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The Catman System - for identifying tops and bottoms

 

  

 

Introduction

Section I.  Indicators in the Catman System

Section II.   Reading the Catman Signals

Section III.   Case Study

Section IV.   Using the Cat Signals

 

Introduction

The Catman System is a basic technical system for identifying and timing tops and bottoms. Taken at face value, exactly as it is, the system works. You can make money simply following these five indicators without complicating it further.

In fact, many times complicating it with additional indicators decreases the success rate. Why? Because trading is about acting decisively. You can’t act decisively, whether its making a timely entry or taking a necessary stop, if you are stuck in “analysis paralysis” like a deer in the headlights. An efficient system that isn’t bogged down with unnecessary analysis will allow you to make more effective decisions. And that’s what trading is all about - effectively playing what you see. 

 


Section I.   Indicators in the Cat System

First of all, let me say that understanding exactly what these indicators are, will not be vital to your success when you are using the system.  In fact, I would say you will have higher success, and a much easier time of it, simply taking things at face value. So whether you call it the 15 MA, or “that squiggly red line“, won‘t make an ounce of difference.  The important thing is knowing where that squiggly red line should be headed.

However, I know how you guys are.  You like to make things more difficult than they need to be, and the more complicated it sounds the more you respect it.   So to satisfy your curiousity, and make myself sound really smart, I will briefly go over what these things are.

 

A.   Moving Averages

According to investorwords.com, a moving average is the average price of a security over a specified time period (the most common being 20, 30, 50, 100 and 200 days), used in order to spot pricing trends by flattening out large fluctuations.  New numbers are added to the average and the oldest numbers are dropped; thus, the average "moves" over time.

The moving average is the most commonly used variable in technical analysis.  It can be used to track daily, weekly, or monthly patterns.  There are different types moving averages, depending on how they are constructed, including simple moving averages, exponential moving averages, and weighted moving averages.  They are normally calculated using closing prices.

Time-frames used will also vary.  A shorter MA, like the 5 Day MA, will be more sensitive and identify changes much earlier.  This will make them more volatile.  A longer MA, like the 200 Day MA, will be more useful for identifying larger trends.

The Catman System uses two fast moving averages, the 5 MA and 15 MA.

 

B.   Stochastics

According to investorwords.com, stochastics is “a model based on the belief that as prices increase (or decrease), closing prices tend to accumulate ever more closely to the highs (or lows) for a given period.“

The indicator consists of two lines, the %D and the %K.  The %K compares the last closing price to the range traded over a selected period.  The number of periods used in the indicator can vary.  The %D is a signal line calculated by smoothing %K.  The original formula used for smoothing the %D was a 3 period simple moving average.

For the Catman System, both the %K and %D are set to P = 14


C.  On-Balance Volume

On-balance volume, or OBV for short, is a technical analysis indicator used to determine when a stock is being accumulated or distributed, by comparing volume to price over time.  Volume is added to the indicator if the closing price moves up and subtracted if the closing price moves down.  No adjustment is made if the closing price is unchanged.

A rising OBV confirms an up-trend or warns of an upward breakout, and a falling OBV confirms a downtrend or warns of a breakdown.  The OBV may also lead the price, so a bouncing OBV while the price is still falling, can be an early warning of a bottom.

 

Section II.   Reading the Cat Signals

 

Reading the signals for a top or bottom using the Catman System, is exactly the same, regardless of the time-frame of your chart.  How you react to those signals may differ, according to the type of trade and whether you are entering or exiting (we will talk about that later), but the signals are the same for every chart, whether its a 15 tick or a 15 minute chart.

 

A.   Setting up your chart

Your chart should be set up to include each of the five indicators we discussed earlier. These are the colors I use for each indicator.

      1.  MA, P = 5 - Green
      2.  MA, P = 15 - Red
      3.  %K, P = 14 - Yellow
      4.  %D, P = 14 - Blue
      5.   OBV - Brown or Orange

B.   Anatomy of a bounce

      1.  Indications of a bottoming

             a.    %K drops to 0
             b.    5 MA begins to curve upward, towards the 15 MA, putting them on a
                     colision course so that if the 5MA continued, they would eventually
                     cross paths and the 5MA would move above the 15MA.  The more
                     perpendicular, the better.
              c.    %D reaches below 20 and begins to curve upward.
              d.    %K spikes up, crossing above the %D
              e.    OBV points upward
              f.     Enter trade and set stop

       2.   Confirmation of uptrending

              a.    The “MA test“ The 5MA continues up, crossing above the 15MA, confirming
                     an uptrend.
              b.    The %D continues to climb
              c.    The %K remains above the %D
              d.    OBV remains pointing upward

C.   Anatomy of a top

        1.   Indications of a topping

               a.    %K spikes to 100
               b.    5 MA begins to curve downward, towards the 15 MA, putting them on a
                      colision course, so that if the 5MA continued, they would eventually cross
                      paths and the 5MA would move below the 15MA.. The more perpendicular,
                      the better.
                c.   %D reaches above 80 and begins to turn downward.
                d.   %K drops, crossing below the %D
                e.   OBV points downward
                f.    Enter trade and set stop.

       2.    Confirmation of downtrending

               a.    The 5MA continues down, crossing below the 15MA, confirming a downtrend.
               b.    The %D continues to fall.
               c.    The %K remains below the %D.
               d.    OBV remains pointing downward.

 

 

Section III.   Case Study
Apple Computer


Let’s look at a trade we made on Apple Computer, and I will try to explain how this works.


A.    Looking for a bottom

         1.   10:06 am

At this time we see Apple moving down to a likely support level, the S1 (That green line. See Stuff on Pivots). But I still would not buy yet. Why not? This is a really common mistake that people make – buying at a support level, without any real indication that it is actually bottoming. Lets review our indications of a bottoming.


                a.    %K drops to 0


                  At 10:06 we see a sharp drop to 0, and even before, at 10:02 am, the %K was close to

              hitting bottom.  So this criteria was met.

                  b.   5 MA begins to curve upward, towards the 15 MA, putting them on a colision

                        course so that if  the 5MA continued, they would eventually cross paths and

                        the 5MA would  move above the 15MA.  The more perpendicular, the better.

                   If you look at 10:06, when that red candle hit bottom, you see the 5 MA was still

               pointing straight down at that time. Also, if you look at the channel between the 5 MA

               and the 15 MA, you see it is still wide, and they are pointing away from each other.

               We need the appearance that the 5 MA is flattening out, or curving up – that the

               channel may be closing.

                 c.    %D reaches below 20 and begins to curve upward

                 At this time the %D had reached below 20, to 11.40, so I was definitely on guard for

                 a bottoming, but until it actually starts to curve upward a bit, this criteria is not met.

                 d.    %K spikes up, crossing above the %D

                 The %K was still at the bottom at this point, so this criteria was also not met.

                 e.   OBV points upward

                 Right at 10:06, the OBV hit bottom, so again, I would definitely be on guard for a

                 bottoming, but until it actually starts to move back upward, this criteria is not met.

 

         2.   10:09 – 10:10 am

Around this time the price was starting to move up and the buying was gaining some momentum.  So let’s go over our indications of a bottoming again, and see if criteria is now met for a long entry.


                  a.    %K drops to 0

                   At 10:06am the %K had hit bottom, so that criteria had already been met.

                   b.    5 MA begins to curve upward, towards the 15 MA, putting them on a colision

                         course so that if the 5MA continued, they would eventually cross paths and

                         the 5MA would move above the 15MA.   The more perpendicular, the better.

                    Now we see the 5 MA flattening out horizontally and starting to curve up towards

                    the 15 MA, so that if it continued, the channel would close and the 5 MA would

                    eventually cross up above the 15 MA. Criteria met.

                    c.    %D reaches below 20 and begins to curve upward

                    The %D was already below 20, but now we see it starting to curve back upward. 

                    So this criteria is now met.

                    d.    %K spikes up, crossing above the %D

                    At this time we see the %K spiking up, and crossing above the %D. Criteria met.

                    e.    OBV points upward.

                    The OBV hit bottom at 10:06, and now we see it uptrending.  So this criteria is

                    met as well.

 

B.    Trade Entry

With the stock gaining momentum off of the support barrier, and all of our criteria met for a bottom signal, we entered a long position around 85.50.  Our stop was any breakdown below the support barrier, in other words any new low, which was at that time 85.27.  Our target was the previous day‘s closing price, which was 86.25.  So our risk was around 25 cents, and our potential reward around 75 cents.  It is important to figure the risk vs reward for each trade, to make sure the entry is justified.


C.   Looking for Confirmation

       1.   10:11 – 10:12 am

Once we enter the trade, we want to keep an eye on our stop and start looking for confirmations of uptrending.  So let‘s look at our confirmation signals.

                  a.    The “MA Test“. The 5MA continues up, crossing above the 15MA, confirming an

                          uptrend.

                  At this time, the 5 MA was on a collision course with the 15 MA, but had not yet

                      crossed above.  If the “MA Test“ fails, and the 5 MA refuses to cross above, the

                  price will fall and can slip back rapidly to the lows. So as the MA Test approaches,

                  you want to be on guard.

                  b.    The %D continues to climb

                  At this point we still see the %D steadily moving upward, which is a good sign.  If it

                  continues moving straight up, it improves the chances of the MA Test passing.

                  c.    The %K remains above the %D

                  The %K at this point is also still spiking upward and holding above the %D, which

                  is another good sign that the MA Test will pass.

                  d.    OBV remains pointing upward

                 The OBV will often hesitate around the MA Test, so you need to keep an eye on that

                 too, but as long as it keeps trending higher, the trade is still ok.

       2.    10:13

As the stock climbs, we want to keep looking for confirmation of uptrending.

                  a.    The “MA Test“. The 5MA continues up, crossing above the 15MA, confirming

                           an uptrend.

                  Now we see the 5 MA crossing up above the 15 MA perpendicularly.  That is the

                       confirmation we need. After that, you want to make sure it stays above the 15 MA.

                  The wider the channel between them on the way up, the better.  If the cross is not

                       clear, more of an intertwining, or if the 5 MA starts to turn back down, the trade

                  may be in trouble.

                   b.    The %D continues to climb

                   The %D is still steadily moving upward.  That is what we want to see.

                   c.    The %K remains above the %D

                   The %K is still spiking upward. As long as it holds above the %D, we are ok.

                   d.    OBV remains pointing upward

                   The OBV is continuing upward after some hesitation at the MA Test.

With the confirmation of uptrending, and all signals still in our favor, we can set our sites on our target and any resistance barriers, and start looking for topping indications to signal our exit.

 


Section IV.   Using the Cat Signals


The signals themselves are clear and easy to read.  The idea is similar to the way a traffic light works.  At every traffic light, the first warning signal before traffic changes direction, is a yellow light.  The second signal to stop is then a red light.  In Germany the yellow light even works both ways. When you are stopping it first turns yellow, then red.  When it changes again, it first turns yellow and then green.

As a driver, you have to choose what to do when the light turns yellow.   You can either stop early when the light turns yellow, or speed up to get through the intersection.  But whenever you make a move on an early yellow signal, you accept more risk.  What if you decide to speed up at the yellow signal before it turns red, and someone going the other direction is in a hurry to get started?   You might make it to your destination faster if you act on yellow, but you are accepting more risk.

The same is true with this system.  Whenever you enter a trade on an early signal, you will realize more potential if you get it right.  However, you are also taking on a greater risk of being stopped or not seeing much follow-though.  By waiting for more confirmation, you are exchanging some potential for more predictability.

The same is true if you exit on an early signal.  You may get out with “safer” exits by exiting on an early signal, which would be appropriate if the trade is high risk, but you may also miss out on further potential if you are exiting early, simply because you are jumpy.

This is generally true for any trading system really.  The greater the potential reward, the greater the risk. There is always a payoff.   So you need to learn which signals and charts are appropriate in which circumstances.  How you react to these signals will depend on several factors including the type of stock, your skill at executing stops, the number of shares you are playing, and the market environment.  Understanding those factors takes some time, practice and experience.

 

 

 

 

 

 

 

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