SYSTEM DESIGN

Make Your Profits Sizzle
Developing Hot Zones

by Massimiliano Scorpio

Can you forecast a bar's close from its open? This technique is helpful in trading recently introduced tradables that don't have historical charts yet, such

In the December 2001 STOCKS & COMMODITIES, I demonstrated a simple method that uses a statistical indicator to help identify profitable patterns. Here, I have taken the method one step further: I've analyzed the behavior of each bar and the relationship between the open and close. If the market is showing a specific pattern, is there any way to forecast the close from the open's position in the bar? I used the key reversal up day (see Figure 1) for the pattern to see whether such a forecast was possible.
 


FIGURE 1: KEY REVERSAL UP DAY. This occurs when the low is lower than the previous low and the close is higher than the previous close.


THE ZONES

You may ask, what exactly do I mean when I say the "open's position in the bar"? I divided a day's bar into six zones (see Figure 2) and selected the following five points:

1. Point 1 is derived from the high of the day plus a measure of volatility. I found that a 10-period average true range? (ATR) is suitable to identify a meaningful short-term volatility measure, so I used 30% of a 10-period ATR and added it to the high.
2. Point 2 is the high of the day.
3. Point 3 is calculated by adding the high and low, then dividing by 2.
4. Point 4 is the low of the day.
5. Point 5 is the low of the day, minus 30% of the 10-period ATR.

This creates the six zones. I then created a code that scans the data to show the following statistics:

  • How many times following a certain pattern that the open of the next day falls in each zone, and
  • In which zone the market then closes.

    • The "position" of the open refers to the zone. This information is useful because you can create a road map for adapting different strategies, creating some interesting short-term trading systems.

    ...Continued in the December 2002 issue of Technical Analysis of STOCKS & COMMODITIES

    Excerpted from an article originally published in the December 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.


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