Trader’s Narrative

As much as trading seems complicated, or perhaps, as much as we fall into the trap of making it complicated, there are really only three types of trades you could ever put on. In order of difficulty, here they are:

With the Trend
Trading with the trend is perhaps the most common, and I would argue the easiest of the three types. Turtle trading would fall into this category, as would dummy trading, Linda Raschke’s “Holy Grail” setup and many others. When you trade with the trend, your thesis is to go along with the crowd and ride the emerging or existing trend. A break-out type play would go under this category, as would a retracement type play - since both are anticipating a continuation of the dominant & previous trend.

Counter Trend

The opposite is to go against the crowd and to anticipate a change in direction. Most would tell you to never “fight the trend”. Although I wouldn’t recommend it to newer traders, it is a legitimate way to trade and make money. Or as Paul Tudor Jones II puts it: “I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.”

Non-Directional

This is perhaps the most “advanced” form of trading and therefore the most difficult to execute. And for those new to trading, it is perhaps the most difficult to grasp. How can you make money if the thing just meanders??! You do so through the modern marvel of financial derivatives. Within a range of prices (blue lines), many option combinations allow you to make money through the sale of a ‘premium’. The simplest is a covered call position (or if you flip it around, a short put position). There are other combos that are incredibly complex and would make a PhD math student go cross-eyed. Do not venture into this territory without a good grasp of the greeks (delta, gamma, vega, etc.).

That’s it! So if you’re totally new to trading, or are a veteran trying to come up with a new strategy, it may be usefult to step back, wipe the slate clean and realize that no matter what kind of trade you put on, it will fall into one of these three categories.

Ahhh, the elegance of simplicity.

If you’ve somehow managed to not learn about Mark D. Cook by now: he is a ‘Trading Wizard’ featured in Schwager’s series of books, a legendary futures trader and the winner of the 1992 U.S. Investment Championship (with a 563.8% return). His most famous contribution to trading and technical analysis is his self named, Cook Cumulative Tick Indicator.

This indicator is, as the name suggests, simply a cumulative count of tick throughout the trading day. The exact recipe is only known to Mark D. Cook but from what he has publicly divulged, we can try and estimate the Cumulative Tick Indicator to a pretty good degree.

First, separate the noise from the signal by ignoring any tick readings within the +/-400 range. We then record and aggregate those readings outside this range at a fixed time interval. We don’t know exactly what interval Mark uses so just pick a time interval: minute, hour, day, etc. The important thing is to be consistent. That’s it! Now you have the super secret Mark D. Cook, Cook Cumulative Tick Indicator. So what do you do with it? Watch the 95th and 5th percentile. If the Cumulative Tick Indicator is above the 95th percentile, sell; if below 5th percentile, buy.

Remember, this is a counter trend strategy so the more extreme the tick, the more vicious the snapback. As with all counter trend strategies, mind your protective stop loss! A trend can persist much longer than you can remain solvent. Never try and be a hero by playing chicken with the market.

But what if you don’t have access to such tick data? You can estimate the cumulative tick by calculating a simple moving average. This won’t be the same as Cook’s Cumulative Indicator, but it is still helpful:

The cool thing about this indicator is that it is quite accurate in pinpointing tops as well as bottoms (see how an oversold extreme in tick flagged the May 2006 bottom). After all, it is an almost real time snapshot of the market’s pulse, racing from greed to fear and back again.

Lets take a look a the recent action in this approximation of the Cumulative Cook Indicator. In early March 2007 it hit an extreme oversold level (-300). If you had any shorts or wanted to press the short side, this was telling you to both lighten up and to think about going long instead.

Then within just a few weeks in mid-March 2007 it reversed and went as high as +500! If you notice, it hit the overbought threshold (+400) when the Nasdaq reached 2450 and stalled. If you were long, it was telling you to lighten up and think about shorting. Remember that this indicator is quite hyper. Either adapt to such short term setups or use a longer moving average to get a more long-term perspective.

Mark Cook uses the NYSE tick, but personally, I think that the NYSE is so polluted with non-common share securities that the tick and any other indicator based on NYSE data has way too much noise to signal ratio to be useful. Thankfully we have the NASDAQ tick which is the same thing really - free of the ‘noise’ from bond funds, munis, preferreds, etc.

Cook has a few more tricks up his sleeve - would he be a Trading Wizard if he didn’t? There is the conjunction trade which relies on tick but is a bit different than the Cumulative Tick Indicator. First, you want a tick reading below -400 (the magical threshold). Second, you want the Dow Jones tick below -22. The ‘conjunction’ of these two gives you the signal (for the spoos). You give it a window of 21 minutes to work.

There are 3 possible outcomes:

• you run out of time (price meanders) and you exit
• you take a 3 pt profit
• you take a 6 pt stop loss

I’m not sure if it’s a great idea to have a 1:2 profit to stop loss ratio but I assume that Cook relies on the high probability nature of this setup to give him positive expectancy.

Finally, Mark D. Cook has a trading setup he calls a ‘tick buy’. This is the simplest one! The signal for a buy/sell is when the NYSE tick gets to -/+1000. That’s it. The thinking is, of course that you buy because market will snap back from such an oversold level. The wrinkle is that you watch and buy the index that cooperates or leads the most. Mutatis mutandis for an extreme overbought tick. So if the NDX is weak, and we get a sell signal (+1000 tick) we then sell NDX (not SPX or OEX which may be stronger).

If you’re interested to know What Mark thinks about the current market, you can read his most recent commentary here. But be aware that Mark tends to have a bias towards the bearish side