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The reversal of a long consolidation

In the previous article we emphasized that our primary goal with the MIDAS method is to provide a means of characterizing price   behavior which is based on underlying realities rather than ad hoc empiricism or numerology. This is fundamentally a scientific   question, quite apart from the tactical matter of utilizing such knowledge for trading advantage. In a broad sense we may thus   distinguish between what might be called the scientific and the engineering aspects of MIDAS, where the former encompasses the   quantitave "laws" which give rise to the S/R hierarchies, and the latter refers to practical trading rules and techniques based on this understanding.

We made a start on the engineering side by showing how the "foothills" could be recognized and used as a low risk/high reward   entry point for intermediate term long positions. Here the window of opportunity is quite wide in time since the foothills have a   typical time scale of the order of months and it is merely a matter of scrutinizing a sufficiently large number of stock charts to find   some likely candidates. Once one gets used to spotting foothill behavior in the gentle undulations of conventional bar charts, a few   hours each month leafing through a book of daily basis stock charts will suffice to identify at least 30 or 40 such candidates   justifying further analysis using quantitative MIDAS methods.

The reversal of a long consolidation or bear leg within a primary bull move, via a bounce from S1 or S2 provides an even better   trading opportunity since the gains come much more quickly and the price objectives are well defined. (At a minimum one expects   to reach the nearest resistance level, usually an R1 or R2. If this is penetrated then the next objective is the previous high.) The   window of opportunity is however much shorter, typically a few days to a few weeks. Furthermore, for any given stock there may   only be one or two such opportunities per year.

Thus while MIDAS methods could be used on single stocks to determine good entry points for long positions suggested on   fundamental (as opposed to technical) grounds, the trader will monitor many stocks ( of the order of hundreds ) in order that   sufficient opportunities will be found to keep capital off the sidelines. To facilitate the application of MIDAS to a large universe of   stocks in real time, we have developed some interesting techniques for compressing a fairly complete MIDAS characterization of   a given stock into a few ascii characters.

This is illustrated in the first figure which contains a Midas chart of EMC Corp. By now this should be so familiar that no  commentary is required. (Although one cannot refrain from marvelling at how well the trend reversals are anticipated!). Above the   chart is a single line of ascii characters and its associated legend.

Note the line of dashes bounded by an "l" (for low) and an "h" (for high). This represents a price range extending from 2.63 to   23.38 in this case. The capital "S" denotes the relative position within this interval of the primary support level S1. The   corresponding positions of the secondary and tertiary supports are indicated by lower case "s"'s. The asterisk is the average price   for that particular day. Thus this so-called MIDAS Profile shows the number of S/R levels (resistance levels use "r" instead of "s"),   their relationship to each other and to the latest price, as well as where they all stand in relation to the high and low for the   historical period in question.

Two further features may be simply added to convey even more information. If a given S/R level is particularly well "validated"   (i.e. it has successfully predicted several trend reversals with little porosity), we can underline the symbol as we have done for S2   (or it could be made boldface if the software and printer permit). In addition, if the asterisk should happen to coincide with an S or   an s, we can replace it with a >> or a > (or << or <) respectively. This has the effect of immediately calling attention to the fact   that the price is at an S/R level and perhaps ready to bounce.

In addition to this pseudo-graphical technique, we generate the three ratios defined in the graph. OBVR is an obv ratio measuring   how far the obv has retreated from its peak value. The closer OBVR is to unity, the more bullish the outlook. DIST (standing for   "distension") is a normalized measure of how close the latest price is to S1. SPRD (for "spread") measures the volatility of the   stock over the historical period of study.

Trading rules can be developed based on these three quantities. For example, one can   only enter long positions when OBVR exceeds a certain threshold, DIST is less than another threshold (i.e. close to S1 and ready   to bounce) and SPRD is greater than a third threshold (to weed out stocks that are not volatile enough to have a sufficient potential   reward). Now a neural network trained on these inputs might have some hope of success!

For a group of stocks, one would then generate each day a table such as that shown in the second figure. With a little practise one   can thereby review a few hundred stocks in a matter of minutes to identify interesting opportunities.