fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 The ARTR of Trading Combining the Science of Technical Analysis with the Art of Reality-Based Trading® BENNETT A. McDOWELL John Wiley & Sons, Inc. i fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 iv fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 The ARTR of Trading Combining the Science of Technical Analysis with the Art of Reality-Based Trading® BENNETT A. McDOWELL John Wiley & Sons, Inc. i fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 Disclaimer: This eBook does not include ancillary media that was packaged with the printed version of the book. Copyright C 2008 by Bennett A. McDowell. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. 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Library of Congress Cataloging-in-Publication Data: McDowell, Bennett, 1957– The art of trading: combining the science of technical analysis with the art of reality based trading / Bennett McDowell. p. cm. – (Wiley trading series) Includes index. ISBN 978-0-470-18772-2 (cloth/dvd) 1. Investment analysis. 2. Speculation. 3. Stocks. I. Title. HG4529.M385 2008 332.632042–dc22 2007049357 Printed in the United States of America. 10987654321 ii fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 For my children, Heather Frances and Brady Bennett, with love and affection. iii fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 iv fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 Contents Foreword ix Preface xi Acknowledgments xiii Diclaimer xv Introduction xvii PART I Reality 1 CHAPTER 1 It’s All About Reality 3 CHAPTER 2 The Reality of Price and Volume 7 CHAPTER 3 Managing Risk: Always Set a Stop-Loss Exit 13 CHAPTER 4 If It Sounds Too Good to Be True . 19 CHAPTER 5 Personal Methods to Increase Trading Success 23 CHAPTER 6 Identify Your Personal ART Profile 27 PART II Art 39 CHAPTER 7 Design Your Business Plan 41 CHAPTER 8 Selecting a Financial Market 47 v fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 vi CONTENTS CHAPTER 9 Selecting a Time Frame 55 CHAPTER 10 Selecting an ART Platform, Broker, and Data Feed 59 CHAPTER 11 Psychology and the Trader’s Mind-Set 63 CHAPTER 12 Artistic Simplicity 67 CHAPTER 13 The Art of Paper-Trading 71 PART III Science and Math 75 CHAPTER 14 Calculating Proper Trade Size 77 CHAPTER 15 Other Formulas and Recipes 83 CHAPTER 16 The Human Brain 87 PART IV ART System Basics 91 CHAPTER 17 ART Is the Total Solution 93 CHAPTER 18 Pyramid Trading Points (P and MP) 97 CHAPTER 19 Market Truths: Price Bars and Volume 115 CHAPTER 20 ART Reversal Bar Signals (1B and 2B) 121 CHAPTER 21 Trend-Trading Rules 135 CHAPTER 22 Countertrend-Trading Rules 141 CHAPTER 23 Scalping Rules 147 PART V Advanced Techniques 155 CHAPTER 24 When to Use Advanced Techniques 157 CHAPTER 25 Scaling Out and Scaling In 161 fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 Contents vii CHAPTER 26 How to Trade Bracketed Markets 167 CHAPTER 27 Software Optimization and Average True Range (ATR) 179 CHAPTER 28 Stop and Reverse (SAR) 183 CHAPTER 29 Higher-Time-Frame Filter 187 CHAPTER 30 Other Filter Techniques 205 CHAPTER 31 Elliott Wave—Ungrounded Assessment 215 CHAPTER 32 Other Ungrounded Assessments 223 Epilogue 231 About the DVD 233 APPENDIX A ART Software Quick-Start 237 APPENDIX B ART Tips 241 APPENDIX C ART Software Technical Support 243 APPENDIX D Resources 247 Glossary 263 About the Author 285 Index 287 fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 viii fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 Foreword his is not your ordinary “get rich quick” book about trading the stock market. Rather, it is a guide to a multimedia approach to learning T and trading, using the Applied Reality TradingR (ARTR ) method of trading. This book and the accompanying DVD explain the concepts and methodology. In addition, the purchase of this book includes a one-month time frame in which to actually learn to trade the system and apply it in real time. This is done by including the ART software for one month, including access to live streaming data and access to a few, designated brokerage firms that can trade directly through the software. In essence, everything that the reader needs—for learning and for seeing how the system works in actual markets—is included with this book. The ART trading methodology is built on software recognition of sev- eral time-tested patterns that can be easily identified for the user. While they are called specific names in the software, these are essentially break- outs and reversals—the meat and potatoes of technical trading. The chart patterns identified can be applied to any type of bar chart—daily, five- minute, weekly, and so on. Moreover, they can be applied to stocks, fu- tures, indices, and forex—or any other market that can be charted. What separates this methodology from many other computer- generated trading systems is that this is not a 100 percent mechanical “black box” system. Rather, this book (and the multimedia associated with it) teach the individual how to apply the various trading signals to the style of trading with which he feels most comfortable. Position traders can trade the trend signals from the software, while short-term swing traders may prefer to take minor signals generated along the way—even trading within a trend, if desired. If you are uncertain which trading style might best suit you, the “ART Profile” exercise in this book will aid you in determining the style best suited to your personality. Risk control is stressed throughout—determining effective position size, setting stop-loss exits, and more. Exact entry and exit points are given with the signals, so that you can judge your risk beforehand, and therefore determine position size as well. One of the many unique features is that ix fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 x FOREWORD stops are based on market conditions (chart patterns and volatility) as op- posed to an arbitrary dollar amount. Therefore, the stops are more logical in terms of market mechanics, which prevents one from being stopped out prematurely, as might happen with “percentage risk” stops. Finally, the techniques can be applied to option trading as well. I have long espoused the idea that any successful stock trading technique can be translated into a profitable option trading strategy, as long as one acts ra- tionally in choosing the expiration month and striking price of the options to be purchased. This multimedia approach to learning may be new to many readers, but the concepts and techniques associated with the ART software are well- suited to such an approach, and the benefits should be great for those who are willing to embrace the ART methodology and fit it into their “trading personality.” —LAWRENCE G. MCMILLAN Author, McMillan on Options, 2nd Edition fm JWBK099-McDowell February 20, 2008 12:49 Char Count= 0 Preface his book, The ARTR of Trading, is a unique opportunity for you, the T trader or investor, to benefit from four fabulous things: 1. A sound trading system and software (Applied Reality Trading or ART) that gives you high probability entries, exits, and risk control—you get a free 30-day trial of the ART software with this book 2.