May 2002 Letters To The Editor
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The editors of S&C invite readers to submit their opinions and information on subjects relating to technical analysis and this magazine. This column is our means of communication with our readers. Is there something you would like to know more (or less) about? Tell us about it. Without a source of new ideas and subjects coming from our readers, this magazine would not exist.Address your correspondence to: Editor, STOCKS & COMMODITIES, 4757 California Ave. SW, Seattle, WA 98116-4499, or E-mail to editor@traders.com. All letters become the property of Technical Analysis, Inc. Letter-writers must include their full name and address for verification. Letters may be edited for length or clarity. The opinions expressed in this column do not necessarily represent those of the magazine. -Editor
TRIX IS FOR TRADERS
Editor,
In the March 2002 S&C article "TRIX Is For Traders" by David Penn, I was pleased to see the accompanying charts of the candlestick variety. The candlesticks put out some early signs for the TRIX to reinforce. The chart in Figure 1 on page 34 of that article shows a fairly clean evening star reversal beginning on May 21 and also a nice little hammer on September 19 calling a halt to the trend and indicating a potential reversal. Both stick formations led the TRIX and reinforced your arguments for what the TRIX was representing.
Thanks for an always stimulating magazine.
- Mike Marchese, Sleepy Hollow, NY
Thank you for writing. Just for some background, the TRIX indicator was first developed here at STOCKS & COMMODITIES by publisher Jack Hutson. - Editor
POINT & FIGURE CHARTING ONLINE
Editor,
Regarding the letter in the January 2002 issue regarding point and figure software, a good site for P&F is PFscan.com. It's a UK company but their software can also be used for the US market. I hope this is of some help.
- Bill Thorne, via e-mail
INTRADAY PRICE PATTERNS
Editor,
I am a trader in a business working with technical/mathematical analysis.With reference to the article "Identifying Patterns" by Dennis Peterson in the Working Money section of the February 2002 S&C, can you provide an example to help clarify the diagram in Figure 4 on page 72?
I am looking for the perfect system for intraday trading. Is there a more precise system? Can you suggest any other mathematical or technical systems for this purpose that can help derive prices?
- Haren Mehta, via e-mail India
Staff Writer Dennis Peterson replies:Figure 4 is an open-high-low-close (OHLC) bar chart, where the open and close are very close to each other and are both in the upper 20% range of the bar. On an OHLC chart, this type of day looks something like a lowercase letter "t" (without the little hook on the bottom). This type of day is a very common occurrence on price charts (for example, see the bar that occurred on October 9 in Figure 5).
You ask, can I suggest another system for business? The short answer is that through the years, I have found that with few exceptions, every indicator looks for some specific market behavior. The problem is that the period of time for which the specific behavior is valid can be short and sometimes you see it too late to take advantage of it. Patterns are the footprints of emotion created by traders. Patterns are reliable. The beauty of reading patterns is that you don't have a preconception as to which way the market will go because you are allowing the pattern to develop. You let the market tell you.
I have found that a common theme for highly successful traders is that most look for patterns as part of their analysis. G.B. Smith of the Street.com is an example of one who uses this method.
WRITING COVERED CALLS
Editor,
I have some comments regarding the March 2002 article "Writing Covered Calls" by Michael Dunham, which appeared in the Working Money section of STOCKS & COMMODITIES.
When an author makes a statement so irresponsible as "Most calls expire worthless, which suggests that selling calls is more likely to be profitable than buying calls," I think it is your duty to step in on behalf of your readers. In this case, the true meaning of "more profitable" is more often profitable, not profitable in aggregate.
Suppose the probability of a call expiring worthless is 90%. Suppose also, on average, the call is sold for $1. Suppose when the seller of the call loses, as will be the case, he loses big, say $20. Then, the expected long-term payoff of selling calls is 0.9*1 + 0.1*(-20) or -$1.10.
Admittedly, my numbers are contrived. However, if this strategy was easy money, since over time most professional money managers underperform the market, this group would have exploited the strategy to its fullest and extracted all available profits. The option trader will undoubtedly lose more money on any single losing transaction than he will make on any single winning one. What will happen in aggregate to the trader is indeterminate and will depend on the trader's skill and some measure of luck. The expected value of this strategy is loss of transactions' costs, costs which, by the way, are more significant than the author leads you to believe.
For some reason, S&C cyclically publishes these "Selling covered calls is easy money with no risk" articles. There is no such free lunch. Perhaps before publishing the next one you should read Fooled By Randomness by Nassim Taleb to help identify mistaken statements such as the one that prompted this letter.
- Kenneth J. Libert Landenberg, PA
Michael Dunham replies:Mr. Libert's letter points out one of the biggest disadvantages to writing covered calls, which is limited upside potential (see the section entitled "Ups and downs of covered calls" on page 82 of the March 2002 issue). While having to sell the stock, in Mr. Libert's example, for $20 below the current value would be very frustrating, it is not a "loss" as Mr. Libert suggests (you keep the premium plus any amount that is out-of-the-money). As stated in the article, "Always consider you have to sell the stock at the strike price selected."
Mr. Libert correctly points out that there are no free lunches. All investing involves some degree of risk. However, the monthly returns received from writing covered calls is an effective tool you can use to help reduce that risk.
ERRATA: DO MOMENTUM INDICATORS FOLLOW TRENDS?
On page 32 of the April 2002 S&C, in the article "Do Momentum Indicators Follow Trends?" by Clive Roffey, an error occurred in one of the four equations given toward the bottom of the page. Equations were listed for the four indicators: MACD, momentum/ROC, stochastics, and RSI.
MACD (moving average convergence/divergence) is the difference of two moving averages, not the ratio, as it was given in the box on page 32. Thus, the equation should have appeared as:
Macd = Short-term MA- Longer-term MA
However, only the box presented the equation incorrectly. The text of the article correctly used the difference.In addition, it has been pointed out that RSI is not the ratio of the number of up days and down days. This is correct; however, we would point out that the technique of separating data by what happened on up and down days is unique to RSI. The reason RSI oscillates is the same reason market breadth indicators - such as up versus down volume - oscillate. The problem is that you cannot literally use the number of days. Separating data by up and down days is still a powerful technique and is the basis for RSI oscillation and market momentum oscillation.
ERRATA: Time-Segmented Value
Editor,
Not to nitpick, but the Worden Brothers proprietary indicator is "Time-Segmented Volume," not "Time-Segmented Value," as it was given in the February 2002 Letters to S&C.- Jim Eaves, via e-mail
Thank you for pointing this out. - Editor
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