The Educated Analyst Sep-Oct 2009

Finding lows and highs with the Fibonacci

Retracements.

Can tall buildings shed

any light on financial markets?

Market Sector Maps, A

new way of Relative Comparison.

THE EDUCATED ANALYST A Free Technical Analysis E Magazine for Traders of Financial Markets

Volume 1, Issue 1 AUG / SEPT 2009

GETTING THE EDGE BACK INTO YOUR TRADING.

www.EducatedAnalyst.com

A Free Technical Analysis E Magazine for Traders of Financial Markets

Volume 1, Issue 1 SEPT/OCT 2009

The Educated Analyst | SEPT /OCT 2009

THE EDUCATED ANALYST SEPT / OCT 2009 - VOLUME 1 Issue 1

5 TO TRADE OR NOT TO TRADE Can the Market Price Analysis tool help with this question? By Robert Lennox.

7 FINDING LOWS AND HIGHS WITH FIBONACCI RETRACEMENTS Alan Oliver shows how an old Fibonacci trick he learnt can aid in finding lows and highs in the market.

10 HABITS OF SUCCESS An in-depth look at the trading success formula. By Ray Barros.

16 MARKET SECTOR MAPS, A NEW WAY OF RELATIVE COMPARISON A look at how technology can give us insight into the markets that we never had before. By Mathew Verdouw.

19 THE CANTILLON EFFECT Tall buildings and what they forecast for financial markets By Phil Anderson.

22 ON THE COUCH WITH CHRIS SHEA Chris looks at the psychology of the winning performance in trading.

26 GANN SWING CHARTS And some good advice on how to use them. By David Burton.

30 USING MARKET CYCLES TO DETERMINE WHEN TO EXPECT A CHANGE IN DIRECTION Dale Gillham takes a look at how he uses market cycles to easily calculate expected changes in the market.

34 THE GARTLEY TRADING PATTERN Ross Beck from Gartley Trader takes a look at the Gartley pattern and gives his advice on its use.

36 HOW TO IDENTIFY TRADE SETUPS FROM CONSOLIDATED MARKETS Bennett McDowell from TradersCoach.com details a powerfully effective trading strategy for consolidated markets.

42 A COMPREHENSIVE LOOK AT TRADING PATTERNS Peter Varcoe gives us his first instalment as he tackles the best way to trade patterns.

CONTENTS

The Educated Analyst | SEPT /OCT 2009

elcome to our inaugural edition of "The Educated Analyst". We are really proud and excited to be able to deliver this free e-magazine to you, and we trust that it is a real benefit to you in your analysis and trading.

I have spent the last 14 years working with traders from a wide variety of backgrounds and as such I have had the fortune of seeing what separates good traders from those that get burnt. The bottom line is the amount of education that they have acquired. In my experience, a successful trader is always someone who has dedicated themselves to learning more about how to trade and to continually search for new techniques that can improve their results. I personally see the level of education acquired as a good measure of how serious a person is in any endeavour in life. Someone who is open to learning new things will always improve, the person who thinks they know it all is destined to stay the same. If you have been Trading for any length of time at all, you know that it is hard work. It takes discipline to follow your strategy when the masses are running the other way. It can be crushing when you have successive losses and its hard to know in times of "crisis" what to do. On the other hand, trading can make you feel ten-foot tall and all-conquering when you are able to successfully master a strategy that is giving you good returns. In The Educated Analyst, we have aimed to put together a collection of articles that will help every active trader; from trading strategies that you may not have heard of before, to psychological tips that will help you understand your own tolerances in how you trade. The Educated Analyst has been designed to help you in your education to become a better trader. No matter where you are in your trading life, there is bound to be a wealth of information in The Educated Analyst that will benefit you. The articles are written by seasoned experts in their field that share our passion for giving you as much information as possible to help you with your trading. We are so grateful that they would share this information so freely. For many of them, education is their business. If you are looking to further your education then please consider what these educators have to offer. I also want to acknowledge at this point the support of four companies that have assisted us with the distribution of The Educated Analyst. Each of these companies also share our passion for ensuring that Traders are equipped with the best information and tools to help them succeed.

Market Analyst Software, who is sponsoring The Educated Analyst and who provides software and data to traders.

Paritech, who provide real-time ASX data into Market Analyst. Kinetic Securities, who provide full-service brokering and real-time data for many of the world markets

through Interactive Brokers. The Educated Investor Book Store, who provide trading and investing books in their Melbourne store and

via their web store. To help us keep The Educated Analyst a free e-magazine, please consider one of our supporters when you are looking for products and services. You will find ads for these in The Educated Analyst. Again, enjoy this publication and feel free to tell your friends about it. If you have any suggestions on topics that you would like covered in future editions, please let me know by emailing [email protected]. Happy Trading! Mathew Verdouw Editor The Educated Analyst

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The Educated Analyst | 5 To Trade or not to Trade? SEPT /OCT 2009

ith just a little basic knowledge of how to use Market Price Analysis (MPA), the trader can get a very reliable answer to that question.

In 1986 Peter Steidlmayer published Markets and Market Logic. In this book he outlined a revolutionary way to represent price data. His method eliminated time from the graphical representation of price. He instigated the Vertical Arrangement of Data or VAD as a method of graphing price action.

Steidlmayers methodology was then adjusted (some say bastardised) and made available as a dynamic intraday trading tool. Until now, traders wishing to use the real power of this tool on daily or weekly price data were forced to hand-chart their VADs and make alternative arrangements for the basic statistics that are applied to MPA. Needless to report, not many traders took up this challenge. A computerised MPA removes this obstacle.

The VAD

The key to using the VAD for trading is identification of the price bar representing the movement out of a distribution or consolidation phase. This is a full topic on its own.

To construct a VAD, the price axis can be considered to be a gigantic magnet drawing all of the price action towards itself. If you look at a series of traditional High Low Open Close (HLOC) bars you will notice a considerable amount of overlap in the ranges. On a VAD this results in a sideways stacking effect.

Take for example six trading days. For convenience the days will be called a, b, c, d, e, and f. Figure 1 shows the progress of how the bar charts converts to a VAD.

Basic Statistics

When representing price data on a VAD, Steidlmayer recognised that the patterns formed by the letters are similar to those on the most basic of statistical representations the normal distribution curve.

Even a casual observation of the curve that forms on a particular chart reveals quite clearly the price at which most price action occurs. This is the price with the largest number of letters or occurrences and is referred to as the price point of control. For some reason the price action gravitates towards this particular price from above and below. That central price has a huge magnetic effect.

From a traders perspective the important question then comes how far away from this point of control should the price action go before it loses its influence? In other words, when can a trade be entered with confidence?

To answer this question the statisticians turned to their Standard Deviation tools. In a normal distribution 68.2% of occurrences fall within 1 standard deviation of the median value. Bottom line dont enter a trade until price action is beyond 1 standard deviation of the median or price point of control.

Good News for Traders What was previously a laborious and painful process is now available at the push of a button and on any time frame being used by the individual trader.

The graph in figure 2 shows the Market Price Analysis (MPA) overlaid on price action for AMP. This is on a weekly chart and covers the period from June 2001 to the end of March 2002. Notice that coloured blocks

replace the letters for each day. The interpretation and pattern recognition remain the same.

TO TRADE OR NOT TO TRADE? That is the Question.

With Robert Lennox

The Educated Analyst |6 To Trade or not to Trade? SEPT /OCT 2009

Figure 2

The MPA parameters have been set (personal preference) to show anything within 1 standard deviation of the major price action level ($19.00) as being coloured red. Statistically, any trade entry within this red zone has a low probability of success under the then current circumstances. In this dynamic analysis tool every day adds to the pool of data and the calculated price levels adjust to the most recent information. Consequently, any trading decisions are base on current and up to date data.

In the AMP example trade entry at $20.60 could be made sometime in the future as that represents price action moving away from the magnetic influence of the $19.00 point of control.

The other horizontal lines indicate price levels corresponding to 2 and 3 standard deviations from the point of control.

Conclusion and Suggestions

The original concept and application of Steidlemayers analysis technique is now readily available to ordinary traders. What is now available is even more powerful than what has been used by intraday traders since 1986. It has evolved into an extremely useful trading tool that aligns trading opportunity with statistical reality.

Simple and effective trading plans can be developed around this arrangement of data and application of statistics.

Only the normal distribution has been addressed above. Other set-ups that are observed on the market price action include the bullish and bearish distributions. Here again some very simple and effective trading plans can be devised to take advantage of this representation of price data.

As with any trading, disciplined adherence to your own money management rules should be paramount. The MPA tool is simply a device to improve the probability of entering a profitable trade.

About Robert Lennox

Robert Lennox is an active trader of Shares, Futures & CFD's and has been trading since the early 1990's. With a background in education, Robert began teaching the skills he developed to successfully trade in the mid 1990's, and has worked with 5 education companies in this time.

Currently, Robert's main focus is his trading, however he also works with two education companies as a guest speaker.

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The Educated Analyst | 7 Finding Lows and Highs with Fibonacci Retracements SEPT /OCT 2009

Crisis...What crisis? In the past few months the word crisis has dominated the headlines. Many people have lost bundles of money, but in saying that it must be remembered that mainly this is due to incorrect analysis of the market movement, trusting other individuals or so called market experts, or simply the head in the sand approach hoping things will quickly improve. In my nearly twenty years of trading, I have developed and refined a trading plan that works very well for me. Even then I am still working, researching and testing new methods, tools and systems to see if I can improve my trading. Has my plan worked in the current crisis? I am pleased to report a resounding yes, just as it has done, and will continue to do so long after I have stopped trading. Firstly, I am an intraday trader, looking for entries and exits within the session. I particularly like the SPI200, the futures contract on the Australian top 200 XJO. This is similar to the S&P500 or the E mini contract. I will open and close a position within the day session; in essence, I dont have an open position overnight, protecting me from wild swings emanating from overseas markets. I guess I like uninterrupted sleep too much.

On September 26 last year, in my newsletter report, I gave a forecast that the S&P 500 would drop to 856 when it was then trading at 1215. The chart with that report is below.

I can still hear the howls of protest, particularly from overseas traders adamant that it would never make it that low because the government had taken steps to halt the crisis. The 856 level was determined by an old trick I learnt many years ago by placing the Fibonacci retracement tool from a high, then dragging the tool down to a low below where the market is trading. I do this until the retracement levels (38.2, 61.8, 23.6 etc) are then resting on highs and lows. You can do this very easily using the Fibonacci Retracements tool in Market Analyst software package.

Finding Lows & Highs

With Fibonacci Replacements. With Alan Oliver

Source: Market Analyst 6 (www.Market-Analyst.com)

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In the above case, you can see that IF the market got down to 856(which is below 1215 where it was at the time) the high at 1300 would be on the 38.2% line and low of 1215 would be at the 50% line and the low at 1131 would be on the 61.8% line. This means the market highs and lows previously mentioned would be in sync with the market at a low of 856. Now we move ahead to Friday October 10, 2008. Friday October 10 is significant for several reasons:

It is exactly one year or 365 calendar days from the all time high, a Gann anniversary count has reached our price forecast and slightly overrun it, something I am comfortable with especially when it retraces on the same day to close above the forecast level and becomes a reversal or Doji bar.

At this point, I have Time, Price and Pattern; these are elementary Gann pointers for a market reversal. This means that Monday, October 13 Australian time, our SPI futures contract traders who study overseas moves will be expecting an upward thrust Monday US trading time (our Australian night time). In expectation of this upward US move, the Australian futures should rally. My definition of an upward trend is higher tops and bottoms, so if the Australian futures

move above Fridays high, the SPI traders have confirmed my expectations and I will be long at 4144. Remember, I will close out the same day to protect my profits so I am only

looking at shorter term trends, not longer term trends. Indeed the market does move above the high on Friday so I am kicked into a long position.

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The end result is that the ferocity of the buying pushed this market up at an alarming rate, and within 3 minutes I was ahead some 40 points on 5 contracts. This is abnormal behaviour, and for me this behaviour can revert just as quickly as it started, so I elected to exit my position with a great profit. As things would have it, I hit the buy button on my electronic platform instead of selling; effectively I am now long 10 contracts when I wanted to be out. (Grey hair, bad eyesight, and getting old, whatever....) I now had to exit 10 contracts and surprisingly enough in the short time it took to do this I made another 10 points profit on my mistake. Sometimes you can be so lucky.... Remember, this trade took around 3 minutes from entry to exit, and then I had a good lunch. Trading is about having a defined set of rules that you know work the majority of the time, implementing those trades that comply with your rules in line with money management criteria. My trading plan incorporates the fabulous work of Fibonacci and W.D. Gann, and its the combination of

these two theories that keeps me on the right side of the ledger throughout any trading conditions. If you take the time to learn these tools, you will also see that some time, effort and practice on your part can reap great rewards when everyone else is yelling Crisis!!

Alan Oliver is a full time trader and private educator. Early in Alans career he worked for two major Australian banks where his interest in the markets began. After developing and successfully honing the skills of a full time trader, Alan left the workforce to trade full time which is what he has been doing ever since. Most recently Alan has written a book on his favourite subject of Fibonacci and the Golden Harmonic ratio. Alan has travelled extensively, been invited as a key speaker to many countries including: Australia, Hong Kong, Malaysia, Singapore, Thailand and China. Alan also runs a web site (named after his book) to assist traders www.tradingwithgods.com .

The Educated Analyst | 10 Habits of Success SEPT /OCT 2009

Risk & Mind Management / Trading Foundations I shall be writing two articles for The Educated Analyst in my quest to identify why only 10% to 20% of traders achieve success. It is almost a clich that trading success is a function of: Winning Psychology (60%) x Risk Management (30%) x A Written Plan (10%) This formula had been known for quite some time. In other words, the roadmaps (the Habits of Success) required to succeed have been clearly laid out for all to see. And given the tremendous advancement in understanding how our brain works and the role of emotion, I would have expected that the ratio of successful traders to unsuccessful traders would have improved since I started trading over 30 years ago. But, looking at the figures, the ratio remains the same - 80% to 90% are long-term losers. And this, despite the fact we went through one of the most sustained bull markets in stocks, gold, and crude oil. That environment should be conducive to trading success, but this has not proven to be the case. So, the question must be asked: why? One answer lies in the unrealistic expectations of each generation of newbies. Relatively few (if any) budding doctors, lawyers, architects would believe that by attending one paid seminar, and/or reading one book and/or attending a series of free previews, they will acquire the knowledge to succeed. But this is not the case with trading. The fact that we are bombarded by hyperbolic claims of easy, quick and meteoric success, suggests that the ads work i.e. the purveyors sell enough products to make it worthwhile. On the other side of the equation, the relatively fewer realistic ads would suggest that genuine vendors are less successful. But this factor is not the complete answer; I have met many genuine committed budding traders who have failed. So again, the question is why is this so?

I think it is partly because trading is a probability game, and because it is a probability game, on any one trade, a raw novice can beat an experienced trader i.e. the novice will make money in the trade while a master will lose money in the same trade. This aspect exists only in trading: If I took Mike Tyson or Tiger Woods or Nadal, I would have no chance of beating them in their chosen sport. As a result of this quirk of nature, the mental paradigms, which would be difficult to overcome, become even more formidable. It does not help that the paradigms are unconscious and that the trading environment is surrounded by two additional barriers to success: 1. There is no formalised educational structure in trading. The gamut ranges from someone like Dr. Brett Steenbarger (who devotes his considerable expertise freely and for no charge to assist the retail trader) to the scam artists who falsify results to prove that their trading systems will have a 90% return and will turn $1 into $1M in 3 months or less. As a result, the environment inadvertently strengthens the unconscious barriers to success. 2. The low barrier to entry. In sports, to compete with the best in the world, you need to attain a certain level of competence - not so with trading. Indeed with CFDs, you can enter the arena with as little as S$1000.00 (about US$750.00).While I am a great believer in the benefits of CFDs in the appropriate context, in this case, all it does is encourage a novice to trade when he has little chance of success. So, we have thus far traced four reasons why the more things change, the more they stay the same: Human nature: wanting something for little effort The fact that on any one trade, a novice can beat a professional The lack of a formalised educational structure and The low barrier to entry

Habits of Success

With Ray Barros


All of these factors impact on the three most important and unconscious barriers. The biggest block to our trading success is what I call our default future. In our childhood we encounter events to which we develop strategies to enable us to be safe, and secure. In time, these strategies become automatic, unconscious responses. To the extent we come from a functional environment, is the extent to which we achieve success - the responses become our strong suits; to the extent we develop dysfunctional responses, is the extent to which we will fail. By functional, I mean with the ability to deal with reality. But whether the responses are functional or dysfunctional, they key point is they are unconscious and automatic responses - and as such, until we become aware of them, they create a default future. In short, the responses are what we dont know, we dont know and until they become known to us, we will continue to respond in the same way, especially during times of stress. In addition, it appears that humans are hard-wired with two traits and these two traits are formidable barriers to our success: 1. Our decision-making process falls predominantly into the Impulsive or Risk Manager mode. Its important to understand that the terms describe a mode of behaviour we tend to fall into; we need to execute our trades in the manner best suited to one of the two modes to which we belong. For more information read: Day Trade?2. We invariably develop two unconscious strategies; the fixed mindset and the growth mindset. We have both, but one tends to predominate. The fixed mindset says that our ability and intelligence is limited. Therefore our success is dependent on the talents we have. Since that too is limited to what we were born with, there is no point in seeking to

(http://tradingsuccess.com/blog/day-trade-725.html).

improve and enhance it. This mindset is seen most clearly with talented individuals who do little to enhance their abilities e.g. John McEnroe. I would venture that this mindset predominates with those that enroll for the sure win, no effort school of trading. The other mindset is the growth mindset that believes in constant and never ending improvement. It is the basis of the recommendations in the Cambridge Handbook of Expertise and Expert Performance and in the book, Talent is Overrated. With this mindset, we believe that success lies in our actions, and it is up to us to achieve what we can with the talent we were given. Like our default future, these traits are unconscious responses and not something that we know, we know or that we know, we dont know. Rather like our unconscious strategies, they fall into the category of something we dont know, we dont know. Since our default future falls into the what we dont know, we dont know category, how do we identify it? The easiest way is to observe our stated outcomes, our behaviour and our results. If our behaviour does not lead to our outcomes but we persist with the behaviour, you can bet your bottom dollar that some unconscious response is at play. For example, you would have a screaming pointer of a response at play if your goal is to attain consistent trading success, and yet you continually breach your trading rules. I have chosen this example because it allows me to bring in the two human traits: 1. The Impulse/Risk Manager decision-making process and 2. The Fixed/Growth Mindset. But before I get into that, let me bring in one more important variable. Denise Shull rightly promotes the idea that as long as we are executing our trades (as contrasted with a computer executing our rules), we must allow for some form of discretion. In some quarters, this may be seen as a breach of rules, but she


likens it to a coach giving his team the play and having the quarter-back make the on-the-field decisions. A good example of this took place for me on FOMC night. I had decided to sell the ES if: I saw volume at 896 and The volume occurred no earlier than 10 minutes after the rate decision was announced. Well, right on the button, strong selling volume came in and at 899, I decided that the strength of the volume meant that at 896, we would see the volume that would trigger the sell signal. So, I took the trade and got filled at 898.75. If I had been proven wrong, I would have exited the shorts. Denise is right, if we do not allow some room for our discretion, we are doomed to not following our rules in situations which not following is the correct thing to do. This brings me to the next point. My dominant decision-making process is that of a Risk-Manager, which is why I have better trading results as an 18-day swing trader than a day-trader. But there are times (usually in the execution of a trade) that I act more like an Impulsive decision-maker, and I am OK with that - as long as I exit the position, if the market fails to do what I was looking for. So, if you are someone who is not following your rules, check to see your decision-making style. If your style is the Impulse mode, then make sure you do some pre-planning as this will help your intuition. Then just execute on your intuition BUT after executing, check the reward/ risk, trading benchmarks, etc. If the trade does not qualify, just exit. Do not anchor your entry price - just exit. In other words, the decisions (normally made by the Risk Manager) before the trade are carried out by the Impulse Trader after the trade. An example of an Impulse category would be most pit traders of old. An acquaintance recently told me: You know theres

one simple reason why most people dont make the improvements in their lives they long for: The reason is

that nothing is going to change in their lives if they dont take conscious actions to make a difference. You have a choice: Either go after the knowledge and opportunities that will make a difference in your lifeor stay where you are. The problem is it is only now that we are discovering how to identify and change what we dont know, we dont know. And until we do that, until we change that to we know what we dont know, all the innovations and discoveries will not make one iota of difference. The last trades I took in the DX (US Dollar Index Futures) and the ES (e-mini S&P Index Futures) highlight the importance of being aware of our unconscious motivators. An example

Regular readers of my blog (www.tradingsuccess.com/blog) know that I started 2009 with a whimper. I failed to recognize that my trading was in an Ebb state, and as a result, suffered the largest monthly loss since I started managing my private closed fund in 1990. Since then, I have been struggling to make a significant dent in the losses. I had great expectations for the two trades, DX and ES. I will focus on the DX here because the ES trade is well documented on the Video/Forum/Twitter free service. Everything had lined up perfectly, and I was very confident that my favoured scenarios would unfold. I entered my first positions at 79.67 and a second set at 80.49. After both entries, the market immediately went my way. But then the DX stalled. I had been looking for a simple correction but instead, we saw a small trading range develop (see Figure 1). The second set of positions I had added to the DX 80.49 proved to be around the middle of a congestion zone bounded by 81.97 and 79.62.


On Thursday June 25, the DX went to the Death Zone of the congestion zone mentioned above and sold off. I was faced with the prospect that: The DX would at least break 79.62 and if it did

that, a breach of 78.83 was likely. A breach of 78.83 probably would resume the US Dollar bear market. If I did not exit and the market broke as expected, I would face a loss or breakeven trade after the market had moved in my favour.

Or would the Death Zone sell signal play false? If I exited the positions, would the DX go up rather than down, and would I have exited my positions prematurely? What if I exited and did not see another setup and trigger to re-enter the trade? I would lose the one chance I had to make substantial inroad into my losses. I have reproduced some of my journal entries to give you an insight into my state of mind. I am comfortable losing up to 20% of my capital - I do not like it but accept it as part of the trading game. When I lose more than 20%, my anxiety levels rise. I respond by cutting position size and making it a priority to bring the losses down under the 20%. Unconsciously, I had placed great faith that these two trades would not only bring me under 20% but would also substantially reduce the losses. Then the blinking

market had done this!! (Quote).

Whenever I feel great stress, I find it useful to rant in my journal - it blows off steam, and it allows me to safely fully experience what I am feeling. Once I have calmed down, I return to myself and then the markets. I realized that the loss and market information I had received on Thursday had triggered my unconscious motivator. Hence the emotional response. That awareness allowed me to deal with market information in a more centered state. Having made a decision, I implemented it and felt better for the way I had gone about it. If I had acted when my unconscious motivator had hijacked my emotions and reason, whatever decision I would have made, would have been wrong for me.

FIGURE 1 Charts made available through the courtesy of Market-Analyst In this article, I have focused on the need to start with the foundations of trading success: risk management and psychology because although more important



than a set of trading rules, they usually are at best given lip service, and at worst, ignored or disseminated with out-of-date material (for example: trade without emotion!). My advice: undoubtedly, you need a set of trading rules but start with a simple one and focus on cementing the foundations. In my next article, I will consider the written trading plan. About Ray Barros

Ray Barros is a professional trader, fund manager, author, and educator with over 30 years experience in the markets.

Ray is the Author of 'The Nature of Trends and has appeared on Singapores Chanel News Asia, Bloomberg and CNBC. Ray has been regularly featured in regional newspapers and publications like Sydney Morning Herald, Your Trading Edge Magazine, Business Times, and Smart Investor. The interviews have focused on his trading strategies as well as his opinions on market sentiment. They have also dealt with his track record, trading philosophy, how and why he got into trading, and what advice he would give to those wishing to become traders/investors.

Ray can be contacted through his website www.tradingsuccess.com.

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The Educated Analyst | 16 Market Sector Maps SEPT /OCT 2009

Technical Analysis / Sector Analysis

For many years a good way to pick stocks was to compare its performance relative to others in the same sector. To be thorough you would also need to compare different sectors to see which way the sectors were moving. All of this added up to many scans and many hours spent studying charts to see how the stocks and sectors compared. Not anymore, in this article Ill show you a way that you can use Sector Maps to quickly identify stocks that are worth more detailed analysis.

Set the Scene

I would classify myself as a relatively short term trader. I like to take a position, set a stop and as my trade moves into profit follow the stop up fairly tightly. Sometimes this means that I am out again very quickly, but if the market moves, I get to stay in for a bit longer. My main method of analysis centres on Gann Squares and geometry, but this takes a lot of time and while I also run a business I cannot analyse all the stocks in this manner. So how do I pick the stocks that I want to analyse and hopefully trade? Well this is where I use the Sector Map in Market Analyst.

What is the Sector Map

The Sector Map is essentially a three dimensional way to view the rise and fall of all stocks and sectors in a market. There have been traditional maps for some time that have shown the capitalisation and growth by size and colour, but the third dimension allows me to see growth (or

contraction) for two different time frames. Perhaps this will be easier with some pictures.

The picture below shows the state of ASX shares on the 23rd June 2009.

Mostly Red so immediately I see that the sentiment on the whole market was a bit sour. Each surface in the map represents a single stock, the physical size tells me how big the company is, or in technical terms, its capitalisation. So in the top left corner you can see the ASXs biggest square which is BHP.

MARKET SECTOR MAPS A NEW WAY OF RELATIVE COMPARISON

With Mathew Verdouw



The colour of each surface tells me how that stock has performed over the last week. Green surfaces tell me that its price has gone up, and a red surface reveals that the price has gone down. The intensity of the colour grades the change in price for me. As an example the bright red surface in the top centre of the map shows me that VII (Vietnam Industries Inc) dropped by 27% over the week. The biggest loser that day.

The height of each surface tells me how the price of each stock has moved over the last 3 months. Each sector also shows the 3 month growth of the sector, but you really need to see that on the video below as it is difficult to show in a picture.

So how do I use it

Obviously how you use Sector Maps will depend on your personal philosophy. Mine is one where I am searching for stocks whose value has plummeted, and then I do some further research on the stocks that I find, to see if I think that they will rebound. If you would prefer to wait for the stocks to move up, you could use this just as well, you would be waiting for some green surfaces to reveal this trend.

I like to find a sector that has had some growth, like at this time it was the Energy Sector. On the sector map I hold down shift and Click my mouse in the Energy area and it will Zoom in to show me only the stocks that are in that sector. Then I grab the Sector Map with the mouse and move it around, looking at the relative heights and colours of all the stocks in the sector.

The three images below are a result of the rotation of the Sector Map.

Once I am looking end on (the last image) I can see that while the sector has improved over the last three months (revealed by its height off the plane) there are some stocks that have performed really badly in that same time. As I move my mouse over the surfaces I can view the details as shown below.

For me, CTP is a standout. Its sector is performing well but something has happened to make this one not perform. At this point I right click on the surface and Open the chart for further analysis.

By the time I saw this chart the stock was already making a bounce back but after doing my Gann Analysis and a quick search on the ASX web site to see why this fall was happening, I was confident that this was a good buy. The stock went sideways for a couple of weeks but it never took out the low of the 23rd, and allowed me to sell on the next retracement for a comfortable profit.

Not all stocks behave this nicely, sometimes they are Red on the Sector Map and they stay that way. But the Sector Map makes it really easy for me to find the stocks that I am most interested in, and then from there do my detailed analysis to see if I want to take a trade or not. Of course, so long as you apply sound Money Management strategies in your trading then you can continue to trade for a long time even when the markets have turned against you.



As the Sector Map is a difficult concept to visualise in 2D pictures, I have included a link to the Sector Map video on the Market Analyst tips page here - http://www.market-analyst.com/tea/links/1

About the Author.

Mathew Verdouw is the Founder of Market Analyst Software (www.Market-Analyst.com). Holding an Honours Degree in Computer Systems Engineering, Mathew set about building a unique technical toolbox that would give traders new and interesting ways to view market data. Mathews dual perspective of seeing the issues that face traders as a Trader and also as an Engineer has given him the ability to drive further development into some of the most innovative techniques ever seen by traders.

Mathew can be contacted by e-mailing him at [email protected].

The Educated Analyst | 19 The Cantillon Effect SEPT /OCT 2009

Tall buildings and what they forecast. With Phil Anderson.

ometime in the very early 1800s, a Manhattan carpenter named Lozier came to the somewhat startling conclusion that the city in which he lived was dangerously

lopsided and had too many taller buildings on its lower end. If any more structures went up, he warned the city, the island would sink into the Hudson River. To head off this expected calamity, Lozier suggested to the city's mayor that a chunk of Manhattan's northern end be hacked off, towed down the Hudson, and then attached to the southern tip. This, Lozier explained, would redistribute the island's weight and ensure no further sinking.

Impressed with the scheme and with Lozier's ingenuity, New Yorks mayor suggested Lozier commence at once, handing over to him from the City Treasury a good deal of cash to do so. To help him, Lozier advertised for workers. Some 500 showed up one morning, shivering in the cold waiting for the boss to show up. As the reader might already have guessed however, our carpenter Lozier was long gone; taking with him the city's money intended to finance the project.

Over the years, New York City has had its fair share of real estate swindles. Another was thought to be in progress when a 50 metre high 'superstructure' was started on a six and a half metre plot of Broadway land in the spring of 1887. The owner, a Manhattan realtor named John L. Stearns, actually owned the neighbouring plot as well, off lower Broadway in New Street. The front plot, however, facing Broadway, had become so hemmed in that Stearns found it practically unsaleable except at a give-away price.

Frustrated, Stearns approached Bradford Lee Gilbert, a nearby architect for a possible way out. The solution, Bradford recalled in his reminiscences, was to build an iron bridge truss, but stand it on its end; a solution that took him a full six months to conceive and design he said later. In this way, the real structure of the building

would start several stories above the curb and help produce the best design to maximize occupancy and rentals. The world's first skyscraper, as the invention was later called, built of skeletal steel was born.

So ingenious was the invention, utilizing the land space as never before, that the design enabled its owner to reap $90,000 a year more in rentals than would otherwise have been possible. A mania for tall buildings quickly developed; a phenomenon that continues to this day. Since then, the opening of successively taller, then tallest buildings, has proceeded in waves: the most remembered being The Empire State Building which opened for business in May of 1931 to great fanfare, but practically empty.

Ive given a name to this phenomenon - The Cantillon Effect: so named after Richard Cantillon (1680 - 1734), an Irish banker of the early 1700's, generally credited today as the first economist to suggest that a change in the supply of money and credit will affect the economy by changing prices. Cantillon recognised that an increase in the availability of credit would result in economic expansion, but that ultimately this would be overdone as prices rose and imports increased. His work pre-dates Adam Smith and was just as important, if not more so.

For maximum forecasting ability, however, the Cantillon effect should only be interpreted in conjunction with the 18-year real estate cycle, at the end of which is when the Cantillon effect will usually be at its most obvious, with easy credit conditions on display and when competition for the worlds tallest is sure to be at its height: the taller the building on the drawing board, the more available and easier to procure is the bank created credit.

The Cantillon Effect


As it happens, the world's tallest buildings have had a distinct and consistent habit of being completed right at the top of the real estate cycle, (since Gilbert's first tower, there has not been an exception to this occurrence at each real estate peak), producing for us - at least so far - the most reliable indicator of an approaching real estate cycle top.

This is hardly surprising: as any decent architect could tell you, though rarely these days it seems, an economist. Tall buildings are just built spaces to make the land pay. As a general rule, skyscrapers are a speculative project, built mostly by developers with other people's money. Such buildings are going to be built only when credit conditions are easing or at their easiest, the time when developers are most flush with funds: hence the link with credit, and to Richard Cantillon.

So what will happen as this latest real estate cycle approaches its low point in 2010? Already, the confluence of tallest buildings into the end of yet

another 18-year real estate cycle (the previous cycle low in the US was in 1992) has repeated, just like every other since 1837. It can also be seen that the geographic location that supports the tallest, usually experiences the severest slump in the years after the general downturn elsewhere. This does not augur well for Dubai. (In Shanghai, the 101-story Shanghai Tower is due to open shortly, being built by Minoru Mori and his associated company. Whilst he is a rich man, a lot of debt - US$ 7.2 billion worth - is financing his ambition. China though, has a tonne of reserves to recover reasonably well from the present world-wide downturn.)

As for what is happening in Dubai, we know that development in recent years was proceeding at break-neck speed and long term it is hard to be too bearish on the whole scenario, but the city will see a few bumps in the road shortly. Whilst information is not easy to come by about what is happening there, (the required information with which to make a judgement is now classified a state secret) there is no doubt a decent


amount of debt and leverage was used. The builders of Dubai are likely to need a hefty state bail-out. Lower oil prices, should this eventuate, could easily create a panic in this location later in the year.

The worlds tallest always open in recession and are never fully occupied.

About Phil Anderson

(Adapted from an article first printed in MoneyWeek, UK, February 8th, 2008)

Phil Anderson is Managing Director of Economic Indicator Service Ltd, an economic forecasting service based in London. Phil uses Market Analyst to help with forecasting and trading decisions. His book The Secret Life of Real Estate was published in the UK in 2008. The web site can be found at http://www.businesscycles.biz

The Educated Analyst | 22 On the Couch with Chris Shea SEPT /OCT 2009

Risk & Mind Management / Trading Psychology.

In this article I want to take a deep look into the actual performance dimensions that lead to consistent and growing profits.

Firstly, let me quickly review some important key attributes of successful traders:

1. A personalized approach I have worked with scores of successful traders, and each individual has a unique strategy which gives them a winning edge. Essentially good strategy integrates a coherent analytical framework combining multiple time frames with the management skills that enable losses to be kept small and to allow winners to be as large as the market allows.

Conversely if you do what the majority does, you wont have an edge and you will lose.

2. Discipline Successful trading is not a hit or miss affair. Success comes from the will to win and the determination and endurance to follow through. Successful traders take a hard headed approach and regard their enterprise as a business rather than an indulgence or hobby. They expect their accounts to accumulate, despite being stopped out often. They know that with discipline and consistency they will prevail. Successful traders have the discipline to remain focused on their business tasks despite the events occurring outside their control, for example panic and extreme volatility.

3. Passion By passion I do not mean an emotional outlet with regard to trading. By passion I do mean enthusiasm, motivation and the commitment to stay with the task, especially as pressure comes on, as it inevitably will.

My clients who succeed really enjoy their trading. Is this surprising? Success breeds success. Trading isnt an ordeal; rather its an absorbing challenge. The successful ones arent ambivalent about it: they want to do it, and do it well. Setbacks do not dent their confidence and enthusiasm (for long), but are regarded as an opportunity to learn and refine their methods. Passion enables them to be self- evaluative and to strive for better outcomes.

Now lets delve deeper into the type of performance that is essential for success. In particular I want to compare the type of thinking and action of top performers, with what is the public or general view which leads to poor quality outcomes.

To do this I want to use an analogy of performance with which you will be familiar: driving a car. For more detail on this analogy refer to my book Licensed to Profit by Trading in Financial Markets.

When you are in command of your car your performance is heuristic. All the complex input sensory data relating to speed, traffic, and direction are integrated within your brain to instantaneously and automatically produce the desired outcome moment by moment that enables you to reach your destination. There is an emotional component to this. These emotions are associated with trusting your self to perform, relaxed and poised, at your best in the dynamic yet dangerous environment, and to enjoy the journey.

On the Couch

With Chris Shea.


This is exactly how top operators approach trading. They perform heuristically in the face of complex market input.

On the other hand it is difficult to achieve top performance in trading if you are effortful, mechanical, judgmental and analytical. Im not saying that analysis is not important. It is. You need a road map. But you dont put the road map in front to your vision when you drive.

But if you have to analyze and deliberate, to think about what you need to do and how to do it before you execute you will probably hesitate, unable to perform well to take advantage of the opportunity as it presents itself. After all if you see a bus coming towards you in your lane, you dont calculate its momentum and your breaking distance or consciously think about what you need to do and how do you do it. Your heuristic performance enables you to short circuit all this. You just hit the breaks and swerve away.

Unfortunately the general view of trading is that it merely relies upon the mechanical application of analysis. But this is insufficient for great trading outcomes.

Learning to trade heuristically

Is it possible for you perform in financial markets, i.e. trade, in a heuristic fashion? Yes of course it is, if you have the will and the patience to learn how to do it and trust it. After all you have already demonstrated your capacity to achieve this feat when you learned to drive your car.

The heuristic approach is Learned Behaviour. It probably wont come naturally. Ironically the mechanical and analytical phase provides you the base to go forward with. Most traders in the break even zone are so close.

Here are 3 key elements I encourage in my clients:

1. Presence You need to stay in the present moment and to keep your mind sharply focused on the trade in front of you. You have to learn to flawlessly execute in the moment what the market is presenting to you. You have to relinquish both past outcomes and the unknowable future. This moment is all that you have to deal with. Nothing else matters now.

In the present moment you remain unattached to your account, your ego and even your desires. You just trust your capacity to perform well in each moment to create success overall.

2. Freedom In that moment, you need to avoid mechanical, judgmental and analytical thoughts as well as negative emotions. You should be trusting in your ability and your acumen to flawlessly execute what you have prepared for and anticipated. You need to release your fantasies about wealth and power emanating from your trading, as well as your anxieties and fears of failure and annihilation.

You are free to act in the moment because you dont have a view or prediction about the market in the future that you need to defend. You are free to implement your strategy. This is emotionally not only liberating but also pleasurable and satisfying.

3. Strategy You need to develop and stick with the routines and procedures that maximize your strategy.

You trust that you will take the necessary action that your strategy requires as the market unfolds. You know that your strategy will project false positive trades as well as winning trades. Accept that as an ingredient of the business.


Your ego or cleverness isnt under scrutiny: the efficacy of the strategy is. Your detachment allows you to put your strategy under the spotlight to use feedback to improve it for the future.

Conclusion

In this article I am suggesting that the way to win at trading is to learn, develop and use the same type of performance dimensions as when you drive your car. Yes you do need an efficient trading platform and excellent market analysis tools. But to profit consistently and handsomely you need to go the extra mile and learn and do heuristic performance in the market setting.

About Chris Shea

Chris Shea is an investor, trader, educator and psychotherapist who specialises in coaching those who want to become and stay successful in financial markets.

His emphasis is focused upon assisting clients not only to overcome their internal barriers but also to discover and implement their own successful approach based on their unique personality, experience and talent, to sustain consistent superior returns.

Through his in depth Best Professional Practice Program Chris has an established track record in coaching clients to develop the skills and drive to become independent, disciplined and very profitable full time traders.

Chris is author of Licensed to Profit by Trading in Financial Markets.

Chris holds a Bachelor of Education, Master of Science as well as a Diploma of Professional Counselling. While based in Brisbane, Australia, Chris has private and institutional clients in Australia, New Zealand, Ireland, USA and Singapore.

www.themarketcoach.com

Do you have a question that you would like to ask Chris Shea? Email your question to [email protected]

The Educated Analyst | 26 Gann Swing Charts SEPT /OCT 2009

Before you start to do anything in trading, you should first make sure you have a very strong foundation and plan of what it is you are going to study, trade and invest in.

Ninety-nine percent of people will never get to the knowledge and understanding of markets and cycles that the great W.D.Gann had. Gann dedicated his life to studying financial markets in an attempt to understand them, spending years studying day and night.

The more time you put into your trading, the bigger the rewards. The biggest failing that people have when they start trading, is that they believe that they can have all the knowledge needed to make all the money of their dreams within a very short period of time. This is not going to happen. You have to start off very slow, and gain more knowledge year by year. It took me twelve years to work out WD Ganns commodity course (full time). Its taken me twenty-five years to decode WD Ganns books The Tunnel thru the air or Looking back from 1940 and The magic word.

Here are five of Ganns principles that I recommend you start following, and keep working towards daily:

1. Good health: the better your health is, the quicker you will learn.

2. Gain knowledge: Start with Ganns seven books. 3. Capital: eliminate your debt and have your own

money to trade. 4. Patience: learn to wait for the market to get to

setups in both time and price (dont jump into a trade too early just to trade).

5. Nerve: when the market gets to your entry point, pull the trigger and place a stop lost.

Another very important thing to do is to get long term accurate data. You cannot possibly study Gann theory without high quality data.

In my opinion, Gann works best on commodities, as there much longer term data available, and also,

commodities cannot declare bankruptcy. Another point to note is that with the USA printing money like Germany in 1923, commodities are where all the money is to be made in the future.

There are a number of swing charts you can look at on Market Analyst. I suggest creating monthly, weekly, daily and point swing charts.

You will see my first chart that I have created is a 91 day (quarterly chart) swing chart of December cotton, cotton was one of Ganns favorite commodities to trade. I have assisted Market Analyst in the development of their swing charts to ensure that the swing charts provide more detailed information than was previously available. As you can see it gives you the dates of highs and lows, cents per/lb the market has moved and number of days up and down. This information assists as it allows you to quickly see the over balancing of time and price. You can see very easily that the market has broken back through the lows of 2004 to 2007 turning the trend up. Its moved up through to May, a seasonal high (In Ganns book How to make profits in Commodities) at .6375 on the 12th.That was up 181 calendar days or half a time cycle (Time in the bible is 360, Time, Times and half Time = 1260 days or years.) Watch for resistance of 252 days up which will equal the move down from the all time high. (252 x 10 = 2520, this is twice 1260).

Gann Swing Charts

By David Burton


Half the move up is at .6757 a natural level to sell off from.

Now that I have my longer term swing charts sorted out, I can look closer at the market action, so I go to a 23 day swing chart (which is Ganns three weeks swing chart). 22.8 days times 16 is 365.25 days (16 planes on Ganns cover of Tunnel thru the air). You again can see very quickly that if we add .2050 cents (the first move up) and add it to .4625 (the last low on the 23 day swing chart in the following image) we get .6675, closest to the .6750 level.



Gann also used the 2 day and 3 day swing chart, depending on where the market was positioned. The next chart is a 2 day swing chart. The 2 day and 3 day swing chart is based on the moon, as the moon changes sign every 2.5 days. The moon controls the masses emotions, so it is good to watch this chart in the final stages of a move. After the market makes a top, it will first over balance price, the first indication that it has turned down. You would then look at the 3 day swing chart to see if it has turned down, and go short with a stop above the swing high of no more the 3%.



In Summary, for greater understanding, read the first 64 pages over and over of How to make profits in Commodities and especially follow his 28 rules on page 43 and 44.

About David Burton

David Burton is the C.E.O of School of Gann (www.SchoolofGann.com), and has been studying the methods of W.D.Gann since 1983 and financial astrology since 1980.

David writes articles on Gann for a number of magazines, and has made many public forecasts in advance like the 1995 all time high in cotton, the all time high in wheat in 1996, the major low in cotton in 2001, the high in cotton in 2003, the all time high in wheat in 2008 (12 years in advance) and the top in the stock market in 2007. Due to the- time that he devotes to his trading and investments, David runs only one workshop per/year.


USING MARKET CYCLES TO DETERMINE WHEN TO EXPECT A CHANGE IN DIRECTION

The Educated Analyst | 30 Using Market Cycles SEPT /OCT 2009

any of you would agree that the basis of trading is to time your entry and exit so as to extract a reasonable percentage of available

profit from a movement in the price of a market. However, if this is true, why then do so few traders actually use time analysis in their trading? In my experience, many traders believe they are using time analysis to enter the market, when in fact they are relying on the more traditional methods of price and pattern to time their entry.

Undoubtedly, price and pattern do have their place in trading, but only when the time is right. In fact, when you use time as your primary analysis tool and then apply price and pattern to aid in fine tuning your entry and exit signals, you will eliminate many of the false, late or inconsistent signals that cause traders to lose money.

Many times in other articles I have used Ganns time projections to demonstrate how you can use this method of analysis in combination with price and pattern to trade the market. While this method of analysis works well over all time frames, it is used primarily for shorter term trading to assist in narrowing down the entry and exit points of a trade to within days of a high or low. Therefore, in this article I want to introduce you to my preferred method of timing, which although not well known, is highly effective and based on the work of Walter Bressert and Ray Merriman.

Walter Bressert is credited with introducing timing cycles into the Futures market in the late 1960s.

Timing Cycles

Bressert found that markets moved from low to low in measurable time frames which he called cycles. As we have identified with Ganns theory of time analysis, cycles are intervals of time that can be repeated to assist in predicting turning points in the market.

According to Ray Merriman, timing cycles are a measurable phenomenon that occurs consistently at regular intervals of time. The phenomenon does not have to occur with 100% regularity, however it should unfold with an 80% consistency or greater during a regular interval of time. A regular interval of time does not mean on a specific date or in a specific week. It means within an interval, or orb of time. For instance, a six week cycle does not mean the cycle unfolds exactly every six weeks, every time; it means a cycle of 5-7 weeks unfolds at least 80% of the time.

Figure 1 shows how a 26 week cycle on CBA unfolded between Sep 99 and Oct 02. Notice that each of the cycles ranged in length from 25 to 29 weeks, which is well within the allowable time frame of 22 to 30 weeks

With Dale Gilham

Figure 1 Source: Market Analyst 6 (www.Market-Analyst.com)



for the lows to occur, which represents a consistency of 100%.

Cycles range from many years down to minutes. Common cycles include 54 years, 18 years, 9 years, 4 years, 22 months and yearly. Notice that these cycles are generally derivatives of each other and unfold to fit within the cycle of larger degree. Once we get below a yearly cycle we change the way we label cycles. For example, a primary cycle is 16-26 weeks, a major cycle is 4-7 weeks and a trading day cycle is 4-7 days. It is important to remember, that the longer the cycle the more dominant it is. For example, a 4 year cycle is more dominant than all the cycles below it.

As I indicated above, cycles are measured from low to low, and have an average time band, plus or minus a period known as the orb, which is 1/6th of the cycle length. In an 18 week cycle, 1/6th of 18 weeks is three weeks. Therefore as shown in Figure 2, the cycle has a time band of 15 to 21 weeks in which the low will occur.

To demonstrate how effective this form of analysis can be I will now apply cycles to the history of the All Ordinaries Index. In so doing I will show you how you

can use this method of analysis to predict where the market is heading in the future.

Predicting the All Ords

When analysing a market or stock you need to look at the complete history to identify the major lows and then work forward in time (using smaller cycles). Because we only have reliable data on the All Ords back to 1982, I will use the Dow Jones Index to highlight how the cycles have unfolded on our market, given that the All Ords tends to the follow the Dow Jones in its major moves.

Figure 3 shows the decline on the Dow Jones from the market highs in 1929, which lead to the Great Depression, into the low in July 1932. This low was in fact a 54 year cycle low, as the previous major crash on the US market was in 1873 some 59 years earlier, which is well within the allowable time frame for a cycle low given that 1/6th of 54 years is 9 years (45 years to 63 years).

If we use July 1932 as our starting point, we can predict the next 54 year cycle low on our market, which would

Figure 3

Figure 2




be due in 1986 plus or minus the orb period of 1/6th (9 years) of the cycle length. Given this, we know with high probability that the cycle low will occur sometime between 1977 and 1995. And as we already know, the next major crash on the Dow Jones occurred on 29 October 1987 or 55 years on from July 1932. The actual low on the All Ords occurred on 11 November 1987 as shown in Figure 4 below.

Figure 4

If we project out another 54 years from 1987, then we can expect the next 54 year cycle low to occur in 2041 plus or minus 1/6th of the cycle length (between 2032 and 2050).

Remember that all cycles are made up of cycles of lesser degree (time) with each cycle being a cycle of lesser degree in a larger cycle. For example, a primary cycle (16-26 weeks) is a cycle of lesser degree within the yearly cycle. Therefore, whenever a cycle of larger degree confirms, all cycles of lesser degree also confirm at the same time. Given this, all cycles of lesser degree from the 54 year cycle will start their next cycle from the

low in 1987 and as such we can start to bring our analysis of cycles down into a time frame that is more relevant to where we are today.

The next common cycle after the 54 year cycle is the 18 year cycle. It is important to note that with an 18 year cycle low, the market does not crash like the 54 year cycle; rather it is a slow decline into the cycle low that takes place over a period of approximately 3 years. In my

research I have found that in our market that the 18 year cycle is around 20 years in length. To calculate when the next cycle low is due we simply add 20 years onto the low in 1987 to arrive at 2007, plus or minus 1/6th (3.33 years) of the cycle length. Therefore, the next 18 year cycle low on the All Ords is due sometime between late 2003 and early 2011.

With this in mind and knowing that there is a high probability that the low will occur before the end of February 2011, which is the outer most limit of our orb period, then the market

will need to peak no later than the end of 2007 after which we would expect a long term bear market of around three years.

Although that said, it is possible that the 18 (20 year) year cycle concluded when the market formed a significant low in March 2003. However, the decline from the high in 2002 only lasted for 13 months which doesnt comply with cycles theory, because the market needs to decline over a period of approximately 3 years. Therefore, the most probable scenario is that the 18 (20 year) year low has not yet occurred, and the likelihood is that we are over half way into the move down into the low. Is it possible that March 2009 was the low? Yes as it fits within our orb period for the low, however we need




to be aware the market only fell for 16 months from the high in November 07. For now, only time will tell whether the current move up is simply a bear market correction, or the start of the next 18 year cycle.

About Dale Gillham

Dale Gillham is the Co-founder and Chief Analyst of Wealth Within, a specialist share market educator and boutique investments company supporting individuals to maximise their investments in the share market. For more information visit www.wealthwithin.com.au

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The Educated Analyst | 34 Gartley Trading Pattern SEPT /OCT 2009

ne of the most important aspects of adhering to any particular trading strategy is to believe that the strategy is a high probability strategy.

It is very hard to believe in a trade strategy if you dont know how it works (I.E. Black Boxes.) With this in mind, lets carefully consider each of the individual legs that unfold in the Gartley Pattern to understand the Psychology behind this high probability set up. Referring to the first example A in figure 27 from H.M. Gartleys book, Profits in the Stock Market, Gartley first identifies a bearish A-B leg . This leg appears to be a significant trend move or impulsive phase with minor rallies punctuating the down trend. At the completion of this A-B leg, we notice a significant rally that is labeled as the B-C leg. This B-C rally exceeds the previous rallies in the A-B downtrend in both price and time. This B-C price action indicates that the previous downward trend might be complete and that the B-C leg might be indicating the beginning as a new impulsive trend move in the opposite direction of the previous A-B move down. This B-C leg is very typical of what happens when traders all begin to cover their short positions after a sustained bearish trend. The B-C leg completes when the short covering is complete. With this in mind, the assumption is that the market will not take out the low at point B as a new trend up will probably continue higher and never look back. Based on this information, Gartley puts his protective sell stop just below point B. Though Gartley mentions the A-B leg in his book, most educators of the Gartley Pattern omit this important aspect of the pattern.

At the completion of the B-C move, Gartley mentions that there will be a minor decline that cancels a third to a half of the preceding minor advance (B-C). In other words, Gartley is looking for a 33% to 50% retracement of the B-C move up. Why does this minor decline take place? This minor decline could be caused by traders that were anxious to get short in the previous A-B decline. These bears were waiting for a significant pullback during this bearish trend down, however the market kept missing their sell limit orders on the rallies. Now that the market has had a significant rally against the downtrend, they start selling at point C and push the market down. Depending on where they get filled, they will put their stops just above point C. This selling from the late bears pushes the market down into what Gartley describes as a minor decline. This original Gartley Pattern ends up having a very different look and feel compared to how it is being taught today. The original Gartley Pattern was quite a simple pattern. Gartley did not discuss any Fibonacci ratios, Elliott Wave, etc. In Gartleys bullish example, it would appear that all he is looking for is a significant rally off of a bottom, followed by a retracement of 33% to 50%. Based on Gartleys original example, the original pattern only included four data points or three legs. It is of interest that the modern version of the Gartley Pattern does not include Gartleys A-B leg. In Elliott Wave terms, the original pattern would appear to be the completion of a Wave Two. That means that if the pattern works,

you would be trading a Wave three, a trade that most Elliotticians would consider very difficult to identify.

GARTLEY TRADING PATTERN

With Ross Beck

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The Educated Analyst | 35 Gartley Trading Pattern SEPT /OCT 2009

If you search the internet for information about the Gartley pattern, you will at some point come across the following picture.

As you can see, the pattern above is a complex five point pattern that has to conform to specific Fibonacci ratios on each of its four legs. The main differences between the modern Gartley Pattern above and the original Gartley Pattern are

1. The labels in the original pattern are A,B,C. The labels for the modern pattern are X,A,B,C,D.

2. The modern Gartley omits the original A-B leg. 3. The modern Gartley emphasizes the equality of

the A-B leg and the C-D leg whereas the original does not.

4. The original Gartley pattern did not include any Fibonacci ratios.

5. The completion of the original pattern was at 33%-50% whereas the modern pattern completes at the 78.6% retracement of the XA move.

Larry Pesavento was the first person to apply Fibonacci ratios to the Gartley pattern. Larry observed that the Gartley pattern appeared to be a more reliable pattern if it completed at a 61.8% retracement or 78.6% retracement. Based on my 10+ years of experience with the Gartley pattern, it appears that if you have to choose between the two of these ratios, 78.6% seems to work the best. With my personal trading, I will only trade the

78.6% Gartley patterns. Why? I would rather trade less often and increase the chances of my wins on the few trades that I make. If you feel a need to trade more

often, it may be time to take a personal inventory. We need patience to wait for good Gartley Patterns, remember Gartley himself said, The art in conducting an operation of this kind lies in..Having the patience

to wait .

In addition, one of the added benefits of using the 78.6% retracement is its proximity to where our protective stop is located. Remember Gartley said, In the other two cases, only small losses

have to be taken. So if we choose the 78.6% versus the 61.8% Fibonacci level to enter, our risk will be reduced if we use the location Gartley suggested for our stop. If we are wrong, we will risk less money with an entry at 78.6% versus 61.8%. One of the other reasons that I prefer the 78.6% level is that the public is typically unaware of this level as it does not appear in the defaults of most Fibonacci retracement drawing tools. Therefore there is contrarian value in using this level. Also, by the time a market arrives at 78.6%, most of the typical 61.8% fib traders have been stopped out. At this point in time, there is a lot of uncertainty as traders watch for a bounce or a break based on their focus on the previous high or low. Also, typically there is an increase in the volatility in the 78.6% retracement area as the market begins to reflect the uncertainty of its participants. The volatility in this zone will help us if we enter with a multiple contract strategy that allows us to leverage the scale out of the market.

About Ross Beck

Ross Beck, FCSI is a professional derivatives trader and publisher of the Gartley Trader newsletter. As a former CTA (Commodity Trading Advisor), in 2007 Ross was one of the top ranked CTA's in the world according to Barclay's Trading Group. Ross is a member of the Market Technicians Association and a Fellow of the Canadian Securities Institute (FCSI). For more information, go to www.gartleytrader.com

The Educated Analyst | 36 How to Identify Setups from Consolidated Markets SEPT /OCT 2009

Money in trading is made from catching a significant trend. Money lost in trading occurs by missing or being on the wrong side of trends. So the real question is How do we protect and preserve our trading capital as we position ourselves to catch the next profitable trend?

Significant trends are known to emerge from market consolidations and it is during these consolidations that traders experience whip-sawing leading to psychological trauma that can cause havoc with a traders life, which can cause the trader to miss the trend altogether!

It is said that markets trend approximately 35% of the time, meaning that 65% of the time they are trend-less. Consolidations are known to occur before many significant market trends and to be a profitable trader you must learn how to exploit these trends while not losing your money when the market is trend-less.

Trend traders need to develop skills to:

Non-Trending Markets Are Lethal To Trend Traders!

1) Identify Non-Trending Markets Quickly To Avoid Trading Losses So They Preserve Their Capital.

2) Have Skills To Identify and Take Advantage Of Non-Trending Markets:

a) Identify and Bracket the consolidation with support and resistance lines forming a clear visual channel and wait for the market to break-out of this channel before trend trading again.

b) Use options or scalp the consolidation for profits while you wait for the next trend to emerge.

c) Move to another market or time frame to trade and come back once a trend emerges from the consolidation.

Lets define a market consolidation. A dictionary definition of a

Consolidations: A Textbook Definition

market is the world of commercial activity where goods and services are bought and sold; without competition there would be no market. A dictionary definition of a consolidation

Is market consolidation an area where little or no new information has come into the market to cause a greater disagreement of value or perceived value which would move prices? And do trends occur because the value or perceived value is changing so much that the price must change to represent the new value? Answering yes to these questions leads to the conclusion that market consolidations are areas where no new value perceptions are being generated. Thus, prices remain tight or range bound. Consolidations are also known as Bracketed, Channeling, or Range-Bound markets.

is something that has consolidated into a compact mass; combining into a solid mass; an occurrence that results in things being united. Reading these two text book definitions leads one to believe that a market consolidation is one where the competition between buyers and sellers unite to form a compact mass. A traders definition of a market consolidation is one where prices have remained range bound within a narrow price channel.

Consolidations by their very nature can not last too long since they become increasingly unstable with time. Most traders view consolidations as a stabilization of price, but consolidations actually become increasing unstable with time. In fact the longer a market remains consolidated, the more unstable it becomes.

The Nature or Psychology Of Market Consolidations

HOW TO IDENTIFY TRADE SETUPS FROM

CONSOLIDATED MARKETS With Bennet McDowell Concepts Based form the Book The ART of Trading published by Wiley, April 2008


Market consolidations have their own cycles. During their initial formation traders are undecided as to value, and the price oscillates. If this condition continues, traders perceptions of this assets value remain the same until new information enters the market to change perceptions.

Until new information arrives, the consolidation becomes narrower and narrower to a point where the consolidation is now very unstable and this is where new trends are born.

The longer or more mature the consolidation is, the larger the trend usually is as well. Lengthy or mature consolidated markets are so unstable that even just a whisper of new information coming into a consolidated market can make it move, but a shout of information can make it trend fast!

Once you spot a mature consolidation, your trading approach should be to bracket the upper and lower part of the consolidation. This helps to avoid unprofitable whip-sawing trades within the consolidation channel caused by insignificant trading reactions from minor market information. It is important that your trading approach not react to every whisper of information that the market ultimately finds meaningless.

By bracketing your trade entries above and below the consolidation channel, you automatically eliminate unnecessary losing trades. If you are an aggressive trader who welcomes the additional risk of a few losing trades within the channel to achieve a superior trade entry price, then you should wait for the mature consolidation to get very tight and thus very unstable.

This will increase your odds of successfully timing the next significant trend and therefore reward your aggressive entry approach. Just as important as the length or time of the consolidation is the low Average True Range or volatility of prices in recognizing the mature end of the consolidation before a significant new

tend emerges. COMPRESSED price bars representing low volatility and a low Average True Range can be significant in determining that the consolidation may be near its end and the new trend may be significant. Any new information coming into a market with compressed price bars could cause that market to move quickly. It is important to note that not all significant trends emerge only from market consolidations. But if you recognize a consolidation in the market, the potential is great for a significant trend to emerge if the consolidation has become so consolidated it has now also become unstable.

The first step is to find markets that are in consolidation so you can be ready to trade the breakout when it occurs. To find these consolidated markets, it will be best to scan for markets with low volatility and narrow price movement. Look for a consolidation with at least 20 price bars before considering it for a potential trade based on "bracketing the high and low of the channel.

Finding & Monitoring Market Consolidations

On daily charts, markets can consolidate for weeks and some for even months, so you will want to monitor several markets simultaneously while they are in consolidation. This way you do not have to wait a long time before entering a trade.

On intraday charts, markets that consolidate for 20 price bars may last 20 minutes or more depending on the intraday time frame you are using.Active traders can use this technique to scan for trade setups, and with 9,000 + stocks, the trader can be quite active! If youre a day trader, you can scan intraday charts looking for consolidations as well.


There is a HIGH probability of SIGNIFICANT trends emerging from markets that have been bracketed for 20 price bars or more! And price bars that are COMPRESSED within a bracketed market have a higher probability of a significant trend occurring when prices break the upper or lower part of the consolidation.

Trading Market Consolidations

Once you have identified the consolidation of at least 20 price bars, the next thing to do is to draw a line on the top and the bottom of the consolidation channel effectively "bracketing" the consolidation Then place your long trade entries above the upper consolidation band, and your short trade entry below the lower consolidation band.

Note on this chart how compressed the price bars are BEFORE the market breaks below the consolidation.

Once the market breaks and begins to trend, stops can be adjusted according to market activity, with the initial stop-loss being placed on the opposite side of the consolidation channel in relation to which way the market started to trend. The ART System quickly identifies key stop-loss levels based on market realities.

Where To Place Your Stops

The stock chart below illustrates a market consolidation in the Nortels stock with upper and lower lines drawn that bracket the consolidation. Trend traders should not attempt to trend trade during a bracketed market and should therefore not take any trades inside the drawn support and resistance lines. Trade entries are then placed above and below the consolidation. On this chart we are using the ART Software for specific entries and

exits using ARTs Pyramid Trading Point triangles for both entries and exits and risk control. For more information on the ART System, see The ART of

Trading published by Wiley & Sons, April 2008. Also note how prices become even

more compressed

towards the end of the consolidation just before this market begins to trend. This occurs often since markets usually spring from compressed price consolidation.

Trade Example Combining Bracketing


Here is another example of how to bracket a consolidation to avoid trading within the bracketed area. On this chart, do not trend trade between the upper and lower blue horizontal lines representing the top and bottom of the consolidation.


1) The set-up for a non-trending market occurs when you can see a 1, 2, 3 pattern develop as shown below. Note that #3 does not exceed #1 and #2 does not go below #0 at this stage:

How To Quickly Identify Non-Trending Markets!

This is a skill that all traders should master. Lets take a look at the stages of identification:

2) Once #4 is in place and does not go below #2, we have a CONFIRMED bracket in place as illustrated on this chart:

3) You now can drawn-in support & resistance lines as in this chart:

Sometimes one good technique is all we need to be profitable traders. Trading from market consolidations may just be the trading technique you have been looking for.

Conclusion

Whether youre a futures trader, stock trader, day trader or position trader, adding these trading concepts to your trading toolbox should prove worthwhile.

About Bennett McDowell

Bennet McDowell is founder and president of TradersCoach.com and created the Applied Reality Trading system traded throughout the world. He lectures and speaks at many Trading Expos and writes for several magazines. His new book The ART of Trading published by Wiley & Sons is a best seller. Bennett McDowell can be contacted through his website www.TradersCoach.com.

Copyright 2009 TradersCoach.com, Inc. All rights reserved. Any reproduction and/or electronic transmission of this document is prohibited without the prior written consent of TradersCoach.com and is a violation of international copyright law.

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The Educated Analyst Sep-Oct 2009