red rock pattern strategy

7/21/2019 Red Rock Pattern Strategy

http://slidepdf.com/reader/full/red-rock-pattern-strategy 1/4

Stocks & Commodities V. 26:12 (72-75): Product Review: Red Rock Pattern Strategy by Dennis D. Peterson

Copyright (c) Technical Analysis Inc.

PRODUCT REVIEW

EQUIS INTERNATIONAL90 South 400 West

Suite 620

Salt Lake City, UT 84101

Internet: www.equis.com

Email: [email protected],

[email protected]

Product: Plugin for MetaStock 10.1

Requirements: MetaStock Profes-

sional 10 for Quote Center, 800

megahertz (MHz) or faster processor;

512 MB RAM; 200 MB available hard

disk space; CD-ROM drive; video card

and monitor supporting at least 256

colors at 1024 x 768; mouse or otherpointing device; Microsoft Windows

XP (Service Pack 1 or higher) or

Windows 2000 (SP 4 or higher);

Internet Explorer version 6.0 or later

with latest service packs; MAPI

compliant email program.

Price: $299

by Dennis D. Peterson

ed Rock Pattern Strategies

(RRS) is a MetaStock plugin

developed by Jeff Crystal,whose resume includes be-

ing a former hedge fund

manager. Although he is busy as a con-

sultant, he still takes the time to educate

traders to his way of trading. Talking to

Crystal and listening in on the free class

will get you thinking about the market

and trading in the ways of the skilled

trader. If you are just starting out, this

will feel like drinking from a firehose.

Actually, it will feel like drinking from

a big firehose.

So what is this all about? As the nameimplies, it’s about patterns. “What

kind?” you might ask. Crystal will tell

you that many are based on Elliott waves

and/or Fibonacci retracements. But he

will readily agree that if you pick five

Elliotticians you might get five answers.

But before we start to worry about

whether a price pattern is an Elliott

wave you would recognize, first we’ve

got to find a way to identify pivot peaks

and valleys.

RRS RESISTANCE

AND SUPPORT CALCULATION

With rare exception, all patterns are

based on resistance and support, which

translates to pivot peaks and valleys.Head and shoulders, double tops and

bottoms, ascending/descending right

triangles and so forth are all defined

with price pivot peaks and valleys. This

is especially true when trying to find

Elliott waves, since the pivots will de-

fine each of the waves. Let’s take a look

at the results of using the RRS Life

Cycle expert on a price chart (Figure 1).

RRS’s actual calculation for resis-

tance and support is proprietary, but we

can get a sense of how much we might

trust RRS’s calculation by applying thezigzag indicator to the price series. Zig-

zag is a way of eliminating noise by

ignoring any change smaller than the

parameter you input. I initially tried a

2% zigzag on closing prices, thereby

saying that I wanted to ignore any price

change less than 2%. I missed some of

RRS’s pivots with the 2% zigzag on

closing prices, but noted that I could

catch more of them if I used a zigzag on

lows for support and a separate zigzag

R

Red Rock Pattern Strategy

FIGURE 1: DAILY S&P500 (SPY) WITH LIFE CYCLE ADVISOR OVERLAY. The Life Cycle Advisor creates theR (resistance), S (support), I (intermediate pivot for position traders), and M (major pivot for investors). It colorsthe price bars either blue (upswing) or red (downswing). Overlaid on the price chart are two zigzag indicatorsto get a sense of how the pivots, R and S created by RRS’s proprietary algorithm, match up. Red zigzag linesare for support while green zigzag lines are for resistance.

on highs for resistance. I then played

with the percentages to finally arrive at

the values shown in Figure 1. My con-

clusion, looking at the few mismatches,

was that zigzag was a reasonable ap-proximation of RRS’s resistance and

support algorithm and was something I

could trust.

PATTERNS

Using the Standard & Poor’s 500 (SPY),

we started by looking at the perfor-

mance of RRS to find pivots. This choice

was intentional, as the first step you

want to take to use RRS is to attach the

Life Cycle Expert to an index because

you want to find a developing pattern.

You find out which pattern by examin-ing the expert commentary. You will

then screen the individual stocks that

make up this index for this developing

pattern using MetaStock’s Explorer soft-

ware. There are 16 patterns encoded in

the Life Cycle Advisor, and becoming

familiar with the language used to de-

scribe each might take some thought.

The bull pullback pattern is the first

you will encounter in the PDF that comes

with the RRS CD. The first page gives an





example of what the pattern looks like.

What you see (Figure 2) looking at this

pattern is that price is moving up (bull-

ish) and that there has been a retracement

or pullback. You might also see that the

pivots labeled S1, R1, S, and R roughly

define Elliott waves 1, 2, and 3 and thatour pullback is wave 4.

On the next page are the parameters

used to define this pattern. Note the

notation (R - R1) > (R1 - R2). What this

shows is that resistance is lessening.

Another way of saying this is that mo-

mentum is gaining — that is, the price

change from the most recent pair of

resistance points is greater than the price

change of the next resistance point pair.

This is a common thread that is woven

throughout all of RRS: increasing up

momentum, as defined by price changeincreasing between resistance pairs, or

increasing down momentum as defined

by price change increasing between sup-

port pairs. Similarly, momentum can

slow to the upside or downside and you

will find slowing momentum in the title

of 10 patterns of the PDF.

These are the patterns that RRS is

trying to identify: a pattern of slowing

versus gaining momentum leading to a

reversal or a retracement; bull rallies

versus bear rallies. At the heart of RRS

is the identification of momentum. So

let’s see what RRS might find.

LIFE CYCLE COMMENTARY

Anyone who has tried to program algo-

rithms to find patterns knows it is a

tricky task. Let’s see what happens when

we use the primary RRS tool for finding

patterns (Figure 3).

We do this by attaching the Life Cycle

Advisor to an index series, and then ask for the commentary to see what patterns

have been identified. There are a num-

ber of descriptors in the commentary,

but the two I want to focus on are

“bullish pattern” and “bearish pattern,”

because it is in these two that you dis-

cover what patterns the software has

seen.

An important aspect of RRS is that the

Life Cycle Advisor is looking for devel-

oping patterns, and since the patterns

are not yet completed, there is some

ambiguity. Consequently, more than one

pattern might be developing. To see

what the advisor would do when facedwith some uncertainty, I chose to attach

the Advisor at May 30, 2007, of the SPY,

because there are a couple of possible

outcomes for that date; it found bullish

and bearish patterns.

If you agree that a reasonable de-

scription of price action has the differ-

ence between successive resistance pairs

as slowing momentum (Figure 4), then

prices might break out to the downside.

A different interpretation of the unfold-

ing events is this: Since the close of the

May 30th bar is within one average truerange of the closest resistance, this could

be the start of an upward breakout, and

hence the possibility of multiple out-

comes at this stage of development.

Even if the pattern had been com-

pleted, there is at least one more issue.

There is a fundamental problem in the

course of coding this type of algorithm

(pattern recognition). While we might

see how the algorithm will identify the

particular pattern, the algorithm can be

XX

FIGURE 2: BULL PULLBACK PATTERN. All 18 patternsare shown in the PDF that is part of the installation disk.The bull pullback pattern needs increasing momentum,(R-R1)>(R1-R2), and then a retracement, delineated bythe arrowhead. Looking at the pivots created by RRS, wenote that a retracement that appears to be an Elliott wave4. At issue with this kind of pullback is that it fits withinFibonacci retracement percentages. In this case, thedesired retracement percentages for the price movefrom R to S are 38.2% to 61.8%.

FIGURE 3: DAILY SPY WITH LIFE CYCLE ADVISOR AND COMMENTARY. Price bars show the resistance and

support points calculated by the Life Cycle Advisor and the arrowhead is at May 30, 2007, a point in time thathas several possible outcomes. The advisor commentary window shows these outcomes under the heading ofbullish pattern: “Are we in a breakout?” with a yes. If you scroll down under the bearish pattern heading, you’ll

see “Are we in a slowing momentum?” with a yes.

FIGURE 4: SLOWING MOMENTUM INTO RESIS-TANCE WITH A DOWNWARD BREAK. One of the keysto identifying this pattern is that the difference in resis-tance pairs is lessening. It means that (R-R1)<(R1-R2).Red Rock calls this slowing momentum.





vulnerable to identifying variations of

the pattern. Thus, some equities tend to

fit some patterns better than others. With

RRS you can attach any of the 18 pat-

terns. And the 18 individual advisors

show you completed patterns because

you want to see how the developing

pattern from the Life Cycle Advisor

compares to the completed pattern.

Besides, there is no way to backtest

these patterns with the indicators pro-

vided. By looking at completed pat-

terns, you will also get a sense of the

reliability of the pattern.

What you need to be aware of is that

the PDF contains a section about basic

patterns and then follows with sections

about derivative bearish patterns and

bullish derivative patterns. What is go-

ing on is that starting with five pivot

series, much akin to Elliott waves, ana-

lyze the pivots for slowing or increasing

momentum and then fill out your arse-

nal of patterns with derivatives. But

there is more, and this is where RRS

again does something special.

RRS INDICATORS

RRS developer Jeff Crystal had a con-

versation with George Lane, the creator

of the stochastic oscillator, that stimu-

lated Crystal’s approach to some of the

RRS indicators. When Lane commented

on how the parameters were chosen for

the stochastic oscillator, he explained

that they corresponded to paydays; they

had no correlation to the market.

Think about that for a minute. How

many indicators where you have to

choose the number of periods work in-

dependently of the underlying pattern

of resistance and support? Or if you

have a reasonable approach identifying

resistance and support using pivot peaks

and valleys, how many work well inde-

pendently of the pivot peaks and val-

leys? Not many, if at all. They kind of

work but seem to miss some events.

What RRS does is modify the number of

periods by the average number of daysbetween resistance and support. Let’s

take a look at Figure 5.

In comparing the standard money

flow index and RRS modified money

flow, what you see is that you have

many more opportunities, six versus 12,

to trade if your trading style is to hold

positions for only a few days or close

out after each trading session. If you

look back at Figure 1 and see how often

resistance and support are found, you

should conclude that RRS is designed

for short-term trading when you con-sider the patterns being found.

Swing trader is a popular character-

ization of this type of trading. For longer-

term trades, there is “I” for position

trader and “M” for investor (Figure 1).

If you want to use I and M pivots, you’ll

need to rely on what you have seen on

the screen only as there is no pattern

analysis done for I and M, just the Rs

and Ss.

Now that we can use average time to

FIGURE 5: MONEY FLOW INDICATOR COMPARISON. The top subchart is the standard money flow index, thesecond from the top is an RRS modified money flow, while the bottom two are daily Arch Coal Inc. (ACI) withvolume. Overlaying all the charts are vertical lines drawn when the modified money flow first crosses above the20 threshold. The horizontal lines in the top two subcharts are drawn at 20 and 80 for both charts. If you are trading

to hold positions for just two days at a time the RRS modified money flow gives you 12 opportunities, while thestandard money flow index gives six.

FIGURE 6: DAILY SPY WITH RRS TIME AND PRICE CYCLES. The top chart shows the average number of daysbetween R and S, while the one just below is the average price change between R and S. These computationsare used to see if price or time is overextended. If the next pivot has not appeared by the average number of daysbetween pivots, then RRS will say you are overextended. The same is for price.

At first glance, RRS seemedto be only a tool, but it isreally a trading system.There is absolutely so muchto like about it.





modify some indicators, two indicators

for RRS were created as a logical fol-

low-on: time cycle and price cycle (Fig-

ure 6). What they tell you is the average

number of bars between pairs of R and

S pivots and average price change. RRS

also has a modified relative strength

index (RSI), and the date/range/ATR in-

dicator, which gives (from top to bot-

tom) average days between pivots, av-

erage price between pivots, ATR, and

what RRS calls the “dropback rate.” It is

calculated as ATR-net movement, where

net movement is (price range between

pivots)/(average days between pivots).

SCREENING

MetaStock screening is accomplished

with a feature called the Explorer. Click-

ing on the binoculars, a menu icon forExplorer, you will find that 21 explora-

tions are available starting with RRS.

They will all look familiar except Sea-

sonal and Pre Filter. Pre Filter is pass-

word-protected and not available, but

Seasonal is akin to Life Cycle Com-

mentary. It identifies those patterns that

are the strongest (Figure 7).

What you see in the reports are scores

for the different patterns, and every pat-

tern in the PDF that can be ranked is

identified as such and as a consequence

S&C

has ranking criteria. The implementa-

tion was to give a score of 1 if a criterion

was met and zero if not. Looking at the

ranking criteria, you’ll see the scores

run from zero to +9 or -9.

You’ll also note that a few criteria

refer to money flow index. The actual

one used is the modified money flow

index, and you will also note that Fi-

bonacci retracements are used as well.

If you know Advanced GET, this will

ring a few bells.

TRADING

Obviously, you could buy or short stock

using these patterns. But Crystal’s back-

ground includes options, and he uses

them in what he calls a “synthetic stop.”

If you are long and market moves below

your support, what about selling a calldeep in the money? The delta should be

close to 1, and you might make up some

loss with time value. So are these pat-

terns good at higher versus lower lev-

els? Once Crystal has a pattern he likes

at the daily level, he is trading at the

five-minute level to get in as soon as the

underlying moves in the direction he

expects, and as a result reports that the

patterns work going lower. Going

higher, such as weekly or monthly, you

are going to lose some detail, so I would

guess it is problematic. Unfortunately,

there is no way to backtest with these

patterns.

SUPPORT

Your best shot at understanding RRS is

to study the PDF. For years, Jeff Crystalhas been giving a course on RRS through

the MetaStock online courses. The

MetaStock technical support, while one

of the absolute best in the industry,

doesn’t always speak fluent RRS. But if

it is a question more about MetaStock,

they are superb.

SUMMARY

When I read a brief description of RRS,

it immediately got my interest. Trading

with patterns while integrating pivots is

a smart way to go. As I examined the

product more, the modification of money

flow index periods with an average num-

ber of days between support and resis-

tance sounded right to me. I wonder if

two standard deviations work even bet-

ter, and should the algorithm count ev-

ery day between the resistance support

pivots?

Perhaps a version of RRS will be de-

veloped where you can input how many

days between Rs and Ss you want thrown

into the average. I always liked the ideaof modifying your choice of Bollinger

band periods and standard deviations

based on the moving average. Robust

systems like RRS always get me thinking

about other possibilities.

At first glance, RRS seemed to be

only a tool, but it is really a trading

system. There is absolutely so much to

like about it, not the least of which is

Jeff Crystal’s generosity.

Dennis Peterson is a Staff Writer for

S TOCKS & C OMMODITIES .

FIGURE 7: SCREENING REPORT USING RRS SEASONAL. Since Explorations are only partially documented, themeaning of the columns are as follows: Over Ext (1 = over extended in price and/or time and 0 = not extended);L/S (4 = Long for slowing momentum dropping to support and -4 = Short for slowing momentum rising to

resistance); u/d(u = 1 for slowing momentum breaking upward and d = -1 for slowing momentum breaking down);1/ret (first retracement after slowing momentum +9 for long position and -9 for short position); M/W (+1 for headand shoulder W and -1 for head and shoulder M); M Ret(+9 for first retracements following W and -9 for firstretracements following M);Bull Bear (+9 for bull pullback and -9 for bear rally). The other columns are averagedays (date) and range (range) between resistance and support, and “used” is the percentage of range above orbelow resistance or support.

red rock pattern strategy

Documents