- 1997: Volume 6, No. 3 A Tool Kit for Traders

Moving Averages

Most traders are well aware that daily price irregularities combined with trend changes by direct observation of daily price action make market trend analysis difficult. Experienced traders know that it is all too easy to lose substantial amounts of money if they try to generate profits by darting into and out of the market in response to daily price fluctuations.

A very dependable tool for the determination of market trend is the use of some method of moving averages. Moving averages are calculated as an average of a number of consecutive prices continually updated as new prices become available. The averages can be for any number of days that you choose. A moving average of prices will fluctuate less actively than the prices from which they are derived. The greater number of days involved in a moving average, the more gradual are the price movements when compared with the corresponding daily price action. Although moving averages of 15 days or more have a tendency to become sluggish and lag prices, a trader using moving averages eliminates or reduces the distraction caused by the often sudden daily price fluctuations, and enables the trader to observe a smoother depiction of the trend changes as they occur. Moving averages will not always put the trader in the market at exactly the right time, but will alert the trader when prices begin moving consistently in one direction. This will aid the speculator in taking profits from the middle of a trend and holding losses to a minimum.

Chartists will plot moving averages using an average of closing prices or other figures representing price action. Trend changes are signaled when the plotted lines cross above or below one another. The chartists will base their trading decisions on these crossings in conjunction with other statistical data. The charted moving averages appear to be based on solid logic and are presently being used by a large percentage of speculators. Caution must be taken, as incorrect application and lack of knowledge about what the criss-crossing of averages and prices actually signifies may result in losses. There are many variations of moving averages, and a wide variety of ways in which they may be used. If the averages are misinterpreted, the resulting profit and loss can be just as varied. Blatant statements such as, "You'll never miss out on a big move if you go long when the moving average goes below current trading prices, and/or short when it goes above," should be viewed with extreme skepticism. A moving average is like any other trading tool and one must know its capabilities and limitations in order to determine its potential value. Then, if it has merit, the knowledge and skill acquired from a disciplined, time-tested trading system may be required to obtain the maximum benefit.

Composite Moving Average

One method of determining the underlying trend direction is the use of a composite moving average. To calculate the average daily price (ADP), average the daily high, low and close for 10 days. Then take this figure and divide it by 10 to obtain the 10-day moving average. For the next day simply adjust the 10 days used before and move them up one day. This 10-day moving average alone is a good indicator of breakouts and a change in market direction. A better indicator is when the average daily price is taken in series of four for 20 days. The most recent four days sum is assigned a weight of 40 percent. The next most recent four-days sum is assigned a weight of 30 percent, and the next most recent four days sum is 15 percent, the one before that 10 percent, and the earliest 5 percent. Then add these and divide the sum by forty to get the composite weighted moving average. As the days move forward adjust the weighted average by chronologically moving the average daily price up one day. The purpose of weighting is to cause the average figure to more quickly reflect a change in current price movement.

Twin Line Bypass System

The Twin Line Bypass System developed by Charles Gann is a relatively simple method based on trending patterns of the highs and lows. To determine the buy and sell points in the market, draw a line connecting the tops of the highs and do the same connecting the bottoms of the lows, thus forming a series of up and down channels. When a channel is going down and it turns around heading upwards, a buying point is indicated when the lows of the upward channel are higher than the lowest high in the turnaround section of the chart. Conversely, a sell signal is received as indicated when the highs of the downward channel are lower the highest low in the turnaround section of the chart. The same rationale is used to cover shorts and longs also.

This method is successful in determining definite and solid turn arounds in the markets. The twin line bypass method is most valuable to the conservative trader because it only gives him signals on the definite major breakouts and keeps him out of the small reversals that often mislead most traders into thinking they are heading into a major turnaround. This method is primarily used for long-term projections, but it also works well for the short-term trader.

The Range Finder

Arne Gronfeldt devised a formula that enables the trader to project the next day's/week's High-Low. In order to project the next day's Low, you add today's High + Low + Close, then divide the sum by 3, then multiply the total by 2, and from that figure you subtract today's High. The result is a close projection of the next day's Low. To project the next day's High, use the same formula with the exception of the final calculation, and instead of the High, subtract today's Low. The result is a projection of the next day's High.

The formula is similar when projecting next week's High/Low. Add this week's High + Low + Friday's Close and divide by 3, multiply the sum by 2 and subtract this week's Low. The result is a projection of next week's High. Use the same formula to project next week's Low by subtracting this week's High. Give this formula a try, as you will discover it to be a very useful trading tool.

Cycles in Commodities

Many things occur in cycles, as cyclical action is one of nature's basic laws. Cycles have been used as a trading tool for 70+ years. Many years ago a man by the name of Hurst developed his own method of trading stocks on the basis of cycles, and wrote a book on the subject entitled Magic of Stock Market Profits.

The cycle method of trading is based on the fact that a pattern from a series of highs and lows occurs in a set number of calendar days. Cycles in commodities can be charted and spotted visually by simply selecting a past bottom which supported a sustained upward move. Count how many trading days elapsed until the next bottom, then go forward the same number of days and see if another bottom was formed. Many times the cycles in a certain commodity will not be immediately apparent due to the fact that there are cycles within cycles which cause the charts to look erratic and random. Cycles are most accurately measured from low to low. It is not unusual for a cycle to have a variation of plus or minus 15 percent, and expectations should be established accordingly.

When trading the cycle method, one must realize that there are times the cycles get upset and erratic. However, once the commodity is allowed to settle down, it will soon resume a new cycle similar to the old one. The cycle method is best used to pick the bottoms and to determine timing for the breakouts.

Conclusion

Analyzing the market has never been an easy task, but when different indicators are used in conjunction with each other, remarkable results can be obtained. It is rare when every technical indicator will agree on the action you should take in a particular market, and no single technical indicator will work 100 percent of the time. Chart interpretation is often open to debate, but it is a matter of widespread interest and can be of considerable value to the analyst if used properly. The more indicators you find in agreement, the better the trading opportunity. Outside news must also be taken in account, as trades are being made because fundamentals essentially govern the markets in the long run. The axiom is, "When reports sound good, things are usually better and when reports sound bad, things are usually worse." This writer has learned the hard way that it is not wise to invest in any futures contract prior to a major report.

The duration, extent and timing of market movements seem to be random and unpredictable. But prices do tend to follow trends and moving averages behave in a predictable manner in relation to prices during trends. It is therefore logical that the use of a trading system that uses these characteristics of price movement, and of the behavior of averages, should yield an overall profit. Gronfeldt devised a trading system that started its evolutionary path in 1968, and he recorded and kept track of every day's trading until his death in 1991. The result of what he discovered was a way to measure the fear, hope, and greed factors of one of the most volatile markets in the world. The way that it is done is to measure the speed of acceleration and decline of an individual commodity using the result of simple manipulation of numbers as the indicator. This sounds simple and in practice it is, but it was far from simple to recognize this pattern in the masses of seemingly random numbers that he transcribed over the years.

There are risks inherent in trading futures contracts, but a reliable time tested trading system will serve to reduce those risks to an acceptable level. Spreads can be very rewarding if they are executed properly. When trading in spreads, a full knowledge of fundamentals is necessary for the trader to correctly evaluate the parameters. Stops, either fixed or moving, almost always reduce the amounts of loss on losing trades, but unfortunately stops can also reduce or eliminate profits. For the more conservative investor who has been afraid of the volatility of the commodity markets, there is the predetermined risk of option trading. A trading system with entry and exit points based on generated signals can be the way for the small investor to get the most value and the best chance for their capital to grow.

In the commodity markets the players are the industry who produce, grow, market and process the commodity, and the speculators who furnish much of the money that keeps the markets liquid. There is fantastic volume in financial futures and bankers, money managers, and insurance companies are also involved. The speculator is one of many hundreds of thousands who are seeking to capture profits from some of the big swings in the markets. The small margin required for entry far outweighs the leverage of the 50% margin required in the stock market. Combine that with many more up and down moves in shorter periods of time, and you can readily see that a small amount of money can make (or lose) large amounts of money quickly. Trading the futures markets is a game of probabilities and the trader must accept the fact that there is no 100 percent. Another market axiom, "the trend is your friend," has value as a trading guideline. There are times that trends will persist for long periods, and a position taken with the trend will more likely be successful than one taken randomly or against the trend. Trading with the trend in a bull market means buying on dips, and in a bear market, selling on rallies.

John Reily purchased the rights to System 2000 after the death of Arne Gronfeldt in 1991. Gronfeldt, a legendary lecturer, teacher, broker and trader, developed System 2000 from his research and market experience of 31 years. As an active trader, John has continued Mr. Gronfeldt's legacy to provide traders with a comprehensive tradiung system. He can be rached by e-mail at learn2000@aol.com