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This is a great way to learn some of the techniques successful traders use so pay attention to this one.

Happy Trading

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Investors were also awaiting the outcome of talks between Greece and its private creditors on a debt swap deal.

Greek officials insist that a deal is on the cards, and many analysts agree that we could see this take place by the end of the week.

=================
News Watch For EURJPY
=================

There are no High Impact News Releases scheduled for the Euro or Yen currency pairs today but traders will eye Euro consumer spending data (Retail Sales).

Remember, the US Non Farm Payroll data will also be released today so if you are in any positions it would be wise to tighten your stops or exit altogether.

============
EURJPY Analysis
============

Looking at the chart image below, we can see that the price has been contained within a triangle pattern.

This helps us see that the price range is narrowing as it approaches the apex of the triangle. In this scenario, we could look for a breakout of the dashed trend lines in either direction. But be wary of false breakouts!

At this moment in time, the bearish channel holds firm yet my system suggests there might be a bullish signal lining up. However, I am reluctant to look for entries with the NFP data due in a few hours and the markets set to close at the end of the day.

Better safe than sorry folks, remember trading is a game of patience. It’s always better to hold on to what you have and live to fight another day. So we will continue the good fight next week.

Until then, all the best!

Happy trading!

CLICK HERE TO READ THE FULL EDITION!

There is a lot of talk about another Japanese ‘Yentervention’ especially as the Yen reaches record levels against both the Dollar and Euro.

==================
News Watch For EURJPY
==================

There are no High Impact News Releases Scheduled for the Euro or Yen currency pairs today but traders will be monitoring the German Unemployment Change and Unemployment Rate data due later today.

=============
EURJPY Analysis
=============

Price fell as expected to the 100.300 level and found support at the lower bearish trendline channel. Since then, price has bounce off this trendline and gone on to make it’s way all the way up to the upper channel trendline. Take a look at the following image:

At this point we could see the market go in either direction. Patience is the key here!

We need to wait for a clearly defined movement in a specific direction before we decide to enter a position.

If price goes up and breaks out of the upper channel trendline, I’ll be looking to the 101.000 level to offer resistance. Should price break out of this level too I’ll be looking to go long.

On the other hand, we may see price dip further down and if there is a breakout below the 100.000 level I’ll be looking to enter to the short side.

It may take a while before we see any significant movement in either direction, but I’ll keeping an eye out for an entry signal throughout the day.

Happy trading!

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Average True Range

Introduction

The Average True Range (ATR) is an indicator that was developed by J. Welles Wilder, Jr. who introduced it along with a few other indicators (Parabolic SAR, RSI and the Directional Movement Concept) in his book, “New Concepts in Technical Trading Systems” in 1978.

The ATR was originally designed by Wilder to appropriately measure the volatility of Commodities, an instrument that typically has gaps and limit moves that occur when a commodity opens up or down its maximum allowed move for the session.

Today, the ATR may be one of the oldest indicators that exist but it is far from being obsolete. What’s very interesting about this indicator is its universal and adaptive nature. That’s why it remains applicable and popular among good trading systems and is used with a wide variety of instruments.

Many trading systems use the ATR as an essential tool for measuring the volatility of the market. The Average True Range reveals the volatility in a particular instrument but it does not indicate the price direction.

Any trader who is keen on designing an excellent trading system should be familiar with the Average True Range and the many ways it can be used to improve the performance of any trading system.

The ATR has numerous functions and it’s generally applicable in finding trade setups, entry points, stop loss levels and take profit levels with reasonable money management technique.

Definition of Terms & Related Concepts

Before we proceed, let’s define a few terms that we will be using frequently as we talk about the Average True Range…

Average True Range (ATR) is an indicator that measures volatility. It is a “moving” average of the true range for a specific given period.

Volatility is defined in terms of market action. An active market is said to be volatile while an inactive market is considered non-volatile. Volatility is directly proportional to the range, so if range increases, it also increases. If the range decreases, so does the volatility of the instrument.

Range is the distance that the price moves per increment of time. It is the distance from the highest price to the lowest price of the day, in other words, equivalent to the height of 1 bar or candlestick. It is calculated by taking the difference between the high point and the low point.

However, if the current candle is a Doji where the price does not move at all, the real price range is actually the distance from the previous close to the open price of the Dogi (current candle). Also, if the close of the previous candle is not within the current candle, the range begins from the close of the previous candle.

It follows that the True Range (TR) is the maximum range that the price has moved either during the current candle or from the previous close to the highest point reached during the candle. True Range is defined as the greatest distance of the following:

A. Current High to the Current Low

B. Previous Close to the Current High

C. Previous Close to the Current Low

Absolute values will be used for the calculations to get the distance between the two points. This is because the aim is to get the distance and not the direction. The first range will be used for the calculation of the initial True Range. We will talk more about that in another section.

According to Wilder, you must consider the value of the range for a number of periods in order for it to be a useful tool to measure volatility. This is why an average of the true range over a number of periods must be obtained. A sufficient number of periods must be used to provide sufficient sample size to obtain an accurate indication of an instrument’s price movement. He considers 14 bars to be the best indicator of volatility and uses it for his Volatility system. You will know more about this system as we go along.

Here is how the ATR looks like when applied on your chart:

Calculation/Formula

To get the Average True Range (ATR), the average of the true ranges of a number of periods of data is computed. The number of periods affects how adaptive the ATR is to recent changes in volatility. For instance, a shorter average of 10 bars makes the ATR more reactive to the current price range and thus has more fluctuations as compared to a longer average of 20 bars that will show a more stable ATR.

The ATR is usually based on 14 periods and can be calculated on an intraday, daily, weekly or monthly basis. We will use 14 periods as our example for the computation.

The computation of the initial Average True Range (ATR) differs from the rest of the ATRs.

Please refer to the following table for our discussion on the computation:

Legend:

CH – Current High CL – Current Low

PC – Previous Close TR – True Range

ATR – Average True Range

Step 1: Compute for True Range value for 14 days.

The first True Range (TR) value is obtained from only 1 period and it is calculated by deducting its Current Low to the Current High. The rest of the TRs will have a value that is the greatest among the 3 computations as defined.

TR for day 1 = Current High – Current Low

Example:

TR1 = CH – CL = 1.36164 – 1.36050 = $0.00113

TR for days 2 to 14 will have the greatest value among the following:

TR = Current High (CH) – Current Low (CL)

TR = Current High (CH) – Previous Close (PC)

TR = Current Low (CL) – Previous Close (PC)

Examples:

TR6 = CH – CL = 1.35959 – 1.35699 = $0.00260

TR9 = CH – PC = 1.36190 – 1.35490 = $0.00700

TR11 = CL – PC = 1.36098 – 1.36381 = $0.00283

We use the absolute values because as mentioned earlier, the aim of this computation is to obtain the distance regardless of the direction.

Step 2: Compute for the Initial Average True Range value.

The first 14-day ATR is the average of the daily TR values for the last 14 days.

Initial ATR

= TR1 + TR2 + TR3 + TR4 + TR5 + TR6 + TR7 + TR8 + TR9 + TR10 + TR11 + TR12 + TR13 + TR14

14

Example:

Initial ATR

= TR1 + TR2 + TR3 + TR4 + TR5 + TR6 + TR7 + TR8 + TR9 + TR10 + TR11 + TR12 + TR13 + TR14

14

= 0.00113 + 0.00084 + 0.00163 + 0.00143 + 0.00191 + 0.00260 + 0.00260

+ 0.00140 + 0.00700 + 0.00389 + 0.00283 + 0.00129 + 0.00362 + 0.00168

14

= $0.00242

Step 3: Compute for the Average True Range value for the rest of the days.

To compute for the ATR for the rest of the days, only the information on the previous ATR is held. Multiply the previous ATR by 13, then add the current TR and divide by 14.

Current ATR = (Previous ATR x 13) + Current TR

14

Example:

Current ATR = (Previous ATR x 13) + Current TR

14

= (0.00242x 13) + 0.00397

14

= $0.00253

Advantages

There are 2 main reasons that made the Average True Rage (ATR) remain popularly used with many trading systems through the decades. The ATR is a remarkable measure of market price movement because it can be used across different financial securities and it also adapts to changing market volatility. Because of this, it plays a vital role in setting your stops or take profit levels.

Useful Across Different Financial Securities

A system that can only be used to trade in one market can be used to trade other markets just by changing the way the calculations are expressed. Using units or multiples of ATR instead of using definitive values such as dollars, points or pips can turn any simple system into a universal trading system.

One of the most common uses of the ATR is setting the stop loss level. Below is a typical scenario of how the ATR can be applied to set your stop for different financial instruments.

Imagine that we are using a simple system to trade with 2 different instruments, a currency pair (A) and a commodity (B). Given that A’s ATR is $0.0020 and B’s ATR is $300, the huge difference between the volatility levels would require us to set 2 different stop loss levels. For instance, our stops may be $0.0030 for A and $450 for B.

On the other hand, if we use values in units or multiples of ATR to set our stop loss for our system, we will need only 1 value to compute the stop loss level for both markets. We can set our stop 1.5 ATRs from the entry price. A’s stop loss level would still be $0.0030 (computed from 1.5 x $0.0020) and B’s stop loss level would also be at $450 (computed from 1.5 x $300).

Adaptive To Changing Market Conditions

Substituting units or multiples of ATR to the usual dollar, point, pip or whatever units of measure used in your system can make it remain applicable in the long run without reoptimization despite any changes in price movement or volatility.

We are well aware that market conditions and, consequently, price movement or volatility, can change and will change either abruptly or gradually. Since the ATR changes in direct proportion to changes in volatility, it can easily bring your stop closer or farther to allow enough space for price movement normally expected for that particular volatility level. Unless the market has changed in direction, you will not be stopped out.

Here’s a typical scenario to prove this point…

If the market quiets down and the ATR of A changes to $0.0010 and B changes to $150, the $0.0030 stop for A and $450 stop for B are now too far, causing you to lose an unnecessarily large amount from every single trade. Similarly, if the market becomes extremely volatile and the ATR of A increases to $0.0040 and B increases to $600, the $0.0030 stop for A and $450 for B are now too close, causing you a higher percentage of losing trades. We need to reoptimize our system to suit the current market conditions.

On the other hand, if we substitute units of ATR to the amounts we were originally using as our stop, our system would greatly improve. When volatility changes, our stops would automatically adjust to accommodate the change. So, if the market quiets down and the ATR of A changes to $0.0010 and B changes to $150, our new stop for A would be $0.0015 (computed from 1.5 x $0.0010) and our stop for B would be $225 (computed from 1.5 x $150). Similarly, if the market becomes extremely volatile and ATR changes to 40 pips, our stop would now be at 60 pips (1.5 x 40).

Notice that the stop loss level is adjusted automatically even if we are still using the same stop loss value which is 1.5 ATR. Our improved system is still applicable and there is no need for reoptimization.

That is the essence of using the ATR in any trading system. Because it can adapt to change and can be used with different markets without altering its value, it significantly cuts off a big chunk of hard work when looking into different markets and its accompanying fluctuations in volatility.

Most systems that use the ATR are applicable not only in the past and the present, but also in the future despite any changes in market volatility.

Interpreting the ATR

Now that we know what the Average True Rage (ATR) is and how it is computed, we need to know what the values of the ATR mean. Depending on its readings, the ATR can be used in all aspects of the trading process.

Low ATR Reading

A low reading of ATR simply indicates that the market is quiet and less volatile. The volume of the market is light. This may mean any of the following:

1. The market is ranging when the ATR is relatively low. There isn’t enough volatility to move the market in an uptrend or a downtrend.

2. Price has reached the bottom or top, which is eventually be followed by price reversal.

Have a look at the image below.

In the first section of the image above, you can see that the ATR is generally low and has now peaks. Notice that the market is just ranging at that time. In the rest of the sections, you will see that an uptrend has formed and every time the ATR reaches its lowest levels, a change in price direction follows.

High ATR Reading

On the other hand, an increased ATR simply indicates that the market is very active and is highly volatile. This would indicate that a much stable trend is imminent because there is sufficient movement in the market for the price to move in an uptrend or a downtrend. The ATR peaks when any of the following situations occur:

1. During a rally or a period of sustained increase in price.

2. During a sustained period of decline in price.

Take a look at the image with the peaks marked below.

As you can see, the ATR increases when the market is moving up or down and it usually peaks when a sustained movement has occurred. However, when the market makes a strong move in one direction that is stronger than the normal fluctuations above, it is assumed that a new trend is now forming (breakout).

Uses

Now that we know what the readings of the Average True Range Mean, we’ll find out how it these concepts can be used with logic in the various aspects of our trading – Entry, Stop Loss, Take Profit.

Entry

Low ATR Reading

When the ATR reaches its lowest levels, a change in price direction usually follows. Here’s how we can use this information to our advantage. When the market is trending, enter only after the price has retraced and is returning to the general trend. Here, we will buy once a retracement has ended and the price continues going up in the uptrend. Inversely, we will only sell once a retracement in a downtrend has ended and the price continues going down.

For example, a 50 period moving average (MA) is used to identify the general trend. The current close must be 2 ATRs or more than the 50 MA to ensure that the general trend is up. To ensure that we are in a retracement (dip), the current close should be 2 ATRs or more below the close 5 days ago. You will know when the dip has ended when a new candle opens and reaches 1 ATR above the previous low. The price is now returning to the general trend, and this is when you enter the buy trade. The opposite of the above conditions will be the rules for entering a sell trade.

High ATR Reading

The market usually becomes very volatile when a new trend is now forming. This is called a breakout, and we can use the ATR values to confirm it. Since the price normally only reaches up to a number of ATRs only, exceeding that level indicates that an unusual phenomenon occurred, a breakout is happening and thus the beginning of a new trend.

Here’s an example. Supposing that the price normally rises or falls 2 ATRs from the previous close, you will only buy if the price reaches 3 ATRs higher from the previous close. Inversely, you will only sell if the price reaches 3 ATRs lower than the previous close.

ATR Cycle

In the previous images, you will notice that a low ATR reading is always followed by a high reading. The ATR is cyclical in nature, increasing and decreasing alternately.

Knowing when the market is quiet is important because it means that the volatility will increase soon indicating a possible trade setup. If we want to refine our signals, we can begin with a period of low volatility and wait for an increase in volatility before looking to enter the trade.

Note however, that the ATR only indicates the volatility and not the direction. You will either sell or buy depending on the direction of the trend.

Some trading systems only place trades after the price has reached the extreme peak or extreme bottom and has reversed. Here, you will buy only after the market has reached a significant decline in price, and you will sell only after a sustained period of increase in price. As soon as the price reversed, traders wait for it to reach a number of ATRs in the new direction before entering the trade. Depending on the system, the values of the number of ATRs and periods vary.

Stop Loss

The Average True Range plays an important role in selecting the stop loss level in a trade. It can also be used to trail your stops. One great example would be Chuck LeBeau’s famous Chandelier Exit. Here, the stop loss level is expressed in ATRs so it also adjusts to the changing market conditions. The stop loss level will be set an N number ATRs from the highest high/close for a buy trade or from the lowest low/close is reached for a sell trade. The Chandelier Exit is so called because it hangs downward from the ceiling of the market. Note, however, that the movement of the Chandelier Exit is only in one direction. It only goes up for a buy trade or down for a sell trade.

The exit rules for systems using the Chandelier Exit may let you stop your loss when the price reaches the highest high of the trade minus 3 ATRs (computed as Highest High – 3ATR) or when the price reaches the highest close reached during the trade minus 3 ATRs (computed as Highest Close – 3ATR).

Take Profit

The Average true range is not only used as a basis for the stop loss level, it also plays a significant role in setting the take profit level.

Our discussion on the use of dollars to express the value of the stop loss level goes the same way if we express it as number of periods or pips. Let’s apply the same principle in setting the take profit. We know that even backtests indicate that a certain value such as 40 pips is the best take profit level, it will only hold true for the time being and may need reoptimization as the market condition changes.

But again, market conditions are ever changing and degree of volatility will always change. If the markets are unusually quiet, we may not reach our 40-pip take profit level. On the other hand, if the market is extremely volatile, you can only take 40 pips even if you could have taken much more than 40 pips. Because of this, 40 pips is not an ideal measure of our profit target.

To have a more stable system, we need a profit target that can adapt to changes in volatility. This can be achieved when we express our profit target in terms of ATRs.

Here’s an example. Given that our backtests indicate that the best profit target is 4 ATRs, it is equivalent to 40 pips in normal market conditions. This time, when the market is extremely quiet, it may only be equivalent to 20 pips. On the other hand, when the market becomes very volatile, 4 ATRs may be equal to 80 pips. There is no need for reoptimization because the ATR based profit target readily adapts to the changes market conditions.

When using the ATR based profit target and the market tends to be extremely volatile, your winners will be bigger than usual because your target profit has increased along with the increase in volatility, even if you will have the same percentage of winning trades.

Just like our example earlier, when the market becomes extremely volatile, the value of our 4 ATR increases to 80 pips. We will get out with 40 more pips as compared to our usual take profit level during normal market conditions.

Setting appropriate stop loss and take profit levels are important aspects of money management that no trader should miss out.

Example

Let me show you the difference that the ATR can make when used in a trading system. Let’s compare 2 systems with similar rules but with different units of measure. Have a look at the System 1 and System 2 below.

The systems above look similar. If the current ATR is 10 pips, you will be entered and exited with the same prices. Both systems are equally effective if only market conditions remain the same. Unfortunately, the market is ever changing and volatility fluctuates. When that happens, System 2 will still be applicable but not System 1. Let me show you what I mean…

Assuming that the market becomes extremely volatile that the current ATR becomes 20 pips, the previous ATR which is 10 pips has been doubled. Have a look at the table below to have a better grasp of the scenario.

As you can see, the entry for System 1 remains the same. With the increase in volatility, you will be entered unreasonably in too many trades. On the other hand, System 2 will give you only the entries that count since its entry has been increased because of the increased volatility.

The same holds true with the take profit level. With System 1, you will be taken out with your profit too early, and you will only get 40 pips per trade even if you could have earned 80 pips. Using System 2 will allow you to get bigger profits because the take profit level increases with the increase in volatility.

For the stop loss, System 1 will now take you out of your trades prematurely. You will be in and out of trades with losses that you are not supposed to get. In contrast, the stop loss level for System 2 is much farther. As volatility increased, the stop loss is increased accordingly to give the price enough space to retrace and go back to its original direction.

Because System 2 adapts to the changes in market conditions, we will achieve a stable win/loss ratio. In addition, our winning trades become bigger as a result of the increased take profit levels due to the increase in volatility. This goes to show that System 2 is a significant improvement of System 1.

Application: ATR-Filtered SMA System

Now you’ve seen how the proper use of the Average True Range can greatly improve a simple trading system. Let me show you how I use the ATR to filter my entries, stop loss and exit/take profit levels for a simple system with 2 SMAs. Here is my RTA-Filtered SMA System.

Currency Pair: EUR/USD

Timeframes:

I use the 15 Minute timeframe to check for the ATR reading before finding trade setups. I also use it to enter my trades. I use the 4 Hour and 1 Hour timeframes to confirm the general trend of the market.

Indicators:

14 Period Average True Range (0.001 level)

8 Period Simple Moving Average (8 Period SMA)

21 Period Simple Moving Average (21 Period SMA)

Rules:

Below are the Buy Trade Rules for my system. The exact opposite will hold true for Sell trade rules and will not be discussed.

1. On the M15 chart, the 14 ATR must be 0.0010 or less before looking for signals.

This indicates that the market is quiet, and a possible breakout is about to occur. I just use the 0.001 level to serve as a visual signal that the ATR has reached a low level in the EUR/USD chart.

2. Wait for the price to be above the 8 SMA and the 8 SMA to cross above the 21 SMA in the H4, H1 and M15.

I do this to ensure that I am in the appropriate trend; I will only enter a buy trade only when the trend is up.

3. Identify the most recent lowest low/swing low then add 3 ATRs to the closing price of that candle (Closing Price + 3ATR). Wait for the price to close above this level.

I can confirm that the downtrend has reversed to an uptrend if the price moves more than 3 ATRs from the lowest close. I use 3 ATRs because this is the recommended multiplier by Wilder.

4. As soon as Point 2 and Point 3 have been met, enter a buy trade.

5. Set the stop loss 3 ATRs below the entry price.

If the price moves against my favor and reaches 3 ATRs below the entry price, there is a bigger probability that the market has completely turned against me. Here, I would rather cut my losses short before it gets out of hand.

6. Exit at the open of the next candle when both conditions are met:

a. The 8 SMA crosses under the 21 SMA.

b. Price crosses 3ATRs from the highest close.

When the 8 SMA crosses under the 21 SMA, it may indicate that the price is now retracing or reversing. I use the ATR reading to confirm this, so only when the price reaches 3 ATRs from the highest close will I take my profit and close my trade.

To get a better idea, have a look at some examples in the next page.

Examples

Buy Trade Example 1:

In the image above, you can see that I started looking for the trade setup along the blue vertical line where the ATR is below 0.001 level.

The price was above the SMAs, and the 8 SMA completely crossed in the H4 and H1 at the close of the candle along the dotted green vertical line. The most recent lowest low was at 1.30899 indicated by the blue horizontal line, and the ATR level then was at 0.0010, so I computed 3 ATRs from there so that I can enter a buy trade when the price exceeds that level.

Recent Lowest Close = 1.30899

ATR = 0.0010

3ATR + Recent Lowest Close

= 3 (0.0010) + 1.30899

= 1.31199

I entered a buy trade at the open of the candle indicated by the solid green line then set my stop loss level 3 ATRs below it.

Buy Entry Price (open of next candle) = 1.31320

ATR = 0.0010

Stop Loss = 1.31020

= Entry Price – 3 (ATR)

= 1.31320 – 3 (0.0010)

= 1.31320 – 0.00300

= 1.31020

Later on, I noticed that the 8 SMA began to cross under the 21 SMA, so I computed 3 ATRs from the highest close to confirm that the trend was now reversing and exited the trade as soon as the price reached that level.

Recent Highest Close = 1.33783

ATR = 0.0014

Highest Close – 3 (ATR)

= 1.33783 – 3 (0.0014)

= 1.33783 – 0.0042

= 1.33363

Exit/Take Profit = 1.33417

Buy Trade Example 2:

In this example, I just repeated the process of checking for signals when the ATR went below 0.001. I then waited for the price to be above the SMAs and that 8 SMA would be above 21

SMA. I entered the trade as soon as the price exceeded 3 ATRs from the close of the previous swing low.

Recent Lowest Close = 1.33068

ATR = 0.0010

3ATR + Recent Lowest Close

= 3 (0.0010) + 1.33068

= 1.33368

I then set my stop loss level 3 ATRs below the entry price.

Buy Entry Price (open of next candle) = 1.33410

ATR = 0.0013

Stop Loss

= Entry Price – 3 (ATR)

= 1.31320 – 3 (0.0013)

= 1.31320 – 0.0039

= 1.33020

When the price retraced and the SMAs crossed, I computed for 3 ATRs from the close of the highest candle and exited the position when the price reached that level.

Highest Close = 1.34477

ATR = 0.0026

Highest Close – 3 (ATR)

= 1.34477 – 3 (0.0026)

= 1.34477 – 0.0078

= 1.33697

Exit/Take Profit = 1.33720

Video

Watch this video to see how I use the Average True Range (ATR) to my advantage in my simple trading system.

CLICK HERE TO WATCH THE VIDEO

Comments/Notes

The use of the Average True Range in expressing the stop loss levels may expose a particular position to greater risks when the volatility greatly increases. As such, it may exceed the maximum risk set by our money management. It is then advisable to have a set stop for emergency situations expressed in dollars, points, or pips. This can be used when volatility increases and the trade is in our favor.

We can also reduce the lot size to reduce the risk exposure, but do this only when volatility is increasing and the trade is going against our favor.

To maximize the profits taken per trade, you can also reduce the distance from the price to your trailing stop once you are already in a stable profit.

Supposing that your trailing stop is originally set at 2 ATRs from the high, and your profit is steadily increasing, you can tighten your stop by reducing the distance between your high/low (for a buy/sell) and the stop to 1.5 ATRs.

Conclusion

Indeed, the Average True Range (ATR) is a brilliant volatility indicator. It identifies the strength of the price movement or volatility. A highly volatile market is typically followed by a quiet market and because the ATR identifies when the volatility increases, it can help confirm the breakout of a new trend. Although the ATR cannot tell the direction of the market, it is still a vital tool in identifying logical entries, profit targets and stops. Aside from those mentioned, the ATR can be used as in conjunction with other indicators or as part of a trading system to help filter trade signals.

Over the decades, this unique indicator managed to not only survive but remain popularly used in many trading systems simply because of these reasons. The ATR can be used in many different ways to help make your system remain applicable despite changing market conditions. It also makes your system suitable for different financial instruments.

I hope that with this report, I was able to show you the significance of the Average True Range in trading when used properly. I suggest you try it out and tweak some settings to see what suits best for your trading style.

By:

Marcille Grapa
www.surefiretradingchallenge.com

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Although I am not a big fan of moving averages as a sole method of trading: if used correctly with another indictor you can greatly increase the accuracy of their use.

The main problem as I am sure you are aware by now is, if you use any kind of moving average as a signal generator the whipsaw kill’s you.

The secret of course is how do you use a moving average and not get whipsawed as frequently?

I have found that if I use a filter with the moving average to help identify a true break;  it keeps you in the trade longer and stops you entering on false break.

I have constructed my own little filter which, I find very useful. I first take note of the open, high, low and close of the time period I am following. Although I take note of the open and close we wont use them in our calculations.

Next I calculate the difference between the high and the low (range) of that period. From there we can make a simple 3 period moving average of the last 3 range calculations. The last part is to subtract the 3 period average of the ranges from the moving average we are using – in this case a 10 period moving average.

So how do we use this information? Well, let’s assume that you are using a moving average: any moving average e.g. a 10 period moving average of the closing price.

Normally a signal would be generated if the closing price were either above or below the moving average. By adding a little filter of the 3 period average of the ranges we can better determine whether the moving average has in fact been breached.

Have a look at the table below.

As you can see from the chart above of the British Pound versus the Us Dollar: on the 7th May the close of the daily bar was 1.5967. The 10-day moving average of the closing price was 1.6000. A close below the average would normally indicate that you should either close or tighten your position. If we apply the 3-day filter of the ranges then the signal would actually be a close below 1.5843, which it closed above.

The next occurrence of closes below the moving average happened on the 2nd, 3rd and 4th of June. Of the 3 days, the only day that would have been of concern would have been the 3rd June. On that day the Moving Average was 1.6378 and the close of the day was 1.6285. After we applied the range signal of 1.6189 it is simple to see that we were in no danger of a reversal on that day.

Don’t complicate this. The example above is for a long trade. All you are doing is subtracting the average of the last 3 ranges from the 10 period moving average (if that is what you are using). Once there is a close below that number the trend is assumed to have changed to down. On the short side, all you are doing is adding the average of the last 3 ranges to the 10 period average (if that is what you are using) and if the close is above that number then the trend is assumed to have changed to long.

You can experiment with the different moving averages and the average of the ranges looked at. The point is, if you are applying basic technical analysis such as trend lines or indicators: you can use this range average as a confirming signal.

You can also build it into an existing method to help improve results. You might also want to look at constructing a system based on this filter.

Good Trading

Best Regards
Mark McRae

Posted by Admin
www.tradingforbeginners.com

I have always used a bit of Gann’s trading methods in my own trading – especially to determine trend. Love him or hate him, it would be a brave trader that would deny that Gann was one of the most influential traders of the last century.

The following article appeared in the December 1909 issue of The Ticker & Investment*Digest.

Some time ago the attention of this magazine was attracted by certain long pull Stock*Market predictions which were being made by William D. Gann. In a large number of cases Mr Gann gave us, in advance, the exact points at which certain stocks and commodities would sell, together with prices close to the then prevailing figures which would not be touched.

For instance, when the New York Central was 131 he predicted that it would sell at 145 before 129. So repeatedly did his figures prove to be accurate, and so different did his work appear from that of any expert whose methods we had examined, that we set about to investigate Mr Gann and his way of figuring out these predictions, as well as the particular use which he was making of them in the market.

The results of this investigation are remarkable in many ways. It appears to be a fact that Mr Gann has developed an entirely new idea as to the principles governing stock market movements. He bases his operations upon certain natural laws which, though existing since the world began, have only in recent years been subjected to the will of man and added to the list of so-called modern discoveries.

We have asked Mr Gann for an outline of his work, and have secured some remarkable evidence as to the results obtained therefrom. We submit this in full recognition of the fact that in Wall Street a man with a new idea, an idea which violates the traditions and encourages a scientific view of the Proposition, is not usually welcomed by the majority, for the reason that he stimulates thought and research. These activities the said majority abhors.

Mr Gann’s description of his experience and methods is given herewith. It should be read with recognition of the established fact that Mr Gann’s predictions have proved correct in a large majority of instances.

“For the past ten years I have devoted my entire time and attention to the speculative markets. Like many others, I lost thousands of dollars and experienced the usual ups and downs incidental to the novice who enters the market without preparatory knowledge of the subject.

“I soon began to realise that all successful men, whether Lawyers, Doctors or Scientists, devoted years of time to the study and investigation of their particular pursuit or profession before attempting to make any money out of it.

“Being in the Brokerage business myself and handling large accounts, I had opportunities seldom afforded the ordinary man for studying the cause of success and failure in the speculations of others. I found that over ninety percent of the traders who go into the market without knowledge or study usually lose in the end.

“I soon began to note the periodical recurrence of the rise and fall in stocks and commodities. This led me to conclude that natural law was the basis of market movements. I then decided to devote ten years of my life to the study of natural law as applicable to the speculative markets and to devote my best energies toward making speculation a profitable profession. After exhaustive researches and investigations of the known sciences, I discovered that the law of vibration enabled me to accurately determine the exact points at which stocks or commodities should rise and fall within a given time. The working out of this law determines the cause and predicts the effect long before the street is aware of either. Most speculators can testify to the fact that it is looking at the effect and ignoring the cause that has produced their losses.

“It is impossible here to give an adequate idea of the law of vibrations as I apply it to the markets. However, the layman may be able to grasp some of the principles when I state that the law of vibration is the fundamental law upon which wireless telegraphy, wireless telephone and phonographs are based. Without the existence of this law the above inventions would have been impossible.

“In order to test the efficiency of my idea I have not only put in years of labour in the regular way, but I spent nine months working night and day in the Astor Library in New York and in the British Museum of London, going over the records of stock transactions as far back as 1820. I have incidentally examined the manipulations of Jay Gould, Daniel Drew, Commodore Vanderbilt & all other important manipulators from that time to the present day. I have examined every quotation of Union Pacific prior to & from the time of E.H. Harriman, Mr Harriman’s was the most masterly. The figures show that, whether unconsciously or not, Mr Harriman worked strictly in accordance with natural law.

“In going over the history of markets and the great mass of related statistics, it soon becomes apparent that certain laws govern the changes and variations in the value of stocks, and that there exists a periodic or cyclic law which is at the back of all these movements. Observation has shown that there are regular periods of intense activity on the Exchange followed by periods of inactivity. Mr Henry Hall in his recent book devoted much space to ‘ Cycles of Prosperity and Depression’, which he found recurring at regular intervals of time. The law which I have applied will not only give these long cycles or swings, but the daily and even hourly movements of stocks. By knowing the exact vibration of each individual*stock I am able to determine at what point each will receive support and at what point the greatest resistance is to be met.

“Those in close touch with the market have noticed the phenomena of ebb and flow, or rise and fall, in the value of stocks. At certain times a*stock will become intensely active, large transactions being made in it; at other times this same stock will become practically stationary or inactive with a very small volume of sales. I have found that the law of vibration governs and controls these conditions. I have also found that certain phases of this law govern the rise in a stock and an entirely different rule operates on the decline.

“While Union Pacific and other railroad stocks which made their high prices in August were declining, United States Steel Common was steadily advancing. The law of vibration was at work, sending a particular stock on the upward trend whilst others were trending downward. “I have found that in the stock itself exists its harmonic or inharmonious relationship to the driving power or force behind it. The secret of all its activity is therefore apparent. By my method I can determine the vibration of each stock and also, by taking certain time values into consideration, I can, in the majority of cases, tell exactly what the stock will do under given conditions.

“The power to determine the trend of the market is due to my knowledge of the characteristics of each individual stock and a certain grouping of different stocks under their proper rates of vibration. Stocks are like electrons, atoms and molecules, which hold persistently to their own individuality in response to the fundamental law of vibration. Science teaches that ‘an original impulse of any kind finally resolves itself into a periodic or rhythmical motion; also, just as the pendulum returns again in its swing, just as the moon returns in its orbit, just as the advancing year over brings the rose of spring, so do the properties of the elements periodically recur as the weight of the atoms rises.’

“From my extensive investigations, studies and applied tests, I find that not only do the various stocks vibrate, but that the driving forces controlling the stocks are also in a state of vibration. These vibratory forces can only be known by the movements they generate on the stocks and their values in the market. Since all great swings or movements of the market are cyclic, they act in accordance with periodic law.

“Science has laid down the principle that ‘the properties of an element are a periodic function of its atomic weight’. A famous scientist has stated that ‘we are brought to the conviction that diversity in phenomenal nature in its different kingdoms is most intimately associated with numerical relationship. The numbers are not intermixed accidentally but are subject to regular periodicity. The changes and developments are seen to be in many cases undulatory.’ Thus, I affirm every class of phenomena, whether in nature or on the*stock*market, must be subject to the universal law of causation and harmony. Every effect must have an adequate cause.

“If we wish to avert failure in speculation we must deal with causes. Everything in existence is based on exact proportion and perfect relationship. There is no chance in nature, because mathematical principles of the highest order lie at the foundation of all things. Faraday said, ‘There is nothing in the universe but mathematical points of force’.

“Vibration is fundamental : nothing is exempt from this law. It is universal, therefore applicable to every class of phenomena on the globe. Through the law of vibration every stock in the market moves in its own distinctive sphere of activities, as to intensity, volume and direction; all the essential qualities of its evolution are characterised in its own rate of vibration. Stock, like atoms, are really centres of energy; therefore, they are controlled mathematically. Stocks create their own field of action and power: power to attract and repel, which principle explains why certain stocks at times lead the market and ‘turn dead’ at other times. Thus, to speculate scientifically it is absolutely necessary to follow natural law. “After years of patient study I have proven to my entire satisfaction, as well as demonstrated to others, that vibration explains every possible phase and condition of the market.”

In order to substantiate Mr Gann’s claims as to what he has been able to do under his method, we called upon Mr William E. Gilley, an Inspector of Imports, 16 Beaver Street, New York. Mr Gilley is well known in the downtown district. He himself has studied stock*market movements for twenty-five years, during which time he has examined every piece of market literature that has been issued & procurable in Wall Street. It was he who encouraged Mr Gann to study the scientific and mathematical possibilities of the subject. When asked what had been the most impressive of Mr Gann’s work and predictions, he replied as follows :

“It is very difficult for me to remember all the predictions and operations of Mr Gann which may be classed as phenomenal, but the following are a few.

“In 1908 when the Union Pacific was 168-1/8, he told me it would not touch 169 before it had a good break. We sold it short all the way down to 152-5/8, covering on the weak spots and putting it out again on the rallies, securing twenty-three points profit out of an eighteen point wave.

“He came to me when United States Steel was selling around 50, and said, ‘This steel will run up to 58 but it will not sell at 59. From there it should break 16 points.’ We sold it short around 58 with a stop at 59. The highest it went was 58. From there it declined to 41-17 points.

“At another time, wheat was selling at about 89c. He predicted that the May option would sell at $1.35. We bought it and made large profits on the way up. It actually touched $1.35.

“When Union Pacific was 172, he said it would go to 184-7/8 but not an eighth higher until it had a good break. It went to 184-7/8 and came back from there eight or nine times. We sold it short repeatedly, with a stop at 185, and were never caught. It eventually came back to 17.

“Mr Gann’s calculations are based on natural law. I have followed his work closely for years. I know that he has a firm grasp of the basic principles which govern stock market movements, and I do not believe any other man can duplicate the idea or his method at the present time.

“Early this year, he figured that the top of the advance would fall on a certain day in August and calculated the prices at which the Dow Jones Averages would then stand. The market culminated on the exact day and within four-tenths of one percent of the figures predicted.”

“You and Mr Gann must have cleaned up considerable money on all these operations”, was suggested.

“Yes, we have made a great deal of money. He has taken half a million dollars out of the market in the past few years. I once saw him take $130, & in less than one month run it up to over £12,000. He can compound money faster than any man I have ever met.”

“One of the most astonishing calculations made by Mr Gann was during last summer [1909] when he predicted that September Wheat would sell at $1.20. This meant that it must touch that figure before the end of the month of September. At twelve o’clock, Chicago time, on September 30th (the last day) the option was selling below $1.08, and it looked as though his prediction would not be fulfilled.

Mr Gann said, ‘If it does not touch $1.20 by the close of the market it will prove that there is something wrong with my whole method of calculation. I do not care what the price is now, it must go there.’ It is common history that September Wheat surprised the whole country by selling at $1.20 and no higher in the very last hour of trading, closing at that figure.”

So much for what Mr Gann has said and done as evidenced by himself & others. Now as to what demonstrations have taken place before our representative :

During the month of October, 1909, in twenty-five market days, Mr Gann made, in the presence of our representative, two hundred and eighty-six transactions in various stocks, on both the long and short side of the market. Two hundred and sixty-four of these transactions resulted in profits ; twenty-two in losses.

The capital with which he operated was doubled ten times, so that at the end of the month he had one thousand percent of his original margin. In our presence Mr Gann sold Steel Common at 86, saying that it would not go to 86. The lowest it sold was 86-1/8.

We have seen him give in one day sixteen successive orders in the same stock, eight of which turned out to be at either the top or the bottom eighth of that particular swing. The above we can positively verify.

Such performances as these, coupled with the foregoing, are probably unparalleled in the history of the Street.

James R. Koene has said, “The man who is right six times out of ten will make a fortune.” He is a trader who, without any attempt to make a showing, for he did not know the results were to be published, established a record of over ninety-two percent profitable trades.

Mr Gann has refused to disclose his method at any price, but to those scientifically inclined he has unquestionably added to the stock of Wall Street knowledge and pointed out infinite possibilities.

We have requested Mr Gann to figure out for the readers of the Ticker a few of the most striking indications which appear in his calculations. In presenting these we wish it understood that no man, in or out of Wall Street, is infallible.

Mr Gann’s figures at present indicate that the trend of the stock market should, barring the usual rallies, be toward the lower prices until March or April 1910. He calculates that May Wheat, which is now selling at $1.02, should not sell below 99c, and should sell at $1.45 next spring. On Cotton, which is now at about 15c level, he estimates that after a good reaction from these prices the commodity should reach 18c in the spring of 1910. He looks for a corner in the March or May option.

Whether these figures prove correct or not will in no way detract from the record which Mr Gann has already established.

Mr Gann was born in Lufkin, Texas, and is thirty-one years of age. He is a gifted mathematician, has an extraordinary memory for figures, and is an expert Tape Reader. Take away his science and he would beat the market on his intuitive tape reading alone.

Endowed as he is with such qualities, we have no hesitation in predicting that, within a comparatively few years, William D. Gann will receive recognition as one of Wall Street’s leading operators.

Good Trading

Best Regards
Mark McRae

Posted by Admin
www.tradingforbeginners.com

It is commonly accepted that there are four stages of a trend. These stages make up a cycle and each cycle has smaller cycles contained within them.

It doesn’t matter whether you like to trade with 5-minute charts or monthly charts. Each market will be in some stage of the cycle as you are observing it.

Before you even think about getting into a trade you should have some idea of where the market is in the cycle. This will help you avoid making the wrong entry. For example, if you have identified stage two of the cycle it doesn’t make sense for you to be short in an up stage.

If you look at the chart below you can see the 4 different stages clearly marked.

Stage One

The start of the cycle (stage one) is where there is very little happening and the market is generally flat. At this stage the market is normally oscillating in a certain range. As this stage ends you often see a breakout of the previous range. The breakout can often be explosive particularly if it has been in consolidation for a long period of time. For markets that can measure volume an increase of volume is an early indication that the breakout is real.

Stage Two

Stage two is after the breakout has occurred and we begin to head North. Depending on the force of the move the market may rally and not come back to the breakout point or it may come back and test that area.

In the chart example the market broke out of the range and then rallied to R1 where it began to retreat to S1. These two points are very important. If S1 were lower than the breakout point or S1 were to rally slight but still remain below R1 then break back down past S1 then the start of the cycle would be in doubt.

What actually happened was that the market came down to S1 and then rallied past R1. The aggressive trader would already have taken a position on the breakout and most likely add to the position as R1 was taken. If you had not entered the market yet then this would be an ideal opportunity to jump in.

The second point to note is that the moving average began to turn up after the breakout giving further support to the beginning of the cycle.

In the case of the chart example I have selected a simple 40 period moving average of the closes. You can use any moving average that suits the time frame you are dealing in.

Stage two continues making higher peaks and higher valleys and may come back to test the moving average a few times.

Stage Three

Stage three is the final thrust of the cycle. You may notice a spike or a double top formation as the trend begins to run out of steam.

In our example the top is fairly flat. R2 is formed and the market retreats to S2. What happens next is the opposite of the start of the cycle. The market stops at S2 and then rallies slightly. The fact that the rally did not exceed R2 is what is significant. Instead the market only reached R3.

As soon as the market broke through S2 it signified the end of the trend. You would also note that the moving average turned down at this point further give support to the end of the up move. If the top was not easily identifiable and positions closed at that time then once S2 was taken any long positions would have been closed.

Stage Four

This is the final stage of the cycle and perhaps the most interesting. Depending on market conditions some traders may now go short. A potential shorting point would have been on the break of S2. The market in our example is making lower valleys and lower peaks. This tells us that there is now a move to the downside.

Before initiating a short on the break of S2 you could measure the start of the whole move at the beginning of the cycle to where the market topped at stage three. You could then calculate the 61.8% retracement (see Fibonacci). This would give you a downside target to aim for and if there was enough meat left in the trade initiate a short trade.

Stage four can be difficult as the market may either go into consolidation again or continue down.

So how can this help your trading? Well, the first thing to do before you enter a trade is decide where in the cycle you are. If you are at stage two then it could be dangerous to go short. It could also be dangerous to enter short if stage two had been building for a long time. Remember the market can’t go up for ever.

On the other hand if we were entering stage four you wouldn’t want to be long. Just by identifying the different stages of the market it can help you lock in profits, make better judgments decisions on whether you should be in the market at all and perhaps give you clues for entry and exits.

Good Trading

Best Regards
Mark McRae

Posted by Admin
www.tradingforbeginners.com

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