Look for linear trends when swing trading | stockbee

7/15/2009

Look for linear trends when swing trading


When swing trading look for linear trends. Buying pullbacks in linear trends is low risk trade. One of the easy way to find linear trends is to use a Fractal efficiency scan in Telechart.
(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))

What exactly does this scan does. It is a efficiency ratio.
It divided net price movement (C - C20) (or in other words how much a stock moved in points term in 20 days) by the total price movement in 20 days. (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))
Let us say a stock is trading at 10 and in 20 days it goes to 30. So it had 20 points move. Now this 20 point move is highly efficient if this stock goes up exactly by 1 dollar every day. In other words it will have very smooth trend.
Now supposing this same stock makes the 20 point move with lot of volatility. It goes up 1 dollar one day, goes down 2 dollar next day goes up 50 cents next, goes up 3 dollar next and so on. Then what will happen in the denominator part of equation (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))
you will get values higher than 20. Greater the value on denominator more volatile is the stocks move.

So the fractal efficiency ratio is ratio of price direction to volatility. From risk management perspective we want a stock with high fractal efficiency as it will likely move smoothly without stopping us out.
What causes the fractal efficiency to be higher is aggressive buyers. If buyers are aggressive in a stock, it seldom has big pullbacks. Such stocks are being aggressively accumulated by buyers and hence are better. That is the basic hypothesis for using it.

The Fractal Efficiency Ratio is described in detail inNew 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 downtrend.

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 IBD 100 or 200 to swing trade, 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 smoother trends continue to be smooth and volatile trends continue to be volatile.

1 comment:

hector said...

Excellent post, STEC has been resilient during this correction and bouncing from the 20 ma like clockwork