Candlesticks, Fibonacci, and Chart Pattern Trading Tools : a synergistic Strategy to Enhance Profits and Reduce Risk

DOUBLE TOPS AND DOUBLE BOTTOMS
•
47
Increasing the swing size will dramatically reduce the number
of trades. Although this might not be attractive for traders who want
to see action, it improves the chances for prof itable trades while lim-
iting commissions and slippage. As a rule of thumb, there should not
be more than 5 to 10 trades a year in a product like the S&P 500 Fu-
tures Index.
Figure 4.1 shows daily data for the DJ EuroStoxx 50 Futures
Index between August 2001 and August 2002. The 13 turning points
marked on the chart are based on a swing size of 300 points.
The appropriate swing size is closely related to the volatility of a
product and has to be determined for each product separately. Com-
puter simulations can do this easily on historical test data. The time
span for the test results should be at least 3 to 5 years.
Figure 4.1
DJ EuroStoxx 50 chart from 8 –01 to 8 –02. Significant turning points. 
c04.qxd 6/16/03 4:17 PM Page 47

---

48
•
APPLICATIONS OF TRADING STRATEGIES
We consider the application of double top formations and double
bottom formations to be a valid investment strategy. Its use demands
discipline, however, since the investor must closely follow stop-loss
rules, prof it targets, or entry rules.
Entry Rule
Traders get a long or short signal if the swing size is broken by the
daily close (on daily data). There are many ways in practical trading
to modify this approach, but the concept remains unchanged through-
out our analysis.
As we demonstrate on computer test runs later on, this approach
is prof itable over time.
Figure 4.2 shows the entry rule for buying and selling.
In addition to entry rules that can help traders track changing
markets, reliable stop-loss exit rules can help them control risk in
their positions.
Stop-Loss Rule
The investor gets stopped out of a position if, after the entry, a previ-
ous peak or a previous valley is broken based on a closing price.
There are many ways to place stop-loss orders. The conser-
vative approach presented here reduces whipsawing. In a strong 
market, however, the loss may be bigger than expected, because po-
sitions are only closed out based on the daily closing price level. The