Sequential: Countdown, Entry and Exit

By: Thomas DeMark

The following is an excerpt from Tom DeMark's The New Science of Technical Analysis

My research confirms the fact that, prior to a price top or bottom, the market announces its intentions regarding price direction loud and clear to any trader willing to listen.  Specifically, the market forewarns the trader whether it is predisposed toward a price top or toward a price bottom.  In other words, the market’s environment or inclination to top or to bottom is first defined by the setup phase.  Because my entire approach is mechanical, as are the additional filters required to actually generate the buy and sell signals, I developed a checklist to simplify this process.  The feature of this approach is its design to buy into weakness and to sell into strength.  Once all the prerequisites are satisfied in the order required, a signal occurs.  Hence, the name Sequential™ was given to the system.

Countdown

Once your setup has been satisfied, the countdown process begins.  Countdown describes the relationship of the close to either the high or the low price two trading days earlier, depending on whether a sell or a buy setup is active.  With respect to a pending buy signal, the close must be less than the low two days earlier; with respect to a pending sell signal, the close must be greater than the high two trading days earlier.  Once a total of 13 closes less than the low two trading days earlier (in the case of a buy), or a total of 13 closes greater than the high two trading days earlier (in the case of a sell) are recorded, a signal is generated.  These 13 closes need not occur consecutively; they will occur only rarely, if at all.  Once intersection has taken place to validate completion of the setup – and beginning no earlier than day 9 of the setup – the countdown begins.  By definition, the countdown period cannot be completed any sooner than 12 days after setup, and that assumes that day 9 qualifies.  Typically, however, one might expect 15 to 30 days to lapse between the setup and the completion of countdown.

Two situations that could arise after setup would cancel countdown.  The first situation invalidates the original setup and requires the process of setup formation to start over.  The original setup is negated at any time subsequent to setup, and prior to a signal, a setup in the opposing direction occurs.  The second situation does not require additional time to form a new setup, but it does recycle (start over) the countdown phase.  In this case, a subsequent setup is formed simultaneously as the countdown process is taking place.  This new setup replaces the original setup and is in concert with the original setup, not contradictory.  This occurs often and is a function of the market’s reevaluating the supply and demand equation and reestablishing the path and the time parameters to the ultimate top or bottom.  In both instances, the original setup and the countdown are repealed; in the second situation, a new setup has been formed through the recycling process.

Entry

Three methods are recommended for Sequential entry.  The first approach enters the market on the close of the day in which countdown is completed.  This is the riskiest entry because the setup can be recycled and the original signal will evaporate the process.  A new signal cannot be generated until the countdown process has been replayed.  Although the potential exists that the trade may produce a loss, it is the only entry of the three that offers the opportunity to buy or to sell at the absolute closing price low or price high.

The second method ensures that price does not recycle and consequently does not forfeit the active signal.  However, it requires a price “flip” – a close greater than the close four days earlier in the case of a buy, or a close less than the close four days earlier in the case of a sell.  By awaiting the flip, insurance is bought that a setup will not be recycled.

The final entry technique is to await a two-day range “flip” once the thirteenth day is identified.  In other words, once the countdown is completed, buy the first time a subsequent close greater than the high two days earlier occurs or, conversely, sell the first time a subsequent close less than the low two days earlier occurs.  This entry perfects the “flip” entry and generally serves as a compromise between entry one and entry two.

Exit

There are two ways in which to exit a trade other than being stopped out of the trade with a loss.  The first method is to liquidate the position once the current setup is completed and price fails to exceed the furthest price level recorded by the most recent inactive setup.  This exit assumes that because the trend has not reversed as defined by the point of termination of the active setup failing to exceed the furthest price of the most recent inactive setup, there is a likelihood of an impending reversal and thus the trade should be liquidated.

The other exit also compares the two setups, but in this instance if any price recorded during the current active setup exceeds the furthest price of the inactive setup, then the position is held until a reverse signal is generated.