November 2001

The August 2001 issue of the Trading Tips newsletter introduced the use of a theoretical Elliott wave formation as an aid in understanding the fundamental behavior of a study.   The theoretical formation will be used this month for understanding the Relative Strength Index introduced by J. Welles Wilder Jr. in his book, "New Concepts in Technical Trading Systems".

Various characteristics can be found in the 7 bar Relative Strength Index (RSI) study applied to this theoretical chart.

5 Wave Minor Trend Analysis:  (blue 1-2-3-4-5 small numbers)

1)  The RSI crosses above 50 in minor wave 1, but stays below 70.

2)  Minor wave 2 may cause RSI to momentarily dip back below 50.

3)  Minor wave 3 takes RSI higher, often to around 80.  In the real world %K will often reach 80 but rarely 90.   Study tip:  It is important to realize that it is minor wave 3 that takes RSI to its highest high!

4)  Minor wave 4 causes RSI to cross below 70 from its lofty high, but remain above 50.  This crossing is the FALSE signal that traders fall for all too often.  Going short because of a turn at 3 is premature, and your stop just above the top at 3 is taken out by the final thrust to the top at minor wave 5.  The psychological tendency is to ignore the signal at 5 because of the loosing short attempted at wave 3.

5)  Minor wave 5 causes RSI to rise again, often crossing back above 70, but the market lacks the duration in trend to elevate RSI to a higher high.  When RSI turns down and crosses 70 the second time, this is the signal.   Study tip:  Look for divergence, where the price action put in new highs, but the study does not.   Divergence between RSI and price is a very strong indicator of a turning point.  Divergence is marked on the theoretical chart with short blue lines. 

3 Wave Minor Correction Analysis:  (blue a-b-c letters)

a)  Minor wave  a  returns to the previous support level of minor wave 4.  But the drop of RSI is huge, falling from a lofty high below 40.  This rapid fall is similar to the rapid rise that occurred in minor wave 1.

b)  Minor wave  b  is a Fibonacci retracement from  a  back towards 5.  The example has its price stopping at the top of wave 3.  The effect on RSI is to rally back above 50, possibly around 60.

c)  Minor wave  c  takes RSI to new lows around 30.  The example shows a drop slightly below 30.   Study tip:  Divergence will not occur this time.   Therefore, the signal to go long is the first time RSI crosses above 30.  This is shown in the example at major waves 2 and 4 (large red numbers) where the market meets the long term support trend line shown in red.

Signal Summary:

The process starts over again as Relative Strength Index behaves in a similar fashion for major waves 3 and 5 as it did for major wave 1.   The a-b-c correction of major wave 4 will be similar to major wave 2.  The ideal place to short is after major wave 5 is in place, at what will be minor wave 2 of the first trend leg of the new major correction.

Study tip:  Relative Strength had three turns with divergence at the end of major waves 1, 3 and 5 marked in red.   RSI turns at the end of the two reaction waves 2 and 4 did not have divergence.   Look for this pattern to help you identify the 5th major Elliott wave.  The divergence signal at the end of wave 5 is the ideal place to go short after a major up-trend, or long after a major down-trend.

Bar Parameter:

Now that the fundamental behavior of Relative Strength Index is understood as the Elliott waves develop in a market, the theoretical chart will be used to observe the effect of different bar parameters on the RSI.  The bar parameter is used in the RSI formula to average the Up and Down net totals.   Changes in the bar parameter affect the volatility of the study as illustrated below.  Study tip:  Use a bar parameter that produces RSI highs around 80 and lows around 20.

Last month's issue discussed the ability of the Ensign Windows program to simulate a real-time data feed for a dummy symbol named DEMO.  This article discusses an Ensign Windows feature to trade paper trades with a simulated order entry form.  With a DEMO chart displayed, click the right mouse button on the chart to display a pop-up menu for the chart.   Click on the menu entry for Sim-Broker to show the simulated order entry form.  This simulation broker can also be used real-time to track trades for any symbol.  Sim-Broker tracks trades for the chart that opened the Sim-Broker form.

In the Order frame, select Buy or Sell, then select an order Type.  The Type can be a market order, limit price, stop or stop and reverse.  The trade quantity can be entered.   Simulated stock trades might use a quantity of 100-200 etc.  For the DEMO symbol, use 1 or 2, or the quantity you would usually trade for ES or NQ.

The next box is where Price is entered, followed by the Submit button.  For practice, select the Buy bullet, Market bullet, with a quantity of 1.  Then click Submit button.  In so doing a time stamped transaction is posted in the log.  It will read:   Buy 1 @ Market.  Shortly thereafter a fill is received back with a time stamp and fill price.

This will initiate a position shown in the Summary frame.  The illustration shows Short with Qty of 4 and the fill price. Further to the right the current price is shown.  The next line in the summary shows the profit/loss for this open position.  Under trades is shown the accumulation of all trades made using Sim-Broker and the total profit loss for all trades.

Underneath the summary window is an edit box where the commission for a round trip trade is entered.  A typical commission is ten dollars.  Next to that is a box labeled Arrows.  When checked the fill prices for buys and sells will be marked on the chart with arrows.  Red arrows mark sells, and green arrows mark the buys.  The chart also shows the stops and limit buys/sells with short horizontal lines.

A position is closed out by buying or selling the opposite side of the position.  After completing a round trip the Position Summary will show Flat, and a horizontal break line will be posted to the transaction log.

Pending limit orders and stops are shown in the pending frame with a price by the checked box.  To enter a limit buy, select Buy and Limit.  The Price window will show a static number that was the current price when the order Type was changed to Limit.  You can use the spinner arrow that is part of the Price box to increment or decrement the price.  Click the Submit button to post a message to the transaction log:  Buy 1 @ .........   The Pending frame will show a check mark by the word Buy and then a price.

If the market goes lower and touches the Limit Buy price, the check in the Buy checkbox will be removed.  A message will post in the transaction log:  Bought 1 @  and the fill price.  Use the buy/sell Limit order to place orders where you want to buy or sell.. Limit buys will be below the current price.  Limit sells will be above the current price.

Likewise, stops can be used to go long or short.  Select Buy or Sell, and market type would be Stop.  The stop also needs a price.  Buy stops are placed higher than current price and will be shown on the chart with a short horizontal green line by the price scale.  The Buy Stop BS checkbox in the pending section will become checked and show the stop price.  Stops are easily adjusted by submitting the stop order again using a new price.  The location of the alert line will be adjusted to the new stop price.  A later stop cancels the earlier stop.

The items that show in the pending frame can be canceled by unchecking the box.  A buy stop is canceled by clicking the BS checkbox.  This removes the stop and the entry made to the transaction log will show   xx BS 1 @ ......   The  xx  in the log entry means 'canceled'.

SAR is a stop and reverse.   If long, enter a SAR at a lower price to go short.  If the SAR price is touched, then the long position will be liquidated and reversed short the number in the Quantity box.  If position is long 5, and a SAR with Quantity 1, it will then sell six, five to go flat and 1 to go short.  SAR can be put on either side of the current price.

The Reset button will clear the summary and transaction log.  Another characteristic is that Sim-Broker is doing a lot of math and tracking trades, and the form needs to be open.  The form can be minimized but not closed.  Sim-Broker will not work if closed.   Multiple Sim-Broker forms can be open simultaneously to track different symbols.

I bought a new computer with monitor on November 9th, 2001, from Sam's Club for $599.  Since I have been totally impressed with both the computer and with Windows XP, I thought many of you would be interested in my experience. 

The eMachines T1110 computer has the following specifications:

• 1 Gig Hz Intel Celeron processor
• 256 Meg of memory
• 30 Gig hard disk
• 12x CD-RW drive
• 3.25 diskette drive
• 56 K data/fax modem ITU V.92 ready
• 10/100 Mb Ethernet card
• Keyboard, mouse and small speakers
• 17 inch flat screen CRT monitor
• Windows XP Home edition pre-installed
• 3 PCI slots, 1 available
• 2 USB ports, 1 serial, 1 parallel, 1 game port, head phone, speakers, and line-in jacks.

It took less than 15 minutes to unpack the computer, and plug in the colored cables to the matching jacks on the back of the computer.  I also connected a cable from the router for the office network to the Ethernet port.   I then powered up the computer and filled in the registration forms.   Windows XP detected my office network and Internet access through the router, and self registered with Microsoft and with eMachines.  In a matter of minutes I was up and running, and beginning my discovery of the new XP operating system from Microsoft.

I used the preinstalled Internet Explorer 6 to go to the eSignal web site at www.esignal.com, and download the eSignal 6.1 software to obtain the Data Manager.  I installed Ensign Windows, entered my account and password in the Data Manager, and was up and running on my eSignal account within a few minutes.   I have not encountered any problem in running the Data Manager and Ensign Windows with the XP operating system.

The more I have used the computer and XP, the more I love it.  It is the fastest computer I have used and feels elegant compared to the 300 MHz computer I have been using.   I really like the operating system and have yet to discover a problem with it, or with the applications I use.   Occasionally I stumble on to a neat new feature of XP such as the Date/Time dialog form includes the ability to synchronize the computer system clock from the Internet.  Another slick tool is the Task Manager which is displayed by a right mouse click on the Start task bar.   The Task Manager includes a Processes tab which shows the CPU utilization broken down by application.  Ensign Windows with Data Manager running is pretty steady at using 2% of the CPU.   The Page File usage is quite constant around 114 MB.

This inexpensive computer from eMachines is really a great computer.  I consider it a 'hot deal' at $599 because it includes the 17 inch monitor, 256 Meg of memory, Ethernet port, a CD-RW for burning CDs, a fast 1 Gig Hz processor, and Windows XP preinstalled.  I have not been disappointed in the slightest.  In fact, I went back to Sam's Club 12 days later to buy another one and was disappointed that they were sold out.