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Figure 12.18 Two sell signals are issued by dual Percent R and Categoy 3 support. Category 3 resistance providestbeinformation necessary for exiting eacb trade.

Chart created with TradeStation® 2000iby Omega Research, Inc.

DSP200009 LHST:1 min 02(05(2000 146 .40 -17.60 -1.20% O=14S3 00 H=1494.00: L=1477.50 V=C

...............:............... Percent R Sell Signals.......... ......

HI, .


- [ 5 2 1 0 <)1 S&P W8 Index D.iy Only LAS I 1

1- -:-

gg -Category 3 Resistance

Directional Day Filter-

1492.00 1460.00 -147B00: 1476.00 1474.00 1472.00 1470.00 1468.00 146600 146400 1462.00 1460.00

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Figure 12.19 Step one determinestbattbetrend for tbe day should be lower since most of tbe activity is below tbe filter line priortotbe 60-minute bar and tbe close of this barisin a weak position. Chart created with TradeStation® 2000i by Omega Research, Inc.

To define the minor trends of the day as they develop, we have in this instance chosen to use the Percent R oscillator, using a 75-bar sensitivity for the slow average and a 50-bar setting for the fast average. For review, this dual setting routine for Percent R must have several parameters satisfied to issue a trading signal. First, for the buy signals on the chart, the slow setting must generate a plot below the oversold threshold of 30 percent. While this condition exists the fast setting must first fall below its individual oversold line at 10 percent and then turn up on a closing basis.

In actual trading one may wish to use multiple oscillators for the short-term trend determination. In fact, this is the recommended method. Unfortunately, the display of multiple dual settings is not practical on small black-and-white charts. When one is able to expand these charts and color code the various indicators the interpretation of the individual patterns is much clearer. We will restrict each chart to a single oscillator for the short-term trend simply for purposes of visual clarity and ease of explanation. Near the end of this chapter a few charts will be included showing all oscillator settings.

Since on this day we will be concentrating exclusively on the sell side of the market, the buy signals from our Percent R combination will be ignored for the purpose of signal generation from the strategy being used in this chapter. It is, however, interesting to note on this segment of our chart several signals against the major trend that a more aggressive trader could use to generate trades that could be useful.

A corollary theory to taking trades only in the direction of the major trend of the day also exists. This is by no means a departure of the main approach to take trades only in the direction of the major trend of the day. This alternate approach is presented only as a choice for the more aggressive trader whose trading style and risk-carrying ability dictate to him or her that more than one or two trades should be taken each day in an individual issue.

This theory allows the taking of trades against the major trend, with certain limits on their parameters. While waiting for the major trend to resume, there are often short-term opportunities of which aggressive day traders may want to take advantage. The theory here parallels our main strategy in that we will take all trades as directed by market-generated support and resistance points. Here we also use another approach by taking trades against the major trend,

only limiting their parameters as to length of time or amount of profit generated by each trade.

In the countertrending mode we use the same theories for entering a trade as are used to establish a position in the direction of the major trend. First, in the example of a long trade on a down day, we must first have a buy window opened by one of the oscillator indicators. Then an appropriate stop level is located using the resistance point closest to the recent market activity. The position is entered as described when the market trades through the stop. So far, there is no difference in the initiation of this trade and one taken in the direction of the major trend. However, it is in the exit phase that things must take on a different light.

Since we are trading against the trend, we are taking more risk in these trades as compared to those taken in the direction of the trend. If these trades are indeed to be productive this risk needs to be reduced, if not eliminated. Although there is no method certain to accomplish this task, attempting to take profits on a limited scale as opposed to riding the trade for all its worth is certainly a step worth taking.

Taking profit on. a trade at a given target is an approach used by many to extract smaller but consistent profits from a short-term strategy. Although profits are limited by the very nature of this exit, they can usually be taken in a relatively short time frame.

A timing exit is also a strategy worth examining when considering an exit strategy for these countertrend trades. Simply exiting the trade after a given period of time can be productive.

Both of these exit strategies are derived from the basic observation that the corrective phases of trending markets do not last long in either time or price when compared to the major trends that appear. Thus there appears a method for designing an exit strategy for these shorter trades against the trend. Traders wishing to utilize these strategies are encouraged to examine carefully the countertrends that develop in their favorite markets, for both average time spent during the correction and also the average price movement that usually results from these moves. You are then able to construct an exit strategy by exiting after the average price movement has occurred or after the average amount of time has expired. It is also possible to devise a strategy encompassing both of these critical parameters.

Considerable observation of the S&P market has shown that a full point can be taken from such countertrends with a significant proba-

bility of success. Figure 12.20 illustrates the manner in which two such trades are generated early on the day in question, after the major trend of the day has been identified and before any trades can be entered in the direction of the dominant trend.

The initial countertrend trade occurs shortly after the 60-minute time frame that determines the major trend. Buy windows are opened up by the dual Percent R buy signals that appear under the market. The buy stop used for entry is placed at 1,475.70, slightly above the Category 3 resistance point at 1,475.50. The buy order is soon filled. With our short-term exit strategy, we can place a limit order one full point above our entry price. The trader should make a practice of entering the limit sell order one point above the actual fill price received when the order is filled. In this fashion one is able to remove any slippage occurring on the entry. This exit strategy is completed when the market reaches the designated price level. Although we have illustrated this trade as exiting exactly one point above entry, this exit as marked does not allow for any

DSP20000S LA.ST-1 min 07/05/2000 C=1463.40"-1 7.80-1.20% 0--<4£3.SjC- H=1494.00" L=1477.50"V=0

0 Minute Ear

Directional Day Filter-

jCategory 3 Resistance

SP2GG0G9) S&P 50Q Index Day Only LAST-1 r

Downtrending Day-Forecast

Category ;

Support......... ...

Percent R Buy Signals

Pt1RFasl(50,ee.1) 54.44 12.00; B6.00 PctR Sloy<(75.70,0) 46.67 30.00 70.00

10:46 11.01

Figure 12.20 Although the highest-percentage trades are generatedin the direction of the major trend, trades against this trend are possible under specific circumstances and using restricted parameters for exits. Chart created with TradeStation® 20001 by Omega Research, Inc.

slippage on the entry. However, one is able to see on the chart that there is sufficient room above the exit level to allow for the addition of any slippage to the exit price. In this case, even if the trader had been forced to add as much as .50 to the entry price to compensate for any slippage experienced on the trade, the exit price at 1.00 above the adjusted entry would still have resulted in an exit at our target price.

The second countertrend trade sets up in much the same fashion. Once again the buy windows are opened by the dual settings of the Percent R oscillator indicator as the market recovers from the formation of a new low. Our entry price is again strategically located just above established resistance, this time set at 1,475.50, fading the Category 3 resistance point at 1,475.30, again to avoid a long fill on a double top.

The new long position is soon filled as the market trades through our stop at 10:30 iM- The market rallies briefly, pulls back only to rebound from the 1,474 level, then trades progressively higher, filling our price target placed 1.00 above our entry level. Again, the prices rally through our target price far enough to compensate easily for a higher exit price, which may have been placed to cover any slippage experienced on entry.

Obviously this trade could have been much more productive than the small one-point profit we have claimed with our fixed point exit. However, remember that we are trading against the major trend of the day in this instance, which carries with it an inherently higher risk level. Attempts to carry these transactions beyond what their historical record indicates is prudent can lead to a success ratio for these types of trades that will ultimately be found to be unacceptable for most traders.

An interesting point here is that, in both cases just covered, the new buy window opens as the market is establishing new intraday lows for the session. It is not uncommon for these countertrend trades to develop in this fashion, especially early in the day as shown here. As discussed elsewhere, individual traders, and in this case those in the S&P pit especially, will drive the market to new lows or new highs in an attempt to run the stops above or below current intraday highs or lows in an effort to capture the market surges that accompany the rapid filling of market orders. Unless there are a huge number of stops resting above or below these intraday highs and lows, these so-called fishing expeditions rarely last for more than a few minutes. What usually follows is a fairly rapid recovery from any new highs or lows that are placed due to the stop-running activity. Traders who use this tech-

nique are extremely familiar with market reactions around intraday highs or lows. When they are successful in driving prices through these levels it is quite important that they recognize when this small move is near its end and the time has come to collect profits for the trade and move on. Being quite familiar with the chart patterns that develop on these trades, these traders are often able to cover their positions quickly. This buying pressure, in the absence of any immediate sellers since they have all now had their sell orders filled, can quickly propel the market higher. These mini rallies can also be accelerated, since those holding the sell stops below the market must cover in the face of mounting losses. The end results of these games are often the quick "pops" in prices that frequently follow the establishment of new intraday lows, in this case (obviously, the same is also true on the opposite side of the market as new intraday highs are made).

Although these rapid recoveries from new lows happen quite often, traders need to be aware that these small rallies must be traded somewhat conservatively if they are to be consistently profitable. Often these recoveries do not extend to the degree necessary to produce an adequate return. Simply buying the market, in this case on the assumption that the new low move has run its course, may not be wise, as it can quickly reverse lower. Our basic strategy that utilizes the placement of buy stops above established overhead resistance is still a logical choice for entering these quick trades against the major trend. Utilizing this support and resistance technique places another hurdle for the market to surpass before we can be convinced that this move is indeed worth trading.

Should the market turn back in the face of this resistance, chances are high that the reaction move would not progress far enough to produce a decent return for our efforts. On the other hand, should the recovery from the newly established low really have legs, the strength exhibited here should be great enough to break previous resistance and go on to give us an adequate return. In other words, our basic use of resistance to enter these trades again provides a filter of sorts to keep us out of some of the trades that may not produce adequate profits.

Again, this alternate strategy is not meant for the beginning trader. Only experienced, aggressive traders desiring additional trading activity should consider taking trades using this countertrend method.

Figure 12.21 details the first of our two short positions that are taken in the direction of the dominant trend.

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