Friday, September 11, 2020

Tools To Improve Market Timing From John Ehlers

I understand John Ehlers will be retiring in the not too distant future and is holding a comprehensive four-day workshop from October 19-23rd that will cover the scope of much of his work.  For those unfamiliar or uncomfortable with the math behind his methods, the workshop could provide a user-friendly, hands-on introduction.  For those willing and able to wrestle with new indicators and ways of processing market data, John's books are excellent resources.  And, on top of it all, there is his MESA software that implements his research.  I'm going out of my way to write this blog post about John and his work because I have always found him to be rigorous, evidence-based, and free of hype.  He publishes the real time track record of his stock picks on the Stock Spotter site and makes himself available to answer questions and help traders.  

Two key insights behind John's work are:  1) by creating better filters for market data, we can create superior technical indicators; and 2) by preprocessing market data (including detrending), we can identify market cycles more robustly.  As I have emphasized many times in this blog, all market time series consist of linear (directional/trending) components and cyclical components.  It is the interplay of the directional and cyclical elements that creates momentum and value patterns that can be traded.  One powerful strategy for trading is to go with market trends and make use of shorter-term cycles within those for timing.  John's work borrows tools from engineering to more readily identify these trends and cycles.

If you click on the chart above, you'll see a 60-minute chart of the September ES futures contract.  Notice in the top panel the red and green lines going through the chart.  Those are shorter- and longer-term MESA adaptive moving averages derived from John's research.  (This particular chart was drawn in Sierra Chart).  The yellow arrows show crossover points.  The MESA averages, because of their construction and filtering, provide crossover signals that are more free of whipsaws and thus more reliable than the standard version.        

Show me a master craftsperson, whether in trades or the arts, and I'll show you someone with superior tools.  No credible subspecialty surgeon uses off the rack, generic instruments and materials.  Similarly, high performing traders cannot expect exemplary results from preset levels of generic indicators.  Our psychology and mindset can be just fine, but they cannot in themselves elevate our craft.  

 Added 9/12/2020:
Here's a screenshot from my tradestation viewing Friday's trade in ES.  The bottom panel is a five-period detrended oscillator that makes it easier to identify short-term cycles in market data by taking trend out of the calculation.  My experience is that market time series are made more stationary (stable) when looking at volume-based bars rather than time-based ones.  In the chart, each bar represents 12,000 contracts traded so that we can see how the day session unfolded.  Note (bottom panel, blue arrows) that we make short-term cycle lows at equal or higher price lows and that the MESA Adaptive Moving Average crosses over between the two cycles (yellow arrow) to shift to a buying mode.  I love buying cycle lows at higher price lows in an early rising market where prior shorts are likely to be trapped.  Note also how the volume transacted at the bid vs. offer price shifted as the market made its low during this period, showing how buyers were becoming more aggressive (lifting offers) ahead of the market turn.  Again, the right tools make all the difference if you're going to master your craft.