March 2007 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

ALEXANDER ELDER'S MACD HISTOGRAM

Editor,

In David Penn's article, "Trading the MACD Histogram, Part II" (Working-Money.com, 12/29/2006), he mentions "P-p-P" and "m-M-m" patterns when referring to "change in slope on the second peal or trough in the histogram." I would appreciate it very much if you could explain this more in detail.

-- Jose Nogueira dos Santos

Technical Writer David Penn replies:

Thank you for writing.

Those specific symbols come from Alexander Elder's excellent book, Trading For A Living. I was unsure if they would be too confusing for readers. The idea is simple, but sometimes explaining it using other tools only makes it seem more complicated.

The "P-p-P" and "m-M-m" patterns are Elder's shorthand way of describing how the histogram moves, moves that can be used as triggers to initiate positions. For example, the "P-p-P" pattern refers to any instance when the histogram is at one level, dips down to a lower level, then rises back up. Numerically, this could be expressed as the following set of MACD histogram readings: -0.221, then -0.230, then -0.208. Those histogram readings were taken from a daily chart of the QQQQ on December 22, 26, and 27, with a buy signal created on the 27th.

The "m-M-m" pattern refers to any instance when the histogram is at one level, moves to a higher level, then slips back down. Numerically, this could be expressed as: 1.21, then 1.27, then 1.26.

Those histogram readings were taken from a weekly chart of CTX on the weeks beginning November 27, December 4, and December 11. A weekly sell signal would have been created as of the weekly close of the week beginning December 11.

I hope that helps. What you are looking for are two types of situations. In one, the histogram is falling, then makes a low and reverses higher ("P-p-P"). In the other situation, the histogram is rising, then makes a high and reverses lower ("m-M-m"). The first case is bullish and can occur during a pullback in an uptrend as well as at a bottom. The second case is bearish and can occur during a bounce in a downtrend as well as at a top.

Thanks again for writing -- and for reading Working-Money.com! [Available through Traders.com--Editor.]


TRADING SYSTEMS DEFINED

Editor,

I found the article "Trading Systems Defined" by Martha Stokes in the January 2007 S&C to be comprehensive and informative, as was her article last October in S&C.

However, I have two questions concerning the author's statement on page 17: "A strong uptrend or downtrend is defined as one that has at least a 35-degree angle of ascent or descent ...."

It seems to me that the angle of ascent or descent is ambiguous -- that is, it is determined by the scales chosen for the horizontal and vertical axes of each particular chart generated. Therefore, there is no way to compare angles on two charts, even for the same stock and time period, if the charts have been generated using different scales.

Thus, under what choice of scales is 35 degrees meaningful, and can the author suggest a method that allows consistency from chart to chart?

-- Robert J. Smith, Verona, NJ

Martha Stokes replies:

This is an intelligent question that deserves a complete answer and is worthy of a follow-up article, so in the meantime I will just provide a condensed answer here.

The goal is not to make the different time frames for charts all have the same angle of ascent. Different time periods will alter the impact of the angle of ascent on a trendline, and that is what you want. The quantity of data needed for long-term analysis will cause the short-term trendline to compress and appear more angled, which is precisely what is needed for long-term analysis. On the opposite spectrum, an intraday trader might use 15-minute candles and view one or two days of data, which would have its own angle of ascent for that type of analysis. However, if that same data was converted to long term, it would disappear. Determining time periods are a critical factor when setting up charts for your primary angle of ascent analysis.

I will outline some specific steps and examples on how to implement this in a future article.


TRADING SYSTEMS DEFINED (AGAIN)

Editor,

In her January 2007 S&C article, author Martha Stokes uses two phrases that appear central to the article but were not defined. The first, core market knowledge, was prominently displayed in both Figures 1 and 2. In Figure 1, the trading pyramid has as its base core market knowledge. Evidently, trading styles (disciplines) derive in some way from core knowledge, but just how is not apparent. In fact, it is not clear just what is meant by trading styles.

The second phrase that appeared several times is "market condition." The sentence "...before you can choose a strategy for the current conditions you must understand what a trading system is..." leaves open just what is meant by "condition" and how it affects a trading system.

Maybe the author can clarify these points.

-- Don Jones, Cisco Futures

Martha Stokes replies:

My original intention was to write periodic articles that cover all aspects of the trading pyramid. I began with an article on trading systems since the January 2007 issue of S&C was themed for trading systems. I hope to write additional articles that clarify in detail all of the levels of the trading pyramid I use.

The trading pyramid was designed to provide a graphical view of the levels of information a trader should have. Here are some brief explanations for the other terms you reference:

Core market knowledge is the base of the pyramid because it represents all the market information a trader needs to have before he or she can fully understand the market, price action, how and when to trade, and so on. Core market knowledge provides answers to such questions as:

My experience as a teacher is that most traders have large holes in their knowledge of the market. Most students of the market have learned some strategies, a handful of indicators, and a lot of market hype and myths but are lacking in their general market knowledge.

Trading styles define how you trade. Trading styles are not strategies. A trading style should be tailored to the trader based on criteria such as risk tolerance, trading experience, and capital. I use a set of 20 rules and parameters to help determine a trader's trading style.

Market condition is the long-term trend, intermediate trend, and short-term outlook of the market. I use technical analysis to analyze current market conditions. The market condition tells me about the strength, energy, bias, and probable direction for the next trading day. With this type of analysis, the trader can anticipate changes in trend and can better determine whether to enter or exit. It provides a foundation for better buy, hold, and sell decisions.

To analyze current market conditions, I look at specific factors, including institutional activity, momentum surges, volume surges, and trend patterns. But I find that as long as the analysis runs about 90% accurate in identifying the market condition, then it's sufficient for good decision-making.


STOCK ANALYSIS AND INVESTING FOR THE SMALL INVESTOR

Editor,

I am an avid reader of your magazine and have been a subscriber for almost two years. On page 39 of "Stock Analysis And Investing For The Small Investor" (December 2006 S&C), author Daniel Subach explains how to figure book value. He says, "A stock worth buying ... should be about 1.5-1.7 times book value. A higher value incurs too much risk."

It is this last sentence that confuses me. The example he uses is if a stock is $20, then the book value would be 31, or 1.55 x 20 (the stock price). It seems to me that the higher the book value to the price of the stock, then the lower the risk of the stock. For example, a book value of $40 or 2 x 20 would be a better risk than 31.

According to the statement quoted above, Subach is saying that is not the case. What am I missing here? Did the author mean to say something different?

-- Ronald Rogers

Daniel J. Subach replies:

You bring up a good point, one that I considered in developing the recommendations proposed in my article.

Over the period that the statistical data was analyzed, I found that book value, or up to 1.5-1.7 times book value, indicated the stock was most likely to appreciate. Factors higher than this number indicated that the stock price could fluctuate substantially relative to the other proposed factors that make up the minimal set of conditions presented in the article (such as market capitalization rate, price/earnings ratio versus earnings growth, EPS growth, and other considerations).

My intention in developing a minimal set of conditions for selecting investments is to help avoid loss of capital and maximize probability of appreciation. The factors I identify in my article were the ones I found to be most useful toward this goal.


INTERVIEW WITH VAN K. THARP

Editor,

I enjoyed reading your interview with Van K. Tharp (November 2006 S&C). His suggestions about using R make great sense. His rules about trading sound deceptively easy, but does he practice what he is teaching?

His credibility would be greatly enhanced if you could publish his trading results using his methods for the past five or 10 years.

-- Paul Gertler

In the January 2007 S&C we published an article by Van K. Tharp about his trading system, "Developing Discipline With Daily Debriefing." That article should help shed more light on the subject.--Editor


TRADING RISK

Editor,

In your interview with Larry Levin ("Larry Levin Has Those Traders' Secrets," January 2007 S&C), Levin says that risk should not exceed two points. Does he mean the basic point (0.01%) or something else?

-- Alec Schmidt

Here's an example of what he means by that: If you are long the S&P at 1250, your stop order would be set at 1248, or two points away from your long entry.

Hope this helps.--Editor


TRADING LOSSES

Editor,

Where's the bad news? By that I mean that nowhere in your collection of publications do you demonstrate that the traders who write for you ever take losses. All of your technical articles are about wins.

Your recent interview with Larry Levin was great. I went and looked up his site and read all about what he teaches. One of his primary lessons? You will lose ... at least initially. Many of your philosophy-oriented articles and articles on trading systems state the obvious: You will lose, sometimes.

I'd therefore like to propose a new section: "Setups, Wins, and Losses." In this section, contributors would explain a completed trade. The article would include a conceptual strategy that pointed them to the trade; the setup, including charts; the entry; the stops they requested; the exit; and finally, a conclusion in which they wrap up their results with their interpretation of why they gained or lost equity.

You might include a combination of trades in the various markets and you should probably include at least one win and one loss.

Were you to include such a section in one of your publications, I believe it would quickly become a very popular addition.

-- Dave Cline

We appreciate your feedback and will certainly consider it. We have always included occasional articles in S&C themed "real-world trading."--Editor


MOVING AVERAGE CONVERGENCE/DIVERGENCE

Editor,

I use the MACD indicator very often. Recently, I been reading a book titled New Trading Dimensions by Bill Williams. In it, he uses several indicators that he named the Awesome Oscillator and the AC Oscillator. Are these basically the same as the MACD?

-- Victor Rendon

The AO and AC oscillators measure momentum. Although their display is similar to the MACD histogram, their calculations are not similar. Thus, the answer to your question is that they are not the same as the MACD.--Editor


ERRATA: ENTROPIC ANALYSIS

In "Entropic Analysis Of Equity Prices" (November 2006 S&C), the reference given at the end of the article to www.johncon.ntropix was incorrect. The correct link is www.johncon.com/ntropix.


ERRATA: TRADERS.COM PUBLICATION

Editor,

I enjoy your Traders.com tabloid publication and have a question about a formula from the January/February 2007 issue. On page 24, there is a formula for relative strength as follows: 

Relative strength =
(Current stock price / Previous stock price)
(Current index price / Previous index price)


My question is, shouldn't there be a division sign between each pair of parenthesis? Shouldn't it read:
  

Relative strength  = (Current stock price / Previous stock price) /
(Current index price / Previous index price)


Your help is appreciated. I would like to try this but I want it to be right before I program it into my computer.

-- Paul Bazylewicz

You are correct. Thank you for pointing out this error.--Editor

Back to March 2007 Contents

Originally published in the March 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.