THE BALANCE LINE TRADES

THE FIFTH DIMENSION

We have now arrived at our fifth and final trading dimension. At first, this dimension may seem a bit more complicated, but it really isn't. In our earlier book, Trading Chaos, we described a signal we labeled the "thumb trade," which was basically a counter fractal signal. Its purpose was to get us into a trade before the fractal breakout signal. This has been profitable throughout the years we have used it, but we have now refined this signal to be even more effective, yielding greater profits and fewer whiplashes. The basics behind this signal are what we label the Balance Line. This line was arrived at through the use of supercomputers (mainframes) and was determined mathematically. The mainframe computers then went through more than five million iterations to find a way to accurately estimate the placement of the Balance Line using a personal computer. We will describe the specifics shortly, but first let's get a picture of what is actually represented. The Balance Line is where the price would be if there was no new incoming information (Chaos) affecting the market at the present time (Figure 8-1). This is where the price would be without incoming information, so we can judge the effect that new information is having in the market by how far away the current price is from the Balance Line. In our research, we constructed a histogram to measure this distance but found that it was almost the same as our 5/34 Awesome Oscillator and proved to be redundant when using the AO. One way to think of the Balance Line is to imagine that it is the Continental Divide. When rain falls on the east side of the Continental Divide, the water will run downhill toward the Gulf of Mexico because gravity is a Strange Attractor. This will happen unless a strong east wind blows the raindrops over to the west side of the divide. If that happens, the windblown rain drops will run down toward the Pacific Ocean rather than the Gulf of Mexico. The wind, in this case, is the new information that changes behavior. A change in behavior is a fractal. In the markets, new information creates fractals (changes in behavior). There will always be a fractal at the end of any trend. When you decided to read this chapter rather than doing something else, that was a behavioral fractal. The Balance Line could also be labeled the Saddle Point, which is the place where a small change in initial conditions produces results that are much stronger than the cause. One of the casualties produced by the new sciences of quantum physics and Chaos is the destruction of our old classical Newtonian idea that for every action there is an equal and opposite reaction. They have also done away with the global theory of entropy, which stated that eventually everything will go down the drain. We now know that there is Neg-entropy which has the capability to produce something from nothing. Think of the Balance Line as the top of the mountain. Whenever new information comes into the market, the price will move away from the Balance Line more easily (it takes less energy, in the form of new information) than it will move toward the Balance Line. A simple way to say this is: "It is easier to go downhill than uphill." In Chaos theory, this is described as the "path of least resistance" (Figure 8-2). Let's take a couple of very simple examples of how the Balance Line operates in any market—stocks, commodities, indexes, spreads, or options. The Balance Line shows us the direction of the current path of ieast resistance in markets. Figure 8-3 is a caricature showing that going downhill (away from the Balance Line) is easier than going uphill. In a similar way, it is easier (takes less energy) for the price to move away from the Balance Line than to move toward the Balance Line. This can be demonstrated by simply examining a chart such as Figure 8-4.

Figure 8-1 What is the BaLance Line?

Notice that the thirteen bars in the box on the left side of Figure 8-4 moved 56 points and were going toward the Balance Line, which is similar to walking uphill. Also notice that the thirteen bars in the next box were going away from the Balance Line. The thirteen bars on the right side covered 161 points because the price was moving downhill. In this illustration, downhill means the price was moving higher. Remember that the Balance Line is the top of the mountain, and it is easier for the price to move away from the Balance Line than to move toward the Balance Line. Figure 8-5 basically repeats the two earlier illustrations, again showing that movement away from the Balance Line is easier (requires less new information) than moving toward the Balance Line. Figure 8-6 i;lustrates the basic -way of finding ne-w inforl.lation from the Balance Line signal. The current price high is lower than the previous high. When we interpret that, we must include the concept that, in any market, there is always a struggle between the buyers and the sellers. The buyers were obviously stronger in the first time period (bar A) than in the second time period (bar B). We know this because they were not able to take the price as high in the second period as it was in the first period. The question can also be asked: Who is in charge and what are they doing? Fortunately, we do not have to know specifically "whoq; we can see the results of the collective "who's" by the price action. The new information is determined by reading the price chart. Figure 8-6 is quite important as a demonstration of how we recognize new information for creating Balance Line signals. Notice that bar B has a lower high than bar A. Looking at this configuration from the buyers' point of view, they were not strong enough in the time period of the price bar B to keep the price as high as the high of bar A. This creates the dotted square above the high of bar B as potential new information. At the end of bar B, the sellers had forced the buyers away from the dotted square. If the buyers regain their strength and move the market up above the top of bar A, a significant change in behavior will occur, giving us a signal to watch for a Balance Line buy opportunity. Study this chart carefully; this concept is sometimes difficult to grasp in a first observation. We will go through several examples to make this clear. Once we can understand where to look for the new information, we can filter in other fractal geometry concepts to create profitable signals. We take two different factors into consideration to get our most reliable Balance Line signal. The first factor is: Where is the signal in relation to the Balance Line? We know that moving toward the Balance Line is more difficult than moving away from the Balance Line. The second factor is the number of new highs or lows needed to create a signal. Like the market, we want to take the path of least resistance (Figure 8 ~ Figure 8-8 contains the rules for our basic Balance Line strategy. Our purpose is to make it easier to get into a directional move when the movement is away from the Balance Line (similar to going downhill) versus toward the Balance Line (uphill). If we are going toward the Balance Line, we place our signal at base + two higher highs (lower lows). If we are going away from the Balance Line, we use base + one higher high (lower low). That is our basic approach. We modify it depending on which zone we are in—a situation that will be covered later on. At this point, let's review and summarize our approach to the fifth dimension, the Balance Line.

BALANCE LINE BUYS

Buy Si~nals When the Market Is
above the Balance Line

In Figure 8-9, Section A shows the simple buy signal created by the base bar B and a higher high on bar 1. Section B illustrates that a higher high, which follows a base bar, does not create a new signal. The base bar is either the current bar or the most recent lowest high. Section C demonstrates a blue light special. The original buy was at the leftmost bar. When a lower high was formed, the buy moved down one bar. When bar B was formed with another lower high, the buy moved down to bar 1. Section D illustrates that if the signal bar is above the Balance Line, we only need the base plus one higher high. As long as the signal bar itself is above the Balance Line, we act as if the entire formation were above the Balance Line. Make sure that you understand these three scenarios so that you can easily find a buy signal above the Balance Line on other charts. Figures 8-10 and 8—11 are examples of how, once the base bar is established for a buy and that pattern is followed by bars with higher highs that do not trigger the buy stop, the buy stop is not affected. The buy stop stays in place unless (a) it is triggered OF (b) another bar with a lower high is formed, creating a different base bar. The last three bars on the right side of Figure 8-10 and the last two bars on the right side of Figure 8-11 do not affect the placement of the Balance Line buy signal. Now let's try a trick question (Figure 8-12).

Here is a tip to speed up your analysis. When the market is making new highs, you cannot have either a Balance Line or a fractal buy signal formation. The market must pull back and create a lower high before a new Balance Line or Fractal signal can be formed.

Buy Signals When the Market Is
below the Balance Line

We know that going away from the Balance Line is easier (takes less energy) than going toward the Balance Line. Because the market always follows the path of least resistance, good strategy dictates that we do the same. (We did that in the previous section.) Now, we are buying below the Balance Line. We will require more energy because we are going uphill. We are going uphill because we are buying below the Balance Line. Figure 8-13, B signifies the base bar. In section (A), we have the typical Balance Line buy signal. We require base plus two higher highs because we are below the Balance Line and therefore are plodding uphill to change the market's energy pattern. Section (B) illustrates that a current bar whose high is higher than the previous bar does not affect the Balance Line buy because it does not create a lower base bar. Section (C) illustrates a blue light special. Note the first buy. It was followed by a lower high, which moved the signal down. The market is giving us a chance to buy lower.
Let's look at the practice charts in Figures 8-14 and 8-15.
In Figure 8-16, the highs are circled because highs are all you are interested in when looking for a buy, and lows are all you check when looking for a sell.

BALANCE LINE SELLS

Sell Signals When the Market Is
above the Balance Line

Figure 8-16 illustrates the typical Balance Line selling signals when the market is above the Balance Line. Section (A) shows the typical base minus two lower lows. Section (B) demonstrates that once a base is formed, a lower low does not create a new signal. A new sell signal can only be created by having a higher low. Section (C) demonstrates a blue light special sell signal. Note that the first sell signal is created by the first three bars on the left side. That is followed by three higher lows, which raises the sell stop up each time a new higher low appears. The current sell is well above the first sale, and the market has given us another blue light special. Again, make sure you understand this chart (Figure 8—16) before reading further. To help you understand, let's do a few practice charts and schematics, in Figures 8-17 through 8-19. Especially in Figure 8-20, we see four different possibilities for the market's creating Balance Line sell signals. Section (A) has the straightforward sell signal. You only need a base bar and one lower low because you are below the Balance Line and gravity is going your way—downhill. Section (B) illustrates that a lower low than the base bar does not alter the signal at this point. Section (C) illustrates a blue light special sell; the market is giving us a chance to sell at a higher price than the one we originally targeted. Section (D) illustrates that if the signal bar is below the Balance Line, we only need a base and one bar with a lower low, regardless of which side of the Balance Line the base bar is on.

PRACTICE PAGES

Figure 8-21 is a quite simple illustration of buying below the Balance Line. The price is below the Balance Line and going downhill (moving away from the line when reading from right to left), so you only need a base and one lower low. Figure 8-2:2 poses another trlck questlon: ls there a Balance Line sell? Why or why not? Again, just as on the buy side illustrated earlier in this chapter, there is no sell here. Remember that for either a fractal or a Balance Line signal, the market must first retrace its move to create lower lows that, in turn, will create a sell signal. Whenever the current price bar is making new lows, you cannot have either a fractal or a Balance Line sell.

TRADING THE BALANCE LINE SIGNALS
IN THE VARIOUS ZONES

Now we are going to add factors that at first may seem confounding but they pay off extremely well in increased profits. We call them filters. They direct us toward the most profit-producing signals. The first filter is the Alligator. We know from earlier chapters that, no matter what signal is created, we only want to trade a signal that is outside the Alligator's mouth and is going in a direction that will keep us outside of the mouth. The second limiting condition is the zone the current price is in. If you are attempting to buy in the Red Zone, you know that you are buying even though the Momentum is down and is accelerating to the downside. That doesn't appear to be to your best advantage. Therefore, our strategy is to make it twice as difficult to buy in the Red Zone. If the current bar is red and we are above the blue Balance Line and looking for buy signals, it would require a base bar and TWO higher highs (rather than one higher high, as in the Green or the Gray Zone). Likewise, if we are above the Balance Line and in the Green Zone looking for a sell, we would normally require a base bar and two lower lows. However, being in the Green Zone tells us that the Momentum is up and accelerating upward, so we require twice as many lower lows (four rather than the usual two, as in the Green or Gray Zone). Another way to express this is: You only double the requirements for a sell in the Green Zone, and you only double the requirements for a buy in the Red Zone. In any other situation, the number required would be the normal number of higher highs or lower lows. Do not forget the other, extremely important filter: DO NOT FEED THE ALLIGATOR!

THE BALANCE LINE TRADES

Real-Time Trading

In Figure 8-23 are the Balance Line trades you would have taken had you been following our trading method between April 17 and July 31 or just over three months. An interesting point should be noted here. Whenever you have a long trend run such as the one in Figure 8-23, you will always have more Balance Line signals triggered than any of the other trading dimensions. The results from trading the Balance Line signals in a trend run can be quite impressive, as evidenced by Table 8-1, which is based on the same time frame as Figure 8-23.

RECAP AND SUMMARY OF BALANCE LINE TRADING

The Balance Line is that place where the current price would be if there was no new incoming information (Chaos).

The Balance Line rules are:

Always read from right to left. Look at the highs only when looking for a buy signal. Look at the lows only when looking for a sell signal. Establish the base bar first. The base bar is the starting point. To find the base when looking for buy signals, look at the current bar or the bar with the lowest high. To find the base when looking for sell signals, look at the current bar or the bar with the highest low.

Once you have established your base bar:

1. For a buy, you need one new high if you are going away from the Balance Line, and two new highs if you are going toward the Balance Line.
2. For a sell, you need one new low if you are going away from the Balance Line, and two new lows if you are going toward the Balance Line.
The final two filters are:
1. You do not sell above the Alligator's mouth and you do not buy below the Alligator's mouth. If you do, you are feeding the Alligator, which can consume all your food (money).
2. If the current bar is in the Red Zone, you double the number of new higher highs to create a buy signal. If the current bar is in the Green Zone, you double the number of lower lows to create a sell signal.
We have now covered the five dimensions for entering a stock or commodity market. Most traders find it more difficult to get out of a trade than to enter a trade. Getting out is always an executive decision. However, four guidelines that I use in my own trading have been effective in maximizing the profits taken from the markets. We will explore these in the next chapter.