Diary of a Professional Commodity Trader Lessons from 21 Weeks of Real Trading_4 pdf

An H&S Bottom in Apple Computer The only stock chart contained in this book, Figure 4.23 shows that Apple Computer completed a magnificent H&Sbottom on the daily chart on March 23.. A M

A Triangle and Running Wedge in Sugar

FIGURE 4.21 Weekly Chart Symmetrical Triangle in

Sugar

The sugar market generated the overwhelming proportion

of profits for the Factor Trading Plan in 2009 Figure 4.21

displays a 14-month symmetrical triangle on the weeklychart at the precise point of completion on May 1 Thispattern launched the largest price thrust in sugar in 28years Figure 4.22 displays the daily chart of the activelytraded October 2009 contract This chart had asimultaneous breakout on May 1 of a six-month ascending

or running wedge

Classical charting principles applied to the stock market

substantial price advances in forex and commodities arelaunched by an upward thrust from a rising wedge I havelabeled this type of chart development as a running-wedgepattern.

FIGURE 4.22 A Six-Month Running Wedge in October

Sugar

An H&S Bottom in Apple

Computer

The only stock chart contained in this book, Figure 4.23

shows that Apple Computer completed a magnificent H&Sbottom on the daily chart on March 23 Notice that themarket retested the ice line on March 30, but the retest didnot violate the Last Day Rule

FIGURE 4.23 A Perfect H&S Bottom in Apple Computer.

A Major Continuation H&S and Symmetrical Triangle in Gold

This market is an excellent example of three patterns

Figure 4.24 displays an 18-month inverted continuationH&S pattern on the weekly chart As a side note, theminimum target of this pattern at 1340 or so has not beenreached as of this writing There is no rule that stipulatesany target must be met Chart patterns fail to deliver theirimplied price moves all the time

FIGURE 4.24 Weekly H&S Bottom in Gold.

There was quite a point of contention within the technical

labeling the pattern as an inverted continuation H&Spatterns was a joke Yet Edwards and Magee in the “bible”

of classical chart principles, Technical Analysis of Stock Trends, stated:

Occasionally prices will go through a series of fluctuations which construct a sort of inverted Head- and-Shoulders picture which in turn leads to continuation of the previous trend … One of these patterns which develop in a rising market will take the form of a Head-and-Shoulders Bottom.

Figure 4.25 shows that the right shoulder of the weeklyH&S pattern took the form of a massive six-monthsymmetrical triangle on the daily graph Also note that thebrief pause following the early September completion of thetriangle formed a five-week H&S failure pattern Thesetypes of small patterns are very useful in pyramiding aposition This small pattern also allowed me to move theprotective stop from the initial Last Day Rule of the six-month triangle to the Last Day Rule of the five-weekcontinuation pattern

FIGURE 4.25 A Large Symmetrical Triangle and Small

H&S Failure on the Daily Gold Graph

FIGURE 4.26 A Bull Market in Copper Loaded with

Continuation Patterns

A Series of Bullish Patterns in

Copper

Figure 4.26 shows a wonderful series of continuationformations during the bull market in copper from Marchthrough the end of December 2009 Notice that the LastDay Rule of each pattern was never challenged, althoughthe stair-stepping nature of the advance was difficult on thenerves As a general rule, demand-driven bull marketscontain a lot of backing and filling, whereas bull movesdriven by severe supply shortages are much sharper Mostbear markets are also quite sharp, retracing in half the timethe ground that was gained during the preceding bull trend

A Failed Ascending Triangle in the USD/CAD Crossrate

Right-angled triangles have the strong tendency to breakout through the horizontal boundary In fact, a breakout ofthe horizontal ice line can almost be expected Yet, onoccasion, a right-angled triangle can break out of thediagonal boundary, usually grudgingly, as shown on theweekly chart in Figure 4.27

FIGURE 4.27 Weekly Chart Ascending Triangle in

The seven-month ascending triangle in the USD/CADhad a bullish bias As shown on the daily chart in Figure4.28, the lower boundary of the ascending triangle wascalled into question in mid April However, even at thattime, my thinking was that the lower boundary was justbeing redefined with a lower slope and that an upsidebreakout was just being delayed Nevertheless, I went with

a short sale on April 14 and was quickly stopped out abovethe April 13 Last Day Rule

FIGURE 4.28 A Tricky Breakout on the Daily USD/CAD

Chart

The downward thrust on April 29 and 30 confirmed thefailure of the ascending triangle and called for a minimummove to 1.09, a target reached in early June This market is

a good example of how patterns initially biased in onedirection can provide a good signal for a move in theopposite direction

A 12-Week Rectangle in the Dow Jones Transport Index

A 12-week rectangle was completed in late July Note thatthe Last Day Rule from July 23 was never challenged (see

Figure 4.29)

FIGURE 4.29 Continuation Rectangle in the Dow

Transports

A Rare Horn in Brent Sea Oil

A horn bottom occurs with a sequence of a major low andtwo higher lows intervened by two higher highs, as showed

i n Figure 4.30 The pattern takes the shape of a Vikinghorn A requirement of the pattern is that overlap existsbetween the two upward thrusts within the pattern Edwardsand Magee did not cover the horn pattern However,Schabacker identified the horn as a classical pattern Ioften refer to the horn bottom as a sloping bottom

FIGURE 4.30 Sloping Bottom in Brent Sea Crude Oil.

The buy signal was triggered in early May when the Aprilhigh was penetrated Note that the Last Day Rule wasnever violated.

An H&S Bottom Launches the

2009 Bull Market in the S&Ps

I was emotionally committed to the bear case in stockscoming off the March 2009 low While I saw the massiveH&S bottom as shown in Figure 4.31, I did not believe it Idabbled on the long side of stocks from time to time duringthe 2009 advance, but I was unwilling to accept the fullimplications of the major H&S bottom The target of thisH&S bottom at 1,252 was nearly met in April 2010

FIGURE 4.31 H&S Bottom in S&Ps.

The preceding charts represent textbook examples ofclassical charting principles These patterns comprise acategory of chart pattern that I call the “Best DressedList”—those chart formations (or series of chart formationsmaking up a large trend) that best exemplify price chartconstruction

At the end of each year my net profitability is, in largepart, dependent on correctly identifying and trading a majorportion of those chart patterns that in hindsight becomemembers of the Best Dressed List In fact, my largestprofits over the years have come from market situationssimilar to and including those shown

In reality, these types of grand chart formations are moreobvious after the fact than they are in real time In mydreams, I imagine a trading year in which all of my tradesare limited to these types of market situations But dreamsare dreams, and real life is real life And in real life, many ofthe patterns I trade do not turn out the way these charts did.Some authors may produce material on classical chartpatterns implying that these were the only situations theytraded But I am first and foremost a trader, not an author,and I need to admit that when I catch these ideal chartpatterns it makes up for a lot of the losses I ring up alongthe way

Points to Remember

It is important for a trader to have a clearunderstanding what constitutes an ideal trade Excellent chart trades do not come around everyday but can take weeks and months to develop Developing the patience to wait, wait, and waitsome more for a market to declare itself is agoal, not a destination As a trader, I seek

While chartists often attempt to jump the gun on

a pattern (including me), markets usually make itabundantly clear when it is time to climb aboard

FIGURE 5.1 The Necessary Elements of a Trading Plan.

Trade Identification

I knew I wanted to be a trader before I knew I wouldbecome a chartist Trading was the “what” of my careerequation Being a chart trader was the “how.” When Ientered the commodity business, my goal was to makemoney as a trader In reality, I did not have a clue what thatmeant

Chart trading made an enormous amount of sense to me

at the point in my career when I began finding my way.Chart trading offered me a unique combination of benefitsnot available with the other approaches I had attempted orconsidered, including:

A means to understand market trend

An indication of market direction

A mechanism for timing

A means to determine risk

A realistic target for taking profits

However, I quickly discovered that there was a hugedifference between seeing chart patterns and actuallytrading them Thankfully, the book Technical Analysis of Stock Trends by Robert Edwards and John Magee offered

some suggestions to the practical challenges of being achart trader Yet, one of my major challenges wasn’taddressed in the book; namely, when I began keepingcharts, I saw patterns everywhere I looked I needed tobetter define for myself exactly what I was looking for in apattern in order to take a trade Were all classical chartpatterns created equal? Were some patterns a better fit to

my personality, risk tolerance, and level of capitalization?

The Practical Problem of the Time Duration of Chart Patterns

With the benefit of hindsight, I now realize that the dilemma Iwas struggling with could be defined as time framing.

There are two realities of classical charting principles thatall serious chartists must confront

First, it is patently easy to see chart patterns in hindsight.Promotional materials from various trading advisoryservices are replete with charts showing how they wouldhave traded a certain market in hindsight But I trade themarkets in real time, and patterns clearly visible in hindsightmight have not been so clear in real time Chart structureconstantly evolves A pattern that eventually provides aprofitable trend might be comprised of numerous smallerpatterns, many of them failing to deliver an implied move.Further, a big move might be ushered in with several falsestarts

A second and related reality is that many patternsseemingly clear at the moment of a trade fail to deliver and

The Story of the “Big” Soybean

Move

During my first year at the Chicago Board of Trade (CBOT), a trader in the soybean pit befriended me This man lived in a mansion in Evanston, drove a luxury German car, and showed every indication of success (which, in fact, he had achieved) soybeans, at the time trading around $5.40 He said he had a giant position So I watched the market for a few days Prices prices return to $5.40 the following week Suffering from this out my pit trader friend and asked him what he thought His statement floored me “I made a small fortune Wasn’t that a great move?”

As it turned out, my friend was a scalper who seldom held a positions home with him overnight To him, a two- or three-cent move was his goal When he initially spoke to me, he had an instinct that soybeans could rally 10 cents within a day or two, gain But he did not explain this to me until after the fact.

So, in the end, I learned a very good lesson Being a “bull” or attached to the words.

Because the structure of a chart becomes redefined over

a period of time (especially in broad periods ofconsolidation), it is crucial for a trader to understand thetime frame that determines candidate trades If a tradertells me he is bullish on a certain market, I ask him if he islong, at what price, what is his target, what is his timeframe, and at what price does he admit he is wrong Theconcept of being bullish or bearish means nothing

GBP/USD as an Example of Time

Framing

Four charts of the British pound/U.S dollar (GBP/USD)illustrate the importance and complications of time frameconsiderations

Figure 5.2 is a weekly chart of GBP/USD from January

2009 through March 2010 The dominant stages of price

late May 2009 through February 2010, and the bear trendthat developed from the double top Two secondarypatterns can also be seen, a 19-week H&S top that wascompleted in late September 2009, but failed, and a 17-week continuation triangle that broke out in early February

2010 to launch the completion of the double top

FIGURE 5.2 Double Top on the Weekly Chart of

GBP/USD, June 2009–March 2010

Figure 5.3 displays the daily price bars of GBP/USD for

an 11-month period of time from April 2009 through March

2010 It is the daily bar chart companion version of theweekly chart shown in Figure 5.2

FIGURE 5.3 Double Top on the Daily Chart of GBP/USD,

June 2009–March 2010

broader period of consolidation is comprised of numeroussmall patterns—that at the time seemed to be importantindicators of expected market behavior The chronology ofthis chart was as follows:

A two-month ascending triangle (Pattern A) wascompleted in late July This pattern failed to propel pricesfor more than three days The brief rally out of the top of thetriangle led to what became the head of a 16-week H&Stop (Pattern B) This H&S top broke out in late Septemberand also quickly failed

The advance from the early October low led to an week complex H&S top (Pattern C) While the completion

eight-of this pattern experienced some initial downwardmomentum, prices stabilized at the December low and thenchopped sideways to higher for the next four weeks In theprocess, I was stopped out of the shorts I establishedbased on the eight-week H&S top

All of these patterns combined to constitute the broadeight-month double top completed in early February with atarget of 1.440 to 1.470

From my perspective, all four of these patterns (Athrough D) were worth trading—in fact, I traded them all.Had any of the first three patterns worked, they could havebeen considered as textbook examples of classical dailychart patterns

Figure 5.4 examines the period September 2009through March 2010, or the last seven months of the periodcovered in Figure 5.3, attempting to identify shorter-termpatterns In fact, seven patterns (labeled A through G) couldhave represented signals for the shorter-term classicalchart trader Figure 5.4 further demonstrates how smallerpatterns become part of bigger patterns that become part

of even bigger patterns and so on

FIGURE 5.4 Daily Chart of GBP/USD, October 2009–

March 2010