New Analytical Method and Tables

As long-time readers will know, Private Trader has always been, first and foremost, a testbed for ideas, a plays to try things out.

Ideas that don't produce good trades are quickly discarded. Those that work find a permanent home.

Beginning Monday, I shall switch entirely over to the price-channel analysis model that has proven fruitful of profitable trades. New methods mean new tables, and Monday's postings will show that new look.

One change will be a switch from three-month daily charts to six-month daily charts, to accommodate the longer period of the outer price channel.

Here's an explainer of what the revisions are about, along with samples of the new analytical postings:

• The new Indicators posting (which replaces the Morningline).
• The new Forex posting.
• The new Watchlist posting.

I use price channel analysis to make trading decisions, although I will use other technical tools and company finances to clarify a chart.

Price Channels

My rules for trading price channels are based on a system outlined by Courtney Smith in his book How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life (Wiley Trading).

Smith focuses on forex, but his analytical techniques are good for any liquid market. He bases them on the Turtle Trading style of trend following.

The technique uses a daily chart with two price channels: A 20-day-average-price channel and a 55-day channel. It also uses the average directional index (ADX) analytical tool.

Here is my version of the rules:

On a daily chart with 55-day and 20-day price channels and the adx . . .
Bull Entry

• Has the price traded above the 55-day upper line (the breakout level on the breakout day)?
• If yes, then is the ADX higher than on the previous day?
• If yes, then open a bull position.

Bull Exit

Exit 1:
• Has the 55-day upper line trended down or sideways for at least five days prior to the breakout day?
• If yes, then has the price closed below the breakout level for two days after breakout day?
  If yes, then exit the position.

Exit 2:
• Has the price traded below a stop, defined as the low on the breakout day or the breakout level (whichever is lower), less that day's 14-day average true range?
• If yes, then exit the position.

Exit 3:
• Has the price traded below the 20-day lower line?
• If yes, then exit the position.

Exit 4:
• Is the ADX 40 or above?
• If yes, is the ADX less than on the prior day?
• If yes, then exit the position.

Bear Entry

• Has the price traded below the 55-day lower line (the breakout level on the breakout day)?
• If yes, then is the ADX higher than on the previous day?
• If yes, then open a bear position.

Bear Exit

Exit 1:
• Has the 55-day lower line trended up or sideways for at least five days prior to the breakout day?
• If yes, then has the price closed above the breakout level for two days after breakout day?
• If yes, then exit the position.

Exit 2:
• Has the price traded above the stop, defined as the high on the breakout day or the breakout level (whichever is higher), plus that day's 14-day average true range?
• If yes, then exit the position.

Exit 3:
• Has the price traded above the 20-day upper line?
• If yes, then exit the position.

Exit 4:
• Is the ADX 40 or above?
• If yes, is the ADX less than on the prior day?
• If yes, then exit the position.

The ADX shows the strength or the temperature of a trend, and price-channel trading requires, above all things, a solid trend. An ADX reading of 40 or above is considered to be high, and below 20, to be low. That assessment is complicated by the rule that requires a position be closed if the ADX declines while it is above 40. That high level is sudden-death territory.

A possible additional trading requirement would be to requires that a trade have an ADX is in the 20s or 30s, and within that group, to prefer the higher ADX levels.

Other Tools

In addition to price channel analysis, I also look at the parabolic sar in making trading decisions. The parabolic sar gives bull and bear signals based on price trends, with time -- or the age of a trend -- also part of the complex mathematics.

The signals produced by the parabolic sar are comparable to those produced by the macd or Person's Proprietary Signal.

Like many technical tools, the parabolic sar tends to whipsaw in non-trending markets. So I give greater heed to its signals when the ADX is higher.

The parabolic sar has a faster cycle than the 55-day/20-day price channels, so I use it to fine-tune entry into a position. For example, if a stock is in price-channel bull phase, but the parabolic sar shows bear phase, then I might want to delay entry to allow for a short-term pullback in the price so I can have a lower basis.

However, it is important to note that in my trading, the price channel phase is paramount.

Trading almost always involves selecting issues out of a large batch of prospects. For that, I look at company financials -- their fundamentals.

For bull positions, I'm looking for companies with a return on equity of 20% or more and debt that is one-tenth of equity or less (debt-equity ratio of 0.1x or less). For bear positions, ROE of 10% or less and debt equal to or greater than equity (debt-equity ration of 1.0x or greater).

For all plays, I prefer to see institutions owning 70% or more of outstanding shares.

I also take a look at the scores on a screening service I suscribe to, InvesTools, which I find to be quite useful.

Also, I look at the growth (or shrinkage) trends for the ROE, sales/revenues and earnings. I agree with Warren Buffet: Past consistency is an important indicator of future results.

None of the financials are deal-killers, but they're important.

And finally, when decision time comes, I look at the chart and trust my instincts. Sometimes a chart just looks right. Sometimes it doesn't. I've been studying charts for 30 years, and I've found the queasy feeling in my stomach can be a pretty good market analyst.

Key to the Tables

In my analytical posts, I use tables, some with color-coded fields, to illustrate the condition of the chart. Following is a key to the column headings and their meaning:

• chan: Channel phase, with green for bull trend, red for bear trend and yellow for neutral trend.
• adx: Average direction index location, indicating the strength, or the temperature, of the trend. Orange for 40 or greater, aqua (light blue) for 30 and up but below 40, magenta (light purple) for 20 and up but below 30, and brown for anything below 20. (Mnemonic: Orange for the overhead sun, blue for the surrounding sky, purple for sunset on the horizon and brown for the earth.)
• traj: Trajectory of the ADX, green for strengthening, red for weakening or yellow for unchanging. Note that if the adx column is orange and the trajectory column is red, then the position must be closed.
• psar: The parabolic sar, either green for bullish or red for bearish.
• bday: Breakout day, the day the price broke through the upper or lower 55-day price line.
• blevel: Breakout level, the price level of the line that was broken through.
• stop: The current stop/loss price. Early in a bull or bear phase, this will be 5¢ below the low or above the high, respectively, on breakout day.
• 2-day?: Marked with an "✔" if the two-day rule is in effect. Under the rule, if the price closes below the breakout level on each of the two days following breakout day, then the position must be exited.

The chan column appears on charts that mix issues in different phases, such as in the morning Indicators and Forex postings. That field is missing in charts that are sorted by phase, such as the Watchlists.

Posting Schedule

Generally, I start posting each day about a half hour after the markets open, at 9:30 a.m. Eastern (6:30 a.m. Pacific, where I live). The schedule may be changed due to travel or appointments.

I start out with the Indicators, which tracks the exchange-traded funds that help give me an overall impression of where the markets are going. These include stock index funds, bond funds, commodity funds and global currency and stock funds.

"Indicators", by the way, is the new name for the posting that I previously called "Morningline".

Next, I post Forex, which tracks the status of the 10 most-traded currency pairs, plus the U.S. dollar/Mexican peso pair (since we are neighbors).

Both Indicators and Forex track the price-channel status of all instruments on each list, including those that are in neutral phase. However, they don't give details, such as when the breakout occurred, the breakout level and the stop/loss level.

The details are given in the ...

... Watchlist, my final regular posting of the day, which may come in several parts, depending upon how long the list is.

The Watchlist covers everything that I'm tracking that is in bull or bear phase, but doesn't list issues that are in neutral phase.

In addition, I shall from time to do postings on individual issues, always with the symbol plus the word "Watch" in the title. As in "SPY Watch" for the exchange-traded fund that tracks the S&P 500. Or "QQQQ Watch" for the Nasdaq 100 fund.

More on the Watchlist

The Watchlist is drawn from several pools of instruments. At the core are the stocks and exchange-traded funds underlying the "penny increment options" that typically have volume of 2 million or more shares per day.

These instruments are highly liquid and have very small bid/ask spreads even on their options. Those two facts alone give the trader an edge.

My Watchlist is by no means a comprehensive list of bull- and bear-phase instruments among the penny increment option stocks. If a trend has been in place a bit and the price has moved, if I'm getting a flurry of gold- or energy-sector stocks, if there's just something I don't like about the chart, like a stock whose signal has been triggered by a godzillian point gap -- I'll pass on listing.

But, rather inconsistently, I will from time to time check big movers during the day, to see if a phase change was triggered. These might be lower volume issues.

The Watchlist shows in-phase exchange-traded funds covered by Indicators and the 11 currency pairs reported in Forex.

I like to follow some sector exchange-traded funds, and also a large number of emerging market funds.

There are certain companies that simply fascinate me, such as Annaly Capital Management (NLY), and they'll show up in the Watchlist when they are in bull or bear phase.

I subscribe to a couple of income-oriented newsletters, which on occasion recommend really obscure stocks. I like to follow them -- on occasion.

I also have a few zombies, that is, trades that didn't pan out, I didn't get out fast enough, and I'm waiting for fortune to turn. Meanwhile, they stalk my portfolio, lurching hither and yon, scaring the children. One zombie is Fannie Mae (FNMA), whose fortunes may in fact never turn. But hope springs eternal.

Also, the Watchlist doesn't sort out listings from the various sources. There are two sections-- bull positions and bear positions -- and within those everything is tossed in, alphabetized by symbol.

That's hit. I've found these methods to work well for me, and perhaps they will for you as well.