Volume & Time

There is more to the market than price.

Disclaimer: content is summarised from Part 5 (Chapter 28 - 33) of 'The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management' by Alexander Elder

Contents:

1. Volume

• How to Measure Volume

• Crowd Psychology

• Trading Pointers

2. Volume-Based Indicators

• On-Balance Volume

• Crowd Psychology

• Trading Signals

• More on OBV

• Accumulation/Distribution

• Crowd Behaviour

• Trading Rules

• More on Accumulation/Distribution

3. Force Index

• Constructing Force Index

• Trading Psychology

• Trading Rules

4. Open Interest

• Crowd Psychology

• Trading Rules

• More on Open Interest

5. Time

• Cycles

• Indicator Seasons

• Market Time

• Factor of 5

6. Trading Timeframes

• Investing

• Swing Trading

• Day-Trading

1. Volume

Volume reflects activity of traders. Volume is usually plotted as a histogram. Change in volume shows how bulls & bears react to price swings. This shows if trends are likely to continue / reverse. E.g. uptrend is confirmed if vol. increases during rally

BID daily, 22-day EMA, volume. (Chart by Stockcharts.com)

Sotheby’s Holdings Inc. (BID) is the world’s biggest publicly traded auction house. It provides a window into what the world’s big money consumption. At (A) & (B), volume increased during the rally, confirming the uptrend. At (C) & (D), volume shrank during rally attempts. Notice false upside breakouts in those areas & kangaroo tail at (C). Rising volume near the right edge confirms power of bears.

How to Measure volume

1. Actual no. of shares / contracts traded

New York Stock Exchange reports volume this way. It is the most objective way of measuring volume.

2. No. Of Trades Taken Place

Less objective since it does not distinguish between a 100-share & 5000-share trade.

3. Tick Volume (TV)

Refers to no. of price changes during a selected period of time. Most changes equal 1 tick. Some exchanges do not report intraday volume, forcing day traders to use tick volume as a proxy for real volume.

Note that since the market is decentralised & reports no volume, you can use the volume of currency futures as its proxy. Futures of all major currencies, measured against USD, are traded in Chicago & on electronic exchanges. We can assume their volume trends are reasonably similar to those in forex, since both respond to the same market forces.

Crowd Psychology

Volume reflects degree of financial, emotional involvement & pain among market participants. Financial commitment is made when a trade begins. Act of buying / selling creates an emotional commitment in most, even if it is a rational decision. Whenever prices move, about half of the traders are hurting. The greater the volume, the more pain in the market.

Losers can be patient if losses increase gradually. Sharp moves makes losing traders cut their losses in a panic. Market is ready to reverse once "bad hands are shaken out", leaving behind a volume spike.

E.g. of removing bad hands: A short seller who wants to cover & take profits / bargain hunter will buy from a trader who sells a losing long position. Bottom-pickers take over the position of a loser. They either catch the bottom / become the next loser.

E.g. A trader who takes profits on long position / top-picker takes over the position of loser who covered his shorts.

Losers who give up on their trades propel trends. E.g. When shorts give up during a rally, they buy to cover, pushing the market even higher. Prices rise, flushing out even more shorts. E.g. When longs give up during a decline, they sell, pushing the market even lower. Falling prices flush out even more longs.

A trend that moves on steady volume is likely to persist as new losers are replacing those washed out.

Falling volume shows a decrease in supply of losers & a trend is ready to reverse. It happens after enough losers catch on to how wrong they are. A burst of high volume suggests trend is nearing its end as masses of losers are bailing out. Many tend to bail out at the same time. Pros quickly close out losing trades & reverse / wait on the sidelines, ready to re-enter.

Volume spikes are more likely to signal reversal of a downtrend as they reflect explosions of fear. Volume spikes in uptrends are driven by greed, a slowermoving, happy emotion. There may be a slight pause in an uptrend after a volume spike.

Volume usually stays relatively low in trading ranges as there is relatively little pain. People feel comfortable with small price changes, hence flat markets can drag on.

A breakout is often marked by a dramatic increase in volume as losers try to cut losses. Breakouts on low volume shows little emotional commitment to a new trend suggesting that prices are likely to return to trading range.

Rising volume during rallies suggest more buyers & short sellers are pouring in. Buyers are eager to buy even if they have to pay up & shorts are eager to sell. Shrinking volume during a rally shows that bulls are less eager & bears are no longer running for cover. Falling volume shows that fuel is being removed from uptrend & is ready to reverse.

Shrinking volume during a decline shows that bears are less eager to sell short & bulls are no longer running for the exits. Falling volume shows that remaining bulls have greater pain tolerance either with deeper pockets / having bought later in the decline. Falling volume suggests downtrend is likely to reverse. This reasoning applies to all timeframes. As a rule of thumb, if today’s volume is higher than yesterday’s, trend is likely to continue.

Trading Pointers

Rule of thumb, “high volume” is at least 25% above its average for the past 2 weeks, while “low volume” is at least 25% below average.

1. High Volume Confirms Trends

If prices & volume rise to a new peak, then prices are likely to retest / exceed that peak.

2. Buying Opportunity at “Climax Bottom”

If prices & volume falls to a new low, that bottom is likely to be retested / exceeded. A very high volume “climax bottom” is usually retested on low volume, offering an excellent buying opportunity.

3. Low Volume + continuation of trend = Reversal

Look to take profits / prepare for reversal. This technique does not work well in downtrends as a declines can persist on low volumes.

4. Volume reaction to reversals

When uptrend ends up in a decline, volume picks in a flurry of profit taking. Major downtrends are often followed by rallies that begin on heavy volume. Once weak bears have been flushed out, volume shrinks, giving a sell signal.

2. Volume-Based Indicators

Rising EMA of volume affirms trend & declining EMA of volume suggests reversal. Volume-based indicators provide more precise timing signals than volume bar.

On-Balance Volume (OBV)

OBV is running total of volume. Each day’s volume is added / subtracted depending on closing price being higher / lower than day before. E.g. if stocks close higher, bulls won hence, day’s volume is added to OBV. If stocks close lower, bears won hence, day's volume is subtracted from OBV. OBV is a leading indicator as it often rises / falls before prices.

Crowd Psychology

Price represents consensus of value. Volume represents emotions of market participants. New high of OBV suggests bulls are powerful & bears are hurting. New low of OBV suggests bears are powerful & bulls are hurting. When OBV pattern deviates from price pattern it shows that mass emotions & mass consensus are different. Crowds are more likely to follow their gut than mind thus changes in volume come before price changes.

Trading Signals

Pattern of OBV tops & bottoms are more important than absolute levels. It is safer to trade in the direction of a trend that is confirmed by OBV. New OBV high confirms power of bulls (buy signal). New OBV low confirms power of bears (sell signal).

OBV gives strongest signal when it diverges from prices. E.g. if prices rally, sell off & rise to new high BUT OBV rallies to lower high this creates bearish divergence & a sell signal. If prices fall, rebound, then reach a new low BUT OBV falls to a less low bottom this traces a bullish divergence & a buy signal. Long-term divergence > short term. When prices are in trading range & OBV breaks out to new high, a buy signal if formed (opposite is true for sell signal)

More on OBV

Granville combined OBV, Net Field Trend Indicator (NFT) & Climax indicator. For NFT, each stock in DOW is given a rating on its OBV pattern as rising, falling / neutral (+1/-1/0). Climax indicator is the sum of NFT of all 30 stocks in DOW. Buy signal is given when market rallies & there is a new high for climax indicator. This method may produce good signals for S&P 500 futures & options.

MCD daily, 22-day EMA, On-Balance volume (OBV). (Chart by Stockcharts.com)

McDonald’s Corp. (MCD) is a stable, slow-moving stock, fairly tight in trading range that is marked with dashed lines. Notice the tendency of MCD towards false breakouts (A)(B)(C)(D). Notice a kangaroo tail at (A). Right edge of the chart shows a free-fall, but while MCD trades near its recent lows, OBV indicator is trading near the highs. This suggests strength & buying rather than selling.

Accumulation/Distribution (A/D)

A/D tracks the relationship between opening & closing prices, in addition to volume. It is more finely calibrated than OBV as it credits bulls / bears with a fraction of each day’s volume, proportionate to degree of win.

If close > open, bulls won hence A/D is positive. Cumulative A/D is the running total of each day’s A/D. E.g. if high-low spread is 5 points & open-close spread is 2 points, only ⅖ of day’s volume is credited to winning camp. In a rally, people focus on the new high, but if closing price is lower than opening, A/D can warn that uptrend is weaker than it appears.

Crowd Behaviour

Opening price reflects pressures built up while market was closed. It tends to be dominated by amateurs who read the news. A/D tracks outcomes of daily battles between amateurs & pros. E.g. It ticks up when prices close higher than they opened, when pros are more bullish than amateurs.

Trading Signals

When the market opens low & closes high, it moves from weakness to strength. As such, A/D rises & signals that pros are more bullish than amateurs. Hence, uptrend is likely to continue. When A/D falls, it shows that pros are more bearish than amateurs. It is likely to reach a lower low.

The best trading signals are given by divergences between A/D & price.

1. If prices reach a new high but A/D reaches a lower peak, sell signal is given. This bearish divergence shows that pros are selling into the rally.

2. Bullish divergence occurs when prices fall to a new low but A/D bottoms out at a higher low than during its previous decline. It shows that pros are using the decline for buying & a rally is coming.

GOOG daily, Accumulation/Distribution Index. (Chart by Stockcharts.com)

Though Google Inc. (GOOG) was trending lower for months, uptrend of A/D showed that big money was buying. Stock falls lower at (B) than at (A), but A/D traces out a much higher bottom (at dotted green arrow). It broke out to a new high (at vertical green arrow) before prices gapped up following a good earnings announcement. Someone knew what was coming, & their buying was identified by A/D & its upside breakout. Technical analysis helps to even out the imbalance of knowledge between outsiders & insiders.

More on Accumulation/Distribution

Note that pros can go wrong, even if you follow a divergence between A/D & price. Use stops & follow the Hound of the Baskervilles rule to mitigate risk. A/D & Japanese candlestick charts both focus on differences between opening & closing prices, but A/D also takes volume into account.

3. Force Index (FI)

FI is an oscillator that combines volume with prices to identify force of bulls / bears behind every rally / decline. It brings together 3 essential pieces of info: direction of price change, its extent & volume during that change. FI + Short EMA pinpoints entry & exit points. FI + long EMA confirms trends & recognises important reversals.

Constructing Force Index

Direction: FI is positive if prices close higher than close of previous bar.

Extent: FI is greater if change in price is greater.

Volume: FI is greater if volume is greater.

Histogram of raw FI is too jagged. It needs MA to be smooth. 2-day EMA of FI provides minimal smoothing to pinpoint entry & exit points. Buy when 2-day EMA is negative & sell when positive, as long as you trade is in the direction of the trend.

13-day EMA of FI tracks longer term changes & confirms trends. Divergence between this & price identifies important turning points.

Trading Psychology

Closing price shows if bulls / bears won. Distance between closing prices shows margin of victory. Volume shows degree of emotional commitment. High vol trends are likely to continue, lower vol trends are likely to end. FI combines price & volume it shows whether head & heart of the market are in gear. A new high for FI suggests uptrend will continue, new low for FI suggests downtrend will continue & flattening of FI suggests reversal.

Trading Rules

Short Term EMA (2-day)

Highly sensitive indicator of the short-term force of bulls & bears. Identify a trend with a trend-following indicator, then pinpoint entry using short term EMA FI. 2-day EMA of FI can help to decide when to double down. E.g. Add longs in uptrends each time FI turns negative, add to shorts in downtrends whenever FI turns positive.

FI can forecast. When a 2-day EMA of FI falls to its lowest low in a month, bears are strong & prices are likely to fall lower. When a 2-day EMA of FI rallies to its highest level in a month, bulls are strong & prices are likely to rise higher.

2-day EMA of FI helps to decide when to close out a position. It identifies short-term splashes of mass bullishness / bearishness. A short-term buyer when this indicator was negative can sell when it turns positive (opposite is true for shorter)

A longer-term trader should get out of position only if a trend changes (as identified by the slope of a 13-day EMA of price) or if there is a divergence between the 2-day EMA of Force Index and the trend.

1. Buy when a 2-day EMA FI is negative during uptrends

Place a buy order above the high price of that day. If uptrend resumes, order is filled. If prices continue to decline, your order will not be executed. Lower your buy order nearer to high of the latest bar & once buy stop is triggered, place a protective stop below the latest minor low.

Most traders chase rallies & get hit by drawdowns. FI finds buying opportunities with lower risks.

2. Sell short when a 2-day EMA of FI is positive during downtrends

Same principle as 1.

3. Bullish divergences between the 2-day EMA of FI & price gives strong buy signals

Bullish divergence occurs when prices fall to a new low while FI makes a shallower low.

4. Bearish divergences between the 2-day EMA of FI & price gives strong sell signal

Bearish divergence occurs when prices rally to a new high while FI traces a lower second top.

5. Whenever the 2-day EMA of FI decreases to ≥ 5 times its usual depth & then recoils from that low, rally is likely in the coming days.

Markets fluctuate between overbought & oversold. Rally is expected after they recoil from a down spike. Note that this signal does not work well in uptrends as markets recoil from down spikes, not up spikes. This is so as intense fear does not persist for very long whilst excessive enthusiasm & greed can persist.

A 2-day EMA of FI fits well into the Triple Screen trading system. Combine the ability of FI to find short-term buying & selling points with a longer-term trend-following indicator.

ADBE daily, 26-day EMA, 2-day Force Index. (Chart by Stockcharts.com)

Using multiple timeframes to make decisions is pivotal. E.g. you may choose whether to be a bull / bear on a weekly chart & choose where to buy / sell using a daily chart.

Adobe Systems, Inc. (ADBE), has a steady uptrend on the weekly chart with its rising EMA (not shown). When weekly trend is up, a 2-day FI on daily chart provides series of buy point signals. Instead of chasing strength & buying high, buy during short-term pullbacks marked by the 2-day FI going negative. Once this happens, place buy orders above the latest bar’s high to ensure you’ll be stopped into a long trade once the downwave loses power.

Intermediate-Term Force Index (13-day)

13-day EMA of FI identifies longer-term changes in the balance of power between bulls & bears. When positive, bulls are stronger. When negative, bears are stronger. Divergences from price identify intermediate & even major turning points. Spikes near the bottoms, mark approaching reversals.

Raw FI identifies the winning team in battle between bulls & bears in any price bar. Clearer signals are given by smoothing the raw FI with MA.

1. When a 13-day EMA of FI is positive, bulls rule. When it is negative, bears rule.

With rallies, prices often jump on heavy volume. When a 13-day EMA of FI reaches a new high, it confirms uptrend. But as uptrend grows older, prices rise slower & volume is thinner. That is when a 13-day EMA of FI starts tracing lower tops. Once negative, it signals reversal

2. New peak of 13-day EMA of FI shows that a rally is likely to continue.

Bearish divergence between a 13-day EMA of FI & price gives a strong sell signal. If prices reach a new high but this indicator traces a lower peak, bulls are losing power to bears.

Note that to create a divergence, this indicator must make a new peak, then negative, & then positive again, but tracing a lower peak.

3. New low of 13-day EMA of FI shows that a downtrend is likely to continue. Bullish divergence occurs if prices fall to a new low but this indicator rallies to positive then falls again to a shallower low. This reveals that bears are losing power & gives a buy signal.

With downtrends, prices drop on heavy volume & the trend is confirmed when a 13-day EMA of FI falls to a new low. As downtrend grows old, prices fall slower / volume dries up hence, reversal is likely.

Adding an envelope to the chart of FI can help you detect its extreme deviations that leads to reversals. This method works well with weekly charts, but not with daily & intraday charts.

SSYS daily, 26-day EMA, 13-day FI. (Chart by Stockcharts.com)

Stratasys, Inc. (SSYS) is 1 of 2 leaders in the rapidly emerging additive manufacturing (AM) market. AM stocks have become investors' favourites. A technical pattern has emerged, with rallies driven by amateurs & sharp declines as they panic and bail out. The 13-day FI catches those waves. When the 13-day FI turns positive, (at green arrows), it shows that buying volume is coming in. That is where a longer-term trader buys & holds.

When the 13-day FI turns negative & stays there, it shows that bears rule. Near the right edge of the screen, a record low of FI begins to weaken as FI inches towards zero. Wait cautiously for an accumulation pattern to emerge & be confirmed by a positive FI. This see-saw movement of stocks passing from strong hands into weak ones near the tops & back again near the lows goes on forever. Hence, FI helps you position yourself with the right group.

4. Open Interest (OI)

OI is the no. of contracts held by buyers / owed by short sellers in any derivative market e.g. futures / options. In the stock market, shares are traded while the company listed stays in business as an independent unit. Most shares are held as long positions, few are held as shorts.

In futures & options total size of long & short positions is always equal, as they are contracts for future delivery. E.g. to buy a call option for 100 shares of Google, another trader sells you that option. In order to go long, someone else has to short.

OI = total long / total short positions. Futures & options contracts last for a set period of time. A futures / options buyer who wants to accept delivery & a seller who wants to deliver have to wait til the 1st delivery day. Waiting period ensures that no. of contracts held long & short are always equal. However, very few futures & options traders plan to deliver / accept delivery as most close out their positions early to settle in cash before the 1st notice day.

OI rises when new positions are created & falls when positions are closed. E.g. OI in April COMEX gold futures is 20,000 contracts (bulls long & bears short 20,000 contracts) If 200 new contracts are created, both bought & sold short, OI rises to 20,200. OI falls when a bull who is long sells to a bear who is short but wants to cover his short position. As both of them get out, OI falls by the size of their trade. If new bulls buy from an old bull that is getting out of long position / new bear sells to an old bear who wants to buy to cover short position, OI is unchanged.

Technicians usually plot OI as a line below price bars. OI in any markets vary by season as huge hedging by industrial users & producers are done at different stages of the annual production cycle. OI gives important messages when it deviates from seasonal norm.

Crowd Psychology

Futures / options contract requires 1 bull & 1 bear. Market trends may change when thousands of traders make similar trades. OI reflects intensity of conflict between bulls & bears. It depends on their willingness to maintain positions. When willingness runs out, they close their positions, reducing OI. In every trade, when prices change, 1 of the 2 will be hurt. Rising OI shows a crowd of confident bulls facing down a crowd of equally confident bears. This points to a growing disagreement between bulls & bears. 1 group is sure to lose but trend will continue as potential losers keep pouring in with such strong disagreements. (ideas from L. Dee Belveal’s: Charting Commodity Market Price Behavior, 1969)

Rising OI suggests a persistent existing trend. If OI rises with uptrend, bears are likely to

retreat as uptrend squeezes them harder moreover, their buying will propel prices even higher.

If OI rises with downtrend, bargain hunters bail out as falling prices hurts them, & their selling will push prices even lower.

OI is unchanged when a bull wants to buy & no bear wants to sell, hence that bull buys from another bull who wants to cash out. OI is also unchanged when a bear wants to sell & bull is afraid of buying, hence that bear sells short to another bear that wants to cash out. When OI goes flat during a rally / decline, supply of losers / bottom pickers has stopped growing.

This flashes a yellow light— warning that the trend is ageing.

Falling OI: When disagreement between bulls & bears decreases, trend is ripe for a reversal. Falling OI shows that winners cash in on profits & losers give up by bailing out.

TYH14 daily, 13-day EMA, open interest. (Chart by TradeStation)

OI reflects the degree of conviction among bulls & bears. Rising OI shows increasing conflict & it confirms the existing trend. Falling OI shows that losers are leaving while winners are cashing in & it signals the nearing end of a trend.

Near the left edge for Mar 2014 Treasury Notes futures (TYH14), declining OI signals a nearing end for downtrend. OI bottoms out at (A). T-Notes at (B) & (C) were in clear uptrends, with rising OI. OI topped out at (D). While prices continue to rise at (E), downtrend of OI warns of an ageing uptrend.

Note that not all charts will be as clear as this. Use several indicators & act only when messages confirm one another.

Trading Rules

1. When OI rises

When OI rises during a rally, it confirms uptrend. It shows that short sellers are coming in & when bailing out, their short covering should push the rally higher.

When OI rises as prices fall, downtrend persists. It shows that bottom pickers are active & they are likely to push prices lower when they give up.

When OI rises as prices are in a trading range, it is a bearish sign. Commercial hedgers are more likely to sell short than speculators. Sharp increase in OI while prices are flat shows that savvy hedgers are likely shorting. Avoid trading against those who likely have better info than you.

2. When OI falls

When OI falls as prices are in a trading range, it gives a buy signal as major commercial interests do short covering, which shows that they expect a rise in the market.

When OI falls during a rally, consider selling. It shows that winners & losers are becoming cautious. Longs take profits & shorts are covering. Majority is ready to reverse.

When OI falls during a decline, take profits on short positions. It shows that shorts are covering & buyers are bailing out.

3. When OI goes flat

When OI goes flat during a rally, tighten stops on longs & avoid new buying. It shows that uptrend is ageing.

When OI goes flat during a decline, tighten stops on short positions. It shows that the downtrend is ageing.

Flat OI in a trading range provides no new info.

More on Open Interest

Higher OI means more activity in the market hence, less slippage risk when getting in & out of positions. Thus, trade contracts with higher OI as a short-term trader. In futures markets, highest OI is usually in the front months. As 1st notice day approaches & OI of the front month drops, while OI in the next starts to rise, roll over your position into the next month.

5. Time

People tend to repeat the same mistakes & hardly plan ahead. Freud showed that the unconscious mind has no notion of time. In crowds, people behave primitively & impulsively. Individuals are ruled by time, while crowds pay no attention to time.

As a trader, focus on time & not just price. Time is dimension hidden from the market crowd.

Cycles

US stock market has an e.g. of a long-term price cycle. The 4-year price cycle exists as the ruling party inflates the economy once every 4 years for the presidential election. The winning party deflates the economy as voting polls close. Stock market rises when the economy is flooded with liquidity & it falls when draining liquidity.

Cycles in agricultural commodities are due to weather, production factors, & mass psychology of producers. E.g. farmers breed more animals when livestock prices rise. The animals hit the market, prices fall & producers cut back. Supply is absorbed, scarcity pushes prices up, & cycle repeats.

Use long-term cycles to identify market trends rather than short-term cycles to predict minor turning points.

Some traders use dist. between peaks to forecast future peaks, same for bottoms. However, by analysing price data using math based programs like John Ehlers’s Maximum Entropy Spectral Analysis (MESA), ~80% of these "cycles" are just market noise. Minds instinctively look for order & illusion of order is enough for many traders.

Indicator Seasons

Like how a farmer sows in spring, harvests in late summer / fall & lays in supplies for the winter, a trader should look to buy, sell, go short & cover at specific seasons. Martin Pring's seasons for prices works well with technical indicators. Differentiate yourself from the crowd, by using the seasons model to identify when prices are low & high, for buying /selling actions.

Seasons are defined by slope & position above / below centerline. E.g. indicator seasons + MACD-H. Slope of MACD-H is the relationship between 2 neighbouring bars. Refer to table below:

These actions may be hard to execute as they run counter to emotions. Just as a farmer pays attention to the vagaries (unexpected & inexplicable changes) of the weather, traders must stay alert. Use several indicators & techniques to avoid getting whipsawed.

The concept of indicator seasons focuses a trader’s attention on the passage of time to plan for the season ahead instead of mindlessly following the crowd.

VRTX daily, MACD-Histogram 12-26-9. (Chart by Stockcharts.com)

We can apply concept of seasons to most indicators, trading vehicles & timeframes (even intraday) This e.g. focuses on daily MACD-H of Vertex Pharmaceuticals, Inc. (VRTX), from the Nasdaq 100.

Autumn: Indicator is above center-line & falling. Establish shorts.

Winter: Indicator is below center-line & falling. Use weakness to take profits on short positions.

Spring: Indicator is above center-line & rising. Establish longs.

Summer: Indicator is above center-line & rising. Use strength to take profits on long positions.

In this e.g., MACD-H looks smooth but be prepared for brief fluctuations, above & below the center-line.

Market Time

Time is relative. We keep track of time in human terms, but other areas of life moves on vastly different timelines. E.g. some insects are born, mature, procreate, & die within 1 day. The market moves at a much slower speed than individuals. Patterns you recognise on charts are likely to occur much later than you expect.

Relative slowness of crowds can bedevil (cause trouble for) even experienced traders. Beginners tend to be late, while experienced traders tend to be too early. Experienced traders often buy before the market finishes tracing a bottom / sell short before it completes a top.

To counter this, first be aware that the market time is much slower than your own. Second, with an early reversal signal, consider waiting for a better signal. Especially so at market tops, which take longer to form than bottoms.

Do not be greedy & trade a smaller size. Smaller positions are easier to hold as reversals take awhile to form. Use multiple timeframes for market analysis.

Factor of 5

The market lives in multiple timeframes. It moves simultaneously on monthly, weekly, daily & intraday charts, often in opposite directions.

Most traders only pay attention to their own selected timeframe til a sudden move from outside of their timeframe hits their account.

Neighbouring timeframes are approx. linked by factor of 5. E.g. 4.5 weeks to a month, 5 trading days to a week, 5–6 hours to a trading day. Day traders go further & look at 10-minute & 2-minute charts.

Review at least 2 neighbouring timeframes when analysing any market. Always start with the longer timeframe for a strategic view & then shorter timeframe for tactical timing.

6. Trading Timeframes

Serious traders plan the expected duration of every trade. Timeframes have their own opportunities & risks. There are 3 groups:

1. Long-term trading / investing: Expected duration of a position is measured in months / years.

+ Requires little day-to-day attention & may lead to spectacular gains.

- Drawdowns can be severe

2. Swing trading: Expected duration of a trade is measured in days / weeks.

+ Many trading opportunities, fairly tight risk control.

- Miss major trends.

3. Day-trading: Expected duration of a trade is measured in minutes, rarely hours.

+ Many opportunities, no overnight risk

- Demands instant reflexes & transaction costs will matter.

Use separate accounts should you trade in more than 1 timeframe to allow you to evaluate your performance in each timeframe.

Investing

Investing demands firm conviction & patience if you are to hold that position through inevitable pullbacks & periods of flat prices.

Major trends easily seen on long-term charts appear uncertain & foggy in real time especially when a stock enters a drawdown. When the investment drops 50% or more, a common development for long-term positions, few have the conviction & fortitude to hold.

E.g. Apple Inc. (AAPL) survived its near-death experience in 2003, when its battered stock was rumoured to be a takeover candidate & grew to be the highest-capitalised, publicly traded company in the world, before collapsing in 2012. Uptrend looks grand in retrospect, but would you have been able to hold through multiple drawdowns, some exceeding 50% Such drawdowns often mark the ends of uptrends.

AAPL weekly. (Chart by Stockcharts.com)

(1) 2003: falls below $10. AAPL's survival is in question. Would you buy?

(2) 2006: rallies to $86, then sinks to $51. If you had 1,000 shares would you

hold? Would you sell when it got back above $80 & appeared to stall?

(3) 2008: rallies to $202, drops to $115. If you had 1,000 shares showing $87,000 drawdown, would you still hold?

(4) 2009: recovers to $192, sinks to $78, below previous low. Drawdown is over 50%. Still holding?

When you decide to buy, use technical signals to ensure a relative bargain rather than a full price. If your investment soars, use technical tools to identify overvalued zones. Be ready to take profits there & repurchase during inevitable pullbacks.

Below we see an e.g. from Alexander Elder's trading diary

F monthly, 26- & 13-months EMA with the Impulse system, Autoenvelope, MACD Lines & MACD-H (12-26-9), and Force Index 13-months EMA with ATR channels. (Chart by Tradestation)

(1) 2007: Ford was on the ropes when new CEO arrived—the man who earlier spearheaded saving Boeing. In the heady atmosphere of a bull market, Ford seemed to have a shot at recapturing its $30 high. Saw a false downside breakout & bullish divergence hence, bought. Grimly held through the bear market.

(2) 2011: Ford spiked above its monthly channel, which was narrower at that time, tracing a kangaroo tail, while monthly MACD weakened. Took profits.

(3) 2011: Repurchased position as monthly prices stabilised in their value zone

Use fundamental analysis to find stocks worth buying. Technical analysis to time entries & exits. Be prepared to buy & sell more than once during a major uptrend.

Swing Trading

While major trends & trading ranges can last for years, they are all punctuated by short-term upswings & downswings. They create trading opportunities to exploit. Swing trading is recommended for beginning & intermediate traders. Trade more to learn more, provided that you practice good risk management & record-keeping.

Swing trading teaches you faster than long-term investing & it gives you time to think, unlike day-trading which demands instant reactions.

Short-term swings can generate meaningful profits, without the gut-wrenching drawdowns of position trades. Swing trades need not watch the screen all day. In SpikeTrade.com, most trades last a few days. Some carry their trades for weeks / months, while others hop in & out within hours. But the holding period for most members is measured in days.

Below we see Alexander Eleder piggyback the Spiketrade group’s pick. Profit was $1.92 per share.

HES daily, 26- and 13-day EMA with 4% envelope, MACD Lines and MACD-H (12-26-9), the Impulse system, and 2-day Force Index. (Chart by Stockcharts.com)

Pro traders are equally comfortable with buying & short selling. Signals are similar but the action quicker—stocks fall 2x faster than rise.

Alexander Elder shorted Hess Corporation (HES) as it was tracing a short-term double top, with bearish divergences in all indicators. He covered & took profits, as prices appeared to stall just below the value zone between the 2 EMAs, while the indicators became oversold.

Learning technique: return to your closed-out trades 2 months later & re-plot charts. Trading signals that looked uncertain at the right edge of the screen becomes clear when you see them in the middle of your chart. With the passage of time, you can easily see what worked & what mistakes you made.

Instruct yourself on what to replicate & what to avoid repeating.

Chart & text below comes from SpikeTrade.com. Each week winner posts a diary of his trade. Peter gained almost 11% in 3 days. However, such spectacular gains are inevitably interspersed with losses.

Carefully entering & exiting swing trades, while cautiously managing money, is a realistic way of surviving & prospering in the markets.

TRQ daily, 22- and 12-day EMA with 11% envelope, MACD Lines and MACD-H (12-26-9), and 20-day RSI. (Chart by Stockcharts.com)

Peter D., a long-term Spiker from Netherlands:

Weekly conditions: Indicators don’t show much movement. MACD is very shallow but

positive & RSI is slowly improving.

Daily: MACD was about to confirm a positive divergence, so was RSI. Prices dove last week but stopped near support.

Initial entry at $3.02, in line with recent lows. It was hit on Monday morning, which turned out to be 1 cent above low for the day & week. Price closed near the high of the day & continued surging on Tuesday & Wednesday. Target was hit on Wednesday, on the way up. The rest of the day saw some pulling back, but price kept in range to close the week on a relatively high note.

Day-Trading

Day-trading means entering & exiting trades within a single market session. Rapid buying & selling demands the highest levels of concentration & discipline. Paradoxically, it attracts the most impulsive & gamblingprone people.

Day-trading appears deceptively easy. Though brokerage firms hide customer stats, in 2000, state regulators in Massachusetts subpoenaed brokerage house records. It showed that after 6 months only 16% of day-traders made money.

Day-trading will find gaps in your knowledge fast & hit you hard. You cannot stop & think like in swing trading.

Use end-of-day charts as you learn to trade. Grow into a consistently profitable swing trader, to develop the trading skill before exploring the faster-paced world of day-trading.

Write down your action plan for day-trading: what will prompt you to enter / exit, to hold / cut. Be prepared to invest plenty of time as day-trading requires hours in front of multiple screens.

Day-trading is also harder as you shoot at smaller targets as seen in the height of price channels. A good measure of a trader’s performance is % of the channel / envelope captured in a trade. E.g. taking 30% or more of a channel’s height is 'A' grade, 10% of that channel is 'C'

Figures will vary on time & between different stocks. Table below shows is just an e.g. for channel heights on daily & 5-minute charts:

Swing traders who use daily charts can do very well in these stocks. A level traders can really clean up (make profits). C traders can stay comfortably ahead of the game while learning to trade.

However, person who day-trades the very same stocks must be a straight A level trader to survive. Anything less results in his account eaten up by slippage, commissions, & expenses. An olympic rowing coach told Elder that in order to row, one must focus on developing the correct stroke. A rower moves his oars the same way, be it on the weekend / at the last lap. What changes are power & speed.

Same with day-trading: same technique, different speed.

Day-trading can be profitable, but it is a highly demanding professional game.