TRADING SYSTEMS
Sustainable And Strong
Profit Locking And The Relative Price Channel
by Leon Wilson
Here’s a technique that will help you identify sustainable
price action and overbought periods, and strong breakouts.
IN the July 2006 STOCKS & COMMODITIES,
I introduced the concept of applying conventional indicators such as the
relative strength index (RSI) to price action. For details, please refer
to that article. For now, adapting range-bound indexes to price action
highlights the bilateral relationship between price direction and price
bias. In order to fully appreciate the correlation between dynamic bias
and price action, you must draw a corresponding yet singular relationship
between price and the indicator.
The moving average convergence/divergence (MACD) defines the dynamic
relationship between two moving averages while moving averages are relative
to price behavior and direction. The fluctuation in price is reflected
within moving average dynamics, while the disparity between moving average
values is quantified by the MACD. The MACD becomes a tertiary link to price.
Naturally, price action is the primary source of data while moving averages
from which the MACD is derived is the connecting link to price.
NO CONNECTING LINK
The problem with bias-based range-bound indexes such as the RSI involves
having both primary and tertiary data but no connecting link between price
and index. Adapting such indicators to prices allows you to perform analysis
in accordance with price dynamics. As the RSI defines bias within price
dynamics it is logical to use this relationship to define a point of unsustainability
against price itself. So how do you solve this problem?
If you combine the relative price channel with a trailing stop, you
have a potential solution to the ongoing problem of profit-locking. A problem
with nonreturning trailing stops is that it cannot define a profit-locking
point relative to dynamic trend development. Until now, the majority of
traders who apply nonreturning stops have been limited to a close below
their trailing stop with little or no profit-locking capabilities.
The primary function of a nonreturning stop is capital protection, not
profit locking. This is a design issue that cannot be corrected through
conventional application. So adapting an indicator such as the RSI to price
action in the form of a price channel will provide the trader with the
opportunity to identify potentially unsustainable trend development and,
more important, a profit-locking point relative to price action and underlying
bias.
...Continued in the January issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the January 2008
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
Return to January 2008 Contents
