EURUSD Warning Signs

EURUSD is making a comeback for the past few trading days. It has risen above its 20 day moving average which is a positive indication. The MACD indicator is still above its signal line showing that bulls still have the upper hand. But we should not lose sight of the big picture. If you look at the down swing from 25 Nov 2009 to 7 Jun 2010, the currency pair traded from its low in Jun 2010 to re-trace around 61.8% of the complete down swing. This coincides with the Fibnoacci Retracement rule and it still shows that the long term trend for this currency is still to the downside. However, we cannot ignore the fact that the currency is making higher lows and higher highs for the past few months. The danger is for the currency pair to fall below 1.30 level. This will violate the higher high and higher pattern. The 2 day RSI is approaching overbought levels and we will likely see the price testing its 20 day moving average in the next few trading days.

STI Trend Score System

I have covered this method in my previous posting.  I am repeating it here for readers that have missed out on this simple indicator that can be used for trading index ETF like STI ETF.

This is a trend indicator that was derived by by Tuschar Chande. It is a method of rating the trend by comparing the current day’s close to the close x days ago.

If today’s close is greater than close x days ago, score = 1

If today’s close is less than the close x+1 days ago, score = -1

Tuschar Chande suggested comparing the close to the closes from 11 to 20 days ago.

Therefore,

Trendscore = 10 day sum of the scores from days 11 to 20.

The trend score for this case will oscillate between +10 to -10.

The metastock formula is given below:
If(C>=Ref(C,-11),1,-1)+
If(C>=Ref(C,-12),1,-1)+
If(C>=Ref(C,-13),1,-1)+
If(C>=Ref(C,-14),1,-1)+
If(C>=Ref(C,-15),1,-1)+
If(C>=Ref(C,-16),1,-1)+
If(C>=Ref(C,-17),1,-1)+
If(C>=Ref(C,-18),1,-1)+
If(C>=Ref(C,-19),1,-1)+
If(C>=Ref(C,-20),1,-1)

Let’s say that we buy 1 lot of Straits Times Index (STI) when the Trendscore reaches +10 and exit the trade when Trendscore becomes negative.

The trade record is given below:

Position	Entry Date	Entry Price	Exit Date	Exit Price	% Change
Long	12-Jan-07	2995.35	1-Mar-07	3133.88	4.62
Long	15-Feb-07	3222.98	1-Mar-07	3133.88	-2.76
Long	28-Mar-07	3224.55	11-Jun-07	3530.38	9.48
Long	4-May-07	3477.9	11-Jun-07	3530.38	1.51
Long	13-Jun-07	3530.12	27-Jun-07	3513.5	-0.47
Long	15-Jun-07	3601.05	27-Jun-07	3513.5	-2.43
Long	16-Jul-07	3679.97	30-Jul-07	3467.36	-5.78
Long	23-Jul-07	3627.97	30-Jul-07	3467.36	-4.43
Long	6-Sep-07	3374.01	23-Oct-07	3670.21	8.78
Long	11-Dec-07	3583.32	18-Dec-07	3301.42	-7.87
Long	2-Apr-08	3046.54	23-May-08	3160.86	3.75
Long	23-Apr-08	3187.23	23-May-08	3160.86	-0.83
Long	28-Apr-08	3189.2	23-May-08	3160.86	-0.89
Long	5-May-08	3236.1	23-May-08	3160.86	-2.33
Long	14-May-08	3203.42	23-May-08	3160.86	-1.33
Long	16-May-08	3207.43	23-May-08	3160.86	-1.45
Long	11-Dec-08	1821.7	13-Jan-09	1776.25	-2.49
Long	17-Dec-08	1782.09	13-Jan-09	1776.25	-0.33
Long	26-Dec-08	1736.99	13-Jan-09	1776.25	2.26
Long	5-Jan-09	1829.71	13-Jan-09	1776.25	-2.92
Long	24-Mar-09	1664.08	19-Jun-09	2237.2	34.44
Long	24-Apr-09	1859.98	19-Jun-09	2237.2	20.28
Long	1-May-09	1920.28	19-Jun-09	2237.2	16.5
Long	28-May-09	2306.08	19-Jun-09	2237.2	-2.99
Long	16-Jul-09	2389.42	19-Aug-09	2567.72	7.46
Long	9-Sep-09	2660.91	5-Oct-09	2604.53	-2.12
Long	17-Sep-09	2674.42	5-Oct-09	2604.53	-2.61
Long	15-Oct-09	2708.48	29-Oct-09	2648.98	-2.2
Long	12-Nov-09	2740.43	22-Jan-10	2850.98	4.03
Long	3-Dec-09	2796.34	22-Jan-10	2850.98	1.95
Long	14-Dec-09	2800.75	22-Jan-10	2850.98	1.79
Long	23-Dec-09	2823.82	22-Jan-10	2850.98	0.96
Long	24-Feb-10	2782.55	29-Apr-10	2932.04	5.37
Long	2-Mar-10	2774.06	29-Apr-10	2932.04	5.69
Long	9-Mar-10	2834.57	29-Apr-10	2932.04	3.44
Long	5-Apr-10	2943.02	29-Apr-10	2932.04	-0.37
Long	26-Apr-10	2988.49	29-Apr-10	2932.04	-1.89
Long	17-Jun-10	2846.94	13-Aug-10	2927.04	2.81
Long	9-Jul-10	2897.15	13-Aug-10	2927.04	1.03
Long	6-Sep-10	3011.03	28-Oct-10	3124.38	3.76
Long	3-Nov-10	3205.28	24-Nov-10	3126.3	-2.46

The net gain from 2007 to 2010 is around 88% (excluding transaction costs).

How To Identify Strong Or Weak Stocks

In momentum trading, traders pick the strong stocks to go long and weak stocks to go short.    However the key question here is how do you determine if a stock is a strong stock or a weak stock?  

You should be able to tell from the price chart if a stock is looking strong.  For example if a stock keeps making higher low and higher high, it falls into the strong stock category.  By the same token, if the stock is making lower high and lower low, it is considered a weak stock.

A more mathematical method is to compute the distance between the current closing price and its 52 week’s price high and price low to determine which is the stronger and weaker stock trading in the market. 

The formula is as follows:

            Strength = (52 week high – closing price)/52 week high

           

            Weakness = (closing price – 52 week low)/52 week low

If you compute the Strength and Weakness value for every stock trading in the exchange and sort it based on its Strength and Weakness, you get a list of strong and weak stocks respectively.

Based on the 7 Dec 2010 closing price of the 500 stocks in the S&P500 index, the list of strong stocks is:

Symbol	Strength	Close	Sector	Industry
CVX	0.003809237	86.30000305	Basic materials	Major integrated oil and gas
IFF	0.005945979	55.16999817	Basic materials	Specialty chemicals
PX	0.008431655	94.08000183	Basic materials	Synthetics
PPG	0.006667501	80.44999695	Conglomerates	Conglomerates
HRL	0.003592821	49.91999817	Consumer goods	Meat products
MKC	0.008097189	46.54999924	Consumer goods	Processed and packaged goods
CCE	0.008907806	25.59000015	Consumer goods	Beverages - soft drinks
XRX	0.009189692	11.85999966	Consumer goods	Business equipment
AMP	0.006901581	54.68000031	Financial	Asset management
AON	0.007722011	43.68999863	Financial	Insurance brokers
MMC	0.008971954	26.51000023	Financial	Insurance brokers
TMK	0.009245737	61.08000183	Financial	Life insurance
BIIB	0.002971281	67.11000061	Healthcare	Biotech
KG	0.004210556	14.18999958	Healthcare	Drug manfacturers - others
BDX	0.005985165	81.37999725	Healthcare	Medical instruments and supplies
ROP	0.002734462	76.58999634	Industrial goods	Industrial equipment and components
PLL	0.007170708	48.45999908	Industrial goods	Diversified machinery
SNA	0.007656701	55.72999954	Industrial goods	Small tools and accessories
ROK	0.008409406	69.56999969	Industrial goods	Industrial electrical equipment
FISV	0.001701587	58.66999817	Services	Business services
CHRW	0.004169377	76.43000031	Services	Air delivery and freight services
COST	0.005994836	69.63999939	Services	Discount variety stores
EXPD	0.006355943	56.27999878	Services	Air delivery and freight services
MCD	0.007412974	80.33999634	Services	Restaurants
ESRX	0.008229714	54.22999954	Services	Management services
AKAM	0.004964156	54.11999893	Technology	Internet information providers
ADI	0.006820523	37.86000061	Technology	Semiconductor - integrated circuits
TXN	0.006837085	33.40999985	Technology	Semiconductor - broad line
CPWR	0.007023698	11.31000042	Technology	Application software
A	0.007919726	37.58000183	Technology	Scientific and technical instruments

The list of weak stocks is:

Symbol	Weakness	Close	Sector	Industry
EOG	0.08708655	92.70999908	Basic materials	Independent oil and gas
CLX	0.080508095	62.18000031	Conglomerates	Conglomerates
DF	0.036465603	7.389999866	Consumer goods	Dairy products
K	0.051353151	48.90999985	Consumer goods	Processed and packaged goods
CAG	0.057359735	22.01000023	Consumer goods	Processed and packaged goods
GIS	0.066244774	35.04000092	Consumer goods	Processed and packaged goods
CL	0.076454904	78.16999817	Consumer goods	Personal products
CPB	0.079652261	33.90000153	Consumer goods	Processed and packaged goods
BAC	0.061467899	11.56999969	Financial	Regional - Mid atlantic banks
HCBK	0.069451875	11.97999954	Financial	Savings and loans
PBCT	0.070491854	13.06000042	Financial	Savings and loans
FHN	0.082618078	10.09000015	Financial	Regional - Southeast banks
AMGN	0.057103121	53.13000107	Healthcare	Biotechnology
ISRG	0.059337495	260.6499939	Healthcare	Medical appliances and equipment
ABT	0.060284018	46.88999939	Healthcare	Drug manufacturers - major
THC	0.076530538	4.21999979	Healthcare	Hospitals
ZMH	0.086449102	50.27000046	Healthcare	Medical appliances and equipment
LLY	0.09435657	34.11000061	Healthcare	Drug manufacturers - major
LMT	0.037046919	69.44999695	Industrial goods	Aerospace/Defense products and services
PHM	0.083197348	6.639999866	Industrial goods	Residential construction
BIG	0.002465646	28.45999908	Services	Discount variety stores
SVU	0.015853673	8.329999924	Services	Grocery stores
SAI	0.067249496	15.86999989	Services	Technical services
RSH	0.084268381	18.94000053	Services	Electronics stores
KR	0.093890482	20.68000031	Services	Grocery stores
CSCO	0.020526284	19.38999939	Technology	Networking and communication devices
NRG	0	18.85000038	Utilities	Electric Utilities
CEG	0.011255981	28.29999924	Utilities	Electric Utilities
ETR	0.022687719	70.41000366	Utilities	Electric Utilities
FE	0.090864527	35.56000137	Utilities	Electric Utilities

You can derive some basic information based on the list.  For example, the Utilities sector is not doing well whereas Technology sector has more strong stocks.  

Investment Madness

We are all prone to having psychological preconceptions or biases that make us behave in certain ways.  These biases influence how we assimilate the information we come in contact with on a daily basis.  They also have an impact on how we utilize that information to make decisions.

Our very own psychological biases have an impact on our investment decisions and affect our attempts at building wealth.

Psychological Bias	Effect on Investment Behavior	Consequence
Overconfidence	Trade too much.  Take too much risk and fail to diversify	Pay too much in commissions and taxes.  Susceptible to big losses
Attachment	Become emotionally attached to a security and see it through rose-colored glasses	Susceptible to big losses
Endowment	Want to keep the securities received	Not achieving a match between your investment goals and your investments
Status Quo	Hold back on changing your portfolio	Failure to adjust asset allocation and begin contributing to retirement plan
Seeking Pride	Sell winners too soon	Lower return and higher taxes
Avoiding Regret	Hold losers too long	Lower return and higher taxes
House Money	Take too much risk after winning	Susceptible to big losses
Snake Bit	Take too little risk after losing	Lose chance for higher return in the long term
Get Even	Take too much risk trying to get break even	Susceptible to big losses
Social Validation	Feel that it must be good if others are investing in the security	Participate in price bubble which ultimately causes you to buy high and sell low
Mental Accounting	Fail to diversify	Not receiving the highest return possible for the level of risk taken
Cognitive Dissonance	Ignore information that conflicts with prior beliefs and decisions	Reduces your ability to evaluate and monitor your investment choices
Representativeness	Think things that seem similar must be alike.  So a good company must be a good investment	Purchase overpriced stocks
Familiarity	Think companies that you know seem better and safer	Failure to diversify and put too much faith in the company in which you work

If you want to read more regarding human psychology and how it affects our trading and investment, please read the book “Investment Madness How Psychology Affects Your Investing and What to Do About It” by JOHN R NOFSINGER.

Smoothing The Bollinger %b

Bollinger bands were developed by John Bollinger and it consists of 3 lines derived from the moving average and standard deviation of closing price.

Sylvain Vervoort, a Belgium based retired electronics engineer who has been using technical analysis for more than 30 years, came out with an indicator SVE_BB that takes the Bollinger band and converts it to an oscillator that range between 0 and 100 (with overshoots).

The Metastock formula for SVE_BB is

period:= Input("%b period:",1,100,18);

TeAv:= Input("Tema average:",1,30,8);

haOpen:= (Ref((O+H+L+C)/4,-1) + PREV)/2;

haC:= ((O+H+L+C)/4+haOpen+Max(H,haOpen)+Min(L,haOpen))/4;

TMA1:= Tema(haC,TeAv);

TMA2:= Tema(TMA1,TeAv);

Diff:= TMA1-TMA2;

ZLHA:= TMA1+Diff;

percb:= (Tema(ZLHA,TeAv)+2*Stdev(Tema(ZLHA,TeAv),period)-Mov(Tema(ZLHA,TeAv),period,WEIGHTED))/(4*Stdev(Tema(ZLHA,TeAv),period))*100;

percb;

This indicator is often a leading indicator with smooth and clear turning points.  Bullish and bearish divergent signal is helpful in identifying entry and exit points. 

Let’s take a look when this indicator is applied to Sembcorp Marine.

Sembcorp Marine broke out of the Bollinger band in early October and it has managed to blow past the $5 mark to reach a high of  $5.20 on 10 Nov.   The stock has pulled back slightly and it looks set to test the 20 day moving average which is at $4.70 level.

The SVE_BB indicator did not make a new high together with the up swing.  This is a warning signal.  If this divergence coincides with a break of support level, it will be a strong indication of further down moves. 

The stock has to stay above the 20 day moving average.  If it breaks this line, the next support line is at $4.50.  

Two-bar Breakout System (2BB)

The 2 bar breakout system is designed to capture short term trends by going long or short depending on the pattern formed by the 2 most recent price bars.  The essence of this method is to look for reversal of the immediate directional momentum.

The rules of this method are:

Long trades

Enter:

1. Today’s low is less than the previous day low
2. Today’s high is less than the previous day high
3. Today’s close is less than the open
4. Go long at the next trading bar if the price goes above today’s high + 1 tick

Exit:

1. Use a trailing stop at previous day’s low

  

Short trades

Enter:

1. Today’s low is greater than the previous day low
2. Today’s high is greater than the previous day high
3. Today’s close is greater than the open
4. Go short at the next trading bar if the price goes below today’s low - 1 tick

Exit:

1. Use a trailing stop at previous day’s high

To see this method in action, let’s try it out on EURUSD currency pair. 

For long trades, the trading record is as such:

Position	Entry Date	Entry Price	Exit Date	Exit Price	Bars Held	Profit/Loss (pips)
Long	5/7/2009	1.3374	5/11/2009	1.3615	3	241
Long	5/18/2009	1.3486	5/25/2009	1.4016	6	530
Long	6/23/2009	1.3936	6/29/2009	1.4044	5	108
Long	7/9/2009	1.3938	7/13/2009	1.3941	3	3
Long	8/18/2009	1.4171	8/24/2009	1.4329	5	158
Long	8/27/2009	1.4349	8/31/2009	1.4281	3	-68
Long	9/30/2009	1.4646	10/1/2009	1.4574	1	-72
Long	10/8/2009	1.4737	10/9/2009	1.4703	1	-34
Long	10/29/2009	1.4841	11/1/2009	1.471	2	-131
Long	11/2/2009	1.4742	11/3/2009	1.4702	1	-40
Long	11/4/2009	1.4811	11/9/2009	1.486	4	49
Long	12/23/2009	1.4332	12/28/2009	1.4356	3	24
Long	12/31/2009	1.4361	1/4/2010	1.4315	2	-46
Long	1/13/2010	1.4546	1/14/2010	1.4454	1	-92
Long	1/22/2010	1.4144	1/25/2010	1.4147	2	3
Long	2/26/2010	1.3571	3/1/2010	1.3614	2	43
Long	3/10/2010	1.3636	3/15/2010	1.3758	4	122
Long	3/16/2010	1.3774	3/18/2010	1.3724	2	-50
Long	3/26/2010	1.3388	3/29/2010	1.3434	2	46
Long	5/27/2010	1.2345	5/30/2010	1.2267	2	-78
Long	6/7/2010	1.1966	6/17/2010	1.2252	9	286
Long	6/30/2010	1.2291	7/5/2010	1.2542	4	251
Long	7/6/2010	1.2558	7/9/2010	1.2623	3	65
Long	7/13/2010	1.2646	7/19/2010	1.2888	5	242
Long	7/22/2010	1.2914	8/4/2010	1.3145	11	231
Long	10/5/2010	1.3785	10/8/2010	1.3855	3	70
Long	10/28/2010	1.3879	11/1/2010	1.3955	3	76
				Total		1937

The method generated 27 long signals with 18 profitable trades giving a total return of 1937 pips.