Understanding the Charts |
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ForexTRM is a Sigma Bands™ charting service for the
currency markets using a contrarian strategy. Four types of
charts are used to help in determining when and how to handle
your trading decisions: curvilinear envelopes, Sigma Bands™
(sometimes called channels), cyclical decomposition charts
and signal band charts.
At ForexTRM you'll find charts for foreign currencies around
the world. If there are any constructive comments about improvements
you would like to see added to the ForexTRM website, please
email us. We look forward to hearing from you.
What are Trading Signals?
Chart 1
Chart ts1
To get a better idea of what Trading Signals are, focus your
attention on the image displayed in Chart 1 above.
Trading Signals are based on the idea that buy/sell signals
are generated when the price crosses above and below a trendline.
Usually, this trendline is a moving average or some exponential
smoothing of the prices. But, in FOREX TRM's Trading Signals
this trendline (always displayed in red!) is calculated according
to a proprietary algorithm. Nevertheless, the use of the red
trendline conforms to customary crossover usage. Thus, when
the price moves above the red trendline we have a buy signal
and when the price falls below the red trendline we have a
sell signal.
Notice also that the current price is displayed in the box
located at the bottom of the chart. Also, the latest buy or
sell price is displayed. This buy/sell price is simply the
current value of the red trendline. As we will see later this
value can also double as a stop loss point.
In addition to the prices and red trendline you will notice
that we also display a set of the Sigma Bands. Note that these
Sigma Bands are not the same Sigma Bands that appear on the
FOREX TRM's Sigma Band chart. These Sigma Bands are designed
to respond faster to changes in both price and momentum. The
Trading Signal chart shows the position of the current price
in relation to the bands. Thus, in each case, we see if the
price is overbought or oversold, as defined in terms of probability.
Finally, notice that the box also contains some comments
and warning messages. These messages refer to the "quality"
of the buy or sell signal. We'll discuss these messages in
detail later on in the FAQ.
What are the benefits of the new Trading
Signals?
The new Trading Signals are designed to give frequent buy
and sell signals. In addition, our new Trading Signals are
designed to show where the buy/sell signal occurs within relation
to the Sigma Bands and to show what is happening with momentum
when the buy or sell signal occurs. This then gives us the
ability to judge the quality of the buy and sell signals.
After all, not every signal can be expected to result in a
successful trade. However, with the ability to judge the quality
of the signal the trader has a better chance of being on the
winning end of a good trade and also a better chance of avoiding
being on the losing end of a bad trade.
What are the differences between Signal
Bands and Trading Signals?
There are two main differences between Signal Bands and Trading
Signals. First, the original Signal Bands were designed to
give the trader an entry point into an overbought or oversold
market based on the overbought/oversold conditions indicated
by the Sigma Bands chart. The new Trading Signals are more
of a stand alone chart. In fact, the Sigma Bands that are
displayed are not the same Sigma Bands shown on our Sigma
Bands chart. They are designed to react faster to changes
in the underlying prices. The trader may act on a buy or sell
signal with the new chart without actually consulting the
original Sigma Bands chart, although this is not advisable.
The other big difference between the two charts is the original
Signal Bands attempts to give an entry point but no exit point.
The new Trading Signals give both. The new Trading Signals
track a buy or sell signal as it is unfolding. Once the buy
or sell signal occurs the algorithm switches mode and tracks
the next sell or buy signal. This process toggles back and
forth indefinitely.
What is the "Fundamental Rule"?
The "Fundamental Rule" simply says
"The further away the price is from the solid, neutral
trendline the higher the profit potential."
The reason the Fundamental Rule is important is because it
allows the trader to spot situations when a trade can be initiated
in either an overbought or oversold region. Prices are naturally
distributed around the solid, neutral trendline on any Sigma
Band chart. The distributions of the price deviations from
this solid neutral trendline are naturally bell shaped in
appearance. Overbought and oversold regions are defined as
the "tails" of this bell shaped curve. The probabilities
associated with the tails are very low. Thus, when prices
move into the tails, that is, the overbought or oversold regions,
then prices will naturally migrate back to regions of higher
probability, that is, toward the solid, neutral trendline.
What messages are displayed on the chart?
There can be as many as three lines of messages included
in the Trading Signals chart. The first line is always the
same. It tells you what the current price is along with the
latest buy or sell information. As stated before, when the
price moves from below to above the red trendline we have
a buy signal and the buy point is the value of the red trendline.
Similarly, when prices move from above to below the red trendline
we have a sell signal and the sell point is the value of the
red trendline.
The second and third line can vary depending of the quality
of the buy or sell signal. The messages are one of three types:
"Notes", "Warnings", and "Danger".
A "Note" is simply a notational message informing
the trader that the signal is occurring under normal circumstances.
A "Warning" message is a message informing the trader
that a signal is occurring under less than optimal circumstances.
Finally, a "Danger" message is informing the trader
that the buy or sell signal is occurring under very undesirable
circumstances.
What does the first message line say?
The first line always gives information about the trade.
First, it gives us the current close or settlement price for
the market the chart pertains to. It then gives the buy or
sell price that is currently in effect. This is the price
at which the price crossed over the red trendline. The third
value is the current value of the red trendline. It can be
used as a stop loss point. More will be said about this later.
What are "note" messages?
Chart ts2
"Note" messages are designed to be information
messages concerning the buy or sell signal. When a signal
occurs it can occur under negative conditions or it can occur
under conditions that the trader would expect to see happen.
For example, ideally a sell signal occurs when the price is
in an overbought region. One could then expect to see a confirmation
message informing the trader that such a signal has occurred.
This is a "note" message. Chart 2 above illustrates
the "note" message for a successful sell signal
for the British Pound.
What are "warning" messages?
Chart ts3
"Warning" messages are designed to be actual warnings
that a buy or sell signal has occurred under less than optimal
trading conditions. For example, suppose a buy signal is generated
when prices are close to the solid, neutral trendline. Ideally,
a buy signal should occur when prices are below the -2 Sigma
level. If the buy signal occurs well above the -2 Sigma level,
then a warning message notifying the trader of the less than
ideal buying conditions, is generated.
Warning messages are generated to simply let the trader know
that something may be wrong. The trader can still act on them.
It's a judgment call. For example, suppose a sell signal occurs
with prices coming down from above the +2 Sigma level? Since
the sell signal occurs below the +2 Sigma level a warning
message could appear. However, if the same signal had occurred
just above the +2 Sigma level then a "note" message
would have been generated. Under these conditions a trader
may indeed want to take a sell position. Again, it's a judgment
call.
Chart 3 illustrates this condition. Notice that the sell
signal occurs at around +1.5 Sigma. This could be a good sell
signal. But, because the sell signal occurred below +2 Sigma
the trader gets a warning message. It's the trader's decision
to act or not act on this signal.
What are "danger" messages?
Chart ts4
"Danger" messages are designed to be extreme warnings
that a buy or sell signal has occurred under very dangerous
trading conditions and should be questioned by the trader.
For example, suppose a buy signal is generated when prices
are in the overbought region, that is, above +2 Sigma. Ideally,
a buy signal should occur when prices are below the -2 Sigma
level. If the buy signal occurs when prices are in the +2
Sigma level, then a "danger" message is generated.
Essentially, a buy signal has occurred when the trader would
expect a sell signal.
In Chart 4 a sell signal occurs just above the -2 Sigma level.
Had this sell signal occurred just below the -2 Sigma level
a "Danger" message would have been displayed. The
danger message would have appeared because sell signals should
not occur when prices are already oversold, that is, when
prices are below the -2 Sigma level. Think about it. Why would
someone want to sell something that is oversold to begin with?
Traders should always take "danger" messages very
seriously. Danger messages are designed to keep the trader
from making bad mistakes.
What about momentum analysis!!??
In our analysis of Sigma Bands we have always stressed the
importance of momentum analysis. Nothing has changed here.
Momentum analysis is designed to keep the trader out of bad
trades and to help identify successful buy or sell signals.
In momentum analysis we monitor the relationship between
the red and black momentum lines displayed at the bottom part
of the chart. Consider, as an example, the red and black momentum
lines at the bottom part of the chart labeled "Chart
1" above. Notice, that when the buy signal occurs, that
is, at the time when the green ellipse occurs, the red momentum
line has moved above the black momentum line. This is the
ideal situation. The two momentum lines have not actually
crossed yet. Sometimes, the two momentum lines just converge.
They will not actually cross yet. That's acceptable on occasion
provided the trader believes the momentum lines will indeed
cross in the next one or two trading sessions. The trader
will have to make a judgment call in such a situation.
Ideally, when a buy signal occurs we see the red momentum
line cross over the black momentum line. This confirms that
momentum is strengthening. This is what the trader should
look for. When a buy signal occurs look for strengthening
momentum. When a sell signal (a red ellipse) occurs look for
weakening momentum. Chart 1, is an excellent illustration
for the case for strengthening momentum.
Ideally we should always see the red momentum line cross
the black momentum line as a buy or sell signal is occurring.
However, in practice this does not always happen. So, if the
red and black momentum lines have not actually crossed then
look to see if they are at least getting closer and closer
to each other. In other words, are the two momentum lines
"converging?" Converging momentum lines can be a
good sign that prices are preparing to reverse direction.
But be careful here. Converging momentum lines are not as
good an indicator as momentum lines that have actually crossed.
Just how close should the lines be? That's a judgment call.
Notice in Chart 2 that we have an excellent example of a
good sell signal. When the sell signal occurs the red momentum
line has dropped below the black momentum line. This helps
confirm the validity of the sell signal, which turned out
to be a good, profitable trade.
The trader should always be concerned when a buy or sell
signal occurs with the momentum lines getting further apart.
Diverging momentum lines usually indicate that the prices
may continue in the direction the momentum is already indicating.
What about stop loss points?
There are those who hate stop loss orders, do not use them
and recommend no one else use them. On the other hand there
are those who swear by them and would not think of trading
without them. We take the view that it's up to the individual
trader to decide for themselves where stop loss orders fit
into their trading strategies.
We don't actually use any kind of special algorithm to compute
a stop loss point. However, we define buy and sell signals
by the value of the red trendline. When prices cross the red
trendline it is a buy or sell signal. Therefore, one could
consider the current value of the red trendline as a stop
loss point. For example, suppose one is in a buy position.
Then the current value of the red trendline could easily be
used as the current stop loss point. If the price were to
drop below this point it would automatically trigger a clearing
of the position. Does one then also want to turn around and
use the same red trendline value to initiate a sell position?
That, of course, is up to the trader. Again, it's a judgment
call.
Notice on Chart 1 above that the first line ends with the
words "trend @". This is the current value of the
red trendline and could be used as a stop loss point, if one
so chooses.
What kind of signals should I look for
when I want to buy?
If you're looking to buy the first thing to look for is the
present price in relation to the Sigma Bands. Ideally, prices
should be below the -2 Sigma level or at least close to the
-2 Sigma level. Remember, the Fundamental Rule tells you that
the profit potential increases the further below the solid
trendline the current price is. So if the buy signal were
to occur at the -3 Sigma level it would be better than a buy
signal at the -2 Sigma level.
The next thing to look for is the actual buy signal itself.
Has it occurred or is it so close to occurring that you're
willing to assume the risk that it will occur? Never buy if
it appears that a sell signal is eminent.
Finally, check to see if momentum is going your way. If you're
going to buy you should feel comfortable that momentum is
strengthening. Without momentum going in your direction the
profit potential could be very disappointing. Chart 1 illustrates
these ideas.
What kind of signals should I look for
when I want to sell?
If you're looking to sell the first thing to look for is
the present price in relation to the Sigma Bands. Ideally,
prices should be above the +2 Sigma level or at least close
to the +2 Sigma level. Remember, the Fundamental Rule tells
you that the profit potential increases the further above
the solid trendline the current price is. So if the sell signal
were to occur at the +3 Sigma level it would be better than
a sell signal at the +2 Sigma level.
The next thing to look for is the actual sell signal itself.
Has it occurred or is it so close to occurring that you're
willing to assume the risk that it will occur? Never sell
if it appears that a buy signal is eminent. Chart 2 illustrates
these ideas.
Finally, check to see if momentum is going your way. If you're
going to sell you should feel comfortable that momentum is
weakening. Without momentum going in your direction the profit
potential could be very disappointing.
Don't be too precise in your selections!
TRM's Trading Signals will be giving you many buy and sell
signals. It will be up to you to filter out which signals
you choose to act on. But in our discussion on what criteria
you should use to make decisions, things can get a bit "fuzzy",
such as buying or selling outside the +/- 2 Sigma level. For
example, suppose that prices are just at the 1.95 Sigma level?
Should you act then? It's up to you but don't be too exact.
Prices may not go any higher and you may be getting a good
sell signal. So use some judgment here. Things are not that
absolute that prices MUST satisfy the criteria. There will
be many good buy and sell signals you may pass up if you become
too literal. Use some judgment here!
The curvilinear envelope (see the chart below) is an approach
to cycle analysis originally suggested by J. M. Hurst in his
1970 ground breaking book "The Profit Magic of Stock Transaction
Timing". Here one sees how the data fluctuates between a set
of inner and outer envelopes. The inner envelope represents
the dominant cycle plus trend in the data. The outer envelope
represents the trend after the cycle is removed. If one has
an idea which way the envelopes are moving, one has a pretty
good idea of the direction of the prices, since the data almost
always remains nominally within the envelopes.
Chart 1
The cycle at the bottom of the graph is based on computations
using the inner and outer envelopes. The "len=..." is the
average length of the cycle displayed (the calculations are
made based on the average time difference between one
low point to next low point).
The Sigma Bands™ chart (see the chart below) is an
indication of the overbought/oversold nature of prices. The
dark center line through the data is a long term trendline.
Chart 2
The three lines above and below this trendline are the 1,
2 and 3 standard deviations of the percent change of
the actual data from the trendline. Anytime the data deviates
above or below two standard deviations from the trendline,
an extreme condition starts to take place (a condition that
only occurs on the order of 2% of the time!), and the probabilities
for a reversal start to increase dramatically. It's at these
extreme conditions a trader can consider taking contrarian
positions that provide minimal risk.
NOTE: It is the Sigma Bands™ chart which is the
key to minimal risk trading. Following the rules to be stated
later one will be able to use the Sigma Band™ charts
(along with the other charts) to take positions in the market
where the prices typically remain overbought or oversold less
than 2% of the time!
Chart 3
The cycle decomposition chart (see the chart above) is conceptually
very simple. Simply add the values of all the sinusoidal type
waves displayed below the price action, to the red trendline
passing through the original time series, and one gets the
original time series to within a small random variation. In
addition, Sigma Bands™ calculations similar to the ones
discussed above are included. As before, these bands give
the trader an indication of overbought/oversold conditions.
In addition, as we'll see later, the red trend line passing
through the data is extremely important, so be sure not to
overlook it.
The signal band charts are used to help pinpoint when to
actually enter a position based on when the Sigma Bands™
charts are alerting you to an overbought or oversold condition.
Chart 4
Like the Sigma Bands™ the signal band charts have a
trendline and three Sigma lines above and below the trendline.
However, they are not used in the same way. Notice that both
charts show a red line running through the prices. It's this
red line that is of importance in the signal band chart. In
the Sigma Bands™ the red line is of very little importance.
What you most look for in the signal bands is when the prices
are ready to cross this red line (very much like a signal
crossover system using moving averages).
Note: You have probably noticed that the charts for Sigma
Bands™ and signal bands are very similar. This is because
signal bands are actually Sigma Bands™ of shorter duration.
They are based on a preset control parameter. For signal bands
the control parameter is 21 periods, for Sigma Bands™
the parameter is set to 250 periods. So for daily data signal
bands are based on 21 days, or one trading month, and Sigma
Bands™ are based on 250 days, or one trading year.
For this discussion please refer to the sample curvilinear
chart provided above and duplicated below.
Chart 5
A number of points need to be made concerning the curvilinear
envelope charts:
- The overall expected path for future prices,
based on present data, is displayed, so one does not have
to guess. The envelopes are designed so that the prices
remain within the bands. Thus, depending on the direction
of the bands, the price is expected to fluctuate within
the bands.
- The wave that is displayed below the envelopes
is the dominant cycle in the price. Always watch the amplitude
of this wave. If this amplitude "damps out", it is an indication
that the cycle is dissipating its energy and the trend
will dominate. If such a situation occurs the envelope charts
will cease to show wave behavior, and the charts will look
very choppy.
- You must watch the charts every
day! The algorithms are adaptive and very sensitive
to changes in market conditions and will reassess conditions
very quickly when the need arises. Daily monitoring
of all four charts is absolutely imperative, especially
when one is considering taking a position, or is in a position!
For this discussion please refer to the sample cycle decomposition
chart provided above and duplicated below. As with the curvilinear
charts, a number of points need to be made concerning the
cycle decomposition charts:
Chart 6
- The cycle decomposition chart displays the
extensions of the individual waves (in red) and its cumulative
effect on the price (in blue). Consequently it is not necessary
to try to manually add the waves to get a price forecast.
- Always monitor the direction of the predicted
red trendline passing through the prices, and be very careful
taking positions that go against it! If the extrapolated
trend is sideways, then playing the cyclic action is acceptable.
However, if the red trendline is trending steeply up or
down, then playing a cycle contrary to the direction of
this trend is risky at best.
- By monitoring the amplitudes of the
individual waves one can get an idea what cycles are dominating
the price action now and in the future. The waves with the
largest instantaneous amplitudes are the dominate cycles.
Watch how their amplitudes expand and contract. Also, watch
how the dominate waves "rotate". At times one or two waves
will have large amplitudes. Then, over time, these waves
will loose their amplitude strength and other waves will
grow in amplitude.
For this discussion please refer to the sample Sigma Bands™
chart provided above and duplicated below. As with the curvilinear
charts and cycle decomposition charts, a number of points
are in order:
Chart 7
- Of the four charts, it is the Sigma Bands™
chart which is the most important!
- The first thing that the Sigma Bands™
tell us is when a price is probably overbought or oversold.
The bands represent standard deviations of the percent deviation
of prices from nominal levels. Thus, when the prices are
outside the plus and minus two Sigma, the price is correspondingly
overbought or oversold. It is at these times that prices
are at levels for a probable reversal.
- The second piece of information is contained
in comparing the red and black lines located below
the prices and their Sigma Bands™ (these are referred
to as the red momentum and black momentum lines). Whenever
you see a divergence taking place between the red and black
momentum lines, it is typically accompanied by a significant
price move, either up or down. Conversely, if the two lines
are practically on top of each other and the bands are moving
sideways, this situation typically corresponds to a period
of sideways, damped out price motion for the most part.
When, the two lines are on top of each other, and the bands
are moving sideways, it is an indication that prices will
follow a trendless path. Prices will tend to drift within
the plus/minus two Sigma. Finally, if the red line starts
to diverge from the black line momentum, this indicates
possible accelerating prices, whether up or down, depending
on whether the red momentum is pulling above and away or
declining faster than the black momentum line.
- As with most momentum indicators, when the
price declines or advances are not being confirmed by new
highs or new lows in the momentum, a reversal is indicated.
For example, look at the price of the Canadian Dollar for
the period May 6, 2003 through June 18, 2003. Notice that
the Canadian Dollar attempted to make a new high on three
separate occasions and failed three times. Notice how on
each successive high the red momentum line failed to make
a new high. In fact, as the Canadian Dollar was testing
its previous high the red momentum line's new "highs" were
declining. Not surprisingly, the Canadian Dollar finally
gave up trying to make new highs and collapsed.
- The red line passing through the prices
is the difference between the closing price and the red
line below the Sigma Bands™. It can be used as a secondary
buy signal, much like moving averages are used; i.e., when
the price penetrates to the upside, buy, and when the price
penetrates to the downside, sell.
For this discussion please refer to the sample signal band
chart provided above and duplicated below. As with the curvilinear
charts and cycle decomposition charts, a number of points
are in order:
Chart 8
- The signal band charts serve only
one purpose; namely, to give an advanced buy or sell signal.
The idea behind this strategy is very similar to the trading
technique using a moving average. There, when the price
falls below a moving average one sells and when the prices
rise above the moving average one buys. The red line running
through the prices serves the same purpose as a moving
average. Keep in mind however that the red line through
the prices is NOT a moving average.
- Unlike the standard moving average
crossover trading system, we have an added advantage.
Specifically, we can also watch when the red momentum
line (at the bottom of the chart) crosses above and below
the corresponding black momentum line. This crossover
typically happens one to two days before the corresponding
price crossover. Notice, for example, in the signal band
chart for the Canadian Dollar, the red momentum line crossed
over the black momentum line two days before the corresponding
price. The price crossover was enormous, but don't expect
this kind of behavior in general.
- Note: The crossover
signals should only be used when the other charts are
indicating either an overbought or oversold condition.
Notice, on the above chart, for example, that a number
of crossovers resulted in whipsawing. This you want to
avoid by using the crossover technique only when extreme
conditions are in play to begin with. Then, the probabilities
increase dramatically that the buy or sell signal will
be a valid one.
Simply put, "momentum inversion" is
when the red and black momentum lines on the Sigma Bands™
charts cross each other while the price is outside the +/-
2 Sigma range. The chart below illustrates momentum inversion
occurring at the top of the bull market in the NASDAQ.
Note: Even though ForexTRM is focused
primarily on currencies the same principles hold for all speculative
markets. We're going to use the NASDAQ stock index to illustrate
momentum inversion because not only is the momentum inversion
criteria well illustrated, it demonstrates a situation where
momentum inversion was showing the coming NASDAQ collapse
long before anyone else was even conceiving the idea that
there was "trouble in paradise."
Chart 9
When everyone was convinced the NASDAQ was going
up forever, the Sigma Bands™ were telling a far different
story. Notice how the red momentum line had fallen below the
black momentum line as the NASDAQ was making new highs. That's
classic momentum breakdown. In addition,
the NASDAQ was approaching plus three Sigma(!), an extremely
overbought condition. Prices in excess of two Sigma and momentum
inversion showing momentum breaking down. This is one of the
two ideal set of conditions for a short (or at least an exit
from this market).
Naturally, for a buy condition you would look for momentum
inversion in reverse; i.e., the red momentum moving above
the black momentum line with prices below minus two Sigma.
When the red momentum is crossing the black momentum to the
upside it indicates the momentum is getting stronger. With
prices below minus two Sigma the likelihood for a price reversal
is extremely high. One should get out of any short positions
and consider going long!
Finally, for an example of momentum inversion in the currency
markets look at Chart 7 above. There again, as the Canadian
Dollar was attempting to test its previous highs the red momentum
line was falling and finally fell below its black momentum
line. The rest as they say is 'history'. The Canadian Dollar
fell to the 71.50 cents area against the U.S. Dollar.
Chart 10
Shortly after May 12, 2003 the Russian Ruble made a new
low against the Canadian Dollar. But notice where the new
low occurred! When the new low occurred the Ruble was approximately
at minus FOUR Sigma!!! When prices reach such extremes
a "blowout" is said to have occurred. Blowouts
are very rare indeed but when it happens it presents
a golden opportunity for profits to be made; that is, for
those with the nerve (and the money!) to take a contrary
position! Before the Sigma Bands™ charts came along
it was practically impossible to spot a blowout and consequently
making money during one was a high risk endeavor to say
the least. But with Sigma Bands™, not only can one
can spot a blowout, but now can identify the proper entry
point for taking a position. Only Sigma Bands™ can
give this kind of confidence.
Notice that with the blowout in the Ruble the red momentum
line had actually crossed above the black momentum line,
a further confidence indicator that the bottom had been
reached.
There are two types of momentum analysis. One is "momentum
inversion". The other is price/momentum confirmation. Take
a look again at the Sigma Bands™ chart below.
Chart 11
On the chart above for the Canadian Dollar we see that
the Canadian Dollar made a new high and then tried two more
times to break its previous high. But notice that as the
Canadian Dollar made the next two highs the red momentum
line was not making a new high but rather had "highs"
that were actually less than their previous momentum highs.
In other words, momentum was falling as prices were
either rising or testing their previous highs. This is a
classic case of momentum not confirming price increases
and is the second criteria we look for when we are looking
for a price reversal beginning to take place.
It goes without saying that the reverse situation holds.
If the prices are falling to the minus two Sigma levels,
or better, and the momentum is not confirming, then good
news! The minus two Sigma level is probably a very good
level to consider taking a long position.
Sideways movement is the curse of trading. Buy low, sell
high is the rule and when the range between the high and
low is small there's very little if any money to be made.
So how does one spot sideways movement? Take a look at the
chart below for the Japanese Yen.
Chart 12
Examine the entire time period displayed on the chart.
There are three observations to be made. First, the price
rarely got beyond minus one Sigma and plus one Sigma, a
variation of only 4.5 yen to the dollar There's no big money
to be made here. Second, notice that the Sigma Bands™
are moving sideways. In other words there's no real trend.
Finally, observe the red and black momentum lines. They're
practically on top of each other!! When the red and
black momentum lines are on top of each other the cycles
have dissipated their energy and the prices will follow
the trend. There will be very little price deviation from
the trendline, so the prices will remain with plus/minus
one Sigma. The trend will dominate!! So if the trend is
sideways and there's no price variation, you have sideways
movement!
In summary, always look for the situation where the red
and black momentum lines start to fall on top of each other.
In such a case, unless the trend is in a strong direction,
its best to stay out. A trendless, low variational market
is a waste of time.
It is important to realize that one must wait for
buying or shorting opportunities. One cannot always be
in the market. You must wait for the right time!!! With
that in mind here are the rules for taking a long position.
See the charts below for an illustration of the points.
Chart 13
Chart 14
To go long:
- Use the cycle decomposition chart to verify
that the price is at a bottom and moving up, or,
that the forecasted bands are at least bottoming
out and preparing to move up. On the cycle decomposition
chart for the Ruble the projected bands are bottoming
out. Even though they're still moving down, the rate
of decent is slowing down. The projected future is UP!
- On the Sigma Bands™ chart verify
that the prices are at least down to the minus two Sigma
level. For our sample chart the Ruble is actually at minus
4 Sigma!
- If the prices are well below minus
three Sigma one need not consider anything more. You're
looking at a blowout and extreme conditions. However,
if the prices are only around the minus two Sigma then
some momentum analysis needs to be taken into consideration.
- Momentum analysis takes one of two forms.
Verify that either the red momentum line has crossed above
(or is at least converging to) the black momentum line,
or, the red momentum line is not confirming the
price decline. If either one of these conditions is taking
place then the long position is a low risk long. If the
price is around the minus three Sigma level the risk is
even less than minus two Sigma.
- When the above conditions are right
use the signal band chart to prepare for a buy entry point.
It is important to realize that one must wait for
buying or shorting opportunities. One cannot always be
in the market. You must wait for the right time!!! With
that in mind here are the rules for taking a short position.
We'll use the Canadian Dollar to illustrate the points.
Chart 15
Chart 16
To go short:
- Use the cycle decomposition chart to verify
that the price is at a top and moving down, or,
that the forecasted bands are at least topping
out and preparing to move down. On the cycle decomposition
chart for the Canadian Dollar the projected bands are
projected to be topping out. The projection is DOWN!
- On the Sigma Bands™ chart verify
that the prices are at least up to the plus two Sigma
level. For our sample chart the Canadian Dollar is actually
a little over the plus 3 Sigma level. But the price is
not well in excess of plus three Sigma so this is NOT
a blowout situation.
- If the prices are well above plus three
Sigma one need not consider anything more. You're looking
at a blowout and extreme conditions. However, if the prices
are only around the plus two to plus three Sigma then
some momentum analysis needs to be taken into consideration.
- Momentum analysis takes one of two forms.
Verify that either the red momentum line has crossed below
(or is at least converging to) the black momentum line,
or, the red momentum line is not confirming the
price increase. If either one of these conditions is taking
place then the short position is a low risk short. If
the price is around the plus three sigma level the risk
is even less than plus two Sigma. In the case of the Canadian
Dollar BOTH momentum criteria are being satisfied.
- When the above conditions are right
use the signal band chart to prepare for a short entry
point.
It is always difficult to decide when to take profits,
but the Sigma Bands™ charts can help in making a decision.
The first thing is to set an initial target for taking
profits. Take a look at the two charts below.
Chart 17
Chart 18
The basic rule for setting the initial target for taking
profits is this: The initial price target for taking profits
is the zero Sigma value at the time the position is taken!!
For the Nasdaq one can expect the price to drop back to
4408; for the Ruble, look for a rise to the .04569CD level.
These are the initial target levels!!! It is important
to reassess your position daily. If the momentum is going
your way, stay with the position. However, once the price
approaches the initial target its important to watch momentum.
If it appears that momentum is strong and increasing then
you may decide to stay with the position in hopes of a rise
to plus one Sigma or better. You have no guarantee that
this will occur! It is reasonable to assume the prices
will go back to the zero Sigma level because prices "gravitate"
to nominal prices. However, prices tend to stay nominal.
So unless the momentum is going your way, in a big way,
take your profits!
The rule for staying out of a market is simple: Stay
out if the conditions for going in do not apply!!! In
other words, it there is no long or short opportunity, then
stay out. Always wait for the opportunities. Don't chase
a market. Don't try to predict a market. Just wait for the
price extremes and then ride the price back to the zero
Sigma line, and take your profits.
Important Disclaimer
In the world of Technical Analysis software developers
speak of "buy" and "sell" signals. This
is simply terminology that has been adopted to denote signals
associated with price crossover points. These buy or sell
signals are not actual recommendations to buy or sell. They
are simply crossover points and it is up to the individual
traders to decide for themselves whether to act of these
signals. Use the signals at your own risk!
Click HERE
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