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The Circular Trading System
Tutorial

 

Using the System

The Circular Trading System (CTS) is based on the trading patterns of specific stocks over a minimum of a 12-month period, and in many cases a 60-month (5 year) period.

The underlying principal is that each stock has a certain characteristic, or "harmonic fingerprint", which CTS monitors to set precision stops each day prior to the market open.

The basic action underlying CTS is that when a stop is hit on a trade, two things happen:

    1 - exit the current trade
    2 - reverse and enter the opposite trade
So each trade is essentially two trades in one: a long becomes a short, or a short becomes a long. More precisely, if you were long a stock, you exit the long and then go short at the same price. If you were short, you cover the short and then go long at the same price. This is why the system is called "circular".

 


 

Starting Out

When you first look at the Daily Trigger List, you will see that all the stocks are currently either in a long trade (a BUY) or a short trade (a SELL). These "Buy" and "Sell" labels are NOT recommendations. They are simply a reference to show you the status of all trades in the system right now.

Rule #1 is to never chase a trade. If a stock is on a buy signal, WAIT for the reversal stop to be hit and then go short. If it is on a sell signal, WAIT for the reversal stop to be hit and then go long.

It is important to undertand that stops are not only exit points, but they are also ENTRY points.

Contrary to popular belief, the entry, not the exit, is the most important part of any trade. If you enter at the right place, exiting is easier, and more likely to be profitable.

To better understand the Daily Trigger List, please note that the most important column is the "Stop & Reverse" price. This is the primary stop. It is the exit stop for the current trade, and the ENTRY stop for each new trade.

The next most important column is the "New Intraday Stop If Filled" column. The ONLY time this stop price should be used is INTRADAY when a trade reverses (from long to short, or short to long). At the end of the day, assuming the new stop is not hit and the trade remains in effect, your stop for the next day will be found in the "Stop & Reverse" column after the Daily Trigger List is updated overnight for the next trading session.

All other columns on the Daily Trigger List are for reference only. To recap, the following explains the labels at the top of the Daily Trigger List:

Symbol Click on the stock symbol to access the 12-month trading history and other important statistics on any stock on the Daily Trigger List
Status The status of the current trade. This is only for reference. It is NOT a recommendation to buy or sell.
Last Price The closing price of the stock from the previous day
Current Trade The nature of the current trade, showing the type of trade, the entry price, and the date the position was opened. This is for reference only, and is NOT a recommendation.
Stop & Reverse Trigger This is the most important column in the table. It shows the price where you should place your stop if you are currently in the trade. It is also the ENTRY price for reversals.
New INTRADAY Stop If Filled This is the 2nd most important column in the table. It shows the price where you should place your protective stop once the trade reverses. This stop is only used once, intraday, whenever a new trade is executed.
12-Month Return The cumulative profit or loss over the past 12 months, on a percentage basis.

 


 

Selecting Stocks

When you first begin to use the system, we recommend that you start out with just one stock so that you can get accustomed to the system.

Since there are often 100 or so stocks on the Daily Trigger List, selecting which stock to trade first might seem like a dart throw. But there are several ways to narrow down your choices.

First, look at the bottom of the Daily Trigger List, and note the stocks that are currently the best performing stocks in the system.

Then look at the trading statistics of each stock by clicking on the stock symbol on the Daily Trigger List.

If you tend to have a low tolerance for volatility, do not select a stock with an ATR (Average True Range) of more than one point, such as TASR, or SWIR. These stocks can have wide swings, and very often a trade might go from a gain to a loss and back again several times before a stop is ever hit.

Another good indicator of volatility is the number of "whipsaw days", as shown on the trading statistics page for each stock. Whipsaw days are the number of times over a 12-month period the stock has seen two stops hit in the same day. Volatile stocks have a higher number of whipsaw days, while other stocks might have only 1 or 2 per year.

The trading history also shows if a stock has seen most of its profits from long positions, or shorts.

And you can also see from the most recent trades if a stock has had a run of small losses because it has been going sideways within a narrow range. Oddly enough, these are sometimes the best candidates, for the longer a stock goes sideways, the more likely it will soon breakout in one direction or the other.

Once you have selected a stock to begin trading with, enter a stop-limit order at the "Stop & Reverse" price shown on the Daily Trigger List. If the stock is currently in a short position, your order should be a BUY STOP-LIMIT. If the stock is currently in a long trade, your order is a SHORT STOP-LIMIT. In either case, your order will not be executed unless and until the stock trades at that price. If by the end of the day the stock never hits that price, your order expires, and you are not yet in a trade. When the Daily Trigger List is updated later that night, note the new "Stop & Reverse" price, and use that to re-enter your stop-limit order the next day. Eventually, that stop WILL get hit, so be patient. This is how you enter a new position. Do NOT chase a stock once a trade is underway. Wait for it to reverse and hit its stop. In this way, the MARKET will bring you into a position rather than picking an arbitrary price to place your order.

Again, remember the primary directive --- never chase a trade. Let it come to you.

Finally, and most importantly, once your order is filled, look on the Daily Trigger List and note the price indicated in the "New INTRADAY Stop If Filled" column. If you are long, set a sell stop-limit at that price, as well as a short stop-limit at the same price. If you are short, set a buy stop-limit at the "New INTRADAY Stop If Filled" price, but enter twice the number of shares you are trading. If that stop is hit, your order will not only cover your short, but it will get you long at the same time. In either case, the "New INTRADAY Stop If Filled" price is only used once, right after a new trade is made, and is only "good-for-the-day". For the next day's stop, look on the Daily Trigger List after the list is updated overnight and use the "Stop & Reverse" price as your stop for the next trading session.

 


 

Expectations

The most difficult part of using The Circular Trading System is learning to trust it.

Most new users start out looking at the excellent 12-month returns and expect similar success instantly. That is not what usually happens.

If you click on any stock symbol on the Daily Trigger List, you can look at the 12-month trading history for each stock. You will notice two things right away:

    - most stocks have more losing trades than winning trades.
    - losses tend to be small, while the profitable trades tend to be large
It is natural to then ask how is it possible for a trading system to be profitable when the trading history shows more losing trades than gainers? The key is in the principle of expectancy.
Expectancy in its simplest form is the probability of a gain (Pg) times the average gain (Ag), less the probability of a loss (Pl) times the average loss (Al). The formula is:

E = ((Pg*Ag) - (Pl*Al))

Take a stock like AEIS, which as of this writing has an apparently poor Gain/Loss ratio of 40/57. That's just about 3 losses for every 2 gains. But the average gain is $1.26, while the average loss is 0.44.

The probability of a gain then is 41.24% (40/97), and the probability of a loss is 58.76%. Applying the expectancy formula, we see:

E = ((.4124 * 1.26) - (.5876 * .44)) = (.52 - .26) = .26

So the expected profit of ALL trades of AEIS is 26 cents per share. Multiply that by 7 or 8 trades per month and you get a very healthy return after 12 months.
The key to success, then, is consistency. Sticking with it even if you encounter a string of losses. The main thing is that losses, when they occur, should ideally be small. And the gains, when a trend kicks in, should ideally be large. By remaining consistent and sticking with the system, profits tend to accumulate and should result in excellent returns by the end of 12 months. It's the results after the first month where new users tend to get discouraged. But by trusting the system and remaining consistent in applying the system, the size of the gains should eventually make whatever losses you take much easier to accept.

So if you start out with a string of losses, please don't be discouraged. It happens, especially when a stock is going sideways and the stops are tight. But you never know when a breakout will occur, and if you stick with it, you'll be in at the start of a trend instead of trying to chase it like everyone else.

One more thing about expectations --- do not expect to duplicate the backtested returns shown here. The computer, when backtesting trades, is a perfect trader. It will always get filled at its stop price unless a gap open never recovers enough to trade there. Generally speaking, because actual trading can never emulate the computer's fills, we recommend trimming at least 30-50% off of the stated system returns to allow for bad fills, gap opens, commissions, etc.

 


 

Using the Trading History Tables

At the top of each trading history page is a breakout of statistics that are pertinent to each stock. The following is an explanation for some of the labels you may not be familiar with:

Avg Monthly Return-The average profit or loss in dollars each month
Total Gains/Losses-Over 12 months, the total number of gains and losses
P/L Gains/Losses-Gains and losses in total dollars, and average per trade
P/L Ratio-The amount of profit for each $1 loss over the past 12 months
Total Whipsaw Days-The number of days the stock has been stopped out twice in one day
Trend-An indication of the stock's current directional movement
ATR-The Average True Range shows the typical daily price range of a stock

 


 

About Stops

There is a big difference between a stop and a stop-limit.

A stop is essentially a market order. When you set a plain stop at a specific price, and if the stock then trades to or through that price, your order will be executed as a MARKET order.

We recommend when you are able to actively monitor your trades that you use STOP-LIMIT orders. A stop-limit combines a stop and a limit order. When the stop is hit, then your broker fills it at the price limit you have specified.

The following links may also help explain it if you're still unsure of the difference.

Stop-Limit Orders
Stop Orders
Limit Orders

That said, there is a time when a pure stop rather than a stop-limit is appropriate. If you are not able to be at your computer at the start of a trading session, or if you have to leave during the day and can't watch your positions, it is probably best to set a pure stop rather than a stop-limit. This will insure that if the market moves against you, you are virtually assured to exit your position when the stock moves through your stop price. The downside, however, is that where you get filled is a not precise, nor is it absolutely guaranteed that you can exit in certain conditions, such as trading halts, limit moves, etc. For example, if your stop is at $11.00 and the stock moves through that price, the market maker might fill you at $10.90 instead of $11.00. This is because a pure stop is a market order, and the price you are filled at depends upon the bid/ask at the time your order is executed.

In anycase, regardless whether you use a stop or a stop-limit to exit a position, ALWAYS use a stop-limit for entering new trades. As mentioned previously, the entry price is the most important part of every trade. If price leaps over your stop and you don't get filled right away, be patient. It usually will "back and fill", literally.

 


 

Dealing With Gap Opens

The gap open is both the bane and the joy of the system. Very often, the system might go long a stock one day before some good news comes out that gaps the stock up a point or more at the next day's open. Or the system might go short a stock a day before some bad news tanks the stock.

That's the good aspect of the gap open, and when it happens, do nothing and enjoy it.

However, there are times you might be long a stock and bad news comes out that causes a sharp selloff at the open, and the opening price gaps over your stop.

If you have a pure stop in place, you will get filled at or near the opening price. This is where a pure stop may be a disadvantage, as sometimes the opening price is the low price of the day, and by the close the stock manages to fill the gap.

But just as often, the opening price might be the high of the day, and exiting at the open will be best.

When a gap open goes against your trade and you have a stop-limit in place, rule #1 is --- do not panic.

Very often, the opening trades are the result of stops getting hit that dictate trades at-the-market rather than a limit price, which often spikes the stock down a little further from its open. But then the stock will often begin to retrace. The key is the opening price.

If the stock trades above the opening price, set a stop just below it. And if the stock trades back up to where your original stop was set, get out there and then reverse. Should it never reach that point but it never trades back down below the opening price, wait for the close, and then get out.

If the stock opens and never retraces any of the gap within the first 30 minutes, and if it never even gets back to the opening price, just get out and take the loss.

Another factor is the market itself. If the gap open is not stock-specific (or sector-specific) from some earnings news, that is all the more reason to be patient sometimes. If your position is primarily trading with the market and there is no other news to account for its movement, it has a better chance of filling the gap at some point during the day.

The main thing is, even though the gap prevented the stop from getting hit and giving you a graceful fill on the exit, the system is still saying "exit the position". Don't hold a loss overnight if it's going to close below your stop.

 


 


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