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Learning to trade is a largely an effort to solve specific trading problems. Here are nine classic problems and the types of trading solutions you'll learn to execute.

Problem 1: Reducing Noise
Problem 2: Determining A Directional Bias
Problem 3: Overlooked Swings, Missed Opportunity
Problem 4: Trends that Don't Last
Problem 5: Go With the Move, or Wait for a Retracement
Problem 6: A Lack of Trending Markets
Problem 7: Capturing Fleeting Windfall Profits
Problem 8: Missing the Beginning of Big Moves
Problem 9: Lack of Diversification


Introduction: Having a comprehensive view of how markets work has a profound impact on both our confidence and our ability to extend and evolve the trading process. In creating the Trend Dynamics courses, we've set out a comprehensive trading method that works well under widely varying market conditions— and in different markets—over long periods of time. In the course of doing so we've identified many of the classic problems of technical analysis—the most pressing problems that all traders encounter.

In the text that follows we summarize and review nine classic trading problems and the solutions found in various Trend Dynamics Course modules:

  • Problem:1 Reducing Noise

    In Market Structure 101, we described price action as "a reflection of energy that is in a continual transition from a state of instability (trend) to a state of instability (congestion or trading range) and back again." Isolating these transitions amidst all the cacophony of the markets, the noise and news and rumors, and doing so with sufficient clarity and enough vision to stay one step ahead of the crowd, is an intellectual and a psychological problem and a considerable challenge. It is, of course, at the heart of successful trading.

    What makes that challenge formidable is that these transitions do not take place in a single, discrete dimension of time nor with any consistent periodicity. Instead they are distributed across a shifting, nearly infinite variety of timeframes. In any given market at any point in time, trend changes, running line movements, congestions, and trading ranges can be occurring over a variety of timeframes simultaneously. Sometimes these timeframes are fractal, making our task a bit easier; but at other times, as when control of price is wrested from one timeframe to another in what appears to be random fashion, they are disjointed and disconnected. Every trader, every trading system, is confronted with this problem. Many a trader has been bankrupted by it.

    Only an omnipresent mind, surely no merely human one, could encompass even for one still moment the complexity of price action as it moves simultaneously across all timeframes, and find within it a replete pattern of accord and harmony. Lacking such omnipresence, we see order in one layer, or at best two or three, within a galaxy of chaos. We simply cannot know precisely what speculative power and force are grasped in the hands of a market's innumerable participants at any given point in time.

    Owing to this instability, swings in supply and demand will at times be wholly inexplicable. Is there any wonder that the markets remain an unfathomable mystery to so many, including long-time observers?

    Noise is price action that falls outside the range of one's threshold of perception. It is relative to the timeframe we're attuned to. But what is mere static on one dimension of time and price, may well have meaning on another. The Catch-22 is that the more timeframes we can simultaneously (and skillfully) interpret, the more order we will perceive; but the more timeframes we monitor, the more prone we become to bouts of confusion and indecision—and the more difficult and complex good execution becomes.

    The problem is that in order to see, to make valid and useful observations of price action we need to find ways to reduce the noise so that we can detect underlying directional biases in the timeframes we're monitoring.

  • Solution to the Noise Problem: Time Filters

    Solutions to the noise problem lie in analysis or synthesis—or in a combination of the two. In analysis, we break something complex down into simple elements. The solution taught in Trend Dynamics is primarily an analytical one. As first explained in Market Structure 101, we use 5-day (5D) and 18-day(18D) time filters to segregate price action into two encompassable components, and in doing so filter out the noise of other timeframes.

    Richard Donchian's (and later Richard Dennis's) line breakout methods and Peter Steidlmayer's Market Logic approach reach for similar analytical solutions to the problem of noise, of diffusion of price action over many timeframes. In Trend Dynamic terms, all these analytical approaches are essentially based on measuring line pressure, which is a direct expression of the imbalance between supply and demand. The concept of line pressure is defined and developed at length through several Course modules.

    Another valid solution is to synthesize the noise of price action. This is typically done by reducing the noise to a baseline, a moving average of prices. In Developing A Trading Plan 301 we teach a unique method of using mean price levels and regressions to the mean in combination with market structure.. The moving average has a number of successful adherents, including such trading legends as Ed Seykota and Marty Schwartz.'

    Both methods of noise reduction use time as a filtering mechanism because, as the First Law states, "Time affects the potency of any price swing."

    Both methods have long been used with great efficacy to extract profits from the futures markets. In fact, virtually every effective trading plan I know of uses one or the other of these methods to help solve, or, at least to dampen, the noise problem to a level that makes analysis practical.


  • Problem 2: Determining A Directional Bias

    "I try to determine what the bias is for the market; then I go from there." says Marty Schwartz. Most effective traders walk into their offices with a bias; they've done their homework the night before. If not, they establish one shortly after observing price action when the markets open. Directional bias is nothing more than the trend controlling the direction of prices over whatever timeframe one is sensitized to.

    Understanding directional bias simplifies a trader's decision-making. A bias allows us to choose one script over another. If measured skillfully, the prevailing directional bias can provide an edge in win-ratio and probability. How we deal with a trading range, how we determine when a trading-range is terminating, becomes problematic unless we have a directional bias. Simply stated, the problem is this: How do we determine and deal with directional bias in price action?
  • Solution: Identify the Influence of a Higher Order Trend

    The analytical approach we use in Trend Dynamics trading courses, essentially breaks price action down into period and swing components to look at precisely how price ranges expand and contract to form trends. There are twelve underlying market principles, that govern all trend and price action. They are derived from studies of market structure (period and swing relationships) and designed to let us predict the likely directional resolution of any given market's price movement based on the recognition of the influence and limitations imposed on lower-order price relationships by higher-order ones.

    An alternate or additional solution is the synthetic approach; which mainly examines a time series as it moves in relationship to a synthesized price level (the mean), and looks to the slope or relationship of moving averages to determine likely directional resolution. In simple terms, trend, whether determined by swings and price structure or by using sloping moving averages tell us whether price is moving and may be expected to continue moving, up or down.

    Both solutions to the problem of determining directional bias have made fortunes for many traders.
    Each has proven itself valid over many decades of price action. In order to make good, reliable use of trend, defined by period and swing relationships, we need to solve two additional problems: 1.) How to normalize and segregate swings that represent similar price-energy efforts; and 2.) How to differentiate between lasting trend changes, on the one hand, and abortive ones on the other.


  • Problem 3: Overlooked Swings, Missed Opportunity

A problem that plagues technical analysis based on swing relationships (swing trading), as typified by the weakness evident in Elliot Wave, Gann, Wyckoff methods, is failure to explicitly define or normalize swings and to classify swings according to whether they represent similar price-energy efforts or at least reach minimum threshold levels of price-energy.

Solution: Define Swings Dynamically

In Trend Dynamics, we use the concepts of a dynamic range (floating line-change levels) and a range penetration of a fixed percentage amount to allow us to measure price efforts of like value and not overlook important price swings. The omission of price swings handicaps our capacity to see the real import of the price structure we are analysing. The First Law (see Twelve Laws) suggests that time provides the conditioning element with which we solve the problem of identifying and measuring swings of like potency. I call this process "normalizing" swings.

The time periods weuse are intervals of 5 and 18 days, which capture and highlight the weekly and monthly swings. To measure price action, I use price penetrations: that is, thrusts in price that penetrate a range by 10% or more (see Market Structure 101) allowing for dynamic adjustment of the amount of penetration relative to the height of the price range. The concepts of floating line changes, maximum threshold, and measured line values allow us to normalize swings consistently. analytical approach we use in Trend Dynamics trading courses, essentially breaks price action down into period and swing
.


  • Problem 4: Trends That Don't Last

Differentiating between valid trend changes and short, meaningless range expansions is a classic trading problem that must be solved by every trend-based trader in all markets. In fact, to recognize this as a pivotal problem is to begin to attain a realistic understanding of trend tenacity and how markets work. Success starts here.

In Trading Strategies 101A , I wrote that the trend we'd like to see unfold and the reality of trend evolution are two different matters. Normal price action is interspersed with many false trend changes; and many a trading range is terminated by an upthrust or spring. This is simply the way that markets balance supply and demand. In order to thrive in this normal market environment, we need clear ways to differentiate lasting trend changes from false ones.

Solution: Using Whole Period and Line Continuation Counts

To confirm a trend change can completely alter our bias. Thus, it is a serious matter. As a rule, correct identification of a trend change requires close and careful observation. I introduced the whole period count (the WPC) in Market Structure 101, as a tool with which to differentiate trend changes from up-thrusts and springs. Later, in Tactical Entries 202, I characterized the WPC as an indication of defensive demand when price holds above a point of change (POC) in a potential upwards movement. Its counterpart on the offensive side is the pressing through the point of change of the line continuation count. (LCC)

The chief solution provided in the Trend Dynamics course material to the problem of identifying important trend changes is to use the whole period count and line pressure as measured by the LCC to mark valid major changes in supply and demand. Upthrusts and springs are then easily identified as price offensives that fail to present the requisite WPC or LCC pressures sufficient to change the trend.


  • Problem 5: Go With the Move, or Wait for the Retracement?

Identifying one's own directional bias, or the direction in which we want to trade, can be strategically useful. But, tactically we need more information, for the simple reason that as a market's probable direction becomes obvious to enough other traders, the risk on entry rises to intolerable levels. Thus, we need to identify spots where risk on a relative basis is more or less attractive-spots where we can make safer entries even in the face of large-scale, sweeping, and well-understood market movements. The problem is exacerbated by the fact that it is often psychologically hard to take these positions.

Furthermore, there are times when a price thrust occurs and momentum carries a market up and away without a retracement. Whether to enter a trend on a breakout or on a retracement can be a vexing problem for traders who use either daily or intraday timeframes. The recurring question is: How does one know whether to buy the breakout or wait for a retracement? .

Solution: See Structure, but Feel the Pace & Rhythm

As a general rule, I find it is better to wait for retracements. The optimal price level at which to take a position is generally in the midst of a clear trend but after a contratrend reaction or liquidation has taken place.

But identifying a contratrend reaction can be tricky. In Developing Trading Plans 301, I presented a two-component typology of trend segments that contain both a contratrend reaction and an offensive line effort. Generally, I prefer waiting for contratrend reactions within a clear ongoing trend. Those retracement entries include simple or complex reactions or with-trend termination of trading ranges.

The 5D RePo first introduced in Trading Strategies101A, and the straight-line reaction (SLR; (see Trading Strategies 102), give us ways to identify the most important lower-risk opportunities that commonly develop within an ongoing trend. Taking a position after a contratrend reaction puts the trader in the advantageous position of being able to calculate a near-term risk/ reward up to a non-trend liquidation point that has at least a 50% to 70% probability of being hit.

But there are also times when a breakout entry can be the tool of choice. One occurs in an emerging trend change when the a wide-range breakout (WRB; see Market Structure 201) comes at an 18D point-of-change after a period of extensive liquidation marked by several previous18D swings comprising a well-identified, well-understood trend in the opposite direction.

The same problem confronts the trader using intraday entries to position himself or herself in classic Trend Dynamics situations. Generally I wait for retracement of some type even when using intraday data, but I also know that not switching to a breakout entry at the right time can cause lost opportunities, and this is something I constantly work on. Generally, I switch to a breakout entry after price oscillation has become narrow, such as following a NR7 day (when the price range shrinks to the narrowest range of the past seven days). Other changes in pace I note are when I see two or more inside periods, or a single inside and narrow range, in a wide-range period. (To learn more about this topic see Unorthoodox Trading Tactics 301 and Formless Trading 505).


  • Problem 6: A Lack of Trending Markets

Underestimating the probability or distribution of zero-trending environments is another recurring problem with most trading methods. In fact, most trading methods are far too dependent on catching high-plurality trends year after year. For traders who depend upon such methods, the conse-quence is often steeper-than-expected drawdowns. energy.

Solution: Non-trend Liquidaiton Tactics

The Nontrend liquidation (NTL), introduced in Trading Strategies 101B, has been a mainstay of Trend Dynamics because it functions well in trending and non-trending environments both. It protects a trader from being dependent on the continuity of trends. We teach Trend Dynamics traders how to make profits in non-trending environments and not to depend solely on catching the rare parabolic move.


  • Problem 7: Capturing Fleeting Windfall Profits

Whether one is a day trader or a swing trader, on occasion a market will become seized by emotion, and price will in consequence rally, or drop, precipitously over the course of a few minutes or a few weeks. The result can be windfall profits.

Capturing these profits is difficult; they often evaporate as quickly as they appear because price has so outrun its time counterpart that a wide price trading range forms. This in turn allows a latitude of swing freedom that permits volatile trading range-like fluctuations.

Similarly, every year a trend-based position in some market will enter a running trend and trade in a very orderly manner only to be topped off in a parabolic move that yields profits of 10- or 20-to-l. Since these "outlying" profits are relatively rare and unstable, they can be especially hard to capture.

Solution: Calculating Kill Zones and Realized Objectives

The best solution to the problem of capturing windfall profits is to look for unexpected, out-of-character expansions of intraday ranges (if you are a day trader) or average weekly or monthly ranges (if you are a swing trader); and then apply the "kill-zone" rules of thumb taught in Trading Strategies 101B. Using Realized Objectives (also see Trading Strategies 101B) are another, but far more subjective way to be alerted to windfall profits that tend to evaporate quickly.

The most objective solution is to watch for sudden range expansions, not those that are clean breakouts of long term structures but rather those that come out of nowhere in thin air, into areas of supply & demand. Ironically, the odd solution to riding out the long-term huge winner is to take a fraction of a position off at some NTL point. Doing so places one in a admirable psychological position, namely being able to ride out the high-plurality running markets with detachment. (A good trader always needs detachment if he or she is consistently to deploy the right tactics to take advantage of any market opportunity.)


  • Problem 8: Missing the Beginning of Big Moves

When we've identified a high quality opportunity to take with-trend positions, we should trade as many of them as possible so long as they make sense in terms of allowable risk.

But if our entry patterns are too intricate, we risk missing out on good trades: The market will not provide the precise pattern we are looking for. In fact, markets fulfill more intricate entry patterns than we ever realize. For example, we may be looking for a specific sort of trend turn only to discover later, to our dismay, that a trend turn of precisely that magnitude did occur- but it was only visible on another timeframe.

Patterns presented in Tactical Entries 201 (such as Doji periods, 0-C switches, narrow periods, and the like) often occur, but ephemerally. In looking for one particularly pattern, perhaps in vain, we may overlook that precise pattern presenting itself in another layer of time that lies just below, or perhaps above our threshold of sensitivity.

Solution: Generic, Non-intricate Entry Patterns

The solution is to develop and use entries that are aren't so intricate--for example, generic entries that virtually always occur when a market reverses. The trick, of course, is to use simple, but not too simple, entries. If an entry is too easily triggered, it will get us in too often, and prematurely.

The line continuation concept (specifically LCC-Offsets and Reversals, presented in Tactical Entries 202) provides a generic entry technique that solves this problem. The 3D 10% close (recommended as an alternative entry technique in Tactical Entries 202) provides another solution to this classic problem.


  • Problem 9: Lack of Diversification

In our review of CTA (commodity trading advisor) statistics in Developing Trading Plans 301, we presented a surprising conclusion--that non-diversified CTAs did not seem to suffer from lack of diversification. Nevertheless, interpreting CTA data can be problematic because of surviorship bias: the possibility that the data itself is lacking because the experience of failing CTA's is filtered out of the data as they go out of business.

Perhaps for a broader universe of traders (those at least equally likely to fail as to succeed) confining one's trading to a single stock or futures contract, or even to a single sector, forces one to reconsider the diversification issue. The root of the problem often stems from a change from trend continuity to discontinuity. (When trending markets are in force, lack of diversification isn't usually a problem.)

Solution: Typological Diversificaiton

As discussed in Developing Trading Plans 301, the solution to this problem is to diversify typologically within the sector or contract. In Developing Trading Plans 301, we explain why a trading plan that has somewhere between 6 and 14 typologically diversified types of trades yields the largest reduction in standard deviation of return.

Of course, if our trading yields a high average percent win in a market characterized by high trend continuity---the S&P or currency markets, for example-we can get by with less diversification.

A good example of a single-contract specialist in a market that goes through prolonged periods of trend discontinuity can be found in Bonds. In an interview published in Intermarket in March 1986, Tom Baldwin, perhaps the single biggest individual floor trader in the Bond pit, said that though he trades in a single market, he plies "about 10 different groups of trades." The value of typological diversification for the non-diversified trader, such as Baldwin, is that it allows him to prosper in a wide range of market environments.


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