Tag: Traders Toolbox

Traders Toolbox: Elliott Wave Theory

Posted on by lindsay

MarketClub is known for our "Trade Triangle" technology. However, if you have used other technical analysis indicators previously, you can use a combination of the studies and other techniques in conjunction with the "Trade Triangles" to further confirm trends.

Elliott Wave Theory categorizes price movement in terms of predictable waves. Beginning in the late 1980s, R.N. Elliott developed his own concept of price waves and their predictive qualities. In Elliott theory, waves moving with the trend are called impulse waves, while waves moving against it are called corrective waves.

Impulse waves are broken down into five primary price movements, while correction waves are broken down into three. An impulse wave is always followed by a correction wave, so any complete wave cycle will contain either distinct price movements. Breaking down the primary waves of the impulse, correction wave cycle into sub-waves produces a wave count of 34 (21 from the impulse wave plus 13 from the correction wave), producing more Fibonacci numbers. Elliott analysis can be applied to time frames as short as 15 minutes or as long as decades, with smaller waves functioning as subwaves of larger waves, which are in turn sub-waves of still larger formations. By analyzing price charts and maintaining wave counts, you can determine price objectives and reversal points.

A key element of Elliott analysis is defining the wave context you are in: Are you presently in an impulse wave uptrend, or is it just he correction wave of a larger downtrend? The larger the time frame you analyze, the larger the trend or wave you find yourself in. Because waves are almost never straightforward, but are instead composed of numerous sub-waves and minor aberrations, clearly defining waves (especially correction wave) is as much an art as any other kind of chart analysis.

Fibonacci ratios play a conspicuous role in establishing price objectives in Elliott theory. In an impulse wave, the three principal waves moving in the direction of the trend are separated by two smaller waves moving against the trend. Elliotticians often forecast the tops or bottoms of upcoming waves by multiplying precious waves by a Fibonacci ratio. For example, to estimate a price objective for wave III, multiply wave I by the Fibonacci ratio of 1.618 and add it to the bottom of wave II for a price target. Fibonacci numbers also are evident in the time it takes for price patterns to develop and cycles to complete.

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You can learn more about the Elliott Wave Theory by visiting INO TV.

Traders Toolbox: How to use the Directional Movement Index

Posted on by The INO.com Team

The Directional Movement Index, commonly called the DMI, is a powerful trend-following indicator. Many false signals generated by indicators such as the stochastics are filtered out by the DMI. Subsequently, this trading and analytical tool gives few signals, but, when generated, they tend to be very reliable.

Many, who at first glance are strangers to the DMI, find they are familiar with the prime component of the index: The ADX or average directional movement index. This discussion will center on the main use of the ADX, the turning point concept.

The DMI consists of three components: The + DI, which represents upward directional movement; the - DI, indicating downward movement; and the ADX, which signifies the average directional movement within a market.

In STRONG UPTRENDING moves, such as the late 1989 and early 1990 rally in the CRB, the + DI and the ADX turn up early in the move and move higher, with the + DI generally holding above the ADX. A high probability signal the uptrend has stalled or ended is generated when the ADX crosses above the +DI and turns down. This signal commonly occurs on the trading period of the trend change or slightly before. It rarely takes more than a few periods past a true trend shift to see the ADX turn down.

The rules for signalling a potential bottom are the same as for a top: Simply substitute the - DI for the + DI. There appears to be one slight difference between tops and bottoms: Generally, the ADX turns from a higher level when marking a top.

Several chart services plot only the ADX. In these instances, it can generally be assumed that a downturn in the ADX which occurs after crossing above 40 will have seen the ADX cross above the + DI if the market had been in an uptrend and above the -DI if in a downtrend. In simple terms, a move by the ADX above 40 followed by a downturn generally signals a probable trend change.

Signals such as those which occurred in May, 1990 and February, 1991 in the CRB index (arrows) can be very valuable in confirming a turn which had been projected by unrelated methods of technical analysis. ADX signals can help confirm the expected completion of a wave structure or to underscore a turn within a critical time period.

The DMI is based on a certain number of periods. I have had the most success with 14 days on daily charts. And with the exception of Treasury Bonds, for which I use 14 weeks, I prefer to use 9 periods on the weekly and monthly charts.

Editors note: While the examples shown are somewhat dated the concept and use of the ADX is not. The ADX indicator is available on MarketClub.

Traders Toolbox: Traders Toolbox: Divisions of eight

Posted on by The INO.com Team

Studying the writings of traders who were active in the first three or four decades of this century has often inspired me to do additional research. This has allowed me to develop additional tools and theories. In reality, what I present in this segment will not "pure" Gann. Instead, I will present applications and approaches which I have found to be useful and successful. Hopefully, this will provide a foundation for anyone who wants to study further on his/her own.

Many of the successful traders from the first half of this century have a reputation of being almost mystical. To many, this is especially true of W.D. Gann. Trader after trader has searched for Gann's "secret" to unlock the mysteries of the market. Many of his tools, and mine as well, are relatively simple and are not secrets. However, after delving into his writings, I have come to the conclusion that his biggest "secret" consisted of two things: HARD WORK and COMMON SENSE. Unfortunately, many would-be traders seem unwilling to do the first and lack the ability to use the latter.

Probably the easiest place to start explaining analytical tools is with a simple method to determine support and resistance levels. To locate what should be among the most important areas of support and resistance in a market, divide the move from one extreme to the other by eight.

As an example, oats posted a high in the summer of 1988 which may hold for some time to come. The monthly oats chart shows the range from the all-time low near 14 posted in 1932 to 393, the 1988 high, divided by eight. These eight points should prove to be important areas of support and resistance for years to come. One way to check this range is to examine whether the eight points have proven significant in previous action. In the oats, it is fairly clear the eighth points have been effective in previous years, which should give one a high degree of confidence these levels will be important in the future.

Gann indicated that the 1/3 and 2/3 divisions of a range (broken lines on monthly oats chart) were important as well. I have found the 1/3 and 2/3 points to be significant, but they will generally take a secondary role to the eighth points.

The divisions of price, primarily the eighth points, can be placed on not only the long-term monthly and weekly charts but on the daily charts as well. As the daily perpetual chart of December oats reveals, the long-term levels of support and resistance are significant to daily action. It was no surprise to see December oats find support at the 250 level as manifested during July and August, 1988. Since the point of the all-time range at 250 had been clearly broken, one would have expected to see this market fall to the level near 202 (which it later did).

The divisions of a range are not limited to the move from all- time low to all-time high. Any sizable range of movement can be divided by eight to determine lesser-degree levels of support and resistance. Note the upmove in 1991 in December silver from February to early June. Following the June high, the eighth points provided reasonable areas of support and resistance on the ensuing decline. The boxed area on the weekly December silver chart represents the action shown on the daily chart. The weekly chart didn't indicate this range was very significant, essentially a corrective rally; yet, the eight divisions still provided valuable reference points.

The power of this tool is obvious.The large-degree eighth points are invaluable as reference tools for support and resistance. Yet, the same principle we'll work on daily charts, smaller ranges and, yes, even intraday charts.

Credit to Glen Ring for this work

Traders Toolbox: More basic Gann

Posted on by The INO.com Team

One of the most important ways a contestant can prepare for competition is to know as much about the opponent as possible. In trading commodities, the primary opponent is the trader's own emotions. Once the emotions are under control, the "opponent" is the marketplace.

Know your market! While there are many analytical tools which may be applied to all markets, not all markets are identical. Markets have individual personalities or tendencies. It is important to study individual markets to learn specific identities.

A clear example of individuality is seen in seasonal patterns. The seasonal tendencies of each commodity are somewhat unique. Identifying a historical pattern can be very beneficial in the process of trade selection. To illustrate, a study of the monthly corn chart reveals March is a poor month in which to initiate a major short position.

With the exception of 1977, since 1972, a sale made in the corn market during March could have been bettered by waiting until later in the year. While impressive on the monthly corn chart, this pattern is even more clear for the December contract (not shown). How is such information applied?

Corn Belt farmers typically face a large portion of production expenses from late February through early April. Obviously, corn is a primary source of income for these producers and the need to generate capital spurs sales of corn in the period of need. By knowing March is a low probability month for favorable prices, plans can be made to market corn prior to the period of seasonal weakness or to postpone sales into later months. Also, producers should avoid selling the new crop (December) during March as the probability of selling at equal or higher prices later in the season is 100 (since 1972).

The applications for traders are rather obvious. If a trader is bearishly inclined, the information would suggest patience needs to be exercised to wait for a higher period of probability to initiate a short position. Bullish traders would try to accumulate long positions during March.

Seasonal tendencies are only one of many individual traits to study. Many markets have certain types of top or bottom formations which occur more often than not. For example, soybeans generally post some form of a triple top when marking a major high. Some markets respect support or resistance levels much better than others. Certain markets like to post a high percentage of turns on a specific day of the week or month. The list goes on.

There is only one way to learn market tendencies: study and study some more. Through hard work comes knowledge. W.D.Gann stated the importance of knowledge very well: "The dif- ference between success and failure in trading commodities is the difference between one man knowing and following fixed rules and the other man guessing. The man who guesses usually loses."

Traders Toolbox: Reversals

Posted on by The INO.com Team

Reversals In my opinion, one of the most misused and abused terms in technical analysis is the reversal or key reversal. I often get calls from both new and experienced traders who are excited about a market because it has just posted a "key reversal." While the action these traders point to often marks a reversal day, such a day (week or month) by itself actually has little significance. There is research which indicates single period reversals mark a turn only about 50% of the time. Which gives about the same odds of indicating a turn using a coin flip.

In my studies, I use a set of rules which help me ferret out reversals which have a much higher probability of marking a turn. Before going any further, I want to clarify the term reversal when used in technical analysis. A reversal does not mean a market will necessarily reverse a trend. A reversal is a formation which may mark a top or a bottom. However, a top or bottom only signals the preceding trend has come to an end. In other words, a top will indicate an uptrend has come to an end. It does not indicate whether the new trend will be down or sideways.

Now, on to the rules. There are six rules which I use to identify a valid reversal. To clarify these rules, I have provided an example of the pattern which I watch for to mark a reversal in the circle on the weekly T- bond chart. I am listing the six rules to identify a reversal high; for a reversal low, simply reverse the parameters where warranted.

To mark a reversal high, first, the market must make a new high for the last six to eight weeks. Second, the market must close lower than the previous day's (or week's) close. Third, the market must reverse the previous day's (or week's) action. To clarify rule three, the day or week preceding the reversal must have posted a positive close. Fourth, the market must post follow through action the next day (or week). Again, to clarify, the market must close lower on the day (or week) following the reversal. Fifth, the reversal must be accompanied by moderate to high volume. And, finally, the reversal must occur in a terminal (critical) area.

Rules one through four deal with the pattern which the market must trace out and are basically self-explanatory. Rule five insures the reversal is not marked on a low-volume day (or week) such as is common in a holiday period. And rule six essentially means the market must be in an area of price or time where a turn could be expected to occur.

Notice the weekly T-bonds chart and the numerous turns which were marked by the valid reversal pattern. If you examine the chart closely, you will notice there are a number of reversal weeks which did not see followthrough action which failed to turn the market. However, it is rare to find a reversal which saw followthrough action that failed to mark a significant turn.