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Jay Norris
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Jay Norris is a 20-year CBOT floor veteran, author of the Best Seller "The Secret to Trading Forex, Futures, and ETFs: Risk Tolerance Threshold Theory", "Mastering the Currency Market", McGraw-Hill, 2009, and "Mastering Trade Selection and Management", McGraw-Hill,... More
My company:
Trading University
My blog:
Seeking Alpha
My book:
The Secret to Trading Forex, Futures, and ETF's: Risk Tolerance Threshold
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  • The Most Important Tenet In Trading: Dow's 2/3rd Retracement

    The following article is an excerpt from the eBook 15 Ways To Improve Your Trading in 7 Minutes or Less

    The Secret to Trading: Dow Theory's 2/3rd Retracement

    Jay Norris

    The most important tenet in trading, and one I have built my success, longevity, and happiness on is straight out of Dow Theory and says that a market can retrace up to 2/3rds of an impulse price move and still maintain its primary pattern. The 2/3rds retracement is the most important level on the chart. It is effective not just for long-term patterns, but the short-term and micro patterns also. This tendency is highlighted in these current charts of the Euro, U.S. Dollar Index, crude oil and gold in Figure 1, 2, and 3.

    (click to enlarge)
    Figure 1. Euro and Dollar Index futures

    (click to enlarge)
    Figure 2. Price Charts of Crude Oil and Gold

    (click to enlarge)
    Figure 3. 2/3rds Retracement Patterns on Intraday EURUSD Chart in February 2015

    This trading tenet is as important now as it was when Robert Rhea wrote about it over 80 years ago. And focusing on buy and sell signals, at these key levels, dovetails with the golden rule of trading: "buy dips in uptrends, and sell rallies in downtrends". No doubt underlying fundamentals determine a markets predominant trend, and that is always the direction we want to trade in, but it is these 66% counter-trend price dips and rallies that cause the majority of retail traders to lose, and provides market-makers and professionals a living.

    The Fractal Nature of Markets

    We have a theory for this collective behavior called Risk Tolerance Threshold Theory, but we know most of our students are not as interested in the behavioral science and academics of this phenomenon as they are in the practical application: successful trading. Before we focus on those applications however, there is one academic subject that will go a long way in helping you to understand how to profit from this market tendency, and that is markets are fractal in nature. "Fractal" means that the same behavior is programmed into the system regardless of the degree, or timeframe, and this behavior is a two way mechanism. So the lower time frame patterns mimic the higher time frame patterns and, the higher time frames mimic the lower time frames. As traders we just need to know that if we have a measurement to determine the current pattern on one time frame then that same measurement will work on all time frames. The 2/3rds retracement is that yardstick. And this same measurement also provides a reliable indication for measuring when a pattern has reversed!

    Applications of the 2/3rds Phenomenon

    Just as important as the actual support and resistance the 2/3rds level provides, perhaps even more important, is what is implied in Dow's observation: A market can retrace up to 2/3rds and still maintain its pattern/trend; therefore a retracement beyond that level will indicate a pattern reversal. That truism in light of the market's fractal nature gives us the means to be able to measure the pattern on any time frame!

    For example, if the high price on the chart came before the low price, and that market has not retraced more than 2/3rds of the difference between those two numbers on a 2 close basis following the low price, that time frame pattern in down --bearish. Likewise if the low price came before the high price, and that market has not retraced more than 2/3rds of the difference of those two numbers on a 2 close basis following the high price, that time frame pattern in up - bullish.

    In the gold chart in Figure 4, we have broken the market down into 3 patterns: the 50-day, the Secondary Pattern, and the Primary pattern. We can identify with confidence the direction of those patterns based the high price, low price, and the closing price - fact based occurrences --in proximity to the 2/3rd retracement.

    (click to enlarge)
    Figure 4. Individual Patterns in Gold market

    By taking this same information and plugging it into what we call our Risk Tolerance Threshold Ratio, we give ourselves a much easier to read, objective graphic where we can see at a glance what the current direction of the tradable patterns are -- See Figure 5.


    Figure 5. Gold RTT Ratio from late Jan 2015

    If you are a short-term trader you would be more focused on the lower time frame patterns and the support and resistance created by them, while a longer-term trader would be interested in the longer-term patterns and levels.

    The RTT Ratio gives us an objective tool for determining trade selection because it definitively measures the trading environment we are in: trending or counter-trending, and provides the foundation for a method that is easily validated.

    Statistical Validation

    We teach that it is not the direction of the individual time frame pattern that is important but the direction of the majority, or collective pattern, that counts. We focus on any 3 successive patterns and trade in the direction of the majority of those three. We have absolute confidence that this collective pattern is a reflection of the influential fundamentals of the day.

    The RTT Ratio helps insure that our trade selection --are we buying or selling? -- is aligned with the current trading environment. It also allows us to back-test or forward-test a methodology or tactic to determine if the effort is more effective in a trending market or a counter-trending market. Charles Dow said the hardest thing in market analysis was determining when the market shifted into a counter-trending environment and how long it would last? Our RTT Ratio, which is based on Dow's observations, identifies the trading environment so we can adjust our strategies and filters accordingly. One of the most powerful advantages you can have as a trader is to simply know ahead of time if you are going to be a buyer or a seller.

    (click to enlarge)Figure 6. Trading-U's 15-minute Benchmark

    The spreadsheet in Figure 6 is our benchmark method's performance on the 15-minute chart for the 30 days prior to writing this chapter. We only took trades that were in-line with the collective pattern at the time of the trade, i.e.: we bought dips in uptrends, and sold rallies in downtrends.

    Jay Norris worked on the floor of the Chicago Board of Trade for over 20 years and has written two books on trading which were published by McGraw-Hill. To receive a free copy of the entire eBook go to: 15 Ways to Improve Your Trading in 7 Minutes or Less.

    To sign up for Jay's free Live Market Analysis held every other Thursday at 10:00 AM EDT go to: Trading-U Trial and choose the "free trial" option.

    Apr 01 5:17 PM | Link | Comment!
  • ESignal Weekly Forex & Futures Forecast For 3-2-15

    See author and Trading Instructor Jay Norris cover the major currency markets while emphasizing the importance of having a static trading plan that provides a benchmark performance on YouTube at Weekly Forecast.

    Jay talks about the advantage of using a systematic, independent approach to market analysis that relies on market generated information only, and highlights the trading performance of the method he employs and teaches year-to-date.

    His focus this week is back to buying dips in the dollar and selling rallies in the Euro.

    While he has put "buying dips" in the Aussie Dollar on hold because of a short-term bearish shift last Thursday he is not looking to sell rallies because of long-term support in the Aussie from .7750 to .7650.

    Mar 02 8:31 AM | Link | Comment!
  • Euro Rally, Greenback Correction At Hand?

    "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves." Peter Lynch, legendary fund manager.

    I completely agree with Peter Lynch's thought process, along with another investor who scoffs at the idea of trying to time market corrections, Warren Buffet.

    No doubt, the trickiest part in investing or trading is to predict a market correction and trickier still gauge how long that correction will last. It takes a ton of patience just to get on the right side of the market long-term, why complicate the process by trying to time shorter-term secondary moves? The only correct answer to that question is because your method tells you to.

    Be Happy, Make Money

    The last 9 months have been great because I was so forthright that a sea change move in the U.S. dollar was on hand --http://www.forexfactory.com/news.php?do=news&id=488201 - and I positioned myself aggressively for that. Regarding my long-term cash positions nothing has changed. I'm still long UUP - The U.S. Dollar Index ETF. As a trader however, I am free to trade whichever way the shorter-term patterns tell me.

    Last year I passed on any short-term counter-trend signals and just waited to buy dips in the U.S. Dollar, and or sell rallies in the Euro. After all the golden rule of trading is: "Buy dips in uptrends, and sell rallies in down trends". I'd be suspect of any strategy where this was not at the core.

    Four Years to 50%

    This year however I will trade those shorter-term, counter-trend signals the method produces, and here is why:

    1. Cuz I can. If you have a method which produces well statistically in both long-term and short-term time frames then by all means take advantage of it.
    2. We are nearly at the 50% retracement level of the previous bear cycle in the dollar and the current bull cycle is in its 4th year -- see Figure 1. (If we take the 2011 low on the Monthly Dollar Index chart as the beginning of the new bull, then this cycle is going on 4 years. (We always want to start a cycle on a higher low or a lower high, and not on the absolute low or high). Given the rally is starting to mature it becomes natural that at some point the rate of acceleration will slow which means more corrective behavior, i.e. more retracements.
    3. Market corrections are faster and more violent than the trends they are retracing. As most traders know it is hard to find fault with profiting from a fast market.

    (click to enlarge)Figure 1.

    Nothing Has Changed, But The Aussie…

    I am no less bullish on the U.S. Dollar and U.S. economy. If the Greenback does correct however and we do see a secondary rally in the Euro once this Greek business fades from the headlines - again - I want to participate.

    Same for the Aussie -- which is a completely different scenario than the Euro --and where there is a chance a long-term bottom is being sewn in.

    Jay Norris is the author of two McGraw-Hill books and teaches the art of trading at Trading University. To see his weekly forecasts on YouTube go to: Weekly Forex Forecast

    Feb 12 2:11 PM | Link | Comment!
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