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first establishes intraday support and resistance points and then breaks through them during subsequent market action. As you can see on this chart, both buys and sells are indicated as a result of this day being classified as a nontrending session. Some strategies are much more effective on nontrending days such as this one, while still others find their major use on trending days. The Directional Day Filter is a valuable tool since it provides the trader a sense of the direction of each session fairly early in the day, enabling the trader to select an appropriate trading solution for the situation at hand.


There is an additional observation of the Directional Day Filter that often signals significant support or resistance for selected market movements. Frequently the market will be turned by the price levels represented by this line.

On the U.S. T-bond chart in Figure 10.13, note first that the Directional Day Filter is clearly predicting an uptrending day. There is significantly more activity above the plot representing our indicator than below the line. Additionally, the close of the bar that represents the analysis time of 60 minutes is also significantly above the Directional Day Filter line.

Note that on three separate occasions, labeled 1, 2, and 3 on the chart, the uptrending market retreated, attempting a correction of the current up move. In all three instances the market turned back higher in the vicinity of the line plotted by the Directional Day Filter. Placing a buy order on the plotted line would have resulted in a four- to five-tick move higher in each instance. In all cases the risk on these trades was limited to three ticks or less.

This chart is an excellent example of a method by which this trading tool can be useful even on a day when a dramatic up move did not occur after being signaled by this indicator. Even though we were not able to capture an extended rally, we were able to participate in several minor moves in the direction forecast by the Directional Day Filter.

For an additional example of resistance as defined by the Directional Day Filter, let us once again refer to the S&P chart used earlier in this chapter.

Tr<iri(?5t,itmri Cb.ut IDUS UO) US Ooml Day Only LAST 5

DOS UO LAST-5 min 07 812000 =96 31 -7/46 -251% j- ".? =99 28 [.=99*25 V=0

Figure 10.13 The Directional Day Filter line often acts as support on


Chart created with TradeStation® 2000i by Omega Research,Inc.

In Figure 10.14, note the area of the chart as marked by the gray ellipse during the 10:45 to 11:15 a.m. time frame. Note that the market has made a significant attempt to put together a rally in an effort to correct the down move that had dominated the price activity early in the trading session. As the market approached the plot line of the Directional Day Filter, note that it was repeatedly turned away by the presence of this line, thereby reinforcing the earlier interpretation of this indicator, which is calling for a downtrend for the rest of the trading session. Note the ensuing negative behavior of the market. Subsequent charts in this section will demonstrate additional uses of this activity of the Directional Day Filter.

Figure 10.15 is an additional chart of the 30-year T-bond (U.S. Treasury bond) market showing an uptrend forecast by our filter followed by a bounce off the support line. The support defined by our indicator is marked by a single black upward-pointing arrow.

Although this bounce off the support line seems to come rather close to the determining time for trend interpretation, note that this is a five-minute chart. An astute trader would have had at least five minutes during which to make the chart interpretation and place the appropriate orders.

ISP UO LAST-1 min :Hgh-14B1 60 Iv

ill i l.

7105/2000 0=1463.40 -40 20 -2.67% 0=1 4BB.00 H=1607.00 L=14B7.20 V=0 CD Median Line (CO) 1460.00 nulas

1462.00 1460 00 1478 00 1476 00 147-100 1472 00 1476rm 1468 00 146600 1464 00 1462.00 1460.00


-f--r- ] .......

, / --

7/05 8:56 9:21 9:46 "l 011 l 0:36 l 1:01 11:26 11:51 12:16 l 2:41 1 6 1:31 1 :S6 2:21 2:46 1

Figure 10.14 The market frequently respects the Directional Day Filter line as resistance on downtrending days.

Chart created with TradeStation® 2000i by Omega Research, Inc.

DUS U0 LAST-5 min 07/18/2000 C=9G*31 -2*16 -2.51% 0~9 2? 14=99*28 1=90*25 V=0


7/13 6:15 3:05 0:55 10:45 11:35 12:25 1:15

Figure 10.15 The bond market finds support dt the Directional Day Filter line shortly after the forecastofan Uptrend bythisindicator. Chart created with TradeStation® 2000i by Omega Research,Inc.

Figure 10.16 describes an alternate method of trading the Directional Day Filter on days with an unusually wide opening range.

Although it is not evident on this five-minute chart of Adobe Systems Inc. ( ), the 60-minute range as marked by the heavy black - bar on the chart is within 25 percent of the average daily range for the prior week for this security. Frequently, when this early range is approaching the range normally achieved during an entire day of trading, it is quite possible that most of the energy of this market has been used up in the early going. Average daily range tends to be quite consistent in most markets. Although the occasional big day can significantly surpass this average, the more likely occurrence is that the range of the current day will end the day quite close to this average.

Consequently, when one observes the intraday range at the 60-minute mark approaching the average daily range, you are forced to consider the possibility that most of the daily range has already been established. With this in mind it probably isnt a good idea to bet on much of a breakout above or below the range for a trading opportu-

VJJTradeSlatrrjn Chart - (ADBEJ Adobe Systems nc LAST-5 n

0 1 8 -5 min 11/17/2000 -C=S2 7S0v*1 Sli2 H.tU%-0=76.688 1-1=79.675 1 = 72.188 V=1440700" Medlar Ljne<8,60)

/60 Minute Bar r /Uptrend Pre-ettetedl-

Category 3 Resistance.


buy on resistance breakout

"Directional Day Filter-"

Category 3 support-

3uy Support at DDF Line

11/17 a-nn a-7< • - m-15 mm n-n< ii-nn n- 12-211 ith hi 4nn v>i

Figure 10.16 When the early range of an issue approaches its average daily range there is frequently little energy left in the market for a sustained breakout. Note that once again the Directional Day Filter line has provided support.

nity. However, as shown in the chart, there is still use for the Directional Day Filter on such a day.

Our filter in this case is giving a strong indication that the trend of the day will be higher. Although it is unlikely that new highs will be made, we still are presented with a trading situation that favors the long side. Recall from previous discussions that the Directional Day Filter line will often provide support on any pullbacks during a rallying day. This chart provides an excellent example of this situation as the market bounces nicely off this line in the 10:30 a.m. area. As shown, buys in this area can be a low-risk trade.

Later in the same day the tendency for a day such as this to rally is again demonstrated as the market establishes a profitable long trade as it breaks above Category 3 resistance near the end of the noon hour.

Although these situations do not present themselves on a regular basis, it is a good idea to keep this strategy in mind for use when trading the early breakouts is not a practical approach to the market.

Figure 10.17, a chart of ADBE, displays two distinct uses of the Directional Day Filter. At the 60-minute mark the majority of the market activity is clearly above the filter line. Also, with the close of the 60-minute bar well above the filter line, the trend for the remaining portion of the trading session is higher.

One of the highest-probability entry methods we will cover in this book involves the placement of buy and sell stops above and below resistance. This topic is discussed in detail in Chapter 13. The combination of using this strategy in combination with the trend forecast by the Directional Day Filter can be an effective tool for the generation of high-probability trades.

Such a trade is illustrated in the chart as this strategy buys the breakout of the resistance marked by the Category 3 resistance point.

A second trade generated courtesy of the Directional Day Filter appears as the market tests support formed by the filter line. Since we are working in an environment with a 75 percent plus probability of trending higher during the day, the odds of buying this pullback to our line are definitely on our side. Incidentally, also notice the Category 3 support point that appears as the market pulls back to the filter line. Although this point, by definition, cannot be completed until three bars have formed beyond the marked buy area, the observation of the convergence of two highly reliable support formations gives us

LJ* TMdfi*>«>lMH» Chsiil - AI)HF A*loh« Systems Inc lAT ;

6 LAST-5 rnin 11/1612000 < > i / • .•! -0.16*. 0=78.666 ¹79.875 1=72.168 V=1440700 Category Se.R(.15).....- 5 500

\, , , , 8500Q>

F II New High

T Category 3 Resistance

i ~ s

\ 60 Minute Bar /


1 ......: Buy Break of Resistance

Uptrend PrerJictec -Directional Day Filter

- .i Category 3 Support.

Buy Support at DDF Line

""» >"" «>" «<" l "4 4 Wn 11-115 11-™ «11-IS \rm 17;4S 1-1 1:35 2:00 2:25

Figure 10.17 Two long trades are generated on this uptrending day, one as a result of breaking overhead resistance and one due to support provided by the Directional Day Filter line and Category 3 support. Chart created with TradeStation® 2000iby Omega Research, Inc.

additional confidence to use the pullback buy strategy each time it presents itself.

By definition, when a specific trend forecast is given by the Directional Day Filter we expect either new highs or new lows to be formed during the remainder of the trading session. We are also expecting, as per the same definition, that the range of the day after the session has ended will be greater than the range indicated by the 60-minute bar early in the day. It therefore follows that the range should expand only on one side of our early range.

This brings us to one of the more reliable uses of this trading tool. Since we are expecting the range to expand in one direction only, we can profit from this knowledge by placing a buy stop above the high of the day if we are expecting an upward trend to develop for the rest of the day. Conversely, if our indicator issues a downward bias we can place a sell stop below the early range.

Figure 10.18 illustrates such a trade in United Healthcare Corp. (UNH). The trend for the day at the 60-minute mark is clearly down,

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