June 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

DOUBLE STOCHASTIC

Editor,
Do you have any information on the double stochastic indicator?

Dave, via e-mail


We published two articles that discussed the double stochastic indicator:

Bressert, Walter, and Doug Schaff [1999]. "The Euro's Weekly Cycles," Technical Analysis of STOCKS & COMMODITIES, Volume 17: June.
Bressert, Walter, and Doug Schaff [1999]. "The Euro's True Colors," Technical Analysis of STOCKS & COMMODITIES, Volume 17: May.

Copies of past articles can be downloaded from our Online Store at Traders.com. Thanks for writing.- Editor

WEEKLY HIGH-LOW-CLOSE?

Editor,

Can you help me find a source for weekly high, low, and close quotes? I used to get them from Barron's but they no longer publish them.
 

Edwin Williams
Fresno, CA


There are many data sources available to traders. Getting weekly data is no different from getting daily or monthly data. Visit our website, Traders.com, and view the category of Data Services in our Traders' Resource database.- Editor

DETERMINING EQUITY GROWTH PERFORMANCE

Editor,

Thank you for another excellent issue of your magazine. I find articles presenting deep original ideas, such as "Determining Equity Growth Performance" published in the March 2002 S&C, the most useful and thought-provoking. By the same token, they probably inspire the most debate.

In this article, there seems to be some inconsistency between the author's definition and usage of the term profit factor. On page 23, the authors define the profit factor as "the ratio of gross winnings to gross losses," which is the way it is usually defined.

In the spreadsheet described in the article, the authors make a simplifying assumption that all winning trades are equal and all losing trades are equal. To keep the assumption consistent, one then has to set every winning trade equal to the average winning trade (AWT) and every losing trade equal to the (minus) average losing trade (ALT). (In the following, let us consider ALT to be the absolute value of the average losing trade, and thus positive.) The authors set the average losing trade equal to minus 1, which makes every winning trade equal to AWT/ALT. In the spreadsheet, the authors call it "profit factor," which is not quite correct: If we denote the total number of trades by TNT, the total number of winning trades by TNW, the total number of losing trades by TNL, and the profit factor by PF, we have Total Gain = TNW * AWT, Total Loss = TNL * ALT. Thus, PF = Total Gain / Total Loss = TNW * AWT / TNL * ALT = (AWT/ALT)*(TNW/TNL), which differs from AWT/ALT by the factor of TNW/TNL.

We can express AWT/ALT in terms of the profit factor and the percentage of profitable trades ("%P") as: AWT/ALT = PF * (TNL/TNW). By definition, %P = TNW / TNT, while 1 - %P = TNL / TNT. Thus, TNL / TNW = TNT * (1 - %P) / TNT * %P = (1 - %P) / %P. Thus, AWT / ALT = PF * (1 - %P) / %P
 
In the attached spreadsheet, which I recreated according to the authors' description, I have inserted a new column B to input the actual profit factor in cell B3. In column C, I replaced the words profit factor with Avg. win / Avg. loss, and in cell C3 put the formula 

=B3 * (1 - A3) / A3.

(In cell A3, I put the value of percentage profitable as a percentage to avoid dividing by 100 in all formulas.)

I believe there is also a useful addition to the spreadsheet. First, in cell H1, I calculate average trade (AT) for the system, which is defined as total net profit divided by the total number of trades. 

AT = AWT * %P - ALT * (1 - %P).

Assuming ALT  = 1, the average trade equals 

AT = (AWT/ALT)*%P - 1 + %P  = %P * ( 1 + AWT/ALT) - 1.

Thus, in cell H1 I put the formula 

= A3 * (1 + C3) - 1.

Positive average trade means, of course, that our system has positive expectancy. Further, we can consider each trade as average trade plus a residual value. I have added a cumulative average trade line to the authors' chart, which is a simple straight line showing our system's performance if every trade were average. The line makes it easier to see how the total performance is determined both by the average trade expectancy and by the residual "noise" from having positive and negative trades.

Also, the easiest way to recalculate the values in a spreadsheet is to press F9.

I hope the above discussion does not detract from the obvious merits of the article. I believe that the authors' deep original idea of expressing the equity curve as an approximate function of only the system's profit factor and percentage of profitable trades is a very useful innovation and merits further research and applications.

P.S. Please feel free to post the attached spreadsheet on your website or use it in any other way. [Editor's note: We have posted the spreadsheet on our website with this letter in the June 2002 Letters to S&C section.]
Equity Growth Generator Excel File

Sergei Dobrovolsky
New York, NY


John Ehlers and Mike Barna reply:

We would like to thank Mr. Dobrovolsky for his thoughtful comments regarding our equity growth simulator. However, we disagree with the assertion that the ratio of average wins to average losses should be used in lieu of the profit factor. As we said in the article, the profit factor (ratio of gross wins to gross losses) is analogous to the payout parameter in gambling. The creation of the generator requires that the probability of winning be orthogonal to the payout when a win occurs. As Mr. Dobrovolsky correctly points out, the ratio of the average win to the average loss involves both the profit factor and the probability of win. Therefore, this ratio and the probability of winning is not an orthogonal set.

Perhaps this perspective might be instructive: We can construct the spreadsheet by putting the winning trades in column B, the losing trades in column C, and the cumulative equity in column D. Then, we could easily sum column B and divide by the number of cells containing a value to compute the average winning trade. Similarly, we could sum column C and divide by the number of cells in column C containing a value to compute the average losing trade. We could then take the ratio of these two values to find the average win/average loss value. This ratio should be approximately the same as the average win/average loss reported by the original system performance. Since we recover the average win/average loss ratio using the profit factor statistic, our procedure must be correct.

All of this calculation leaves the computation of the equity curve unchanged. The important point of the article is that hypothetical results can vary substantially from real experience because of the influence of the statistics. In an effort to be as consistent as possible, the user should find the system with the best combination of percentage winners and high profit factor.

OPTION REPAIR STRATEGIES

Editor,

Kevin Lund and Tom Gentile's discussion of recovering from a losing stock trade in "Repair Strategies With Options" (December 2001 S&C) is seriously misleading. Although when discussing other strategies, the authors do mention the potential for further losses if the stock keeps going down, they neglect to explicitly state that the same is true with the option repair strategy.

Worse, the enthusiasm they show for the option repair strategy could leave readers with the impression that the strategy actually hedges the stock position, when in fact the strategy leaves at risk the entire value of the stock position controlled.

The most obvious example of this misleading enthusiasm is when they write that the "one drawback of the repair strategy" is that it limits upside profit potential. The fact that if the stock continues on a path to zero the trader will suffer a complete loss of the capital he still had invested in the stock position at the time he put on the option position is, in my mind, certainly a second drawback worth mentioning.

The option repair strategy is a good one, but it has a positive benefit only if the stock reverses course and appreciates in price, and is only appropriate for a trader willing to keep at risk the capital still invested in the stock. A good test is that if a trader would not be willing to put new capital at risk in the stock at its depressed level (assuming he had no position already), then the option repair strategy is inappropriate.
 

John P. Lamberton
Flushing, NY


Kevin Lund replies:

I clearly stated in the beginning of the article that the technique was one to implement only if the trader continues to believe his original conviction in the direction of the stock or underlying is correct. I didn't feel I needed to go into great length on this in the article, since the article is as the title says: a repair strategy to implement when one is called for.

Most readers will understand that a long position is entirely at risk. I never stated that this hedged the downside. Again, the potential for total loss is still apparent, although it's just not necessary to discuss in the context of this article, since it would be stating the obvious.

TRIX STRATEGY

Editor,

I enjoyed David Penn's article on the use of the TRIX in the March 2002 S&C, and it reminded me that I also have found it a valuable tool over the years. I have been using TradeStation for years and am embarrassed to admit that I have never been able to master its "EasyLanguage." Do you know where I can find a strategy using TRIX written in TradeStation 6 EasyLanguage? I would like to backtest some daytrading strategies using the TRIX in various time periods.

William Hays, via e-mail


See also the next letter.- Editor

TRADESTATION EASYLANGUAGE FORMULA FOR TRIX

Editor,

I am a subscriber and have been for several years. I read with interest the article in the March 2002 S&C by David Penn titled "TRIX Is For Traders." I have attempted to locate the EasyLanguage formula for the momentum indicator without success. Could you provide me with the formula or advise me as to where I could find it?

Doug Krueger, via e-mail


David Penn replies:

In TradeStation, clicking on the Trix indicator on the chart displays this code: 

{ Triple Exponential Average }
inputs: Price( Close ), Length( 9 ) ;
Plot1( TRIX( Price, Length ), "TRIX" ) ;
Plot2( 0, "ZeroLine" ) ;

  

{ Alert criteria }
if Plot1 crosses over 0 then
 Alert( "Indicator turning positive" )
else if Plot1 crosses under 0 then
 Alert( "Indicator turning negative" ) ;
{ ** Copyright (c) 1991-2001 TradeStation Technologies, Inc. All rights reserved. ** }

TRIX INDICATOR

Editor,

I was unfamiliar with the TRIX indicator before David Penn's March 2002 article in S&C. Intrigued, I decided to build my own spreadsheet version.

To ensure my calculations were correct, I created my first chart with data from the Nasdaq 100 (QQQ) to compare against Penn's chart. My TRIX chart ended up looking a fair amount different. For a third comparison, I looked at a TRIX chart of the QQQ through ProphetFinance.com. Their chart was more similar to mine than to the chart in the article. For example, Penn commented in the article that there was a slight drift upward toward the zero line in late August, but in my chart and the one that ProphetFinance.com generated, the TRIX indicator broke the zero line in late August. Further, in the article the TRIX indicator stays above the zero line from early October to late December. In my version and in the ProphetFinance.com chart, the TRIX indicator oscillated above and below the zero line several times in that period. The differences between the three versions of the data were significant enough to function as opposing indicators!

This leads me to my question: Is the discrepancy between these charts a result of different data sources, calculation methodology, human error, or some other factor(s)? For your reference, I calculated my TRIX chart using a nine-day and 12-day moving average with similar results, although the 12-day moving average tended to trend more closely with the chart in the article. Any insight would be helpful.

Mark Reynoso, via e-mail


David Penn replies:

After receiving your letter, I redid the TRIX charts in both MetaStock and TradeStation with nine-day periods and got charts that resembled the ones in the article. Then I went to ProphetFinance.com and ended up producing a chart that sounds similar to the one you got -- with an above-zero line spike in the TRIX in late August.

I cannot figure out which periods Prophet Finance's TRIX indicator uses. By adjusting the period length in my MetaStock and TradeStation charts, I was able to reproduce a chart that looked more like the Prophet Finance chart. But by this time, I had reduced the period length to four days!

If you had used a shorter period than nine days, then I could see how a 12-day period would "trend more closely with the chart in the article." But if you are sure you used a nine-day exponential moving average of closes, and then performed the process of taking an exponential moving average of the previous exponential average and so on (as shown in the article), then I'm not sure how you could have gone wrong.

Try plotting the TRIX against the QQQ on a chart other than Prophet Finance (if you don't own charting software, there may be other web-based options). The TRIX can provide very clear signals and can be deployed in a variety of ways. I did neglect to mention in the article that the TRIX was one of the first indicators STOCKS & COMMODITIES magazine ever investigated, beginning with an article back in 1983 by S&C publisher Jack Hutson, which was titled "Good TRIX."

GANN APPROACH

Editor,

1. Can you recommend any charting services appropriate for the W.D. Gann approach, with accurate, up-to-date (real-time over the Internet), prices, including the open, high, low and close?

2. Are there any cheap paperbacks on the Gann approach, or cheap teaching on the Internet?

Derek Wildman, via e-mail


Try checking with Gannsoft at Gannsoft.com or 509 684-7637.- Editor

ERRATA: CREDIT WHERE CREDIT IS DUE

Editor,

I read Dennis Peterson's interesting article in the Working Money section of the April 2002 S&C, titled "What Are Pivots?" I guess copying is the highest form of flattery: The spring-upthrust patterns are identical to what I published in my 1977 book Stock And Commodity Market Trend Trading By Advanced Technical Analysis, page 111. Seems like you could have at least given me credit.

John Hill, via e-mail


We regret that the credit to you was inadvertently deleted during the production process. The author of the article, Dennis Peterson, did credit you correctly in his original manuscript. Please accept our apologies.

For those readers not familiar with the work of John Hill, we interviewed John in the July 1998 issue of S&C. He has published Futures Truth -- which tracks trading systems and reports the results and is about the only publication of its kind -- since the 1970s. Futures Truth has always been a valuable resource for traders because it's one of the few places traders can view objective, third-party results of commercially available trading systems on real markets. Today, readers can also read John's daily technical commentary on the markets at the Futures Truth website, FuturesTruth.com.

We've published several articles by John Hill over the years, including "Trading And Scalping Techniques" (July 1984).- Editor
 
 

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