CHAPTER 8
Bar Patterns: Estimating Risk and Setting Bar Size

ANSWER 8.1   EGN with Bar Pattern

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  1. Closing point reversal.
  2. Bar has a higher high and lower low than bar before, and closes below the prior close.
  3. It's similar to a bearish engulfing line.
  4. A bearish engulfing line must open at or above the prior close. This is not required for a closing point reversal.

ANSWER 8.2   F with Bar Pattern

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  1. Key reversal.
  2. Opens well above previous high, and closes toward the low of the bar.
  3. Dark cloud cover.
  4. The body (open to close range) does not overlap that of the prior bar.
  5. Arrow drawn to breakaway gap.
  6. Even though the bar extends beyond the prior high, and closes toward the bottom of the bar, it did not open above the previous bar, much less well beyond its high.

ANSWER 8.3   GILD Risk (NASDAQ)

  1. $8,000/$7.66 per share = 1,044 shares. One might want to round down to 1,000.
  2. Risk is proportional to the square root of time. Therefore, $7.66/$3.13 = 2.45. Target bar length = one day/2.452 = one day/6 = (6.5 hours * 60 minutes per hour)/6 = 65 minutes.
  3. Risk of ruin = EXP((70,000 * ((LN(1–.55))–LN(.55 * 1.50))/70,000)) = 0.50 percent.
  4. Risk in dollars = 70,000/((LN(.00001))/((LN(1–.55))–LN(1.5 * .55))) = 3,685. Risk in units = $3,685/$7.66 per share = 481 shares.

ANSWER 8.4   M with Kase DevStops and Kase Reversal Amounts

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  1. Warning = $1.30, Rev1 = $1.71, Rev2 = $2.20, Rev3 = $2.78.
  2. $51.29.
  3. 1,000 * $1.71 = $1,710.
  4. $20,000/$2.78 per share = 7,194. Rounding down, one might trade 7,000 shares.
  5. If using TrueRange, one would divide one standard deviation of TrueRange by the average TrueRange (ATR). The reversal value related to the warning line is the ATR, or $1.30. The reversal value, Rev1, is one standard deviation over the ATR, so one standard deviation = Rev1 – ATR, or (1.71 – 1.30)/1.30 = 0.31.

ANSWER 8.5   BLMN Daily with Double Stops and Relative Risk

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  1. 0.50 (middle value to the right).
  2. This chart is more risky because it has a higher relative risk value.
  3. The lines are more or less parallel.
  4. An inactivity stop might have been appropriate here.

ANSWER 8.6   Risk of Ruin

  1. Risk of ruin = EXP((75,000 * ((LN(1 – .55)) – LN(.55 * 1.5))/20,000)) = 10 percent.
  2. Risk per trade = 75,000/((LN(.05))/((LN(1–.55))–LN(.55 * 1.5))) = $15,175.
  3. 100 – .99 = .01, 10% * .01 = 0.10% = .001. Risk per trade = 75,000/((LN(.001))/((LN(1 –.55)) – LN(.55 * 1.5))) = $6,581. So this is a (20000 – 6581)/20,000, or .67, 67 percent.
  4. Cutting the risk per trade down to 33% cuts risk of ruin down to only 1 percent of the original risk. So reducing risk per trade is a good way to reduce risk of ruin.
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