THE MAGIC OF MOVING AVERAGES
Scot Lowry
TRADERS PRESS, INC.® P.O. Box 6206 Greenville, S.C. 29606
Books and Gifts for Investors and Traders
Copyright ©1998 by Scot Lowry. All rights reserved. Printed in the United States of America. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher.
ISBN: 0-934380-43-0
Reprinted by agreement with the author, Scot Lowry Published April 1998
TRADERS PRESS, INC.® P.O. Box 6206 Greenville, S.C. 29606
Books and Gifts for Investors and Traders Please write or call for our current catalog.
1-800-927-8222 FAX 864-298-0221
[email protected] http://www.traderspress.com
This book is dedicated to the following:
To Kim, for all your unselfish help. To Brian, for your assistance and patience. To Deena, for your creative input. To Juanita, for doing all the things behind the scenes that no one gets credit for. To Jim, see, I told you.
INTRODUCTION
The reason for writing this book is twofold: first, after years of studying charts, I have been able to identify an occurrence in market trading that can almost ensure high returns with minimal risk. This approach to trading is very clear and easy to understand. Which leads me to the second reason for writing this book. For a long time I have felt this system was too simple to wan-ant a book, but over time, I became increasingly convinced that the system that you are about to learn has been overlooked by the vast majority of people. I once asked a friend of mine, who was instrumental in my decision to write this book, why more people had not seen this. His response was, "more often than not, people do not see the forest for the trees". In other words, the trading plan you are about to see is so simple that it defies logic. It is not complicated, it is not time consuming, and it has no difficult formulas to try and understand. It is an easy, layman's approach to profitable trading in the futures markets.
1
As I mentioned earlier, I believe this approach to trading has been overlooked by many. On the other hand, it is so basic that it is hard to believe that it isn't being used by quite a lot of investors already. Here's why. As many of you already know, the basis behind any market move in a particular direction is founded upon one simple principle - there are either more buyers than sellers (in which case the market goes up), or there are more sellers than buyers (in which case the market goes down). So why do I believe that other investors are somehow arriving at the same area on the charts as I am to place buy or sell orders? Because, as you will learn, this trading strategy places orders above or below where a particular market is trading at that time. When the ,market price finally trades at our price, the market has a tendency to continue in that direction at a rapid pace, which tells me there are many other orders placed to buy or sell at the same price I have chosen; i.e., more buyers than sellers forcing the price up, or more sellers than buyers forcing the price down.
One more note to make before we embark on a short journey on how both experienced and novice futures traders can learn a very simple and successful approach to trading.
Chapter one is a brief overview of how futures and commodities trade. This chapter is
2
devoted to those who have never dipped their hands into the excitement of trading futures. It will explain in simple terms how and why futures trade as they do, and give you an understanding of terms and phrases used in the markets. For those of you who have been trading in the past you may find this tiresome and may want to move on to chapter two.
It is to be related that all commodity and futures charts, trades, systems, patterns etc., discussed in this book are for illustrative purposes only and are not to be construed as advisory recommendations. There is the chance of substantial loss in futures trading and there exists no trading plan with a foolproof system. Past performance is no indication of futures results with this trading system or any other. It should be further noted that the ideas and trading systems in this book are solely those of the author and do not necessarily reflect those of Data Transmission Network, the advertiser, or anyone else affiliated with this book in any way. Futures trading is risky and traders do lose money. Before investing in the futures market one should be aware of the potential profits and losses involved. Any trades that an investor attempts should be discussed with his or her broker before implementing. The information contained herein has been obtained from sources believed to be reliable; however, it cannot be guaranteed.
3
CHAPTER ONE
Before learning a trading strategy it is important to have a general understanding of how and why markets move. You need to know why we have commodities markets and what their purpose is. You need to fully understand how and when orders are placed and to know about the different orders that exist. Proper placement of an order with your broker is of the utmost importance; errors can become extremely costly.
In the mid-1800's the first commodity exchanges opened to the public. They were devised to keep prices stable; i.e., to keep prices from having exaggerated swings either up or down. If these trading arenas had not been open to the public we would never know from one day to the next what prices would be in the stores. Exchanges were implemented to keep prices from skyrocketing one day and plummeting the next.
4
How is this done? Let's first look at a commodity with which most people are familiar wheat for example. Wheat is used for many purposes throughout the world,- but most people associate wheat with bread. So let's look at a world where there was no exchange to keep prices in check. Suppose that last year there was a drought in the wheat growing region. This would inhibit the growth of the wheat crop and would consequently mean a smaller crop. How would that affect prices of bread in the stores? The price would go up. Here are the reasons why: first, the farmers would have put just as much time and effort into raising a small crop as they would have into raising a large crop. Their costs were the same and they need to make the same amount of money in either event. So they will charge more for a bushel of wheat, driving up the price to the bread maker, which will eventually be passed on to the grocery store and ultimately to the consumer. Second, if bread producers know there will be a shortage of wheat, they will be willing to pay a higher price to ensure that they receive the quantity of wheat needed to make as much bread as demand warrants. Again, higher prices are passed on to the ultimate bread purchaser. This is the basic law of supply and demand. If supply is short and demand is stable, price goes up.
5
Now let's look at the other side of supply and demand - the scenario where bread prices would go down. Instead of a drought in the wheat fields, we have perfect weather and the crop yield is quite large. In this hypothetical situation the farmer could have more wheat than he can sell. The bread producer only needs enough to make the same amount of bread he made last year (assuming the demand stays the same). The farmer doesn't want the costly task of having to store the excess wheat. He wants to sell it. So he is willing to accept a smaller amount of money per bushel to sell his crop. He also knows there are many other farmers trying to sell their wheat. Now the bread producers can shop around and offer less money per bushel until they get the price they want. As farmer after farmer lowers the price to sell his crop, price may well have dropped to the point the farmer is no longer willing to sell. Sometimes the offered price is less than the cost to harvest.
Now let's speculate on what happens next in the supply and demand chain. We know the bread producer paid less per bushel for his wheat, and we are fairly certain the grocery store knows this as well. So, at this point, my assumption is that the grocery store and the bread producer will agree on a price per loaf of bread so that the grocery store can stock it's shelves. Now we can rest assured that the price for a loaf of bread this year will be cheaper than next. We know the savings will ultimately be passed on to the consumer...
6
Once again the laws of supply and demand take over. Assuming again that demand is the same, we have an overabundance of supply which forces price down. It is easy to see now why the price of bread could be very high one year and very low the next, or could change daily as the people involved speculate how the weekend rains or the temperatures overnight affected the crop. These are hypothetical situations used to show what could happen to the price of bread (and every commodity in the world) if this were a world where no • commodity exchanges existed. There would be constant and wild price fluctuations and the public would not know from week to week the price of a particular product. The solution to the dilemma was to get the public involved to help set the price of commodities. This was done through the development of the first commodities exchange the Chicago Board of Trade. CBOT was set up to control grain prices, which at the time, were the staple of American life. By getting the public involved (the people paying for the loaf of bread), it was easier to keep the price of wheat from skyrocketing. The public could sell wheat on the exchange if the price went too high, thus forcing the price down. Theoretically, the more people involved in trading any particular commodity, the
7
more price stability there will be, minimizing to some degree, wild price swings.
Let us look at how the futures market works. Futures and commodities trade today at what traders expect prices to be in the future. Each commodity trades in individual months. For example, wheat has contract months of March, May, July, September and December. These contract 'months specify at which time a delivery of that particular commodity is to take place. So let's say that today is August 23, and the price of December wheat is $3.83 per bushel. Let's also say that there has been a rumor that the wheat crop will not be very large this year. We just learned that if the crop is small, the price of wheat should go up between now and December. So today we buy a contract of December wheat at $3.83 per bushel. We have between today and sometime in December to sell that wheat contract. Since we bought today we hope the price goes up so that we can sell the contract higher than our purchase price. In this example we will assume the price goes up to $3.94 per bushel by September and we do not think it is going much higher. So we sell our wheat 'contract at that price. The difference between $3.94 and $3.83 is eleven cents. Since the value of wheat on the futures market is $50 for every one cent, our profit is $550. ($0.11 x $50.00 = $550.00) On the other hand, had we sold wheat at $3.83 in August and bought it back in September for $3.94 we
8
would have lost $550 - which, of course, is not our objective.
But wait. How could we have sold wheat in August when we didn't own any? This is what is referred to as "shorting" the market - you sell first and buy back later. This is sometimes confusing, so I will approach explaining it in as simple a fashion as possible. Using the above example let's assume the rumor we heard was the wheat crop was to be very large instead of very small. In this case we would surmise that the price would go down from the current $3.83 per bushel. In order to profit from that we would want to sell wheat rather than buy wheat. To do so we must enter into an agreement with someone who is a buyer of wheat at that price. We tell the buyer, in our agreement (or contract), that we will sell him one contract of December wheat at $3.83 today. Now we have until December to buy a contract of wheat from someone at some price. Our hope is that the price of wheat will drop between now and December so that we can purchase it at a lower price. If the price drops to $3.72 and we buy the wheat at that price we will have fulfilled the terms of our agreement to buy and deliver the one contract of wheat. We also would have made the difference of $3.83 per bushel and $3.72 per bushel, again it is eleven cents at $50 a cent, or $550.
9
If you are still confused, try this example. Forget the chronology of time. Regardless of time we bought wheat at $3.83 a bushel and sold wheat at $3.94 a bushel in the first example. We bought wheat at $3.72 a bushel and sold wheat at $3.83 a bushel in the second example. It doesn't matter whether you buy first and sell second, or sell first and buy second. The bottom line is the difference between the two prices which represents your profit or loss potential. If you sell first, you want the price to go down. If you buy first, you want the price to go up. That is all you really need to know to be an effective, profitable futures trader.
As this book progresses you will learn a certain approach to trading. This trading program requires the use of two types of orders that will be placed with your broker. For our purposes these will be the only two types we will cover. Other fundamentals about trading are not necessary as far as we are concerned.
To understand the first type of order let's once again use the first wheat example. In that example, wheat is trading today at $3.83 per bushel. Since we think the price of wheat is going up we will want to place a buy order. As you will learn in a later chapter, we never buy anything at the current market price. You will also learn that there is a certain line on the chart that we will look for and we will place our buy order above that line. So let's
10
suppose this line we will be looking at is at $3.86. We will place our buy order above that line, say at $3.91. That means we will not be buying wheat until the price of wheat gets to or above $3.91 per bushel. This is referred to as "buying on a stop". When the price of wheat does trade at that level, our order will be executed and we will have bought wheat. To place this order with your broker you will say to him, "Buy one (or more if you are buying more than one) contracts of December wheat at $3.91 on a stop." The reason for this order is that if the price of wheat goes down from the current price of $3.83 per bushel instead of up, we never got in the market, because we will not be buyers until the price goes to or above $3.91 per bushel. We don't want to buy wheat if the price is going down. We want to buy our contracts on price strength in the market, not weakness. If we take the second example of wheat, we are looking for the price of wheat to go down. The current price of wheat in the second example is $3.83 per bushel. Again there will be a line on the chart that we will look for to place our sell order below. Let's say that line is at $3.80. We will then place our order to sell at $3.78 per bushel. This is referred to as "selling on a stop". The way you would place your order with your broker is "Sell
11
one (or more) contracts of December wheat at $3.78 on a stop." This time we will not be selling wheat until the price of wheat drops to or below $3.78 per bushel. This time we are looking for weakness in the market, not strength. To reiterate, if the price
goes up from $3.83 per bushel we never got involved in the trade. We only sell wheat when the price drops to our offered price of $3.78 per bushel. This is the order you will use most often when trading this system; buying or selling on a stop. The next order you will learn is to be used only after you are very proficient at trading, or you may never use it. I say that because it can be a very risky trade. It is not used when trading the basic system you will learn, but it is used on other trades that will be shown at the end of this book. These will be trades that go against the grain of the market, which is why they can be quite dangerous, but when they work they are extremely profitable. They are not for the inexperienced trader. The way this trade works is as follows. Let's say wheat looks as though it is close to making a high in price (referred to as a top) and will stop, turn around, and start going down - based on what you will learn later. We will at that point place an order to sell wheat at a specified price or better. For example, let's say wheat is trading at $3.95 per bushel. The line on the chart we are following is at $4.05. In this example we do not
12
think the price of wheat will go above $4.15 per bushel. This is when we. will place an order with our broker to sell wheat at $4.05 or better, with a protective buy stop at $4.21, which is a price above which we do not think wheat will go. That means that when wheat gets to $4.05 per bushel we are selling. This is dangerous because if the price of wheat continues upward we can incur heavy losses. Our losses would be the difference between $4.05 and $4.21 - the price of our protective buy stop. ($4.21 - $4.05 =$0.16, $0.16 x $50.00 = $800). $800 is a round figure because the losses could exceed that with slippage. Slippage is a term used when the actual price filled on your stop is worse than the price you have entered. This can occur in fast moving or thinly traded markets. By the same token, if we think the price of wheat has reached a bottom and wheat is trading at $3.45 per bushel, we will again find the line on the chart that we are watching, at a price below $3.45. Let's say it is at $3.38. At this point we will place an order with our broker to buy wheat at $3.38 per bushel or better. That means the price of wheat must drop from $3.45 to $3.38, and we will be buying wheat in a falling market. A protective sell stop would need to be entered below the $3.38 level, around $3.30 per bushel. This is what I mean by going against the grain of the market - you can see why there is inherent risk involved.
13
Let me re-emphasize the fact that this second style of placing orders is not used in the basic trading system in this book, but is used for more risky trades that only an experienced trader should attempt.
hope this general overview will give you enough understanding of how markets operate to get you started. This is by no means all there is to know about trading futures and commodities, but it should be enough to get you on your way using a basic trading plan that does not incorporate a lot of formulas, fundamentals, seasonals, etc. There are many topics written about such things and if your interest goes beyond basics then you will find a multitude of books from which to choose. I
14
CHAPTER TWO
There are so many trading techniques around now that it. is hard to choose one that seems to work consistently. When I first started trading in the futures markets I began using a system that worked sometimes but more often than not it turned up losing trades. I continued trading and found that whatever system I used worked one time, but then failed the next. I spent years pouring over the charts and reading market news each night as to why a particular market moved that day. Then, all of a sudden, it came together! A clear picture began forming and I was able to see a concise pattern occurring over and over. The same formations continued to happen before major market moves on every futures chart! I was astounded, how could it be this simple and blatant? How could this have been before my eyes every day and I had missed it? It seemed there had to be more to it than this, but after years of watching and back testing I found out there was not more. It really was this simple. Do not misunderstand me, I have by no means figured out the commodity markets in general, 1 don't think
15
anyone ever will. What I have figured out is one series of events that occurs prior to a market move. And this one series of events allows you to place your buy or sell orders above or below where a market is trading at that particular time. It also tells you where to place your initial protective stops. You will know roughly what your potential loss will be prior to your entry into the market. The advantage to this trading system is that you will not need to wait long to find out if you are right or wrong in the direction the market will be moving. In most cases you will know within a few days. At that point you will either be able to move your protective stop to lock in more profits or you will no longer be in the market because you were stopped out with a loss. The latter is what we will try to avoid. Exercising patience in your entry order is extremely critical. At all costs, never try prior anticipation of the direction of the market after learning this trading system. I have already done that. Not only does it not work, it is quite costly. It's like trying to teach a pig to sing, it does not work. You must wait for the proper signals to act on before placing your trades.
My system of trading involves something that has been around since the first hour of the first day the first market started trading. I have done nothing spectacular. All I have done is devise a different approach of using what already exists. What already exists are moving averages. These lines are used quite frequently by many traders
16
around the world. Moving averages are already one of the most popular ways of trading, but by the time you finish reading this you will have a whole new outlook on them and how to employ them for maximum advantage: You will learn a new way to look at markets, and one thirty-second glance at any chart will tell you whether a market is worth trading or not. You won't get in at the bottom, nor will you get out at the top. But that is not necessary to be in on extremely profitable trades. This system will also eliminate guesswork on market direction.
For those of you who are not familiar with moving averages, following is a brief explanation. A moving average is the average of a specified amount of prices divided by the total number specified. They change on a daily basis as the price of each market changes. Here is a formula to use when figuring a moving average: MA — (P 1 + P2 + ...Pn)/n MA - represents moving average. PI - represents the price on the first day. P2 - represents the price on the second day. Pn - represents the last day in the series. n-represents the number of days in the series.
17
A moving average is just what it says it is, it moves from day to day. To calculate a moving average, you must drop the first number of the sequence (P1) and add a new one to the end. The new one added to the end would be the closing price for that particular day. So if you were calculating a four day moving average you would, at today's close, add today's price to the series and take away the closing price from four days ago. Then you would recalculate. Below is an example of how this is done.
December Cocoa Day August 12 August 13 August 14 August 15 August 18 August 19 August 20 August 21 August 22 August 25 August 26
Four day MA
Close (P1) (P2) (P3) (P4)
1515 1527 1516 1512 1563 1553 1569 1618 1601 1615 1653
1517.5 1529.5 1536 1549.25 1575.75 1585.25 1600.75 1621.75
For example: 4 day MA =_1515±1522±1516±1515+1527+1516+1512=1517.5 4
18
As these averages move on a daily basis you will see patterns emerge on the charts that will help you identify trends and show you opportunities to buy or sell. When looked at properly they seem to tell us in advance what will happen next. In a lot of cases they act as arrows pointing to the direction the market intends to go. You will also find that for whatever uncanny reason, the markets will quite often wind up in the "Danger Zone" in the days prior to a major news event - (The Danger Zone will be delved into later). In some instances the markets will emerge from this "Danger Zone" a day or two before the news is announced, giving us an indication of possible future market direction. I think this happens when somebody knows something he or she is not supposed to know. In any case, it can be quite helpful - unless they were wrong. It is always best to stay out of the markets until after the news breaks. Let's move on to what these moving averages mean.
19
CHAPTER THREE
Throughout history, man has searched for the ability to see into the future. Wise men who seemed to possess certain gifts of clairvoyance were called seers or prophets. In ancient Greece, at the temple at Delphi, priests attained almost god-like status by teaching seekers to look within to see what lay beyond. Centuries later, the priests at the Oracle of Delphi are remembered as some of the most reliable seers and prophets of all time.
The basic trading system described in this book focuses on a series of events that occur to create a rare formation. No system that predicts the future is 100 percent accurate, but this particular formation not only indicates which direction a market is headed, it gives the investor a margin of safety as he or she enters the market. It is a system of superb reliability. It is for that reason we borrow from the past and name this occurrence the Delphic Phenomenon.
20
Before we start into the trading aspects, I want to explain which moving averages I use and why. This system employs the use of three moving averages, the four day, the eighteen day, and the forty day. These work out the best and have the most consistency. Certain markets have different moving averages that are used by the traders of those markets, but the vast majority use these three and it is with these that I have found the most success.
The first example we will use is the 1997 July Soybean chart (page 23). I have chosen this chart because it contains virtually all aspects of criteria needed when capturing the beginning movement of the Delphic Phenomenon. Refer back to this chart as you continue reading. There will be other charts shown later which reveal the same patterns, but some will not be as "textbook" as this one.
The way I use these averages is quite simple. The first step is to wait for the eighteen day moving average to cross over the forty day moving average (in either direction). For clarity, let's say the eighteen day moving average crosses from below the forty day moving average to above the forty day moving average. At this point, the only thought you should have is to start looking for a buy signal. Whenever the eighteen day moving average is above the forty day moving average we are looking
21
for a buying opportunity. Once the eighteen day moving average is above the forty day moving average we will wait for the actual price of the market to go above the eighteen day moving average, and then drop below it, for the first time. This is our buy signal! This is what we are looking for. This is the stage in the Delphic Phenomenon that tells you what lies beyond. It is at this point that we call our broker and place a buy order just above the eighteen day moving average. If you get filled on your buy order, you will have your broker place a protective sell stop just below the forty day moving average. The difference in price between your entry point in the trade and the forty day moving average will be your initial risk in the trade. As the market moves up you will be able to move your protective stop up accordingly. You will continue to do this until such time that the market reverses direction, trades .at your sell stop price and exits you from the trade.
The reverse of the above example would be for a selling opportunity. In which case you will watch for the,eighteen day moving average to cross from above the forty day moving average to belQw the forty day moving average. As soon as this happens you will be looking for your sell signal. That sell signal will come when the actual market price moves from below the eighteen day moving average to above the eighteen day moving average, for the first time. At this point you again call your broker, but this time you will be placing a sell order
22
08/28/97 19:5S CDT CHARTS - Techn - SOYBEANS Jul 97
CBOT Pg ALARM „
N
ecoudtiine mark dip
• • market price rises above 18, • for the first time
place protective sell stop below 40 market price dips below 18, for the first time
23
just below the eighteen day moving average. If the market drops and fills your order, you will then call your broker and place a protective buy stop just above the forty day moving average. Once again your initial risk for the trade will be the difference in price between your entry point and the forty day moving average. As the market price drops you will move your protective buy stop down to lock in more profits until the price changes direction and trades at your stop price.
These last paragraphs are the essence of the Delphic Phenomenon trading system. Remember, you only place your trade the first time the market price goes inside the eighteen day moving average after the eighteen day moving average crosses the forty day moving average. There will be other times the market price dips inside the eighteen day moving average, but I will rarely place a buy or sell order on the other side of the eighteen day moving average in those cases. The reason is that too many times the market run from that point is short lived. A good case in point is the area on the July 1997 Soybean chart ( page 23) at the upper left center. Around April 1st the market came out of the eighteen day moving average to the upside. It was the second time the market price had dipped inside the eighteen day moving average since the eighteen day moving average first crossed the forty day back in December. As you can see, the brief spurt was short-lived. Had your protective stop been of ample distance to give the market opportunity to move,
24
your profits may not have been very high, if you realized any profits at all.
When I say that your protective stop was of ample distance to give the market room to move, almost everyone wants to know what "ample distance" is. Welcome to the hardest and most difficult question that ever existed in the commodities markets. I sometimes wonder if there is an accurate measure of ample distance. Certainly it is different in every market and it is different from day to day. I typically will place a protective stop half-way between the eighteen day and forty day moving averages. This is what I use as "ample distance". Had that been done on the July Soybean chart (page , 23), the second time the market dipped inside the eighteen day moving average and rose above it, as described in the previous example, the trade would have produced small profits. The point being, I don't think there is a perfectly safe place to have your protective stops. No market proceeds along like clockwork.
The best place I've discovered to place my protective stop is below the forty day moving average on initial entry into the market in a buying situation, and just above the forty day moving average in selling situations. I then like to give the market about one week to make up it's mind on it's
25
future direction. As the market moves in my favor after that approximate one week, I move my protective stop to about half the distance between the eighteen day and forty day moving averages. I continue to move it, on a daily basis, until I am eventually stopped out of the trade. In some cases that turned out to be a good time to get out of the market, and in others, staying in longer would have been better. This method of trailing a stop has had the greatest amount of success for me so far. You may want to play with that and see if you can arrive at a better means of gaining more ground. If you do, I would love to hear about it. You may wonder why I have chosen to wait for the market to go inside the eighteen day moving average before I place my buy order on the outside of it. You might say "Why not buy into the market as soon as the eighteen day moving average crosses the forty day moving average, or why not just buy as soon as the market crosses the forty day moving average?" The answer is that quite often the market price will jump across the forty day moving average, run up high enough to cause the eighteen day moving average to cross the forty day moving 'average, and then just go right down again without ever coming back up. Sometimes the market price will jump up above the forty day moving average and go right back down without ever having enough strength to stay long enough to pull the eighteen day moving average across it. Remember, it is not a buying situation until the eighteen day moving
26
average is on top of the forty day moving average, •and it is not a selling situation until the eighteen day moving average is below the forty day moving average. So the reason for waiting for the market price to go above the eighteen day moving average and dropping below it before we place a buy order is this: if the market continues down - we never got in the market at all. You will find that, in most cases, the first time the market cros g es the eighteen day moving average after the eighteen day moving average crosses over the forty day moving average, there will be enough buying pressure to send the market for a nice run. Your protective stop will be placed on the side of the forty day moving average opposite the eighteen day moving average. If the market fails in its attempt to continue upward after crossing the eighteen day moving average, you will know what your losses will be and your stop order is set below another crucial line of support. It is, in other words, where it should be - below the line of support of 'a market. Market support is a term used to identify where supposed buy orders are already in place, giving enough buying pressure to keep the market price from going lower. Market resistance is a term given to an area where supposed sell orders already exist, giving the market price a cap (or top) that price should not breach.
Therefore; it is the very essence of this trading system that you will be in on a market move going in your favor or you never got in the market at all. The only other scenario is that you got in the
27
market and were stopped out with a loss. A loss you were willing to risk before you started. Another point I'd like to make is that you must keep up with reports that will come out on different markets. For instance, there are crop reports, cattle on feed reports, unemployment reports, etc. I make it a point to be out of any markets the day before a report is issued regarding that market. The only exception to this rule is if I already have high profits on the trade and my protective stop order is well above my original entry level, I may then consider maintaining my position. The reason for this is that no matter how good things may look, a report can totally alter the course of any market if there is unexpected news. I will mention options only once in this book. I do not trade them except on two occasions. The first is the day before a market news report. At that time I will place a trade only if the futures chart shows me I should be placing a buy or sell order based on the Delphic Phenomenon. If, for example, the corn chart shows me that I should be placing a buy order above the eighteen day moving average tomorrow, and tomorrow is the day of the crop report, I will buy a corn call option today. This, too, involves risk but the risk in options is usually much less than the risk in futures.
28
The second occasion in which I use an option is if the futures market I plan to trade requires a large risk, based on how far away the forty day moving average (where my protective stop will be) is to my entry into the market. In that case I will decide at what price , I would have placed my buy (or sell) order on the futures chart. I will then call my broker and tell him that when the futures market trades at that price, to buy a call (or put) option at the market price. The strike price of the option will have been predetermined between my broker and me. I won't waste time explaining how options work, if you choose to use them your broker can explain them to you.
I try to avoid the use of options because you have two enemies in that game - price and time. The only real enemies in the commodities and futures trading system you have been reading about are price and impatience - the greater of the two enemies is impatience. These opportunities to buy and sell based on the Delphic Phenomenon do not happen every day. You must wait for them to develop. The old adage about patience being a virtue has tremendous application here. Overzealousness will destroy an account in a very rapid fashion.
Now that you have a basic understanding of when you should place your buy and sell orders and what to look for in a chart we need to move on to
29
more specifics. Not every single time that the eighteen day moving average crosses the forty day, and the market drops inside of it do you place your buy or sell order. There are certain times to do this and certain things to look for. The following will be critical information needed to trade this system successfully. There will also be more charts to emphasize these criteria. Before you go to the next charts I want you to return to the 1997 July Soybean chart (page 23). Near June 1st, you would have been filled on a sell order had you followed this trading system. Your protective stop would have been placed above the forty day moving average. Note the proximity of the forty day moving average to the eighteen day moving average. They are not very far apart (compared to other charts you will see). Also, notice how quickly (eight days) the market price took to come back above the eighteen day moving average after the eighteen day moving average crossed below the forty day moving average. Critical!! These are the relationships you want to find. These are the ones with the best opportunities for successful sell trades: the eighteen day and forty day moving averages are close to each other, and a quick move of the market price down and then back up again, above the eighteen day moving average. The opposite would apply for a buying situation. On the same chart, go back to the first week of February. Had you been trading this system at that time you would have placed your buy order above the eighteen day moving average. Your protective stop would have been placed below the forty day moving average.
30
It seems easy, and it is, when a chart shows such a clear pattern. Sometimes the charts will not be as specific.
The next chart shown is the 1997 October Live Cattle (page 32). In this chart you will see near the end of December the eighteen day moving average crosses above the forty day moving average. On this occasion the market did not make a quick drop inside the eighteen day moving average. The market price did not drop inside the eighteen day moving average until the first week of February, twenty-five trading days later. That is usually too much elapsed time for me to place an order on the other side of the eighteen day moving average. Granted, you could have made profits on the trade in this case, but too often the following breakout from the eighteen day moving average at this point is short lived. This is a situation that requires close attention. As stated before, the best time to get in on a sizable move is when there is fairly little time between the eighteen day moving average crossing the forty and the market going inside it. The opportunity still exists, but this is a decision I would give serious thought to first. Following this upward move the market again drops, this time pulling the eighteen day moving average below the forty day moving average. When the market price went above the eighteen day moving average, we would have placed sell orders below the eighteen day moving average (around the middle of March). This trade resulted in a small
31
87/22/97 18:22 CDT CHARTS - Team - CATTLE, LIVE Oct 97 \,,W%,ttk•
\‘.
f%,.:,'VW'NrS, \4 A \V‘`'.
On'tMn'AMW-4.YtrAWN''., '')V\ -
32
CME Pg ALARM 4g. VA*44NPs* •.?
,
\*I.A
loss. The protective stop just above the forty day moving average was elected and that took us out of the trade in late March. The large move upward after this pulled the eighteen day moving average above the forty day moving average. Once again our opportunity arrives to place a buy order above the eighteen day moving average after the market price drops below the eighteen day moving average. About the middle of April we are in the market again, after our buy order is filled. This resulted in a very profitable trade. Going along the same chart we have a sell off in Live Cattle starting about the first of May, and the eighteen day moving average is pulled below the forty. The waiting begins. We are waiting for the market price to go above the eighteen day moving average before placing a sell order. This does not arrive for a long period of time, over twenty days since the market price first crossed below the forty day moving average. Too long in this case. This presents an opportunity to place a buy order at or below the eighteen day moving average. This will be explained in a later chapter. This is one of the dangerous trades for experienced traders. The point is, if there is too much space between the eighteen day moving average crossing the forty day moving average, and the market price dropping and then going in between the two, it is not the time to be placing the traditional order that you have learned thus far. What we are looking for is a rapid drop (or rise) in the market price right after the eighteen day
33
moving average crosses the forty. When there is a long gap between the eighteen day moving average crossing the forty day moving average, and the market price going inside the eighteen, you could be flirting with disaster if trying to employ this system at that time. The number of days required between the market price dropping (or rising) above (or below) the eighteen day moving average is not etched in stone. It is based more on how the charts look at the time. If you take the time to study the charts in this book and pay close attention to the difference between the charts listed under "Delphic Phenomenon" versus "System Failure" the clarity of the entire trading system will eventually jump off the page at you. When you understand the relationship of time to the occurrence of the Delphic Phenomenon you will have all you need to pick these formations out with a quick glance at any chart. You will find as you follow current charts or look into historical charts that the Delphic Phenomenon occurs quite frequently. It is a very simple approach to trading futures and commodities utilizing a system that will bring about substantial rewards while at the same time limiting risk. There are times when this system causes us to miss entire market moves because the market price of a particular commodity does not go inside the eighteen day moving average in a rapid fashion after the eighteen day moving average crosses the forty day moving average, but these are few and far
34
between. Our goal, however, is not to be in on every market move, only to be in on the more certain and conservative trades in order to minimize risk while employing the Delphic Phenomenon system. We do not subject ourselves to potential large losses by simply jumping into a market that appears to be heading in a certain direction. The Delphic Phenomenon uses a very easy means of finding an entry point and a position to place our protective stop order. By so doing you are well aware of the potential losses existing in that particular trade. These locations are based on tangible spots in the charts and are based on points of inherent meaning. There will be shown, later, other ways to enter the market without using the Delphic Phenomenon. These are means of picking key turnaround spots, and gaining exceptional entry points. Before we get to that let's look at a 1997 September corn chart (page 36). Here lies the same pattern as the Soybean chart.. First focus on the time around the end of January. Just prior to that, the eighteen day moving average crossed above the forty day moving average. The market drops inside the eighteen day moving average shortly thereafter. Our buy point is just above the eighteen day moving average; and our protective stop is placed below the forty day moving average initially. As the market moves up, we trail our protective stop order half-way between the eighteen day moving average and the forty day moving average. Around the middle of March, we
35
CBOT Pg ALARM
10/12/97 14:14 CDT CHARTS - Techn - CORN Sep 97 MA s. . 3
\MU.V1.>4.?:,
\ , •,
\k`M\K,N.,„
• k•st,'%,
,, ;;;;.„
market price dips below
18, for the first time
36
\'•
would have been stopped out of the trade with a very handsome profit When the market turns downward in the middle of April the eighteen day moving average goes below the forty day moving average. This time we wait for the market price to go above the eighteen day moving average before placing a sell order below it. That day does not come until the middle of June. By using the Delphic Phenomenon to trade, we would have missed out on the entire move down. Employing other tactics at our disposal we would not have missed out at all. In a later chapter you will find out how we could have sold short in this market long before the eighteen day moving average ever crossed the forty day moving average. I want to discuss one more chart before moving on to some of the more exciting things to look for while trading futures and commodities. That next chart will be the 1997 September cocoa (page 38). It will be followed by other charts so that you will be able to find the formations for yourself. As you can see, trading by the basic system alone can be very exciting because it is so simple and profitable. It is incredibly easy, and one thirty-second glance at a chart will tell you if the market is worth trading or not. The more exciting part of trading futures is yet to come.
I chose the cocoa chart to emphasize once again the point that when a market makes an
37
CRC Pg ALARM
09/13/97 14:29 CDT CHARTS - Techn - COCOA Sep 97
U\\
N\
•"•`.
38
"."`
\
\:,k 4A
extended run (causing a . long gap) after the eighteen day moving average crosses the forty, it is not time to place an order above (or below) the eighteen day moving average. Near the first of March the eighteen day moving average crosses above the forty day moving average and the market price does not drop inside the eighteen day moving average until the first of April. This is usually too long, and the point is made clear by the brief burst over the eighteen day moving average around the end of April. Do not get sucked into these moves! Have patience. After that burst up, the market drops and the eighteen day moving average crosses below the forty. When the market price goes above the eighteen day moving average we place a sell order below. The situation around the middle of May is a hard call to make. If our sell orders were too close to the eighteen day moving average, we would have gotten into the market and taken a loss when the market crossed the forty day moving average and hit our protective stop. Had our sell orders been farther away from the eighteen day moving average, below the low set on that one particular day, we would have never been involved in the trade. That brings up an important question. How far from the eighteen day moving average should an order be? As with all stop orders, that's the toughest question in trading. There is no definitive answer. Each market is different, and each day is different. I've tried a number of ways to find a
39
precise distance from the eighteen day moving average, including previous lows, retracements, different mathematical formulas, etc. After all the effort seeking a magical spot, I have found that it is best to simply place your stop order a few price ticks below the eighteen day moving average. You will see, as you study the charts in this book, that when the market price begins its run from the eighteen day moving average it has a tendency to really move. By placing your order close to the eighteen day moving average you will be in for better fills as the market moves in your favor and, likewise, will reduce your losses if the market should reverse course on you.
The next move on this chart is to the upside and with it comes the eighteen day moving average, crossing the forty day moving average near the end of May. Around the first of June the market drops below the eighteen day moving average and we have the perfect scenario; a quick drop of the market price into the eighteen day moving average, as soon as the eighteen day rises above the forty day moving average. We place our buy order just above the eighteen day moving average and off we go. When a market moves at breakneck speed as this one did use a different strategy for placing my protective stop. In almost all cases, any market that makes an extremely big move in one direction is followed by the same on the reversal. Don't be fooled into thinking something will go up forever it doesn't! All markets that go up, will eventually
I
40
come down. The higher and faster they go up, the harder and faster they will usually fall. Therefore, in situations like this I will trail my protective stop order half-way between the eighteen day moving average and the four day moving average. (See, we do use the four day moving average sometimes). By doing so, we would have been able to sell out of the market near the highs around the end of June, with tremendous profits. Study the following charts to test your understanding of this trading system. The more you study them the clearer the Delphic Phenomenon will become. You will be given a quiz at the end of this book. If you fail the quiz, you will have to read this chapter over. Do your best.
41
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
42
O8/29/97 19:SS CDT CHARTS - Techn - SOYBEANS Jul 97 s, '", NW N.N, \\z
43
CBOT Pg MARK
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.) Allow market price to drop below the eighteen day moving average, for the first time.
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
7. Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
44
Place a SELL order below the eighteen day moving average.
07/22/97 18:22 CDT CHARTS - Techn - CATTLE, LIVE Oct 97
45
CHE Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.) Allow market price to drop below the eighteen day moving average, for the first time.
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
7. Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
46
Place a SELL order below the eighteen day moving average.
10/12/97 14:14 CDT CHARTS - Techn - CORN Sep 97 Ak:AtAltk &=kk:
W4r
47
CBOT Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
— 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
48
•
09/13/97 14:29 CDT CHARTS - Techn - COCOA Sep 97 ".„
•\‘'
\A `, * `*.% • "
49
\‘‘`
Pg
ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
09/14/97 00:20 CDT CHARTS - Techn - US TREASURY BOND Sep 97
51
CBOT Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
52
10/09/97 13:81 CDT CHARTS - Techn - DEUTCHEMARK Dec 97
53
IMM Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
54
10/05/97 12:54 CDT CHARTS - Techn - SILVER (SOOO OZ) Dec 97
,N4VW
COMEH Pg ALARM
\auth.t: smilek.A4Mt, " itiAL'It:MWAtimzsm\4* ft\ IA\ \4
s'
55
AVA,4VWW,q,AN,
\*I
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average,for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
10/8S/97 12:47 CDT CHARTS - Techn - COPPER, HIGH GRADE Oct 97 ' ■V:Tr;>ir ' ° • \'*3fl ` 134''7IV 4\VT M"VagetWst‘s"&ata,,,
AvviNKV, • t
8Y.
\
k
57
•
COMEX Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
58
09/14/97 09:10 CDT CHARTS - Techn -
U S DOLLAR INDEX Sep 97
59
FINEX Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
60
10111/97 14:46 CDT CHARTS
eC
WEAN OIL Jan 98
61
CBOT Pg ALARM
CHART KEY FOR THE D LPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
62
115/12/97 15:11. CDT CHARTS - Techn - LEAH HOGS Dec 97
OlE ;.11
63
Pg
ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Allow market price to drop below the eighteen day moving average, for the first time.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
7. Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
64
Place a SELL order below the eighteen day moving average.
89114/97 18:47 CDT CHARTS - Tecbn - GOLD (188 OZ) Weekly
.
COMEX Pg ALARM
\\
\
65
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.) Allow market price to drop below the eighteen day moving average, for the first time.
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
7. Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
66
Place a SELL order below the eighteen day moving average.
87/22/97 18412 CDT OIARTS - Tecbn - ORANGE JUICE Weekly
67
NMI Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON I.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
68
CBOT Pg ALARM
09/20/97 14:42 CDT CHARTS - lean - OATS Weekly
pw,„.(h\si
k$,
ts
\' 1,- •
69
k.,,‘
;`*ws
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
70
\ VN
119/14/97 18:18 CDT CHARTS - Techn - SWISS FRANC Weekly .
•s
s „,kt
71
ISM Pg
ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.) Allow market price to drop below the eighteen day moving average, for the first time.
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
7. Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
72
Place a SELL order below the eighteen day moving average.
R9/20/97 12:28 CDT CHARTS - Tear' - DEUTCHEHARK Weekly
73
IHH Pg ALARM
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
74
HYHEX Pg ALARM
09/21/97 10:14 CDT CHARTS - Techn - OIL, CRUDE Weekly
,':&.4ag",2100N1Ov.w
*Re
75
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
CEC Pg ALARM
10/65/97 13:44 CDT CHARTS - Techn - COFFEE, C Weekly
\
77
CHART KEY FOR THE DELPHIC PHENOMENON
1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
78
10/11/97 25:40 CDT CHARTS - Team - AUSTRALIAN DOLLAR Weekly \‘\ ,„„
'c;tAk
79
INN Pg ALARM •\\.‘'r‘
CHART KEY FOR THE DELPHIC PHENOMENON
I.
2.
3.
4.
S.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
Allow market price to drop below the eighteen day moving average, for the first time.
7.
Allow market price to rise above the eighteen day moving average, for the first time."
Place a BUY order above the eighteen day moving average.
8.
Place a SELL order below the eighteen day moving average.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
11/82/97 11:80 CST CHARTS - Techn - HONG KONG HANG SENG ..x , \`4,. \ >.‘.4‘• . • \ \\:W \
8!
CHART KEY FOR THE DELPHIC PHENOMENON 1.
2.
3.
4.
5.
Eighteen day moving average crosses above the forty day moving average. (You are now looking for a buying opportunity.)
6.
Allow market price to drop below the eighteen day moving average, for the first time.
Eighteen day moving average crosses below the forty day moving average. (You are now looking for a selling opportunity.)
7. Allow market price to rise above the eighteen day moving average, for the first time.
Place a BUY order above the eighteen day moving average.
8.
After confirmation of a fill from your broker, place a protective stop just below the forty day moving average,
9. Place a protective stop just above the forty day moving average.
Once the market begins moving in your direction, trail your stop halfway between the eighteen day and forty day moving averages.
82
Place a SELL order below the eighteen day moving average.
09/14/97 11:47 CDT CHARTS - Ter.lin - PARIS CAC 40 '< ,.
18/11/97 13:55 CDT CHARTS - Tecbn - EURODOLLAR, 3 11Th Dec 97
IHN Pg
ALARM
••• ‘`‘V
•
"44k, ,
Vs• ,=-Q. -A, • •
Mnislv.5t1W's , .... ... ,
208
st„.-4.„
,
10/12/97 15:11 CDT CHARTS - Team - LEAN HOGS Dec 97
. . . . . . . . . .
m01 ..
At -
- -kA10
209
. . .
:
DIE Pg
ALARM
10/11/97 14:37 CDT CHARTS - Techn - CATTLE, LIVE Dec 97 ' "*" OA' . ek," at?ak k\krat,
„8
.\
DIE Pg ALARM
",•.ft`A,)
. 4° .As.;\\*. "..0 :•k„,
\Mg *i6ai&it/L, WMTn-771 k
210
10/05/97 13:44 CDT CHARTS - Techn - COFFEE, C Weekly
htki
404,4AKIWA, .
.
qNskt4,3nki,',„
% taAW.U.S.cha.,
211
CEC Pg ALARM
12110/9? 09:40 CDT CHARTS - Tochn - S&P SOO STOCK INDEX Veakly
•Avi,'
V-,t>\t%vvz.-AtitbA
212
TOM Pg ALARM
10/10/97 09:46 CHARTS - Techn - S&P BOO STOCK INDEX Dec 97 „ CDT \ \Q,2
\
8
s
•O' •)1
•.(k, "
\
•
rs,WZ,,,
213
••■.‘ ,
\\
c ,
S \ ‘V` y,f,, •k's
\
ION Pg ALARM ‘cet e \
10/10197 09:S1 CDT CHARTS - Techn - NYSE COMPOSITE INDEX Dec 97 NNFE Pg
214
ALARM
18/18/97
09:S7 CDT CHARTS - Titan - US TREASURY BOND Ueekly
215
10/29/97 21:14 CST CHARTS - Techn - HEATING OIL *2 Dec 97
HYMEN Pg ALARM
xq.„
",,,T,Mak k-N
mvzsrovx-mr cmwe,A,,R;79 •
T
ts.: \>>
'
CHAPTER SIX
No book written on trading futures markets is complete without a chapter concerning money management. This is a chapter I suspect most readers will, at best, skim over or disregard altogether. I suggest you continue reading because this chapter is perhaps the most important of all. You see, I have been in your shoes; whether you are a seasoned trader or a novice, I have been where you are now. I say that because you have read this book to this point, and that alone tells me you are looking for something new that works. Furthermore, it tells me either you are frustrated because you have traded before and can't get where you want to be or you have never traded before and are looking for a way to increase your net worth. In the first case, have you ever asked yourself if you had used proper money management, would you be where you are now? Don't lie to yourself, how many traders have been right on the direction of the market but been stopped out due to a stop placed too close to the market? I know I should not make this assumption, but I would bet that it is close to 100 percent. Now you are asking what this has to
217
do with money management. Everything! You see, in my opinion, if you cannot place your protective stop where it belongs on the charts, you have absolutely no business being in the trade. How does that fit into money management? Let's go back to the first chart used in this book, the July 1997 Soybean chart (page 23). The first trade recommended on that chart was to buy July soybeans near the beginning of February when the market price crossed above the eighteen day moving average. On this occasion we would have a buy order placed around $7.46. When we were filled on this order, our initial protective sell stop would have been placed below the forty day moving average somewhere in the $7.15 area. This is a difference of $0.31, or thirty-one cents per bushel. Each one cent move in soybean futures is equal to $50. That equates to $1550 per contract, ($0.31 x $50 — $1550). If this trade had been a losing trade, you would have incurred a $1550 loss. If you were trading with a $3,000 account (which I do not recommend doing), your losses would have exceeded 50% of your account. That is poor money management. By the same token, if your account was worth $24,000 and you decided to trade eight contracts of July soybeans, the results are the same over 50% loss if the trade turned out to move against you. Trading in this fashion is a losing battle. This is where proper money management comes in. The first rule is to have enough capital in your account to risk the trade to the protective stop and have enough left over to trade again if a losing trade were to happen.
218
Some traders place protective stops based on how much money they are willing to risk. I tried that a couple of times and decided it would be easier to just send in a check for the rest of my money. In other words, it did not work for me! Futures markets do not move in straight lines, they fluctuate. You must give the markets room to move if you expect success in this business. It is the only way. You must place your protective stop where it belongs on the chart, and you must have enough money in your account to back up that trade and live to trade another day if that particular trade goes the wrong way. Never lose sight of the fact that there is not a trading system in the world that has a 100 percent success rate. It simply does not exist and never will. The best you can look for in a trading system is to end up with more winning trades than losing ones, and if you practice proper money management your winners will make up for the losers in a big way. It has been said that a successful trader has a 40% success rate, which means that 60% of his trades lose money. I personally think we can do much better than that.
Where does that leave us with the money management question? This will always be a personal choice, and as with all things in trading futures, there are no clear answers, and how can there be - after all, it is the future. With that in mind, my suggestion is to never open a futures account with less than $10,000; $20,000 would be a better starting point. I recommend that you trade
219
one or two contracts of any market per $10,000 in your account. Of course this would be based on where the market is at any given time and where your protective stop should be in relationship to that market. It would also be based on the margin (the good faith deposit required to trade any given commodity) required per contract. If you are looking for a percentage figure, I would use a risk factor of between 15% and 20% per trade. As you slowly increase your account you will be able to increase your contracts traded. Do not attempt to make a million dollars your first time around, it is possible - but highly unlikely. The money is there to be made, but do not rush it, it will come with patience. Never look at this as a get rich quick scheme, avarice will not win in the end. This can be a get rich slow scheme if you use four tools: patience, discipline, money management and a good trading system. These will reward you greatly in the long run.
As you trade there will be times when you have a number of winning trades in a row. About this time you start to feel like superman. You begin to feel that you have become so good that all of your trades will be winners. This is when bad things can happen. You may have a tendency to stray from trading the system, whether you get in the market too soon or trade five contracts instead of one. Something will go wrong and you will be in for an unfortunate situation. This is where lack of patience, discipline, and money management will
220
come back to haunt you. You must remember that you are trading the future, and no one knows the future with certainty. You must not get impatient and want to get into a market because you are "certain" it is going in a specific direction. The more sure you are of what direction a particular market is going to take (when trying to anticipate a market move prior to confirmation through your trading system), the more likely it is you will be wrong. The more you listen to news reports on radio or television, or from recommendations from other people, the more likely it is you will be wrong. It has been said that 80% of the general public who trade futures lose money. It should follow, that if that were true, you should do just the opposite of what the general public does! The general public has a tendency to believe what they read in newspapers and magazines, or to believe what they hear on television and radio. That is one of the reasons they are usually wrong. Block out what you hear or read, the charts will tell you what is happening. I suggest you only pay attention to factual reports, such as crop reports, government reports, etc. A problem still persists with these reports as well. Professional traders will always know more than you do, and they will also be able to read between the lines of a report to find things that you cannot. The best thing to do is to stay out of the market when a report is to be issued. Watch how the market reacts, if a bearish report comes out and the market goes up, then obviously there is more somewhere that tells a bigger tale. You will find that the charts tell a truer story of what is
221
happening. For some strange reason the answer to the future direction of a market lies deep within the confines of the charts alone. It is your job to learn to read these charts and to decipher which direction that will be. If you take the time and effort to do this you will reap the rewards you are seeking.
Many people get caught up in the euphoria and excitement of trading futures, and when that happens it is easy to stray from the fundamentals of money management. There are things that are critical to conservation of money in the daily trading regimen of commodities. Although it may appear, at this time, that trading will be easy and there will be multiple dollars to make, do not assume it will be as easy at it seems in the previous pages. Yes, the charts exist, as do the formations. The hard part is realizing these formations as they occur. In hindsight they are simple, but in real life they sometimes are not as clear. If you maintain a discipline and trade by the recommendations in this book you should do fine, but you must understand that there will be losing trades along the way. Do not be discouraged by these, and foremost, do not try to make up the difference in the next trade. Trading in desperation is the single biggest mistake you can make in this business. Accept the loss because, as stated earlier, your account should be sufficient enough to handle a loss and live to trade another day if you use proper money management. Wait with patience for the proper entry point in the next trade that fits the basic trading system. Do not
222
try to make up for the loss by jumping back into the market without a clear plan, that is only asking for trouble. The basic formations will occur somewhere in some market again. Wait for them to happen!
223
Chapter Seven
Now that you have learned the Delphic Phenomenon, along with some other key formations to search for, it is time to test your skills as a trader. The time has arrived for your quiz. In this quiz you will be tested only on the Delphic Phenomenon. If you do not have a full grasp of this trading system you should go back and study the first chapters once more before taking your quiz.
The first part of your quiz involves the chart on page 225. It makes no difference what chart you are using since all futures carry the same formations. In other words, every market acts the same. Using this chart and employing the Delphic Phenomenon, you are to look at the chart and determine where your order should be placed, what your order would be, or if no order should be placed at all. You are to assume that the weekly chart in this case verifies whatever your order is. If you are ready and full of confidence, turn the page and move on. The first one should not be too difficult for you.
224
• wt:
•
tr)
C■1
See how easy it was? If your order was the same as mine, it should read as follows:
"Sell one (or more, of whatever this market is) at $342.00 on a stop."
The actual price you chose for your order can vary from the $342.00 I chose as long as your sell stop order was placed below the eighteen day moving average, which in this case, comes in around $346.00.
If you did not place your order as stated above do not move forward in the book just yet. You should go back and review the Delphic Phenomenon trading system. For the benefit of anyone who did not place an order as outlined above, I want to identify traits of the Delphic Phenomenon that appear on this chart (after they have reviewed chapter three).
Please note on this chart at the top right; the eighteen day moving average crossed below the forty day moving average. This alerts us to look for a selling opportunity. The next event that occurs is that the market price rose above the eighteen day moving average for the first time. This is our loud siren that tells us it is time to place a sell order below the eighteen day moving average. If the
226
market continues up, we never got involved in this trade. If the market drops, we will be filled on our order - just below the eighteen day moving average.
For those of you with the correct answer you may go to the chart on page 228. Therein lies the final result of this trade. All others should go back and retake the test until they understand the appropriate order.
227
DOW JONES INDUSTRIAL
AVERAGE, APRIL 1, 1929 THROUGH DECEMBER 1, 1929
4 18 40
.
.
.
.
.
.
.
4
. . BASIC TRADING SYSTEM October 16, 1929 SELL
BLACK TUESDAY
4/1/29 4/28/29 5/15/29 6/20/29 7/12/29 8/23/29 9/18/29 10/18/29 11/29/29
228
Congratulations! Had you known this trading system and been alive and trading the markets in October of 1929, you would have called your broker on October 14, 1929 with your sell stop order of $342.00 on the Dow Jones Industrials. Your order would have been filled on October 16, 1929, and you would have been short the stock market. Therefore, you would have sold short the stock market thirteen days prior to Black Tuesday, October 29, 1929.
Before moving on to the next question of your quiz I would like to point out a few more interesting formations appearing on this chart, use the chart on page 231. Note the parallel moving averages (four and eighteen) denoting a buy on the left hand side of the chart. After the market drops, it pulls the eighteen day moving . average below the forty day moving average. The market price then rises above the eighteen day moving average, a parallel of the four day and eighteen day moving averages is now forming. This time it is a declining parallel, signaling a buy. It is also confirmation of a "system failure" when the market price does not continue downward, below the eighteen day moving average. Remember, "system failure" signals a huge reversal move, upward in this case. So even if you missed the declining parallel lines, you should not have missed the fact that a "system failure" occurred and you would have had a buy order above the forty day moving average.
229
The next formation would be a bounce from the forty day to the eighteen day moving average in the center of the chart. This would have turned out to be a losing trade. This is a good example to show that this can be a dangerous trade; when it works, it is marvelous, when it does not work, you take your loss and move on. One more formation occurring on this chart prior to the Delphic Phenomenon, is another bounce from the forty day to the eighteen day moving average. This event happens at the top of the chart. If you were not still sweltering from the loss when you tried trading this bounce earlier, you would try it again here for a fantastic fill in this market, shorting the stock market on or about September 17, 1929 - over a month before the crash of October 29! And only about 12 points off the all time high thus far set in the Dow Jones Industrials.
The last note to make on this chart is the existence of the second hump just prior to the last bounce discussed. That clearly shows itself after the market went on a strong bull run after breaking out of the eighteen day moving average in the center of the chart. Remember, when trading the second hump formation, if the market price touches the forty day moving average after forming the first hump, that first hump is negated and you must start over. Note the first hump negating itself after touching the forty day moving average in the center of this chart!
230
DOW JONES INDUSTRIAL AVERAGE, APRIL 1, 1929 THROUGH DECEMBER 1, 1929 40 TO 18 BOUNCE - SELL AT THE 18
. . . . BASIC TRADING SYSTEM October .16, 1929 SELL . . . . . . . DECLINING PARALLEL LINES SIGNAL BUY .....
I. . . . . .
BLACK TUESDAY
4/1/29 4128/29 5/15/29 6/20129 7/12/29 8/23/29 9/18/29 10/18129 11/29129
231
Are you prepared for your final test question? If so, refer to the chart on page 233 and use the same rules as described on the first test question. Look at the chart, decide what your order would be - if any, and determine the price and direction of the order.
232
illggeSMORMIUMECii:W...10Aaka
ttat,V.
233
\KW:
Your order on this chart selection should read as follows, "Sell one (or more, of whatever this market is) at $2530.00 on a stop)". If you had placed your order too close to the eighteen day moving average in this situation you may have been filled earlier and been stopped out for a loss when the market bumped over the forty day moving average for a brief time. Use patience when placing these orders! Suppose you had placed your order too close to the eighteen day moving average and had gotten into this market prematurely, but were willing to place your protective stop high enough above the forty day moving average to give the market room to move, you would still be in a good position for what the following market move was to be. I emphasize the fact that, in either case, whether you are placing an order to be filled below the eighteen day moving average or placing a protective stop above the forty day moving average, you must neither be too close with your entry position nor be too close with your protective stop, give the market room to move. If you exercise caution with both of these orders you will have much better success.
Had you placed the proper order for this market, your outstanding order to sell at $2530.00 on a stop would have been phoned in to your broker on September 30, 1987. It would have been filled on October 6,1987. This would have made you short the stock market thirteen days prior to Black Monday, October 19, 1987.
234
DOW JONES INDUSTRIAL AVERAGE, APRIL 1, 1987 THROUGH DECEMBER 1, 1987 . . .
4
. . .
40
. . . . . . .
.................................... 1 October 6, 1987 SELL
\ •
4
40 . 18
\\ \
.
\\
.
\ \\
.
.
.
.
.
.
BLACK MONDAY •
5/03/87 6/15/87 7/14187 8/12187 9/16/87 10/06/87 11110187 11/23/87 12/1/87
235
Remember, in both of these test questions, your protective stop is not to be given to your broker until your order is filled. As soon as you are notified of your fill by your broker it is up to you to identify where the forty day moving average is, at that time, and place your protective stop at a safe distance above the forty day moving average.
I commend all of you who were able to pass the quiz; you should now be ready to strike out on your own. I suggest that if you do trade by this or any other system you do it first on paper without using real money . This gives you a better idea of how far away from the moving averages to place your orders and protective stops. You gain a better understanding of how markets move, which is critical to successful trading. When you begin paper trading, do it for a few months before you invest real money. The markets will always be there and they will always trade the same - that should be evident in that you just passed a test using a chart that existed 69 years prior to the writing of this book! There is no rush to get in the market now or at any other time. Exercise your patience when paper trading as well as when waiting for the proper entry time into one of the markets. Patience, I have learned, is the single greatest asset you can have in being a successful trader. Good luck to you all, and happy hunting.
236
