Anticipating the Trend

ANTICIPATING THE TREND

TD SEQUENTIAL, TD COMBO, AND TD SETUP TREND

Of all the indicators we have created, TD Sequential, TD Combo, and TDST are certainly the most versatile. Their utility and accuracy in identifying long-term low-risk price reversal zones have withstood the test of time and the evolution of many markets. With the advent of computer technology, we have been able to take these indicators a step further to uncover a host of trading abilities and applications previously unimaginable. Much to our surprise, not only have these indicators demonstrated that they are effective low-risk, long-term trading methods, but also that securities and their related options can be applied intraday with remarkable precision.

Markets that have recorded yearly or all-time price highs within the last few weeks can be traded with the long-term upside trend since that is the path of least resistance. Think of this trading opportunity as a rare experience, since at an all-time price high no one who has ever bought this market has endured a loss, and therefore there is limited overhead supply from disenchanted buyers; any pullback presents a trader with a buying opportunity within a reactionary mode. Conversely, at an all- time or yearly market low, no one who has purchased the market is enjoying a profit and consequently any rally should be viewed as a selling opportunity. Similarly, when the overall market or index is at a yearly price low and simultaneously a specific market is demonstrating strength by trading at its high for the year, a clear message is being sent that should the market reverse higher, the strong market should be a distinct leader and outperform others. Likewise, when the overall market or index is at a yearly price high and simultaneously a specific market is demonstrating weakness by trading at its low for the year, this is a clear indication that once the overall market reverses lower, the individual weak market should underperform the overall market and possibly become a casualty of the economy.

The situations cited in the previous paragraph are ideal opportunities for traders involved in trading the trends of underlying securities over an extended period of time, but not as proxies or options representing these markets on a day-trading basis. Sooner or later, however, the trend will exhaust itself and price will reverse. Once a trader purchases an option contract the trading game of “beat the clock” commences. In many instances, the market will do what the trader wants it to do. However, the important question is, will it do it within the lifetime of the option contract? Because timing is so critical in determining when to purchase an option contract, it is extremely important that purchase be deferred until the market is prepared to reverse its trend. It is senseless to buy an option and then wait weeks for the market to move because time premium evaporates so quickly. Conversely, it serves no purpose to purchase an option after the underlying market has already recorded a price reversal, the new trend has been established, and the momentum is accelerating. The obvious change in trend has more than likely attracted numerous buyers who are aware of the change and their aggressiveness should significantly increase the value of an option’s premium beyond any intrinsic value.

Because the timing of the purchase of the option contract is so important, it is necessary to apply market timing indicators which will identify to traders ideal low-risk and low-premium entry points. One such indicator designed to accomplish this is TD Sequential. We developed TD Sequential and TD Combo over 25 years ago as a method of identifying when a market has reached a point of trend exhaustion. TD Sequential and TD Combo are price anticipatory indicators designed to buy into price weakness and to sell into price strength. These indicators’ greatest features include their objectivity, as well as the fact that their calculations and results are mechanical and reproducible. Another advantage is that they can both be applied to any market without the necessity of optimizing its parameters—there is no need to implement different settings for different markets. The parameters are universally set and applied regardless of whether the investor trades stocks, futures, indices, or foreign markets. One of the other features of TD Sequential and TD Combo is that they have both withstood the test of time very well. Whether the environment was a bull market, a bear market, or a trading range market, these two indicators have performed effectively throughout the years. Finally, TD Sequential and TD Combo have been proven to work well over several different time periods, from monthly and weekly charts all the way down to the lowest common time denominator, one-minute charts. Their versatility enables a trader to either day trade or position trade with both consistency and accuracy. In theory, a series of market perspectives from months and weeks could be coordinated with similar readings all the way down to a five- and one-minute basis. Nevertheless, calculating a daily TD Sequential or a TD Combo reading and then combining it with the one-minute activity is reasonable and easily accomplished. In fact, as a floor trader on the Chicago Board of Trade, T.J. successfully applied these indicators to the financial futures on a one-minute price activity basis to identify potential low-risk short-term price reversal levels. Similarly, day trading options works very well when utilizing TD Sequential and TD Combo, particularly in more active, volatile, and liquid markets.

Before you decide to quit your job and curse out your boss—thinking these indicators will deliver an obscene amount of profits—keep in mind that TD Sequential and TD Combo are indicators, not systems per se and are by no means the Holy Grail of trading or the perfect market timing tools. We’ll tell you right now, they are not going to anticipate market turning points every time, nor will they be correct every time. In fact a long-standing, light-hearted criticism expressed by both authors has been the fact that TD Sequential has successfully predicted “10 out of the last 7 market price reversals” implying that 3 were likely premature and consequently wrong. Despite this perceived shortcoming, we believe no other indicators are capable of anticipating market tops and bottoms as consistently as TD Sequential and TD Combo have over the past 25 years. The distinct advantage of these related trading tools is that they are designed to sell unemotionally into market strength and buy into market weakness regardless of news, fundamental outlook, or any other factor unrelated to market dynamics. Provided a trader applies uniform parameter settings for the indicators over all markets and time periods, practices sound money management, and is capable of controlling his or her emotions, then these indicators should become an important trading companion, greatly contributing to a trader’s success.

A large portion of any trader’s success is attributable to his or her method of money management. Controlling one’s losses and allowing one’s profits to run is a lesson which is easy to teach but unusually difficult to learn and practice. Most books devoted to trading fail to emphasize the importance of riding at least a portion of a market trend. Option trading using TD Sequential and TD Combo provides an objective and mechanical dimension to trading which complements sound money management principles. The advantage of option trading with TD Sequential and TD Combo is that a position can be taken for far less money, or a much larger position can be taken with the same initial capital outlay. In addition, since the maximum loss of a long option is simply the initial cost of the position, the option acts as an inherent stop loss. Because these losses are predetermined by the trader at the time the long option position is initiated, price drawdowns in the underlying asset are not as threatening. Therefore, oftentimes options provide more leeway, and consequently more comfort, to traders than owning the underlying asset—the trader can hold an option position for a longer period of time without worrying about the financial impact of an adverse price move, since the trader’s risk is defined at the time the option is purchased. If entry is premature, and price continues to move against the option position, a trader need not worry about exiting the position due to accruing losses and missing out on the desired price move, since the option conveys its trading rights for a specified time period with a defined risk level, regardless of the price of the underlying security. Selecting the time frame in which to apply these two indicators is left totally to the trader’s discretion. However, if a trader prefers to hold positions for periods longer than a couple of trading days, then daily low-risk TD Sequential and TD Combo opportunities should be monitored. If a trader desires to be actively trading intraday, then it is prudent for him or her to follow one-minute TD Sequential and TD Combo activity. This choice is up to the trader, but operating intraday should be performed within the context of the bigger picture—by requiring intraday (one-minute) TD Sequential or TD Combo entries to conform to the daily indications, the results will often provide the reinforcement a trader needs to participate with the market’s flow. Regardless of his or her preferred operating time horizon, an option buyer has the ability to time option market entries effectively and anticipate expansions in a call’s premium off a market low and expansions in a put’s premium off a market high by applying TD Sequential and TD Combo.

TD Sequential and TD Combo can be utilized to anticipate not only price reversals in the underlying stock, but also reversals in options as well. Although not always possible and definitely not required, these indicators can be applied to the option trading activity much like they are to the underlying security. In the past, we have relied upon the activity of the underlying security to dictate the TD Sequential low- risk entries or the TD Combo low-risk entries and then, in turn, we have applied the results to the option market. This was more a matter of option chart availability and convenience rather than choice. Due to the fact that the option charts are more readily available today, when trading options we occasionally look for both to confirm, or at least if one chart passes our qualifications’ test, the other chart should produce similar indications since the option follows the activity of the underlying security. If one were to apply TD Sequential or TD Combo directly to an option, we suggest it be utilized on the more liquid and actively traded expirations and strike prices.