TECH TALK

Notes

Any arrows displayed in our site were generated manually and are NOT automatically inserted by the computer.

Since we are running this analysis at the end of October 2004, the charts presented are recent ones, not from four or seven years ago, so that traders may relate to recent trading events. The charts were selected based on their tutorial evidence.

INTRODUCTION

The Alpha Slow Indicator (ASI) is the main indicator we use for timing the trend reversals.

As we have often mentioned, our trading approach looks for reversals of an established trend so that we may enter a trade shortly after the new trend (the reversal) starts developing.

Our attempt to identify the incipient trend has a double goal:

• We want to jump early into the new trend since we subscribe to the maxim that “the trend is our friend”
• As a consequence we can place a tight stop not too far from the extreme point where the previous trend has ended.

Of course we know that the new trend may abort once we enter a trade (always placed at the market) but that is precisely the advantage of our approach to the stop location and the fact that its maximum value is limited (3.00 points in the E-Mini S&P).

Thus while we will never buy a bottom or sell a top, we may benefit from the potential of the new trend as it develops.

One of the most celebrated traders ever was London-based Nathan M. Rothschild, who went on to build a dynasty of bankers and traders that has lasted for almost 200 years. He was apparently criticized by the fact that he didn’t seem to identify tops or bottoms, a remark to which he replied: “I may lose the first 20% or the last 20% of a move but my interest is to keep the 60% in the middle”.

Incidentally, in our E-Mini manual we also tell of his famous coup by day trading the London stock market the day Napoleon was defeated at Waterloo.

COMPONENTS

Although the ASI, like everything else used in our systems including the Alpha Channel, is fully disclosed in our manual (even the TradeStation code is not protected) it is evident that in this analysis we cannot reveal its details.

One important advantage built into the ASI is the fact that we use volatility as a measure of the timing of a reversal. We must say that to the best of our knowledge only TradeStation, Metastock, RealTick and CQG can incorporate into the ASI our volatility analysis. But traders using any other system will still benefit from the concept we use, although occasionally the timing will be one bar late. What will be missed using these other charting packages is the ability to read a warning of an impending change in volatility, usually a sign of a change in trend. But the trading signal is identical.

The ASI has three lines with the middle one providing the trend direction while the other two will help in timing the signal. In order to increase the probability that the new trend will be in force, we also use the Alpha Channel that somehow “brackets” the position of the price. Thus our trading rule (there is only one) for a long in the E-Mini states:

-“Buy at the market (or …) when the ASI line crosses above the lower …. AND the price bar closes inside or above the Alpha Channel. Place a sell stop at ….. but never larger than 3.00 points.”

The rule allows for a trader to reverse each trade (the omitted words inside the parenthesis above) but we strongly recommend that traders will stick to the main trend as defined at all times on the screen. Sticking with the main trend will lead to some missed good countermoves but trading it will be less stressful. It will also help reduce the percentage of losing trades while increasing the size of the winning ones.

In the chart above the ASI trend component is the thicker, blue line. The thin, broken line is the upper line of the indicator while the solid, thin line represents the lower line.

BUT THERE IS MORE

The chart below for October 15, 2004 also shows another advantage of the ASI, visible in any chart using our volatility studies.

The broken line that ends at point a and is the upper line of the ASI does not display the same effects of whipsawing as the price bars or even the lower line, as the down trend from the high at 9:42 AM CST progresses. Similarly the lower line that ends at point c also shows less volatility than the price bars, thus suggesting the uptrend had further upside even after there was an exit signal when the indicator line crossed under the upper broken line.

The next chart for October 8, 2004 also shows several signals for potential trades. But a trader that would stick to our suggestion of trading only in the direction of the main trend would skip trades 3 and 5, ending the day with only three trades.

Breakouts

The chart below for September 28, 2004 has the relatively narrow intraday trading range that has been common in recent weeks but serves to exemplify another useful characteristic of the ASI: its breakouts.

At points a and c we can see that after the initial buy signals were generated as the ASI crossed above the lower line, the ASI indicator line broke above its previous levels. This confirmed that the uptrend was gaining strength and would allow a trader to add new trades to the longs already open. One of the best ways of squeezing more potential profits from a trend is to pyramid trades on top of winning positions.

The breakouts are usually easy to identify and the trained eye will in time be able to also detect the subtle breakout at point b. On the short side we can also see a breakout to the downside at point d although that would be of little use since the market was near closing time. Additional breakouts are identified as a1 and c1 in the October 15 chart.

The last chart that we present in this analysis is for October 29 the last trading for the month and the 75th anniversary of the 1929 crash. It is interesting to note that although the intraday range was extremely narrow, a scant 7.50 points, the ASI was able to pinpoint a few trades and save what could be considered a frustrating trading day.

Large intraday ranges are the fuel from which large profits can be made but that type of day is not as frequent as it used to be. Of course this has a good side because we know that range contraction (when making a profit is harder) will be followed by large range days, precisely those where the potential for comfortable trading is available.

It is unfortunate that we do not know what kind of intraday range we will have when the market opens every morning. But the right attitude is to trade only when a trading signal can be identified. It would be foolish to trade every minute of the day and the wise trader will wait for the higher probability signals to develop before he or she decides to initiate a trade.

Our experience suggests that days when the range is less than 8.00 points are hard to trade, which does not imply that they will be necessarily losers. However when the range goes above 10.00 points the probability of decent profits increases almost geometrically with the range expansion.

ADDITIONAL FEATURES

The ASI also provides other type of visible analysis.

Moves near the zero line

One feature is the fact that signals from ASI’s zero line area are a good signal in support of long trades. Thus if a buy signal has been generated and the ASI turns up again within the same uptrend, traders may decide to add more long contracts to an open position. Conversely, if a sell signal has been generated and the ASI turns down from the zero line area, this may lead to adding more short contracts to an open short position.

Distance between the two outside bands

The other helpful feature that can be identified from the charts is the relative distance between the upper and the lower AS lines.

In the previous charts traders may notice that when the outer bands travel in a more or less parallel fashion, the trend develops in a relatively steady way. This will suggest that the trend is continuing, thus implying that the trend remains strong. The Alpha Channel also helps define the eventual trend strength, eventually confirming this signal.

But as the trend may come under question, the relative distance of the two outside bands starts narrowing, alerting to the possibility of a reversal. Often the two bands and the ASI form a very tight “knot” as they converge and this provides an alert of an imminent change of direction. That is what happens most of the times, but at times that tightness can actually be a precursor of an acceleration of the existing trend. In these instances the Alpha Channel also provides an indication of the likely direction of the next move.

Experienced traders may adapt to their own system

Frequently we learn of traders who are using our system and incorporating its ideas into their own trading approach.

Let’s face it. Most of the traders who buy our system had been trading and were not very successful with the systems they were using. Otherwise why would they spend money with another system? But all along many of those traders developed ideas or learned chart interpretation using some types of indicators and patterns.

Well, since our system is totally disclosed and the parameters we recommend can be modified, any new buyer has the ability of adapting our system to what they have learned in previous, and probably expensive, education.

This doesn’t mean that we feel that changes to our system are necessary; if we thought so we would have made the desirable improvements as we did with the latest and final upgrade. But a new buyer may feel more comfortable by knowing that the tools that we use are not only fully disclosed but can also be blended with the trader’s toolset at his or her discretion.