Long Term Secrets To Short-Term Trading

Figure 3.10 Using timing to increase our profits. 
The legendary Jesse Livermore said it best, "It was never my thinking that did it for me, it was my 
sitting that made the big money. My sitting!" 
He added, "Men who can be right and sit tight are uncommon." 
What I am trying to get across to you is that catching the big swing (within the time frame you are 
trading) is the only way I have been able to make millions of dollars trading. I finally figured out that I had 
to let my profits run to be able to pay off the losses that are as natural to this game as breathing is to life. 
Losses will most absolutely come to you. That is a given, 
Figure 3.11 The timing makes all the difference. 

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it will happen, which gives rise to the obvious question, what can we do to offset these chunks out of our 
rear end? There are only two ways to overcome this negative, we must either have a very low percentage of 
losing trades and/or a substantially higher average profit than loss. Time, and time alone, will give you 
larger profits, not thinking, not fancy dancing, not trying to buy and sell every top and bottom. That is a 
fool's game. It is not a matter of opinion-it is provable, as the simple system presented in this chapter so 
clearly demonstrates. 
By now, you should have learned how the market moves, the three most dominant time cycles, and be 
developing a sense, or feel, for the underlying order in what appears to be chaos. But most of all, you 
should have learned to hold on to winners to the end of the time frame you are trading for. In my case, I'm 
trading for 2-to 5-day swings. Whenever my greed factors have convinced me to take a quick profit-or 
overstay my time period-I have paid dearly. 

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Chapter 4 
Volatility Breakouts 
The Momentum Breakthrough 
Necessity may, or may not, be the mother of nvention, but for sure it is the fatber of taking chances. 
Momentum is one of the five concepts that can bring us short-term trading profits. It is what Newton 
was talking about when he said an object once Set in motion tends to stay in motion. So it is with stocks 
and commodities: once price starts to move, it will most likely keep going that direction. There are almost 
as many ways to measure momentum as there are traders. I will not delve into all of them, just the ones I 
have found to work, and the concept, I trade with. There are other approaches; any one with a fertile mind 
should be able to go past where I have. Mathematicians, this is the chapter where you can bring all your 
techniques, concepts, and formulas to play. This is where you have a distinct advantage over those of us 
limited to basic addition. multiplication, and subtraction. 
I doubt that anyone fully understood how the markets work until the mid-1980s. Sure, we knew about 
trend; about overbought and oversold markets; about a few patterns, seasonal influences, fundamentals, 
and the like But we really did not know what caused trend or, more correctly put. how it began and ended. 
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We do now and it is time for you to learn this fundamental truism of price structure and movement. 
Trends are set in motion by what I call "explosions of price activity." Succinctly, if price, in one hour, 
day, week, month (pick your time frame for trend identification) has an explosive move up, or down, the 
market will continue in that direction until there is an equal or greater explosive move in the opposite 
direction. This has come to be known as an expansion in volatility and verbally captured by the phrase 
coined by Doug Brie "volatility breakout," based on my early 1980 work. 
It gets down to this, price has an explosive breakout, up or down, from a center point. That is what sets 
or establishes the trend. Thus we have two problems; first, what do we mean by an explosive breakout (how 
much of an up or down move), and second, from what point do we measure this expansion in price? 
Let's start with the beginning, what set of data should we use to measure the expansion? 
Since my working thesis is that we need a very quick explosion of price change I like to use daily range 
values-the difference between the day's high and close. This value shows how volatile the market has been 
each and every day. It is when this volatility increases out of recent proportion that trends change. 
There are several ways of taking this measure. You might use the average range for the last X 
number of days, various swing points, and the like. Bi and large though, I have found that using just 
yesterday's range as my cornparison of volatility works wonders. Let's say yesterday's range was 12 cents in 
Wheat. If today's range exceeds that range by some percentage. the trend probably changed, at least that is 
the way to wager. This would be a clear in dication price has had a new impetus driving it in a direction, and 
price. Like any object once set in motion, tends to stay in the direction of that motion. 
It is really as simple as that, a pickup in range, substantially greater than yesterday's range implies a 
change in the current market direction. 
That also leads to the second problem: From what point do we measure the expansive move, up or 
down? most traders think we should measure from today's closing price. That is typical thinking; we usually 
compare price change from close to close. But it is not the correct answer. I will get to that in a moment, but 
first let's consider points from which to measure this expansion: we could use the close, the average price of 
the current day, or perhaps today's high for a buy or today's low for a sell. 
Let's look at the very best results of several nonrelated commodities using a variety of points for 
measuring the explosion. Table 4.1 shows buying tomorrow at a percentage of today's range added to 
today's close. The data, listed in order, shows the commodity, percentage of range, dollar profit. accuracy, 
and average profit per trade. 

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In this table I have even provided the best percent of the previous day's range to add to the close for a 
buy and to subtract for a sell. In this, and all data shown, no stop was used and you were always long short. 
This table shows only the best percent volatility add-ons for buys and subtracts for sells; and again in 
the data for Table 4.1, we added the volatility factor or filter to the previous day's close. Using cattle as an 
example, if price rallied 70 percent of the previous day's range above the close, we bought and sold short at 
50 percent of the day's range subtracted from the close. 
Next, look at buying tomorrow at a percentage of yesterday's range added to yesterday's high or 
subtracting that same amount from yesterday's low for a sell signal (see Table 4.2). 

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Although this concept makes money, again on the best-fit basis, it does not do as well as adding or 
subtracting a value from the close. A simple way to compare the results is to determine the size of the 
average profit per trade. In the add-to-the-close method, it is $327 a trade and $313 for the add-to-the-high 
and subtract-from-the-low technique. 
The next set of data adds a percentage of today's range to tomorrow's open and buys there for a long 
entry or subtracts a percentage of today's range from the opening for a sell. The results appear in Table 4.3. 
A careful look at the data shows us the average profit per trade is higher at $389 and the accuracy is 
also higher; five commodities in this test showed an accuracy of 50 percent or higher while none of them did 
in the first two tests. 
My conclusion is that the best point to add or subtract a volatility expansion value to is tomorrow's 
open. I have always traded this technique with the open, but in preparation for this book, I did the preceding 
tests to see whether my judgement was right and was pleased to see facts fit my intuitive conclusion. 
As short-term traders, we can use this concept to tell us there is a high probability of a further extension 
of price we can capitalize on. I will not trade just because of such an entry but will use this as my entry 
technique when the time and conditions are correct. 
Of all the trend entry approaches I am aware, from moving averages to trendlines, oscillators to Ouija 
boards, and fancy math to simple charts; I have never seen a more consistently profitable mechanical entry 
technique than volatility breakouts. It is the most consistent of all entries I have ever traded, researched or 
seen. Now let's look at some ways of using this basic concept. 

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Simple Daily Range Breakouts 
From the preceding we have learned that we should add our breakout value to tomorrow's opening. 
Now the questions begin; What's the best value?. There are several good ones, but the simplest is to take 
today's range adding a portion of it to tomorrow's opening. Just that simple approach has been a consistent 
moneymaker since I first discovered it almost 20 years ago. 
It is now time to go a bit beyond these results and create a trading model that is actually tradable (i.e., 
it makes money in an acceptable fashion). Figure 4.1 shows the result of buying and selling bonds on the 
open every day at a distance of 100 percent of the previous day's range above the open for a buy and 100 
percent below the open for a sell. 
A protective stop of $1,500 or 50 percent of the previous day's range subtracted from our entry is used 
as our protective stop while our exit is the Bail Out or the first profitable opening after entry technique. 
This does make money, $73,468 with 80 percent accuracy on 651 trades. On average, the system makes 
$7,000 a year and would require a $13,000 bankroll to net the 70 percent a year gain. The drawdown of 
only $10,031 is quite good for such a basic system. A problem can be seen in that the average profit per 
trade is only $112.86; this needs to be higher. The data set is from 1990 through August 1998. 
Any idea how we might accomplish such a lofty goal? For now, let's try our basic TDW (Trade Day 
of Week) strategy to see what happens if we only