A publication of Guppytraders.

com Pty Ltd ACN 089941560

Ph 08 89270061 Fax 08 89270125 Box 40043 Casuarina NT Australia 0811
www.guppytraders.com. Email Daryl_Guppy@compuserve.com

The Australian Internet Trading Weekly

Weekly for Monday January 14, 2002 Based on Thursdays Close 22 pages
With contributions from L Wilson and P Rak
Guppy Trading Essentials Chart pak, Metastock , Ezy Charts & SuperCharts. Data from JustData, Paritech, MarketCast & Keyquotes.

Stocks mentioned in this

issue
ue

CONTENTS

XAO, DOW, RGS, ORG,

ANZ , IRE
Note. The more computer
appearing after a
icons
section heading, the more
advanced the material.

Starting Points p1
Selecting Trading Techniques p4
The January Effect p6
Riding With Probability p10
Using Rounding Tops p 12
Trading Statistics - January p15
Readers Questions Constructing the Guppy MMA Oscillator p17
Chart Briefs - IRE p19
Newsletter Outlook Trend Redevelopment p20
Newsletter Notices p20
Sample Portfolio Performance p22

STARTING POINTS
SUBJECT SUMMARY
TRADING OR INVESTING?
These two activities are usually seen
as quite separate. We believe they are related
because in both activities the objective is to
accumulate capital and protect what you have.
The increasing number of collapses in
industries bound by prudential requirements
and regulations, and supervised by investment
authorities suggests that the old axiom
Nobody cares as much about your money as
you do is still true.
Market exposure is about risk
management, no matter what the time frame.
Those who believe that time, by itself, is an
antidote to risk end up increasing risk
dramatically. Protecting your future calls for
active risk control. In this newsletter we show
readers the techniques used in trading. They
also apply to investing.
Trading and investing use different
times frames, but the risk remains the same and
it remains our personal responsibility.

14/1/2002

Every now and then it is useful to stand back from

the market and take a wider look at market performance
and behavior. We do this on a regular quarterly basis, with
a more substantial assessment every six months. The
objective is not to predict where we think the market will
go on the next quarter or six months. The purpose is to
develop a broad understanding of the character of the
market, and to decide two issues.
The first is whether our current trading approach is
appropriate for the current market, and if it will continue
to be appropriate for the way the market is developing. If
the answer is yes, then our task shifts to management of
existing trades, and the identification of potential trades
based on the same trading principles. If the answer is no
then we must decide the second issue.
If the nature of the market has changed, then we
need to develop a set of trading approaches and strategies
which are best matched to the current and projected
market conditions. This may mean revising the exit
conditions on existing trades, perhaps closing them earlier
than anticipated. It certainly means we do not take on any
1

new trades based on the old analysis conditions.

The XAO extract shows this process. During 2001 there were five distinct trading patterns.
They did not conveniently occur at the beginning and end of each quarter. Some of them are more
easily seen retrospectively than in real time. All of them called for an appropriate set of trading
approaches.

Area A was traded most effectively with range trading techniques. It was a good time to collect
profits from trending trades taken in the previous December and which had begun to stall or run out of
momentum. New trades were based on shorter term rallies, or the movement between support and
resistance points.
Area B showed strong upward trending activity. This was a good time to buy stocks as they
broke away from downtrends and established new up trends. Although initially identified as early rally
opportunities, these breakouts quickly developed trending characteristics. Traders coming into the
market in February were able to join established trends with confidence.
Area C delivered consistent warning signals, and traders who had not taken profits towards the
end of area B had the opportunity to lock in profits. Trading activity in this period was based on short
term opportunities and rally trades. There was no expectation that these would develop into longer term
up trends because of the general bearishness of the market.
Area D was unusual because it was a reaction to a single event September 11. However, this
was a continuation of an existing trend that in most years would lead to an October sell off. This is a
good period for applying put warrant strategies. In 2001, October came early and the opportunity to
benefit from the normal October rebound also came early.
Area E called for rebound trading. The overreaction in area D was most likely to develop a
rebound. The rebound is suitable for trading with warrants, and with stocks showing good price
leverage. Some traders bought stock in this period in anticipation of a new up trend developing, as did
happen in area F. This strategy carried higher risk because the rebound from these types of dips does
not automatically lead into a new period of up trending markets. In 2001 this strategy paid off, and

14/1/2002

these longer term trend traders were able to capture substantial profits. Those using short term rally and
momentum driven strategies also captured multiple profits.
Area F captures the strong trending activity that often starts in November in the Australian
market and which carries forward into December and the early parts of January. Here we apply trend
trading techniques. These include turning rally trades into longer term trades, and jumping on up trends
that were established in area E.
Each area calls for a specific range of trading techniques. Those that worked well in area A did
not work well in area B. Area A tactics did capture some profits, but an early exit missed the additional
profits available from the strong up trends that continued for several months. It is easy to see these
areas on historical charts. It is more difficult to recognize the start and end of these periods in real time.
It is easier to recognize these periods after they have started, and with good risk control and stop loss
techniques, traders should be able to exit from these areas as they end.
Using an inappropriate mix of trading tools and approaches has the capacity to severely limit
the returns available from trading. Some traders specialize in just one style of trading technique. They
may find it easier to trade Area B and Area F on the chart. This is a valid approach because they use
their skills to make substantial returns in these periods. They remain out of the market in the other
periods because they know they do not have the skill to trade these effectively.
More experienced traders recognize the changes in each period, and quickly adapt their trading
approaches to suit the new conditions. Even with this adaptability, there are few traders who can trade
these different conditions with consistent success. Inevitably they will have a favorite trading
technique. The selection depends on the character and personal preferences of the trader.
We stand back from the market every quarter so we can develop an overview of where we have
been and how the market might develop. When markets change dramatically or significantly during the
quarter, we go through the same processes. Every six months we take a longer break away from the
market, turning off the screens and taking a holiday. These six monthly breaks are the time for broader
assessments and the setting of objectives for the coming six months. What did we do wrong in the past
six months, and what did we get right? Have our skills improved in certain areas and declined in
others? The answers help decide our focus for the next trading period.
Although we start with broad market analysis, we need also to be aware of the performance of
important sub sectors of the market. Which sectors are important depends on our preferences. Those
interested in price leverage tend to focus on the speculative indexes, small miners and small
industrials. Those who like trend opportunities may decide to focus on industrials, healthcare and bio
tech, retail or media. Those who want lower volatility, strong trends and better dividends might focus
on banks and other financial sectors.
Some of these sub sectors will be performing differently to the broad market. Where they are
moving in the opposite direction they do so with a note of caution. A strongly performing sector in a
broadly falling market will feel the effect of the market fall. It may be delayed, but it will happen.
Trends may end prematurely, or rapidly.
Sectors performing at about the same as the market offer a lower sector risk, but this often also
means lower returns. Sectors which are outperforming the market offer accelerated growth, but also an
increased risk that they will pull back to the broader market performance. Trading the outperforming
sectors calls for good stop loss strategies.
As the trader drills down into each sector, the individual companies are also grouped into the
under achievers, the index followers and the over achievers. The selection of a sector does not
determine the exact selection of a stock.
Our objective is to start the process of market analysis to determine what trading approaches are
suggested and to decide on which techniques may be usefully applied.

14/1/2002

SELECTING TRADING TECHNIQUES

RELATED TOPICS
TIME IN THE MARKET
Trading objectives
should be matched with time
in the market. The greater the
time exposure - weeks or
months - the greater the risk
of the market moving in an
unpleasant direction. Open
positions held for a long time
must offer better returns for
the risk associated with the
time in the market.
Trades offering
smaller returns should be
closed when they have spent
weeks failing to reach your
profits. Matching time in the
market against risk and with
potential reward is a
judgment call, but unlike a
safe, but low paying CMA
account, the market carries
risk.
High risk markets
are best traded for a short
time span with maximum,
usually leveraged, returns.
Risk management also means
time management

14/1/2002

Our first stop is the weekly chart of the All Ordinaries. We are
interested in the characteristics of the trending activity which starts in the
November-December period and which carries through to January and
February. This is a consistent characteristic of our market, and it is more
than just the January effect discussed elsewhere in this newsletter.
The first observation is that the rallies that start in the December
period have turned into strong and clear trending activity consistently
since 1998. This is a repeated characteristic that can be traded.
Our first conclusion is that this trend development can be traded.
Open positions that are already part of a steady trend development will
remain in place. New positions can be opened in established trends. New
positions can be taken in young trends that have developed after recent
breakouts from downtrends. Entry opportunities based on buying price
weakness as prices take a temporary dip back towards a trend line are
low risk because on balance, the up trend is likely to continue.
The second observation is that the length of this trending period
has declined. In 1998 the trend remained intact from December through
May. By 2001 the trend spanned December to March. The consistent
trend has been towards a shorter period. The sample period, 1998 to
2001, is small, but our interest is in the most recent behavior. Unless
there are dramatic and remarkable changes, it is most likely that the
conditions that prevailed in 2001 will most likely prevail in 2002.
Although there has been a shortening of the period of the Christmas
trend, the trend characteristic itself has not disappeared.
Our second conclusion is that the late February to mid-March
period is most likely to be a good time to capture profits. This does not
mean the market will collapse in this period. It means that traders

will be more alert for price action that signals the end of a trend. In a strong trend there are
times when traders ignore these signals. They treat them as a price weakness within the context of a
trend.
In a strong trend this is an entry opportunity. New traders use these pullbacks to jump onto
established trends at better than expected prices. Traders who already own the stock may use these
price retreats as an opportunity to pyramid their existing positions. They buy more stock in anticipation
of a trend continuation. This type of opportunity is shown by the blue arrow as prices move on to make
new highs.
When we see the same relationship in a
market that has a historical tendency to weakness
at this time we approach the signal in a different
way. The price dip becomes a leading indicator of
a trend change. It is an alert signal that tells the
trader to more closely manage the trade and to
actively take the opportunity to sell out on the next
temporary price rally. This generates two sell
signals.
The Sell 1 signal is difficult to see in real
time. Initially it looks just like a trend
continuation. Traders treat it as an exit signal
when it is considered in conjunction with other
market factors. In this case they use the Christmas
trend time frame. A dip like this in January is most
likely to be a buying opportunity. A dip like this in
late April is more likely to be a sell signal.
The Sell 2 signal is a trend break signal. Prices have closed below the trend line, and this is a
temporary rebound. Many new traders hold onto stock at this point, believing that the trend break was
false, and that prices will resume the upwards trend. Experienced traders apply the standard stop loss
strategies in this situation and take the exit to lock in profits. It is difficult to judge whether traders
should take advantage on the sell 1 or the sell 2 signal.
The third observation on this chart is the characteristic sudden collapse of the market when the
Christmas trend ends. The past four years have ended with sudden, dramatic and prolonged price
declines. Traders who wait for the sell 2 signal may find that stop loss protection is reduced as prices
move quickly below their stop loss exit levels. The length of the sell off varies, but the severity of the
sell off remains consistent. In all years except 1999, the collapse of the Christmas trend has carried the
market to lower levels than the start of the Christmas trend. Hold onto stock purchased in the Christmas
rally period and there is a very good probability that it will be worth less in May and June than it was
in December.
Our third conclusion is that the end of the Christmas trend may come quickly, so as we move
into the March period we need to tighten the stops on open positions. This means using a variety of
stop loss indicators with different degrees of sensitivity. A stock may be monitored with a parabolic
SAR stop loss, or a 2xATR approach. When the exit signal is delivered, the trader might then shift to a
slightly less sensitive stop, such as the value of a moving average, a stochastic or oscillator based
signal. The objective is to heed the alert and be prepared to act decisively when the second exit signal is
generated.
The fourth observation is when the market has succeeded in breaking above the resistance level
around 3370. This adds a bullish flavor to the trend continuation through the early part of 2002. This
makes this pattern more bullish that the Christmas trend in 2001 where the market was unable to push
to new highs.
Although market commentators are likely to make a lot of noise about any breakout to new
highs for the XAO, this is less important than the continuation of the trend and the time frame. Traders
14/1/2002

look for good trend trading opportunities to continue through to March and possibly into April and
May.
On past behavior, it is most likely that any XAO retreat to the trend line in January is likely to
be consistent with a continuation of the trend. This suggests an entry opportunity. Many traders will
look for these retreat conditions and use them as a opportunity to enter the market. Other traders will
join existing stable trends at current market prices with the intention of riding the trend for several
months.
Although there are always opportunities for rally trading, the current market development also
rewards the trend traders. Our newsletter focus will shift to the methods used to identify and manage
these types of opportunities.
Some readers will look for a fifth conclusion based on this chart analysis. They expect a
prediction about how the market will perform in 2002. January magazines and newspapers are full of
these predictions. They include the hardy perennial about a resources sector recovery. I have heard this
every year since 1988, and sometimes it is true. Long term predictions about the market are largely a
waste of time. Somebody will get their prediction right, but this is more often a result of luck than of
analysis skill.
We find it more useful to set a framework for trading action rolling forward at least 3 months,
and out to 6 months. This is a probability framework, and at any time we are prepared to stand back
from the market and re-adjust it. What counts is not being right in a prediction, but being profitable in
our trading. The analysis provides a framework for action. If the framework proves inappropriate, then
smart traders change the framework. They do not try to make the market fit their preconceived ideas.
You can fight the market with dollar notes, but it is always a losing game. When the bulls are running,
we run with them. When the bears are hunting, we take defensive positions and apply defensive
strategies. Consistent success comes from being able to recognize the bull or the bear. It does not come
from predicting when they will appear.
This analysis is also set against a background of the statistical marker performance in January.

THE JANUARY EFFECT

SUBJECT SUMMARY
MARKET STATISTICS
These statistics are compiled from an 11 year
data base of the All Ordinaries commencing in January
1988. They include intra-month results where each
month is assessed on a higher or lower close than its
open. Inter-month analysis compares the relative
performance of each month with the previous month or
group of months. This tells us if this month closes
higher than the previous month. It also gives us
information about the potential for months to move as
part of a multi-month trend. Finally, we match the rise
or fall of the month with the overall performance of the
market.
Daily analysis identifies those days of the week
with extraordinary % returns, and those days which rise
more frequently. This may show Friday in a particular
month as a good day to buy, and Wednesday as a good
day to sell. These results also show us the propensity of
any given date in the month to rise over the past 11
years. Some dates have a history of falling and this may
provide buying opportunities.
These statistics are helpful in establishing a
general view of the market and its average behaviour.
Traders use this as a benchmark to assess current
behaviour.

14/1/2002

Market myths are powerful influences on

behaviour. We all look for the best prediction of
what will happen in the coming year. This activity
is broadly useful if only to better understand how
less informed participants are likely to approach
the market. We can then choose to trade with
them, or against them. The January effect is a
statistical correlation drawn from the US market.
It has a flow on effect to other world markets, and
to the Australian market. The January effect, or
barometer, has predicted the annual performance
of the stock market with amazing accuracy. The
correlation is so strong that traders can use this as
a high probability situation. It should be
remembered that while the prediction for the
market may be accurate, it has several limitations.
It does not mean that the particular
stock that you have selected will
also rise.
It is an accurate tool based on the
S&P composite index.
It is far less accurate when applied
to NASDAQ, the XAO, and other

markets
Yale Hirsch publishes the Stock Traders Almanac (www.hirschorganization.com) which
compiles a number of significant statistical relationships in the US market. The following comments
are drawn from the almanac.
The performance in January, falling, rising, or flat, is an accurate indicator of overall market
performance 90% of the time, based on a 50 year trading history. As world markets have increasingly
become interconnected due to the spread of technology, the linkage between US market performance
and the ASX performance has become tighter. This has been further enhanced by the complete
takeover of the ASX All Ords calculations by Standards and Poors so they can be included in the
Morgan Stanley Capital Index on a world basis.
The chart extract
shows the relative monthly
performance since 1990. The
relationship can be divided
neatly into two periods. In
period A, there is little direct
relationship between the two
markets. The XAO swings
dramatically above and
below the performance of
the DOW. This is the period
when it was common to
observe that when the US
sneezed Australia got a cold.
Our market overreacted to
even small leads from the
US. It also moved more to
its own tune, reacting to
purely local, rather than
international events.
By 1995 this
relationship changed as
shown by area B. The
All Ords fell into step
with
the wider
international
market.
This was facilitated by
changes in exchange
regulations, currency
transaction conditions,
and the development of
more
effective
computer based trading
platforms that made
international
trading
easier for the US fund
managers. Although the
Australian market is
not in lockstep with the
US market, as shown in
area C, there is a broad
14/1/2002

relationship in this period.

This relationship changed significantly with the effective takeover of the Australian indexes by
Standard and Poors and their inclusion in the MSCI Index. We show the XAO rather than the S&P
ASX 200 on this chart, but the relationship is very clear. In 2000 our market moved in the same general
direction as the DOW, but there were periods of significant difference. When the DOW was declining,
our market was moving upwards and there may have been some justification for the claim that
Australia was somehow exempt from world economic events.
This changed in 2001. The All Ords followed the lead of the S&P 200, which in turn was lock
stepped to the DOW. We see a difference in degree, but not direction, in this period. This close
relationship opens up some different trading strategies for those who trade the SPI and Exchange
Traded Funds. It suggests it is unwise to back the direction of the Australian market if it is moving
counter to the US. It suggests that counter trend trading on the SPI has a higher probability of success if
the trade is in the same direction as the DOW. On a monthly chart the relationship looks to be
concurrent, but on a daily basis there is greater room for temporary divergence between the two
markets.
This close relationship that existed between the two markets since 1995 has now become
closer. This means that if the January barometer is appropriate and accurate for the US then we can
expect these statistical relationships to feed through to the Australian market.
We test this observation using a monthly chart extract starting in 1995. We start here because
we know from the comparative charts that the strong US/Australian correlation starts in this period and
it is the consistency of this Australian January effect we are interested in. The close in January is an
accurate indicator 57% of the time. This is a slight increase on the previous correlation which was
50%. It is too early to know if this increase in correlation is due to the impact of the MSCI index and if
this will consistently improve the relationship between the two markets. The January effect offers a
slight advantage for those who want to predict market activity. But it is important to note that in some
years, such as 1998, traders may have to ride out substantial dips before reaching their objective.

14/1/2002

The second relationship in January that Hirsch explores is the first five days early warning
system. The market action in the first five days of January are used as an indicator of the overall market
performance for the remainder of the year. This relationship suggests that the gains, or losses, made in
the first five trading days match the direction of the market for the year. There are exceptions created
by extraordinary events such as the Gulf War in 1990. The September 11 attacks did not create the
same exception. The first 5 days on the DOW in 2001 closed down, as did the market by the end of the
year.
The weekly chart
plots this relationship and it
looks solid with just two
exceptions. The first five
days have a 66%
probability of showing the
direction of the trend for
the following years. The
exceptions are 1995 and
2000. It is too early to tell
if this is part of a 5 year
pattern, although we will
be alert for this possibility
in 2005.
The first 5 days in
January 2002 have closed
higher.
This suggests,
statistically, that the XAO will close higher at the end of
2002. This does not mean a steady market rise. Traders
who base their decisions on the behaviour of the first 5
days in January often end up relying on nerves of steel
to ride out the annual September and October declines
and the painful recoveries. This relationship casts a
more bullish light on the coming year. As traders, we
need to use more effective measures to control the risk
in each trade, and in the companies we choose to add to
our portfolios. It is a fools paradise to believe that we
can hold onto a falling stock just because the first 5
days in January rose, or because January finished higher
for the month. We will certainly use the January effect
to climb on board rising stocks that may, or may not, be
correlated to the general January market rise. We will
not rely on the January effect to protect profits, or to aid
in the recovery of declining stocks.
We use these statistical correlations as a broad
basis for understanding the potential behaviour of the market. They can be applied, with caution, to
index trading using SPI products from the Sydney Futures Exchange, or some of the warrant issues
available. When it comes to trading individual stocks, these types of market predictions are less useful.

14/1/2002

RIDING WITH PROBABILITY

SUBJECT SUMMARY
PREDICTION OR FORECAST?
Chart analysis is often confused
with predicting or forecasting the
market. This confusion is enhanced by
those who confuse trading and investing.
Chart analysis uses the action of price
and volume to clearly show how the
market has behaved. For traders, the past
pattern of behaviour helps to identify
market situations that have a high
probability of a specific action. The
trading approach requires the trader to
develop a plan to cope with the
probability, or when that probability
does not eventuate.
When we cross the road we
pause at the kerb, check right, left and
right, then cross. The curb tells us
changed conditions ahead, but it tells us
nothing about the actual events on the
road. We prepare to behave in a
particular way depending on what the
road reveals. Here the trader prepares to
act one way if certain conditions are
met, and another way if different
conditions are met.
Forecasting uses the higher
probability situations in an attempt to
project future price action and acts in
anticipation of this. It straddles the
boundary between trading and investing.
Here we stand at the traffic lights,
stepping out confidently when the walk
sign flashes. Sometimes we get wiped
out as a car crashes through the walk
signal, but most times the signal is
reliable. When we see the signal we can
forecast the action for a selected period
of time. Here traders act when the event
occurs.
Prediction is a different beast
altogether. It carries a high level of
certainty about the occurrence of events
at a specific time. Some Gann and Elliott
wave analysts make quite specific
predictions. This is like saying that I
know there is a set of traffic lights at the
end of the block, and that at 10.38 am
the signal will be flashing walk. This
leaves little room for probability,
although there are times when such
predictions match the co-incident events.
This means the predictions come true.
Separating the co-incidence for accurate
predictive ability is difficult. The
tendency with prediction is for traders,
or investors to act in anticipation of the
event.

14/1/2002

This sample trade has an unusual management feature. It

is based on the time elapsed since the stock was first mentioned
in Shares magazine. Apart from this feature, the trade uses
essential trend analysis features. On this basis, a suitable time
for closing the trade is over the next week as statistically, these
types of trades have a lower probability of trend continuation in
the third month after they were mentioned in Shares magazine.
The balance of probability is now declining, so our objective is
to take advantage of any price rise over the following two
weeks to close this trade. This calls for some intraday
management of the exit.
The first step in this management process is to tighten
the trailing stop loss conditions. This is designed to lock in
profits and avoid the situation where we still hold the stock as
it falls below the previous stop loss point at $1.15. This
involves two processes. The first is based on the micro picture.
The second takes a broader view.
The micro picture concentrates on the relationship
between the current daily stop loss, calculated by the count back
line. This is calculated from the high at point A. It sets the stop
loss at $1.15 and this level has not been triggered. These stop
loss lines come from the Guppy Trading Essentials charting
package.
Our concern in this sample trade is that the sideways
movement is consistent with the deterioration of the existing up
trend. The danger is that prices will fall below this stop loss line
and trigger an exit. This still makes the trade profitable, but we
would like to do slightly better. This is an issue because of the
way we have added a time frame to this trade management.
This time frame is a further condition that supports our
conclusion of a trend decline.
Micro management of the subsequent price action does
not mean watching the screen each day. Instead we place a
minor stop loss one tick below the CBL stop loss. A price dip
below this level is a signal for an exit on the next day. The
conditions of this stop loss have changed. It is based on the
most recent high bar within the band created by the CBL stop
loss and the previous high used in the CBL calculation.
Additionally, the trigger comes from any price move below this
minor stop loss. We do not rely on a close below this minor
level.
As a new high is made, the minor stop loss is
recalculated. This is very tight management, and it is important
to understand that it is applied only because the time
management feature of this trading technique has statistically
indicated a higher probability of trend decline.
On Monday RGS moves to a new high that is higher
than the high at point A that was used to calculate the original
CBL stop loss. The new CBL is at $1.18. A minor stop loss
based on this new high is at $1.20 one tick below the bottom
10

of the most recent highest bar. This micro-managed stop loss level has locked in a substantial profit in
what we believe is a trend in trouble.
The continued
upwards price moves
on Tuesday
and
Wednesday change our
perspective. On a
broader scale, this
signals a breakout
from the sideways
pattern
that
has
prevailed over recent
weeks.
With
our
intended profit intact,
we step back and take
a broader view of trend
developments.
The significant
feature is the trend
line. Up until mid
December, this line
acted as a support line.
Prices moved above
this line, pulled back to
this line, and then
bounced away. Mid
December saw prices
fall below this line and stay there as they moved in a sideways consolidation band.
Now prices have broken above the band and this suggests a new role for the old trend line. Now
the trend line is most likely to act as a resistance level. We can expect prices to rise and touch the trend
line, and then to fall back. This is the type of action we anticipate in area C. This action is typical of
this price and trend relationship. In some cases, prices continue in an up trend for many weeks, using
the old trend line as a resistance point. However, in most cases this represents a last gasp of a renewed
trend. The resistance is too strong, and the trend declines.
This conclusion is consistent
with the time frame analysis we have
applied to this trade, although it
suggests we were premature in
calling an end to the trend last week.
This underlines an important feature
of trading. Trading is not about
prediction. It is about assessing the
balance of probabilities. Given the
combination of factors in this trade,
we assign an 80% probability to a
trend decline and collapse. Instead,
we find the 20% probability of trend continuation has been triggered in this example.
If our focus was on being right or wrong in our predictions this would be a cause for concern.
Instead, we recognize that these conclusions are probability statements, and the specific trading action
we take is designed to take action to protect ourselves against the 80% probability of a trend collapse
14/1/2002

11

using minor stop loss points and to allow us to take advantage of the situation should the 20%
probability outcome develop.
With this trade it is the big picture considerations which become important. A count back line
stop loss calculated from the new high shown at point B sets our stop loss at $1.24. This is equal to the
previous all time high. An exit at this level delivers very acceptable profits. Of course at exit at $1.30
delivers even better profits. Our objective is still to manage the trade using the time feature. These
conditions are set against the broad stop loss calculation, and the micro management used to set a
minor stop loss condition. On this chart, the minor stop loss sits at $1.26.
Statistically, stocks traded in this way have a 50% probability of continuing in an up trend in the
third month after they were first mentioned in Shares magazine. RGS may fall into this 50%. If it does,
we take advantage of this renewed trend growth by applying tight stop loss conditions designed to
protect the open profit in the sample trade.

USING ROUNDING TOPS

SUBJECT SUMMARY
ROUNDING TOP
A rounding top is defined by a series of
lower highs at the top of a trend. This is a
distribution pattern caused by stockholders selling
into the market. The market is weaker, and does not
absorb the selling, so prices try to make new highs,
but are unsuccessful.
The rounding top looks like a head and
shoulders pattern, but the difference is in the way
the lows cluster around a single level every time the
price retreats. This creates a quite definite support
level. Prices consistently test this level, but when
they bounce up they do not create new highs. The
collapse of a rounding top can be quite sudden so
traders sell into the rallies.

14/1/2002

One of the main benefits of recognizing

patterns in price charts is the way these patterns can be
used to project price targets. These targets are areas of
high probability. They do not mean that price will
reach the target and move no further. Instead these
price projections help to define price areas where there
is a high probability that any price action will pause
before developing new directions. It is this pause that
gives the trader the opportunity to take action to cut a
loss, capture a profit or to make a new entry decision.
One of the most powerful reversal patterns that
signals the end of a trend are those described as a
rounding top, or rounding bottom a saucer. When
rounding tops appear, they tell the trader, and the

12

investor, that there is a high probability of a trend collapse. The rounding top is quite different from a
sideways consolidation pattern. This pattern can be defined by two parallel horizontal trend lines. The
price movement is boxed in and tells us that prices are consolidating prior to a new move.
In contrast, the rounding top is most easily defined with an arc. There is no clear bottom defined
by a support area. There is no clear top defined by a resistance level. Instead prices move upwards, then
sideways, and then steadily downwards. This is a slow pattern that develops over weeks and months. It
is not a short term 3 or 10 day pattern. Most times it is not possible to recognize the pattern until it is
around three quarters completed. It is the slowness of this pattern that traps many investors because it
seems to offer hope that prices will recover. These investors treat this pattern as a consolidation pattern
when they should be treating it as a distribution pattern.
A distribution pattern forms when shareholders begin to sell their stocks to capture profits. They
distribute their holdings to others because they believe the up trend has come to an end. This is not a
sudden dumping of stock. The distribution is slow and steady as investors accept progressively lower
prices in their attempt to get out of the stock.
The ORG* chart shows a rounding top.
The arc is plotted like any trend line. The
objective is to capture the bulk of the upper price
points. The arc tool in the Guppy Traders
Essentials chart pak is used to define the
rounding top in ORG. The shape and curve of
the arc is adjusted by dragging the left hand or
right hand edge as required. We use the $2.75 as
the bottom of the arc, based on the rebound test
of this level in recent weeks. Other traders might
place the bottom of the arc around $2.76.
Although we use an exact price projection from
this pattern, there is often not an exact place to
plot the bottom of the rounding top. We look for
the logical points where the arc might start and
finish.
Once the arc and its base are plotted the next task is to measure the distance between the peak of
the arc and the base line. For this we use the projection tool for the Guppy tool box. We start by
plotting
measurement
line A. Once this line is
plotted, right click on it
to
bring
up
the
properties box and select
Add Projection Line.
This creates a vertical
line that remains the
exact length as the
measurement line and
which can be moved to
any position on the chart
display.
This is shown as
line A1. This projection
line can be plotted from
any starting point. In
this chart example we
started the plot to the
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13

right of the original measurement line A. Once positioned, an additional line is projected to the right, or
left, to intersect the price scale. This sets the potential downside target for ORG at $2.255. Traders who
use $2.76 as the base of the rounding top will set a slightly higher target price.
The target level is a zone where traders can expect prices to pause before moving on. The target
zone is a level where new price action develops. Although traders treat this zone as a high probability
showing where prices are likely to fall, they do not treat this area as a prediction point. That is, when
price get to this level, traders do not buy the stock in anticipation of a trend reversal.
Some traders look for a
trend reversal that mirrors the
original rounding top collapse.
They anticipate a recovery that
follows a saucer shape. This
projection is shown as line B.
Although it appears to be a
logical development, it is a low
probability outcome. Even if this
style of recovery did develop, the
time frame is measured in
months. If a saucer pattern
develops most traders will wait
from the saucer breakout before
entering the trade. The techniques for this are discussed in last weeks newsletter.
The outcome with the lowest probability is shown by line A. It is highly unlikely that price will
shoot up quickly from the target zone. The stock has fallen steadily as long term investors abandon it.
It requires a dramatic and major change in prospects for the big money the investors the flock back
into the stock. This signals a dramatic re-valuation and rapid action. It is less likely to occur in a blue
chip stock or large mid cap stock like ORG.
In markets not driven by excessive fear or greed, the most probable outcome is shown by line C.
The stock languishes in a prolonged sideways movement. It may lose a little more value, but it is
unlikely to increase substantially in price. Quite simply neither traders nor investors see a bright future
for the stock. These long term consolidation patterns eventually lead to trending activity. However it is
not possible to predict how this may develop when the target zone is first hit. At best, these
consolidation patterns suggest there is limited downside in trading the stock. The risk of further falls is
contained, but the future for price rises is also bleak.
In a bearish market, the projection target is an initial stopping point in a price collapse. In these
conditions the most likely outcome is a continued fall after a minor pause. This is shown by line D.
Such falls are often very rapid and cause considerable damage to traders who bought the stock on the
target level and who do not have the discipline to sell quickly on stop loss. Often these are traders who
bought the stock on the first price pause because it looked cheap when compared with the previous
highs at the peak of the rounding top pattern.
The importance of the rounding top lies in the way it confirms the end of an up trend and in its
ability to set a potential downside target. Stockholders who recognize the pattern will be able to take an
exit to protect their capital rather than staying with the trade hoping for prices to recover. Those who
thought of buying the stock near the bottom of the rounding top will know to stay away.
A rounding top pattern is not used to set the conditions for a subsequent rebound. Traders will
watch how price activity develops once the target level is reached. Once the consolidation is completed
there may be opportunities to trade a new rising trend. However these opportunities are typically weeks
and months after the target area has been reached.
NOTE. The release date for the Guppy Traders Charting Pak is the end of January. Up to date
details are on the website under the New Additions link.

14/1/2002

14

TRADING STATISTICS JANUARY

SUBJECT SUMMARY
MARKET STATISTICS
These statistics are
compiled from an 12 year data
base of the All Ordinaries
commencing in January 1990.
They
include
intra-month
results where each month is
assessed on a higher or lower
close than its open. Inter-month
analysis compares the relative
performance of each month
with the previous month or
group of months. This tells us if
this month closes higher than
the previous month. It also
gives us information about the
potential for months to move as
part of a multi-month trend.
Daily
analysis
identifies those dates with
extraordinary
percentage
returns, and those which rise
more frequently. These results
also show us the propensity of
any given date in the month to
rise over the past 5 years. Some
dates have a history of falling
and this may provide buying
opportunities.
These statistics are
helpful in establishing a general
view of the market and its
average behaviour. Traders use
this as a benchmark to assess
current behaviour.

January is the last month of the Christmas rally that starts as

early as late November. The prospects for January as an up month are
very strong. January has delivered a bullish performance in 73% of the
last 11 years. This is stronger than the bullish 64% for December, and
the balance is weighted towards a continuation and end of the bullish
trend. When January is an up month there is only a 50% probability
that January will also be an up month. There is an even chance that the
Christmas rally will end in January.

The surprising result is when January is a down month. When

this happens there is a 100% probability that February will be an upmonth. This provides buying opportunities on weakness in January.
Some traders use this as an opportunity to add to existing positions if
January turns out to be a down month. Other traders use a January
down month as a signal for aggressive buying going into the February
rally. January is a down month 27% of the time.

By considering how the month has performed over the past 11 years, traders can develop
several trading strategies. The first group of strategies are entry and exit strategies based on the
performance of the month.
The average gain made
during January is 2.88% which
is a significant gain over the
average increase for December
of 0.75%. The poor average
December figures hide some
very useful gains in individual
stocks. Statisticians will draw
many other relationships for 11
years of market performance but
we are interested in broad
relationships. It is inappropriate
to use these relationships as a
predictive tool, but they are
useful in providing a broad
14/1/2002

15

background to market behavior which assist traders in deciding what weight they should give to bullish
or bearish behavior during the month.

The final group of trading tactics using these types of statistical relationships are based on the
average performance of individual days of the month over a 6 year period. This is not to say that the
performance for each day will be repeated, but it helps to establish the average range of market activity.
The analysis of the results for each date in January shows:
Highest average return of 0.66 for a day is on January 6.
The lowest average return of 0.85 is on January 21.
There is also a 74% probability that on any day of January, the market will show a loss or
sideways movement for the day.
When we use these statistics
on a day by day basis, we must be
cautious.
These
show
the
performance of the XAO as an index
and the level of volatility is
dampened because of the way the
index is weighted towards larger
stocks. In 2001 the best return open
to high - on any day for the year was
on September 18 with a 2.94% This
was also the best one day gain for
2001 as the open was also the low for
the day.
. The largest one day loss open to low - was on September 17 when the US market re-opened
after the September 11 terrorist attacks. This was a 5.16% loss and was also the largest one day loss for
the year. The high of the day was also the open. The largest swing day ranges for the year are on down
days. The third largest is the bullish day on September 17.
These extremes are dampened when we consider the average return for individual dates in the
month. When we consider index performance we may need to factor this upwards to get a better
indication of the way individual stocks may perform. A highest average return of 0.8% for a day on
14/1/2002

16

March hides significantly better one day returns available from individual blue chip, madcap and
speculative stocks.
On the broad scale of general performance for the month, and in the relationships between
months, the statistics are useful in establishing broad trading strategies. When we look at the
relationships on a date of the month basis, the relationships are much more volatile. Any selected date
on 2002 may perform much better, or worse, than the same date, on average, over the past 6 years. It is
unwise to rely on a repeat performance of any given day. However, there are clusters of days where
there is a high level of agreement between the historical and current performance. We examine these
relationships every month.

READERS QUESTIONS - CONSTRUCTING THE GUPPY MMA

OSCILLATOR
By L Wilson
INDICATOR REVISION
OSCILLATORS
Indicators based on oscillators are
plotting cyclic activity. This is where a
relationship moves between and upper
and lower boundary. This boundary is
often decided on the basis of a
relationship with a previous point. If the
boundary is exceeded then we know a
new trend has been established. More
commonly, the boundary signals a
turning point as prices tend back towards
the centre point between the boundaries.
Oscillators are used to identify turning
points by measuring the speed and
momentum of the surges of crowd
activity. Oscillators assume there is a
boundary, and this is not always

14/1/2002

There have been some queries regarding the

construction of the Guppy MMA Oscillator for both Metastock
and Ezychart. We will start with Ezychart first.
Ezychart users do not have the capacity to write
formulas as they do with Metastock, so we will have to
compromise to some degree. We do this by using the price
oscillator and entering the median moving average values. For
those of you new to Ezychart or not familiar with indicator
alterations, first click on indicator at the top of your screen
then scroll down and click on preferences at the bottom of the
menu. You will now have a split table in front of you. Click on
Price Oscillator in the Indicator Setting section and this will
bring the price oscillator window to the front. You will notice
references to short and long term moving averages.
For the short term moving average, enter 9 and insert 45 in the
long term moving average section. On the left of your window
you have Tool Bar Selection. Tick the price oscillator box

17

and this will place the indicator button on your main screen. Now tick the Set as Default box and
then click finish. You must tick Set as Default otherwise the previous settings will remain as the
oscillator parameters.
Ezychart users must remember that the price oscillator operates on the calculations of two
moving averages where the Guppy multiple moving average consists of twelve, so there will be subtle
differences between Metastock and Ezychart displays. In addition we do not have the capacity to add a
trigger line if required in order to replicate the MACD but this should not necessarily be seen as a
disadvantage. We still receive all the benefits of divergence signals and all zero line cross overs are
reflective of crossovers of the Guppy multiple moving average. A bonus for EzyChart users is now we
have the option to perform searches for crossovers of the Guppy multiple moving average using the
above price oscillator parameters. Just run your analyzer as normal and select price oscillator cross over
at step two. Now providing you ticked Set as Default as instructed earlier all selected stocks will
have experienced a Guppy MMA crossover within the specified period.

For Metastock users, the process is a little more involved. First open your indicator builder and
click on New. Now enter the following formula:Name:- Guppy MMA Oscillator
Formula:((Mov(CLOSE,3,E)+Mov(CLOSE,5,E)+
Mov(CLOSE,8,E)+Mov(CLOSE,10,E)+
Mov(CLOSE,12,E)+Mov(CLOSE,15,E))(Mov(CLOSE,30,E)+Mov(CLOSE,35,E)+
Mov(CLOSE,40,E)+Mov(CLOSE,45,E)+
Mov(CLOSE,50,E)+Mov(CLOSE,60,E)))*10;
(Mov((Mov(CLOSE,3,E)+Mov(CLOSE,5,E)+
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18

Mov(CLOSE,8,E)+Mov(CLOSE,10,E)+
Mov(CLOSE,12,E)+Mov(CLOSE,15,E))(Mov(CLOSE,30,E)+Mov(CLOSE,35,E)+
Mov(CLOSE,40,E)+Mov(CLOSE,45,E)+
Mov(CLOSE,50,E)+Mov(CLOSE,60,E)),13,E))*10;0;
For readers interested in price oscillator configuration and not requiring the trigger line, only
enter the first half of the formula. I multiply my values by a factor of ten. This gives a full number
indicator value on screen which I find much easier to interpret than all those zeros. The multiplication
factor is not essential to the operation of the indicator, so you may delete it if you wish. Now that you
have entered the formula, make sure the Show in Quick list box is ticked and click OK. There all
done.

CHART BRIEFS IRE

By P Rak
TRADING TECHNIQUES
CBL STOP LOSS
This stop loss rule uses
the range activity of the stock to
set a stop loss point. The range
is the distance between the high
and the low for the day. It is
calculated using the Count back
Line approach. Taking the most
recent highest high in the
intermediate term trend the stop
loss point is calculated by
counting back three lower bars.
The horizontal line drawn at the
bottom of the third bar is the
stop loss point. This stop loss is
not related to the 2% rule. The
line suggests the conditions
where the trend may be
weakening. When used with
open profits, it provides an exit
signal to protect those profits.

The daily price bar chart shows a relatively new stock, IRE,
which commenced trading in late October 2001. The stock has an
average daily trading volume of 153 000, and since trading commenced
has been moving sideways, with most price activity between $2.10 and
$2.20. There is no indication of trending behaviour.
Analysis of new stocks for trading opportunities is difficult, due
to the absence of much historical price data and therefore the indicators
and patterns that derive from it, such as moving averages and well
defined straight edge trend lines. One of the first common indicators
able to be used are Bollinger bands, which require around 6 weeks of
price history. The Guppy MMA and Price Oscillator require at least
three months of trading history.
This means we need to place a greater focus on the tools of risk
management and blue sky trading to determine whether a newly floated
stock that crosses our screen is an opportunity. Risk management tools
that assume primary importance in new stocks are CBL stop loss and
profit protection levels. Tools of blue sky trading include blue sky
target setting (see below), supported by straight edge trendlines and
basic chart patterns where available. Darvas boxes are also a useful tool
in trading new or blue sky stocks.

UP CONDITIONS
The dominant feature on the daily price bar chart is the development of a consolidation band.
The distance between support level and resistance level is $0.10, therefore 4.76%, which means that
IRE is not a candidate for channel trading.
A sustained breakout above the $2.20 resistance would increase upside probability. An initial
price target can be set by projecting the width of the prior consolidation band ($0.10) upward from the
top boundary of the band to give an initial target of $2.30 ($2.20 plus $0.10). Tools such as a straight
edge trend line or Darvas boxes can be applied to the breakout.

DOWN CONDITIONS
A fall through the support around $2.10 will increase the probability of downward movement.
Downside price targets are set in a similar way as upside targets above, hence around $2.00, which
corresponds to the low in IRE. The lack of developed support levels in new stocks increases the
importance of risk management methods such as CBL stop losses.
14/1/2002

19

NEWSLETTER OUTLOOK TREND REDEVELOPMENT

We remain in a cautiously bullish outlook as the market moves beyond the Christmas trading
period. The index behavior confirms this is part of a general November and December rise that often
continues strongly into January. Our preference remains towards the management of longer term trend
trades rather than maximizing short term profits.
Each week we make a choice about the material we include and the subjects we cover. The selection is based on
our outlook for the current and coming market. Our objective is to illustrate effective trading strategies that readers can
apply to current market conditions. We do not identify recommended individual stocks. We identify opportunities and
appropriate trading methods for them. Our outlook is not a forecast. It is a probability framework. Use it as just one part of
the other information you are reading about the market. Our summary outlook will be included each week.

NEWSLETTER NOTICES
EXPERIENCE HURTS
In the newsletter prior to Christmas we noted the way the market has a habit of developing
unexpected bursts of activity between Christmas and New Year. One strategy to take advantage of this
is to place sell orders well out of market. These take advantage of these Christmas spikes. It is a
strategy we use.
Unfortunately, experience and newsletter notes are no antidote to stupidity. In November due
to the shutdown of the Noalls online trading site, we transferred our business to AOT On Line to take
advantage of stop loss conditions and other electronic services. This meant that our old good until
cancelled sell orders had to be re-entered. It seems we missed one in the transfer.
However, believing that we hade reinstated all GTC orders, we foolishly did not check this
when we added new GTC sell orders for the Christmas period.
The result? You guessed it. The one stock we overlooked took a gallop between Christmas and
New Year, hitting our targets and taking out our sell order except our order was not there! We missed
a 60% profit and it is entirely our responsibility.
The gallop has turned to a stumble, with prices collapsed back to a pitiful 5% profit. This trade
now calls for new management techniques. This is one mistake we will not make again.

14/1/2002

20

GUPPY CHARTING SOFTWARE

Over the past few months we have been working with Market Analyst to develop a Guppy
Trading Essentials charting package. This is built on the Market Analyst platform and includes basic
charting essentials and a specialist Guppy toolkit. We had hoped that the software would be fully
completed by December. However, there is still some fine tuning required and we will not release this
product until we are satisfied it is running smoothly.
This charting package is open platform and can read Metastock, Assci, txt,, Freeway and other
data formats.
The package is developed by Market Analyst and
uses indicators developed by Daryl Guppy and Alan
Hull. The charting package is distributed by Dane Boag
Pty Ltd via a new web site which is licensed to use the
Guppytraders name. Full details of the package,
including a fully working demo copy will be available
from www.guppytraders-essentials.com
This is charting software that grows with your trading skill.
This charting tool box includes all the standard charting tools you would expect, from Relative
Strength Index and MACD to Moving Averages and Linear Regression.
Display options include bar, candlestick, Kagi, several point and figure choices and line charts.
This pak includes a specialist tool kit developed from Share Trading and Trading Tactics by
Daryl Guppy. These are automatic count back lines, stop loss lines, the Guppy Multiple Moving
Average, automatic Darvas boxes, chart inversion and more. This pak includes the Range
Indicator and Rate of Return indicators from Active Investing by Alan Hull.
An essential analytics tool kit is included.
Compatible with most data formats.
This charting tool box is compatible with other tool kit modules from Market Analyst Software,
including Gann and Fibonacci. These can be added at any time to build a charting tool box to
suit your trading needs.
Other toolkits will be available, including candlesticks, day traders Tony Oz and others for the
real time version, advanced point and figure, etc.
We have not been involved with the development of Ezy Charts since mid 2001, and like many
users, we have concerns about data choices and service support. Our involvement with Market
Analyst has been designed to overcome these issues which we believe are important for all traders.
In future issues of the newsletter readers will see the same coverage of Metastock, Ezy Charts,
Supercharts, and the new GTE pak. We will continue to recommend the most appropriate software
for clients based on the skill level, experience and needs of each individual client.

MISSED ISSUES OVER CHRISTMAS

Some readers will choose not to take their laptops with them on their holidays and will
miss downloading some of the January issues. You can download the newsletter from any computer
simply by typing in your password. The password does not depend on the computer you are using. If
you miss an issue at any time, just drop us a note at support@guppytraders.com listing the issues you
missed and we will email them to you.

14/1/2002

21

NEWSLETTER SAMPLE TUTORIAL PORTFOLIOS

TUTORIAL PORTFOLIO 1 - MONEY MANAGEMENT
Starting cash position $100,000 - no brokerage or slippage 2% of risk = $2,000

Stock
RGS

Price

Qty

$1.060

19,000

Pur Value

Close

Entered

20,140

IDX

Price
$2.700

24,510
4,370.00

Percentage

Qty
7,500
Entered

CBL stop loss

1.2900

12-Nov Open Profit

Trend lines and time deadlines

Stock

Cur Val

Pur Value

Close

20,250

21.70
Cur Val

2.7900

12-Nov Open Profit

Percentage

20,925
675.00
3.33

SUMMARY MONEY MANAGEMENT

Overall profit to date since July 1, 2001 = $54,205 or 54.2% return on trade equity.
Profit 2000/01 = 59.2% return on trade equity.Profit 99/00 = 111.2% return on trade equity
Profit 98/99 = 102% return on trade equity. Profit 97/98 = 94% return on trade equity.
Profit 96/97 = 66.5% return on trade equity.

DISCLAIMER AND COPYRIGHT Guppytraders.com (ACN 089 941 560) Pty Ltd is not a licensed investment advisor.
This publication, which is generally available to the public, falls under the ASIC Media Advice provisions. These analysis
notes are based on our experience of applying technical analysis to the market and are designed to be used as a tutorial
showing how technical analysis can be applied to a chart example based on recent trading data. This newsletter is a tool to
assist you in your personal judgment. It is not designed to replace your Licensed Financial Consultant or your Stockbroker.
It has been prepared without regard to any particular person's investment objectives, financial situation and particular needs.
This information is of a general nature only so you should seek advice from your broker or other investment advisors as
appropriate before taking any action. The decision to trade and the method of trading is for the reader alone to decide. The
author and publisher expressly disclaim all and any liability to any person, whether the purchase of this publication or not,
in respect of anything and of the consequences of any thing done or omitted to be done by any such person in reliance,
whether whole or partial, upon the whole or any part of the contents of this publication. The information contained in this
newsletter is copyright and for the sole use of trial and prepaid readers. It cannot be circulated to other readers without the
permission of the author. Each issue now incorporates fingerprint protection that enables us to track the original
source of pirate copies. Contributed material reflects the personal opinion of the authors and are not necessarily those of
the publisher. Stocks held by the authors are marked* and are not to be taken as a trading recommendation.

14/1/2002

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