In this issue:
A Simple, Powerful Method for Trading Different Market Environments
Contributed by the Dynamic Market Lab, LLC
In 2004, the Dynamic Market Lab, LLC (our, us, we) introduced John Ehlers’ signal processing applications for the markets to the MetaStock community through introduction of the Adaptive Cycle Toolkit (ACT). The intent was clear; demystify powerful, but complex concepts and mathematics for immediate application to trading in the easily understandable MetaStock formula format. As time passed, it became apparent the real insight behind his pioneering work lay not in bringing these engineering tools to bear for market analysis, but in recognizing how these tools should be combined for maximum effectiveness.
In this article, we present one of the best approaches revealed by our extensive work with ACT. The approach is simple, powerful, and allows a trader to quickly, confidently identify different market environments, and execute a logical approach to capitalize on them, or stand down. The approach is described in the ensuing paragraphs, and all code is available from MetaStock with purchase of ACT. Discussion of the approach may appear complex, but we want you to understand the concepts, and feel comfortable with them. Fret not, application of the tools is very simple.
Three ACT or ACT modified functions are used to a) identify trend, b) measure trend strength and noise, and c) identify low risk entry points within a trend. A multi-faceted trading approach across different market modes (trending, drifting) is then suggested. The discussion below may appear complex, but the application of the tools is simple.
This approach is based on the Laguerre Transform, a modified version of David Sepiashvilli’s Trend Quality Indicator (TQI) (the ACT TQI), and a fisher transformed version of the Laguerre Stochastic.
OK, now you have been patient, and the fun begins...
Use crossovers of price against the Laguerre Filter as the earliest warning of a trend change. Compare these crossovers to the ACT TQI. If prices are above the Laguerre Filter and the ACT TQI is > 1, a strong uptrend is likely in place, and do not trade against it. If prices are below the Laguerre Filter and the ACT TQI is < -1, a strong downtrend is likely in place, and do not trade against it. If you are trend follower, you can use these confirmed signals to initiate a trend position. We leave this to the viewer to examine the charts presented. We believe the confirmation points of the two indicators, and the trend direction to trade, are straightforward.
Mean Reversion Trading: (i.e., buy dips in an uptrend, sell peaks in a downtrend)
Mean reversion trading is based on the simple principle that when prices move far away from their average price they tend to move back to their average. This may be true in both trending and drifting markets. However, we should not employ this approach without a sound method. A strongly trending market can move prices farther from their average than expected.
Use the position of prices relative to the Laguerre Filter, and the ACT TQI to determine the market’s state. If prices are above the Laguerre Filter, and the ACT TQI is > 1, enter long trades only when the fisher transformed Laguerre Stochastic is below -2.5 standard deviations (oversold). If the price “hooks” down near the Laguerre Filter, this is even more desirable for entering long trades. If prices are below the Laguerre Filter, and the ACT TQI is < - 1, enter short trades only when the fisher transformed Laguerre Stochastic is above +2.5 standard deviations (overbought). If the price “hooks” up near the Laguerre Filter, this is even more desirable for entering short trades.
This allows us to buy dips in an uptrend, and sell peaks in a downtrend. We are capitalizing on both trend and price extremes, and using both to raise our odds of success. It is not recommended to use the oscillator values alone to take trades in the opposite direction of a strong trend. At this point, our examination of the market’s state indicates a strong trend exists, and we should not trade against it.
Range Bound or Drifting Markets:
If prices are above the Laguerre Filter, and the ACT TQI is -1< ACT TQI <1, enter long trades only when the fisher transformed Laguerre Stochastic is below -2.5 standard deviations. If prices are below the Laguerre Filter, and the ACT TQI is -1< ACT TQI <1, enter short trades only when the fisher transformed Laguerre Stochastic is above +2.5 standard deviations. During very noisy, drifting scenarios, prices tend to “hang on” to the Laguerre Filter, they are not above it (uptrends) or below it (downtrends.) In such cases, this may not be worth trading, unless the trader is selling options or option spreads to collect premium decay. These are lower probability trades because we do not have the benefit of a strong trend. These trades are strictly “range bound” trades. They may be very profitable during extensive periods of market drift. At the first sign of a price crossover of the Laguerre Filter or ACT TQI value moving beyond the +1/-1 limits, and in directions against your trade, exit immediately.
Please refer to the attached slides, and vertical lines indicating examples of these trade setups based on the rules explained above.
Three carefully designed tools allow a trader to operate a simple, powerful approach across a spectrum of market conditions. Although the concepts behind the indicators we have discussed may be complex, applying them is not.
Trading is often the most successful when it is simple, and based on sound principles of market behavior. We hope that we have provided a more powerful perspective on market behavior© for you, and that you will take a look at the powerful tools and concepts in the Adaptive Cycle Toolkit (ACT).
ACT is available from MetaStock’s site in a convenient downloadable format on a risk free trial.
The Adaptive Cycle Toolkit (ACT) is a product of the Dynamic Market Lab, LLC. The techniques described in this article, and the software and related manuals, are based on approaches some consider to be experimental. As a result, this information is offered for educational purposes only. Concepts or techniques presented are not guaranteed or warranted to be profitable.
Users apply the product strictly at their own risk. They must understand that trading in stocks, commodities or other instruments has significant risks, and substantial losses may occur.
The creators of this product or authors of this article are not acting in a capacity as investment or trading advisers. Readers of this article or users of the product must accept full responsibility for their investment or trading decisions, and should seek professional investment counsel before beginning a trading/investment program.
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How do I create a custom list?
Contributed by MetaStock Support
The Custom List Manager lets you create your own lists. The lists chan contain as many instruments from as many groups as you want. You can use these lists in the Power Console to view charts, run explorations, and run system tests. Here's how you can create your own custom lists:
1) To create a new custom list, click on either the "Tools" menu or click the "Manage Custom Lists" button at the bottom of the power console.
2) After the Custom List Manager opens, click "New."
3) Enter a name for the list.
4) Enter symbols, one at a time, in the "Select Instrument(s)" field, clicking "Add" after each one.
OR look the instruments up (if you don't know the ticker symbol).
Search by the instrument name or symbol and options will auto populate below. Select the appropriate instrument name and click "OK."
5) Click "Save" to return to the Custom List Manager.6) You can access your newly created Custom List by clicking on "Tools", then "Custom List Manager" or the Power Console.
Bollinger Bands - Part 1
Contributed by Breakaway Training Solutions
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Hi Alex, I am having the same issue as Pelican. I have the ACT addon but I cannot figure out how the smoothing was done. Please, let me know if you have the code for the smoothed ACT IQT. Thank you
Edited by user Friday, February 5, 2016 9:58:00 PM(UTC)
| Reason: Not specified