How to find stocks with smooth trends | stockbee

## 5/22/2007

### How to find stocks with smooth trends

Amanda has written:

Thanks for the suggestion to go through the charts of stocks in last 5 years up 100% plus. After going through them one by one, I now see what you are talking about clearly, but there are couple of things I noticed. Some stocks have very smooth trend, while some are very volatile. If you look at recent stocks like TBSI, SNHY, DRYS, SID, GTI, FWLT and many others, they had very smooth trend, while some are very volatile. I would like to trade the stocks with smooth trends. Is there a way to easily find such stocks early in their trend.

If you see stocks making big moves, some are very choppy and some have very smooth trend. Obviously from risk management terms, finding a smoother trend is better. It also allows one to pyramid and requires lower stop. Also it is better to enter smoother trend immediately while more volatile trends are best traded using anti trend entry.

One of the easiest way to find smooth trends is by using Kaufman's Efficiency Ratio or Fractal Efficiency Ratio. The Fractal Efficiency Ratio is described in detail in New Trading Systems and Methods by Perry Kaufman.

Fractal Efficiency ratio is derived by dividing the net change in price movement over n periods by the sum of all component moves, taken as positive numbers, over the same n periods. If the ratio approaches the value 1, then the movement is smooth, if the ratio approaches 0, then there is great inefficiency or chaos. So fractal efficiency basically is a measure of relative market speed to volatility, and can be used as a trading filter to avoid choppy or flat stocks.

To understand this better lets look at a stock price move for 60 days. Stock A makes 60 point move in 60 days. Each of the day the stock moves up exactly by 1 dollar. This would give an efficiency ratio of 1. Now say for stock B, it also moved 60 points in 60 days, but with higher volatility, some days up 3 points, some days down 2 points. The efficiency ration would be lower as the denominator in the ratio will be large.
Now if you want to calculate the efficiency ratio in Telechart, you can try this modified scan for 60 days.

60 Day Efficiency Ratio

(C - C60) / (ABS(C - C1) + ABS(C1 - C2) + ABS(C2 - C3) + ABS(C3 - C4) + ABS(C4 - C5) + ABS(C5 - C6) + ABS(C6 - C7) + ABS(C7 - C8) + ABS(C8 - C9) + ABS(C9 - C10) + ABS(C10 - C11) + ABS(C11 - C12) + ABS(C12 - C13) + ABS(C13 - C14) + ABS(C14 - C15) + ABS(C15 - C16) + ABS(C16 - C17) + ABS(C17 - C18) + ABS(C18 - C19) + ABS(C19 - C20) + ABS(C20 - C21) + ABS(C21 - C22) + ABS(C22 - C23) + ABS(C23 - C24) + ABS(C24 - C25) + ABS(C25 - C26) + ABS(C26 - C27) + ABS(C27 - C28) + ABS(C28 - C29) + ABS(C29 - C30) + ABS(C30 - C31) + ABS(C31 - C32) + ABS(C32 - C33) + ABS(C33 - C34) + ABS(C34 - C35) + ABS(C35 - C36) + ABS(C36 - C37) + ABS(C37 - C38) + ABS(C38 - C39) + ABS(C39 - C40) + ABS(C40 - C41) + ABS(C41 - C42) + ABS(C42 - C43) + ABS(C43 - C44) + ABS(C44 - C45) + ABS(C45 - C46) + ABS(C46 - C47) + ABS(C47 - C48) + ABS(C48 - C49) + ABS(C49 - C50) + ABS(C50 - C51) + ABS(C51 - C52) + ABS(C52 - C53) + ABS(C53 - C54) + ABS(C54 - C55) + ABS(C55 - C56) + ABS(C56 - C57) + ABS(C57 - C58) + ABS(C58 - C59) + ABS(C59 - C60) + 0.001)

Stocks do not have a perfect efficiency reading of 1. Even a small anti trend move lowers the efficiency reading. The above formula scan will give you values between 1 to -1. If you sort by this scan, the higher ratio stocks will have smoother trends, while reading between 30 to 0 will show very volatile stocks. Generally
Efficiency Ratio readings above +.30 are very favorable to define persistent uptrends while readings under -.30 often denote steady downtrends.

You can try various time periods on this ratio. Generally you should use lower time frames of 20 days or so.
20 Day Efficiency ratio
(C - C20) / (ABS(C - C1) + ABS(C1 - C2) + ABS(C2 - C3) + ABS(C3 - C4) + ABS(C4 - C5) + ABS(C5 - C6) + ABS(C6 - C7) + ABS(C7 - C8) + ABS(C8 - C9) + ABS(C9 - C10) + ABS(C10 - C11) + ABS(C11 - C12) + ABS(C12 - C13) + ABS(C13 - C14) + ABS(C14 - C15) + ABS(C15 - C16) + ABS(C16 - C17) + ABS(C17 - C18) + ABS(C18 - C19) + ABS(C19 - C20))

So when choosing stocks from 100% list or IBD list, if you use the Efficiency Ratio as filter you can find more smoother trends. Or for any given stock the Efficiency ratio quickly tells you how smooth the trend is. Generally it is observed that smother trends continue to be smooth and volatile trends continue to be volatile. That is the reason it is called Fractal Efficiency Ratio.

If you are interested in more details about this Efficiency Ratio, I suggest you read New Trading Systems and Methods by Perry Kaufman.The Efficiency Ratio is used in KAMA, Kaufman's Adaptive Moving Average , as one of the smoothing constant to determine trend smoothness and speed. You can use KAMA and this ratio in variety of ways to design trading systems.

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dave said...

wouldn't this hurt returns since it seems smoother trends would most likely come from stocks with large floats?

Not necessarily. If there is buying pressure and stock is being aggressively accumulated, even a small float company can have smooth trends.

BILL said...

I use TC extensively and filtered this against the IBD200.. Interesting charts.. I am a long time user. Will check against time in past to see outcome..

Art said...

Paradeep thank you for this post on finding stocks with smooth trends, and the Telechart scans. I continually stand amazed at what your years of experience can teach us. And that you do that. You are a special person.

I began a new watchlist called 60d EffeciencyRatios. Went back through my various watchlists created by your scans (ie 25d, 50d, episodic pivots, etc). Copied all stocks from those various lists >30 into my new 60d watchlist. As I began spacing through my new watchlist I was amazed at how beautiful practically each chart looked.

Surely, I thought, one could get creative with this list. For example I did a SortBy of Price compared to, first, the 50dsma, then the 20dsma. I found many stocks bouncing off the 20d (to consider investing into), not too many off the 50d.

Seeing I'm out of cash right now I think I'll check out the IBD200New list now and try to prepare better for the next time.

Thanks Again for your extensive help and for the Telechart scans. You have caused me to see, and use, TC in a far different light.
Art

Silver said...

Pradeep, there is a potential problem with the formula you've mentioned. If the C - C20 (20 day) cost hasn't changed (= 0 or very small), the formula would not work well. This could happen if the stock price rises, falls, and rises again so that the current price is equal or close to the price 20 days ago.

In this case, one could break the formula into two parts and take the average. C-C10 / () and C10-20 / () A better method might be to apply this formula programmatically to the price trends highs and lows. If the price high or low were x days ago, the formual would be C - Cx / () If the next trend high or low were 7 days ago, the formula would be Cx - Cy / () and keep doing this untill the target number of days is met and then take an average weighted by the number of days for all the results.

In the case you mentioned the value would be near 0 for the ratio, which tells you that this stock was very volatile.