July 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
TECHNICAL ANALYSIS
Editor,
This technical analysis business seems intriguing. Is the art and science of it developed and practiced by many? How long has TA been practiced? - Mark McClatchey, via e-mail
I credit Charles Dow with developing the first technical analysis system, which some call Dow theory. Dow was the cofounder of Dow Jones & Company and the first editor of The Wall Street Journal in 1889. The Dow Jones Industrial Average was first published in 1896.
Intellectual debate about the validity of technical versus fundamental analysis has gone on for more than a hundred years. From a practical standpoint, both methods are useful. Fundamental analysis requires a great deal - or ideally, all - current information about the tradable. Technical analysis looks mainly at history (price, volume, earnings over time) to surmise how future prices may move. Most traders use both fundamental and technical analysis. Those who use a chart or computer to trade are using technical analysis.
Reiterating the pros and cons of whether technical or fundamental analysis is a better trading approach is a waste of time; there is enough information on both sides to debate endlessly. However, both technical and fundamental analyses take practice to master, and neither are perfect. Technical analysis requires less data input to derive useful buy and sell points, whereas with fundamental analysis, you can't know all the news and information about a tradable that you need to make good decisions.
To write a proof paper about the validity of technical analysis would require you to first become an expert in technical analysis. Once you become an expert technician, you realize that the methods of technical and fundamental analyses are not mutually exclusive. I would suggest that you learn how to trade and skip the ongoing debate. Read the news, but confirm your trade positions with technical analysis.
Technical Analysis of STOCKS & COMMODITIES, The Traders' Magazine, has been published for 20 years and has always been the first and best source for information about technical analysis techniques.-Jack K. Hutson, Publisher
DISPLACED MOVING AVERAGES
Editor,
I have searched at your website for information on the displaced moving average and had no luck. Can you help? Preferably, you will have an example on how to compute them. - Don Mateja, via e-mail
Try "Back To Averages" by John Sweeney in the April 1991 STOCKS & COMMODITIES (Volume 9, Number 4), available from our Online Store at Traders.com.-Editor
RATING: EXCELLENT
Editor,
I know it's a lot of work to archive all your past articles, but it's great to be able to find that material online and then pay a reasonable fee to download it for reading or printing out a copy if needed. It saved me a trip to a library; that's time, miles, and dollars saved. - David Barnard, feedback from our website
PAIRS TRADING
Editor,
I tried to duplicate the results from "Daytrading Stock Pairs" (May 2002 S&C) and I encountered a few problems. The backtesting results from the TradeStation strategy given in Traders' Tips in that issue (page 83) were vastly different from those in the article.
After looking more closely at possible problems, I corresponded with one of the article's authors, Mark Conway, about the fact that the article referenced intraday data back to 11/6/2000, while TradeStation 6 only has data back to 11/28/2000. Conway replied that the original code was from TradeStation 2000i, so I assumed the older version had data going further back. He also explained that he used a different algorithm for determining position size. Still, the discrepancies were too large, even after optimizing for large ranges of the two input parameters.
I then tried to look at a specific example of a trade the article presented, the long ABGX-short MEDX trade on 1/05/2001 from page 31. I recreated the charts and found that the simple calculation for the spread that I was getting was different from the one used in the article. In the article, the ABGX long position is closed at 4:00 pm when the spread crosses over the zero line. This calculation is only based on yesterday's close of two stocks and their last prices, in this case the closing prices of the 10-minute bars. However, using the code from the Traders' Tip section on page 83, and looking at 1/05/2001, the spread does not cross over zero at 4:00 pm but rather at 9:40 am.
So after having spent many hours looking at this article and being unable to verify the conclusions of the authors using the same data and same calculations, I am wondering if I am to fault for these disparities, or whether there is another problem. - Patrick Sulin, via e-mail
Gaston Sanchez, product manager at TradeStation Technologies, replies:
Many factors can impact a user's results when performing an analysis using a TradeStation strategy. Apparently, you ran into some of these issues, namely the amount of data being analyzed and position size management. These are both factors that can have an impact on the performance of a strategy ranging from minimal to sizable, depending on the strategy used.
Another factor is that the articles upon which the Traders' Tips are based do not always clearly define each of the elements used by the author in developing the analysis technique or TradeStation strategy that the article discusses. That doesn't mean the article is providing misinformation, but merely that it is not providing all of the information that would be necessary to exactly reproduce the authors' figures or results. When the Traders' Tips are written, we do our best to fill in any holes that are left by the author, but without complete information, exact reproduction of the authors' figures and results cannot be promised.
As I recall, the "Pairs Trading" article provided an overview of the TradeStation strategy and examples, but it lacked some detail. That detail can easily explain the difference between a crossover on a chart at 9:40 am instead of 4 pm. I believe that by communicating directly with the article's author, you are taking the best approach to resolving the issues you are experiencing. If the author is unwilling or unable to assist the reader, though, TradeStation does offer EasyLanguage support (basic) and consulting (fee-based) services to the user, but without complete information, even those alternatives cannot guarantee that the user will be able to obtain exactly the same results as the author did in the article.
BOND MARKET TIMING REVISITED
Editor,
I'm a subscriber. I read the article "Bond Market Timing Revisited" in the June 1997 S&C and I'd like to implement the bond trading system as described by Jay Kaeppel. However, I can't locate one of the two indices I need to do that, which is the Barron's gold mining index. Can you help? - Michele Prignano, via e-mail
Jay Kaeppel replies:
I will send you a comma-delimited ASCII file (GMI.CSV) containing the data:
Date, GMI Index, 52-week
% rate of change
Please note that the GMI bond indicator is currently [as of April 18] very bearish for bonds. The 52-week rate of change in gold mining stocks is roughly +40%, which is a very bearish reading.Editor's note: We have posted the ASCII file at the subscriber area of our website at https://technical.traders.com/sub/sublogin.asp. Login requires name and subscriber number.
10 RULES FOR OPTIONS TRADERS
Editor,
Great article by Joe Luisi in the March 2002 S&C ("Ten Rules For Options Traders"). I was very interested to read about someone doing something I have just started doing, which is selling options instead of buying them.
I am currently selling options on the OEX and SPX. I trade the OEX and have been selling SPX futures options as well. I typically sell very far out of the market (8-12%), and I'm getting anywhere between 5% to 8% after fees each month. I am selling credit spreads in both accounts, mostly on the put side because they pay better (much better after September 11). I have built my own probability tables with data going back to 1982, so I know what my odds are on any given trade and what kind of premium I have to get in order to accept that risk. (I use the VIX as a risk adjuster for premiums.) I think of myself as an insurance company selling insurance, or the slot machine at a casino. I will win lots of small ones and occasionally have to pay one out.
I just started selling options in September (I've already made up my losses from 9/11/01) and I have a couple of questions:
Rule 9 was to avoid overlap, which clearly I'm not doing (SPX and OEX being essentially the same, and I have been selling the same side of the market). Any suggestions as to what other markets I should look at or what markets to trade? Other futures options on commodities? Bond indexes? Individual stocks (which I don't like because of the single stock event risk)? Should I not be trading in the futures market or vice versa, or are both okay? What am I missing here?
Second, what are your sell rules when the market is going against you?
Thanks for your help. I decided to subscribe to STOCKS & COMMODITIES because of this article. - Thomas Quick, via e-mail
Joe Luisi replies:
I would diversify when selling options. Pick the market you are most comfortable with, such as the OEX or SPX, and then look at a few others. Some other good option markets are the 30-year T-bond, gold, and some currencies, such as the yen or euro.
I also agree with you about stock options. Since 75% of a stock's move is correlated to the DJIA or S&P 500, you are not getting the diversification you should.
Stock options and futures options are equally fine, provided there is enough volume and liquidity. Margins and commissions tend to be better for futures options, but there is definitely more volume with OEX options than S&P 500 futures options.
My sell rules are very easy: If the price of the option that I sold has doubled, I exit on the open the next day.
READERS' CHOICE AWARDS
Editor,
The software product Advanced GET won your Readers' Choice Award for the past seven years for best Futures Trading System and for the past six years for best Stock Trading System.
Please advise who won it in 2001 and 2002. I cannot find this information on your site. - John Morris, via e-mail
We publish our Readers' Choice Awards in our Bonus Issue, which is an extra issue mailed only to subscribers. The Readers' Choice Awards results are not posted on our website.
I checked our last three Bonus Issues and found Advanced GET at the top of the popularity list for both the Futures Trading Systems and Stock Trading Systems categories.-Jack K. Hutson, Publisher
SINGLE-STOCK FUTURES Q&A FOLLOW-UP
Editor,
I read Don Bright's article, "Strategies For Single-Stock Futures," in the May 2002 S&C. I have two questions for which I would appreciate Bright's insight:
1. Do you believe there will be more or less trading of stock options with the advent of single-stock futures?
2. In the last paragraph of your article, you indicate that SSF will alter the pricing model of options.Can you elaborate on that statement, please? - Kent Saxe, via e-mail
Don Bright of Bright Trading replies:
I don't think that the listing of the single-stock futures (SSF) will have too big of an effect on the volume of equity options being traded, but I do think they will have an impact on the pricing models. When we look to the basics of options pricing, we take into consideration the historical volatility of the stock, the "cost of carry" of the stock, and the "beta" (that is, the movement in relationship to the overall market), among other things. Many of these factors will change if we replace a futures contract with the underlying security. We have to consider the rollover of the futures contract and the stock delivery of the expiring options. Time factors of the expiring futures contract will also come into play (since, obviously, the stock does not "expire"). We will alter our models for dividend payments and interest rates as well.
These are a few of the factors you will need to take into consideration with option pricing models.
4% Solution
Editor,
I was intrigued by the Working Money article by David Penn, "Trends And The 4% Solution," which appeared in the May 2002 S&C. I would love to learn more about the 4% solution and price channels, but I could find little information in either John Murphy's or Steven Achelis' books on technical analysis. Could you point me to more specific information, including the exact rule for the 4 % solution? - Boyd Cobbley, via e-mail
David Penn replies:
The best source for information on what I referred to as "the four percent solution" is Marty Zweig's Winning On Wall Street. He refers to the strategy as The Four Percent Model Indicator and credits Ned Davis as well as himself for coming up with it.
Zweig used the 4% model on the ValueLine Composite Index from May 6, 1966, to April 12, 1985, and got a 16.4% annualized return (long and short trades) compared with a 2% buy and hold. I love this sample period because it includes so much of the 1966-82 secular bear market in stocks. Too many people use the 1985-2000 period (or worse, 1995-2000) as their sample period for stock strategies. I have a hard time trusting such stock strategies because they are based on a sample period that includes one of the best secular bull markets in stocks ever!
Nevertheless, I've looked at the 4% model indicator on the Nasdaq, the S&P 500, and the Dow Jones Industrial Average from 1985 to 2000, just to extend Zweig/Davis' work a bit. I found the indicator (I round up from 3.5%) led to significant outperformance in the Nasdaq over that period, with the DJIA coming in second (both long and short trades compared with buy and hold). The indicator underperformed somewhat with the S&P 500, but I suspect that if I had included 2001, the results might have been different. For example, a long-only strategy using the 4% model indicator on the Nasdaq in 2001 would have produced a return in the neighborhood of 30%. Going long and short would have delivered returns in the neighborhood of 90% by December 5, 2001.
I use the price channels as an easy way of keeping track of where the 20- (or 30-) day highs and lows are. So any time you hear someone talking about 20-day, 30-day, or other highs and lows, you can probably use price channels to track them effectively.
Hope this helps. Good luck.
FIBONACCI RATIOS
Editor,
Wow! What an article by Rudy Teseo on Fibonacci ratios ("Those Ubiquitous Fibonacci Ratios," Working Money, March 2002). He managed to completely avoid describing any practical use of this mathematical marvel. I have traded for 20 years and have used Fib ratios most of that time, primarily for retracement levels. How is it that Teseo doesn't display a single chart showing them working? He obviously doesn't have a clue as to their use, or he wouldn't have embarrassed himself with that article. I would expect such shallow coverage from some lame business section writer of a daily newspaper; your otherwise stellar magazine let this one slip through the gap. If you want an article describing how to really use these levels, let me know. - Neil Lustyk, via e-mail
Articles found in the Working Money section of STOCKS & COMMODITIES magazine are for beginning-level technical analysis enthusiasts. The article meant to merely introduce the idea of Fibonacci ratios to new traders and describe the different ways in which Fibonacci ratios can be used, not to provide in-depth coverage of the topic or real-time analysis using them.
In addition, the article included six charts demonstrating the use of Fibonacci ratios. - Editor
THE ART OF POSITIVE SLIPPAGE
Editor,
I am happy to see your magazine maintaining a high standard and contributing toward advancing the knowledge of technical traders in a highly subjective and confusing field such as trading.
However, it is my opinion that the article "Mechanical Trading System And The Art Of Positive Slippage," which appeared in the 2002 Bonus Issue, makes several inappropriate references to terms and techniques whose meaning and use has been clarified long ago. Specifically, the idea of trying to improve the performance of a mechanical trading system by applying discretionary techniques has long been proven ineffective and even inappropriate, especially in the case the discretionary techniques can be incorporated in the backtesting of the system and do not relate to news information or fundamental economic factors (thus resulting in a new mechanical trading system altogether).
More important, relating to the material in the article, the use of the term slippage is in my opinion unfortunate, since its definition is "the difference between estimated and actual transaction cost." Although the use of the term has been extended to the simulated performance of mechanical trading systems to mean the difference between backtested order fill and actual order fill, it seems that the use of the term by the author of the article relates to some discretionary technique to improve a mechanical system's performance and not to measure prevailing market factors affecting slippage (such as market liquidity). I would therefore attribute this abuse of the term to a language difference and interpretation. - Makis Charokopos, via e-mail , Athens, Greece
DO MOMENTUM INDICATORS FOLLOW TRENDS?
Editor,
Clive Roffey's April 2002 article "Do Momentum Indicators Follow Trends?" deals with Welles Wilder's RSI. It appears as though Roffey is summing up days (each up day gets a +1) and summing down days (each down day gets a -1). But it is my impression the RS part of the RSI does not merely sum up days and sum down days, but rather that it involves summing up day closing prices and summing down day closing prices. This is a substantial difference. (I just looked at the RSI discussion in three recently published texts. One talks about summing gains and summing losses. The other two refer to averaging up closes and averaging down closes.) An article following Roffey's approach but using closings would be interesting. - Hugh Logan, via e-mail
Thanks for writing. See the erratum on page 19 of the May 2002 S&C titled "Do momentum indicators follow trends?" -Editor
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