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34

the trend of the day is based on one side or the other of the early range being in place quite soon in the day. A downtrending day is one that establishes the high of the day quite early and makes several new lows for the day. Conversely, an uptrending day features the early establish, ment of the days low followed by multiple new highs being made by the market. Sideways days are defined as days during which both new highs and new lows are placed on the chart as the day progresses. Since the day pictured in Figure 12.10 does in fact set both new highs and new lows after the trend is defined early in the day, it meets our definition of a nontrending day. Readers should review Chapter "Directional Day Filter," for further details on this process.

There is an alternative method that can be implemented on days that have been tagged with the nontrending label early in the day. Realizing that this determination is being made very early in the day on a historically volatile market, many traders will defer their judgment for an additional 30 minutes of the session. Doing so will allow any early trends to develop that may affect the ultimate trend prediction for the day. In this case, delaying the trend projection for another half hour

Figure 12.10 Both buy and sellsignals may be entered during a sideways iday. Support and resistance levels are critical in selection of high-probability (entry and exit points on a wide-ranging day. (Chart created with TradeStation® 2000i by Omega Research, Inc.

would have caused the trend determination to change from nontrending to lower for the rest of the day. Obviously, this altered trend prediction from the Directional Day Filter would have been technically incorrect, because a downtrend projection assumes that there will be no new highs for the day, which is not the case here. Although this altered interpretation was not effective in this particular instance, it is a strategy worthy of note that will be useful in selected situations under certain market conditions. Different markets certainly respond differently to this important trading tool. Traders are encouraged to evaluate carefully the historic performance of this indicator as applied to their favorite markets in light of their individual trading strategies.

Concentrating on the first portion of the chart (Figure 12.11) first notice that, as the market is making new lows shortly after the trend determination, we are presented with two successive buy windows opened by the dual stochastic indicators. Since we are enabled to take both buy and sell signals as a result of a sideways trend determination, we place a buy stop slightly above the Category 3

ii Cbiiil (DSP ZO> StP 500 tndcK - Day Only LASl-1

DSPZOLAST-1 min 11 3/2000 C=135650 -38 00 -2.72%: 0=13B6 30 H=1403.00 1=1377.00 V=65658

Nontrending

Dual Stochastic Buy

":" Category 3 Support

Dual Stocnaslic Duy

41" 9"1 91" ~~31 1: 111111 1n1b mi

Figure 12.11 The initial short position is entered as dual stochastic opens a Sell window followed by penetration of Category 3 support. The position is liquidated upon violation of Category 3 resistance. Chart created with TradeStation® 2000i by Omega Research, Inc.



resistance plotted slightly above the 1,355 level at 9:45 AM- A solid line marks this level. As the market progresses lower a new, iower Category 3 resistance point appears, allowing us to move the buy stop to the lower level that is marked by the next solid line. Shortly thereafter a second dual stochastic indicator appears, reinforcing the systems buy window.

However, the next significant event shifts us into a selling mode as a dual stochastic sell window is opened, as marked on the chart. With our emphasis now shifted into a selling mode we immediately cancel the previously placed buy order, replacing it with a sell stop below the most recently plotted Category 3 support point. A solid line drawn just under the 1,345 line marks this level.

Our initial entry into the market on this day is accomplished when the market trades through our sell stop at 10:39 establishing our short position at 1,344 as the market makes a new low for the day.

Now that we have a position in the market we must focus on step four, which will protect our position as trading continues. To place our protective stop we look to the most recent resistance point created by actual market activity. This initial stop in this case rests at 1,347.20, slightly above the resistance point. A dashed line labeled as 1 marks this stop level. Also note that we now have additional dual stochastic buy signals appearing readily on the chart, indicating that the market is entering an oversold area.

At 11:10 a.m. we receive another Category 3 resistance point, allowing us to drop our trailing stop slightly below our entry level, thereby assuring us of not taking a loss on this trade. Our stop is moved to 1,343.10, slightly above the newly calculated resistance level. The dashed line labeled 2 marks the positioning of our new stop.

Shortly after 11:15 a.m. we receive a third lower resistance point that once again allows us to lower our buy stop, increasing the profit level now firmly protected. Dashed line 3 designates the new protection point. The position is stopped out at 1,340.20 as the market trades through our buy stop.

There is another alternative to the activity just described as our trade was exited. At this point we are receiving buy signals from our dual stochastic indicator. Also, the Directional Day Filter has told us to expect both new highs and new lows to be formed sometime today. If we had not entered a short position earlier we would be actively searching for our first entry into the market. With all

these factors in mind it is reasonable for us to consider a reversal trade rather than the exit that was just described in detail.

A reversal trade is simply a trade where, instead of only exiting the present trade, we also enter another trade in the opposite direction. In effect, a reversal trade is actually two trades, one being liquidated at the same time the second trade is being established in the other direction. In this example, instead of buying one contract at 1,340.20 to exit the short position, we simply place the order to buy two contracts at the same price level. One buy liquidated the short position while the other established the new long position.

One common theory involving the subject of reversal trades, especially on sideways days such as this one, is a simple one. If you have sufficient reasons to exit your short position, you are quite sure that the market is no longer going down and it is about to go higher. If you are certain that the market is about to reverse, why not reverse to long, maximizing profit from your analysis that the market is about to change direction. Of course, as always there is the other side of the coin. If you are incorrect in your research and the market moves even lower, you have not only limited your potential for profit, you also begin immediately giving back accumulated profits as the market moves against your new long position. Reversals are a great strategy when you are right. If youre wrong you can get into trouble quickly.

It is only on nontrending days that we should consider reversing positions when presented with the details discussed in the previous paragraph. If the day has been designated as a rally day, we will consider only buy signals from our entry indicators. If the day is forecast to be in a downtrend we will consider only short positions.

Figure 12.12 provides details on the next trade of the day. As mentioned previously, there is now a buy window open on our chart as a result of a new dual stochastic plot. Although a considerable distance away, our first high-probability buy point is located at 1,344, slightly above the most recent Category 3 resistance point. Obviously, simply buying the market when the dual stochastic buy signal appeared would have rendered a greater profit for the trade, but as we have discussed before the probability of this trade being successful is much higher by using our resistance point to place a buy stop. By acting in this fashion we are forcing the market to break previously defined resistance and prove to us that a trend change has indeed occurred.

Having entered on the long side, it is immediately necessary to



Figure 12.12 Although the Category3 resistance level is a considerable distance from the point at which the buy window was opened, it offers the safest method ofenteringthe long side for the second trade of the day. Chart created with TradeStation® 20001 by Omega Research, Inc.

enter a protective stop for the trade. Our initial stop loss rests slightly below the last Category 3 support point, delineated by the dashed line labeled 1. This stop loss point is particularly significant in this case as it is also located slightly below the low of the day so far. Often the floor traders will run the stops beneath the daily lows, expecting the market to drop even further if they are successful. We do not want to stay in a long position should this event occur, hence a second valid reason for stop placement at this point.

As was the case in previous trades, as the market rises and new Category 3 support levels are uncovered, we are able to pull our trailing stop up behind us, first decreasing the potential loss for the trade and then locking in higher exit levels.

As the market reaches possible exit levels, it is important to regularly monitor the various buy and sell windows as they open and close. In this instance, we are working under the influence of sell windows for a considerable portion of the uptrend. Had the market penetrated any of the sell stops placed at levels 1, 2, or 3, it

would have been permissible under our system rules to reverse our trade at these points rather than simply exit. The reversals are possible because a selling window is open at the time of the reversal.

However, as the market finally takes out our sell stop as level 4 is penetrated, system rules allow only an exit since there are no sell windows open at the time. Hence, the position is exited at 1,354.50 for a profit of around 10 S&P points.

The final section of the trading day is shown in Figure 12.13.

The same situation that allowed only an exit on the previous trade, the open buy window from our dual stochastic routine, now allows us to place a buy stop above the last plotted Category resistance at 1,358.50. This buy stop is soon triggered as the market continues higher. The black up arrow designates the actual trade.

Granted, the overall strategy would have been improved had we simply stayed in the long position rather than exited and then entered again at a higher level as we are doing here. However, at the point of the previous exit there was a significant chance that the market could have turned here, gone lower, and wiped out a significant

TradeSldtion Ch.ul - (DSP 20 SRP 500 indek - Day Only LAST-1 t

DSP 20 LAST-1 mill 11 0 0 0=1359.50 -38.00 -2.72% O13B6.30 H=1a03.00 L=1377.00 V=6585B

Dual Stochastic £eJl

,()« Sell

a- af-w

-:--1

1300.00

1355.00

P13500Q

Etoehactic Buy

:ategory 3 Support

Exit

On Close ji3« eg

-134G0Q -13J500

12:16 1231 1Ti1H 1-01-

1-1 -"1 ?"» ?« 3-01

Figure 12.13 The last trade of the day is a reversal trade since a sell window is open when the market penetrates Category 3 support. Chart created with TradeStation® 2000i by Omega Research,Inc.



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