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Higher Than Average Net Returns Using “Relative Correlation”

"Relative correlation" refers to the attributes of price movement and signals. These attributes, when all found together, create a powerful system for signal and confirmation.

This is based on the use of candlestick signals and other technical signals (including gaps, triangles, and wedges, for example).

The attributes include:

  1. Strength and duration of trends - when a trend is strong (meaning moving in one direction very consistently) and has good duration (meaning lasting longer than just a few sessions), it creates one of the attributes leading to strong reversal or continuation.
  2. Proximity of reversal or continuation to the edges of the trading range, meaning resistance at the top or support at the bottom. Signals appearing at these crucial proximity levels tend to be far more reliable than when they are found elsewhere. This means that reversal is more likely when a reversal signal appears, and continuation is also more likely when a continuation signals appears at these levels. Added strength for reversal is found when a signal occurs as price gaps above resistance or below support.
  3. Signal strength is measured by the attributes of a signal. In general, more contrast in breadth of signal days equals stronger signal and greater likelihood of expected price direction (reversal or continuation). Certain candlestick signals are likely to lead to expected price behavior more than others, so emphasis on these candlestick signals further bolsters the rate of success in timing of trades.
  4. Confirmation signal strength is just as important. A strong confirmation signal bolsters confidence in the likelihood of reversal or support.

A few key observations: Strong trends tend to lead to strong reversal or continuation signals. And these in turn tend to lead to stronger than average confirmation signals. The resulting price direction (reversal or confirmation) also tends to be stronger than average in this case.

The same is true on the other side. A weak trend tends to lead to weak signals and weak confirmation; and the results are also weak, meaning they are more likely to fail or contradict the indicated direction.

Is relative correlation just a theory, or does it work? I have conducted a two-year study using this theory and executing 578 trades during trading hours, using bid and ask appropriately and adjusting for trading costs on both entry and exit. Based on the relative correlation approach to trading, 91.6% of these trades were profitable; and the average annual rate of return was 35%. All of these trades can be studied and analyzed free of change in the archives of my website, ThomsettOptions.com where trades are shown by entry date, basis, close, profit or loss, and rate of return.

A have written a book documenting this theory and its application. It is published by FT Press and is available by December 27. The title is Profiting from Technical Analysis and Candlestick Indicators. It can be ordered from www.ftpress.com or www.amazon.com - here is a summary of the table of contents:

Introduction-The Self-Fulfilling Prophecy

Chapter 1-Charting Techniques - Predicting the Future

Chapter 2-Traditional Analysis - the Power of Pattern Recognition

Chapter 3-Candlestick Patterns - Recognizing Evolving Strength or Weakness

Chapter 4-Reversal Signals - Spotting the Turning Point

Chapter 5-Continuation Signals - the Mid-Trend Signs

Chapter 6-Combining West and East - Candlesticks and the Technical Signs

Chapter 7-Confirmation - an Essential Second Part of a Signal

Chapter 8-Support and Resistance - Key Price Points in the Trend

Chapter 9-Moving Averages - Finding Statistical Correlation

Chapter 10-Volume Indicators - Confirmation of Price

Chapter 11-Momentum Indicators - the Exhaustion Point

Chapter 12-Signals Failures and False Indicators - the Misguiding Signal

Chapter 13-Beyond the Signal - Candlestick Pattern Moves

Chapter 14-Risk Reduction Methods-Using Charting Techniques to Manage Risk

Appendix A: Hypothesis Summary

Appendix B: Hypothesis Testing

Endnotes

Index