Kagi charts: when time does not matter … too much!

This post is for those of you that want longer term approach, many weeks at least, and don’t mind their portfolio swinging up and down with larges waves. Maybe it will make you appear very clever if you can decipher and explain the chart to someone unaware of this technique!

For an in-depth introduction, please refer to Steve Nison’s book:

You may also refer to these sites: stockcharts or Colibri Trader.

I do not agree to use ATR as reversal amount as your chart will change over time, and you will loose track of why you entered the market. Just use the 3% reversal, it will do a perfect job!

Again, I am assuming you already know about Kagi charts which look like this one for Marvell. See last green arrow shows a positive and undoubted profitable signal!

Kagi charts filter out the daily noise and we are left with raw trend. Remember that people may change opinion at any time, so the charts may look convoluted from time to time.

There are interesting traditional figures mentioned in Steve Nison’s book that do appear from time to time. It does not hurt to pinpoint those patterns!

The basic buy signals, when kagi line goes from red to blue, appear quite often but obviously there are many false signals! Pretty much like the TLB charts (previous post), we need some tools to filter them out.

For each vertical segment, between 2 u-turns, we consider high and low to be top and bottom of each segment, open is the low for up moving lines and close is the top (opposite for down moving lines). Easy, isn’t it?

Bollinger bands are again useful, fantastic! Even the good old MACD feels more comfortable with this kind of charts. Let’s look at Gilead chart:

MACD divergences warn you about upcoming changes. Bollinger bands are clearly closing on on prices during consolidation and breakouts are solid confirmations. We can use the %B indicator to tell us when the bands are moving away from each other. Here is Tesla chart:

Tesla

As you can see, in May 2020, an inverted 3-buddha bottom appeared, was soon confirmed my MACD crossover. Then in October, the %B has crossed its signal line (a 5 candles exponential moving average). We are on board! On March 5th, we get a 3-buddha top, we are out with a cool 162% gain. We are not playing the down move from there since the overall trend is still up, and Bollinger bands are contracting. Beginning of April, we are again getting again a buy-signal (2-level break following inverted 3-buddha bottom confirmed by MACD), up to you to play it or not! Note how those Bollinger bands are quite flat from 2017 till end middle of 2019, they tell you not not to play any signal in any direction!

A word of caution must be mentioned here! Back to probabilities!

The probability of a trend change given the fact that you see a reversal patter (double window for instance) AND Bollinger bands expanding AND MACD greater than signal does ONLY mean potential reversal. We are improving the odds in our favor but I can not give you figures because backtesting on those charts in not possible. I tested manually over maybe two hundreds of charts, about 50% of trades should be profitable. The fact is you don’t know how far will the trend go. This is why, should you have time, it is good to revert back to old candlestick charts and draw the fabulous action-reaction lines to find out the potential!

That’s it! Those of you wanting material for week-end perusal, you get it!

Until next time, trade safely!

S&P500 market analysis June 2nd 2020

Hello! Mister Market is very optimistic, has gone through the last 2 reactions lines and has stumbled also further from the random path.

This optimism is really puzzling if you are looking at the news on TV but remember that S&P500 is driven mainly by the GAFA’s and Internet sector is big winner of the pandemic. Home office has proved a success for many companies and is going to be a source for cost reduction in the months ahead. Crisis are always the time when creativity works best and remote office was a solution only waiting for the opportunity to prove itself useful in crisis and at any all time!

What do we need to do now? Of course, keep a close watch on index evolution as it scrolls through upcoming reaction lines. There are then many stocks that are still low without any reason other than cash has flown to immediate winners such as Amazon, …. The other sectors such as 5G will restart shortly, American Towers is already making new all time highs! Fasten you seat belts and enjoy the rides!

Until next time, trade safely!

Three-Line-Break or the integrated trend-volatility tool

I have been a fan of Three-Line-Break (TLB) trading for long time because it is a KISS (Keep it Simple Stupid) methodology and takes no time to make decisions, which is mandatory when you have an other full time job! As long as I did not have any backtesting tool and was working only small caps which are trending usually for longer period of time, then the feeling was there was a positive expectancy. However, from time to time, I experienced losses more than I liked, and felt like missing trend departures.

Once again I assume you are already knowledgeable about the basic topic. For more details on TLB, please refer to here

Backtesting becomes possible when you can actually display the TLB back on daily chart. On the following chart, you can see on the right the TLB chart, with red and green lines; these appear on the left candlestick chart as red and green boxes.

There are signals from TLB that you would obviously not take after adding our usual 3 single Moving Averages for instance.

When we backtest over long period of time the TLB strategy on standalone only, we surely are disappointed.

Let’s look at Apple. First with TLB, taking buy and short signals, 300%

Taking our 3-moving averages on the long side only, we fare far better!

So if you hate candlestick charts, then you need to put those 2 technologies together. First add the 9 and 18 averages on on your TLB chart.

The size of each TLB line represents also the volatility, though you don’t know how long it took to have this volatility increment. Fair enough, the daily volatility is filtered out to show the trend volatility. The ROC indicator should be very talkative. I am displaying the ROC 9 days on this chart:

Any time, ROC crosses 0, or just touch down 0 and goes back up are good entry points. When ROC is positive, just filter out the short signals. An other confirmation is SMA9 is above the SMA18. And there are also divergences to help anticipate trend change!

You may also look at the volatility of 3LB, this time using Bollinger bands, because TLB lines stick to 2 standard deviations!

I tried to move back these good-looking curves to candlestick charts for back-testing but to no avail. So I can not show you the backtesting result.

As a conclusion, if you are not after option trading where time does matter, these TLB chart are a very good tool. Overall trend is given by a single moving average, which allows easy filtering of false signals.

That’s it. Until next time, trade safely!

Random comments, some answers, and other random thoughts…

Thank you all of you for writing supportive comments. This blog is, as far I know, absolutely unique, I have no competition! Maybe I should charge a few hundred bucks just for viewing,… just kidding!

I am going to answer here in bulk manner to the comments.

The blog platform

The blog is powered by WordPress but is an offshoot provided by https://vivaldi.net/ Vivaldi is an awesome browser, but they also offer a free web-mail, a very good alternative more privacy focused that Gmail and similar, plus a free blog. You can have your blog up and running in less than 10 minutes. Should you start your own blog on a related subject, let me know and I will reference here. You are also welcome as guest writer on this blog.

The blog is surely working with latest navigators such as Firefox or Vivaldi, but you may experience problems with old Internet Explorer.

Starting a new blog

I am no guru about blogging, I am sure you can find good material on the web. I started out with same idea as the posts I write: Keep It Simple Stupid (KISS). After a few months of writing, I see audience is increasing through number of real comments (not spam), so great!

Pretty much you can revive your old desktop with a new wallpaper, you need a good picture so that your blog looks good. I recommend your browsing Deviant Art, they have plenty of original pictures and web art.

About comments

I don’t know how WordPress behaves when you leave a comment and if you get many annoying emails. If you come back often here, use a disposable email for entering public comments, e.g. this service or that one

Captcha for plug-ins: I do not know.

If you want more in-depth exchange, you are welcome to email me: dragon trader at vivaldi.net. Or @ randomerrance on Twitter.

RSS

I understand you can use this link: https://dragontrader.vivaldi.net/feed/

About statistics and probability

There is a big difference between these two notions and you must understand it. As finance often says “past performance is not indicative of future performance”. We may hate to say it, but they are right. You can calculate statistics of past performance, e.g the number of winning trades over last 10 years, the average performance, … and thus the overall expectation of the strategy. If the expectation was negative over the last 10 years, why do you believe it will work in the future?

Also as discussed in some posts, the probability of winning does not tell you anything else than, on average, you should win x% of the time and so you can experience long loosing streaks based on that probability. Also having a good probability of winning (say 51%) does not mean a positive expectation, you need to control the losses and make sure the gains fare much better than losses, at least 2x. Stock picking comes into play here: small volatility also means low risk of course but low gains, most often not good enough to have positive expectation. Trading is playing with stocks or securities that have the capability to land you big gains! Do not look too far: Apple is such one, as well as Microsoft or even Visa. Of course, many Nasdaq stocks such as Tesla are far better choices to push your expectations skywards!

Investment publications often boast about their past wonderful performances, they even sometime annualize the figures (e.g 1400% based on 1 trade that made 20% in 10 days!) but they never report publicly about their failed trades, their overall performance and expectation. Some may be quite good a stock picking, but you should always wonder whether the writer is not somehow the market maker, especially with small caps, so he needs many subscribers not only to have a very profitable newsletter but also moving the market in author’s intended direction! The folks are Sock Gumshoe do a wonderful work deciphering the teasing of such newsletters, so a good source to find trade-able stocks!

That’s it! until next time, trade safely!

S&P500 market analysis May 25th 2020

I am sure you have noticed by now that this blog is totally original and I will not cover the basic indicators, their usage, … There are millions of sites that copy/paste from each other and you won’t learn from them anything but the basics. It is always a good idea to come back to basics, but profitable trading is about having an edge, so none of basic indicators work for very long, when too many traders are using one, market becomes sort of immune to it!

With this blog, I aim to help you kick some ideas down the road and if you wish you can share on this blog. Maybe it does not work for you as expected, but it may inspire others. Just drop me an email (see pinned message) and I will publish your article!

Let me share a story. For very long years, I made a few trades per year and had absolutely no idea how to get in or to get out. so I did some buy and hold based on randomly selected analysis, watching the stocks loose as much as 50% then going back up… And one morning I had an idea: imagine a very tall tree and there is a big coconut hanging from the top branches and a monkey happens to walk by and being thirsty. The easiest part of course is climbing, reaching the top, secure yourself to branches with feet and one hand while extending the other hand to take the fruit. Then suddenly, one branches cracks. You are still hanging from one branch with one hand but you are still safe, sort of! But for how long? The second branch is bending now and you must make a decision: free fall to the ground (not a good idea) or jump down other branches. This is how I started designing my first trailing stop! See? Let me know how you come up with trading strategies, fun to share and comment!

I still have plenty of ideas to share. I will not share publicly the details of my very best strategy because I am using it, but there is no problem sharing older research material that you can choose to improve on your side and share with the club! Just to give you an idea, we will look at in future posts:

  • EMA, DEMA, and the collection of moving averages
  • Accumulation / Distribution
  • The wonders of smoothed ROC
  • Kagi trading with volatility
  • 3-line-breaks trading with volatility
  • Others

So far I have demonstrated:

  • Markets follow a random path which can be drawn.
  • Markets can trend and this is due to their random nature. See here.
  • The randomness can be measured by volatility. The raw volatility (be it 1-day momentum, True Range, …) is the one to be analyzed and understood
  • You should not try to confirm stubbornly a strategy because cases where your strategy does not work surely exist and might even be the most profitable cases! Market’s got some sense of humor :-))

Now, as title implies, let’s look at S&P500 and where it is going!

As a continuation from previous post, I have left the random walk path and you can see that our drunken man does not seem capable to go more that 2 steps away from the main path.

If you have read my initial posts, you know I like a lot Action/Reaction lines because tops and bottoms are often building on those. Here we are precisely with 2 solid blue lines across the path. Unless S&500 goes through forcefully, we are in for a reversal. I have included Accumulation / Distribution at the bottom, which is a good indicator when you have nothing better, just add a 20-days simple moving average. There is not much energy: look at the slope of price versus indicator! We need some very good news to move up now! So yes, I would wait a few more days to see where we are going and go short if confirmed for an objective at 2400. This is absolutely no advice!!!

Until next time, trade safely!

Spotting and trading the Random Walk path!

After discussing raw volatility, standard deviations, no way we don’t have a discussion about ATR aka the Average True Range. This post will definitely blow you mind, I am going to demonstrate that markets are REALLY following a random walk path, pushing from one side to the other in a precise manner.

For introduction, please read again my previous post about drunkard’s walk.

Let’s consider an observation period of n days. The Highest High (HH) and Lowest Low (LL) may be considered as lamp post from which our drunken guy is walking. We know that on average we should be able to find him at a location situated at square root of n multiplied by average stride length or the Average True Range over n days to use financial wording.

Here is how it looks:

The red line is where Bulls expect price to be, whereas the Bears are waiting for the prices to reach the green lines. These are all average expectations of course, and these objective can be reached any time during the observation period. Please remember that down markets are usually twice faster that up markets.

What if we consider the middle price between these 2 expectations??

Let’s do a bit of maths:

  • Today’s high (H) is expected at LL + 2 * √n * ATR(n)
  • Today’s low (L) is expected at HH – + 2 * √n * ATR(n)

So the middle point can be defined as:

MP = .5 * ((H+L)/2 +(HH + LL)/2)

Of course price will not be there, X does NOT mark the spot, but it is a fair expectation about where prices should be, if there were no other information.

Let’s display it on a real chart!

We are going to use n = 36 in this post, you can use anything between 4 and 100, but make sure the square root is an integer for what will be following.

Ouch! It hurts the eyes. But you need to think of it differently. It is not a simple moving average, it is always using the most significant average of the day, between 1 and 36. Anyway you can already see that, when prices are above the path (light blue color),then trend is up. The path leaves a chance to prices to retrace and tends to be closer to them before a reversal.

Let’s not stop there and use a standard average of this path to smooth things out. Now follow my reasoning!

If the random walk theory holds, then the path we have spotted may very well be a lamp post so the actual prices should hover at exactly a number of strides from the lamp post, not 3.7 strides, 4 really! Let’s do it and display some lines at exactly every 2 steps (2 ATR’s) from the middle path.

Whaouh!!!!!!!!

The red/green line is the smoothed out path. Prices are pushing along the lines, see only a few examples highlighted in red circles here:

Just amazing.

One way to see it is to consider the middle path as the median line if you were using an Andrew pitchfork, first lines above and below are the MLH (median line high) and the other lines are warning lines!

Even better, if you are looking for warning lines above a major bottom, each represent a price objective. In the case below, the price identified on first warning line is reached a the top second red circle within .30$! (97.70 vs 97.42!)

Trading strategies are quite straightforward from then on:

  • From a warning line far below median path, play return to the path
  • From middle path that is going, play the trend and put a stop on a visible line below the price
  • If price is ‘in the central pitchfork’, most likely there is no trend!

Now, you will tell, this is an example, sure it does not work with last market conditions? Yes it does!

Here is Nasdaq recent price action, stopped on a warning line!

Or McDonald. Doing quite well!

Final thoughts: Market is moved by demand and offer. Behind these are drivers are humans or robots programmed by humans who can change their mind any time, giving the market a random outlook. This post would be worth many more investigations. Dr Andrew and his pitchfork really had a hint, but without computer, it was definitely more difficult for him. This is maybe the first explanation why Andrew Pitchfork are working and why it is so difficult to identify the right pivots to draw the pitchforks! Anyway, the random walk proves to a very good model, again because we are not trying to fit the data into a specific model or data distribution!

Feel free to comment or send email.

Until next time, trade safely!

Bollinger bands from a different perpective

As a blog about volatility, of course, there must be a post about Bollinger bands, which is the most common way to assess volatility. More especially, finance have based all their systems, assuming that prices are a Gaussian distribution (aka bell curve).

If this statement was true, then only 2.14% of prices should be outside the 2 standard deviations (aka sigmas). For one year, say 200 days, 4 days should be oversold or overbought, as commonly said!

Fair enough, let’s work a quick indicator that tells us how many sigmas the prices are from the average. We are taking John Bollinger’s definition.

Indicator = (close – 20-days average of closing prices) / Standard deviation 20 days

Let’s look again at Apple graph over last few months!

We have gone beyond the 2 standard deviation at least 8 times, sometimes for a few days. It is not looking good! If you are looking at S&P500, it reaches -3 sigmas once a year at least, when it should be the case more or less once every 8 years. Of course, it is probabilities, and this can happen more often. Correct, but there should be also long years without this far reaching. Which is not the case!

Now that you have spotted this interesting paradox, you have a new edge for trading! The best to trade Bollinger bands is just to NOT draw them. Remember that bubbles and parallels pointed by by Bollinger specialists are mere illusions!

Instead use our small indicator!

The indicator displays many divergences:

  • Blue ones are standard divergences with the price to spot reversal
  • Green ones show hidden divergences in the direction of the trend

I have highlighted a red one to show one that did not work. Be careful, if the trend is strong, wait for a signal to profit by the divergence, at least let the price go over the short moving average.

See, it is easy! For standard divergences, make sure first point is in oversold or overbought area, as indicated by the 2 sigmas lines.

One you are in, don’t get out of your trade at the 20-days moving average (strategy called ‘return to mean’), use a trailing stop, the green average for instance.

That’s it. Some people would charge you 5000$ per year to then send you the signals by email. If you do sell this service, please remember my commission!

A deep dive into volatility trading – part 2

Everyone has different ideas about what volatility is, what it measures and how to use it (when it is known!). Volatility is a measure of speed, a measure of risk, a measure of objective (see my posts about random walk), a measure of noise, a measure of whatever your imagination lets you think of providing you can link it to some facts. Remember that volatility is just a number and trying to fit in a box will lead to misunderstanding of other boxes that the number may fit in an other dimension.

Volatility is usually calculated by means of variance and standard deviation, but this assumes market is a Gaussian distribution and prices almost never err beyond 3 standard deviations (once every 34 years to be accurate) but THAT IS NOT THE CASE! Price goes beyond 3 standard deviations at least 3 times a year on indexes and individual stocks. The model is wrong but all financial tools (options, warrants, …) are based on that and, as surprising as it may seem, it gives us an edge to play against finance.

If you have observed the 1-day momentum in part 1, some bells should have started to ring. Let’s look at an other one:

Look at momentum value! Most of the time they are contained within a specific range. Exceptions are results announcements or market corrections. Don’t you find it strange?

Think about this. You want to buy a small flat, 35 square meters, seller wants 40k€. You being budget conscious, you may propose 39.5k€, saving some money to refresh the kitchen. You propose 500€ below the asked price. It may work!

Second situation: you are now buy a condominium 800 square meters, seller wants 4.7M$. Now you make a bid at 4 699 500$, or 500$ below the asked price. This is mean (in the sense of contemptible!). Now only will the seller think you are kind of psycho or moronic psycho, but you are clearly at risk of not getting the flat, which is pretty bad if you think flat price may go up 30% in next 10 years!

Now look at Apple graph again. Negotiations are in the same range, whether Apple is priced at the 200$ or 300$!

Once you have observed this, you know YOU HAVE AN EDGE!

There are many reasons why this happens. Sure enough HFT (High Frequency Traders) are playing with 0.01€ variations and they have volumes to play with. But think also about a call warrant: price goes up if price of associated stock goes up, but it is driven down by expiration time AND lower volatility. Get it? Finance has an edge!

The rules for volatility trading are thus this simple:

  • Buy when volatility is high and going down
  • Short when volatility is low and going up

Without disclosing the (smoothing) formula, let’s look at a volatility indicator that makes sense (bottom of the graph). Volatility goes down when prices climb up and volatility increases when the market hiccups giving opportunity to buy with very good timing!

That’s it! Because I am not using a predefined model to fit in the data, the data speaks back to me! Until next time, trade safely!

Volatility Trading System superior performance

I wrote in some previous posts that volatility trading improves the performance of any trading system. Is it the case? Really? How better is it?

The goal of volatility analysis is to get rid of loosing trades as much as possible, so if you go from 30% winning rate to 60%, then number of consecutive loosing trades will be narrowed down, the overall profitability will increase.

Let’s start this demonstration with a simple yet very interesting trading system:

  1. Buy when close > SMA(9)(close) > SMA(18)(close) > SMA(50)(close)
  2. Get out of the market when close is crossing under the SMA9

Close is today’s closing price, so you buy at the opening the next day. SMA(x) are x days simple moving averages. I am not taking short positions for this exercice, the rules would be exactly opposite.

Here is the graph of Apple over last few months. The 3 moving averages are shown by red (9 days), green (18 days) and blue (50 days) color. Some entries are shown with green arrows and selling the position by red crosses.

Looks good, doesn’t it? As long as the stock is capable to trend and Apple perfectly fits this criteria, this trend trading system should be ok.

Let’s now run a systematic simulation for a portfolio (10k$) with only one line and re-invest 100% of the profits. Here is the result:

Over 20 years, you multiplied your capital by 8! Great 🙂

But a few considerations are needed:

  • A buy&hold strategy would have yielded much more (x18)
  • you get 35% winning trades, a win/loss ratio of 1.67, biggest gain is 14257$, largest loss is 6226$
  • As expected from calculation in previous post, we can get a series 12 loosing trades in a row

Psychologically it is tough to handle, but could be worse. If you traded Cisco instead of Apple, the result is negative! That is because volatility is not big enough!

Now if you traded Bitcoin with this system, you are a billionaire! See the graph and report just below! Notice an almost 300M$ loosing trade, that is undoubtedly hard on the psychology!

Now I am adding volatility control on Apple, on top of previous one:

See? Now we multiply our initial capital by 41 (started from 100k$), beating by far buy&hold strategy! Now we get 68% winning trades, a win/loss ratio of 3.77, max 7 consecutive loosing trades but 16 long series winning trades 🙂

That’s it for today! Until next time, trade safely!

Should you want to share your ideas…

Hi all,

I hope you enjoy reading this blog. Volatility trading is like being a dragon slayer, you are fighting the mythical chinese beast that is unpredicatable. This is emulated in some chinese martial arts school where unpredictability is key to win your fights!

If you feel comfortable presenting and exchanging ideas, write articles on this blog, you are welcome to contact me: dragontrader at vivaldi.net or randomerrance on twitter. Spammers will be barred immediately! I may have only a few years thinking advance but I believe we can make a killing on the markets. As title indicates, it is a club, free to join, free to leave, …

It is NOT allowed to post very detailed advice on which stock to buy or short. I will only post market analysis from time to time. As they say in WallStreet and in China, there are those who know and those who tell, and these are not the same. We want to be those who know and enlighten the path of knowledge to others.

Talk to you very soon!