The Detrend is an indicator that's been around a long time. I don't know who the originator was or when it was developed. The Detrend attempts to measure variations of price about a zero line which represents the Trend, hence Detrended. We define the Trend as a given Moving Average, then we mathematically make that average constant, or the zero line.

The formula for the Detrend is simple:

Detrended Oscillator = Close minus Moving Average.

A reasonable variation is the high or low, minus a given Moving Average as depicted on Chart 7-5.

Some of my colleagues believe incomprehensible math equates with genius, and therefore to profits. I always believe in keeping things as simple as possible. Since I did my research on the indicator in the early 80s on an 8088 processor, keeping the math simple was a practical, as well as a philosophical consideration .

I approached research on the Detrend in the same way as I approached research on the DMAs. I observed the quality of the indicator's usefulness, in trading situations, over a broad spectrum of data. I used none of the typical optimization techniques popularized someyears later.

In observing literally thousands of data sets, with a wide variety of combinations of the detrend (simple, weighted, exponential, and mathematical MAs, of the median, high, low, close, etc.), my final conclusion for the best data sets were:

1. The close (today) minus a three day simple Moving Average of the close.

and

2. The close (today) minus the seven day simple Moving Average of the close.

Of the two data sets, the 7 day MA of the close is clearly the most useful in the context I apply it. I still use both data sets, however, particularly under Strategy 1, described below.

Aside from the profits generated from this laborious enterprise, the most gratifying aspect is that I see no reason to change the parameters today, over 15years later!

USING THE DETRENDED OSCILLATOR:

Now, let's talk about how to use this powerful and versatile Oscillator in a variety of easy- to-apply strategies.

STRATEGY 1:

When your position reaches 70, 80, 90, or 100% of average Overbought/Oversold, take your profit.

The key considerations for employment of Strategy 1 are:

The Time Frame we use to calculate Overbought/Oversold and... the definition of what is meant by average Overbought/Oversold.

Here's where experience comes in. I always calculate OB/OS levels on a daily basis, i.e. daily data, even though 80% of my trades are off a five minute chart. Let me put this a little differently, so there is no misunderstanding. I never use intraday charts to calculate OB/OS levels for determining Logical Profit Objectives, even though intraday charts are where my position may be taken. To determine OB/OS levels, I look back over the Oscillator peaks and valleys. I consider about six months of the most recent daily data.

Average Overbought/Oversold is a value judgment, not a strict mathematical calculation. If I have three Overbought peaks as in Chart 7-3 with values of 96.85, 101.00, and 100.70, I'd take approximately 98.00 as an average Overbought.

I'll typically have my order resting in the market at a price equivalent to approximately 90% of the Oscillator's average Overbought level. At that point, I say "adios" to the trade. You might choose a lower or higher percentage. A resting day order is always best to take advantage of unexpected news or large traders pushing the market around for their own purposes. If it doesn't get hit, you cancel it orjust let it expire.

Okay, so you have the Oscillator value in mind where you wish to take your profit. You can't call the floor and tell them to take you out at a seven day Detrend of 88 (90% of 98); you need a price. To get that price ahead of time, you need the Oscillator Predictor which I'll describe in some detail at the end of this chapter and in Appendix G. If you don't have the Oscillator Predictor to precalculate price levels which correspond to the Detrended Oscillator levels you wish to act on, you have another option. Some analysis software (Aspen Graphics and TradeStation®, among them) will allow you to set an alert at a given level on an indicator. You hear a beep, you exit the trade. While this is acceptable, the problem with setting an alert on the indicator is that you might miss the trade by the time you hear the alert, act on it, and contact the floor. These price levels

are by definition unstable. These prices typically do not last for long, unless the market is in a runaway mode. It is conceivable that if you give aprice order when the alert goes off, that you will only get out in runaway markets, i.e. those situations that would enhance your profit by staying in! So, if you use an indicator alert to get your exit point, simply exit at the market, and hope for the best. Those Mercedes and Jags in the basement parking garage of the Chicago Merc aren't there by accident. Market orders are one of the reasons the locals are able to buy them, so beware.

If profits were taken each time extremes were reached in Overbought, as shown on Chart 7-3, you would not suffer the draw downs of the subsequent pullbacks. These pullbacks are where most traders would have been stopped out by improperly tightening their stops. These pullbacks are for reentering against Fibonacci retracement levels. They are not for exiting!

When you employ the strategy of utilizing Logical Profit Objectives properly, your percentage of winning trades should increase dramatically, but you may not be there if the market really takes off and keeps going. You could, of course, hold multiple contracts and take Logical Profit Objectives on only a portion of the contracts you hold. It might interest you to know that I have run parallel accounts in which I have taken LPOs on all positions, partial positions, and none at all. Over time, the hands down winner is taking LPOs on all positions.

There's a corollary for Strategy 1. Let's say you're trading an intraday Time Frame and you are using Fibonacci Profit Objectives. The strategy would be to take close-in Objectives (COP's), when operating at or near these extremes in price, as defined by the Detrended Oscillator. A variation of this technique is used even by floor traders I've taught. Their actions in the pit change significantly as these Overbought and Oversold levels are approached. Your actions can change too. Think about it. If a market reaches 70% to 90% of average Overbought on a given day, it is likely that the market will meet resistance and at a minimum, consolidate for the next several days. Under these circumstances, avoid "buy stopping" old highs. Look for, and position yourself, on dips intraday, against Fibonacci support areas. Then, immediately exit against old highs, when the price nears average Overbought again, or when you get close to a Fibonacci Objective, whichever comes first. Remember, the price levels that produce OB/OS will change each day. This is a dynamic condition and dynamically calculated market levels are generally hands down winners over those that are statistically calculated, such as fixed money stops.

Now, I understand that some of you may hesitate to take Logical Profit Objectives because you lack adequate entry techniques that will get you back into the market, once you exit. Part of that problem is addressed below. Most of it will be answered when we study advanced Fibonacci Analysis, DiNapoli Levels, CHAPTERS 9, 10, and 11

STRATEGY 2:

The Detrended Oscillator can be used as a filter for any entry technique.

I had a high percentage of poor entries before I knew about, and understood, high quality entry techniques. An entry is not only poor if it ends up in losses, it's also poor if it puts you under significant pressure before the market goes your way. I dramatically reduced these unfortunate situations by the use of the Detrended Oscillator to determine what value of average Overbought/Oversold was apparent at my prescribed entry levels. If the price level at entry exceeded approximately 65% of Overbought/Oversold, I simply wouldn't take the trade. Ifthe signal stayed in effect the following day, I would again look at the Detrend, to see ifthe trade was now "safe." Ifyou're unsure of how to set up the Detrend on your equipment, you can try this. Go to your Oscillator Set Up menu, take the one day Moving Average of the close (which is the close), minus the seven day simple Moving Average of the close. That should work... then, just look at the value of the Oscillator at the time your entry signal is given and see how Overbought or Oversold the market is, before you act. 4

Consider Chart 7-4 and imagine a simple system where you would be long when price is above the MA on close and short when the price is below the MA on close. I have pictured a non-displaced 12 day simple MA because that's typical of what many traders use. Two buy signals have been selected for this example.

The thinking here is simple and obvious. If you take a buy signal in a highly OB situation (unsafe), it is likely to produce more pain than one taken at a reasonable (safe) level of OB/OS. In this case, both signals would have produced profit for you, if you weren't bored or frightened out of the trade, i.e. if you stayed with the system criteria. If, however, the system criteria carried an intraday stop, or if the stop was tightened, the unsafe entry may have produced a significant loss.