September 2002

(This article is applicable to forecasting discussed in this and prior issues of the Trading Tips newsletter.  This article is reprinted by permission of Lambert-Gann Educators, Inc.  

The forecaster predicts what a market should do.  Once traders have used proven forecasting techniques to compile a forecast, the forecast dates and/or prices are noted on the traders' chart and in their trading diary.  The forecast is but one component of their written trading plan.  With the forecast duly noted, their role as a forecaster has ended.

The trader uses all of his or her trading skills to trade (or not trade) what the market does, not what the forecast said it should do.  As soon as people consider risking money in the market, to trade a forecast or a proven market set-up, they are now wearing their 'Trading' cap.  From this point onward it is their skills as a trader that are utilized.

The Advantages of Forecasting

The reason many people spend time learning how to forecast is that a well-prepared forecast, traded correctly, can enhance trading profits dramatically.  In addition, a forecast helps give traders confidence in staying with a longer-term trade.

Professional traders use forecasting to allow them to enter a market closer to a confirmed bottom or top.  They also lock in more profits by using tighter stops as a forecasted turning point approaches.  If the market does not change direction as forecasted, it is of no concern to them as they are in the market and the market is moving in the direction of their trade.  They keep using their trading skills to stay in the trade according to their written trading plan.

Professional traders also use forecasts to prepare for a possible trading campaign - that is to trade a possible large market move once a major market top or bottom has been confirmed.  Both Gann and Livermore regularly reminded traders that the big money was made trading the big moves and forecasting skills can make a significant difference in trading such moves.

The Pitfalls of Forecasting

Some traders fall in love with their forecasts.  They enter a trade, but fail to replace their 'Forecasting' cap with their 'Trading' cap.  They are then fully exposed to some of the pitfalls of forecasting.

Forecasting has the potential to reduce a trader's profitability for some inadequately prepared people.  This is usually due to one or more of the following reasons:

1. They were not a consistently profitable trader before starting to apply forecasts to their trading.  As a consequence, they attempt to trade a forecast and not the market reality.
2. Even when the forecast appears to be working, they take the confirmed trade according to their rules, however they then assume that the market must keep trending in its new direction.  If it does not, a profitable trade soon becomes a losing trade.
3. Once they have a forecast in their minds, they find it difficult to ignore the forecast and to trade the market in the opposite direction to the forecast when it is clear that the forecast did not work.  For example, if a forecast suggests that a major top should occur in late October in a given year and the market is still rising strongly in November, a professional trader would know that there is only one direction in which to trade, and that is with the trend - upwards.  Many traders will suffer a huge opportunity cost when they allow a forecast to scare them into inaction when the forecast fails.

The biggest enemy of traders who forecast is their ego.  Successful forecasts work wonders in feeding one's ego, but it is trading skills that translate a successful forecast into trading profits.

Conversely, a failed forecast is just that.  It is not a negative reflection on the worth or skills of the forecaster.  No forecaster is 100 per cent correct.

A forecast that does not result in a market reversal, does not necessarily mean a trading loss.  In fact, if a trader is wearing his or her 'Trading' cap, it is more than likely to end up being a very profitable trade as the market continues in the direction of the trade.

By all means become a good forecaster.  Just ensure that you always remember that it is your skills as a trader that will make you the enhanced trading profits. A good forecaster who cannot trade, however, is likely to end up on an ego trip to the poor house.  That is why we teach you how to forecast - but we always place greater emphasis on teaching you the skills required to trade.

I'm complimented that you would consider including in a newsletter, but if better content comes along, I wouldn't be disappointed not to see it.  In case you would include the charts, I've attached the gifs, fairly crude compared to Crystal Ball charts.  Was just expressing an opinion, and demonstrating a familiar Pesavento theme with respect to Jim Twentyman: "Defy human nature ... do the work yourself".  However, I recognize many are far more capable at certain activities, and am most willing to work with those ... given the opportunity, I'd jump. 

This note is to show interest, support, encouragement, applause, and willingness to do whatever it takes to help, or at least see the continuation of the Crystal Ball charts.  Thanks for the chat room training session.  I was impressed by the Larry Pesavento article ... reinforced his "Artificial Intelligence" book, re: Tomahawk.  With the comments regarding timing, I am keeping an eye on an ephemeris, and reread his "Planetary Harmonics".

After I read the article I started to work with some projections based on the moon, Mercury, Venus, Jupiter, etc... Yes, a long road there, but sometimes
very interesting timing, especially with inversions or slight adjustment forward and/or backward a few, or quite a few bars.  My charts don't look close to the Crystal Ball charts ... perhaps more cycles of different length and amplitude all being summarized by one line.

Not much adjustment in this one, except the blue line needed to come back a few bars, just using the inverted.  Yes, different times of the day might be fit by different curves.

You might guess that Larry hardly ever mentions any of the solar system in his chat room; there are many that just cannot handle such references, and I
have the impression he wouldn't want to waste his time with the responses (especially if it meant typing).  He also doesn't mention the neural net timing very often, most likely for the same reasons.

I was very, very impressed by the results generated from your efforts.  I would like to see such effort continue, doing whatever I could to help, participate or otherwise contribute.  Hey, granted it might take me a bit of time to catch up.  There are two traders I would like to emulate and Larry Pesavento is one of them.  In that light, the timing is number one, price pattern is number two; working well enough with the patterns, but missing the key of timing.  

I appreciate the open format of www.dacharts.com, and there are no doubt many benefits to that system.  Admittedly, I hadn't looked at the site very often before the chat room comments, but I caught up tonight ... really incredible advancement.  If it is necessary to reduce flak from the uninterested, closed minded, or plain antagonistic folk, ... reduce distribution to those that are interested and supportive.  I would like get my name near to the top on a distribution list, password area, whatever would work, to keep the information flowing.  Naturally, I am very impressed with Ensign Software's Crystal Ball work.

Great software, super support, and brilliant insights.  Thanks again.  Best regards, Stephen Pavel

OK, I plead guilty to tantalizing patrons of the chat rooms by posting examples of Ensign's research efforts to the www.dacharts.com web site.  The examples have shown the next day's probable price action prior to it happening.   Thus the forecast has taken on the name of Crystal Ball.  Here is an example forecast for ES U2 that was generated and posted to www.dacharts.com on Saturday, August 17th, showing the probable price action for Monday, August 19th.

It was with great interest, anticipation, and pleasure to watch ES U2 (2-minute chart) behave as predicted.  The actual market is shown with the forecast in this illustration captured during the day on Monday, August 19th.   The time stamps on the chart are for the Mountain time zone.

Market action in the afternoon experienced a slight rightward phase shift departure from the forecast.  The forecast was adjusted by realigning the forecast 11:40 peak with the actual peak at 12:08.  The balance of the afternoon with the Crystal Ball forecast realigned to the right is shown in the next chart.  Quite amazing isn't it, that a forecast could be calculated in advance and actually come to pass with any degree of resemblance?   Such is the on-going Crystal Ball research effort at Ensign Software.

The advantages and pitfalls of working with forecasts is discussed in the lead article.  We must all remember that a forecast is dealing in probabilities, not certainties.  The primary characteristic the Crystal Ball is showing is the TIMING of a turn, where statistically it is likely to occur.  The predicted turn may come early, on-time, late or not at all.  The example shows the predicted 11:40 peak came late at 12:08.  In spite of that, the subsequent duration of the down trend that followed and subsequent up trend into the close were still relative to the actual turn at 12:08.

Crystal Ball is a research effort still in development.  Sample charts have occasionally been posted to the www.dacharts.com web site.   New ideas are being tested.  Current results are very promising, however.

There are two similarities between Ensign Software and the stock market.  The first is that you can spend a lifetime attempting to learn all there is to know about how they work.  The second is that each present great opportunities to prosper.  One of the oldest methodologies used to analyze price movements in any market is candlestick patterns.  Price action when plotted on a chart using candlesticks to represent the highs and lows of prices traded and the main body of the trades that take place, reveal patterns that repeat themselves.  These repeating candlestick patterns present excellent trade opportunities.  Many traders are aware of candlestick formations, however they are not inclined to invest the time and study necessary to memorize all the nuances that are reflected in each different pattern.  In September 2001 I wrote an article about the Triangle formations.  The Triangle pattern is a single trend indicating formation that signals the trader as to which side of the market to trade.  Since the introduction of the Triangle program these formations have been very effective as a trend indicator.  If anyone would like to review the various triangle buy and short signals that where generated by the program, I have listed the signals from the daily chart of the QQQ Nasdaq tracking stock at the end of this article.

In the past year I spent time learning and reviewing Candlestick pattern formations to see if they would be of any benefit to my trading.  I found that there are library shelves filled with lists of various types of bars and formations in Candlestick terminology.

Some are very good while most are worthless for trading.  The few formations that I found useful in live trading turned out to be extremely useful.  They are of course not fool proof, however, what I found was that they are easy to read and interpret.  The entry and stop loss points are very clear cut.  The only problem for a trader is finding these formations.  This is where the power of Ensign reigns supreme.  In order for a series of price bars to qualify as a particular candlestick pattern the bars must meet a series of criteria that uses multiple combinations of highs verses lows, opens verses closes, bullish bars verses bearish bars, all intertwined together.  As everyone is aware it would take you forever to review every chart checking to see if this high is above that high and if this bar was bullish or bearish.  Trust me you cannot remember all the combinations of rules let alone find the time or have the inclination to search for such situations on charts.  Attempting to search for these formations on an inter day basis has until now been a pipe dream.  Here is where the power of Ensign comes to the rescue.  I have expanded the capabilities of my Triangle program to include a scan tool for bearish and bullish candlestick patterns.

I have narrowed the list of candlestick formations down to only include the most reliable formations.  Using my program these formations can be located in a matter of seconds depending on your computer.  Ensign code allows the user to scan for these formations in any time frame.  I have integrated these formations into my trading system in a very simple and easy to follow method.  First, I run my Triangle trend indicator on the NQ and ES futures charts and on the QQQ and DIA tracking stocks.  If the Triangle short signal has been triggered then I click a button looking for any bearish candlestick patterns for a good short entry. If the Triangle trend bullish trigger has been hit then I click a different button and scan for any bullish candlestick patterns on the 5 minute charts.  If you cannot make money trading with these signals then I suggest you find another occupation.

Before I give a description of the various candlestick formations that the program will scan for and how to trade them I would like to first briefly cover two additional functions that I have coded into my program.  The first is a very good Support and Resistance tool.  Clicking the 6 button in the program allows the user to scan for the highest high and the lowest low within a user defined previous number of bars.  The data is printed in the data output window for easy review and storage.  You can do this in any time frame, which makes it very useful on an inter day basis.

For example, after the first 30 minutes of trading I just click a button and within seconds alerts are set at all short term support and resistance levels.  Thirty minutes later I just clear the existing alerts, click the button and the new price support and resistance alerts are set.  How easy is that.  Thank you Ensign.

Finally, most traders use what I refer to as conventional studies such as the Relative Strength Index or Stochastic.  With that in mind I added a conventional Ensign studies scan to the Triangle program.  It allows the user to input up to three different Ensign studies and scan your quote page symbols for various data. For example, I like to scan the 60-minute charts looking for RSI in oversold or overbought territory.  The user of the program can input what values you want to search for as extremes.  If you want to look for RSI over 70 but Stochastic over 80 you just input those numbers on the main page of the program and click the button.  Ensign does the rest of the work for you without you having to review one chart.

In addition to the various studies, Ensign provides what are known as study flags.  These flags provide you with very useful information about the various studies.  For example, when you scan for RSI above 70 or below 30 you also can enter a flag number that will provide a true false statement about the direction of the study average.  If the study average is rising it will print true if one flag is entered.  My program allows any combination of studies and flags to be used in the scan mode.

In this section of the article I am going to give a brief description of the individual candlestick formations that the program will scan for in any time frame.  Each will have a chart example showing what makes the pattern and how to trade them.  In honor of this very large bear that has been making himself right at home for some time now I will begin with the bearish candlestick patterns.  Then I will finish up the bullish candlestick formations for your review.

CANDLESTICK PATTERN FORMATIONS

These are all well-known formations that present great trade opportunities.  The patterns are most reliable when they occur at or near either a Fibonacci support or resistance level.  Additionally, it is best to trade candlestick formations as signals to the end of a counter trend.  On the main page of the program the user can turn on or off the scan for whichever one of the formations that you want.  You can also control if you want an alert set or not.  This is a very useful function.  For example, if you want to keep the alerts set from the daily signals active, however at the same time you want to continue running the scans on your 5 minute inter day charts, you just disable the alerts settings.

For all traders that only trade the mini’s these candlestick formations can be of great use even if you do not trade individual stocks themselves.  I have found that scanning the list of individual symbols that make up the DIA provides much needed information about impending moves in the market tracking stocks or futures.  When the scan pulls up 10 or 15 bullish signals it provides an early warning of a possible reversal in the futures.  Also, all the candlestick patterns also occur on the individual futures charts.

BEARISH CANDLESTICK FORMATIONS

1. BEARISH HARAMI – This is a bearish reversal pattern.  Prices will have been rising when the last bar in the formation stalls.  The body of the last bar is contained within the body of the previous bar.  The last bar is a bearish reversal bar.  Go short when prices trade below the low of the last bar in the formation.  Place a stop loss at the high of the last bar in the formation.

Note:  There are various combinations that make up a bearish Harami formations.  The body of the bar that contains the Harami bar can be a bearish bar instead of the bullish bar used in the chart example.

2. CONFIRMED BEARISH HARAMI  (Three Inside down) – This formation occurs when the bar after the last bar of the bearish Harami pattern confirms the bearish pattern by closing below the closing price of the bearish Harami bar.  The signal is to go short when prices trade below the low of the last bar of this pattern.  This pattern occurs regularly and is considered a stronger bearish signal then the Harami pattern.

3. BEARISH ENGULFING – This pattern is formed when prices have been rising and the last bar in the formation gaps open higher in the direction of the bullish trend and then reverses and closes lower then the main body of the previous bullish bar.  This creates a bearish reversal bar that is engulfing the previous bullish bars body.  Go short when prices trade below the low of the last bar which is the engulfing bar.  Use the high of the engulfing bar for your stop loss.  If prices are to far away for a stop loss pick a logical stop.

4. CONFIRMED BEARISH ENGULFING  (Three Outside down) – This pattern occurs when the bar after the last bar of the bearish engulfing pattern confirms the bearish pattern by closing below the closing price of the bearish engulfing bar.  The signal is to go short when prices trade below the low of the last bar of this pattern.  This pattern is considered more reliable then the bearish engulfing formation.

5. BEARISH JB- This is a formation that occurs when you have three long bullish bars in a row each with a higher high.  The last bar in the formation fails to reach the high of the previous bar and that bar is a narrow range bar.  Go short when prices trade through the low of the last bar in the formation.  In Section 6 of the main page of the script the user can control the minimum values for the up moves in the three up bars of the formation and the maximum size of the last bar.  This allows you to use higher values when scanning daily signals as opposed to a 5-minute intra day scan.  Use the high of the last bar as your stop loss.  (This is not a well-known candlestick pattern it is just something that I have seen so many times before that I included it in the scan).

6. BEARISH ABANDONED BABY-  This is a reversal pattern of the bullish trend.  Prices are rising and then a price bar gaps up.  This gap bar is a narrow range bar.  The low tail on the gap bar does not overlap the high of the previous bar.  Prices then gap down on the following bar and close lower then they opened.  Go short when prices trade below the last bar in the formation.  On the main page of the program you can control the minimum size of the first gap up bar.  If you only want the gap bar to be a star or Doji star you reduce the maximum star value control.  Use the high of the last bar in the formation for your stop loss.

7. BEARISH DARK CLOUD – This is a reversal pattern that occurs when prices have been rising.  First you get a long bullish bar.  That is followed by a bar that gaps open above the last price of the long bullish bar but then closes below the mid point of the long bullish bar.  Go short when prices trade below the low of the last bar in the formation.  On the main page of the program you can control the minimum size of the long bar.  This should or can be adjusted according to the time frame that you are scanning.  A long bar on the daily chart is a different value then a long bar on the five minute chart.  Use the high of the last bar in the formation as your stop loss.

8. BEARISH LAST ENGULFING -  This reversal pattern is formed when prices are rising.  A bullish engulfing bar then forms.  (Refer below to Bullish Formations).  The price bar after the bullish engulfing bar is a bearish bar that closes below the close of the bullish engulfing bar.  This pattern is most reliable if it occurs at a recent 14 period high.  Go short when prices trade below the low of the last bar in the formation.  Use the high of the last bar for your stop loss.

9. BEARISH KICKER -  This pattern can signal a reversal of prices.  It can occur anywhere on the chart and will signal a reversal of the current trend. This scan is also controlled by the PointLossBeforeReversal and PointGainBeforeReversal controls on the main page of the program.  The bearish kicker is a two bar formation where the first bar is a bullish bar.  The next bar opens at the same price that the bullish bar opened but reverses direction and closes as a bearish bar.  Go short when prices trade below the low of the second bar.  This formation is most effective if both bars are not narrow range bars.

In this 5-minute chart example you can see that depending on your trading style this trade could be a winning trade or you could be stopped out for a loss.  Wait for prices to close below the low to enter.  If you enter aggressively and prices reverse to the upside it is much more prudent as a trader to exit the trade when the stop is hit and then reenter the trade a second time.  Commissions are a much less painful then waiting around to see if the signal is correct.

BULLISH CANDLESTICK FORMATIONS

1. BULLISH HARAMI – This is the reverse of the bearish Harami.  It occurs when prices have been falling and then the last bar stalls and does not trade below the close of the previous bearish bar.  The Harami bar closes below the open of the previous bearish bar.  Therefore the body of the last bar is contained within the body of the previous bearish bar.  Go long when prices trade above the high of the Harami bar.  Place a stop loss at the low of the Harami bar.

Note:  There are various combinations that make up a bullish Harami formation.  The body of the bar that contains the Harami bar can be a bullish bar instead of the bearish bar used in the chart example.

2. CONFIRMED BULLISH HARAMI  (Three Inside Up) - This formation occurs when the bar following the formation of a bullish Harami bar closes above the close of the Harami bar.  This is a confirmation of the bullish Harami and a stronger signal.  Go long when prices trade above the high of the last bar in the formation.  Use the low of the last bar for your stop loss.

3. BULLISH ENGULFING - This formation occurs when prices have been falling a minimum amount.  The last bar in the formation gaps lower at the open and then closes above the open of the previous bearish bar engulfing the entire body of the bearish bar.  Go long when prices trade above the high of the bullish engulfing bar.  Use the low of the engulfing bar as your stop loss.

4. CONFIRMED BULLISH ENGULFING  (Three Outside Up) - When prices first form a bullish engulfing pattern if the next bar closes above the last price of the bullish engulfing bar then the pattern is confirmed and is a stronger signal then the bullish engulfing signal.  Go long when prices trade above the high of the last bar in the formation.  Use the low of this confirmation bar for your stop loss.

5. BULLISH ABANDONED BABY- This is a reversal pattern that forms when after prices have been falling a price bar gaps lower.  This gap bar is a narrow range bar and does not overlap with the previous bearish bar.  The next bar gaps to the upside and closes higher then it opened.  Go long when prices trade above the high of the last bar in the formation.  Use the low of the last bar for your stop loss.

6. BULLISH LAST ENGULFING - This pattern is a reversal pattern that occurs when after prices have fallen to a new low prices form a bearish engulfing bar.  The bar following this bearish engulfing bar reverses to the upside and closes above the last price of the bearish engulfing bar.  If it occurs at a 14 period low it is more reliable. Go long when prices trade above the high of the last bar in the formation.  Use the low of the last bar for your stop loss.

7. BULLISH KICKER – This reversal pattern occurs when the first bar of the formation is a bearish bar.  The second bar opens the same as the first bar but goes in the opposite direction and closes as a bullish reversal bar.

SAMPLE OUTPUT

When you run the bullish or bearish candlestick scan all relevant information is displayed in the script editor output window. Below is an example of how the data appears and the information provided.

-Bearish JB - possible reversal .                This tells you the name of the formation found.
NQ #F Last Price=910                             This tells you the symbol and the last price traded
09-03-02                                                 This tells you the date of the signal
1300                                                        For the Inter day scan mode this line will provide the time of the bar that follows the last bar
                                                                of the formation that has been located.  Using the End of Day scan this bar time will indicate the
                                                                bar time for the last bar of the formation.
Resistance =907.5                                    This gives you the current support and resistance values
Support =904.5                                        based upon the values you input on the main page.
**Signal Bar Volume Alert (Signals high volume on last bar in formation)
  *Formation Volume Alert (Signals high volume when formation is found)

In conclusion, it should be clear that there are many combinations of these various  functions that the Triangle program will perform that can be of great use to every trader.  For example, you can use the conventional studies scan to find a list of stocks that are in over bought territory.  Then use the bearish candlestick scan on that list looking for a top to short.

On some days due to market conditions there may not be any candlestick patterns that form on the 5 minute chart.  On most days there are plenty.  If however there are no candlestick patterns to trade it is quite easy to use the short term support and resistance levels to find trade opportunities.  The combinations and uses are only limited by your own imagination.   Good luck.

Triangle Buy Signals from Daily QQQ tracking stock.

10/03/2001 – Buy at 30.43
10/11/2001 – Buy at 33.20
11/06/2001 – Buy at 37.06
12/04/2001 – Buy at 40.49
12/06/2001 - Trigger price 43.24 (Prices never tested trigger price)
05/17/2002 - Trigger price 33.41 (Prices never tested trigger price)
07/08/2002 - Trigger price 26.55 (Prices never tested trigger price)
01/16/2002 - Short at 39.15
02/04/2002 - Short at 37.33
02/19/2002 - Short at 34.97
06/07/2002 - Short at 28.42
07/23/2002 - Short at 22.73

That is a track record of 9 for 9 (100%) on the QQQ signals since the program was released in September of 2001.

Note:  You cannot trade with a weak computer system.  Every time your system locks up or cannot handle the data or charts you risk losing more money then what a good new system will cost.  I had a great high test 4 monitor system built by a customer of mine and a fellow Ensign user Dale Fisher.  You can contact Dale at tigocerous@tigocerous.com

Note:  (10-26-2004)  After reading your newsletter article about selling trading systems I came to the conclusion that you were right as usual.  I stopped offering my program to the public and went back to what I do,  trade.  Trying to provide support became a huge burden and was not worth the effort.  I would be on line answering questions to get a monthly fee and end up missing a trade that would cover a hundred customers.  Additionally, as you are well aware, what works fine for one person may be considered trash by another.  I love Ensign.  And I love my program, which has been refined and improved.   If you want to add a note with the article that I am no longer offering the Triangle program that would be great.