ASIA PACIFIC’S PREEMINENT TRADING MAGAZINE

www.traders-journal.com

VOLUME 2 ISSUE 4

Interview with
J. Welles Wilder
FX - Filtering Out
the Noise
Persistency
Paramouncy
Principle
SG$8.80 / A$13.80 / HK$68 / RM$19.80

Trading Tools:
Candlesticks and Crossovers
CBOT’s New $25 ‘BIG’ Dow Product
Selling Options
Action and Reaction Lines
ISSN 1793-2149

MICA (P) 352/05/2005

 CONTENTS

6 FROM THE EDITOR

TRADING FOR A LIVING
8 Welles Wilder is best known for his technical
indicators – now considered to be core indicators
in technical analysis software. These include
Average True Range, the Relative Strength Index,
Directional Movement and the Parabolic Stop and
Reverse

TECHNICAL ANALYSIS
14 Candlesticks and Crossovers
Cornelius Luca, author of several trading books, explains the
advantages of using candles when gauging the validity of
intersections.

18 The Power Of Persistency

Dave Landry, author of several trading books, explains
persistency and how we can use it to trade strong trends.

22 Short-Term Trading with Action and Reaction

Lines
Dr Mircea Dologa, MD, CTA, a commodity trading advisor
(CTA), explains a useful analysis technique.

30 SLIPSIDE
BOOK REVIEW
32 The Risk Doctor Takes the Voodoo Out of Options
Trading
Options Trading: The Hidden Reality by Charles M Cottle
reviewed by Traders’ magazine

BOOK FEATURE - INTERVIEW

34 Interview with Charles M. Cottle
For over twenty five years, Author, Lecturer, Teacher, Floor
Trader, Financial Software Developer, Consultant, and one
of the founders of the second largest options brokerage
in the world, Charles Cottle (The Ri$k Doctor), has made a
career disseminating information on understanding Financial
Services For The Real World.

4 VOLUME 2 ISSUE 4
 BOOK EXTRACT
43 Options Trading: The Hidden Reality by Charles
M. Cottle
Embedded butterflies in Wide Butterflies.

OPTIONS
48 Selling Options: The Real Story
Jim Wyckoff, financial journalist and technical analyst,
explains the advantages and disadvantages of selling
options on futures.

PSYCHOLOGY
50 The Paramouncy Principle – Emotional
Intelligence and the Small Investor
Dr. Mike Elvin, author, explains how the journey to
investment competence is a challenging yet rewarding
path.

TRADING SYSTEM DEVELOPMENT

54 Trading with the Big Boys —Tips and
Strategies for Taking Advantage of CBOT’s New
$25 Dow Contract
John F. Carter, trader, explains the new Dow DJIA $25
Futures Contract and what opportunities and advantages
this offers to traders.

59 Filtering Out the Noise

Doug Schaff, who has traded the FX markets for close
to 30 years, explains how to filter out the noise and how
many confirmations are needed to enter a trade.

MARKET OBSERVATIONS
63 The Kiwi: a global market canary?
Matt Blackman, market analyst for www.TradingEducation.
com, examines some troubling developments in two of
the smallest economies of the OECD.

68 ECONOMIC CALENDAR
70 UPCOMING EVENTS
VOLUME 2 ISSUE 4 5
TRADING SYSTEM DEVELOPMENT
DOUG SCHAFF

Filtering Out
the Noise
Doug Schaff, who has traded the FX markets
for close to 30 years, explains how to filter
out the noise and how many confirmations
are needed to enter a trade
Introduction
At FX-Strategy (FXS) we build technical forex trading sys-
tems to help us and traders like you make profitable trad-
ing decisions. But as good as a trading system is, it is still
only a tool. Even the best trading systems have their limi-
tations. I am going to show you how to filter out market
noise to improve the odds that the trade signals you choose
to act on are profitable ones.
We are going to take a look at a trending market and a
sideways market. In the first market we will try to catch
a trend in progress and in the second we will see if we can
find a market retracement that is about
to occur. In both of these markets I
am going to show you how I confirm
that a trade is worth taking.

Confirming Trend Signals

When I am day trading I like to start
at 7:30 AM EST. Europe is well into
its session and East Coast bank traders
have not yet settled into the office. On
Thursday April 20, I opened up my
charts at 7:45 AM, saw the GBP/USD
falling and that the FXS FAMA 15
System had produced the first of what
would turn out to be several sell signals
that day, as shown in Figure 1.
1. FAMA 15 went short GBP/USD at
1.7889 at 1:30 AM
2. System exited short position at
1.7876 at 2:15 for a 13 pip profit. Figure 1 – GBPUSD 15-minute chart with FAMA 15 System, 19-20 Apr 2006

VOLUME 2 ISSUE 4 59
 TRADING SYSTEM DEVELOPMENT
I like to use FAMA 15 because it
trades with the trend; at least it is de-
signed to do so. And those are the
safer, more reliable trades. Here is
more information on the system.

Introducing FXS FAMA 15

System
In an uptrend FAMA 15 buys at the
FAMA midline, targeting the Hi
Band to take profits. In a downtrend
the system sells at the midline and sets
the Lo Band as a profit target.
Though the system is designed for
15-minute currency charts, traders
have reported that it can be useful in Figure 2 – The Schaff Trend Cycle showed the downtrend was still active.
other timeframes as well. I pulled up a 1-hour GBP/USD chart and applied the
Schaff Trend Cycle (“STC”), as shown in Figure 2. The
Characteristic: Short-Term, Trading with the Trend
STC shows trend momentum, the strength of the trend.
System Indicators: FXS Filters (blackbox) – Identify Trend Direction
The 1-hour STC showed bearish trend momentum. The
FXS – Adaptive Moving Average – Identifies Timing
STC had fallen to zero and stayed there. This confirmed
FAMA Hi Band – Profit Target for Long Positions the bearish trend. As long as this is the case I will take sell
FAMA Lo Band – Profit Target for Short Positions signals that FAMA 15 generates. Note: IF the STC began
Indicator FXS – Adaptive Moving Average: 5,2,0 rising above 25 then I would NOT take a FAMA 15 sell
Parameters: signal.
Timeframe: 15-Minute
The Next Sell Signal: At 8:15, FAMA 15 produced a sell
2005 backtested results for FAMA 15 show the system signal at 1.7824. The STC was still “on the floor” near
produces an average of 19 pips a trade about 70% of the zero on the 1-hour price chart, confirming the signal. I
time. (More information on FAMA 15 is available at went short the Pound.
www.fx-strategy.com)
FAMA 15 sells into a downtrend on
a pullback to the FAMA midline. A
FAMA 15 trading signal gives me
market timing as to when to get into
a moving trend. But on the morning
of April 20th, the Pound was already
at 1.7809. It had been steadily fall-
ing since the day before. Given that
the average daily trading range for the
GBP/USD had been running around
125, and the market had already fall-
en that much, I wanted to be cautious
about selling. Even if a FAMA 15 sell
signal popped up on the screen I was
not going to take it unless I had inde-
pendent confirmation that the strong
downtrend was still active.
To cross-check the trading signal
Figure 3 – The next FAMA 15 sell signal occurs at 8:15.

60 VOLUME 2 ISSUE 4
Trade Entry Recap
A two-step process was used to enter
the trade.
• Identify Prospective Trade – with
FAMA 15 trade signal
• Confirm Trade Signal - using STC
on the 1-hour chart
During the 9:30 pricebar, FAMA 15
exited at 1.7800 for a profit of 24
pips. The 1-hour Schaff Trend Cycle
remained bearish throughout the day
and FAMA 15 caught two more prof-
itable sell trades.

Confirming Range-Trading
Signals Figure 4 – When momentum conditions agree, CT 30 sells at the Upper Price Channel
We saw how the FAMA 15 System + 3 pips and buys at the Lower Price Channel – 3 pips.
trades with the trend, and how to
use the Schaff Trend Cycle (STC) to
confirm its trade signals. Now we are
going to take a look at a range trading
market. A trading system that I like
to use in range-trading markets is the
Channel Trend 30 (“CT 30”). We
are going to look at it on a 30-minute
EUR/USD chart.

Introducing Channel Trend 30

CT 30 uses an 8-bar Price Channel
indicator as shown in Figure 4. A
blackbox momentum indicator is
hidden. The system sells short or ex-
its long positions at the upper price
channel +3 pips. It goes long or exits Figure 5 - Pro Commentary provides high-quality daily Support / Resistance numbers
short positions at the lower channel
– 3 pips.
How Channel Trend 30 Works
2005 backtested results for Channel Trend 30 show that
On April 19th Channel Trend 30 generates two trading
the system produced an average of 21 pips a trade approxi-
signals as shown in Figure 4.
mately 70% of the time. (More information on Channel
Trend 30 is available at www.fx-strategy.com) One was a winner and one was a loser.
• Sell Signal at 3:30 at 1.2359 exited at 8:00 at 1.2332 :
Characteristic: Short-Term Momentum, Range Trading + 27 pips

System Indicators: FXS Filters (blackbox) – Identifies Momentum • Buy Signal at 20:30 at 1.2364 exited at 7:00 April 20
at 1.2324 : - 40 pips
Price Channels – Trade Entry and Exit Points
Is there a simple, reliable indicator that we can use to
Indicator Price Channels (8) cross-check these range-trading signals? Yes there is. Sup-
Parameters: port/resistance levels can be used to confirm or reject trade
Timeframe: 30-Minute signals produced by range-trading systems such as Chan-
nel Trend 30.
VOLUME 2 ISSUE 4 61
 TRADING SYSTEM DEVELOPMENT

Using Support/Resistance as Confirmation • Identify Prospective Trade – with Channel Trend 30

trade signal
I get my support/resistance numbers from Pro Commen-
tary, a daily currency market forecast that covers seven ma- • Confirm Trade Signal - using Support/Resistance Lev-
jor currency pairs. Figure 5 shows the top portion of the els
April 19, 2006 Pro Commentary Report that provided the
support/resistance numbers I used for the EUR/USD that Conclusion
day.
You can significantly improve your trading odds by using
Placing the support/resistance lines on the 30-minute a confirmation process such as the one described above.
Euro chart gives us a basis to cross-check trading signals Practice making trading decisions in a demo trading ac-
as they occur. The bias that day emphasized a resistance count using automated trading systems. Remember that
band between 1.2370 and 1.2400, which is also shown on one of the best qualities trading systems – that they gen-
the chart below. erate automated signals – can also work against them.
Taking a moment, that
second step, to confirm a
trade signal’s validity can
significantly boost the
probabilities of a winner.
You will occasionally re-
ject trades that turn out
to be winners. But you
will avoid low-probabil-
ity trades and come out
better for it.
FAMA 15, Channel
Trend 30 and four oth-
er built-in systems are
available on FX-Strat-
egy Pro Charts on a trial
basis (www.fx-strategy.
com). You can pull up
descriptions on the FXS
trading systems on FX-
Strategy’s website or on
Pro Charts.
Figure 6 – Channel Trend 30 signals with Support/Resistance Levels
For more information
First Trade Signal Confirmed about Pro Commentary, market commentary authored by
Figure 6 shows that the 3:30 sell signal at 1.2359 occurred forex veteran Ian Copsey, please visit the FX-Strategy web-
close to 1.2372 resistance. The 1.2370-1.2400 resistance site at www.fx-strategy.com. Support/Resistance numbers
band is expected to hold. This confirms the Channel in this article are courtesy of Pro Commentary and used
Trend 30 sell signal. Traders can take the trade. here with permission by the author.

Second Trade Signal Rejected All Trader’s Journal readers are welcome to test out Pro
Commentary and Pro Charts, themselves, for free.
The buy signal at 1.2364 that appeared later that day oc-
curred below strong Resistance which had been tested
during the day and held. Buying just before strong Re- Doug Schaff has traded the FX markets for close to 30 years. His
sistance greatly lowers the chances of a successful trade. company FX-Strategy was created to assist currency traders and
Thus, there was no confirmation of the buy signal. The investment advisors with trading decisions. Training courses are
buy trade signal was rejected. available. Please visit his website at http://www.fx-strategy.com
for more information.
Trade Entry Recap
As with FAMA 15, the trade entry process for CT 30 has
two steps:

62 VOLUME 2 ISSUE 4