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Figure 12.33 Trade sigaals geaerated are displayed with both the familiar dots used oa previous charts as well as the actual oscillator plots.
Chart created with TradeStation® 2000i by Omega Research,Inc.
track successive changes in support or resistance, since these numbers are needed to place accurate trailing stops.
To maintain a reasonable amount of order to this process, I suggest you seriously consider a traders checklist similar to the one shown in Figure 12.34. I have created the checklist in an Excel spreadsheet simply for ease of presentation. Although I find this format useful, other formats could obviously be created.
The first column is used to label each trade with its own identification number. The next column records the major trend of the day as described by the Directional Day Filter (DDF) using a +, -, or 0 for an uptrend, downtrend, or a trendless day, respectively.
The next columns are used to register each oscillator signal as it appears on the chart. PI is used to identify a slow Percent R indication for a trade, while the P2 column confirms a Percent R indication for the trade when the faster setting of the indicator gives its signal. The next four columns are used to track first the slow and then the fast setting of each oscillator as they occur.
Figure 12.34 A simple traders checklist will assist the trader ia processiag the iaformatioa aecessary to geaerate a high-probability trade.
When columns through H are completed, then one immediately examines the chart for an appropriate support or resistance point to be used to place a buy or sell stop. This number is recorded under the appropriate column, either I or J.
As the market continues to trade it is entirely possible that a new support or resistance number will be generated such that you will need to make an adjustment in the placement of the appropriate buy or sell stop. Although it is possible to simply replace the price level representing the old stop level with the new one, I would suggest that you simply use the next lower row to record the new point. This is extremely helpful when you go back to study your trades at the end of the day. If several entries and exits are made, which is often the case with this strategy, it is most helpful to have these support and resistance numbers recorded so that you may easily retrace all of your steps for each trade as they actually occurred. The movement of these stops is probably the hardest thing to re-create at the end of the day when you critique your activities of the previous session.
These same support and resistance columns are used to record both the initial placement of a trailing stop and any changes that may be made as the trade progresses and you move this stop to protect your position prior to liquidation.
Also, you may wish to use the next column to record any order numbers, ticket numbers, and so forth associated with each order placed or each cancel and replace order that occurs as things progress. Recording this information can be very valuable should it
PUTTING IT ALL TOGETHER
become necessary to correct any errors made during order placement and fill reports.
The final columns are used to record actual fill and offset prices when you receive them.
1. Combining the Directional Day Filter with dual settings of the popular oscillator indicators is an effective tool for the identification of high-probability trades in the direction of the major trend of the day.
2. Market-defined support and resistance is useful in the actual placement of buy and sell stops.
3. The same support and resistance tools can be used effectively to establish levels for trailing stops to protect a position and eventually exit the market.
4. A structured four-step method of trade generation can be an effective method for creating high-probability trading signals.
5. A simple, effective traders checklist is a useful tool to aid in the organization of each trade.
DIRECTIONAL DAY FILTER BREAKOUT SYSTEM.
In Chapter 10 covering the Directional Day Filter I briefly mentioned a breakout system that makes use of this simple tool for day trading. In this chapter I will cover the design, customization, and implementation of this system in detail.
Although this approach does use the Directional Day Filter as a setup routine, the system we are going to build here is considered to be a completely different trading method than the one developed previously using the four-step approach to enter in the direction of the major trade of the day. Obviously the two systems can be used together. Just be aware that the two approaches are quite different in their methods.
As discussed earlier, the system is a basic system that trades the breakout of the early intraday range as defined by the Directional Day Filter. If the filter is predicting an uptrend for the rest of the day, the system places a buy stop slightly above the intraday range. If the forecast is for a downtrend, the system places a sell stop slightly below the intraday range.
Although the basic system is about as simple as they come, the effective implementation of this idea in actual trading becomes a bit
more complicated. As with any system or trade, you must decide when and where to enter and when and where to exit. The fine-tuning of these critical decisions will ultimately determine the overall profitability of the system.
There are four basic parameters that must be addressed for this to be an effective system. They are:
1. Time of the breakout.
2. Exit strategy.
3. Stop placement.
4. Stock selection.
In Chapter 3, "People, Prices, Personalities, and Probabilities," there was a brief discussion concerning the different manner in which each particular security or commodity contract responds to various trading parameters. Understanding the response of your favorite stock will be absolutely essential to your success with this system. Each issue responds in its own manner to any system, but particularly to this one. There is significant variance in the time of the breakout and the proper exit strategy among the many issues I have tested with various versions of this breakout system. Later in this chapter there are a series of bar graphs displayed that graphically point out the wide variances of stock issues to selected parameters of this system.
As a general rule, the higher-priced, more volatile issues will respond most favorably to this system. Consider that we are, with this system, attempting to capitalize on quick intraday price moves. The item being traded must exhibit significant price swings to generate the type of movements we are looking for. The quieter, lower-priced issues that are usually confined to relatively narrow, less volatile ranges will not exhibit the types of price changes that are necessary for our system to make profitable entries and exits.
Even within the more volatile, higher-priced stock sectors there will be significant differences among issues that affect the placement of entry and exit stops as well as the determination of profit targets.
I will present as many graphs and statistical tables in this section as is practical in an attempt to present readers with a fully functional, basic day trading system that can be implemented with the basic information you find here. This approach will also fully apprise readers of
the absolute necessity of fully understanding the response of every issue to be traded using this strategy. Although I will present statistical tables and graphs on many of the popularly traded issues, it is not practical to cover every issue that could be effectively traded using this technique. Readers carefully walking through the creation of an effective setup for trading several issues in this chapter will gain the experience necessary to develop a similar strategy for an issue or commodity contract of their choice.
I will first demonstrate a method by which anyone could develop such a system without the aid of sophisticated charting or trading software. I will create the system using basic charting observations and a logical step-by-step method. Keep in mind as we walk through this process that although a computerized system is quite helpful in developing such a trading strategy it is entirely possible to do so with a pencil, a lot of paper, and good, black coffee. Chapter 14 will cover the basics of automated system development and testing.
I have selected charts of QLogic Corp. (QLGC) for the security to be used to demonstrate the adaptation of this system. This issue is actively traded, with an average daily volume of 2.65 million shares traded over the last six months of 2000. Its volatility is well suited to this system, its range has been fairly consistent over the testing period, and there have been no recent splits to skew the data. Obviously this is not a recommendation for readers to buy or sell this issue. This is simply the issue I have chosen to demonstrate the process of developing a trading system from the Directional Day Filter data. There are multiple issues that can be effectively traded using this strategy.
STEP ONE: SET BREAKOUT TIME
The first critical issue to address when implementing this system is the timing of the critical breakout. We must determine with the greatest degree of accuracy possible the time of day when the breakout strategy is to be implemented to be the most effective.
The first step is to analyze as much data as possible, testing each practical time frame for the percentage of days during which, after this time frame, a breakout occurred on only one side of the current intraday range.
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