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stochastic, Percent R, and RSI to demonstrate the generation of high-probability trades using these two unique approaches. This technique enables accurate entry in the direction of the dominant trend of the day.

Each chart will be displayed detailing the signals from the Directional Day Filter in combination with the dual settings of each of the oscillator indicators. A separate chart is included for each oscillator in combination with the Directional Day Filter. This configuration will allow the comparison of all three combinations against each other.

In most cases the data used to create these examples will be configured as a one-minute chart. In selected instances three- or five-minute charts will be presented when the nature of the data dictates. The effective data compression is printed in the upper left corner of each chart. For example, the notation in the upper left corner of Figure 11.2, later in this chapter, reads "ADI LAST-1 min," meaning that this is a one-minute chart of ADI with the last price of each bar marked as the close of that bar. The notation on Figure 11.11 reads "DISH LAST 3 min>» as this is a three minute chart of Echostar Communication Corp.

In all cases the settings used as inputs for the dual oscillator indicators remain unchanged for all charts presented in this section.

As stated in the Introduction to this book, the entire purpose here is to describe in detail the use of several trading strategies in multiple situations. The material is not presented as a specific trading system. It is rather supplied as a group of tools that both new and experienced traders will find useful either in enhancing their existing trading styles or in the actual construction of entire systems from the ground up.

Therefore, when examining the following material do so with the understanding that these examples are meant to describe multiple applications of several tools under several real market conditions. This section is not meant to describe a hard-and-fast trading system that must be followed to the letter to be successful. It is hoped you will find material here that will be helpful in your trading activities. Examine the remainder of this section carefully, selecting the tools and combinations of strategies that will be most beneficial to your individual trading style.

trading theory TRADING THEORY

3 iSfcfThe premise of our basic theory is to take major positions only in 3 the direction of the major trend of the day after it has been re-I SRl vealed by the Directional Day Filter. To accomplish this task we ;;*V look to identify exhausted corrections from the major trend and 1 H take positions after this exhaustion is complete.

The simplified graphic in Figure 11.1 further describes this the-I ory. On the graphic the major trend is obviously higher. Trends rarely progress in a straight line. Frequently, the market will pull j back for a short distance for a variety of reasons. The momen , * pauses in the trend are often referred to as corrections. Two such . corrections are labeled on Figure 11.1. When these corrections reach * " their terminations they are referred to as being exhausted. Our objective is to enter the market as close as possible to these exhaustion i 5 points in order to participate in the major trend of the day. Our t4i strategies will not always be able to time our entry as precisely as * described by the upward-pointing arrows in Figure 11.1. Our objective is to identify these prime entry points as closely as possible in s order to place our trades with the highest probability of success.

Our first group of charts uses data from Analog Devices Inc. si (ADI) to describe entries into an existing downtrend. We will ini- tially examine trading signals issued by the dual stochastic indica-l when used in conjunction with the Directional Day Filter (Figure 11.2).

At the 60-minute point of the session note that the majority of the market activity thus far is below the filter line. Additionally, the close of the 60-minute bar is far below the filter line and in the lower portion of the intraday range, forecasting a downtrend for the remainder of the trading session. Therefore, this strategy will look to assume positions only on the short side of the market and, for the purpose in this section, which is only to generate entry signals, ignore any signals generated on the buy side.

The dual stochastic method used here is the exact routine that was described in detail in previous chapters. To review, a slower, ]\v 45-period stochastic must first pass above the 70 threshold and re- }1 main there while the seven-period, faster stochastic passes aljove ..i the 90 threshold and turns down on a closing basis to generate the

Figure 11.1 Trends frequently exhibit corrections along the way. Prime entry points are found at the exhaustion points of these corrections. Chart created with TradeStation® 2000iby Omega Research, Inc.

<*1 ( 1)) Analog Devices Inc LAST-1

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Dual Stochastic Sell Signals

-Directional bay Filter=

95 501

. 60 Minute Line Downtrend Forecast

31W» mil ., j r)

Figure 11.2 Sell signals from dual stochastic during a downtrending day. Chart created with TradeStation® 2000i by Omega Research, Inc.

sell signals plotted on the chart. Users are of course encouraged to change these threshold values and period values to create strategies appropriate for their own trading style, individual market, and time frame being traded.

The initial sell signal was issued near the 95.50 area as the market corrected against the sharp market drop that occurred shortly after the market opened. A second selling indication appears a few bars later as the fast stochastic turns higher and then back lower in response to the minor market rally that completes the final serious attempt at a rally for this issue during this trading day. Note that the market also encounters resistance at the Directional Day Filter line. Traders taking either sell signal are soon rewarded with a significant drop in the market.

Additional sell signals are issued later in the day as the market again puts in an attempt at a corrective rally. It is doubtful that these signals could have been used in a profitable manner. When using these indicators on the market and time frame of your choice, situations such as these should be carefully isolated and examined over a significant amount of market data. Close study of these patterns enables the trader to adequately quantify the response, if any, that should follow the appearance of such a signal when it appears again. One may in fact conclude after such examination that it is not prudent to reenter the market after a move of this magnitude in ADI. The same observation on another issue may reveal that entries under the same circumstances are indeed profitable. As mentioned frequently, these tools are designed for the individual trader to enhance or build his or her own trading strategy. Thoroughly researching questionable signals such as these is the first and most important step in the design of such a trading theory.

Figure 11.3 places the dual Percent R signals on the same data.

To once again review, the dual Percent R indicator operates in much the same manner as the dual stochastic tool, with the slower average being above the lower threshold while the faster setting moves above the upper threshold and then turns lower. As before, I am using a 50-bar setting for the slow plot and a 75-bar setting for the faster calculation. When this event is completed, a dot is placed above the bar that generated the final pattern indicating a sell signal. For purposes of simplicity and clarity we are placing

Figure 11.3 Dual Percent R signals on theidenticaldata used in Figure 11.2. Chart created with TradeStation® 2000i by Omega Research,Inc.

the dots only on these charts that are being used as actual trading examples eliminating the familiar plots on the bottom of the charts. Real-time traders may prefer to observe the actual patterns of each Percent R formation unfold as the values are created. This has the effect of giving the trader a heads-up that a buy or sell signal is about to be issued by the indicator.

Again only sell signals are considered, as we are working with a day with a forecast for a decline in prices. We have here several sell indicators from the dual Percent R in relatively the same area of the chart as where the dual stochastic signals appeared on the first chart of this group. You will soon note that, due to its unique construction, the dual Percent R indicator will issue signals on a more frequent basis than the other two oscillators used in these examples. As a result, you will see that some of the signals from Percent R will appear on the chart a bit ahead of the prime entry point. When you complete your further research you may find that this indicator as used here may end up being a heads-up indicator in its own right. Used in this fashion the dual Percent R indicator may be the first indicator to ap-

pear, acting as a qualifier of sorts for the actual trading signal to be issued at a slightly later time and perhaps at a bit more favorable price level for the trade in question. Signals generated by the dual stochastic and dual RSI indicators are not usually as frequently plotted, but may be found to be a bit more accurate in their trade placement function. Traders may therefore find that the appearance of Percent R signals may be best understood as an indication that conditions are forming that may lead to the placement of a trade. These signals will often be confirmed a few bars later by dual stochastic and/or dual RSI, resulting in a more accurate placement.

Of interest also on this chart is the fact that there are no further sell signals issued by Percent R until the final stages of the trading session, probably too late to be useful for a day trade with a reasonable expectation of generating a profit.

Since the emphasis here is on the use of multiple trading tools in conjunction with one another, it is useful to point out that there was no heads-up signal from dual Percent R prior to the short signals issued by dual stochastic during the 1:00 to 1:45 p.m. time frame. The lack of this signal from Percent R may well have led the trader to ignore the sell signals issued by dual stochastic at this point. In retrospect, the lack of confirmation of this signal by dual Percent R was of value, as the trades that would have been generated here would have had a rough time producing a favorable result.

The third and final chart in this group, Figure 11.4, details signals from dual RSI during the same trading session.

To review briefly the actions of this indicator, recall that this tool operates in much the same fashion as our two previous examples. The slower RSI average must first be above the lower threshold while the faster average must climb above the higher threshold and turn lower on a closing basis to generate the sell signals represented by the dots on the chart. Again, for clarity the actual tracings of the operative RSI plots have been removed from these charts. These signals are generated using a 5-bar and a 14-baT setting for the fast and slow components, respectively.

Much the same picture unfolds here as dual RSI again issues sell signals in the same area as was indicated by dual stochastic and dual Percent R. Traders experienced in the observation of all three of these oscillators in combination with the Directional Day

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