Wednesday, August 6, 2008

Trading Stocks Without Predicting the Future

A few weeks ago, Stockcharts.com introduced Renko charts, and, since that time, I have really developed an appreciation for this charting style. Renko charts, like candle charts, are a Japanese charting style. Renko charts differ in that they do not factor in the passage of time, and, thus, only use price in their construction.

I feel that Renko charts can be used very effectively to determine trends. The chart below is a monthly Renko chart of the Canadian financial sector and goes back three and a half years:


Outlined in the chart above is a buy and sell system that I am using in my own trading. The system has the following rules:

  • Buy signals are generated when the price is in a column of 4 white bricks or more and above the moving average line.
  • Buy signals are removed when your long position moves against you by 4 bricks
  • Sell signals are generated when the price is in a column of 4 dark bricks or more and below the moving average line
  • Sell signals are removed when the short position moves 4 bricks against you

By following these simple rules, the areas shaded yellow you would be long, the areas shaded in orange you would be short, and the area where there is no shading you would be neither long or short.

Although these rules are simple, they allow a trader to gain an edge in that they will allow you to:

  • Buy strength in bull markets
  • Short sell weakness in bear markets
  • Avoid getting involved with weak counter-trend moves (like what we have now in financials)
  • Cut losses short
  • Let winners run
  • Separate emotions from decision making
  • Avoid hours of analysis or try to predict the future

I sense that most traders are hesitant to following such a simple plan, as it is sometimes felt that making money in the market surely must involve more than this. However, after spending thousands of dollars on books, and years of research, there is no question in my mind that any trading method must involve these rules.

3 comments:

Anonymous said...

I have been an occasional lurker and first time poster. I appreciate your blog and its incisive analysis. I want to thank you for providing the benefit of your experience on your use of the Renko Chart as a useful-but-not-overly-complicated technical indicator. Given how I just watched my gold miner and GLD investments lose significant value I am looking for some way to add some rules to my trading since I have a busy day job and do not have much time to check on the markets. Before seeing your post, I just assumed that I should just choose the long-term bullish trend for gold given what still awaits the housing, financial sector, US govt. bailouts-R-us attitude etc. But I am going to try out Renko charts and subscribe to stockcharts.com to see if I can get a bead on trends.

If you do not mind a few questions about your methodology:

1) Do you always use the monthly chart?

2) From your chart you seem to favor the absolute points setting rather than the average true range setting for the box value. Do you always choose a box value that is approximately 1/200th of the 50-month moving average?

Thank you again.

Danny Merkel said...

anonymous,

Your strategy of investing in gold due to the fundamental reasons you mentioned is a valid one, and a strategy that I employ myself. However my strategy involves holding gold for at least 10 years.

In the meantime, you are right, you can also use a rules based trading approach that I mentioned to enhance returns.

To answer your question, I use monthly charts in conjuction with daily charts. I use the monthly chart to determine the intermediate trend, and the daily chart for the short term trend. I only buy or short-sell when both charts are aligned.

It is really up to your personal trading style. I suppose you could even set up a 60 minute Renko chart, and use the same rules as outlined with my monthly charts if you are a short-term trader.

I previously used ATR based charts, but they started to annoy me because as the ATR changes throughout the day, boxes that are printed tend to disappear.

I do have a rule of thumb for creating the charts. Using 1/200 of the 50 month moving average sounds reasonable. Basically, as long as the chart fits reasonably on the screen, it is fine for my purposes.

If you are going to sign up for stockcharts.com, could you please plug in my name or email address (dannymerkel@hotmail.com) when asked if you were referred. Thanks!

Anonymous said...

Thanks for the information on your charting methodology. Will be glad to note that you referred me to stockcharts.com. I have been exclusively "buy-and-hold" as to gold and gold mining stocks up until now because of fundamentals, but given the depth of the correction (particularly for some of the junior miners) and recalling the correction in mid-2006, I think I am going to try and play it safer with the trends at least for some portion of my holdings esp. in retirement accounts where I do not have to worry about capital gains taxes. Thanks again.