The Expander Strategy. With three criteria for successful setups

Wieland Arlt places great emphasis on three criteria in his trading setups: a high probability of entry, a long distance to the targeted goal, and a clear message when the market is different. How these criteria can be combined in one strategy, please read below.

With his three criteria for a good strategy, Wieland Arlt sets the bar high for the selection of his trades. Let us look more closely at the three criteria: a high probability of occurrence is the basis for successful trading. That proper potential to the goal is desired, should be a matter of course for all traders and needs no further explanation. The desire for a clear message of the market makes sense since traders have to decide again and again whether they should open or close a position. A clear message makes decision-making easier and helps to reduce misinterpretation. With the expander strategy, Wieland Arlt depicts these three criteria in his trading. The basic idea is to identify situations in which the movement dynamics of a market already have a certain maturity and is not only flattened, but is transformed into a correction. The expander serves as a symbol for this, which can only be stretched to a certain extent before it springs back. The expander strategy is intended to identify market situations where the price is just at the point of the spring-back. An entry is made when the price begins to correct the previous movement and has already taken the first steps. The expander strategy can be applied not only as an anticyclic countertrend strategy, but also as a procyclical trend-following strategy.

The basic idea

The Bollinger tapes * developed by John Bollinger are used for the expander strategy. In the original version, John Bollinger used the bands with a simple 20-day calculation basis and two standard deviations. We take this setting. The interpretation of the Bollinger Bands states that prices on the upper band are relatively high and prices on the lower band are relatively low, and on the other hand, that well over 89 percent of all prices lie within the bands. This is important for understanding the expander strategy: If 89 percent of all prices are within the bands, eleven percent of all prices are outside. The key question is: how likely is it that the outside prices return to the bands again? Thus we have at least partially met the first criterion of the high probability of occurrence. If the prices are outside the Bollinger bands, then this overshooting indicates that the market has already extended its prices very far. The expander begins to spread and approaches its reversal point.

Position opening

With the overshooting out of the bands, a value becomes the focus of the attention. Only when the market begins to correct, the price returns to the Bollinger bands. A second component of the expander strategy is the interpretation of the resulting candlesticks (see Infobox). These are of crucial importance. By which can be better understood, how the market reacts to the upper or lower shadow of a candle and the core body itself? Here, clear signs of movement-weakness and reversal of the price have to be considered. Typically, in the case of a previous upward movement, candles such as the shooting star or formations such as the Dark Cloud Cover or the Evening Star may be considered; after a previous downward movement the hammer, the piercing pattern or the Morningstar. In addition, the Doji as well as the Engulfing pattern are interesting. The entry into a position takes place either by market-order or stop-order, if the presented candles-formations or formations are formed on a closing price basis. The fact that a position is opened only when the market actually shows the desired reaction, traders can expect a high hit probability – the first criterion is fulfilled.

Stop loss, price determination and position management

The criterion of a long distance to the goal can be better fulfilled for trades in trend-phases than in trendless-phases. The first goal of the expander strategy is defined by the mean Bollinger band – the simple moving average over 20 periods. As this does not remain static, but follows the price trend, the position may be hold longer than in other strategies. For example, if a position is opened, many traders determine a fixed profit target at a chart-technical relevant point (for example, a support or a resistance). When the target is reached, the exit is done. If the target is not reached and the price oscillates somewhere between the target, the starting price and the stop loss, the question arises where and when an exit should take place. If the price target is defined at the middle Bollinger-band, so it changes with the market movements and above all also with the elapsed time. There is also an exit criterion at the same time, if the market after the opening of the position is rather non-directional. In this case, the middle Bollinger band glides to the price and the position can be resolved accordingly at a relevant point. For anticyclical countertrend traders, the middle Bollinger volume is the defined price target. Associated with this is the observation that corrections in trend phases bounce off regularly at the middle Bollinger band and the original trend movement is resumed. In this case, it would be a pity if accrued profits would be dropped again. On the other hand, the average Bollinger-band can be the first price target and, for example, close part of the position. The subsequent price-target is determined by the opposite Bollinger band. If the momentum rises, the opposite Bollinger band will move a little farther away from the price and the profit target can be extended by a few points. In this way, the trader always remains flexible and can align his position with the actual market conditions. Before the profit determination, however, the loss limitation must be determined. Because the expander strategy is based on a situation in which the price has exhausted its momentum and enters a correction, the stop loss can be placed with some air at the end of the entry-candle or entry-formation. In this sense, the stop loss also satisfies the third criterion. If a market succeeds in moving in the extended state further into the already dynamically chosen direction then the indicated correction was nothing more than a brief breathing through. Such a tempo should not be confronted by any trader. The position management can be extended in such a way that the stop loss is dragged to the previous candle after a period closure – In a long position to the respective low, in a short position to the respective high of the previous candle. This position management is particularly recommended for an anticyclical countertrend trade.

Trading examples

Figure 1 shows the DAX future in the daily chart. In the course of a decline in the price, the FDAX drops to point 1 and forms a reversal in the form of a piercing pattern. In order to avoid false signals, a stop buy order is placed above the red candle high; The stop loss is set below the low. Subsequently, the FDAX runs straight up to the upper Bollinger band and forms an evening star formation at point 2. At the latest with this signal, the position should be resolved. After the following correction was very moderate – also a reason to follow the candle signals – the market rises to point 3 and forms a not quite correct shooting star, which has its high outside the Bollinger. In the combination of the three candles at point 3, an evening star can also be recognized, which triggers the following correction. An entry is made through a stop sell order below the shooting star's low; the stop loss is above the high. Afterwards, the price goes directly to the middle Bollinger-Band and runs to the point 4. There again a hammer is formed which carries the position up to the upper Bollinger band with a stop buy order and simultaneously establishes an upward trend. Figure 2 shows the Dow Jones Index in the 5 minute chart. With a brilliant opening, the index shoots through the Bollinger bands and a resistance. At point 1, a reversal formation takes the form of a bearish engulfing pattern in the remaining minutes, which is confirmed, but immediately canceled. Only after the market has re-marked the day's high point with a false-breakout, the expected downward movement is started. At the end of the event, it should be made clear once again that the stop loss requires some air and the consideration of the market must always be made on the closing price basis of the individual candles. The entry is below the mentioned formation; the stop loss is at a distance of three points over it. This should suffice in the intraday trade, in order to avoid false-signals. As target was first the lower Bollinger band set, which corresponds to a profit of about 100 points. Since the expander strategy follows the market movements, the price target on the lower Bollinger band is flexible and is reached at point 2 with around 75 points of profit. A partial exit would have been offered at the middle Bollinger-Band.

Conclusion

With the expander strategy, we have come to know a simple, high-quality, and regularly applicable strategy, which can offer a high probability of occurrence and an often high chance / risk profile. Since markets in the trend –development not only rise or fall, but their movements always correct, the expander strategy offers excellent entry into these respective movements. 

Wieland Arlt is a Graduate economist, CFTe, an active trader as well as a certified coach and trainer. At trade fairs he is a popular speaker. In his Torero Traders School, Wieland Arlt combines proven trading concepts and experienced practical experience from more than ten years with his experience as a management coach.

get-ready@torero-traders-school.com

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