Dunnigan's work in the early 1950s is based on chart formations and is purely technical. Although an admirer of others' abilities to perform fundamental analysis, his practical approach is contained in the statements:
"If the economists are interested in the price of beans, they should, first of all, learn all they can about the price of beans." Then, by supporting their observations with the fundamental elements of supply and demand, they will be "certain that the bean prices will reflect these things. "7 .
Dunnigan did extensive research before his major publications in 1954. A follower of the Dow theory, he originally created a breakaway system of trading stocks and commodities, but was forced to drop this approach because of long strings of losses even though the net results of his system were profitable. He was also disappointed when his 2y3 Swing Method failed after its publication in A Study in Wheat Trading. But good often comes from failure and Dunnigan had realized by now that different measurements should be applied to each market at different price levels. His next system, the Percentage Wheat Method, combined a 2'A% penetration and a 3-day swing, introducing the time element into his work and perhaps the first notion of thrust, a substantial move within a predefined time interval. With the 2lA%, 3-day swing, a buy signal was generated if the price of wheat came within 2% of the lows, then reversed and moved tip at least an additional 2'A% over a period of at least 3 days.
For Dunnigan, the swing method of charting8 represented a breakthrough; it allowed each market to develop its natural pattern of moves, more or less volatile than any other
7 Wiiiiam Dunnigan, Selected Studies in Speculation (Dunnigan, San Francisco, 1954, p. 7).
'TO. Gann, How to Make Profits in Commodities (Lambert-Gann, Pomeroy, WA, 1976). This book devotes a large section to swing charts and includes many examples of markets prior to Dunnigan's work.
market. He had a difficult time trying to find one criteria for his charts that satisfied all markets, or even all grains, but established a $2 swing for stocks where Rhea's Dow Theory used only $1 moves. His studies of percentage swings were of no help.
Dunnigan's final development of the Thrust Method combined both the use of percentage measurements with the interpretation of chart patterns, later modified with some mathematical price objectives. He defines a downswing as a decline in which the current day's high and low are both lower than the corresponding high and low of the highest day of the prior upswing. If currently in an upswing, a higher high or higher low will continue the same move. The reverse effect of having both a higher high and low would result in a change from a downswing to an upswing. The top and bottom of a swing are the highest high of an upswing and the lowest low of a downswing, respectively. It should be noted that a broadening or consolidation day, in which the highs and lows are both greater or both contained within any previous day of the same swing, has no effect on the direction.
In addition to the swings, Dunnigan defines the five key buy patterns: .
1. Test of the bottom—where prices come within a predetermined percentage of a prior low
2. Closing-price reversal—a new low for the swing followed by a higher close than the prior day
3. Narrow range—where the current day's range is less than half of the largest range for the swing
4. Inside range—where both the high and low fall within the prior range
5. Penetration of the top—by any amount, conforming to the standard Dow theory buy signal
All of these conditions can be reversed for the sell patterns. An entry buy signal was generated by combining the patterns indicating a preliminary buy, with a thrust the next day confirming the move. The thrust was defined as a variable price gain based on the price level of the market (for 1954 wheat, this was from % to l!4i). Dunnigan's system attempted to enter the market long near a bottom and short near a top, an improvement on the Dow theory. Because of the risks, the market was asked to give evidence of a change of direction by satisfying two of the first four patterns followed by a thrust on the next day. Any variance would not satisfy the conditions and an entry near the top or bottom would be passed.
The same buy and sell signals applied to changes in direction that did not occur at prior tops and bottoms but somewhere within the previous trading range. In the event all the conditions were not satisfied and prices penetrated either the top or bottom, moving into a new price area, the fifth pattern satisfied the preliminary signal and a thrust could occur on any day. This was not restricted to the day following the penetration. So that if nothing else happened, Dunnigan followed the rules of the Dow Theory jp insure that a major move would not be missed. -
It has been said by followers of Dunnigan's method that his repeat signals are the strongest part of his system; even Dunnigan states that they are more reliable although they limit the size of the profit by not taking full advantage of the trend from its start. Repeat signals use relaxed rules not requiring a new thrust because the trend has already been identified. Two key situations for repeat buy signals are:
1. A test of the bottom followed by an inside range (interpreted as market indecision)
2. A closing price reversal followed by an inside range
A double thrust occurs when the first thrust is followed immediately by a second thrust; or, after the first thrust, a congestion area develops, followed by a second thrust in the same direction as the first. Although Dunnigan used a fixed number of points to define his thrust, today's traders may find the standard deviation of the daily price changes or another volatility measure as a more practical basis for identifying significant price moves.
Dunnigan worked on what he hoped would be a generalized version of his successful Thrust Method and called it the One-Way Formula. Based on his conclusions that the Thrust Method was too sensitive, causing more false signals than he was prepared to accept, he modified the confirmation aspect of the signal and made the thrust into the preliminary signal. He also emphasized longer price trends which smooth performance and reduce signals.
With the upswing and downswing rules remaining the same, Dunnigan modified the thrust to require its entire range to be outside the range of the prior day. For a preliminary buy, the low of the day must be above the high of the prior day. This is a stronger condition than his original thrust, yet only constitutes a preliminary buy. The confirmation occurs only if an additional upthrust occurs after the formation of, or test of, a previous bottom. There must be a double bottom or ascending bottom followed by a thrust to get a buy signal near the lows. If the confirmation does not occur after the first bottom of an adjustment, it may still be valid on subsequent tests of the bottom.
For the One-Way Formula, repeat signals are identical to original confirming signals. Each one occurs on a pullback and test of a previous bottom, or ascending bottom, followed by an upthrust. Both the initial and repeat signals allow the trader to enter after a reaction to the main trend; The Dow approach to penetration is still allowable in the event all else fails. The refinement of the original thrust method satisfied Dunnigan's problem of getting in too soon.
The two previous methods show a conspicuous concentration of entry techniques and an absence of ways to exit. Although it is valid to reverse positions when an opposite entry condition appears, Dunnigan spends a great effort in portfolio management9 and risk-reward conditions that were linked to exits. By his own definition, his technique would be considered trap forecasting, taking a quick or calculated profit rather than letting the trend run its course (the latter was called continuous forecasting).
A fascinating calculation of risk evaluation and profit objectives is the Square-Root Theory. He strongly supported this method, thinking of it as the golden10 key, and claiming support of numerous esoteric sources such as The Journal of the American Statistical Association, The Analysts Journal, and Econometrica. The theory claims that prices move in a square root relationship. For example, a market trading at 81 (or 92) would move to 64 (82) or 100 (102); either would be one unit up or down based on the square root. The rule also states that a price may move to a level that is a multiple of its square root. A similar concept can be found greatly expanded in the works of Gann (Chapter 14).
NOFRI'S CONGESTION-PHASE SYSTEM
Markets spend the greater part of their time in nontrending motions, moving up and down within a range determined by near-stable equilibrium of supply and demand. Most trend
9 Each of his writings on systems contained exampies of multiple-fund management of varied risk.
10 Refers to the Greek description of Fibonacci ratios.
followers complain about the poor performance that results from markets that fail to move continuously in one direction. However, their systems are designed to conserve capital by taking repeated small losses during these periods to capture the big move. Eugene Nofri's system, presented by Jeanette Nofri Steinberg, is used during the long period of congestion, returning steady but small profits. Nofri's system does not concern itself with the sustained directional move; therefore, the user of the Congestion-Phase System can wait to be certain of a well-defined congestion area before beginning a trading sequence.
The basis of the system is a 3rd-day reversal. If prices are within a congestion range and have closed in the same direction for 2 consecutive days, take the opposite position on the close of day 2, anticipating a reversal. If this is correct, take the profits on the close of trading the next (3rd) day. Nofri claims a 75% probability of success using this technique, and the Theory of Runs supports that figure. If there is a 50% chance of a move either up or down on day 1, there is a 25% chance of the same move on the next day, and 12'A% chance on day 3- Considering both commissions and variation in the distribution, an assumption of 75% is reasonable.
Because the basis of the Congestion-Phase System is an unlikely run within a sideways price period, the substitution of a 4-day run instead of the current 3-day run should increase the profitability and reliability of the individual trades while reducing the number of opportunities.
The Congestion-Phase System is only applied to markets within a trading range specifically defined by Nofri. Users are cautioned not to be too anxious to trade in a newly formed range until adequate time has elapsed or a test of the support and resistance has failed. The top of the congestion area is defined as a high, which is immediately followed by 2 consecutive days of lower closing prices; the bottom of the congestion area is a low price followed by 2 higher days. A new high or low price cancels the congestion area. Any 2 consecutive days with prices closing almost unchanged (for example, ±2 ticks) are considered as 1 day for the purposes of the system. These ranges occur frequendy and can be found by charting prices using the last 10 days. In cases in which the top or bottom has been formed following a major breakout or price run, a waiting period of 10 additional days is suggested to ensure the continuance of the congestion area and limit the risk during more volatile periods. Remember, systems that trade only within ranges offer many opportunities that should be exercised with patience.
A congestion area is not formed until both a top and bottom can be identified. Penetration of a previous top and formation of a new top redefines the range without altering the bottom point; the opposite case can occur for new bottoms. If a false breakout occurs lasting 2 or 3 days, safety suggests a waiting period of 7 days. Logical stops are also possible, the most obvious places being the top and bottom of the current congestion area, but closer stops could be formulated based on price volatility.
The Congestion-Phase System can stand alone as a short-term trading method or can be used to complement any longer technique. When trying to improve entry or exit fills, the system qualifies as a timing device but only within the congestion areas defined by the rules. It is not intended to be used in all situations. The converse of the system says that an gritry signal given outside of a congestion area should be taken immediately because longer periods of prolonged movement in one direction are most likely. But in a trading -range, the Congestion-Phase System may turn a moving average technique from a loser to a winner.
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