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Section I. Indicators in the Catman System Section II. Reading the Cat Signals Section IV. Using the Cat Signals
First of all, let me say that understanding exactly what these indicators are, will not be vital to your success when you are using the system. In fact, I would say you will have higher success, and a much easier time of it, simply taking things at face value. So whether you call it the 15 MA, or “that squiggly red line“, won‘t make an ounce of difference. The important thing is knowing where that squiggly red line should be headed. However, I know how you guys are. You like to make things more difficult than they need to be, and the more complicated it sounds the more you respect it. So to satisfy your curiousity, and make myself sound really smart, I will briefly go over what these things are. A. Moving Averages According to investorwords.com, a moving average is the average price of a security over a specified time period (the most common being 20, 30, 50, 100 and 200 days), used in order to spot pricing trends by flattening out large fluctuations. New numbers are added to the average and the oldest numbers are dropped; thus, the average "moves" over time. The moving average is the most commonly used variable in technical analysis. It can be used to track daily, weekly, or monthly patterns. There are different types moving averages, depending on how they are constructed, including simple moving averages, exponential moving averages, and weighted moving averages. They are normally calculated using closing prices. Time-frames used will also vary. A shorter MA, like the 5 Day MA, will be more sensitive and identify changes much earlier. This will make them more volatile. A longer MA, like the 200 Day MA, will be more useful for identifying larger trends. The Catman System uses two fast moving averages, the 5 MA and 15 MA. B. Stochastics According to investorwords.com, stochastics is “a model based on the belief that as prices increase (or decrease), closing prices tend to accumulate ever more closely to the highs (or lows) for a given period.“ The indicator consists of two lines, the %D and the %K. The %K compares the last closing price to the range traded over a selected period. The number of periods used in the indicator can vary. The %D is a signal line calculated by smoothing %K. The original formula used for smoothing the %D was a 3 period simple moving average. For the Catman System, both the %K and %D are set to P = 14 C. On-Balance Volume On-balance volume, or OBV for short, is a technical analysis indicator used to determine when a stock is being accumulated or distributed, by comparing volume to price over time. Volume is added to the indicator if the closing price moves up and subtracted if the closing price moves down. No adjustment is made if the closing price is unchanged. A rising OBV confirms an up-trend or warns of an upward breakout, and a falling OBV confirms a downtrend or warns of a breakdown. The OBV may also lead the price, so a bouncing OBV while the price is still falling, can be an early warning of a bottom.
Section II. Reading the Cat Signals Reading the signals for a top or bottom using the Catman System, is exactly the same, regardless of the time-frame of your chart. How you react to those signals may differ, according to the type of trade and whether you are entering or exiting (we will talk about that later), but the signals are the same for every chart, whether its a 15 tick or a 15 minute chart. A. Setting up your chart Your chart should be set up to include each of the five indicators we discussed earlier. These are the colors I use for each indicator. 1. MA, P = 5 - Green B. Anatomy of a bounce 1. Indications of a bottoming 2. Confirmation of uptrending a. The “MA test“ The 5MA continues up, crossing above the 15MA, confirming C. Anatomy of a top 1. Indications of a topping a. %K spikes to 100 2. Confirmation of downtrending a. The 5MA continues down, crossing below the 15MA, confirming a downtrend.
Section III. Case Study
Let’s look at a trade we made on Apple Computer, and I will try to explain how this works. A. Looking for a bottom 1. 10:06 am At this time we see Apple moving down to a likely support level, the S1 (That green line. See Stuff on Pivots). But I still would not buy yet. Why not? This is a really common mistake that people make – buying at a support level, without any real indication that it is actually bottoming. Lets review our indications of a bottoming.
At 10:06 we see a sharp drop to 0, and even before, at 10:02 am, the %K was close to hitting bottom. So this criteria was met. b. 5 MA begins to curve upward, towards the 15 MA, putting them on a colision course so that if the 5MA continued, they would eventually cross paths and the 5MA would move above the 15MA. The more perpendicular, the better.
If you look at 10:06, when that red candle hit bottom, you see the 5 MA was still pointing straight down at that time. Also, if you look at the channel between the 5 MA and the 15 MA, you see it is still wide, and they are pointing away from each other. We need the appearance that the 5 MA is flattening out, or curving – that the channel may be closing. c. %D reaches below 20 and begins to curve upward At this time the %D had reached below 20, to 11.40, so I was definitely on guard for a bottoming, but until it actually starts to curve upward a bit, this criteria is not met. d. %K spikes up, crossing above the %D The %K was still at the bottom at this point, so this criteria was also not met. e. OBV points upward Right at 10:06, the OBV hit bottom, so again, I would definitely be on guard for a bottoming, but until it actually starts to move back upward, this criteria is not met. 2. 10:09 – 10:10 am Around this time the price was starting to move up and the buying was gaining some momentum. So let’s go over our indications of a bottoming again, and see if criteria is now met for a long entry. a. %K drops to 0 At 10:06am the %K had hit bottom, so that criteria had already been met. b. 5 MA begins to curve upward, towards the 15 MA, putting them on a colision course so that if the 5MA continued, they would eventually cross paths and the 5MA would move above the 15MA. The more perpendicular, the better. Now we see the 5 MA flattening out horizontally and starting to curve up towards the 15 MA, so that if it continued, the channel would close and the 5 MA would eventually cross up above the 15 MA. Criteria met. c. %D reaches below 20 and begins to curve upward The %D was already below 20, but now we see it starting to curve back upward. So this criteria is now met. d. %K spikes up, crossing above the %D At this time we see the %K spiking up, and crossing above the %D. Criteria met. e. OBV points upward. The OBV hit bottom at 10:06, and now we see it uptrending. So this criteria is met as well.
B. Trade Entry With the stock gaining momentum off of the support barrier, and all of our criteria met for a bottom signal, we entered a long position around 85.50. Our stop was any breakdown below the support barrier, in other words any new low, which was at that time 85.27. Our target was the previous day‘s closing price, which was 86.25. So our risk was around 25 cents, and our potential reward around 75 cents. It is important to figure the risk vs reward for each trade, to make sure the entry is justified. C. Looking for Confirmation 1. 10:11 – 10:12 am Once we enter the trade, we want to keep an eye on our stop and start looking for confirmations of uptrending. So let‘s look at our confirmation signals. a. The “MA Test“. The 5MA continues up, crossing above the 15MA, confirming an uptrend. At this time, the 5 MA was on a collision course with the 15 MA, but had not yet crossed above. If the “MA Test“ fails, and the 5 MA refuses to cross above, the price will fall and can slip back rapidly to the lows. So as the MA Test approaches, you want to be on guard. b. The %D continues to climb At this point we still see the %D steadily moving upward, which is a good sign. If it continues moving straight up, it improves the chances of the MA Test passing. The %K at this point is also still spiking upward and holding above the %D, which is another good sign that the MA Test will pass. The OBV will often hesitate around the MA Test, so you need to keep an eye on that too, but as long as it keeps trending higher, the trade is still ok. 2. 10:13 As the stock climbs, we want to keep looking for confirmation of uptrending. a. The “MA Test“. The 5MA continues up, crossing above the 15MA, confirming an uptrend. Now we see the 5 MA crossing up above the 15 MA perpendicularly. That is the confirmation we need. After that, you want to make sure it stays above the 15 MA. The wider the channel between them on the way up, the better. If the cross is not clear, more of an intertwining, or if the 5 MA starts to turn back down, the trade may be in trouble. b. The %D continues to climb The %D is still steadily moving upward. That is what we want to see. The %K is still spiking upward. As long as it holds above the %D, we are ok. The OBV is continuing upward after some hesitation at the MA Test. With the confirmation of uptrending, and all signals still in our favor, we can set our sites on our target and any resistance barriers, and start looking for topping indications to signal our exit.
Section IV. Using the Cat Signals The signals themselves are clear and easy to read. The idea is similar to the way a traffic light works. At every traffic light, the first warning signal before traffic changes direction, is a yellow light. The second signal to stop is then a red light. In Germany the yellow light even works both ways. When you are stopping it first turns yellow, then red. When it changes again, it first turns yellow and then green. As a driver, you have to choose what to do when the light turns yellow. You can either stop early when the light turns yellow, or speed up to get through the intersection. But whenever you make a move on an early yellow signal, you accept more risk. What if you decide to speed up at the yellow signal before it turns red, and someone going the other direction is in a hurry to get started? You might make it to your destination faster if you act on yellow, but you are accepting more risk. The same is true with this system. Whenever you enter a trade on an early signal, you will realize more potential if you get it right. However, you are also taking on a greater risk of being stopped or not seeing much follow-though. The same is true if you exit on an early signal. You may get out with “safer” exits by exiting on an early signal, which would be appropriate if the trade is high risk, but you may also miss out on further potential if you are exiting early, simply because you are jumpy. This is generally true for any trading system really. The greater the potential reward, the greater the risk. There is always a payoff. So you need to learn which signals and charts are appropriate in which circumstances. How you react to these signals will depend on several factors including the type of stock, your skill at executing stops, the number of shares you are playing, and the market environment. 1. Entries This is not as much of a problem. The idea is, we want to limit as much risk as possible in our trades, both entries and exits. So to limit risk risk in our entries, we obviously want to wait for a "good" signal.. and be conservative. Do not enter on an early signal. Wait for A - E.. and if they dont happen.. leave off F. 2. Exits To be continued...
A note about discipline… If you look back over charts and track all signals throughout the day, you will soon see that some of them have ample follow-through and some are small scalps. You won’t know until they develop, so it often pays to act on all the set-ups. The good thing is that risk is small because the stops are clear. So you have little to lose and a lot to gain by following all the signals. And if you are diligent, you can easily rack up several points a day. This is also an important key to overcoming emotional trading. Forget the money, forget the price of the stock even, and focus on the signals and set-ups. Keep stops when its appropriate and hold on until you see an exit signal. Watch the signals and rely on them. By putting your focus on the signals, it will minimize emotions and keep you from second-guessing your decisions, which is a deadly trading error. |
