An Example of the Dow Jones Industrials (^DJI) Trading System using the SBV Oscillator

October 10, 2008

DJI SBV beats the stock market crash

+20% on the DJI in a week

Improve the system by protecting profit

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In our daily market outlook, we wrote: "As we already mentioned in January 2008 and in September 2008, when the SBV hit extremely low levels, we recommend that you lower the negative level from minus 20% to minus 60-70% after such a strong bearish volume accumulation. This is for those who use our 60-day SBV(20) simple trading system. The reason is that it could be enough to confirm a recovery. The odds for a continuation of this afternoon's rally are increasing." The same principles could be applied to the 30-day chart. When we have an extremely oversold market defined by a large bearish SBV accumulation (a lot of red) and when the SBV is hitting extremely low negative levels, it could be a mistake to wait until the SBV rises to minus 20% before closing a position. Waiting when minus 20% levels are reached could wipe out a major portion of the profit.

We represent our system in simple fashion in order to deliver the main points of using the SBV Oscillator. Yet, this does not mean that the system is perfect and without room for improvement. Every trader must adjust this system to his personal trading style and risk tolerance and develop rules that not only help to cut losses, but also help to protect profit.

In the current market condition when the SBV hits minus 100% level and starts to advance, a trader may set stop when he/she wishes to pocket the profit. For example, a riskier trader may close the short position and open a long position when the SBV rises to minus 70-60% (after such strong oversold levels). On the other hand, a more conservative trader may close the short position when the SBV rises to minus 70-60% and stay in cash until the SBV climbs to minus 20% and only then open a long position. Another trader may close the short position when the SBV rises from minus 100% to minus 80% and open a long position when the SBV is above minus 50%.

As you can see, different rules can be created, depending on your personal trading style, how you fill about the market and what you learn from other technical indicators. The main point is that the rising SBV indicates a Bullish sentiment and, when the market is strongly oversold and extremely volatile (the DJI can move 5% up or down very easily) after such a low negative SBV, it could be too late to close the short position when the SBV reaches minus 20%.

This week's SBV chart example is based on the 30-day SBV(20) DJI (Dow Jones Industrial) chart. This week's SBV chart example is a continuation of a previous example of October 3, 2008. In this week's example, we use the settings that were previously used to show the consistency of our trading system over a long period of time.

Since July 24, 2008, we have been paying close attention to the Dow Jones Industrial 30-day SBV(20). The result has exceeded all of our expectations.

Chart 1. Relationship between the SBV oscillator and index reversal points. DJI index. 30-day view. 1 bar = 30 min. SBV(20)

It's Simple and profitable

In our trading example, we applied the following simple system which is based on our SBV indicator:

1. Once the SBV indicator has declined below minus 20% (the indicator will now show red), we will enter a short position (if we are not already short).
2.  Once the SBV indicator has advanced above minus 20% (after having been below that level), we will enter a long position (the indicator still shows red).
3.  Once the SBV indicator has rallied above plus 20% (the indicator will now show green), we will enter a long position (if we are not already long).
4.  Once the SBV indicator has declined below plus 20% (after having been above that level), we will enter a short position (the indicator still shows green).
5.  Additional Stop Loss Rule - If the SBV had fallen into negative territory and has begun to rise, but has not hit the signal line, close the short position when the SBV is back in positive territory, and stay in cash until a new buy signal appears. Do the opposite for a long position.

Improve the system by cutting losses:

Despite a loss of 358 points on 9/18/2008, the simple trading system has generated more than +8% profit on the DJI during the last month. We recommend that you adopting additional stop-loss rules that suit your personal risk tolerance. The system presented below is very simple. Before using it in actual trading, we recommend that you fine-tune it to adapt it to your personal trading preferences and risk tolerance. For instance, you may create additional rules to take a loss if prices move 150 points against your position. In our example, adherence to this rule would have reduced our losses by 228 points.

Table 1: Trades based on the 5-rule (additional stop-loss rule) system.

Note: The 20% level for the SBV indicator was determined in relation to the prevailing market conditions at the time that the trading examples were selected. In order to establish the optimal critical levels for the SBV indicator, traders should consider the current market situation and review the history of prior volume surges, including their magnitude (i.e., the level that the SBV indicator reached).

Our charts are unique in that they give traders the opportunity to choose the specific chart settings that best fit their personal trading styles and risk tolerances. Traders can thus develop and test their own trading systems. On our charts, you can scroll back in history to test any system that you have created.

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