Trading By The Book - Part IV CHAPTER 1 The Daily Oscillator

The daily oscillator, unlike the weekly oscillator, is placed on an absolute scale. I want to know when the oscillator is overbought or oversold,

I defined the long term trend as being how I see prices trending on the weekly charts. The intermediate term trend is the trend that prices are making on the daily charts, and the short term trend is the trend prices are making intraday. All I need to know about intraday prices are reflected by the open, high, low and close that I see reflected in the last bar appearing on my daily charts.

In keeping with the orders of magnitude I previously explained, it can be seen that the long term trend (1 week), is 5 times the length of the intermediate term trend (1 day). The short term trend represents one order of magnitude less than the intermediate term trend, The short term trend represents approximately 5 hours of intradaYjr ading. this varies from market to market but is close enough for my purposes. There is nothing magic about orders of magnitude.. If I were trading on an extended long term basis, I woutd use the monthly charts long term, the weekly charts intermediate term, and the daily charts short term. In fact, when 1 am trading mutual funds, thats exactly what I do.

. When trading intraday, I would use the daily chart as my long term chart, the hourly chart as my intermediate term chart and a 10 or 15 minute chart as my short term chart. This method wit! work in any time frame.

For a daily oscillator, it is possible to use any of the popular oscillators that are available, as long as they show overbought/oversold.

It doesnt matter whether stochastics, RSI, %R, etc., is used as long as it has an absolute scale. Whichever one is picked must be used consistently. No switching back and forth. Learn to use it and to read it with all its particular idiosyncrasies. For computer trading, pick one and stay with it.

There is one other requirement RSI, %R, etc., must be set to reflect 5 days, otherwise the signals wili come too late. That means that most of these studies as shown on charts coming from chart services will be unusable. They tend to show longer term oscillators for their daily charts.

If a computer program containing Stochastics is used, then set the parameters for the Stochastic as closely as possible to 5,3,3.

The object of using this methodology is to learn to see the movement of prices without the need for such an oscillator. Stochastics measures the grouping of closes. When closes group in the upper portion of a series of bars individual trading ranges, then Stochastics will rise. When closes group in the tower portion of each bars trading range then Stochastics will drop. These are things that can be seen by a trained eye in a manner better than what an oscillator can show.

= %K

close - 5 day low 5 day high - 5 day low sum 3 %K1 / 3 = %D

Enter high in column 1. Enter low in column 2.

Enter highest high of last 5 days in column 3. Enter lowest low of last 5 days in column 4. Enter todays close in column 5.

Subtract 5 day low from todays close and enter it in column 6. Subtract 5 day low from 5 day high, and enter it in column 7. Divide the number in column 6 by the number in column 7. This is %K. Enter %K in column 8.

Sum last 3 days %K. Divide sum by 3 and Multiply by 100. This is %D. Place %D in column 9.

Plot %D on the daiiy chart above and below a 50% line, on a scale from 0% to 100%. 70% or above is overbought. 30% or lower is oversold.

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Heres an example (figures rounded to two places); Day/-

<~plot 25.

If desired, %K may also be plotted and then used as a full Stochastic. I dont use it that way because Im not interested in when one line crosses the other. However there is nothing wrong with trading using the full Stochastic.

Without a computer, heres how 1 calculate my daily oscillator - it is one-half of the Stochastic called %D.

I utilize a short term daily oscillator because I want it to be responsive to the time frame in which Im trading. Im looking for a move that will last from two days to two weeks. If 1 can stay in longer, thats fine.

%D will be my daily oscillator. It tracks the position of daily closing prices within the recent range.

By trading from prices and the daily oscillator in conjunction with the weekly oscillator, I avoid the problems that come from blindly buying oversold signals and setting overbought signals as some traders do. The daily oscillator may give some good buy and sell signals when prices are in a trading range, but all too often they give too many signals and I end up getting whipsawed. Also, oscillators give premature signals when a market is trending. -"

Im filtering the daily oscillator signals against the weekly oscillator signals. Then 1 will filter the daily oscillator signal against an intraday signal.

In effect, what Im going to do is to give a market three tests before i enter any

trade.

To show the daily oscillator and the intraday breakouts, Im going to use a continuous chart for illustrative purposes, so that I wont have to keep changing contract months. The continuous charts accurately reflect the way the market looked at the time the trading was done. The gny difference Is that the prices have been adjusted to bJend the months together. Each price bar from high to low is the same magnitude as it was during the months it was traded, and each price bar is exactly as it was In relation to the ones prior and subsequent to it.