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About the Authors xvPart I PreliminariesChapter 1 For Beginners Only 3Purpose of This Chapter 3The Nature of Futures Markets 3Delivery 4Contract Specifications 5Volume and Open Interest 9Hedging 11Trading 15Types of Orders 16Commissions and Margins 19Tax Considerations 19Chapter 2 The Great Fundamental versus Technical Analysis Debate 21Part II Chart Analysis and Technical IndicatorsChapter 3 Charts: Forecasting Tool or Folklore? 27Chapter 4 Types of Charts 35Bar Charts 35Linked Contract Series: Nearest Futures versus Continuous Futures 39Close-Only ("Line") Charts 40Point-and-Figure Charts 42Candlestick Charts 43Chapter 5 Linking Contracts for Long-Term Chart Analysis: Nearest versus Continuous Futures 45The Necessity of Linked-Contract Charts 45Methods of Creating Linked-Contract Charts 46Nearest versus Continuous Futures in Chart Analysis 48Conclusion 51Chapter 6 Trends 57Defining Trends by Highs and Lows 57TD Lines 66Internal Trend Lines 73Moving Averages 78Chapter 7 Trading Ranges 83Trading Ranges: Trading Considerations 83Trading Range Breakouts 86Chapter 8 Support and Resistance 91Nearest Futures or Continuous Futures? 91Trading Ranges 92Prior Major Highs and Lows 94Concentrations of Relative Highs and Relative Lows 101Trend Lines, Channels, and Internal Trend Lines 106Price Envelope Bands 107Chapter 9 Chart Patterns 109One-Day Patterns 109Continuation Patterns 122Top and Bottom Formations 134Chapter 10 Is Chart Analysis Still Valid? 149Chapter 11 Technical Indicators 155What Is an Indicator? 155The Basic Indicator Calculations 157Comparing Indicators 157Moving Average Types 165Oscillators and Trading Signals 167Indicator Myths 170Indicator "Types" 172Conclusion 173Part III Applying Chart Analysis to TradingChapter 12 Midtrend Entry and Pyramiding 177Chapter 13 Choosing Stop-Loss Points 183Chapter 14 Setting Objectives and Other Position Exit Criteria 189Chart-Based Objectives 189Measured Move 190Rule of Seven 194Support and Resistance Levels 196Overbought/Oversold Indicators 198DeMark Sequential 199Contrary Opinion 203Trailing Stops 204Change of Market Opinion 204Chapter 15 The Most Important Rule in Chart Analysis 205Failed Signals 205Bull and Bear Traps 205False Trend Line Breakouts 211Return to Spike Extremes 213Return to Wide-Ranging Day Extremes 216Counter-to-Anticipated Breakout of Flag or Pennant 219Opposite Direction Breakout of Flag or Pennant Following a Normal Breakout 222Penetration of Top and Bottom Formations 225Breaking of Curvature 229The Future Reliability of Failed Signals 229Conclusion 231Part IV Trading Systems and Performance MeasurementChapter 16 Technical Trading Systems: Structure and Design 235The Benefits of a Mechanical Trading System 236Three Basic Types of Systems 236Trend-Following Systems 237Ten Common Problems with Standard Trend-Following Systems 244Possible Modifications for Basic Trend-Following Systems 247Countertrend Systems 254Diversification 256Ten Common Problems with Trend-Following Systems Revisited 259Chapter 17 Examples of Original Trading Systems 261Wide-Ranging-Day System 261Run-Day Breakout System 268Run-Day Consecutive Count System 273Conclusion 278Chapter 18 Selecting the Best Futures Price Series for System Testing 279Actual Contract Series 279Nearest Futures 280Constant-Forward ("Perpetual") Series 281Continuous (Spread-Adjusted) Price Series 282Comparing the Series 285Conclusion 287Chapter 19 Testing and Optimizing Trading Systems 289The Well-Chosen Example 289Basic Concepts and Definitions 291Choosing the Price Series 293Choosing the Time Period 293Realistic Assumptions 295Optimizing Systems 297The Optimization Myth 298Testing versus Fitting 310The Truth about Simulated Results 312Multimarket System Testing 313Negative Results 314Ten Steps in Constructing and Testing a Trading System 315Observations about Trading Systems 316Chapter 20 How to Evaluate Past Performance 319Why Return Alone Is Meaningless 319Risk-Adjusted Return Measures 323Visual Performance Evaluation 335Investment Insights 343Part V Fundamental AnalysisChapter 21 Fourteen Popular Fallacies, or What Not to Do Wrong 347Five Short Scenes 347The Fourteen Fallacies 349Chapter 22 Supply-Demand Analysis: Basic Economic Theory 359Supply and Demand Defined 359The Problem of Quantifying Demand 362Understanding the Difference between Consumption and Demand 363The Need to Incorporate Demand 366Possible Methods for Incorporating Demand 368Why Traditional Fundamental Analysis Doesn't Work in the Gold Market 371Chapter 23 Types of Fundamental Analysis 373The "Old Hand" Approach 373The Balance Table 373The Analogous Season Method 374Regression Analysis 375Index Models 376Chapter 24 The Role of Expectations 379Using Prior-Year Estimates Rather Than Revised Statistics 379Adding Expectations as a Variable in the Price-Forecasting Model 380The Influence of Expectations on Actual Statistics 380Defining New-Crop Expectations 381Chapter 25 Incorporating Inflation 383Chapter 26 Seasonal Analysis 389The Concept of Seasonal Trading 389Cash versus Futures Price Seasonality 389The Role of Expectations 390Is It Real or Is It Probability? 390Calculating a Seasonal Index 391Chapter 27 Analyzing Market Response 403Evaluating Market Response for Repetitive Events 403Chapter 28 Building a Forecasting Model: A Step-by-Step Approach 413Chapter 29 Fundamental Analysis and Trading 417Fundamental versus Technical Analysis: A Greater Need for Caution 417Three Major Pitfalls in Fundamental Analysis 418Combining Fundamental Analysis with Technical Analysis and Money Management 426Why Bother with Fundamentals? 427Are Fundamentals Instantaneously Discounted? 428Fitting the News to Price Moves 431Fundamental Developments: Long-Term Implications versus Short-Term Response 432Summary 435Part VI Futures Spreads and OptionsChapter 30 The Concepts and Mechanics of Spread Trading 439Introduction 439Spreads--Definition and Basic Concepts 440Why Trade Spreads? 440Types of Spreads 441The General Rule 443The General Rule--Applicability and Nonapplicability 443Spread Rather Than Outright--An Example 445The Limited-Risk Spread 446The Spread Trade--Analysis and Approach 448Pitfalls and Points of Caution 449Chapter 31 Intercommodity Spreads: Determining Contract Ratios 453Chapter 32 Spread Trading in Stock Index Futures 461Intramarket Stock Index Spreads 461Intermarket Stock Index Spreads 462Chapter 33 Spread Trading in Currency Futures 471Intercurrency Spreads 471Intracurrency Spreads 473Chapter 34 An Introduction to Options on Futures 477Preliminaries 477Factors That Determine Option Premiums 480Theoretical versus Actual Option Premiums 483Delta (the Neutral Hedge Ratio) 484Chapter 35 Option Trading Strategies 487Comparing Trading Strategies 487Profit/Loss Profiles for Key Trading Strategies 489Part VII Practical Trading GuidelinesChapter 36 The Planned Trading Approach 559Step 1: Define a Trading Philosophy 559Step 2: Choose Markets to Be Traded 560Step 3: Specify Risk Control Plan 560Step 4: Establish a Planning Time Routine 563Step 5: Maintain a Trader's Spreadsheet 563Step 6: Maintain a Trader's Diary 565Step 7: Analyze Personal Trading 565Chapter 37 Seventy-Five Trading Rules and Market Observations 567Entering Trades 568Exiting Trades and Risk Control (Money Management) 569Other Risk-Control (Money Management) Rules 570Holding and Exiting Winning Trades 570Miscellaneous Principles and Rules 571Market Patterns 572Analysis and Review 573Chapter 38 50 Market Wizard Lessons 575Appendix A Introduction to Regression Analysis 589Basics 589Meaning of Best Fit 591A Practical Example 593Reliability of the Regression Forecast 593Appendix B A Review of Elementary Statistics 597Measures of Dispersion 597Probability Distributions 599Reading the Normal Curve (Z) Table 604Populations and Samples 606Estimating the Population Mean and Standard Deviation from the Sample Statistics 607Sampling Distribution 608Central Limit Theorem 609Standard Error of the Mean 612Confidence Intervals 612The t-Test 614Appendix C Checking the Significance of the Regression Equation 619The Population Regression Line 619Basic Assumptions of Regression Analysis 620Testing the Significance of the Regression Coefficients 620Standard Error of the Regression 627Confidence Interval for an Individual Forecast 627Extrapolation 630Coefficient of Determination (r2) 630Spurious ("Nonsense") Correlations 634Appendix D The Multiple Regression Model 637Basics of Multiple Regression 637Applying the t-Test in the Multiple Regression Model 640Standard Error of the Regression 641Confidence Intervals for an Individual Forecast 642R2 and Corrected R2 642F-Test 643Analyzing a Regression Run 644Appendix E Analyzing the Regression Equation 649Outliers 649The Residual Plot 650Autocorrelation Defined 651The Durbin-Watson Statistic as a Measure of Autocorrelation 651The Implications of Autocorrelation 654Missing Variables and Time Trend 655Dummy Variables 658Multicollinearity 663Addendum: Advanced Topics 666Appendix F Practical Considerations in Applying Regression Analysis 673Determining the Dependent Variable 673Selecting the Independent Variables 675Should the Preforecast Period Price Be Included? 675Choosing the Length of the Survey Period 676Sources of Forecast Error 677Simulation 678Stepwise Regression 679Sample Step-by-Step Regression Procedure 680Summary 681References and Recommended Readings 683Index 685