TRADING SYSTEMS
Sustainable And StrongProfit 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