eSignal Learning: Trading Education Articles from 2006

Archive of Trading Education Articles

Integrating Andrews’ Pitchfork with Other Tools for Successful Trading
By Dr. Mircea Dologa, MD, CTA, a commodity trading advisor of www.pitchforktrader.com*
Posted: Apr 7, 2006

I firmly believe that a trader’s consistency comes from fully comprehending market context. We cannot take action until we know exactly where we are now, what phase we are in and, especially, where we are going.

I couldn’t agree more with Charles H. Dow, when he said more than 100 years ago, “To know values is to comprehend the meaning of the movements of the market.”

William P. Hamilton, the illuminator of The Stock Market Barometer, and Charles H. Dow’s faithful successor as editor of The Wall Street Journal, enjoyed quoting one of America’s greatest financiers, “If I had 50 percent of all the knowledge that is reflected in the movements of stocks (securities), I am confident that I would be far better equipped than any other man on Wall Street.”

In order to have a global view of the market, and then act locally, we at www.pitchforktrader.com tried to create a synergy between the features of the pitchfork and “other tools”.

Andrews’ Pitchfork

In the beginning of the 1960s, Dr. Alan H. Andrews created a 60-page course, based on the work of Roger W. Babson, that mainly followed the Action and Reaction Newtonian Principle. Figure 1 – The pitchfork is a very ergonomic and prolific tool, showing the patterns of directional movements in direct synergy with slant or horizontal trendlines (shown here: Only daily floor pivots), thus creating, through their intersections, energy clusters.

If we had to synthesize Dr. Andrews’ course into just few lines we could say:

The median line attracts, in a magnet-like manner, the market price.
As the price nears the median lines, it creates, at any one time, one of three movements: Reversal, violent piercing or narrow range. That last one will prepare the next price outburst.

It’s not this author’s intention to provide an exhaustive explanation of Dr. Andrews’ course. I will try, rather, to explain, first, the morphology of the pitchfork, and then, later in the article, its indispensable dynamics.

The geometrical structure of the pitchfork is based on three pivots: P0, P01 and P02 (ensuing highs or lows), chosen in such a way that the constructed formation ideally describes the market (see Figure 1).

Be aware that the intersections of the median lines and other important trend lines are creating the energy clusters, which occur at the levels where the market price is susceptible to reversing or, conversely, to breaking through, with huge bars, at the speed of a freight train.

Once we find the optimal three pivots, we draw the median line (ML) from the anchor (P0) through the middle of the P01-P02 swing. The ensuing upper (U-MLH) and lower (L-MLH) median lines are constructed by drawing parallels to the median line from the P01 and P02 pivots. The further parallel lines to U-MLH and L-MLH are the warning lines, especially needed in highly volatile markets.

The trend lines drawn from P0 to P01, or from P0 to P02, are named the trigger trend lines and dominate in the movement of the market price outside the pitchfork main area. Their breakout indicates low-risk, high-probability trades.

Elliott Wave Principle

It’s not really known if Ralph Nelson Elliott was familiar with Dow’s Theory, which explains the three market movements: The primary trend (tide), secondary reactions (waves) and minor fluctuations (ripples). It can be clearly observed, though, that the Elliott Wave Principle has some roots in Dow’s Theory:

The market moves in waves that are organized in impulsive and corrective patterns.
The five waves of the impulsive pattern are in the direction of the market, where the waves 1, 3, 5 are impulsive and the waves 2 and 4 correct them.
The three waves (named A, B and C) of the corrective pattern are in the opposite direction of the market. Wave B corrects wave A. Wave C continues in the direction of the wave A move.

The Elliott Wave Principle is governed by strict rules and guides:

Wave 3 can never be the shortest wave of the impulsive pattern.
Wave 4 never overlaps wave 1 in the stock market. However, it’s allowed a minor spike overlap of approximately 17 percent in the commodities market.
Wave 2 can never retrace more than 100 percent of wave 1.
An alternate principle is the guardian of the sanctuary, which voids any wave structure that doesn’t comply with the established rules and mainly applies to the architecture of corrective waves and that of the impulsive waves.
Fibonacci ratios are the preferred tools for controlling the lengths of the extensions and retracements of all these impulsive and corrective waves.

Once again, our intention is not to exhaust Elliott’s work in a few lines. After this brief synopsis of his waves’ composition and function, I’ll provide further explanations while I present the specific market movements.

Market Context

As I have already stated, contextual comprehension of the current market is one of the vital guiding principles of a trading life. It provides a basis for market analysis by defining an exact location at a given moment and framed by the market outlook. Moreover, it builds the framework of disciplined thinking. When you do your pre-open preparation, you see the dual facets of the context revealed.

This preparation begins at the end of the previous day’s market and is concluded with a last check-up within the 60 minutes of the pre-open market. Before studying the multiple time frame charts (the first facet of the context), such as weekly, daily and the specific operational time frame (60-, 30-, 15- and 5-minute, for index trading), the trader will concentrate on inter-market analysis (the second facet of the context). The ensuing day’s development will really depend, not only on the fundamentals of the “just closed” market, but also on the “contiguous” markets.

For instance, if you are trading European indices, such as the DAX, FTSE or CAC40, the “contiguous” markets’ conditions are these:

How the S&P 500 closed before the Nikkei 225 opened
What the Nikkei’s 225 afternoon behavior was and how it closed
Whether crude oil’s price is cruising along or attaining extremes (once again)
Whether the U.S. dollar is still battling the Euro
What the BUND’s (German bonds’) fluctuations are

As they say, “Always trade where the sun rises…while the others sleep.”

Larry Williams, a great trader and teacher, once said, “…market movement is a combination of trend, which is a function of fundamental values and considerations, and gut-raw human emotions. Simply put, fundamentals are the father-of-trends and emotions the mother-of-daily fluctuations.”

When you study the weekly, daily and 60-minute charts presented in this article, you see a trending bias. The pre-close of the 5-minute chart reveals an up-sloping pitchfork (Figure 2) with a wave 3 in progress. We can say that the marked is in an overall up-sloping trend, and the price is continuing the impulsive pattern toward the termination of its last wave (W5).

Preparing for the Morning Trades

Once we get the dual facets of the context out of the way, we can then concentrate on detecting our morning low-risk, high-probability trades.

Figure 2 – The Integrated Pitchfork Analysis Framewor

The synergy between the pitchfork and “other tools” defines Integrated Pitchfork Analysis, giving a real edge to the trader. It shows in detail how the market behaves and where it is going.

For purposes of this article, from the multitude of “other tools” that I could have used, I’ve shown Elliott waves and Fibonacci ratios (primary and minor wave projections and retracements), multiple time frame floor pivots (daily, weekly and monthly), energy clusters and Stochastics.

On the pre-close pitchfork shown in Figure 2, the following corroborating factors are the signs of an imminent long entry, after the opening:

A very steep, up-sloping median line
A triple mirror bar pattern at the last reversal zone (the 4082 level)
A zoom and re-test of the warning line n° 3 (the 4084.5 level)
The huge, up-sloping bar, exhibiting the speed of a freight train, closing in its upper quarter
A “holy grail” pullback leaning on our weighted moving average
An overbought Stochastic just after the inception of wave 3
The traditional wave 3 1.618 of the W1 limit not yet reached (The pre-close high at 4090 represents only a 1.500 Fib ratio. Judging by the steep slope of the median line, and the momentum, we can expect an up-sloping morning market reaching at least 2.618 of W1 at the 4103 level while topping the upper median line, or even the upper warning lines.)

I used the primary W1, the minor waves, w1 and w5 of W3, and the prior trend correction Fibonacci ratios to better pinpoint the termination level of wave 3. Seeing a strict pitchfork will imply that the price projection of the ongoing steep slope market move will have enough saved energy to reach the upper warning lines (WL-01 or WL-02). On the other hand, if it fails to attain these levels, it will be a proof of a market up-sloping failure and an excellent opportunity for a low-risk, high-probability short trade.

Execution of a Morning Trade

The ideal pre-arranged entry for the morning trade (Figure 3) is at the 4090.5 level, one tick above the high of the day’s huge last bar (close) level with a stop loss two ticks under the day’s close (the 4087 level). We will try to play with the market’s money as soon as possible.

We will enter a break-even stop with an ensuing cancellation of the already existing stop loss. Its value is one Average True Range bar -- ATR(21) -- having a size of 4 - 6 points on this particular time frame. This value will only guide us in the process of hiding behind an ongoing bar’s low. Its approximate location will probably be at 4095 level (4090.5 +5 points).

The market opens exhibiting an “Oops phenomenon” -- an opening below the prior day’s close, followed by a market counter-move filling of the just-opened gap.

For aggressive traders, there is a possible long trade opportunity that involves entering at the 4088.5 level (one tick above the previous day’s close) with a stop loss at the 4087 level (the opening bar’s low). We have, instead, chosen a more conservative trade.

Figure 3 – The “three pawns technique” is the foundation of consistent trading. It consists of a progressive order of entering the market, as soon as it is propitious, with three types of orders: Trade entry (long here), stop loss order and profit target order.

The first target of two trading units (out of three) is chosen at the multi-level cluster at approximately the 4100 level because the following conditions are observed: Floor pivot cluster (daily R1, weekly and monthly), W3 extension of 2.618*W1 and because the 4100 level is a whole, easily memorized value. Once the exit level is defined, the trader will immediately enter a pre-arranged order. There is no second target. We’ll let the market come to us and be trailed out for the remaining one trading unit.

Figure 4 – The; market shoots straight up, right through the opening. In only 15 minutes (out of 11 hours of daily trading time), it already traveled more than 20 percent of the daily trading range.

As expected, the pre-open, high-steam momentum catapulted the price, in only 15 minutes, right through the target n° 1. I exited with the two trading units at the 4100 level. The remaining one unit is waiting to be trailed out.

Figure 5 – The high-steam market is continuing its move behind the W3 extension of 2.618 of W1.

Figure 6 – The role of Integrated Pitchfork Analysis is clearly shown here; the market’s high-steam momentum was suddenly stopped at the energy cluster formed by the pitchfork’s warning line, n° 2, and the multi-level Elliott wave extensions.

This high-momentum market (Figure 6) was halted at the 4108.50 level, coinciding with a multi-level cluster: The W3 extension of 3.00 of W1, the correction of the prior trend of a 1.382 Fib ratio and an elongated w5 minor wave of W3 ( 9.00 of w5). We can clearly see here that the use of the pitchfork is the primary tool for establishing an energy cluster. The advance of wave 3 stopped exactly at the warning line n°2

Before stopping completely, resulting in a reversal, the market formed a trading range (not seen here), with a “last gasp” move to 4110.5. The upper median line served again as a strong overhead resistance level, causing the reversal of the over-extended wave 3 (3.25 of W1).

Money and Risk Management

Let’s talk a moment about money and risk management. We have expressly chosen a very tight stop loss of 3.5 points (75 euros) instead of the usual 6 to 8 points because of the omnipresent risk of high-steam market momentum. The reward will come to 9.5 points per trading unit, against a risk of 3.5 points, giving a reward / risk (R / R) ratio of 2.7.

One should never trade this volatile futures market using an R / R ratio of less than 2 because of the omnipresent risk of high leverage. Why should you take a high risk? There is always another trade!

Concerning the P&L statement, the total number of trade points is 29.5: 19 points for the first two trading units and 10.5 points for the third, trailed-out unit, an overall amount of 737.50 euros, approximately 870 of current U.S. dollars.

The Successful Trader’s Credo

Every trader should have only one “credo”: In this business you only make money if you don’t consistently lose money. This can only be accomplished through the use of risk control and money management. Most novices don’t understand that the business of trading is the only business where the losses are planned, and it is, in fact, quite normal to lose money -- as long as you have and master the best tool(s) for your kind of market.

*Originally published in The TRADER’S Journal, January / February 2006. Reprinted (and modified) with permission from Dr. Mircea Dologa, MD, CTA, a commodity trading advisor and founder of a new trading concept for young and experienced traders alike at: www.pitchforktrader.com.