|A Written Trading Plan|
|A Written Trading Plan|
|Written by Ray Barros|
|Saturday, 01 May 2010 13:00|
In this article I'll set out what I believe to be the first element of a discretionary trading plan.
Identification of the Trend of a TimeFrame
This is a major component. The purpose of a plan is to indicate when the probabilities favour success. Identifying the trend of a timeframe and asking the questions below, provide us with our trading strategy i.e. with an action that has the blessing of our probability assessment.
1. What is the trend of the trader's timeframe? Is it likely to continue or change? And
2. What is the nature of the current structure's directional move, simple correction or complex correction?
To answer these questions, I use Barros Swings. Barros Swings are similar to Gann Swing Charts and Arthur Merrill's Filtered Waves; but they are different to Gann in that they have a price component and they are different to Filtered Waves in that they have a time component.
Barros Swings show the trend of calendar timeframes
1. Daily (intra-day, 5-period)
2. Weekly (daily 5-day)
3. Monthly (daily 18-day)
4. Quarterly (weekly 13-week) and
5. Yearly (monthly 12-month).
If we define uptrends as higher swing highs and higher swing lows, downtrends as lower swing highs and lower swing lows and sideways trends as about equal swing highs and about equal swing lows, then by using Barros Swings we can at once place any trend in perspective.
But, before I show some examples, I need to mention one more idea that I use: as a rule of thumb, the line direction of a timeframe will define the trend of the next lower timeframe; and therefore, the correction in a timeframe will probably show as a change in trend in the next lower timeframe.
That out of the way, let's look at some examples. Lets start with the S&P.
FIGURE 1 S&P
Some technicians suggest an arbitrary number e.g. 8.5 months for a Daily chart. My solution is to say that we look at the data from the most recent higher timeframe swing extreme. In this case, I'd treat the beginning of the current 18-day structure as the low of March 6, 2009 (666.80) this is the most recent confirmed 13-week low (black). The 13-week confirmation occurred when the 13-week line turned up.
Figure 2 shows the 18-day swing (red) structure since the March 09 low.
FIGURE 2 S&P Cash - 18-day Barros Swing
It shows that the last point of support for the 18-day swings uptrend is 1044.50. Once that low is taken out, whatever you have in the 18-day trend, you don't have an uptrend.
Figure 3 shows the DX (US$ Index) trend since the Nov 26. 2009 low. But where as the 18-day swing (red line)? The answer is under the Black Line (13-week equivalent). In other words, the quarterly swing is so strong that it's preventing any 18-days swings. (Only 5-day swings [blue, weekly trend] are in evidence).
FIGURE 3 DX
Since the 13-week line is up, we assume that the 18-day trend is up.
Figure 4 is a Crude Oil example. We see an uptrend since the Dec 24 2008 low. The last point of support rests at 69.825 a break of that price and whatever trend we have in the 18-day swing, it's not an uptrend since we have broken the sequence of higher high and higher lows.
The main way is through a number of change in trend patterns. The four main patterns I use I call, Lagging Change in Trend Patterns; one of these must be present at any change in trend. Three involve breach of a previous swing extreme; one, The Upthrust, allows for early entry. It's important to understand that because the swings identify similar swing magnitudes, all changes in trend are easily identified:
They involve the breach of a prior swing low in an uptrend and a prior swing high in a downtrend.
Once this occurs, whatever you have in that timeframe, you no longer have an uptrend or downtrend. Of course, the breach may simply be the result of a higher timeframe correction. If the higher timeframe finds support as soon as the lower timeframe breach occurs, the higher timeframe will resume its trend and will drag the lower timeframe with it. This results in a false breakdown or breakout.
But the false breakdown (breakout) becomes clearly identifiable through analysis of the higher timeframe swings. This adds a dimension to our analysis that is not normally available.
Let's look at an example of an Upthrust Change in Trend. At time of writing, an Upthrust has setup in the S&P (Figure 5).
FIGURE 5 S&P Change in Trend
Figure 5 shows the elements of the pattern:
1. A sustained prior trend - in this case an upmove since March.
2. The S&P has broken above a previous high, 1150.25 and now has a high at 1156.72. The new high is currently within the parameters I set for a 'false breakout'.
3. There is a visible Upthrust Pattern on the 18-day swing (red line).
4. The quarterly swing line (black line) is statistically overbought.
So what do I mean when I say the quarterly line direction is overbought? This brings me to another way Barros Swings help answer the question: continuation or change?
Change in Trend Patterns are reactive, we only know that a change in trend pattern has happened after the event. Statistics of the higher timeframe line direction provide a filter to change in trend patterns. This idea makes use of the principle I mentioned earlier: that " the line direction of a timeframe will define the trend of the next lower timeframe; and therefore, the correction in a timeframe will probably show as a change in trend in the next lower timeframe."
In this case, the 13-week swing up has moved mean +3 standard deviations of a normal impulse move. That being the case, the statistics for the 13-week swings are telling us that there is a high probability that the 13-week line will correct and in doing so, my trader's timeframe (the 18-day swing) will change its trend.
Theoretically a mean +3 standard deviation move has less than a 1% chance of continuing without a correction. But as Keynes said, the markets can remain irrational for much longer than you or I can remain solvent. In other words, the market can move in one direction way past any theoretical extremes; for example Crude Oil at one stage moved mean + 6 standard deviations. That's why I wait for a change in trend pattern to form before assuming a trend change has occurred.
There are two ways then for Barros Swings to help answer the question: continuation or change?
1. Through change in trend patterns, all of which are reactive in nature, and
2. Through the statistics of the next higher timeframe swings. These are early warning signals and filters for the change in trend patterns.
In later articles I'll conclude this topic and cover the other elements of a written trading plan.