and the 9-day cross the 18-day.

We like triple moving average systems because they provide the advantage of a neutral zone as opposed to the continuous reversal trade generated by single or double moving average methods. For example, in the 4-9-18 system, when 4 crosses 9, we exit our position and do not enter a new position until 9 crosses 18. We also like triple systems because the crossing of 4 and 9 is a quick earnings mechanism, which solves some of the problems associated with returning too much income we mentioned earlier. We believe that in a good trading system, exits should always be faster than entries. Entries should be slow and selective, perhaps requiring an extraordinary event to enter the trade. Exits should be slow enough to allow profits to flow in, but fast enough to eventually lock in the bulk of the potential profit.

The triple MA is also used in Williams' world famous trading strategy "Alligator" with parameters 13 - 8 - 5.

 

3.1.7. Four moving averages

 

The use of four moving averages is not as strange or complicated as it seems. When used properly, the four moving average approach circumvents some of the problems inherent in moving averages without losing any of its virtues. The method uses four moving averages in sets of two. The two longest moving averages are used strictly as trend identifiers and are most easily applied when set as oscillators. The two shorter moving averages are more sensitive and are used for timing entries and exits (usually based on crossovers), trading exclusively in the direction signalled by the longer-term oscillator.

Trading against the trend is eliminated by definition. If there is an uptrend as determined by the long term oscillator, only long trades will be accepted based on the short term crossover signal. Conversely, only short trades will be accepted when there is a downtrend. There will be neutral periods during trend corrections and sideways market movements, when the short-term and long-term moving averages fail to confirm the direction. Jerks will not be completely eliminated, but their number will be significantly reduced.

 

3.1.8 Finding a filter

 

Instead of blindly following all crossovers, many traders use different filters to determine the suitability of the primary signal. Filters fall into two categories: price filters and time filters.

Filtering signals by price usually means delaying entry into a trade until the price satisfies some additional criterion. This can be determined by measuring the magnitude of the breakout behind the moving average or by measuring the distance that one moving average has from the other after crossing. The trader, in this case, is looking for confirmation that the moving average crossing was not a random price event, but is in fact a trend change. A new trade will not begin until the price has surpassed the moving average by some minimum value. Another variation on this filter would be to wait for prices to rise by some percentage relative to the moving average. The next possibility (which we find generally accepted) is to wait for a given period after the crossing until the market has reached a new peak or trough in the last p days, which is a channel break. One of our favourite filters or confirmation methods is very simple: wait for the close in the direction of the new trend.

Time filters use waiting for a certain number of time periods after a cross before entering a trade in the new direction. Many traders who use moving averages have noticed that most twitches occur very close to the beginning of a trend, and a slight delay in entering will help avoid most of them. The waiting period is usually one to five days. If price stays on the new side of the moving average for the minimum time period, we conclude that the signal was correct. Obviously, the longer the waiting period, the less twitching there will be, but at the same time it can lead to such a late entry that the bulk of the movement is missed.

3.1.8. Conclusions on the use of moving averages

 

Moving averages are the simplest and most elegant trend-following studies available. Up to a certain limit, they can be very effective, but their limitations can be significant. Most markets spend more time in sideways movement than in trending movement. A non-trending (flat, channel) market can bring down a most carefully chosen moving average system. Here are some of our thoughts and conclusions on how to help your moving average system survive.

Try to limit your trading to trending markets. Diversification helps, but don't trade all markets in the same way. At any given time, typically less than 50 per cent of all markets can be defined as trending. Most of the time the actual number of them is significantly less. Find a way to objectively determine whether a market is trending or not and only then apply moving averages. We recommend Weilder's DMI / ADX as a reliable study that measures whether the market is trending or not. The simple explanation is that when the ADX is rising, the market is trending, and when it is falling, the market is losing direction. The channel breakout filter we mentioned earlier can also be effective.

Long-term moving averages generally react too slowly to be useful for exits. Use an alternative exit strategy. We think the most common mistake with moving averages is to use the same set of moving averages for entries and exits. If you use slow averages, you will be slow to exit and lose most of your income. If you use a faster moving average, you will have better exits, but you will find that you get jerks on the entries.

 

3.2 MACD

 

The Moving Average Convergence-Divergence Trading Method (MACD for short) was developed in 1979 by Gerald Appel as a timing tool for the stock market.

The MACD is best used as a trend-following study. The MACD trading method works particularly well in quiet long-term markets, where you can stay with the main trend while ignoring weaker price movements. One of the best uses of the MACD would be to use it on weekly or monthly charts as an indicator of long-term market direction. Usually using the MACD in a flat market is not successful. Look for divergences when the markets are not in a trend.

The MACD is a combination of three exponentially smoothed moving averages, which are represented by two lines. The first line represents the difference between the 12-period exponential moving average and the 26-period exponential moving average. The second line (called the signal line) is the approximate exponential equivalent of the 9-period moving average of the first line. Exponential values of 0.15, 0.075 and 0.20 are used. The MACD is usually displayed as an oscillator line or as a histogram.

Most software allows users to change the values when calculating the MACD. Some systems require exponential values while others use the available number of periods for the three moving averages. It is advised not to try to change the initial MACD values to fit the data curve. However, it is important to note that Appel recommends two different sets of values, one for the buying side of the market and one for the selling side. Both use a 9-period (0.20) signal line, but the combination of 0.15, 0.075 is only recommended for the selling side. The values for the buying side are 8-period (0.22) and 17-period (0.11).

Using a buy formula and a sell formula can require a completely different way of thinking from casual MACD users. It is always good to stick to the original, but you should be aware of the developer's way of thinking when you use any technical study. If the default settings for the sales side of your software are set to the most common values, or if the software does not allow you to change these values, you may find that you are not using the MACD the way its developer intended. Ideally, your computer monitor should be set up to display a price chart and two additional charts, one to show the buying side MACD and one for the selling side formula. You will find that the buying formula is slightly faster and slightly prone to twitching. The selling formula is slower. The intention seems to have been to buy quickly and try to hold the position in order to let the profits flow. We think it would be possible to apply the buy-side construction to both formulas, provided there is an understanding of their original purpose. For non-equity markets, you can stick with the standard sell-side formula until you need a faster and less reliable signal.

The basic MACD signal is a crossover. Buy signals are generated when the faster line crosses the slower line from below, while sell signals are generated in the opposite case. We would like to warn you right away: in most markets, trading mechanically at every MACD cross will result in frequent jerking and significant losses. You will quickly find that narrow trading ranges are devastating for the indicator, giving many false signals and collecting losses. Fortunately, there are additional MACD interpretations to help traders avoid the jerks and other drawbacks.

The MACD method can be used to identify the points at which the market becomes overbought or oversold, and is thus susceptible to a reversal. By looking at the faster of the two MACD lines, Appel, for example, established overbought/oversold areas for the S&P index at +/-2.50 on the MACD scale. For the NYSE index, he recommends +/-1.20. When another line has reached these critical areas, any crossover generates a buy or sell signal. Crossovers that occur before the extremum level is reached can be ignored, and thus most twitching will be removed. With a little research, similar levels can be detected for any market that is in a wide trading range with large price movements. Remember, the MACD is best used as a long-term trend following tool rather than a short-term trading timer. Signals occurring in the middle area of the MACD chart should only be accepted if another validated indicator confirms that the trade will be in the direction of the trend.

One very curious way to use the MACD is to mark a jump before crossing by drawing a trend line on the MACD itself and then trading on a breakout of the trend line instead of waiting for a crossover. A MACD trendline breakout can precede an important change in the market and serves as an early warning signal of a market turn. MACD crossings which are preceded or followed by a breakout of the trend line have much more technical significance than MACD crossings by themselves. Aggressive traders might consider entering the market immediately after a trendline breakout in anticipation of a MACD crossover, while more cautious traders might wait for an actual crossover to confirm. Remember, if you trade relying solely on trendline breakouts without waiting for a crossover, the trade will have little justification in case a crossover does not occur in the near future. You could get into an unfortunate situation using the MACD system and will be forced to look for some other method to exit the market.

3.3 Envelopes

 

Envelopes can be as simple or as sophisticated as you want them to be. The simplest is a simple moving average with bars on each side, calculated as a percentage of the value of the moving average on a given interval. For example, a 10-day moving average with the bars removed by 5 per cent from the average. The area inside the two bands theoretically acts as a buffer zone which will contain prices within itself, mainly when the market is inside the trading range. The beginning of a trend will be indicated when prices break through the band. When a correction or end of trend occurs, prices will move back inside the bands in the direction of the moving average.

Envelope curve calculation:

 

Upper curve = SMA (CLOSE, N) * [1 + K / 1000]

Lower curve = SMA (CLOSE, N) * [1 - K / 1000]

 

Where:

UPPER BAND - upper line of the indicator;

LOWER BAND - bottom line of the indicator;

SMA - simple moving average;

CLOSE - closing price;

N - period of averaging;

K / 1000 - value of deviation from the average (in tenths of a percent).

 

In envelopes, the moving average can be smoothed exponentially or in some other way. The percentage of prices contained within the bars may vary depending on what position is being considered, long or short, biasing the study towards higher volatility in the direction of the trend. For instance, in an uptrend market the bar could be placed 5 per cent above the moving average and 10 per cent below. Another possibility is to use moving averages of peaks and troughs as bands on either side of the closing moving average. Bands were conceived to contain within themselves and identify price movements within a trading range. Any breakout outside the bands should signal.

There are almost as many trading rules for envelopes as there are rules for their construction. The rules are (or should be) based on the idea that an envelope contains a significant amount of market price movement and that a move outside one of the bands is a deviation from price behaviour and should be responded to.

Traditional trading rules for envelopes are:

1. Enter the market in the direction of the breakout at the moment the band is crossed. This signals the possible start of a trend.

2. Exit and change positions when the opposite bar is crossed.

We recommend using crossovers based only on closes outside the band boundaries to avoid some twitching. Prices will often jump out of the boundaries during the day and close inside the bands.

Another option:

1. Enter the market in the direction of the breakout at the moment the band is crossed.

2. Exit the market when the moving average between the bands is reached, but do not change positions.

Both sets of rules guarantee that the main trend will not be missed. The first set of rules is basic and gives a regular reversal system.

Each trader chooses their own, most preferred set of trading rules. The advantage of the second set is that the bands are also used for entry, but the moving average is used for exit. If prices are inside the bands after a trade is stopped, the market is in neutral zone and there will be no new trades until a new breakout. Another reason why some traders prefer the second set of rules is that the theoretical risk on each trade is reduced to the distance between the band and the moving average instead of the full distance between the bands.

Like moving averages, envelopes work well in trending markets and not so well in frequently changing markets, and the "best" envelope changes over time. Frequent optimisation to find the right values is useless. It is recommended to trade in the trend direction when the price jumps out of the envelope, and to use counter-trend techniques when it is inside.

A logical and effective technique, which is rarely discussed, involves using the bars as overbought/oversold indicators so that the trade is inside the bars and not outside. This technique has been used very successfully when markets have been in a sideways trend. The trading rules are relatively obvious and simple. Buy as soon as the price touches the lower band. If the trade goes against you, as indicated by a close outside the lower band, exit quickly and take a small loss. If the trade starts moving in your direction, as it often will, stay in a profitable position and reverse the trade on the upper band, applying the same rules, only in reverse. This method seems effective because it combines the tactic of taking small losses and large gains, with a trading strategy of buying on troughs and selling on peaks. The real challenge is making sure you are in a sideways trend.

How do you know if the market is in a limited trading range or in a trend? An objective method is to use the ADX. If the ADX is falling, trading inside the envelope can be very advantageous. If the ADX is rising, the market is trending and you are better off using the envelope method following the trend.

 

3.4 Bollinger Bands

 

Bollinger Lines (Bollinger Band - BB) takes its name from its creator - John Bollinger, market analyst at CNBC/Financial News Network, and is constructed as a band around the average, but the width of the band is proportional to the standard deviation from the moving average over the analysed time period.

A decision based on BB analysis is made when the price either rises above the upper BB resistance line or falls below the lower BB support line. If the price fluctuates between these two lines, there is no reliable signal to buy or sell on the basis of the BB analysis. The decision to open a position is made only when the price chart crosses the BB line to return to its normal position.

Sometimes a BB crossing means a "false-break", i.e., when prices just tried a new level and immediately went back. In this case you have an opportunity to work against the trend, but carefully assess whether the breakout was indeed a fake one. A good confirmation in such cases is the volume indicator, which should decrease sharply in case of a false breakout.

Additional signals of BB lines. Convergence of BBs is observed when the market calms down and no significant fluctuations can be seen on it. There is a consolidation to the continuation of the current trend or the appearance of a new trend. The divergence of the BB is observed when the current trend becomes stronger or a new trend starts. Divergence with increased volumes is a good confirmation of a trend. The average is a good support level in a bull market and a good resistance level in a bear market.

The indicator contains 3 lines: the central one is the MA moving average. The other two are the upper and lower limit of the range with a shift of s standard deviation from itself.

Moving average SD is a measure of price stability, i.e. with 0.68 probability the price will deviate from the mean by 1, with 0.95 probability by 2 and with 0.99 probability not more than 3.

To calculate the moving average, we take a period of 30 to 48 hours and 21 days.

The parameter s -2.5

Formula: MA= (1/n) E{P(i)}

P(i) - closing price

i - vary from 1 to n

SD = 1/n √ E[p(i) - MA²]

BBU = MA + s x SD

BBL = MA + s x SD

If the parameters are chosen correctly, the channel will correspond to the equilibrium state of the market, and all price exits must be accompanied by a return to the equilibrium state. About 5% of prices should be outside the lines, 95% should be inside the lines.

3.5. Parabolic System

 

Parabolic price/time systems (Parabolic) are trend-following technical studies which try to overcome two problems common to most trend-following trading systems: return lag due to delayed signals to exit and failure to include time as a factor in calculating stopping points. The parabolic formula solves the problem of price lag by narrowing stops at an increasing rate when a new peak or trough is reached. The parabolic formula also incorporates a time factor into the calculation, allowing stops to remain at a distance for a short period and then approaching them inexorably regardless of price action. The result of this time function is that prices must continue to move in the direction of the trend, otherwise trading will be halted.

We believe the Parabolic system is an excellent technical tool when used only for exits. We do not recommend it for entries or as a reversal system as its developer intended.

The parabolic formula was first described by Welles Wilder in 1978 in his book "New Concepts in Technical Trading Systems". Wilder was searching for a system which could capture the most of earnings in the trend market without relying on any external methods of income retention. Parabolic calculations result in a series of trailing stops which, if triggered, signal a trend reversal. Stops are recalculated daily (or for each time period you use) and get closer as the trend progresses. If the trend fails to continue, the sliding stop will reverse and a new time period will begin.

A parabolic system is a reversal system which is always in the market looking for a trend. The parabolic system is not considered one of the best trend following technical studies that can work on its own. However, in combination with other indicators it can be extremely effective. The Parabolic System is most valuable when used as a method of placing stops.

In order to use it most effectively, it will be helpful to explain the nature of the different elements that make up the Parabolic System. As we said, the Parabolic System was conceived by Wilder as a negotiable system.

Wilder called the point at which the system reverses, "Stop And Reverse" (SAR). As you can see in the figure, a series of SAR points form a line similar to a trend line, but taking the shape of a parabola, so that the stop points remain close to the market.

 

To calculate the first SAR you must choose some sort of starting point. Wilder recommended going back a few weeks on the chart and finding a significant peak or trough there to start the calculation. Most computer studies start on the left side of the screen. If the first few days are trending upwards, then the formula will assume an uptrend. If the first few days are downward, the formula will assume a downtrend. For practical use, it does not matter which direction the Parabolic system starts, because it will end up on the trend side.  We recommend that software users with variable window widths make sure that the Parabolic window contains at least 100 data points. Without these minimum data points, the first SAR points may determine incorrect trends.

When the first entry point and the first SAR are set, the formula for subsequent SARs is as follows: SAR (tomorrow) = SAR (today) + AF*(EP - SAR (today)).

AF is the acceleration factor and EP is the extreme point (peak or trough) of the previous trade (EP - extreme point). Note that the price of the previous extremum and the acceleration factor are used together to keep SAR points close to the trend.

The price of the previous extremum EP is quite clear. AF, however, is what makes the Parabolic system unique. AF is a weighted factor. Wilder used an initial AF value of 0.02. AF then increases by 0.02 each time price creates a new extremum, leading to accelerating points on the chart. AF does not increase until a new ER is produced, and it never rises above the value of 0.20. Thus, the range of variation of the acceleration factor is from 0.02 to 0.20 in increments of 0.02. These are the default values for most software packages, but can sometimes be set by the user.

A change in AF values will manifest itself in approaching or receding SAR stops, thus making the system more or less sensitive to market movements. If AF increases, stops get closer and the system becomes more sensitive. If AF decreases, the stops are removed and the system is made slower. The following charts allow us to compare AF values starting at 0.01, in 0.01 steps, and AF values starting at 0.03, in 0.03 steps.

It is almost always possible to find a set of initial values and step values for a Parabolic system that will show a return when tested on historical data. We recommend to use standard default values. Try to avoid fitting the indicator to the data curve.

Wilder made the following important observation in his book: "I have tried many different accelerating factors and found that a series increase of 0.02 works best, however, if you want to customize your system to change the breakpoints possibly used by other traders, use a range of incremental increases between 0.018 and 0.021. Any incremental increase in that range will work well."

Wilder seems to have been worried about too many stops at one market point, and this worry is justified. Some acceleration modifications may not serve the purpose of optimization, but to make your stops different from those used by the crowd. Remember, the Parabolic System is a widely known and popular study, perhaps much more popular than Wilder envisaged when he suggested individualising the formula.

Although the Parabolic system solves one of the major problems of most trend-following indicators by placing the setups closer to the market, it still fails when the market becomes volatile, i.e. non-trendy. What is needed is a filter that will reduce entries into unstable markets and an entry timer that will allow the parabolic system to do what it does best - set stops in trending markets.

Wilder understood the limitations of the Parabolic system and suggested to use it together with a directional movement index (DMI) or commodity selection index (CSI), but he didn't give any specific prescriptions or rules.

 

4. Flat indicators and oscillators

 

Momentum, ROC, CCI, RSI, Stochastic, MACD-histograms;

4.1. RSI

The Relative Strength Index (RSI) is probably the most popular of all the flattened oscillators. The index gives reliable overbought and oversold signals in most market conditions. RSI also produces excellent long-term divergence patterns, which can be used to identify major peaks and troughs. RSI can be used both as a mechanism of income and as a tool for fine-tuning market entries derived from signals from other methods.

The RSI formula was invented by J. Welles Wilder Jr. and was explained in full in his 1978 book "New Concepts in Technical Trading Systems". RSI calculates the ratio of upper closes to the lower closes on a specified time frame and shows the result as an oscillator with a scale from 0 to 100. The formula is as follows: RSI = 100 - (100 /1 + RS), where RS = average upper closing within the last n days divided by the average lower closing within the last n days. A value near 0 indicates an oversold market, while a value near 100 indicates an overbought market. Wilder recommended the use of a 14-day time period, which he understood as half a cycle in most markets.

When using 14 days as the default value, market peaks and troughs can be expected to occur some time after RSI rises above 70 or falls below 30. We do not recommend buying or selling exactly at these values because when there is a trend, RSI often "sticks" to one end of the range for days or even weeks, giving false evidence of a peak or trough.

Wilder and others have advocated the use of some standard charting techniques with RSI, arguing that certain index figures predict similar underlying data patterns. What follows are a few examples of RSI signals that we find useful based on our own research and experience.

 

4.1.1. Failure Swings

 

The first of these formations is the false swings, which are easier to observe on the study of the RSI proper rather than on the underlying chart. A false swing consists of a spike formed by the RSI rising above 70, followed by a new spike with a lower peak than the first. A real sell signal is made when the lower point between the RSI spikes is crossed. A buy signal would be an inverse pattern with two spikes pointing downwards and then crossing the high point between them upwards.

A false swing can be a powerful signal. Remember, the best signals occur when the first spike goes well over 30 down or well over 70 up. You cannot afford to ignore such events. They usually mark significant intermediate changes in market direction. Beware of false swings, which have so many small deviations that they take a long time to detect. Our experience suggests that the best false swings occur rather quickly and are easy to spot.

 

4.1.2. RSI divergence patterns

 

Weekly Charts.

The most significant and powerful RSI signals come in the form of divergences between the index structure and the underlying chart structure. We have found these divergences to be particularly useful in detecting major long-term peaks and troughs on the weekly charts.

Daily charts.

We recommend using the 10-day and 14-day RSI to detect daily divergence patterns. Note that the divergence is confirmed by the inability of the RSI to reach a new trough, showing that the market is technically strong. Make sure that your entry into buying comes after the day of the rise marking the bottom of the second spike and not at an earlier time.

While it is difficult to formulate a rule of thumb, you will find that divergences which have peaks separated by just a few days or more than 10 weeks do not usually give good signals.

 

4.1.3. Filter of occurrences

 

One of the most common problems faced by trend following systems is entering the market after a strong reversal. The entry is never exactly on a market turn, but occurs after a significant price movement in a new direction. Often a short-term trend reversal movement makes the market either overbought or oversold, making it vulnerable to a short-term correction. Almost everyone has encountered this problem after receiving a trend following signal caused by a powerful change in direction. So when to enter the market?

 The solution to this common problem. If the RSI value is above 75 (if you are buying) or below 25 (if you are selling), then delay your entry. Only enter when the RSI returns back to a level between 75 and 25. There will necessarily be minor market corrections, and your entry will not come at overbought or oversold levels.

 

4.1.4. Re-entry with RSI

 

Let's assume that your trade has been stopped and the trend is still going on. What you need in such a situation is a precise way of timing the re-entry, so that your initial loss is minimal.

Use a short-term (e.g. 3-day) RSI and wait for it to reverse, and only enter in the direction of the trend. To illustrate, let's assume your indicators say the market is moving downwards and you need a re-entry point. Next, let's assume that the RSI has been falling and is now below 50. Try to wait for the RSI to return above 50, then when it turns down, sell immediately. Expecting a slight upward movement of the very sensitive short-term RSI has the effect of easing any intermediate-term overbought or oversold conditions, allowing you to re-enter during a minor trend correction.

4.1.5. Income fixing with RSI

 

One of the most valuable applications of RSI is using it to lock in income. It is always nice to sit back and let the returns flow, but using relatively slow studies will inevitably result in the loss of some income before the exit signal is generated. You need an exit method that recognises quickly when the market is at a peak, combined with a stop-tracking method that allows income to flow while the market continues to move.

Try using the short-term RSI to lock in earnings, the 10- or 14-day RSI is usually not sensitive enough. A profit-taking signal finishes when the RSI reaches 75 or higher (25 or lower if you are short), and then returns 10 points or more. For example, the RSI rose to 87 and then went back down to 65. At this point, the market slows down and steps must be taken to protect your gains. Set stops at either the nearest trough in the last n days or at a predetermined value, whichever is closer.

We have found that the n-day trough is very useful as a tracking point. Quite often the market will move backwards without triggering your stop and you can keep tracking it for quite some time.

 

4.2. Stochastic Oscillators

Stochastic oscillators (Stochastics) are designed for use in flat markets. A stochastic oscillator is one of the best tools in this area. If you care about staying on the trend side, it can also be used in trend markets.

Stochastic oscillators were popularized by George Lane, who has been using them in his investment education courses since the early 50s. He perfected the use of stochastic oscillators over the years of his trading career and was able to find innovative ways to make them work well in almost any situation.

The basic formula for a stochastic oscillator is as follows:

 

%K = (Ct - Ln ) / (Hn - Ln) x 100%,

 

Where

Hn - the highest price of the last n periods;

Ln - lowest price for last n periods;

Ct - current price;

%K = today's close minus the trough of the last n days, divided by the peak of the last n days, minus the trough of the last n days;

%D is a slow stochastic, three-period moving average of %K.

 

The %K and %D produce what is known as a fast stochastic oscillator, which is rarely used due to its excessive sensitivity.

The fast %K and %D, again smoothed by the three-day moving average, produce a slow stochastic oscillator, which is used more often.

In what follows we will look at the slow, smoothed version of the stochastic oscillator.

The stochastic oscillator formula expresses the relationship between today's close and the range between the peak and trough of the past n days. For example, if today's close is 30 and the range over the last 10 days is 20 to 50, then the fast %K = 30 - 20 / 50 - 20 = 0.33 represents a relatively small value. If today's close is 40, which is closer to the top of the range, the fast %K will be O.66. %K and %D cannot be less than 0 or greater than 100. As days accumulate, %K and %D will be represented as lines oscillating between 0 and 100. Values close to 0 are theoretically indicative of an oversold market. Values close to 100 theoretically indicate an overbought market.

The basic stochastic oscillator signals are crossings of the lines %K and %D combined with the level of %K and %D, which indicate an overbought or oversold market. Oversold conditions are normally indicated by %D values below 30 and overbought conditions above 70. Values of 80 and 20 are also often used. There are also traders who are indifferent to %K and watch when %D reaches overbought or oversold levels.

 

The arrows in the figure mark the entry points into the market for buying or selling.

Usually the recommended time period for a slow stochastic oscillator is 18, but George Lane applies a wide range of values, finding what he understands to be the dominant cycle of the market being traded and then using half of this number as the period for the stochastic oscillator. Experience and testing suggests that a range between 9 and 12 is the best compromise between the speed of signals (crossing %K and %D) and the suitability or logical completion of the signal they produce, with a minimum of false signals. Like all other technical studies, stochastic oscillators respond faster to market action when using shorter time periods, and slower on longer periods. We will discuss some technical techniques used by other technical analysts to speed up signals. We believe that these techniques are not necessary. If you need faster signals, simply shorten the time period. Keep in mind that faster is not always better. You should look for a safer signals and not the fast ones.

Stochastic oscillators work best on broad price ranges or on soft trends with a slight upward or downward bias. The worst market for the normal use of stochastic oscillators is a market which is in a steady trend and subject to only minor corrections. In such a market, the stochastic oscillators will produce many flagging entry points which will be quickly extinguished by the trend. If you continue to use standard trading techniques with stochastic oscillators, you will end up with a serious losing streak. Remember: the trader who coined the adage "the trend is your friend" was not using stochastic oscillators.

How to identify and quantify a market which is in a "strong" trend? There are many ways, however, if the course of a "strong" trend is not obvious, try to measure the trend with the ADX. You can trade with the stochastic oscillator on a trend if you ignore the usual 70/30 or 80/20 overbought and oversold levels, and enter the market on the signal of the end of trend resistance given by the stochastic oscillator crossing at any level. However, there are better ways to follow the trend, and we believe that stochastic oscillators get their main value as trough and peak indicators.

 

4.3. Momentum

 

Many traders use Momentum more than any other tool, except perhaps for moving averages. Momentum is not always used by them as the main tool, but traders keep a close eye on it and use it along with other technical studies to make more timely trading decisions. Among the many reasons for its popularity are its simplicity, versatility, and the fact that it is considered a rare "leading indicator. Aside from simply reacting to the direction of prices, torque can change direction before prices do. Very few technical studies can arm a trader with such a valuable leading indicator.

Because of the versatility we have discussed, momentum is difficult to classify as a trend following or flagging indicator. It can be used to show the trend direction and can also give very good overbought/oversold cautions, making it a useful flotation trading tool. This seemingly simple indicator actually contains much more information than what is immediately apparent. The wealth of information hidden in the calculations opens up many options for using the momentum. A full understanding of what we are calculating should help you exploit the full potential of torque.

The torque indicator provides us with an accurate measure of market speed and to some extent the limit to which the trend is still full. The calculation is simple: subtract the closing price n days ago from today's closing price. The result will be a positive or negative number fluctuating around the zero point or line. The formula is as follows:

 

M = Pt - Pt-n

where

M - moment;

Pt - today's closing price;

Pt-n - closing price in n periods (usually n days) before Pt.

The value of n is the only part of the formula that can be changed by the trader, and most commonly the value of 10 is used here.

Some software packages allow the user to select open, peak, trough, close and some other price values for periods. We see no reason to use anything other than a close in the calculation. The result of the calculation is a technical study that oscillates around the zero line (which makes it an oscillator). If the market is moving up, the momentum will cross the zero line from the bottom to the top and, in general, it will maintain an upward slope. If the market moves down, the momentum oscillator will cross the zero line from top to bottom and, in general, will maintain a downward slope. All of this looks simple enough, but the momentum oscillator has other and more complex properties. For example, the farther apart in price Pt and Pt-n are, the greater the distance between the momentum values. When the market is moving quickly in an upward direction (we will assume that the market is bullish), the momentum oscillator behaves in the same way. But when the market is approaching its peak and closing prices become closer together, momentum slows down considerably and the momentum line becomes horizontal or slopes down, even though prices may continue to rise. When the market peaks and negative Pt - Pt-n values appear, the momentum line will begin to dive behind the zero line. Momentum clearly signals that the market speed is slowing down. The momentum formula measures not only the speed of movement, but also the rate at which that movement slows down. It describes both the speed of the market and the rate of change in that speed when the market is approaching a peak or passing its peak. As the market deviates further, negative momentum values become dominant and its line will approach and cross the zero line from time to time, signalling a change in trend direction from bullish to bearish.

What makes momentum react in this way? In order for the momentum value to increase and its direction to be upward, recent price values must outperform older ones. If recent price values are the same as older prices, the momentum line will be flat, even though the market is still moving up. If recent prices are less than the old prices, even if prices are still rising, the rate of change will further slow down and momentum will fall. The flattening and subsequent deflection of the momentum line down ahead of time shows us something that a normal price chart might not show. Momentum gives us an early warning that the market is slowing and that the rate of price increase is now slowing.

 

 

4.3.1. Momentum signal - trend following

 

When Momentum is used as a trend-following indicator, its most important signals come at points where the zero line is crossed. When the line is crossed from bottom to top, momentum is bullish. When the line is crossed from top to bottom, it is bearish. We would not recommend entering into a position against the direction of the momentum.

The number of times the Momentum line crosses the zero line depends on the time period used for calculating the momentum. Like other indicators, shorter time values will cause torque to be faster and respond better by crossing the zero line. Longer values will generally slow torque signals, reducing the frequency of crossovers. The smoothing effect of longer periods is obviously not the result of averaging more data, since the formula does not involve averaging closing prices. The simple logic is that if there is a trend, it will take more time to return to the price set 40 days ago than to return to the price of 10 days ago. We know traders who successfully use a wide range of time periods from 10 to 40 days. Many cycle traders seek to link the period of Momentum with the length of the cycle in the market.

Because lengthening the period of momentum will make the oscillator less responsive, and shortening it can lead to twitching, some traders find it useful to use relatively short and sensitive momentum values, and then set the bounds above and below the zero line. They then use crossing the boundaries instead of crossing the zero line as signals for new trades. When momentum fluctuates within the boundaries, it is not a signal for a new trade. This results in the market being forced to "confirm" its movement before entering a position, all of which eliminates a lot of the twitching caused by frequent zero line crossings.

Keep in mind that the most significant gains can be made when both momentum and prices are accelerating. As we have described, the slope of the momentum line will decrease when the rate of price increase slows down. An obvious and effective application of momentum would be to not enter a new trade until the momentum line slopes in the direction of the trend. When momentum moves back towards the zero line, the trend is by definition weakening or disappearing, so trading in this area can be futile.

 

4.3.2. The Momentum Signal - Going against the trend

 

Because momentum measures acceleration or deceleration of the market, it becomes quite useful as an overbought/oversold indicator. When the market reaches a peak, momentum flattens out and begins to fall often well before the actual market peak. A similar divergence in direction will occur at market troughs. Assuming no significant change in market volatility, the line drawn on the long term chart connecting the momentum peaks, parallel to the zero line, and the line connecting the momentum troughs, also parallel to the zero line, will represent overbought/oversold areas.

The main trading strategy here would be to sell immediately on a breakout of the upper zone, with a protective stop above recent peaks, and to buy immediately on a breakout of the lower zone, with a stop below recent troughs. Profits can be taken when the opposite zone is reached.

This flotation strategy will be productive if recent market action occurs in some price range, but if the market makes a significant breakout, it will obviously fail. We have seen formulas which attempt to deal with this problem by normalizing the momentum so that it always fluctuates between -1 and +1 or -100 and +100. This can be done by dividing the momentum values by some invariable value. We do not see much value in such an approach. Normalisation of the oscillator values will not prevent the market from a breakout, if conditions for such a breakout arise. The normalised momentum will act in much the same way as the RSI or some similar indicators in a trend market. Values will cluster at the top or bottom of the scale and give continuous buy or sell signals. The standard non-normalised momentum will continue to rise or fall to a theoretically infinite level, confirming the continuation of the trend and advising the trader not to use flattish strategies.

 

4.3.3. Long-term trading using momentum

 

One of the most productive ways to use momentum is to identify a long-term trend, and once the trend is determined, trades should only be made in that direction. This rule should greatly increase profitability by eliminating unprofitable trades that go against the trend. Momentum not only tells you the direction of the trend, but also gives you an idea of its strength. This valuable information will keep you out of trouble.

Our research shows that in most markets, 25-period Momentum, based on weekly charts, is a surprisingly reliable indicator of a long-term trend. Trend trading is particularly advantageous when the momentum line moves quickly away from the zero line. However, be very careful about following the trend when momentum peaks and when the momentum line veers back towards the zero line.

A logical combination of technical studies in this case would use long-term momentum to find the trend, medium-term moving averages to enter the trade when momentum is strong, and shorter-term flux indicators such as stochastic oscillator or RSI to take profits when momentum weakens.

Colby and Meyers, in their book The Encyclopedia of Technical Market Indicators, in one of several tests of momentum, optimized the rate of change on about 20 years of NYSE data (Rate of change is an indicator essentially identical to momentum.) Their trading rules were simple: buy when the indicator crosses the zero line from bottom to top, and sell when it crosses it from top to bottom. Holding a position after the first cross, passing the peak, and closing only after the opposite cross may be of academic interest, but it seems to us to ignore the basic properties of momentum (or ROC). Trading with momentum as a pivot method ignores the fact that slowing momentum is a signal to exit the market, or at least to switch to a different trading method than would be used if the market were still moving up. Unsurprisingly, the overall returns have been disappointing and the losses quite severe.

One very simple momentum test was also conducted by Bruce Babcock and described in his book The Dow Jones - Irwin Guide to Trading Systems. He tested 10-day and 28-day momentum using a simple pivot method of crossing without stopping. The results were breakeven, which is encouraging given that neither momentum nor any other oscillator should be used to trade in this way.

 

4.3.4. Trading using momentum divergence

 

We have always observed that the divergence between the technical study and the market often produces effective trading signals. Divergence between an oscillator such as Momentum and the market can occur when the market and Momentum create a high peak, then both retreat, and then the market creates a new peak which is not supported by the new peak of the Momentum oscillator. The theory is essentially that the divergence indicates weak support for the market and that it will not be able to continue climbing once a new peak is created. Price and momentum divergences are quite varied, a 10-period momentum based on daily charts will reveal many divergences and many significant trading opportunities, especially if the longer 25-week momentum is in its decline phase. Our standard cautionary tale regarding divergence trading says to wait until the divergence is fully confirmed before entering the market. A premature entry can very likely leave you on the wrong side of a trending market.

 

4.3.5. Using the momentum of other indicators

 

Many of the technical studies we have mentioned in this book measure market strength in one way or another. This is usually expressed by the slope of the line obtained by calculating the study. For example, a moving average that is in a strong trend is usually indicative of a strong market trend. The steeper the slope, the stronger the trend. Determining the exact degree of strength can be very subjective if we only look at technical research, but if we consider the momentum or rate of change of an indicator, we can objectively calculate the strength of a trend. This opens up new possibilities for us. We can filter out weakly trending markets and concentrate our efforts on markets with unusually strong trends. Or, if the market is not trending, we can buy on downtrends and sell on uptrends.

We believe that momentum has many worthwhile applications and can be rated as one of the most useful technical studies available to the trader. An imaginative and inventive technical analyst should find many interesting applications for this indicator, which is ahead of the prices, rather than following them.

4.4. ROC

Here, we will very briefly consider the Rate Of Change (ROC), because most of today's software packages provide this indicator in addition to timing, but despite that they are essentially identical. Rate Of Change has the following formula:

ROC= 100 (Pt / Pt-n)

A level of 100 is equivalent to the zero line of the torque graph. The only possible difference or advantage that can be discerned here is that when you use ROC instead of momentum, you do not have to deal with negative numbers. The trading rules and practical applications are the same for both indicators.

 

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If there is a GAP going downwards, we can assume that a downtrend is about to form.When an "information gap" appears in the quotes flow.This event should be considered as one of the technical aspects when the market stalls on the background of a long absence or on the eve of the release of, particularly important news. If the forecast for the respective asset coincides with the news event, the price gaps on that asset will be minimal, otherwise, a large and beautiful GEP can be seen on the chart.Gaps are more clearly visible in highly volatile assets that form small candles on the chart. Their frequent appearance is characteristic of the stock market and the metals market. GAP as an analysis and trading toolThe formation of price hollows (GAPs) can be used in trading practice as a separate pattern or as a supporting tool in a trading system, the rules of which do not prohibit it. In the analysis of the market situation, the GAP is perfectly combined with any analytical tool. There are several variants of its use in trading, depending on the place and time of its formation. Famous and world-renowned traders also use it in different ways, everyone has his own view of the situation regarding the price gap.There is also a basis that unites the different views - the boundaries formed by the GAP should be viewed as a price channel, bounded by significant price levels. By breaking one of them towards the second level, the price signals that it will not tolerate a "void" and will soon fill it. This event should be used when opening a position in the direction of the breakout. What are the GAPs?The model is classified by the size of the gap in price and its direction, allocating four categories: An ordinary GAP - it is characterized by a small gap, barely visible on the price chart and is insufficiently informative for technical analysis. Most often such a gap on the chart is quickly covered by a trend.The Gap Breakout is a more useful type of Gap, occurring at the opening of the market. It is characterized by the price breaking through trend levels and channel borders.Acceleration gap - such GAP is characterized by its abrupt formation on the accelerated trend, rapidly gaining strength.Gap depletion - places of its formation should be looked for near strong price landmarks. The price always returns to the level where the GAP was formed, in order to fill the "market void" created by it. Famous traders recommendWhen they say "famous traders", they do not mean just successful traders, but people with deep knowledge of the specifics of the market, laws of its operation, and patterns in price movement. John Murphy is a well-known trader, money manager, brilliant analyst, and author of many works devoted to trading. His trading experience is about 30 years.J. Murphy believes that the result of market forecasting by means of GAPs depends on the place of their formation on the price chart, and also distinguishes four types of this candlestick pattern:Simple - its appearance is characteristic for the calm market, this kind of gap is not of interest for forecasting its further direction. Its formation on a specific asset indicates a small interest of players in this asset, so even a small amount of investment can contribute to its appearance. Analysts ignore this signal.On the Gap - In terms of potential profits, such a GAP is interesting. It appears in the final phase of the formation of a certain price pattern and may indicate a significant change in the market situation. It occurs less frequently, but it is closely related to almost all known patterns and is a confirmation of the signals from them. Its appearance often occurs against the background of growing trading volume and its market void is rarely, rarely or almost never overlapped by the price. Murphy derived his own pattern for this GAP - the higher the volume at its formation, the less likely it is to overlap the price in the long run.On the breakaway - it is characterized by formation along with the trend, it is often situated in its middle, several price gaps may appear at once. It is a signal to the continuation of the current trend even at small volumes of trade. We should count the points before the Gap formation and multiply the result by 2 to find the number of points the price will be able to pass before the reversal.On the flying out - it is formed in the final phase of the trend with the gaps of 2 and 3 types preceding it. Traders use it as a signal to open opposite deal when the price is in the range of its channel and rushes to its closing. Jack Schwager is a trader best known for making accurate forecasts of price movements on the futures market. He is head of Fortune Group holding company, researches dynamics of hedge funds, conducts seminars on "Market Analytics".J. Schwager, like J. Murphy, also distinguishes four types of GAP:Normal - not informative, recommends ignoring it.Gap on breakdown - it is formed when the price leaves a certain range. Schwager recommends it to be used as a strong trading signal, provided that this GAP does not overlap the price for several trading days.Acceleration Gap - formed in parallel with the acceleration of the trend and can be formed several times for several consecutive days.Exhaustion Gap - drawn at the final stage of a trend, it is used as a signal of an imminent change in the trend.Many successful traders are excellent analysts, who are able to conduct a deep analysis of the market and give the most accurate quotes forecasts. You should listen to their recommendations. 
04.05.2021
IndexaCo
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3 major cryptocurrency trader mistakes
3 major cryptocurrency trader mistakes Cryptocurrency is in vogue these days, and its popularity continues to grow. With the frequent emergence of new cryptocurrencies and people with high social clout, such as Ilon Musk, scribbling daily tweets on the subject, the concept of digital currencies continues to gain momentum.Subsequently, millions of people from all over the world are turning to the most famous cryptocurrencies such as Bitcoin, Lightcoin, Etherium and others to take advantage of lucrative investment opportunities and make quick money.Cryptocurrency trading mistakes to avoidWhile it's true that smart investments in cryptocurrencies can indeed yield impressively high returns in relatively short periods of time, it's also important to understand the volatility of cryptocurrency trading.By having the necessary knowledge and information in advance, you can hedge against potential losses and only make investments that bring you returns. Here are 3 major mistakes that almost every novice cryptocurrency trader makes and that you should try to avoid in order to make better investments. Mistake #1. Making emotionally motivated trading decisions Even though cryptocurrency trading involves risks, trading decisions are usually made strategically with a lot of market fundamentals, trends and signals in mind.With all the hype surrounding cryptocurrencies, people are often tempted to deviate from their strategies and make decisions based on emotion due to winner's syndrome, environmental pressure or similar biases.People may even start panic selling as soon as they see an unexpected negative trend in the market. While people like to believe that deviating from their strategy and making decisions based on emotion can help them minimise losses in a falling market, this is not entirely true.Even if things don't go as planned, it is best to review your strategy and develop a contingency plan instead of making decisions based on emotion. Using modern trading software and automation can help you minimise emotional biases in your trading strategy. Mistake #2. Ignoring risk management techniques Just like any other investment, diversifying your portfolio in cryptocurrency trading can go a long way in helping you mitigate risk. A good strategy to diversify your crypto portfolio is to trade in pairs. Popular cryptocurrency pairs include BTC/EUR, BTC/USD, BTC/BCH, BTC/ETH and BTC/GBP.Another very effective method of risk management is the use of a stop loss. This tool allows you to automatically liquidate your investment as soon as the value of your asset reaches a specified price. You can use stop-losses after carefully analyzing your risk tolerance and incorporate this method into your broader cryptocurrency trading strategy. Mistake #3. Using an unsuitable trading platform Buying and selling cryptocurrencies largely depends on the type of platform you use to make transactions and track price trends. Using the wrong cryptocurrency trading platforms can make it difficult to track and analyse market trends.This will deprive you of vital trading signals and information that can lead to a positive investment outcome. People are often inclined to use unsuitable platforms and end up making bad decisions.In order to trade cryptocurrencies such as Bitcoins in the most efficient and effective way, it is important that you choose a legitimate platform.Regardless of your expertise or experience, the platform should offer tools that allow anyone to engage in profitable cryptocurrency trading. Conclusions With the right information, knowledge and assistance, cryptocurrency trading can be seen as an incredibly effective tool for generating income and multiplying your start-up capital. If you manage to stick to best practices and avoid typical mistakes, positive results are almost guaranteed.
03.05.2021
IndexaCo
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Stop Loss on Forex
Stop Loss on Forex A Stop Loss is an exit order that is used to limit the amount of loss a trader can take on a trade if the trade goes against him. It also eliminates the worry that every trader inevitably faces when being in a losing trade without a plan. No trading system will make a profit on every trade all the time, and losing trades are natural. Successful risk management means minimising losses. A stop-loss can be an effective solution to this.If you decide to use a stop loss, it is important to find a good place for it. If the stop order is too close to the current price, there is a risk that price volatility will hit this order during a false move, and then go in the direction you expected, so you will lose money and earn nothing. If the stop order is too far away from the current price, the trader could be vulnerable to large losses if the market reverses against his expectations. Algorithm for choosing Stop Loss types There are many types of stop losses. Here's the algorithm for choosing what works for you: Step 1: Discretionary or system stop?The position of the stop loss can depend on whether you are a discretionary trader or a system trader. In discretionary trading, it is up to the trader to decide which trades to make each time. The trader places a stop order at a price at which he does not expect the market to trade according to his forecast. In doing so, he can take into account various factors that may vary from trade to trade.In system trading, trading decisions are made by the trading system. A trader either opens positions manually following the trading system signals, or the trading process is automatic. Here Stop Loss orders are placed according to the trading system's risk/profit and win/loss ratios. Step 2: Determine the size of stop loss.Stop LossThe size of this stop loss depends on the trader's account size. The most common is 1% of the account per trade. For example, if your capital is $1,000, you can afford to lose $10 on, say, a EUR/USD trade. That's 100 pips per 0.01 lot (1 micro lot). The upper limit of such a stop is considered to be 5%. As you can see, this approach is not a logical answer to what is actually happening on the price chart.Stop on the chartThe size of this stop depends on the technical analysis of the price action carried out by the trader. This is usually where a support level is determined and a stop loss is placed below it for a long position. Technically oriented traders like to combine these exit points with stop rules for charting stop orders. Such stops are often set at the highs/minimums of the fluctuations.Volatility StopThe size of this stop depends on the amount of volatility in the market. If the volatility is high and the price fluctuates widely, a trader will need a larger stop to avoid the stop. In the case of lower volatility, a trader puts a smaller stop. Volatility can be measured using indicators such as Bollinger Bands.Time StopsTime stops are based on a predetermined trade time. Imagine you are a day trader, trading only during a certain session and closing your positions before it ends. You can set a time limit, after which your position will be closed. You can do this with Expert Advisors (EA) or with trading robots.Margin StopsThere is also one aggressive approach to forex trading that we do not recommend. Some traders take advantage of the fact that forex dealers can liquidate their clients' positions almost as soon as they activate the margin call. A trader may divide his capital into several equal portions and deposit only one portion into his account. He then chooses the size of the position and the potential margin call acts as a stop loss. Be forewarned that these trades are only appropriate with small amounts of money. Please note that this type of trading is intended only for a maximum of one open position at a time. Step 3: Static or trailing stop?The static stop retains its place once set. The trailing stop adjusts as the trade moves in the trader's favour to further reduce the risk of an error in the trade.For example, a trader has opened a long position in the EUR/USD at $1.3100, with a stop loss of 50 pips at $1.3050, and a take profit of 150 pips at $1.3200. No changes will be made to your order until a profit on your open position exceeds 50 pips. If the Euro rises 50 pips to $1.3150, a trader may adjust his stop order by 50 pips to $1.3100. When you move your stop loss to the entry level (as in this case), it becomes a break-even stop order: if price reverses and the trader's stop order triggers, he will not get any money, but he will also lose nothing. Every time the price moves 50 pips from the current stop loss in favor of the trader, the server sends an order to change the current stop loss level to within 50 pips of the current price. In other words, Trailing Stop automatically moves your Stop Loss order following the price.Trailing Stops are mainly used by traders who enjoy trading trends but do not have the ability to follow the price movement all the time.Trailing Stops in MT4. To set an automatic trailing stop in MT4, right-click the order in your terminal window, select "Trailing Stop" and select the desired trailing stop size. Please note that the minimum level for the automatic trailing stop is 15 pips. It is important that the trailing stop loss is set on the client's trading platform and not on the server. If the trader closes the terminal or loses the internet connection, the trailing stop will be deactivated, but the stop loss set by the trailing stop will remain active.To deactivate the trailing stop, select "None" in the "Trailing Stop" sub-menu. If you want to disable trailing stops for all open positions and pending orders, select "Clear All" from the same menu.Step 4: Waiting for trading resultsOnce the Stop Loss is set, do not increase it. Only move your stops in the direction of the trade (rolling stops). You have already made your decision. If the market went against you and your stop was hit, analyse your trade and see what you did wrong. Don't get too upset about the failure. What you need is to succeed in the next trade, so move on to the next opportunity.
02.05.2021
IndexaCo
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Using the MACD indicator in forex trading
Using the MACD indicator in forex trading The moving average convergence/divergence indicator (MACD) is one of the best solutions to use when working in the financial markets. Learning how to implement the tool is crucial to a trader's success. We will examine three common MACD strategies. What is the MACD? This tool is one of the most commonly used in technical analysis. It is an impulse indicator that tracks the trend. That is, it determines whether the trend is upward or downward. Therefore, it can be used to provide trading signals and identify trading opportunities. How does the MACD work? The MACD uses three components in its work: two moving averages and a histogram. The two lines may look like ordinary moving averages (SMAs) but are in fact multi-level exponential moving averages (EMAs). The basic, slower line is the MACD line, while the faster line is the signal line.If two moving averages converge, they are said to be "converging", and if they move away from each other, they are "diverging". The difference between the two lines is represented on the histogram. If the MACD was trading above the nought line it would confirm an uptrend, below it the indicator would be used to confirm a downtrend.If the market price was found to be on an upward trend, making higher highs and lower lows, and breaking through key resistance levels - traders can open long positions. While traders can choose to go short if the asset is in a downtrend, which is characterised by lower highs as well as lower lows or breaks support levels. Three common MACD trading strategies There are a number of MACD strategies that can be used to find opportunities in the markets. Three of the most popular strategies include:CrossoversHistogram reversalZero crosses Crossovers The MACD line together with the signal line can be used in much the same way as a stochastic oscillator, with the crossover between the two lines providing buy and sell signals. As with most strategies, a buy signal is given when the shorter, more reactive line - in this case, the MACD line - crosses the slower signal line. Conversely, when the MACD line crosses below the signal line, it gives a bearish sell signal.Because the crossover strategy is lagging in nature, it is based on waiting for movement before opening a position. The main problem the MACD has with weak market trends is that by the time the signal is generated, the price may have reached a reversal point. This would be considered as a "false signal". It is worth noting that strategies that use price action to confirm the signal are often seen as more reliable. Histogram reversal The histogram is probably the most useful part, and the bars represent the difference between the MACD and the signal lines. When the market price is moving strongly in the direction, the histogram will increase in height, and when the histogram is contracting, it is a sign that the market is moving more slowly.This means that as the bars of the histogram move further away from zero, the two moving average lines move further away from each other. Once the initial expansion phase is over, a hump shape is likely to emerge - a signal that the moving averages are contracting again, which could be an early sign of an impending crossover.This is the leading strategy, unlike the lagging crossover strategy mentioned above. The reversal is based on the use of known trends as a basis for positioning, which means that the strategy can be executed before the market movement actually occurs. Zero crosses The zero-cross strategy is based on either EMA crossing the zero line. If the MACD crosses the zero line from below, a new uptrend may occur, while a MACD cross from above is a signal that a new downtrend may start.This is often seen as the slowest signal of the three, so you will generally see fewer signals, but also fewer false reversals. The strategy is to buy - or close short - when the MACD crosses the zero line from below, and sell - or close long - when the MACD crosses the zero line from above.This method should be used with caution because its delayed nature means that fast, volatile markets will often generate signals released too late. However, as a solution to provide reversal signals for long wide moves, it can be very useful. When using a zero-crossing strategy, it is important to understand where to exit the market or make a stop. When is the best time to use the MACD? There is no such thing as the 'best' time to use the indicator, it will depend entirely on you, your personal preferences and trading plan. For some, there may not be a right time to apply it, as they do not take a technical approach to analysis or prefer to use many other indicators to identify price action.However, if you decide to use MACD, the best timing will depend on which of the above strategies you want to use. If you choose a lagging strategy, you will have to keep a close eye on the MACD in order to get signals as quickly as possible. But if you choose a leading strategy such as the bar chart, you could spend less time monitoring, as the signals should appear earlier.
01.05.2021
IndexaCo
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Profit by DMI and ADX
Profit by DMI and ADX Directional Movement Indicator (DMI)Average Directional Movement Index (ADX) The vast majority of profitable trading systems involve some form of trend following, however most of the time they are not in a trend strong enough to produce worthwhile returns. For the reason that successful traders employ the tactic of taking small losses and letting the profits flow, non-trend markets seem to generate only small losses. As a result, those who follow the trend tend to lose money and most of the time in most markets. Their cherished dream of success is due to finding a random market with a trend strong enough to bring in big profits. A common method of "finding" big trends is to invest in different markets in the hope of hitting one of the profitable markets. Unfortunately, such investing adds more losing markets than winning ones. The usual procedure for investing consists of seeking the best market results by hitting a few good markets while having to endure a wide range of bad ones.Fortunately, there is a very practical solution to the problem of identifying and measuring the trend direction of the market. A proper interpretation of the Average Directional Movement Index (ADX) allows traders to significantly improve their performance in finding good markets and cutting off the bad ones. We have probably done more research and work with the ADX than any other indicator because we have found the ADX to be an amazingly valuable technical tool with many practical applications. In order to give our readers a complete understanding of the ADX, we must begin with a basic explanation of the Directional Movement Indicator (DMI) used to derive the ADX. The DMI Concept Directional Movement is a concept that J. Wells Wilder Jr. first described in his 1978 book "New Concepts in Technical Trading System", a classic work on technical analysis that we heartily recommend. (See "Recommended Reading" at the end of the chapter.) The Directional Movement Indicator (DMI) is a useful and versatile technical study that has two remarkable functions. First, the DMI itself is an excellent market directional indicator. Second, one derivative of the DMI is the important Average Directional Movement Index (ADX), which not only allows us to identify markets that are trending, but also provides a way to assess trend strength.The calculation of directional movement (DI) is based on the assumption that when there is an uptrend, today's price peak should be higher than yesterday's. Conversely, when there is a downtrend, today's bottom price should be lower than yesterday's. The difference between today's and yesterday's peak is an upward move or +DI. The difference between today's and yesterday's troughs is a downward move or -DI. Internal days where today's peak or trough is not superior to yesterday's are essentially ignored. The positive and negative DI are separately averaged over a period of a few days and then divided by the average "true range". The results are normalised (multiplied by 100) and shown as oscillators. For readers with mathematical inclinations, we have included detailed calculations. Fortunately, we can now produce the necessary indicators with only three or four taps on the computer keyboard. Calculation of Directional Movement (DM - Directional Movement) A Directional Movement is the largest part of today's price range that is outside yesterday's range.Outside days will have both +DM and -DM.     Use the larger one.The inside days have zero DM.Limit days will have a DM calculated as in the diagrams shown above. For example, for an upper limit day (first chart) +DM will be the difference between A and the upper limit reached on the next C day. ADX calculation 1. Measure the directional movement (DM).2) Measure the true range (TR - true range) which is defined as the greater of:a) The distance between today's peak and today's trough.b) The distance between today's peak and yesterday's close.c) The distance between today's trough and yesterday's close.Divide DM by TR to obtain a directional indicator (DI- directional indicator).DI=DM/TRThe result can be positive or negative. If it is positive, it is the percentage of the true range that has risen on the day. If it is negative, it is the percentage of true range that is down for the day. +DI and -DI are usually averaged over a time period. Wilder recommends 14 days. Then we get the following calculations:+DI14 = +DM14/TR14 or -DI14 = -DM14/TR14+DI and -DI are two of the three values normally shown as DMI. The third is the ADX obtained as follows:4.   Calculate the difference between +DI and -DI. DI DIFF=|[(+DI)-(-DI)]|5.   Calculate the sum of +DI and -DI.DISUM=|[(+DI)+(-DI)]|6.    Calculate the directional index of motion (DX).DX=( DI DIFF/ DISUM)*100100 normalises the value of DX so that it falls between 0 and 100. The DX itself is usually very volatile and is not shown. 7.   Calculate the moving average DX to obtain the Average Directional Movement Index (ADX). The smoothing is usually on the same number of days as the +DI and -DI calculation.8.   Further smoothing can be done by calculating a derivative of the ADX moment type called the average directional movement index rating (ADXR -average directional movement index rating).ADXR = (ADX t + ADX t-n) /2where t is today and t-n is the day the ADX calculation started.Displayed on the computer screen as an oscillator, directional movement moves upwards when +DI is greater than -DI. If +DI is less than -DI, the movement is directed downwards. As the two lines diverge, the directional movement increases. The greater the difference between +DI and -DI, the greater the directionality of the market or the steeper the trend. Wilder used 14 days as the basis of his calculations because he considered 14 days an important half cycle. We think there are more optimal time periods depending on what you are going to do with DMI and ADX.DMI studies on a computer monitor usually appear as three lines: +DI, -DI and ADX. (Some programs present the ADX separately for convenience.) As we said, the results of DMI calculations are normalized (multiplied by 100), so the lines will fluctuate between 0 and 100. The important ADX indicator is derived directly from +DI and -DI and measures the magnitude of the market trend. The higher the ADX, the more directional the market has moved. Correspondingly, the lower the ADX, the less directional the market has moved. Note that when we say "directional" we can mean either upward or downward. The ADX does not distinguish between a rising and falling market. It is important to clearly understand that the ADX measures the magnitude of a trend, not its direction. It is perfectly normal for the ADX to clearly rise while prices are falling because its rise reflects the increasing strength of the downtrend.The other oscillators, +DI and -DI, show the direction. When +DI crosses with -DI and goes higher, the trend is up. When +DI crosses with -DI and goes lower, the trend is downward. The further apart the lines then diverge, the stronger the trend.In his book, Wilder also describes the calculation of the average directional moving index rating or ADXR (average directional moving index rating). This is simply the sum of the ADX at the beginning of the period (say 14 days ago) and today's ADX divided by two. This extra smoothing of the ADX was done by Wilder to attenuate the fluctuations to the point where ADXR can be used in a market comparison calculation called the Commodity Selection Index. From our perspective, the ADX has been sufficiently smoothed initially and additional smoothing is not necessary. In fact, for our purposes, the smoothing that has been done to produce the ADXR reduces the performance of the indicator. DMI Performance Testing Quite a few DMI and ADX performance tests have been published. The results have generally been better than most other indicators. Here we will give some examples.Bruce Babcock has tested the DMI and described the results in his book "The Dow Jones - Irwin Guide to Trading Systems" (see references at the end of the chapter). When testing the DMI, Babcock entered into a long position at the close when the general directional movement was positive. When the general directional movement was negative, the system conversely entered into a short position. The results of Babcock's testing showed that over a five-year period, the 28-day DMI was profitable over a wide range of markets. However, the internal losses were significant because no stops were applied. The system tested by Babcock was the simplest use of the indicator and many of Wilder's basic rules were broken. Importantly, Wilder's suggestion to use waiting for the top or bottom of the day to cross the DI on entry was ignored (we found Wilder's recommendation for entry significantly reduces twitching). In Babcock's test, income was taken clearly at the crossovers and no attempt was made to take income earlier. The fact that the DMI showed significant returns under these conditions is amazing! Although we do not recommend trading DMI in this way, the Babcock test showed that a fairly long DMI could prove to be a useful indicator for setting entry times.A more realistic test/optimisation was conducted by Frank Hochheimer of Merill Lynch Commodities. Hochheimer tested two cases: case 1, which followed Wilder's basic rules, and case 2, which simply traded on crossovers. Most of the markets used 11 years of data. Since this test was also optimization, it tested +DI and -DI by independently changing the number of days used in each (something we don't recommend doing). Not surprisingly, case 1, which followed Wilder's suggestion of entering a buy or sell at the level of the previous day's peak or trough, proved more profitable. Optimisation of DI periods showed that the best time intervals lay between 14 and 20 days. Our independent testing of ADX on different data sets confirms the profitability of this range from 14 to 20 days with the best results shown on 18 days.The Encyclopedia of Technical Market Indicators, Colby and Meyers did a very curious DMI test with the ADX built in. They entered at the +DI and -DI intersection only when the ADX was rising. They exited when the ADX fell or a reverse crossover occurred. They only tested the New York Composite on weekly data, using intervals from 1 to 50. The best returns were on time intervals of 11 to 20 weeks. They noted that of the many indicators they tested, the DMI method had the fewest losses and is worth further investigation.At first glance it may appear that Colby and Mairs were following the trend, trading only on the rise of the ADX. However, because they applied trading based on +DI and -DI crossovers after the ADX rise, the system was more of a counter-trend method because the rising ADX was the result of the presence of the trend before the current crossover. When +DI and -DI crossed after the ADX rose, it was a signal to trade in the opposite direction of the trend as measured by the rising ADX.We find the ADX moderately useful as a timing indicator, despite some positive test/optimisation results mentioned earlier. The DMI is a trend following indicator, and is subject to the same weaknesses as any form of trend following. When markets are not in trend, +DI and -DI cross in different directions constantly, producing one painful twitch after another. These are sensitive indicators that give good results in trend-following markets, but it is precisely this sensitivity that leads to twitching when the market gets into a sideways trend. However, we are very enthusiastic about using the ADX as a derivative of the DMI as a filter to help select the most successful trading method for each market at any time. Using ADX We suspect that the ADX indicator is often neglected due to the obvious drawback of its lack of correlation with price movements. Someone examining the ADX rising in passing while prices are falling could conclude that the indicator gives false signals about the direction of the market. It is critical to properly understand from the start that the ADX alone does not tell you the direction of the market. The ADX can fall when prices are rising and rise when they are falling. The purpose of the ADX is to measure the strength of a trend, not its direction. To determine the direction of the market, you must use additional indicators such as DMI. Some technical analysts attach great importance to the ADX level as an indicator of trend strength, and they would argue that a value of 28 indicates a stronger trend than a value of 20. We have found that the direction of the ADX is much more indicative than its absolute value. A change upwards, for example from 18 to 20,shows a stronger trend than a negative change from 30 to 28. A good basic rule of thumb could be formulated as follows: as long as the ADX is rising, any ADX value above 15 indicates a trend. We recommend you become familiar with ADX and use it in conjunction with your favourite technical indicators. You will soon discover certain levels of rising ADX produce outstanding results with your favourite indicator. One indicator works well when the ADX rises above 15, and another works well when the ADX rises above 25. When the ADX begins to decline at either level, it is an indication that the market has gone sideways and is forming a sideways trend. We'll explore the significance of rising and falling ADX in more detail and suggest suitable trading strategies. Rising ADX A rising ADX indicates an advancing strong trend and suggests the incorporation of trend-following trading strategies. Technical indicators that need strong trends, such as moving average crossovers and breakout methods, to generate large returns should work very well. Almost any trend following method should produce excellent results in a favourable environment, predicted by a rising ADX. Keep in mind that a rising ADX also provides valuable information about which trading technique might fail. Knowing what not to do can be just as important as knowing what to do. For example, popular trading techniques use overbought/oversold oscillators, such as RSI or stochastic oscillator, and look for sell signals when the market is trading at overbought levels. However, if the ADX is rising steadily, it should serve as a warning that a strong uptrend is underway and the oscillators' sell signals should be ignored. When the ADX is rising, overbought/oversold indicators tend to approach one extreme or the other and remain at that level, giving repeated signals to trade against the trend. If you follow the oscillator signals, the losses can become very significant. The fact that the ADX is rising does not necessarily mean that we cannot use our favourite oscillators. It simply means that we must accept signals going in the direction of the trend. A falling ADX Falling ADX indicates a non-trending market, where we should use a counter-trend strategy instead of trend following techniques. Overbought or oversold oscillators, which give signals to buy on troughs and to sell on rises, are the preferred strategies when the market is in such a trading corridor. Indicators such as the stochastic oscillator and RSI should give correct signals when the price is fluctuating within the limited area of its trading range.Due to the fact that buying on troughs and selling on uptrends produces very modest returns at best, many traders prefer to trade only in the direction of the major trends. In that case, it would be best to simply ignore trend-following signals while the ADX is falling. Of course, ideally one would like to have a profitable counter-trend strategy in addition to a trend following strategy, and apply each method in line with the direction of the ADX. ADX Problems: Spikes We would be doing a bearish disservice by claiming that ADX will solve every problem a trader can encounter. ADX also has its own disadvantages. One problem is that on long periods (we prefer 18 days, as mentioned earlier), which are best applied to most markets, the ADX suddenly changes direction, taking the form of a spike. Spikes usually occur at market peaks when prices suddenly shift from a strong uptrend to a strong downtrend. The source of the problem with the ADX is that it cannot correctly recognise a new downtrend. ADX will still include in its calculations a historical period with a strong move in the positive direction, while at the same time taking data from a new period with a strong move in the negative direction. As a result of the input conflict, the ADX will fall for a while until the old movement in the positive direction is squeezed out of the data, at which point the ADX will begin to rise again due to the new downtrend. In a market that has produced a spike, the ADX may not alert to the trend in time, preventing it from catching much of the rapid downtrend.We will try to find a solution to this problem. One possibility is to switch to a shorter ADX period when the market is at a level where a spike can be expected. We have noticed that some markets often produce spikes (such as metals and grains), while others tend to produce flat tops (Treasuries and securities). ADX does very well on flat tops without the kind of problems that arise on spikes. We would prefer to refrain from any subjective classification of markets, if at all possible, so we continue our search for more objective solutions. Fortunately, market troughs rarely take the form of spikes and the ADX does a very timely job of identifying uptrends as they develop. ADX problems: Lagging One characteristic of the ADX that can turn into a problem is that it is slightly slower than many other technical studies. When the ADX begins to rise, many trend-following indicators will already give a signal to enter. For example, +DI and -DI will cross before the ADX begins to rise. It is more than likely that at the time of this early entry signal, the ADX was still falling, so the entry will need to be ignored. In practice, in this situation, the rising ADX becomes a signal of timing to enter the market in the direction of the trend. Faster technical studies are able to determine the direction of the trend, and the ADX is used to set the time of entry. During a trend, faster indicators can provide additional entry signals which, if the ADX continues to rise, must be followed. You will find that some thought and planning will be required to coordinate the ADX with other technical tools.We view the delay as a small price to pay in order to avoid the costly twitching that can occur if you enter a trade during an ADX deviation. However, the lag time can be set depending on market characteristics and individual trader's preferences. A few markets are more likely to be in a trend than others. For example, the currency markets have moved well over the last few years. In markets which have been trending well, the time frame of the ADX could be shortened to produce faster signals. If lagged entries are frustrating for you, shorten the ADX time frame. If twitching frustrates you, keep the ADX period at 18 days. Lagging is not a problem when using a counter-trend strategy during an ADX drop. Day Trading with ADX Perhaps due to distortions caused by large gaps between yesterday's close and today's open, ADX does not work as well when applied to charts with a period of less than one day. Using a 5-minute chart and ADX with a period of 12, the gaps between the open and close can be wiped out after an hour of trading, and the ADX will give the usual first hour trend strength information. However, many day traders prefer to use 20-minute or 15-minute charts, in which case it is difficult to avoid possible DMI and ADX distortions caused by gaps between the close and the open.More often than not, the standard 18-day ADX can provide valuable long-term information which helps in day trading. The day trader should pay attention to the presence of any trend indicated by a rising ADX, and only enter short-term trades if they are going in the same direction as the trend. When the ADX is falling, short-term trades can be held in either direction. Almost any day trading method can be improved by first checking the ADX to determine if a trend exists.In short, we consider the ADX to be one of the most useful technical indicators. When we trade our management programmes, we usually look at the ADX first before performing further analysis. We find that the trend measure extracted from the ADX is an invaluable guide in choosing the best strategy for each market. The simple but important information provided by the ADX allows us to increase our winning percentage in trades by a significant amount. Many of our trend-following results tests only show the importance and value of the ADX when it rises. Waiting for the ADX to rise often means a delay in relation to our desired entry time, but the belief in mandatory trading success combined with the obvious benefits of reducing the number of losing trades is a more important reward.In addition to its usefulness on entries, the ADX can be an exceptional help in timing exits from trades. An important pattern noted by Wilder is the possible short-term top or bottom, heralded by the intersection of the +DI, -DI and ADX lines. A market turning point often occurs when the ADX line first turns down, after the ADX crosses first +DI and then -DI from below. We agree with Wilder's conclusion that this downward pivot could be a good time to lock in gains following the trend, or at least close most contracts that are part of a profitable multi-contract position.The ADX can be very useful to exit in a different way. When the ADX is falling, it shows that we should take a small income instead of letting the income flow in. When the ADX is rising, it shows the possibility of large returns and therefore we should refrain from exiting prematurely. Having an accurate indication of when to take small profits and when to expect large returns can be a huge advantage to any trader. This rarely mentioned use of ADX can be just as important as its use in choosing an entry technique.
09.04.2021
IndexaCo
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Profit - CCI
Profit - CCI Commodity Channel Index (CCI - Commodity Channel Index) The Commodity Channel Index was first described by Donald Lambert in the October 1980 issue of Commodities (now Futures) magazine. Despite CCI's 11-year history and its presence in almost all futures-oriented software packages, we know of few traders who actually use it. We do not know why, but we suspect that one of the reasons may be the lack of literature on this indicator, as well as Lambert's insistence on binding CCI to the theory of cycles. Despite the references to cycle theory, Lambert's original article is probably still the most accessible explanation of how to use CCI.Like most technical studies, CCI requires some understanding of its origins in order to be used effectively. The mathematical and statistical concepts behind CCI are a bit difficult to understand when first examined because its formula is more complex than RSI, MACD and the stochastic oscillator, which can be more or less intuitively understood. The CCI formula is partly statistical, which makes it difficult to show the relationship between the price change charts and the resulting indicator charts.The CCI formula creates a usable number that statistically indicates how far recent prices have moved away from the moving average. If prices have moved far enough, a trend is established and a trading signal is generated. We tend to divide the technical studies into two groups; those which are best used as counter-trend indicators, such as the RSI and the Percent R, and those which are good at following the trend, like the moving averages. The CCI is an indicator which follows the trend. An overview of Lambert's basic theories The CCI formula calculates a simple moving average of the average daily prices [(peak + trough + close)/3] and then calculates the average deviation. The standard deviation is the sum of the differences between the average price of each period and the simple moving average. The average deviation is then multiplied by a constant (Lambert suggests 0.015) and divides the difference between today's average price and the simple moving average. The result is presented as a single number, which can either be positive or negative. The trader can change the number of periods, which are used to calculate the simple moving average. As you might expect, shortening the time span makes the index faster and more responsive to small market movements, while lengthening the time span slows down the index and smooths out market volatility.On a computer screen, the CCI is usually displayed as an oscillator or histogram, which oscillates in different directions around the zero mark. Since the index measures how far prices have moved away from the moving average, the CCI allows us to measure the strength of a trend. In theory, the higher the value of the CCI, the stronger the trend and the more profitable the trade should be in the direction of the trend. Lambert originally developed the CCI to find the beginning and end of supposed seasonal cyclical price patterns. He felt the need to have an indicator that would identify where cycles start and end. This seems like a clear contradiction to cyclical theory, because if you know there is a cycle, you must know where it starts and where it ends, otherwise there is no cycle. The obvious need for an indicator like the CCI shows that imaginary cycles must have been completely uncontroversial and unrepeatable.Lambert made the moving average part of the formula modifiable so that the user could somehow adjust the CCI to the intended cycle length. His research showed that for best results, the moving average used in CCI should be less than one-third the length of the expected cycle. But the test results tables in the article showed that the five-period moving average performed best, regardless of cycle length (another indication of the weakness of Lambert's cycle assumption).CCI uses a simple moving average instead of an exponential one so that prices of the distant past will be discarded and will not affect the results. Some arbitrary constant of 0.015 used in the CCI formula has been added to scale the index so that 70 to 80 percent of the values fall into a channel between +100 percent and -100 percent. Lambert's premise was that fluctuations between channel boundaries were considered random and had no trading value. He suggested going long only when the CCI was above +100. A significant drop below +100 is considered a signal to exit a long position. The rules for a short position are the same: sell below -100, buy back above -100. As we mentioned earlier, Lambert did research which indicated that the CCI period length should be set to less than one third of the cycle length. He tested a number of different period lengths, ending with 20 as the standard number, but suggested that this number should be adjusted for each market individually. (We do not dispute that the period length should be set in such a way as to satisfy the historical data.) Twenty is the default value for CCI by most programs. Some positive test results Colby and Meyers in their book "The Encyclopedia of Technical Market Indicators" tested the CCI on weekly prices of the New York Composite using the original trading rules. This procedure seems to be a curve fitting, but their results are interesting. The most profitable time period tested turned out to be very long - 90 weeks. However, anything between 40 and 100 weeks gave good results and could easily be as profitable today as the 90 week period. Our caveats regarding optimisation can be found in chapter three.Colby and Meyers pointed out one important aspect of the 90-week CCI that should not come as a surprise. CCI on a 90 period almost always misses the early phases of an incipient trend. In today's stock market, skipping the early phases of a trend often means missing out on much of the potential return. Lambert's early research showed that the shorter-term CCI would be a leading or coincident rather than a lagging indicator, and Lambert used a time period of 5 to 20 days. To regulate the time lag produced by the 90 week CCI, Colby and Meyers decided to ignore the +/-100 extremes and use zero line crossings to produce earlier entry and exit signals. They called this indicator the "zero" CCI and found it much more advantageous than the original +/-100 signals. As an aside, note: even though when testing a trading system using the concept of zero CCI on weekly NYSE Composite data, Colby and Meyers got better results than the popular 39- and 40-week moving average systems now defended by many stock market traders, this does not mean anything yet. Using the CCI as a long-term trend indicator The monthly CCI can be very effective as an indicator of long-term market trends. Take a look at the following monthly charts with CCI signals with a period of 20 on the zero line instead of the +/-100 mark.The first chart is for the Japanese Yen. In addition to the sequence of trading signals there are two other noteworthy features of this chart.First, the faster the rise in the CCI from 0 to 100, the stronger and more decisive the trend it has detected. Second, the faster the fall in the CCI after it reaches 100 usually means that the trend is losing its strength and that profits should be protected by a halt at this point. On the treasuries chart we should note the use of CCI trend lines for early exits.We recommend trying to use a monthly CCI with a period of 20 for a longer-term directional move, while using a shorter-term indicator to set entry and exit times in the direction of the monthly trend. This strategy should be particularly effective during a rapid rise in the CCI from 0 to 100. After the monthly CCI peaks, it would be wise to consider suspending trading in this market until the CCI starts rising again.A situation similar to the monthly CCI can be seen on the weekly charts. A quick rise from 0 to 100 should definitely indicate an established trend. Try using the weekly CCI to set trading times in the direction of the monthly charts when the CCI is in a rising period. Exit when the weekly CCI makes a peak or when another indicator warns you that the intermediate-term trend is losing strength. An alternative strategy is to start trading small lots when the zero line is first crossed and then add positions as the CCI accelerates and the trend strengthens. Start closing positions when the CCI stops, indicating that the market is ending the move.Trading multiple positions based on weekly charts will obviously work best in markets with slower movement and controlled risk, where large long-term positions are preferred. Using the daily CCI Our research has shown that the 20-day CCI, used on its own, does not work well in most markets. Its main drawback of missing the beginning of strong trends can be a really negative trait in fast and volatile markets. This slowness can be overcome by using the 10-day (or even shorter term) CCI or by entering at zero. But faster methods become extremely vulnerable due to frequent twitching. We can always set the CCI to meet each market, but we are pretty sure it is just tweaking the curve and do not recommend this method.We recommend combining the CCI with another indicator for daily trading. Because one of the problems with the CCI is its tendency to err in estimating the volatility of trending markets, it seems logical to look to the DMI/ADX as a duplicate trend indicator. If the ADX is rising, then the market is in a trend, and it can begin to trade on the signals CCI. If the ADX is falling, then the market is volatile and should not be traded, at least not with a trend-following indicator such as the CCI. Exit after the CCI creates a peak and moves further towards the zero mark. An alternative exit strategy could be to use stops on the last peaks or troughs after the CCI correction has begun. Our testing has shown the usefulness of each of these basic approaches. A few observations Our research has shown that in a general sense CCI is a tool, in many ways similar to ADX, which can help in assessing the overall trendiness of the market. As we pointed out earlier, the faster the CCI rises, the stronger the market is trending. While it is mathematically possible for the CCI to move upwards when the market is not trending, this is unlikely in practice. Remember that the CCI can provide traders with important information even when it does not provide entry signals. If the market stays inside the +/-100 range most of the time, it shows no trend, so you should avoid this market or use a counter-trend strategy.We have found that the best markets to trade are those where the CCI has recently produced spikes multiple times, protruding beyond 100 in one direction. We have also observed that first trades against a set CCI trend are usually very unprofitable. If the market has been trending and showing a series of CCI moves on one side of the 100 range as we have just described, do not reverse your trading direction on the first CCI move that breaks the 100 mark in the opposite direction. A short pass to the opposite side of the range is probably an opportunity to add a new position, not a demonstration of a trend reversal.  Avoid jerking We have also seen that our often-recommended technique of waiting for confirmation after a trading signal is an exceptional method of avoiding most of the jitters when using CCI with a faster period. We have found that when CCI generates spikes after the +/-100 level, it is almost always better to wait for signal confirmation before making any moves. When the CCI rises above 100 wait for the market to produce a significantly higher close before buying. We have noticed that much of the 100 level breakout has only turned out to be a one or two day event, especially on the shorter term. The entry confirmation technique avoided most of the twitching and at the same time caught all the big moves. The confirmation technique also allows us to switch to the faster CCI we need to overcome the lag problem without getting caught in the twitching as one might expect. For example, a 10-day CCI with a confirmation requirement will produce much faster signals and probably produce twitching less often than a 20-day CCI applied in the normal way.
08.04.2021
IndexaCo
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On the world's financial markets and stock exchanges. Part 11
On the world's financial markets and stock exchanges. Part 11 1. What is a trading strategy?  A trading system or strategy is the result of careful and meticulous study of the financial markets. It is the apogee and logical outcome of the future trader or active investor. It reflects all analytical work and willingness to react to any changes on the market.A trading system allows bringing orderliness into trading operations, adjusting prognostic methods to individual needs of a trader, removing or reducing the psychological burden during the decision-making process. Professionally built trading system is a pledge of success in carrying out operations.It is not enough just to analyze the market, it is also necessary to build a forecast and implement it, as well as take into account risks that the trader assumes.A trading system includes a certain set of conditions and rules that determine moments and order of performing the following actions:opening of a positionposition closingWhen constructing a TS, a number of questions should be answered:what tools to use when carrying out operations (stocks, commodities, currency pairs)?which method of analysis to use (technical, fundamental or a combination of these)?what time interval should be used?which indicators to use?operating principle (trend, channel)What lot to work with?what rules apply for opening and closing the position?How long should the position be held?how to set a stop-loss? 2. Basic rules for building a TS To build a trading strategy, the trader needs to consider the basic rules of constructing the TS:Positive expectation - a property of the system to be generally profitable over a long period of time. It is determined by the fact that the average profit of all trades during the testing period is greater than 0.Small number of rules.Stability of the system.Varying of trade lotsRisk control, capital management and diversification.Mechanistic nature of the system.Applicability.To correctly approach the construction of TS, taking into account deep understanding of how financial markets work, you should remember about some principles:Principle 1.Price is determined by the supply and demand ratio. Conclusion: Only the behaviour of the price is relevant.Principle 2. The future behaviour of prices is probabilistic.Conclusion: You can make a lot of money in the market if you estimate the probabilities correctly;the probability of winning increases with an investment horizon.Principle 3. The market moves along the path of least resistance.Conclusion: Overcoming resistance levels indicates the path of further movement.Principle 4. The market has inertia.Conclusion: do not count on a quick change in the direction of the price movement. 3. Options  Based on the aforementioned conditions, the main examples of TS operation are working on the level breakout and rebound (it's recommended to remember the theory of Dow about the construction and purpose of support and resistance levels, and the candlestick analysis).To begin with let's remember about types of resistance and support levels.First of all they are not just lines on the chart plotted on price highs and lows, they are zones, which are several points wide and are determined by how participants react to certain movements (spread, expectations, aggressiveness or conservativeness of entry, etc.)Resistance and support levels are of 2 types:inclined, which form price channelshorizontal, which are divided into 3 types- technical (built directly on the maximum and minimum price points or on the greatest contact)- psychological (they are usually round figures or price comfort levels for central banks)- historical (the same as technical but with a longer time horizon or built on a longer time frame).The levels are described in increasing order of importance. The passage of such levels has several stages:Piercing - the price passes the level (resistance or support) only by the shadow of the candle and then goes back. It is a "Warning!" signal and only confirms the presence of the level.A breakout is a signal to open a trading position.It appears when the price closes below the support or above the resistance level. It can be of 2 types:- Breakout with confirmation - when the price returns to the level, determining its changed status (resistance to support and vice versa). It is used for conservative strategy. It is the best signal! It is used less often, than the other varieties- Classical breakout - when the price goes sharply below (above) the level. It is a good variant for a pending order and happens much more often.As a rule, upon exiting the channel, the price makes a sure distance equal to the channel width - that's our profit according to TS work on breakout.The placing of pending orders in such TS is determined by general rules (buy-stop, buy-limit, etc.). A good example of breakout of a sloping price channel is a price exit from a triangle pattern.Question: Find the points of opening a trading position here.To determine the necessity of the concept of money management, you need to clearly understand the non-linear relationship between losses and profits that exists in trading in general. A loss of 10% would require you to make a subsequent profit of 11% to get back on track. And after a loss of 50%, you would need to make a profit of 100% to get back on track. The general consensus of analysts is that the maximum allowable loss, which would still allow a turnaround, is 30%. At this loss, it would be necessary to make a 50% profit afterwards - this is considered achievable. A loss of 50% or more is almost certain to result in the financial death of the investor. What is capital management? Rules for placing a stop - order.Selection of trading lots.The % of TS in the ratio of profitable to losing trades.The ratio of risk-return.When to close a trade or where to place the profit?The basic rule of stop-order installation:Stop order is placed only where there is a high probability of price moves in the opposite direction!Stops are placed on 2 principles:at levels of previous highs or lowsin target zones restricted by our deposit.The choice of trade lots is closely related to your deposit and is subject to the recommendation of not more than 10% of total trades at a time.The average percentage return of the trading system is 3 / 7, i.e. 30% of profitable trades. This is a perfectly working TS. A good one is 50/50. Here the explanation will be the risk-profit ratio or the rule of stop and profit order placement. A simple recommendation: for each point of loss, the expected profit should be 3 points. Example. A stop order is placed 30 pips away from the current price value. In this case the expected return should be 90 pips. Using the risk-profit ratio 3 / 7, the total loss after 10 trades will be 7x30 = 210 points, while the profit will be 3x90 = 270, which is a profit according to the results of the reporting period.The most difficult thing in the future is to determine the profit point:Expected target zone (Fibonacci series, support and resistance levels)Indicative exit (the most popular) - an exit based on indicator signals.Statistical expectation (channels, triangles) 
07.04.2021
IndexaCo
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