TABLE 11 -9 Results Using Price-Volatility Scaling

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The plotted results appear to be much better than the tabulated results. This can be attributed to the increased risk at higher price levels. Although the number of boxes in a losing reversal remained small, the value of the loss increased by a factor of 25 from the bottom to the top of the chart The few profits and losses that occur at higher price levels will be so significant in the final results that the earlier trading performance is unimportant.

Both variable box approaches offer unique possibilities for identifying trends but increase the problems of risk management. Some of these effects can be offset by reducing the invested margin as prices rise. Other techniques are discussed in Chapter 23.

12 Charting Systems

The rapid growth of computerization has had a great impact on technical tradmg. The first to be affected were the moving average, or mathematical trending methods, as well as easj-to-program indicators, followed by sjstematic optimization. More recently, econometric analjsis, cycles, and pattem recognition have been the subject of new computerized research. Many quote services that offer graphics can convert a bar chart to a point-and-figure chart at the push of a button. Yet the techniques normally used in classic charting, such as trendlines, channels, and apecial pattems, have not yet been bombarded with automated analjses.

The sjstems inchided in this chapter are those that might be used by- a traditional chartist. They do not all require the presence of a chart to be followed, but they are clearly of natural price pattems. The time that it takes for a price to move from one level to the next is not significant in many of these charting sjstems-, it is only- the level itself that is important. The only restriction is that the sjstems presented could all be verified and tested using a computer.

SWING TRADING

The foundation for the largest number of chart-based sjstems is the swing chart. Similar to point-and-figure, a swing is an upward or downward movement of a minimum size, regardless of the time it takes to achieve that move. Unlike point-and-figure. there are no boxes, and the notation does not use Xs and Os. The only difference between one swing chart and another is the swing filter Once prices have reversed from a high or low point by- the minimum amount apecified by the swing filter, a new vertical line is drawn in a cohimn to the right of the current one. An example of a swing chart is given in Figure 12-1.

Rules for using the swing chart generally follow those of point-and-figure. New buyand sell signals occur at points where the new swing penetrates the level of the prior sw ing in the same direction. Secondarj signals are given if the new signal is in tile same direction as the existing frend. Stop-loss orders can be placed at frend reversal levels or al a point of fixed dollar loss.

A swing method is very different from a moving average technique because it does not require prices to move to a new level to maintain the existing frend. In a swing philosophy, prices can move sidewajs or stand atill within a frend. Analjsis v, ill find its athibutes similar to a breakout method.

The following sjstems are all unique, but at the same time they are clearly simple variations of the swing method of charting.

A Classic Chartisf s Swing Method

Onginally, all swmg charts were the product of analyzing a price chart. They observ ed pattems that preceded the more modem percentage retracements that now need a pocket calculator. A classic technique for finding the swing highs and lows uses the following steps and is shown in Figure 12.2.

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FIGURE 12-1 Standard bar chart with corresponding swing chart, (a) Bar chart.(b) Swing chart.

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(Minimum Revereal L Size)

1. Begin at a bar (or new dsy) where the highs a bar (an upswing), or both lower than the highs a

i lows are both higher than the highs and lows of the previous i lows of the previous bar (a downswing)

2. If an upswing, connect the highs of the two periods.

3. If the next period continues to have higher highs and lows, connect the highs.

4. Continue until a bar occurs that has a lower low without making a higher high. This indicates a possible swing change based on the pattem of the next bar.

5. if the next bar has a lower high and lower low, the highest high of the swing is connected to the new lowest low and a swing change has occurred.

FIGURE 12-2 Conshucting a classic swing chart.

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6. If the swing reversal fails, the upswing continues when a new higher high and higher low occurs.

This particular method is called a "2-dsy" (2-period) technique, because it requires two periods to identify a swing change. The greatest benefit of this swing method is that it finds fast changes in market direction; however, it is recommended for its ability to identifj stop-loss points and control risk rather than for its entry timing.

The Livermore Sjstem

Known as the greatest trader on Wall Street, jesse Livermore was associated with every major move in both stocks and commodities during the 30-year period from I9I0 to 1940. Livermore began his career as a board boy, maridng prices on the high slate boards that surrounded the New York Stock Exchange floor. During this time, he began to notice the distinct pattems, or habits, in the price movement that appeared in the cohimns of numbers. 2

As Livermore developed his trading skills and eventually took his position as a professional trader, he maintained the habit of writing prices in cohimns headed Secondarj Rally, Natural Rally, Up Trend, Down Trend Natural Reaction, and Secondarj Reaction. This may have been the basis for what is now considered a swing chart.

Livermores approach to swing trading required two filters, a larger swing filter and a pendration filter one-half the size of the swing filter. Penehations were significant at price levels he called "pivot points." A pivot point is defined in rehoapect as the top and bottom of each new swing and are marked with letters in Figure 12-3.

As mentioned earlier, the swing chart differs primarily from the point-and-figure chart by having no box size. By measuring the change in trend as a reversal of the minimum swing filter size from the last high or low swing, the pivot points are alwajs posted at the exact price at which they occurred. In point-and-figure charting, using a lO-poinl box, a price rally that fails 5 points above the previous box will not be posted; a point-and-figure reversal is measured from the last posted box; therefore, the size of the price reversal needed to indicate a directional change may varj up to the size of one box.

Livermores frading technique is a unique interpretation of the swing chart. Positions are taken only in the