For the sequential pattem, the sell signal is the reverse of the buy. Traders should expect that the development of the entire formation will take no less than 21 dajs, but tjpically 24 to 39 dajs.

Entering the Sequential

Once the buy signal occurs, there are three choices for entering the market. The first is to enter on the close of the day on which the countdown is completed; however, this risks a new setup situation that will extend the conditions for an entry. The second requires a directional confirmation, the close greater than the close 4 dajs ago, but it avoids the possibility of recycling. The third is to enter a long when the close is greater than the high 2 dajs earlier, a compromise between the first two techniques.

asE DeM.irk.TheNewScie

:e "f Technical Analysis (J..hii Wiley &Sons, ISM) 303

FIGURE 12-10 A sequential buy signal in the Deutschemaifc Deutsche Mark

S-etce Logical bf.«i,.tfionlJ.«bnes, be . .,Thic -j, 11

Exiting the Sequential

A number of exit conditions, consistent with the tjpe of pattems, provide the trader with clear rules to liquidate the current trade. First, the current buy setup is complete, and ttie lowest price recorded does not exceed the flirthest price recorded by the recent inactive setup (normally the previous sell setup), if, on the other hand, any price recorded in the current buy setup exceeds the fiirthest price of the previous sell setup, then the position is held until a reverse signal occurs.

Two stop-losses are also recommended. For a buy signal, the true range for the lowestrange day of the combined setup and countdown period is subtracted from the low of that lowest day to create a stop-loss. Alternately, the difference between the close and the low of the lowest day is subtracted from the low of the lowest day to form a closer stop-loss.

Considering Complex Pattems

There seems to be an extreme contrast between the simple robustness of a breakout sjstem and the very complex set of circumstances that produce a signal for DeMarks sequential. The philosophic consistency of the bredcout sjstem is demonstrated by appljing

increasingly larger breakout criteria to the same market and observing that the reliability and profits per trade both increase, indicating that it becomes more selective, and those trades that occur have a better performance profile, in the case of a single pattern, such as an island reversal or DeMarks sequential, there is no way to measure this robustness. For the sequential, the time taken to identify a signal must also limit the number of signals that are possible. Eadi trader must decide whether this pattern selection produces a better set of trades, or if it is too demanding to survive the test of time.

13 Spreads and Arbitrage

A position taken in opposing directions in related maikets. contracts, options, or sliares is called a spread, or straddle. \Vhen the djuamics of the spread can be definitively calculated, such as the price of two bonds of the same maturity and the same grade, or the price of gold in two different locations, the transaction can he considered an arbitrage. For futures maikets, the most common use of the term spread relates to two delivery months of the same maiket. For example, a trader may take a long position in March Treasurj bonds and a short position in the.june contract (for the same vear). The expectation is that prices will rise and that near-term delivery will rise faster than the deferred, netting a larger profit on the Icng position and a smaller loss on the short.

A spread is most often a way to reduce both the rid; and, consequently, the potential profit that exists in an outright long or short position. A spread is commonly placed in two deliver} months of the same maiket, a combination of futures and phjsicals in the same market, or in two options of different strike prices or maturities. The reduction in rid; depends on the relationship between successive delivery months, which varies considerably with the maiket traded. These can be summarized as follows:

Financial maikets nearest to delivery react more quickly and with greater magnitude to changing interest rates, economic data, and supply and demand situations. The deferred contracts will respond more slowly, because the lasting effect on the maiket is not as clear. Precious metals, such as gold, platinum, and silver, were once considered pure carrj maikets. Successive delivery months would alwajs trade at a hier price due to the interest rate component of holding inventory. If the price of the metal rises or interest rates rise, the cost of carrj increases and the spread between months widens, if metal prices or interest rates decline, the spread narrows. If metal prices and interest rates move in opposite wajs, the effect on the spread is dampened to varjing degrees. There has been an evolution in the industrial use of precious metals, primarilj in electronics, which has increased the consumption and changed the pattems to reflect a more industrial look.

Industrial metals, such as copper, m-ill show normal carrjing chaiges under most circumstances, but they are affected by, demand to the extent that prices have been known to invert for significant periods of time. Because of their fundamental changes, silver prices inverted for the first time in 1997.

Foreign exchange rates are dependent on the prevailing economic outlook for the specific country, combined with their balance of trade. A stable economy will show nearlyunchanged forward rates; a weakening economy will cause the deferred contracts to be discounted. Prices tend to become more volatile as they move awajlrom equilibrium, whether higher or lower. Because exchange rates are quoted in terms of other currencies, everjthing must be viewed as relative to another economy".

Agricultural products (,cropsj contain awell-defined carrjing chaise within each crop year. Rxpeaed variations in both supply and demand have made delivery, month pat

terns differ fran one another; however, prices rarely achieve full carrj (Note that potatoes are an exception to the normal pattems shown by agricultural products.) Livestock markets are noted for products that cannot be stored and redelivered, therefore, the prices for any one contract month are based on anticipated supply and demand at the time of delivery Feedlots and fanners have been known to deliver early when prices were high or when production costs were rising., however, this will cause an unreplaceable shortage in the nearest deferred months (Figure 13-1). Pattems in

PeirvJ r..wfman,"TecWcBlAi,BlyEiE,-inTheHan.tt:.o..k..fFinanciBl Futures. NancyH R. .th.-tein (ed ) ilJci.iw-Hill, New Yk. 19S4)

FIGURE 13-1 Interdelivery price relationship and terminologj. (a) Precious metals, (b) Indushial metals, (c) Foreign exchange, (d) Agricultural products, (e) Interest rates.