Profit from Uncorrelated Trading Methodologies
When crossing the street, we mainly use our sense of sight, but we also use hearing and our sense of touch to detect vibrations. Each sense provides us with a different representation of the street and the traffic. They’re all true, yet they’re all different. By combining multiple uncorrelated senses, we gain a more complete picture of our environment.
Likewise, at PrescienTrading, we believe our market cycle analytics provide unparalleled power at predicting future prices in financial markets. If we had to choose only one trading methodology to trade with, we’d certainly choose our own. However, we’re not limited to just one methodology, so while we rely on our own trading methodology as the foundation of all our trading decisions, we often cross-check against other uncorrelated trading methodologies discussed below. We also incorporate several of these methodologies into our PrescientSignals trading signals service.
Each of these trading methodologies is extremely powerful and could be traded profitably in isolation, but each provides a different perspective on the market. By considering multiple perspectives, we gain a more complete understanding of what the market is communicating to us.
The Prescient Line
Before we discuss other trading methodologies, let’s review the history of cycles analysis and explain how our approach differs from conventional cycles analysis.
Edward Dewey and JM Hurst were the pioneers of cycle research. They quantified a phenomenon that we intuitively know to be true. All markets move in cycles. This is because markets are controlled by people who have emotions, which are influenced by natural cycles. The entire universe moves in cycles. From the movement of planets to the tides, to seasons, to the sun rising and setting every day according to a known cycle, everything in nature is cyclical. In markets, we see a continuous oscillation between fear and greed. As price rises, people become greedy and more and more buyers pour into the market. At a certain (predictable) point, price reaches an extreme level, traders start to take their profits and price begins to fall. At this point, fear takes hold and price may fall faster. Since fear is a stronger emotion than greed, price tends to fall faster than it rises.
While fear and greed may be the principal drivers of price, there are many secondary cyclical influences that vary depending on the market. For instance, the price of agricultural commodities is influenced by weather patterns, which are themselves cyclical. The metals are influenced by economic cycles, which are themselves influenced by other cycles. Thus in any given market, there will be many cycles at work and each market will have its own unique cyclical signature. The goal of cycle analysis is simply to identify the cycles. We don’t care what causes the cycles. Our only concern is to determine which cycles are in play along with the length (frequency) and strength (amplitude) of each cycle.
Dewey was doing his research before computers were invented. Hurst had access to early computers, but the processing power was a tiny fraction of what we have today, even in our phones and watches. Real time cycle analysis was impractical, so they focused on identifying fixed cycles. Hurst developed a nominal cycle model that identified cycles ranging from 1 day up to 18 years in length. This model allows for limited variation in the cycles, but it’s based on the premise that fixed cycles exist. Perhaps in his day, that was true and to a certain extent, it’s true today. However, the world has become much more complicated. Nowadays, markets are mostly traded electronically and many markets are open 24/7. With the advent of computerized trading models, along with increasing manipulation of the markets by governments, hedge funds and institutional trading, the cycles have become much more complex, making it difficult to trade profitably using fixed cycles. Cycles still exist, but they are now a moving target.
David Hickson of Sentient Trader is one of the leading thinkers in market cycle research today. David created Sentient Trader, an excellent cycle analytics platform based on Hurst’s research. He is unquestionably the foremost living authority on Hurst cycles. While we greatly admire David’s work, we believe Hurst cycles have an inherent weakness in that they presuppose the existence of fixed cycle lengths. Sentient Trader is flexible in terms of allowing for deviation from these fixed cycles, but we question why we need to start with a fixed cycle length and then compensate for the inevitable variation?
Our cycle analysis algorithms don’t make any assumptions about fixed cycles. Our algorithms are dynamic and start with a clean slate every day, analyzing the cycles that exist today, based on the recent price action. The result is that the cyclical picture may completely change from one day to the next. It doesn’t mean yesterday’s picture is suddenly invalid. Yesterday’s cycles may still be in play, but if a stronger cycle emerges, our algorithms identify it immediately. The consensus of our algorithms is presented in our unique and proprietary indicator, the Prescient Line, which projects price forward in time by a specified number of bars, often with astounding accuracy.
Drummond Geometry was developed and refined over many years by the legendary Canadian trader, Charles Drummond. Drummond Geometry deals with the energy of the market, as expressed by the PL Dot, a 3-bar moving average of the high, low and closing prices, shifted forward by one bar. The relationship between price and the PL Dot indicates trend direction and strength. The PL Dot is always either pushing or refreshing. When it’s pushing, price is moving away and when it’s refreshing, price is moving back toward the PL Dot.
Drummond Geometry is one of the most powerful trading methodologies we’ve encountered. Although the PL Dot is the core principle of Drummond Geometry, the full trading methodology is extremely sophisticated and requires years of study. Drummond has written more than ten books on the subject and with the help of his partner, Ted Hearne, created a 30-lesson multimedia course. Drummond Geometry includes a proprietary set of support and resistance lines that often yield uncanny accuracy in terms of price targets.
Drummond Geometry is an ideal compliment to cycles analysis because it’s far more accurate at identifying support and resistance areas than conventional technical analysis indicators. For example, suppose the market is currently in a long downtrend, but the Prescient Line has turned upward, predicting an upturn in the market. Examining the Drummond Geometry indicators, you can see that price has cleanly broken through a major support area at 1,000 and the next significant support area is at 990. The optimal play would be to monitor the market and wait til price has entered the next support zone before entering a long position.
Heikin-Ashi is an objective derivative of Japanese candlestick charting. Traditional candlestick patterns often have significant predictive value, but their interpretation allows for much subjectivity. Additionally, since there are over 100 candlestick patterns, learning and applying this methodology to your trading can take years of study and practice. Heikin-Ashi both simplifies and objectifies candlestick analysis, replacing the myriad of patterns with an objective set of rules.
Heikin-Ashi candles use modified OHLC values that differ significantly from the true OHLC values. Thus, while Heikin-Ashi candles may look similar to traditional candles, they don’t show the true prices and are really more of an indicator than a true representation of price. Green candles indicate an uptrend and red candles a downtrend. We also plot the PL Dot on the Heikin-Ashi chart, using it to confirm trend changes. A trend change requires both a change in the candle color and price crossing the PL Dot. Heikin-Ashi charts have a built-in lag of one bar, but we can compensate for this lag using a secondary indicator, created by Dan Valcu, called HA Delta, which is the difference between the modified open and close prices.
HA Delta is a leading indicator, often predicting market turns several bars in advance. When HA Delta crosses its 3-bar moving average, that indicates a possible price reversal. We also take note of the HA Delta value in relation to historical values and look for divergences between HA Delta and price. HA Delta can be noisy, so in lieu of a standard moving average, we use the Jurik Moving Average (JMA), as the basis for HA Delta. JMA is a proprietary indicator developed by Mark Jurik of Jurik Research. It’s similar to a standard moving average, but uses advanced signal processing to filter the noise without introducing any lag. Thus, if you compare our Heikin-Ashi charts with conventional Heikin-Ashi charts, you’ll observe our charts are smoother and catch all the same valid signals, yet avoid many of the false positives.
Continuing with the example mentioned above, once price has entered the support zone at 990, we’d use Heikin Ashi and HA Delta to monitor the trend and look for a sign of a reversal. When HA Delta crosses its 3-bar moving average, we’d take that as a preliminary signal to enter the long position. If we’re being aggressive, we could enter immediately, or we could wait for a green Heikin-Ashi bar to appear and price to cross the PL Dot before entering. To recap the sequence of events:
- The Prescient Line forecast an upturn.
- Price entered the Drummond Geometry support zone at 990, suggesting a potential reversal area.
- HA Delta crossed above its 3-bar moving average, indicating the upturn is imminent.
- The first green Heikin-Ashi bar appears and price crosses the PL Dot, signaling the upturn is underway.
RSI is one of the most popular technical indicators. It shows the direction and strength of the current trend and warns of extreme price levels. It also alerts to possible reversals when it diverges from price. However, conventional RSI is quite noisy and has an arbitrary static length, which may or may not be applicable to the current market condition. Our Dynamic RSX indicator addresses both these issues.
RSX is another proprietary indicator from Jurik Research. It works the same way as RSI, except it uses Jurik’s advanced zero-lag smoothing algorithm to filter the noise, resulting in a much smoother and more reliable indicator.
Our Dynamic RSX uses the Jurik RSX indicator, but we dynamically adjust the length to the length of the strongest active cycle on a bar-by-bar basis. Thus, Dynamic RSX automatically adapts to the current market condition based on its cycle lengths. The opportunity for a major trend change is greatest when RSX reaches an extreme level. Although RSX can remain at an extreme level for a long time, when the trend finally does reverse, it often presents a big trading opportunity. In Drummond terms, the price has moved far from the PL Dot. Like a stretched spring, it contains much potential energy and is due for a refresh back to the PL Dot. Conversely, when RSX is meandering around the zero line, the market has little energy. In this scenario, other indicators may yield perfectly valid signals, but the lack of energy may limit the size of the move and the profit potential.
As strong proponents of technical analysis, we maintain that the current price and recent price action contain all available information about the future price. While no one can predict the future with absolute certainty, we can project future prices based on current price action. Technical analysis doesn’t care about earnings, economic indicators, weather, planetary movements, the price of tea in China or anything else that could possibly affect price, because all that information has already been factored into the price. We don’t care about the “why”. We we only care about the end result.
And yet, sentiment is hard to ignore.
Sentiment is unique in that unlike most fundamental factors, it’s a leading indicator. When an economic report is announced, it has an immediate influence on price, but the price action leading up to that report already reflects the consensus about what the report will contain. Thus, except for sentiment, fundamentals are mostly lagging indicators and in the context of short-term trading, have little value in predicting future price.
If we were to express sentiment in mathematical terms, it would be a derivative of price. Sentiment represents the crowd’s opinion of future price and at extreme levels, the crowd is usually wrong. Therefore, if we can measure sentiment and be alert for extreme values, we can often profit by betting against the crowd. We can trade profitably without considering sentiment, but it never hurts to have another tool at our disposal.
We hope this article has been helpful in illustrating the benefit of using multiple trading methodologies. The trading methodologies mentioned are the ones we use, but there are certainly many other trading methodologies . The key is to find what works best for you and when combining trading methodologies, avoid redundancy by ensuring they’re uncorrelated.
Subscribers to our PrescientSignals trading signals service gain access to daily indicator values from most of these trading methodologies, including:
- The Prescient Line
- Drummond Geometry support and resistance areas
- Dynamic RSX
- Heikin-Ashi and HA Delta
To learn more about PrescienTrading, visit our website at https://www.prescientrading.com