Volume VII, Number 4 April 1991 $10.00

Evaluating the Merits of ThendFottowing vs. Overbought/Oversold

Trading Systems-� Have you have ever considered

the dynamics of the two tradingphilosophies: Trend Following andOverboughy'Oversold? The two areessentially opposites. With somecareful consideration, you may for-ever abandon the latter as a viablemeans of winning consistent profits.We'd like to place the question in a

, tatistical perspective to stimulateYome thought on this subject.

The trend follower's philosophy isto cut losses short and to let profitsrun. His typical trading record showsmany snall losses and a few verylarge profits. A trade-by-trade distri-bution of tlre tend-follower's profisand losses has the following generalappearance.

0TREND FOLLOWER PATTERN

The overboughy'oversold user isvmore likely to experience many small

orofits and occasional very largetvrsses. The disribution of profits and

losses for this analysis typically

looks like the example below. Thismight be expected when studies likeRSI. stochastics and 7oR. are usedexclusively as overbought/oversoldindicators.

OVERBOUGHT/OVERSOLD PAfi ERNThe trend-following approach may

appearto require more capital becausereserves must be maintained to sur-vive the inevitable losses. These areusually recouped when the occasionallarge profit materialize s. Obviously,the trend-following trader must resistthe temptation to take a developingprofi tbeforetherade hasrunits course.

In the overbought/oversold sce-nario, profits may come easily, butafter several gratifying profits in arow, a large loss is to be expected. Onecatastrophic loss may wipe out yourhard-earned profrts and could pushyou permanently from the market.

For many, this story may mark afamiliar theme. Knowing the pitrallsin advance may give you the courage

Perpetual Contracts vs.Continuous Contracts......... 2More 0n Seasonals............. 3Mofe Candlesticks... .. . ..... 3Oil - Who Needs lt?............... 4Ask Qrstomer Service..... . 5

0

to go forward with greaterconfidence.The distributional form for your own

personal approach can be comparedwith what we have proposed as thetheoretical form by preparing a histo-gram showing the quantity of nadeslogged at price intervals over therange of profits and losses.

If two candidate trading philosophiescan be classihed at the opposite ex-tremes that we have proposed hereand their respective mathematicalexpectation is equivalent, whichshould befavored? The answerwouldbe the approach which requires theleast capital. The rcliable measue,retum on investment, should certainlyhave a bearing on the trader's choiceand this concept should be invoked.

The only method I know to realisti-cally solve the problem of det€rmin-ing capital suke requirements is therandomization of trading by gener-atingprofits and losses through a MonteCarlo Simulation. TheTrading SystemPerformance Evaluaton"is designedto make this decision for vou.

This b,rief article was not intended asa promotion for the Trading SystemPerformance Evaluator, but in someways it is. That product can evaluateeither of the above approaches.

Knowing capital stake requirementsshould b,ring every trader a long waytoward understanding the chances ofsuwival in nearly any candidate trad-ing game. E

be approxi mately one toseveraldaLbefore the series you have commit--ted to follow rolls into the next con-tract. I would think the typical usercould get very confused given thisrequirement.

On the negative side, ContinuousContracts lack the stationaritypresent in Perpetual contract databecause the market is viewed in anever- altemating mode of expandingand conftacting time to delivery.This phenomenon causes pro_blemsin long-term market synthesis andsimulation of historical databecausevolatility altemates from active totame and the vantage point, time-to-delivery, is not constant. A seconddisadvantage is that given the earlyassumed contract expiration (the20th of the month prior to expira-tion), the market volatility up unti^r- '

and slightly after first notice daPescapes from the time series; yet thetrader may find himself in the mar-ket in the nearest contract well pastthe 20th of the month. And if vol-ume and open interest are importantto your system, their effects may bemore significant in the nearest con-tract (following the 20th of the priormonth) when it is ignored. than inthe actual contractwhich is observed.In other words, a fa.lse correlation ofprice effects and volume or openinterest effects could easily prevail.

Perpetual Contracts cwe a-11 of theabove defects with the exceptionthat the user must choose an actualcontract in his trading upon whichhe applies the signals derived froq-the Perpetual Contract data. Marketsynthesis and simulation for Perpetual Conffact data can be readilFaccommodated with few comDro-

CSI's Answer:Regarding the use of Perpetual

Contracts versus Continuous Con-tracts, each has an advantage overthe other, so it is difficult to make adecision for a given specific use. Iknow of no testing that rigorouslycompares the two in real time trad-ing, but herc are some comments indefense ofeach based on apriori andtheoretical grounds.

Because the Continuous Contractuses actual data for t}e cunent con-Eact. there is a distinct advantage inContinuous Confact use if yourtrading methods are of a very shortterm. Suppose you were tradinglivehogs, which for a Continuous Con-tract application would extract datafrom all even-numbered deliverymonths plus July. In this event, youwould probably require a systemalgorithm that wouldcomplete a buy/sell round trip in 20 days during partof the year and 40 days in the re-mainder. For longer periods youmust face the problem of rollingforward into successively more cur-rent contracts in the same trade di-rection. On an actual applicationbasis as you approach the 20th of themonth prior to delivery, the nextfade you will enter in the oppositedirection will inevitably be taken inthe next futures contract. This would

How Perpetual Contracts' andContinuous Contracts Compare

Recently Mr. T.D. Feldberg, a cus-tomer in Lnndon England wrote ask-ing if we would comment rcgardingPerpetual Contracts and ContinuousContracts and how each deals withthe problems of discontinuity andstationarity.

Before providing my response, Iwould like to review the characteris-tics of Mr. Feldberg's definition of aContinuous Contracl His Continu-ous Conffact is like a nearest futurescontract with two exceptions. First,his continuous conuact applicationuses the nearest futures contract dataonly until the 20th day of the monthpriorto expiration. Secondly, to miti-gate price gaps upon roll over to thenext delivery month, his ContinuousContracts adjust the prices of the ex-piring contract to the level of the newcontraci For instance, if on rolloverday the next contact is rading 80points higher than the expiring con-fract, then all the prices of the oldcontract would be moved up by 80points to exactly match the nearbycontract. This method alters the dailyprices themselves, but maintainsidentical price relationships. Someforms of continuous confacts buildthe time series in the opposite manner,making it necessary to add or subtracta constrnt to derive the actual price ofthe current contract. compro-

. 7ises. There is also no long-sideV .

bias other than inflation (which ispresent in both continuous and ac-tual data) and results are as close tostationary as possible. PerpetualContracts work well with sho -termtrading, and they are also an excel-lent medium for longer term Ead-ing. Intermarket and intramarketspread work is an additional butvery significant natural extensionof Perpetual Contract capability.Given this information and knowl-edge of your own specific needs,perhaps you can make a more ln-formed decision as to which arebest for your needs. E

CandlestickCharting RevisitedLast month we ran an article on

Yandlestick Charting. Our motivewas not to criticize this technique,because it does paint a more de-scriptive picture of market dynam-ics than standard charting methods.Since Candlestick Charts havestimulated so much intercst, wewanted to point out that they havesome limitations as well.

One of our loyal customers Mr.Irwin Porter, President of Candle-stick Fax, responded to our articleillusffating how the use of hisCandlestick Charting methodologywould successfully trade the T-Bondscenario we used in our illustration.

Mr. Porter holds seminars teach-ing Candlestick Charting and trad-

1-,ng methodology. For more infor-mation, contact him at 139 Castle

., -\ockRd.,Quinter,KS 67752. You-6an call him at (800) 729- 3913 or

o13\7s4-39r3.D

MoreOnSeasonals -The unleaded gasoline price

chart and seasonal index ofunleaded gas included in theenclosed flyer tells an inter-esting story. Notice the pre-dictive power of the index.We advise adding the #62contract seasonals to yourportfolio for all commoditieswhich relate to items you fol-low.

Also note the S&P 500 ver-sus its seasonal index . Thevertical line on the chart marksthe point precisely one yearearlier than the last data pointshown. The seasonal index,of course, repeats year afteryear. Note the apparent orperceived predictive powerhere as well. The enclosedflyerlists the available indexeswhich we hope our readerswill consider. We believe thatno trading opportunity shouldbe entertained without firstexamining the respectivecommodity's seasonal chart. E

GoodNewsAbout TSPEThe Trading System Performance

Evaluator is now ready to ship.Earlier tests indicated that substan-tial improvements could be made tomake it more user friendly. Conse-quently, we decided to absorb fte heatand spend the time and money toproduce a superfine piece of soft-ware. We are now confident thatthose of you who have purchased orwill purchase this software will bemore than pleased.

Our only delay as we prepare thisnewsletter is the printing process forthe manual. Please expect your copysoon after receiving this message.We apologize for the inconveniencethis has caused many of you whoordered this software before the endof the year. A 107o discount will becredited to all purchasers ofTSPE todate. This is in addition to the l07adiscount given on allpurchases madebefore December 16, 1990. u

who lived through it would agree withyou.

h thetrading ofcommodities andineconomic analysis, oil could substi$tefor a wide range of economic indicesbecause it influences such a wide rangeofproducs. C-onsideroilasarade-off tointercst mtes, grairs, and many otheragriculrural producs. You may garnmorc insight into our economy fr om theresource known as oil than any otherproducl We errcourage our custorne$to investigate spread surdies dtat trackfteprice ofoil and fte inverseofthepriceof oil with a broad range of producs.There is a near limidess abundance ofopportnities waiting to be discoveled

C-onsidu tlrc lead/ag relationshipbenveen light crude ad the S&P 500 inthe #62 seasonal "connacs" shown on

page 3. The inverse of the price of (leads the market by 2 to 4 nrondrsYassuming seasonal characteristics.In my opinion there is nothing morereasonable than this finding, andthere is no evidence which will sup-poft the hypothesis that a change inthe importance of th is product in oureconomy is likely to occur.

Some may say that we are "suetch-

ing it" when we suggest that fte stockmarket follows seasonal forces. Whenyou see the lagged relationships be-tween the stock market and the crudeoil market which does exhibit sea-sonal characteristics you rnay want torethink sone ext book assertions. I

for Prosperous Trading,

P-uX";^,Best Wishes

07i

Oil - Who Needs It?The media and some politicians

have not done a goodjob of hformingthe general pubtc about the impor-tance of oil to our economy. Oil is notjust fuel for our ttrinty can ard enerryfor our fumaces. O.il is used virtuallywerywherc. Widroutitmassivelayoffsandunenplol,rnentwouldoccur. Manyof our electic power generating plantswould sit idle most of every day.People could not get to their place ofemployment, the economy wouldvfutually stop, andworldfoodstrortagesand even famine cor:ld result

A war over oil had to happen.There was no other choice given thecircumstances. Anyone who takes adifferent view does not know what oilmeans to us and the entire world.

Ourfarmproduction would slow toa crawl. Farm machinery for cultivat-ing, planting, fertilizing and harvest-ing would virtually sit idle. Imagine aworld without these products: plastic,nylon, polyester, vinyl, mylar, styro-foam, insulation, paint, rcpe, lightfixhn€s, fumiffie, wall covering build-ingproducs, lutricants, insulated wire,computer chips, tire s, many autoaarts, shoes, clothing, elecEic power,roads, toys, polishes and hundreds ofother things.

An economy without oil wouldseem like the year 1900 or before. Mylate grandfather who fought in theSpanish American War in 1898, toldme that he would buy gasoline at thegeneral store one gallon ata tfune. Fromthe stories he told me, he got aroundwith a horse andbuggy or else walkednearly everywhere he had to go.Some may ake the position tlnt thiswould be an acceptable r€sulL but few

'quiGmdt ol Qt]id(Tde6 wdid r€quie a raii A$ intnosl valoo ot 294070, l.. ormplo. b be sbsd 6d l€s rddFs m adiustnml

A vobm6 d o{ inldEl ol maoiirde

CSI ERROR REPOFT MARCH 1991

Tho

9102089102089102089192089102089102119102129102'15910219910219910221910??2910225

Tolal Vol. = 339Volume = t5,Volume = 78Volume = t06Volume = 259200 607s0214@0, 21405u15 88228690 875012837 128433640 3637849 8s08037 8175

2585 2585 2585 25,39621 9628 9615 27fr10 2894 2802 28909379 9382 9373 9373Toralvol. = 3t595 lotalo.l. = ngnTotalVol. = 3t6t TotalO.l. = t3t85TotalVol, = 5895 Toral0.l. = 18666Iotaluol. = 14552 Toral O.l. = 5tt0eTotal Vol. = 2475 Tolalo]. = n45Totalvol. = 1596 Tolalo.l. = 57309s03 9507 9419 9424Toralvol. = 5484 Totalo.l. = 38018871 898 870 887854 876 854 8621815 12915 12915 12915

all monlhsallmonlhsall monthsall monthsall monthsall months6/91all months1081,52,573t926/91,46,55,58,59

91022s 199 ZH910t25 144 TQ910301 21 W910301 5542 NBA910301 38 RL910301 47 ZL910301 48 ZZ910301 92 AH910301 80 ZK910301 46 7J910306 144 TQ910307 3 CO910308 20 SU910308 20 SU910311 2U EU

101 CR101 cR'101 CB101 cB101 cB258 BC'101 CB? 2 8 V69 PAs495 NCA38 BL20 SU69 PA

all months3/915/917 t919i913/91,55,58,599/91,43,44,453t929i91,52,57

503/91,s6,603/91,55,56,59,603t926/9'l7/91,53,57

Totalo.l. = 15280.1. = 685ol. = ct7o.t. = 385ot . = 2159190 6069s2140, 213808815 88228575 867012815- 128263646 36/.2813 8227950 8115

v Ask Customer ServiceEach month in this column, the CSICustomer Service staff addresses asubject ofinterestto many users. lnthis issue Dave, Karen, Rudi, Susanand Tami will discuss how Quick-Trieve@ Automation can enhansetechnical analysis with QuickPlot@/Quickstudy@ version 4.0 or 4.01.

I like my new QuitkPlotprogram, but I find I have to pressa lot more keys to perform studie sthan I did with my old QuickPlot.Is there a wa! to econornize onkeystrokes while kceping the ad-vantages of version 4.0?

Let QuickTrieve Automa-tion come to the rescue . This macrofeature will let you pre-program allthe studies you wish to perform in asession and run them automatically.Once you start the process, you cansit back and relax while QuickPlotcreates and prints charts of all yourfavorite markets and studies.

ing a macro with QaickTrieve Au-tomation?

. 5elow. Start at the QuickTrieveYnain menu, the QuickManager@

- {nenu or at any point in QuickPlot;-,peration where you will want to

start this Drocess everv time.

l. Press <ALT> <L> to begin thelearning process. A screen promptsaying ENTER QA # will appear.Enter any letter or single-digitnumber to name this macro, beingsure to remember it for future use,

2. For completely automatedanalysis, proceed with data retrievaland chartmaking as desired. Makeall the chads with-all thestudicsyou'll want to porform normally.QuickTrieve Automation willrecord each keystroke to repeat insequence at your convenience. Besure to include the Print Screencommand (*) as needed to printyour charts.

3. When you have finished youranalysis session, but before exitingtheprogram. press <Alt> <L> again.This will mark the end of the learn-ing session and record the macropermanently in your QuickTrievesoftware.

4. To use your macro, return tothe starting point for this macro.Press <ALT> <P> to play back themacro. A screen prompt sayingENTER QA # will appear. Enterthe letter or single-digit numberyou named this macro. The entireseries ofkeystrokes will be repeated,making QuickTrieve perform thesame functions you requested ini-tially.

I like to look at my chartson the screen, but not necessarilyprint them. Also,I don't necessar-ily want to study the same markets

e v ery day. C an Qufu kT riev e Auto -mation help me?

It sure can! You can use adifferent macro with various stud-ies for each commodity, stock orgroup oftradeables. The techniquedescribed below keeps you in chargeof the pattem and flow of analysis,but it speeds the process quite a bit.Here is an example of how it might

-werk-fe+1ou..-

You might make many smallmacros that simply add studies tothe chart on the screen. With thistype of macro, you can pick the dataseries for display, then automati-cally add a series of studies such asCSI-STOPSM, RSI and MAC/D, forexample.

To do this, first make a basicchart of any time series. With thechart shown on the screen, beginthe learning process by pressing<ALT> <L>.

The ENTER QA# prompt won'tshow up on a QuickPlot chart, butyour computer will beep. Enter theletter or number you want to namethe macro when you hear the beep.

Go through the normal menus andscreen prompts to add studies toyour chart, then press <ALT> <L>again to mark the end ofyour macro.

You cal repeat the same studieson any chart that is loaded by itselfon a QuickPlot chart. Just press<ALT> <P> when the chart is dis-played, then type the appropriateQA# (or letter) at the beep. Yourstudies will be added to the screenwith lightning speed. E

How do I get started mak-

The basic steos are outlined