Professional Documents
Culture Documents
Vol. 1: 2001-2004
13 Know thy market: Gauging typical price behavior (Active Trader, Oct. 2001)
30 Bull vs. Bear The details matter (Active Trader, Nov. 2002)
71 Nasdaq 100 volume and the QQQ (Active Trader, July 2004)
TRADING Strategies
ON-TARGET trading
Taking profits is a balancing act: Hold on too long
and you risk giving back your gains. Get out too soon
and your gains might not be worth holding on to.
By using a scientific approach to solve this puzzle
you can establish intelligent profit targets that
BY THOM HARTLE enhance your performance.
250
Step 5: Drawing conclusions from the
testing. Based on this testing we can 200
conclude that the MFE approach is an
150
appropriate method for determining Short positions
profit targets. You can use the MFE to 100
create targets that suit your risk toler- Long positions
50
ance by using larger or smaller values
depending on how active you want to 0
1 3 5 7 9 11 13 15 17 19 21 23
be. Other MFE measurements may be
used for targets, such as percentage
price movement or a ratio based on the FIGURE 8 EQUITY CURVES
current average true range. Also
remember that other issues must be The bottom curve shows the performance of the original system. The top
addressed when designing a system or curve shows the performance with the addition of a 50-point profit target.
strategy, such as slippage and commis- The target continues to add profits to the system while the original
sions, risk and required capital. trend-following technique is in a flat period.
3,400
Granted, this targeting method is
based on hindsight. So, the first step 2,900
would be to test the approach on differ-
ent (and more) historical data and see if 2,400
the performance holds up. This is called Target plus
1,900
“out-of-sample” testing, and is a very trend-following positions
necessary step if you wish to draw reli- 1,400
able conclusions from your testing.
Finally, as with all technical trading 900 Trend-following
methods, past profitable performance positions
does not guarantee future profits, but if 400
you take the time to do this type of
work you will gain both experience and -100
2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48
develop profitable techniques. Ý
T he Ergodic Candlestick Oscillator (ECO) is detailed in CSI) and a short-term EMA (generally five days for the CSI).
William Blau’s book, Momentum, Direction, and
6.96
EMA Double =
(1-a) EMA + a(EMA Double(t-1)) A -19.61
ECO crosses above the signal line
where MACD .05
EMA Double(t-1) =
-.03
yesterday’s EMA value
-.11
Blau uses the notation B MACD crosses above the signal line
-.18
EMA(EMA(P,r),s) to indicate a long- 2/22/2001 2/23/2001 2/26/2001
term EMA (generally 26 days for the Source: Fibonacci Trader (www.fibonaccitrader.com)
I n 1992, Standard and Poor’s (S&P) and Barra worked in partnership to produce As our first criterion, we will
growth and value subsets of S&P’s equity indices. The S&P 500/Barra Growth and begin with a list of undervalued
S&P500/Barra Value Indices separate fast-growing companies from slower growing, stocks — those that have fallen
or undervalued, companies, based upon a price-to-book value calculation (the price of in price and reached their high
the stock divided by the “book value,” or net worth of the company). historical dividend yield. How-
The price-to-book ratio captures one of the fundamental differences between com- ever, we are faced with one
panies classified as value companies or growth companies: Growth companies tend to problem: By putting capital into
have higher price-to-book ratios than value companies. Also, price-to-book ratios tend undervalued companies, we risk
to be more stable over time compared to alternative measures such as the price-to- the possibility that the stock
earnings ratio, historical earnings growth rates or return on equity. Consequently, the price may languish, trading
growth and value indices experience relatively low turnover. sideways for a considerable
Companies in the growth index have higher market caps, on average, than those in the amount of time.
value index. As a result, there are many more companies in the value index than the However, use of technical
growth index. As of this writing, the Growth Index had 125 companies while the Value analysis allows you to spot situa-
Index listed 375 companies. More information can be found at the Standard & Poor’s Web tions that indicate price action is
site (www.spglobal.com or www.spglobal.com/indexmain500style_data.html) and beginning to move into an
Barra’s Web site (www.barra.com). uptrend. A good tool for this is
called the Ergodic Candlestick
Oscillator (ECO), developed by
• The earnings have improved in at least seven of the last 12 William Blau. In the charts that
years. follow, we will plot the ECO as a histogram and the signal line
as a dot. For more information, see “Market timing: ECO,” p. 9.
In mid-January 2001, IQ Trends listed 30 companies as Our plan is to look for stocks from IQ Trends’ undervalued
undervalued, 89 in rising trends, 116 overvalued and 114 in list and then use the ECO to determine which ones are in an
declining trends. Many of the companies listed have been uptrend. The trend turns up when the ECO histogram is in
around most of the past century and are household names, negative territory and rises to the point that the signal line is
such as JP Morgan Chase and Eastman Kodak. Figure 4 (p. 97) not within the histogram. Our work will be with weekly charts.
BY THOM HARTLE
The second characteristic is the difference between closing FIGURE 3 CLOSE-TO-CLOSE CHANGES
prices on a day-to-day basis. Figure 3 (right, bottom) shows The absolute value between closing prices indicates the
the absolute values of close-to-close price changes over the closing differences tend to be between $1 and $1.50, except
for the earlier observations. The blue line is the three-period
moving average of the bar-to-bar closing price differences
The simplest of statistics and the red line is the 10-period moving average.
behavior. 3.5
3.0
2.5
same period. As would normally be the case, the differ- 2.0
ences in closing prices are, on average, less than the daily
1.5
ranges (and the same volatility spike occurs at bar 13). As
in Figure 2, the blue line is a three-period MA and the red 1.0
line is the 10-period MA. Here, the averages tend to be .5
between $1 and $1.50, except for the early observations in 0
the example. Price bars
To delve further into this aspect of the QQQs’ price Source: Excel
continued on p. 15
50 80 66
36 38 54 52
40 60
30 22 20
19 40 32
20 13 24 22
8 15
10 5 7 3 5 7 20 8 10
0 0 0 1 0 5 5 7 4
1 2 0 1 1 1
0
0
Range Range
Source: Excel Source: Excel
To understand any market, On days the market closed down, the open was equal to the
high only 10 times. The market turned down after reaching
a high between one cent to 50 cents 84 times. The market
you must measure was up between 51 cents and $1 65 times before reversing.
Price bars
and classify its behavior 100
84
90
in terms of probabilities. 80
65
70
60
is down $1. 50 38
If you are developing a short-term systematic approach
40
based upon indicators, you can substitute a hard-money
30 18
stop based on typical behavior of the market instead of
waiting for an indicator to give a signal at the close. 20 10 9
4 3 1 3 1
For example, when reviewing your test results you might 10 0 1 0 1 0
uncover that if your system was long and the indicator sig- 0
nals a reversal point that causes losses greater than $3 at the
close, you could substitute a hard-money exit rule based on Range
the statistics that show the market rarely recovers after it Source: Excel
has moved a certain amount intraday. In addition, knowing
the market’s typical behavior can help you better decide To understand any market, you must measure and classify its
how much capital to risk on any one trade. behavior in terms of probabilities. You can combine these sta-
tistics with other analytical techniques and build sound trading
methods based on concrete price behavior characteristics.
In his book Trading in the Zone: Master the Market with This kind of analysis reveals each market has typical behav-
Confidence, Discipline and a Winning Attitude, trader and author ior patterns, as well as the potential to — on any given day —
Mark Douglas writes, “The best traders treat trading like a trade outside of its typical pattern. That is a fact of life in trad-
numbers game, similar to the way in which casinos and pro- ing, but by using simple statistics, you’ll be better equipped to
fessional gamblers approach gambling.” trade effectively. Ý
BY THOM HARTLE
BY THOM HARTLE
up and down markets. Measuring the distance between closing prices provides a second perspective on market
Figure 3 (right) shows the volatility. Close-to-close moves reflect price gaps between bars.
difference between closes
for the bars in Figure 1, with 4.5
three- and 10-bar moving
4.0
averages. Note that there is
an outlier (an extreme read- 3.5
ing) at data point 48 — a
closing difference of $3.91. 3.0
This reading is much larger 2.5
than the same bar from
Figure 2 because of the low 2.0
close on May 7 and a gap-
1.5
up opening and high close
on May 8. Although a larger 1.0
price gap occurred a few
bars later, the close-to-close 0.5
move was not as exaggerat-
0
ed because the bar before
the gap closed near its high.
Some traders may want Day
to use average “true range” Source: Excel, data by eSignal
(the greatest absolute differ-
ence between today’s high financial press never says the market
and today’s low, today’s high and yes- closed up today twice the average true A different perspective
terday’s close, or today’s low and yester- range, but they do comment on closing A different way of viewing this price
day’s close) for this calculation. differences — e.g., today was the highest information is shown in Figure 4 (left).
However, by choosing close-to-close and close in three weeks, or at one point the The price data is adjusted so that each
high-minus-low ranges, you have statis- stock was down $6 from yesterday’s bar’s opening price is zero, the high is
tical references to know when market close, and so on. With historical num- the net gain from the open, the low is the
activity is significant relative to what bers in hand you can put price action in net decline from the open, and the close
many other people in the market are perspective and separate facts from is the difference from the open. This per-
talking and thinking about. After all, the hyperbole. spective highlights how much the mar-
ket moved above or below
the open on a given day.
FIGURE 4 ADJUSTING THE DATA The next step is to segre-
gate the bars in Figure 4 in
This graph shows the daily ranges plotted with the opening price at zero. This highlights
terms of days the market
how far above or below the open the market moved and where it closed on different days.
closed up from the previous
3.0 close (Figure 5, p. 26) and
days the market closed
2.5
down from the previous
2.0 close (Figure 6, p. 26). This
1.5 analysis will reveal whether
1.0 the market has any observ-
0.5 able tendencies on up-clos-
ing or down-closing days.
0
During this 60-day peri-
-0.5 od, the market closed up 28
-1.0 bars and down 32 bars.
-1.5 (Keep in mind that some
-2.0 bars closed below the open
but above the previous close
-2.5
or above the open but below
-3.0 the previous close.) As you
Day might expect, the bulk of the
intraday price movement is
Source: Excel, data by eSignal continued on p. 26
Those of us without an innate feel down for the day only nine times in 32
observations (28 percent). Also note that
SPYmade no unusual surges or declines
for the markets can perform simple during this period. However, there are
only 60 bars of data, so a longer-term
analysis that allows us to understand view would be required before reading
too much into these statistics.
Figure 10 shows a steadily declining they are now. Gauging the typical price
The data tells us series of lower highs. In other words, movement gives you a set of practical
even though the market did close up for references for what is high and what is
that unless there’s the day, there was enough selling pres-
sure to push prices well below the open,
low in the markets you trade, so you
don’t have to guess. And anytime you
BY THOM HARTLE
145.00
140.00
135.00
130.00
125.00
120.00
115.00
110.00
105.00
100.00
95.00
90.00
July Aug. Sept. Oct. Nov. Dec. 2001 Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 2002 Feb. Mar. Apr. May
Source: eSignal
150.00
145.00
140.00
135.00
130.00
125.00
120.00
115.00
110.00
105.00
100.00
95.00
July Aug. Sept. Oct. Nov. Dec. 1999 Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 2000 Feb. Mar. Apr. May
Source: eSignal
70
What’s it all mean?
66 It is clear that entry, risk
management and profit-
60 taking tactics need to take
53 into account the market
trend, bear or bull. A trader
50
cannot use the same buy
setup and risk points that
40 were effective during the
35 bull market run because
33
the behavior of the market
30
changes during bear phas-
es. Consequently, it’s pru-
20
20 17 dent to spend time devel-
oping a sound trend indi-
8
cator, and then design
10
4
trade setups based on the
2 2 2 2 1 trend.
0 0
0 Many new traders get
into trouble by ignoring
these realities. Here’s how
Open-to-low move ($) the typical trader learning
Source: Excel, data by eSignal curve might progress: First
you learn you have to cut
your losses and let your
FIGURE 8 BULL MARKET OPEN-TO-LOW MOVES ON UP-CLOSING DAYS profits run. If you devel-
The bull market had most of its open-low moves for up days in the $0.01 to $0.25 range, oped your trading tech-
as opposed to $0.26 to $0.50 for the bear market. This indicates traders are more likely nique during the 1990s bull
to support prices in a bull market. market, you could have
designed a viable system
55 that used tight stops
50 because, as Figure 8 shows,
50 in the bull period SPY typ-
45 ically traded down in the
42 42 neighborhood of only $0.25
40 to $0.75 from the opening
36 price, and still closed up.
35 33
However, if you failed to
30 recognize the market’s per-
24
sonality change during a
25 downtrend, you may have
20 18 bought after the open
(when the market was
15 showing initial weakness),
and felt confident if the
10 8
market subsequently
5 5
5 3 2
moved into positive terri-
1 1 tory. But during a down-
0 0 0 0 0 0
0
trend (characterized by
persistent down closes), it
Open-to-low move ($) is unlikely the market will
climb well into positive ter-
Source: Excel, data by eSignal
ritory, as Figure 9 shows:
Equity curve
DRAWDOWN MANAGEMENT
Your system has given you four losing trades in a row.
Should you take the next signal, or move to the sidelines?
Here are some thoughts on how to determine when to
stay out of the market and when to jump back in.
$40,000
BY THOM HARTLE
$35,000
Equity line
F
C
$30,000
Because of the congested market conditions that prevailed for a good portion
of the test period, the system’s profit targets were not met as often as they
would be in a trend environment. This underscores the importance of under -
standing the price behavior your system relies on to generate profits.
Stick to the rules
Having a rule that tells you when your 10-year T-note continuous futures (TY), daily
system is failing to perform permits you 93,000
to move to the sidelines based on logic
and discipline, rather than fear. The
more you can remove emotion from 92,000
trading, the higher your chances of
long-term success.
For the techniques outlined here, the
91,000
choices of a 10-period moving average
and a 10-trade moving window with a
50-percent threshold were arbitrary.
Other parameters may work better or 90,000
worse, and should be explored fully
before trading.
Finally, this study highlights the 89,000
value of developing a trading method
and documenting all of its trades —
both historically and in real time. Doing 88,000
so allows you to perform the kind of
analysis described here to manage your April May June July August Sept.
money in a more scientific fashion. Ý
3 10 24 1 8 15 22 1 12 19 26 3 17 24 1 14 21 1
Source: CQGNet
Opening
bars represent short-term
volatility lows out of which
price can move sharply. This
The bars at A, B and C are all relatively narrow-range bars that represent
short-term consolidations. Applying specific entry rules allows you to take
advantage of moves out of the consolidation when volatility increases.
I
80.00
C
W
BY THOM HARTLE
hen analyzing the ume (total volume in stocks that are
broad market, many down for the day) can provide addition-
traders consult vol- al insight into market behavior.
ume to confirm price Typically, if up volume is greater than
moves. Total volume is most often the down volume, the market will be up on
subject of this analysis, but comparisons the day, and vice versa. Figure 1 (left)
of up volume (total volume in stocks shows an example of the relationship
that are up on the day) and down vol- between daily up and down volume.
The top half of the chart is the S&P
500, and the bottom is the difference
FIGURE 1 UP AND DOWN VOLUME
between up volume and down vol-
Up volume reflects how much trading is occurring in stocks that are trading up for ume. When the S&P closed up, the
the day; down volume is the opposite. This bottom part of the chart plots up volume difference between up volume and
minus down volume. Up volume was usually higher on days the market closed up, down volume was positive; on days
and vice versa. the market closed down, the differ-
ence was negative.
S&P 500 (SPX), five-minute 950.00
BY THOM HARTLE
The largest average 10-minute range (4.46 points) was the 9 a.m. period,
which corresponds to when many economic reports are released.
the trading day exhibit noticeable
volatility characteristics by analyzing
10-minute price bars in the S&P 500 E- Time 8:30 8:40 8:50 9:00 9:10 9:20
Mini futures (ES) between 8:30 a.m. and
3:10 p.m. CT, from Jan. 2 to March 31, Average range 3.62 3.68 3.60 4.46 3.54 3.32
2003. This daily trading period coincides
with normal market hours at the New
York Stock Exchange (NYSE) plus 10
FIGURE 2 9:20 PERIOD VS. THE 12:20 PERIOD
minutes (we will see if anything interest-
ing occurs in the futures after the NYSE The 9:20 periods are plotted as a line and the 12:20 periods are plotted
closes). The total historical analysis peri- as a histogram. There were only six times (less than 10 percent of all
od encompassed uptrends, downtrends occurrences) that the 12:20 period had a larger range than the 9:20 period
and sideways price movement. the same day.
The total number of price bars over
these 61 trading days is 2,440 — forty 8.00
10-minute bars per day. The narrowest
7.00
price-bar range was .50 points and the
largest was 15.00 points. (We are not 6.00
concerned with direction, just the ranges 5.00
of the 10-minute bars throughout the
trading day.) 4.00
3.00
Intraday time patterns
Figure 1 (opposite page) shows the aver- 2.00
age ranges for each 10-minute trading 1.00
period in the trading day, beginning
with the bar that opens at 8:30 a.m. and 0.00
the final bar that opens at 3 p.m. The Day
most volatile time of the day is the first
Source: Excel; data from CQGNet
hour of trading, when the 10-minute
average ranges noticeably exceed those
during the rest of the day as traders dis- FIGURE 3 2:20 PERIOD VS. THE 12:20 PERIOD
count overnight events.
Here the 2:20 period (plotted as a line) is compared to the 12:20 period
Table 1 (top) lists the average values
(plotted as a histogram). The 12:20 range was larger than the 2:20 range 15
for the first hour, and shows the largest
times (25 percent of all occurrences) the same day.
average 10-minute range (4.46 points) is
the period beginning at 9 a.m., which is 10.00
likely because so many economic
9.00
reports are released at that time.
Referring back to Figure 1, the average 8.00
ranges taper down to less than 2 points 7.00
at 12:10 p.m., climb again as the market 6.00
nears the close, and finally drop off in 5.00
the final few bars. It is safe to assume the
4.00
combination of a lack of news and the
3.00
lunch hour plays a role in the declining
volatility during the middle of the trad- 2.00
ing day in Chicago. 1.00
This initial analysis suggests the best 0.00
trade opportunities are early in the trad-
Day
ing day. After all, markets are all about
continued on p. 51 Source: Excel; data from CQGNet
0.60
0.50
0.40
0.25
0.20
0.10
averages to the
0.05
medians, almost all
0.00
Figure 4 (opposite page, top) charts Average range 0.19 0.18 0.17 0.19 0.17 0.15
the difference between the median and
average values for all the 10-minute
periods. Almost all the values are posi- FIGURE 8 AVERAGE MINUS THE MEDIAN, QQQ
tive, indicating there is a positive skew
Most of the differences between the averages and the medians are positive
to the data — which means the ranges
indicating a tendency for the ranges to be larger than the mid-point of the data.
tend to be larger than the median range.
Interestingly, the 12:20 p.m. and 12:30 0.0300
p.m. periods have negative values, again
highlighting how the market slows 0.0250
down during the noon hour. (The 2:40 0.0200
p.m. hour has a negative difference, as
0.0150
well.)
How common is a 9-point range for a 0.0100
10-minute bar? Figure 5 (opposite page, 0.0050
middle) sorts the ranges by size, from
0.0000
the smallest (.50) to the largest (14.75)
and the number of occurrences. The -0.0050
most common range is 2 points (313 -0.0100
occurrences). The number of ranges 2
points or larger is 1,702 (69.8 percent).
There were only two 10-minute ranges Time
of 9 points. Source: Excel; data from CQGNet
Figure 6 (opposite page, bottom) plots
the time and size of 10-minute ranges Nasdaq 100 index-tracking stock (QQQ). the average ranges exceeded those of the
that were 6.25 points or larger (there The narrowest range was 3 cents, and remainder of the day. Table 2 (middle)
were 32 such occurrences). Twenty-three the largest was 63 cents. Figure 7 (top) lists the average values for each 10-
(72 percent) occurred before 10 a.m., shows the average ranges for each 10- minute period in the first hour.
with the most (nine) occurring during minute period throughout the trading Figure 8 (bottom) plots the difference
the 9 a.m. bar. day. between the average ranges and the
As was the case with the S&P E-Mini median ranges for each 10-minute period.
Analyzing a second market: QQQ futures, the most volatile time of the day Again, almost all the differences are posi-
Let’s review the same period for the is the first hour of trading, during which continued on p. 53
The individual 10-minute ranges for the 9:20 period are plotted as a line and
the 12:20 periods are plotted as a histogram. There are only three occurrences
when the 12:20 period had a larger range than the 9:20 period.
0.60
35
The high is exceeded
30
25
20
15
10
5
0
from low to high values and looking at
the top 25 percent of the unchanged vol- -5
ume results in 63 observations, with the -10
lowest unchanged volume reading of
this group just over 24.1 million shares -15
The low is exceeded
and the highest 58.3 million. Now let’s -20
look at the market action following a
high unchanged volume reading.
Figure 1 (opposite page) shows the
FIGURE 3 DEGREE OF MOVEMENT — UP MOVES
S&P 500 cash index and the unchanged
volume level at each day’s close. May For the most part, higher unchanged volume levels were followed by bigger
23, 2003, (bar A) was an inside day and moves above the previous high.
the unchanged volume was just under
39 million shares. This reading was the 30
12th highest reading during the obser- The high is exceeded
vation period. The following day, the 25
S&P 500 index traded below the low of
bar A by 0.09 points, but the market then 20
rallied and the index made a high 17.56
points above the May 23 high.
15
The day after bar B’s unchanged vol-
ume reading of 25.6 million, the market
10
traded 2.69 points higher than bar B’s
high, then reversed and traded below its
5
low by 3.89 points. Bar C had an
unchanged volume reading of 31.8 mil-
0
lion, and the index traded 13.73 points Lower Unchanged volume Higher
above the previous day’s high before
reversing and closing near the open.
Finally, on bar D the unchanged volume
was 32.5 million, and the next bar vio- FIGURE 4 DEGREE OF MOVEMENT — DOWN MOVES
lated the bar D low by just 0.84 points Unlike the higher unchanged volume/up move relationship shown in Figure 3,
before turning up. this table shows little correlation between unchanged volume levels and down
Two of the four examples had sizable moves the next day.
moves, one traded both above and
below the previous day range, and two 20
made slight down moves before revers- The low is exceeded
18
ing to the up side. Were there any notice-
16
able patterns here?
Of the 63 observations with 14
unchanged volume of 24.1 million 12
shares or more, there were only three 10
times the following day was an inside 8
day. Of the 60 remaining examples, only
6
five took out both the previous day’s
high and low, forming outside bars. 4
Figure 2 (top, right) shows how much 2
the following day’s low or high exceed- 0
ed the previous day’s low or high when Lower Unchanged volume Higher
continued on p. 56
Potential applications
24.8 million shares unchanged The patterns following high unchanged
825.00 volume readings can help clue you in to
different opportunities or risks by
revealing the typical behavior following
certain price bars.
800.00
For example, this analysis suggests if
today’s high is approximately 15 or
more points above the high of yester-
10 17 24 31 day’s high unchanged volume day, the
April
likelihood of higher prices becomes
Source: eSignal more remote. Similarly, a low that
exceeds the high unchanged volume
the previous day’s unchanged volume points. For days when the previous day’s low by more than 10 points on the
exceeded 24.1 million shares. Of the unchanged volume was greater than downside is a low-probability situation
higher highs, 12 were 10 or more S&P 24.1 million shares and the low was for a short trade. Ý
points higher, with six exceeding 20 exceeded, the market fell more than 10
points. The average difference was 9.14 points 11 times. The average difference
T
S&P 500 can indicate when the broad rend analysis of the stock market can take several
forms: measuring an index’s percentage change
market is making a genuine move over a period of time, comparing the index to a
moving average and so on. Furthermore, some
or when it’s faking people out. traders refer to tools such as the number of advancing stocks
relative to declining stocks and volume to determine a particu-
lar trend’s strength or weakness.
Spread analysis, or measuring the
TABLE 1 S&P 500 COMPOSITION price difference (or ratio) between two
The S&P 500 consists of the 500 largest publicly traded companies measured stock indices, is another way to gauge
by market cap. It is designed to reflect the broader market. the robustness of a move in the stock
market. By identifying the typical rela-
Top stocks Top groups tionship between two indices and recog-
nizing when that relationship deviates
General Electric 3.19% Financials 20.50% from its pattern, you can determine the
Microsoft Corp. 3.06% Information technology 16.20% trend and identify potential reversals.
Pfizer, Inc. 3.00% Health care 14.80% Also, although this approach is general-
ly longer term, you can track the
Exxon Mobil Corp. 2.67% Consumer staples 11.70% Nasdaq-S&P spread on an intraday basis
Wal-Mart Stores 2.62% Consumer discretionary 11.10% to insure you are on the right side of
intraday trends.
Citigroup Inc. 2.45% Industrials 10.40%
This study analyzes the relationship
Johnson & Johnson 1.71% Energy 5.80% between two of the most popular stock
American International Group 1.60% Telecom services 3.90% indices, the S&P 500 (SPX) and the
Nasdaq 100 (NDX), which also underlie
IBM 1.59% Utilities 3.00%
the two most popular equity index
Intel Corp. 1.51% Materials 2.70% futures contracts, the S&P 500 E-Mini
(ES) and the Nasdaq 100 E-Mini (NQ),
Source: Standard & Poor’s 6/30/03 traded at the Chicago Mercantile
The Nasdaq 100 is comprised of the 100 largest companies trading on the
Nasdaq (financial companies are excluded), based on market cap. The index
is heavily weighted with technology stocks.
Top stocks Top groups
1. Microsoft Corp. 10.15% 1. Computer & office equipment 28.39%
2. Intel Corp. 5.10% 2. Computer software/services 28.01%
3. Cisco Systems Inc. 4.49% 3. Telecommunications 11.69%
4. Amgen Inc. 4.28% 4. Biotechnology 11.45%
5. QUALCOMM Incorporated 3.65% 5. Retail/wholesale trade 9.86%
6. Dell Computer Corp. 3.24% 6. Health care 4.51%
7. Comcast Corporation 3.07% 7. Services 3.16%
8. Oracle Corp. 2.82% 8. Manufacturing 1.94%
9. eBay Inc. 2.65% 9. Transportation 0.99%
10. Nextel 2.48%
Communications, Inc.
individual stock holdings and a breakdown of its most heavily cent), followed by information technology (16.20 percent). In
represented groups. terms of growth stocks, the technology industry offers far more
The Nasdaq 100 contains a much higher percentage of tech- opportunities than the financial services industry.
nology stocks than the S&P. Table 2 shows the computer and Microsoft (MSFT) is the most heavily weighted individual
holding in the Nasdaq 100 and the second most heav-
ily weighted in the S&P 500. Because it accounts for a
FIGURE 2 HIGHLIGHTING LEADERSHIP large enough percentage in both indices, MSFT has a
relatively muted effect on the spread between the two.
The growth-oriented Nasdaq 100 tends to lead the S&P to the Because of its large technology component, in an
upside as well as the downside. When it doesn’t, as was the expanding economy the Nasdaq 100 should lead (i.e.,
case at points C and F, this lack of leadership can result in rise at a faster rate than) the S&P 500 when the overall
trend weakness in the overall market. market is moving higher because more money man-
agers and investors will be attracted to the potential of
G growth stocks. On the other hand, in a declining eco-
1,300 nomic environment, financial services companies offer
D
1,250 a safe haven for money (plus, many financial compa-
nies pay dividends). That will tend to pull money
1,200 away from Nasdaq stocks and into S&P stocks. As a
A result, the Nasdaq 100 should lead the S&P when the
1,150
market is moving lower, as well.
1,100 In other words, a bullish stock market is reflected by
Nasdaq E-Mini (NQ), daily
an uptrending Nasdaq 100-S&P 500 spread (the
H Nasdaq 100 price minus the S&P 500 price). A bearish
E 1,000 stock market will be characterized by a downtrending
Nasdaq 100-S&P 500 spread.
B 950
Weekly perspective
S&P 500 E-Mini (ES), daily
900 Figure 1 (p. 35) shows the Nasdaq 100-S&P 500 rela-
tionship from the fourth quarter of 2002 into the sec-
300 ond quarter of 2003. The top and middle charts show
New high the Nasdaq 100 E-Mini and S&P 500 E-mini futures,
275 respectively, while the bottom panel shows the spread
between the two.
F
250 Both the Nasdaq 100 and the S&P 500 futures con-
tracts reached new lows in October 2002. However,
C 225 during the fourth quarter of 2002, the Nasdaq 100
embarked on a substantial rally, bettering its July 2002
NQ-ES spread, daily 200 high; the S&P 500, however, was unable to surpass its
21 1 12 19 27 2 9 16 23 1 14 21 28 1 summer (August) high. The Nasdaq-S&P spread
May June July Aug. jumped sharply higher, reflecting the Nasdaq 100’s
more accelerated rally. Both markets peaked in
Source: CQG, Inc.
December 2002 and moved downward until February.
The Nasdaq-S&P spread made a slightly lower low
office equipment industry group comprises 28.39 percent of in January, just below its December low. As the S&P 500 moved
the Nasdaq 100, followed by the computer software/services lower, the spread started to climb again, reflecting the Nasdaq
group at 28.01 percent. 100’s outperformance relative to the S&P 500. The Nasdaq 100
The top group in the S&P 500 is financial stocks (20.50 per- made the second low of a double bottom in March 2003, at
BY THOM HARTLE
Increasing the time frame to 30-minute bars reduces the number of pivot
highs and lows. breaking the day into five 81-minute
bars increases the chances of identifying
S&P E-Mini (ES), 30-minute
1,030.0 the ultimate high or low for the day. If
2 3 we were using five-minute bars, the
chances of identifying the ultimate high
1 1,028.0 or low during the day would be remote
1 because of the high number of pivot
lows and highs.
1,026.0 The choice of 81-minute bars is most
appropriate for trading if you are fol-
lowing the trend on the daily time frame
1,024.0 (a multiple time frame approach). For
3 2 example, if the daily trend was defined
A 3 as up based on the market closing above
1,022.5
1 1,022.0 a rising 20-day moving average, you
2
could enter on pivot lows on the 81-
minute bar time frame.
1,020.0
Multiple time frames
C 1
In Figure 6 (opposite page), the daily
B 3 1,018.0 range is plotted as boxes that “encapsu-
2 late” the five 81-minute bars for each
day, along with a 20-day moving aver-
1,016.0 age (plotted as a “step” line). In essence,
9/5/03 9/8/03 the encapsulation rectangles are like
Source: Fibonacci Trader transparent daily bars that allow you to
see the intraday action on the 81-minute
FIGURE 5 THE 81-MINUTE BAR bars.
At point A, the daily bars form a pivot
Using 81-minute bars divides a trading day into five bars, reducing the num - low (labeled 1, 2 and 3); bar 2 temporar-
ber of pivot highs and lows to one each. ily penetrates the 20-day moving aver-
age. The combination of the rising mov-
S&P E-Mini (ES), 81-minute ing average and the formation of a pivot
2 1,030.0 low on the daily time frame signals an
uptrend. Trades can be based on the for-
mation of pivot lows on the 81-minute
1 3 1,028.0 time frame, entering on the close of bar
3 (or on a move above bar 2’s high) of an
intraday pivot, and risking a move to
1,026.0 the low of the entry bar.
1 However, if this represents too much
3 risk and you prefer to trade shorter-term
1,024.0 price bars, you can work backwards to set
up a similar multiple time frame analysis
on the time frame of your choosing.
1,022.5
1,022.0 Let’s use five-minute bars as an exam-
2 ple. Using the same approach of five bars
of the short-term time frame per one bar
1,020.0
of the longer-term time frame, you would
use 25-minute bars to define the trend
and look for pivot lows and highs on the
3
five-minute bars to enter trades. (Using
1 1,018.0
25-minute bars does leave one unaccom-
2 panied five-minute bar at the end of the
trading day, however.)
1,016.0
9/5/03 9/8/03 Figure 7 (opposite page) shows five-
minute bars encapsulated on a 25-
Source: Fibonacci Trader
minute basis. Each red rectangle repre-
BY THOM HARTLE
Pattern probabilities
1. (C22-C21)/C21>0.01
2. E22<E21
3. (E22-D22)/(C22-D22)<0.10
price move, the maximum price move and the minimum price
move — in the three days following the completion of a price Each condition is preceded by the “IF” function, and the
pattern. “1,0” at the end of the argument indicates that if all the con-
To perform this kind of analysis, you must first import the ditions are true, “1” will be entered in the appropriate cell in
open-high-low-close price data for the period you wish to test the F column; if even one of the conditions is false, “0” will
(the “open” column is hidden here). The period here spans be entered. By dragging this formula to fill all the cells in col-
May 31, 2000, to Dec. 13, 2000; many of the rows are hidden umn F, each bar that fulfills the pattern criteria will be
to conserve space. flagged with a 1. (Alternately, if you have programmed the
Column F contains the pattern’s conditions. In Excel, it is pattern conditions into your analysis software, you will be
easy to string together several “If” conditions that describe aable to automatically include this information when you
offload the price data to the spreadsheet.)
pattern. In this case, the pattern is a bar with three conditions:
Columns G-O contain the close-to-close price moves, MAE
1. The high must be at least one percent above the previous and MFE values for the three days after each pattern occur-
high; rence. Dragging the formulas makes calculating the numbers
2. The close must be below the previous close; for the sheet a very simple process. This analysis could be car-
3. The close must be in the bottom 10 percent of the price ried out for as many days as you wish. Also shown is the total
bar. number of patterns that occurred.
For example, row 22 holds the data for
FIGURE 5 BASIC PATTERN TEST the Oct. 24, 2000, pattern and shows the
market dropped 1.89 percent the day
Column F contains the pattern criteria. The remaining columns show the after the pattern (day 1), had an MFE of
closing price differences, and MFE and MAE values for qualifying price bars. .69 percent and an MAE of -2.40 percent.
By the close of day 2, however, the mar-
ket had risen 1.57 percent, and so on.
The summary statistics at the bottom
allow you to judge the probabilities of
the raw pattern signal. These are only
examples of the kinds of statistics you
could include. Others are the percentage
of positive and negative returns at each
time interval, a separate breakdown of
positive returns and negative returns,
and so on.
If a pattern’s probabilities are favor-
able, you can then proceed to developing
and testing trading rules to maximize the
pattern’s potential.
BY THOM HARTLE
U
FIGURE 1 UNCHANGED VOLUME
The price of the Nasdaq 100 index-tracking stock is nchanged volume is the volume of stocks with
shown here with the level of unchanged volume below. prices that are unchanged from the previous
day’s close. It is one of three components of the
39.00
Nasdaq 100 index-tracking stock (QQQ), daily total trading volume provided by the New York
A B Stock Exchange and the Nasdaq. The other two are up volume,
which is the total volume of those stocks currently up on the
C 38.50 day, and down volume, which is the total volume for stocks
down on the day.
“Trend, consolidations and unchanged volume” (Active
38.00 Trader, October 2003, p. 44) analyzed the NYSE unchanged vol-
ume to see if it highlighted trading opportunities in the S&P
500. The research showed high unchanged volume readings
corresponded to the market being in a balanced state, or what
E 37.50 typically takes the form of a congestion period. Seasoned
F traders know trends emerge from such periods, and if the mar-
ket as a whole is congested at the close of one day, it is worth-
37.00 while to anticipate a trending day the next day.
D Because of its popularity, the price action of the Nasdaq 100
G
index-tracking stock (QQQ) and the unchanged volume of the
Nasdaq Exchange will be the focus of this analysis.
36.50
Trading implications
One thing that stands out is the opportu-
nity for short-selling traders: A break
below the previous day’s low following
a day with unchanged volume of 35 mil-
lion or more resulted in at least 16 cents
follow-through 75 percent of the time.
Day traders should pay special atten-
tion to those days that follow high
unchanged-volume days because there
were only 10 inside days out of 125.
Therefore, you can expect the high or
low of a day with high unchanged vol-
ume to be violated the next day. You can
use your favorite setups to take advan-
tage of this if the market opens within
the previous day’s range.
This research should be kept up to
date, as market volatility can change.
These numbers could be very different a
year from now.Ý