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     indian_rose
Member
Username: indian_rose
Post Number: 5
Registered: 11-2004Rating: N/A
Votes: 0
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| | Monday, May 09, 2005 - 03:26 am: |  
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Hi all,
Can any one please clarify me about the entry,s/l, and exit set up in divergence trading using 14 day RSI or 5,3,3
stochastic.I find the prices reaching 3 or 4 peaks while
the osicllators are continiously showing divergence from the fist peak in prices.Any short trade would have hit s/l continiously for consecutive 3 trades atleast.But the 4th trade...leads to huge profits.How to trade this?
Also.I would love to hear your comments about my style of
trading.I am paper trading for the past six months.I dont
rely on any indicators except BB. When my intution tells me
to go short or long,I mark my entry and s/l but I do not
trade.At the end of 3 to 4 days I end up with profits (in paper ofcourse).Last month I traded twice actually and ended with nice profits.Can I continue trading or is it dangerous?
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david_louisson
Member
Username: david_louisson
Post Number: 48
Registered: 02-2004Rating: 
Votes: 4
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| | Monday, May 09, 2005 - 07:42 pm: |
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indian_rose
Before I begin I should point out that, although I've been studying TA and trading since 2000, I'm an occasional dabbler rather than a serious trader.
Which indicators you use is largely irrelevant. The bottom line is that you enter on a price bar, and exit on a price bar. Any indicators can be calibrated to give an earlier or later entry/exit. (earlier will, on average, deliver greater profit, but less frequently; that is the finely judged compromise). Personally, I am not a fan of indicators, but many successful traders use them. If you are going to use indicators, it is vital to understand exactly what they are measuring, and how.
"Can any one please clarify me about the entry,s/l, and exit set up in divergence trading using 14 day RSI or 5,3,3
stochastic."
Follow the trends. Entering trades solely because there is divergence is suicidal, because divergences (in oscillators like RSI and stochastic) signal decelerations that don't necessarily result in a reversal.
"Any short trade would have hit s/l continiously for consecutive 3 trades atleast.But the 4th trade...leads to huge profits.How to trade this?"
It's possible (but hard work) to trade successfully with a win rate of 25%, but obviously the one win must be big enough to offset the other losses. Requires small position sizes, much patience and discipline, and income streams outside of trading to compensate for the lengthy losing streaks. Ideally you should try to work toward developing a system that delivers > 50% winning trades, and where the winning trade is, on average, at least 2 to 3 times the size of the average losing trade.
To help get you started: pick "low risk" stocks that are moving in harmony with the market. The key, then, is to find reversals at extremes, that offer what appear to be "low risk" entries. For me, a low risk entry (for a LONG trade) has the following characteristics:
1. The longer term trend for the stock is upward.
2. The price has retreated to a short term extreme, within the context of this upward trend.
3. There is now evidence of a reversal from this extreme.
4. The sector of the stock you are trading, and preferably the overall market, are simultaneously starting to trend upward.
5. With reference to point 1, the probability is improved if the longer term trend is still in relative infancy, i.e. the longer any trend persists, the more imminent its eventual reversal.
6. The return/risk equation is favorable.
Of course, exactly the reverse applies if you are looking to trade a SHORT position.
However, if you are serious about trading, I think you need to step back and:
1. Do some serious research on TA. Start here: http://www.stock-anal.com/ubb/Forum1/HTML/000684.html
I'm not saying that my own approach is any better or worse than anybody else's (there are plenty of more experienced and successful traders than me). But there are a wealth of links in this thread, to some of the most comprehensive (and free) material on TA that is available on the Internet. Buy and read books on TA (go to amazon.com or your technical bookstore). If you don't do your own reading, you'll continue to post the same old questions (RSI, stochastic) on forums such as this. Very few contributors are likely to have the patience to write volumes here, especially to respond to questions that have been satisfactorily answered elsewhere, either on or outside of this forum.
2. Decide what parameters you want to use – time frames; market: stocks, derivatives, forex, etc; a basic approach that suits your personality, goals and lifestyle (e.g. how much time do you want to spend trading each day, how many positions do you want to manage simultaneously, etc).
3. Validate your approach by back-testing. Convince yourself that it will deliver positive expectancy (i.e. higher overall gains than losses) over a sample that is statistically significant. Experiment: try earlier/later entries and exits, tighter/looser stops, and study the effects that these have on individual trades. It's all about trial-and-error, making adjustments to find formulae that deliver profit over differing market conditions (bull, bear, trending, ranging, volatile, inert, etc).
4. From the results in (3), formulate your trading rules. These must ultimately include – stock selection, entry, exit, risk management (stop loss), position size, level of diversification – as an absolute minimum.
5. Paper trade until you gain a feel for the market you're trading – what is more likely to happen than not – and you feel confident that your system will deliver in a "real life" scenario. No cheating, no retrospective plays!
6. Set aside an amount of capital for trading purposes – money that you can afford to lose. Follow your rules (whether mechanical or intuitive) until you're either financially free, or wiped out. Treat each trade as a learning exercise.
Trading is a vast topic. There are a million potentially successful approaches. You never stop learning – about TA, about management, about the markets, about yourself.
Good luck!
David
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david_louisson
Member
Username: david_louisson
Post Number: 49
Registered: 02-2004Rating:
Votes: 2
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| | Tuesday, May 10, 2005 - 06:20 pm: |
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Footnotes to my post:
Firstly, the following thread might also be helpful:
http://forum.incrediblecharts.com/messages/11/295533.html
Secondly, the chart below (a recent excerpt from the UK mining sector index) illustrates what I mean by "low risk" entries (for a short term trader) in my previous post. You will find countless other similar examples in other posts here, and in technical analysis books and websites.
Note that these are short positions, exploiting a downtrend (note how the yellow lines step progressively downward, showing lower highs and lower lows). No indicators are employed. The white zigzag line has been drawn manually, retrospectively showing the gradient of each move – prices tend to move more swiftly in a downtrend than an uptrend (fear of loss is a greater motivator than greed, perhaps?). The four entry points are shown by the white arrows, entry being at the open following the previous day's "signal" (see below). Note that the first, third and fourth of these deliver profit; the second gets stopped out. That is a 75% win rate.
Here is how each entry complies with the "low risk" rules in my previous post:
1. The long term trend is downward (yellow lines, green standard error channel).
2. The price has retraced to a "local" high.
3. There is a filled (close < open) red (close < yesterday's close) candle, signalling the probable start of the next wave downward.
The first and third entries followed a retracement to the std error channel, increasing their probability of success, and improving the return to risk ratio.
Note that (as always) the outcome is dependent on not merely picking the probable direction of the move, but (1) the length of the move and (2) how quickly you are able to enter, and exit, in order to catch as much as possible of the move, before it is too late. Thus profit is forfeited both at the entry (waiting for confirmation of the downward movement), and exit (confirmation that the downward movement has ended). The faster movement in a downtrend makes it more difficult to "catch" these trends.
Note the lengths of the downward "legs" of the white zigzag path, compared with the upward "legs". Given that profit is dependent on the length of the move, it is easy to see how the probabilities improve by trading "with the trend".
A possible (profit) exit is the mirror image of the entry, i.e. the first unfilled (close > open) blue (close > yesterday's close) candle preferable near the bottom of the channel. Other approaches are to trail your stoploss, or close out immediately the price retreats back inside the "smart" (black) channel.
A possible (stoploss) exit is the highest high of the previous cycle, i.e. level with the peaks in each leg of the zigzag. Setting a much looser stoploss might have given 3 wins from 3 trades, but (in general) it affects the average win size to average loss size, and also your position sizes, if you size according the fixed fractional method. How early one enters/exits, and how tight/loose one sets stoplosses, are two of the finely judged compromises that must be mastered. Trial-and-error is your best teacher.
This is a very simple example, using only basic candle patterns and channels, but it illustrates the main points. This type of trend-based approach will prove much more successful than trading divergences; it provides your "bread and butter" profit. Note how important it is to follow the maxim of "letting profits run", to ride each downward move to the maximum possible extent. The assumption must always be that the trend will continue, until there is compelling evidence to the contrary.
A longer term trader might seek to capture the entire move in a single trade.
David
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nightstalker
Member
Username: nightstalker
Post Number: 798
Registered: 04-2004Rating: N/A
Votes: 0
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| | Tuesday, May 10, 2005 - 08:45 pm: |
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Excellent posts there David - you've put a lot of time and effort into your replies to the original poster, and most who would have read this would have benefitted. Thank you 
As a trend follower, I find your principles are particularly relevant. The main point you make with which I agree most strongly is the use of a trailing stop. I'm quite happy to use a trailing stop - mine are based on support/resistance levels - and to obey one's particular set of rules. I think trying to pick the extremes of ANY move, either the top or the bottom, is fraught with danger and is likely to leave you with egg on your face. I'm also quite happy to take the 60-80% chunk out of the middle of a trend, and not trying to pick the bottom or top. When my stop is hit, I activate my method for exiting on that stop. Each person would develop their own method for setting and handling stops, and mine works for me.
I use manual stops, not automatic, as I feel that automated stop-loss "bunny" raids are becoming too frequent now, and I don't want to be shaken out of a trend on the whim of a manipulator with a fast computer... ;)
Regards, NightStalker
"The trend is your friend till the bend at the end"
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tony_m
Member
Username: tony_m
Post Number: 304
Registered: 01-2003Rating: N/A
Votes: 0
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| | Tuesday, May 10, 2005 - 11:56 pm: |
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Indian Rose,
If you are starting out, dont over complicate matters but think about adopting a tried and tested trend trading system. It looks like you might be trying to overly complicate a relatively simple process.
There are countless excellent articles on the forum about various trend trading systems but I would suggest you go back over the last couple of years and look at posts by Snifter who had a good handle on weekly based trend trading. A good and typical example can be found at http://forum.incrediblecharts.com/messages/12/333776.html see the entry on August 4.
Many people including me use the same process in principle with variations in the detail. However the process is always the same, identify stocks in solid uptrends, buy in pullbacks, use stoplosses. You will need some way of quantifying the trend strength, Snifter advocated ADX11 > 25, I use the Alan Hull ROAR (Rate Of Annual Return) > 30% to do the same.
The course notes on the Alan Hull website http://www.alanhull.com/download/Active_Investing_0312_com.pdf are worth downloading and digesting. He advocates another variation of weekly trend trading which works for a lot of people.
Hope this helps....Tony_M
(Message edited by tony_m on May 10, 2005)
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indian_rose
Member
Username: indian_rose
Post Number: 6
Registered: 11-2004Rating: N/A
Votes: 0
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| | Wednesday, May 11, 2005 - 02:45 am: |
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Thank you David and Tony for your informative postings.As I am in hurry today I will join later with you on this subject.
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indian_rose
Member
Username: indian_rose
Post Number: 7
Registered: 11-2004Rating: N/A
Votes: 0
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| | Sunday, May 15, 2005 - 06:16 am: |
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Hi David,
In your post dated 090505 you have said
“2. The price has retreated to a short term extreme,within the content of this upward trend.”How do you define the uptrend? Of course a lot depends on the time frame we trade.I prefer to have positions for a week.(like swing trading).If the trade is going favourable,(including corrections) I don’t mind holding it for months together as everyone of you do.
I had gone through Snifter method some months back.(Thank you,Tony..for pointing it
Out ).Here,in India,the index has dipped below the weekly m.a.s of Snifter,and remained there for two to three weeks.Now the prices are kissing the 26 period m.a. from below.As per Snifter,I should go short on the index.
As per Dr.Elders method,(Triple screen trading) ,the reading in weekly MACD is negative.It also points out a short trade. Am I right,if I say the main trend is down? Please clarify me...If you have your own way of defining the main trend,will you please let me know.I am a bit confused here,I want to ascertain the main trend in more than one way just to
Satisfy me.
“The price has retreated to a shot term extreme”
How do you define this extreme? Do you take up the market reversals through the turning bar candles or through any predefined fib.ratios.Or by placing a buy order on the top of the previous days high?
Though I have been trading the markets since 1984, I am new to T/A.Only last year I was aware of the TA existence and from there I am trying to rejuvenate my trading.I am trying to attach the index chart here.But I don’t know whether it will come nice.
Indian_rose
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david_louisson
Member
Username: david_louisson
Post Number: 51
Registered: 02-2004Rating:
Votes: 1
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| | Monday, May 16, 2005 - 12:29 pm: |
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Indian_rose
I tend to use a different method (shorter term, higher diversification, don't use indicators or mechanical stoplosses, prefer a non-trending market, etc) to the more "textbook" approach applied by many of the contributors to this forum, so I'll leave it to them to answer your specific questions in more detail. However, some of the general principles that follow may be helpful; take them or leave them, as you wish.
Definition of uptrends and downtrends:
An uptrend consists of higher peaks and higher troughs; a downtrend consists of lower peaks and lower troughs. You can see these clearly in the head-and-shoulders and inverted head-and-shoulders diagrams at http://www.incrediblecharts.com/technical/head_and_shoulders.htm
Look at the chart in my post above – this is a downtrend because the peaks and troughs are getting progressively lower. Then there is a wait for the reversal (upward) or "pullback", and then one enters immediately the downward journey resumes, from this local "extreme". Re-read my earlier post and it will hopefully make sense.
You can also see the longer trends by using "summary" techniques:
(i) weekly or monthly price bars – are they moving upward or downward; or
(ii) a long term moving average – prices will lie above the MA in an uptrend, below it in a downtrend.
In the shorter term context of price bars, an uptrend is a succession of higher highs and lows; a downtrend lower highs and lows. There are also "inside" days (lower high, higher low) and "outside" days (higher high, lower low).
See http://www.incrediblecharts.com/technical+analysis.htm
Go to the links in each section for excellent background TA material. The sections "Chart patterns", "Short-term patterns" and "Reversal days" make for a good start.
"The price has retreated to a shot term extreme. How do you define this extreme?"
This is essentially a judgement call, but basically when:
1. in a longer term uptrend, the price rebounds upward from a local trough (this is the "low risk" entry for entering a long position);
2. in a longer term downtrend, the price rebounds downward from a local peak (this is the "low risk" entry for entering a short position);
Again, see Colin's head-and-shoulder patterns for timing the entry, and stoploss, considerations.
Please note that the chart in my above post was something of an over-simplification. Normally I would wait for the price to reverse back inside the black channel before fully closing the position, because one unfilled blue candle is generally insufficient proof of a reversal. Depending on what the overall market is doing, I might decide to partially close a position to lock in some profit, and then let the remainder run as long as possible.
Now some general remarks:
When analyzing the profitability of your system, there are two essential factors:
a) the number of winning trades to losing trades (e.g. a value of 60% means 6 wins out of every 10 trades, on average);
b) the average win size to average loss size (e.g. a value of 1.7 means that the average win is 1.7 times the size of the average loss)
Note that wins and losses are calculated after deducting costs.
Note also that combining (a) and (b) gives the profit factor (PF), "expectancy" or "edge" (call it what you will)
See: http://forum.incrediblecharts.com/messages/12/408975.html
A good (and realistically attainable) target is to aim for > 50% value of (a), and > 2 for (b). The latter means you are choosing trades where the profit potential is > 2 x the distance from entry to your stoploss.
I've brought this up because I want to discuss some of the biggest issues surrounding entry and exit, irrespective of trading time-frame, market traded, instrument used, indicators used, etc. Irrespective because the bottom line is that you must necessarily enter on a price bar and exit on a price bar. Provided that your method involves some kind of trend following, all of the following points apply:
1. How soon after the trough (long position) or peak (short position) you enter.
The earlier you enter, the higher the risk, in the sense that a "genuine" reversal might not have occurred, i.e. it is just a minor deceleration ("noise") along the trend. As compensation, the earlier entry will generally attain a more favorable entry price.
Hence an earlier entry will, on average, increase (b) but decrease (a). In other words, your profit will be greater on the occasions that you do win, but you will win less often. This gets back to your original question about divergences. Every trend must necessarily decelerate before reversing, and divergences will tend to pick up these decelerations. But not every deceleration will actually result in a profitable reversal. Hence the higher risk.
Conversely, a later entry will, on average, increase (a) but decrease (b). The later entry increases the probability that a profitable trend is emerging; however, one is forfeiting eventual profit at the start of the trend, by entering at a less favorable price.
As I've said elsewhere, profit is determined not by WHETHER the price moves in the anticipated direction, but HOW FAR (and how quickly). Profit is attained only if the price moves far enough to overcome costs (see point 3 below). Because it is difficult to predict how far price will move (some traders attempt to use previous support and resistance, others Fibonacci retracements or space/time ratios, as a guide), if the trend turns out to be short lived, then delaying entry too long actually results in increased risk.
2. How tight your stoplosses, and trailing stops, are.
It is widely accepted that the exit is more important than the entry. Here are some major reasons why.
If you set your stoploss too tight, you will get prematurely stopped out of trades that would ultimately result in a profit, more frequently. This is a double whammy: suffering a loss, AND forfeiting a potential profit. However, the tighter stop means that your losses will always be small. This results in an extremely poor (a) value, but a high (b) value.
The same applies to trailing (profit-taking) stops. A tight trailing stop will guarantee locking in some profit, but has the potential to prematurely curtail extended future profit. In other words, it can "cut winners short".
Of course, the converse applies if stoplosses, and trailing stops, are set more loosely. The "looser" the stop, the less frequently premature stop-outs will occur, but the greater the average loss (or forfeiture of profit) becomes, when the stop is triggered. Hence the value of (a) increases, but at the expense of (b).
Another major reason why stop-setting is crucial, is its effect on fixed fractional position sizing (the method that most traders seem to use). As an example, let's say your trading account balance is $10,000, and you are willing to risk 2% (the recommended maximum) on a given trade. 2% of $10,000 is $200. Let's suppose that stock XYZ gives a "buy signal" at $2.00, and you decide to set your stoploss at $1.90. Then if the stop gets triggered, you will lose 10c per share purchased. Given that you are willing to put $200 at risk, then you would buy 2,000 shares (i.e. 2,000 shares @ 10c loss per share = $200 loss).
However, if you were to set your stoploss at $1.95, and it is triggered, then you will lose 5c per share purchased. Given that you are willing to put $200 at risk, then you would buy 4,000 shares (i.e. 4,000 shares @ 5c loss per share = $200 loss).
In other words, the tighter the stoploss ($1.95 vs $1.90), the more shares purchased (4,000 vs 2,000), and the more capital "tied up" in the transaction (admittedly an irrelevance if one is trading derivatives on low margins). Assuming that one works to the above formula, the loss is the same ($200 vs $200), but the potential for return is doubled (4,000 shares x favorable price movement vs 2,000 shares x favorable price movement). Offsetting this is the greater likelihood that the stoploss will be triggered (as already discussed).
An alternative to using a trailing stop is to extract profit by closing positions "progressively", by selling off parts of the position immediately arbitrary target points along the way are reached. The advantage to this approach is that the profits taken are totally secure, whereas stops are more vulnerable to gaps and slippage, especially should a position suddenly "earthquake". The drawback is that potential profit is being sacrificed prematurely, should the trend proceed to "mature" a great deal further.
One final point: some traders don't use "mechanical" stoplosses. But to do so requires both the judgment to recognize when a trade has "gone awry", and the discipline to exit immediately at that point.
3. The three costs involved. These are:
(i) Transaction costs: brokerage, spread, slippage, financing costs, etc.
(ii) Profit forfeited between the trough/peak and the entry point (determined by how early/late the entry is – see point 1 above).
(iii) Profit consumed between the trough/peak at the end of the trend, and the exit (determined by how tight the stops are – see point 2)
If you can (on average) overcome all of these costs, you will profit; otherwise you will lose. That is the bottom line.
All of the above applies to any trend following system. Whatever your method, you should BACK-TEST it across a sample (large enough to be statistically significant) of historical data. Here's why:
(i) The overall results will give you values for (a) and (b), telling you how THEORETICALLY profitable (or otherwise) your system is. This is especially important if you plan to be a "mechanical" trader (i.e. entries/exits follow a set of iron-clad mathematical rules).
(ii) A study of the individual trades will help you gauge whether you are (on average) entering too early or too late, and whether your stops are too tight, or too loose. If you plan to be a "discretionary" or "intuitive" trader (i.e. entries/exits follow a set of general principles, applied with judgement), developing this kind of "feel" for what is likely, or unlikely, to happen in different situations, is absolutely vital.
(iii) Study the losing trades, and find out the reasons why. Vary your parameters, and see their effect on (a) and (b). What effect does eliminating/alleviating the losing trades have on the winning ones? Find the best compromise.
(iv) The most important reason to back-test (as if the above were not enough) is CONFIDENCE. You must believe that your system will continue to work, even during the rough times, if you are going to continue applying your system with DISCIPLINE. This is even more important for a discretionary trader, whose more "flexible" rules provide greater temptation to deviate.
(v) It's important to test different samples across differing market conditions (e.g. bull market, bear market, trending, ranging, volatile, inert). This will help tell you over which conditions your system performs best, and what adjustments need to be made to cope with the differing underlying "climates".
One caveat to back-testing. Unlike casino-based games of chance, the "markets" (in reality, crowd behavior driven by – amongst other things – greed, fear and other emotions) do not run according to precise probabilities. What has happened in the past is only APPROXIMATELY more likely, than not, and in some APPROXIMATE form, repeat itself in the future. So back-testing results are guidelines, no more. But if there is any non-random behavior amongst the chaos, then it can be mathematically approximated, and (God willing!) profitably exploited.
4. Effects of (a) and (b) on trading cashflow, and psychology
Putting the math aside for some real-life practicality: Some traders are willing to live with a system that delivers a value of (a) < 50%. As we have seen, we can time entries and set stoplosses to balance (a) and (b) to suit our personalities, goals and lifestyle. To deliver long term profit, the product of (a) and (b) must deliver positive expectancy. In other words, if one is willing to let (a) slip as low as 40%, then (b) must exceed 1.5, and so on. However, if trading is one's primary source of income, then there are other important considerations.
The first is cashflow. A low value of (a) could mean a long wait for the next big winning trade, necessitating careful household budgeting.
The second is psychology. Again, a low value of (a) could mean a long wait for the next big winning trade, leading to any of impatience, despondency, lack of confidence, and ultimately temptation to deviate from the system's rules and principles.
David
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dogalog
Member
Username: dogalog
Post Number: 1361
Registered: 03-2004Rating: N/A
Votes: 0
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| | Monday, May 16, 2005 - 12:55 pm: |
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David greetings,
Are you writing a book? like your post is highly relevant,researched,uncontroversial in saying something about how it is,but david this opened with 'trading since 2000 but not all that much'
can you explain some reasons for why you have this fully setup plan,yet it is not taking you there,as in trading.
I hope you don't see this at all as a Criticism,i was just wondering,that's all.
I don't starvote but your above is pretty 5/maybe 4 to me.
regards
jr
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david_louisson
Member
Username: david_louisson
Post Number: 52
Registered: 02-2004Rating: N/A
Votes: 0
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| | Monday, May 16, 2005 - 08:46 pm: |
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Auto-Fit Trendlines
Nifty(Indian Index