Friday, February 18, 2011

Cofnas, Sentiment Indicators

The Crossley Bird ID Guide is, to my mind, a good segway to Abe Cofnas’s Sentiment Indicators: Renko, Price Break, Kagi, Point and Figure: What They Are and How to Use Them to Trade (Bloomberg Press, 2010). Cofnas contends that the best way to use the chart types he describes is “in tandem with candlesticks” because “using all five charting methods together [will] generate enhanced confirmations of key price points.” (p. 8)

Each chart type has a “best use” in trading. The price break chart is best at detecting the beginning of a trend, projecting reversal points, and confirming cycle turning points. The Renko chart detects “micro changes in sentiment and momentum.” The point and figure chart shows support and resistance lines, projects breakout ranges, and balances bulls and bears. And the Kagi chart is good at timing the turnover of sentiment. (p. 7) Let’s look very briefly at the first two types of charts here.

Price break charts, available on Bloomberg Professional workstations but easily programmable on other platforms (Cofnas spells out the construction logic), are often known as three-line break charts, although there’s nothing sacrosanct about the number three. They could be set up as six-line break charts just as easily. The idea is that “a series of black columns will be followed by a white column if the high of the previous [x-number of] black columns is broken by the new price. … A black column is added if the low of the previous [x-number of] white columns is broken.” (p. 23)

Cofnas explains how to understand the strength of price movement using price break charts and describes trading strategies (focusing on entries). He also looks at combining cycle analysis with price break charts, describes multiple market applications of price break charts, and explores the use of price break charts in option trading.

If price break charts are used to improve trade entries, Renko charts help the trader exit a profitable position. “Renko chart-based trading is a pure reaction strategy for profit protection. This strategy follows a simple dictum: Never let a profit turn into a loss.” (p. 111) Setting the parameters of Renko charts can be tricky. First, “the setting size needs to be the smallest level at which the detection of a change in sentiment is meaningful.” Second, it has to reflect the trader’s risk level. Third, the shortest chart interval (preferably of three) has to be relatively high frequency. Fourth, the trader has to define the number of bricks needed to start legging out of a position and the number needed to close the position. (p. 112)

Throughout the book Cofnas provides ample illustrations of trades using a range of instruments, some of which were new to me. He tackles the question of how to trade economic news. And, in his most ambitious project, he introduces the Price Landmark Matrix, a database spreadsheet which “allows the trader to have the advantage of using alternative charts without actually having to display them.” (p. 183)

There is a lot of material in this book, some designed for traders, some for programmers, and some not signaled in the title (cycle analysis and text mining, for instance). The book would undoubtedly have flowed better if its scope had been a bit narrower, but the tradeoff is that Cofnas touches on many ideas that are not currently mainstream. I suspect that most traders could profit from reading Sentiment Indicators. Like Crossley’s bird ID book, it offers the trader a multiplicity of perspectives from which to identify a good trade.

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