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The 4% Rule

This rule applies whether you are trading commodities futures, currencies, markets, or stocks.

The “BIG MO” is a technique that relies on major shifts in momentum to throw off buy and sell signals.  Momentum trading relies on catching the beginnings – “catching a falling knife” – (or endings) of a price move.  Such an approach is used by traders interested in bottom fishing, when prices are falling, or snagging a top in the market, when prices are rising. 

The “BIG MO” can be riskier than the trend-following approach because shifts in momentum can be unproven and short-lived, causing traders to feel they zigged when they should have zagged.  This can often occur in trending markets.  As an example, a momentum trader may try to catch a countertrend rally – a short-term uptrend going in the opposite direction to the prevailing downtrend, or a short-term downtrend in a predominant uptrend – only to have the position fail as the countertrend rally dissipates. 

This does not preclude the fact that momentum-based strategies have a significant advantage when it comes to catching big market moves early in the game. 

The fundamental difference between a trend trader and momentum trader lies in the fact that a momentum trader will be into a bottom long before a trend trader based solely on the different signals they employ.  The trend trader will usually wait for confirmation that a new uptrend has indeed occurred and proven itself.  “Show me the money.” 

Another subtle difference lies in the fact that as momentum shifts, and a new trend appears to be under way, most momentum traders will take profits quickly, unlike trend traders.  Alternatively, they may wish to start using a trailing stop, or totally shift gears and play trend trader for a while to optimize their potential profits, which means of course riding out the trend. 

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Now, let’s have a look at “The 4% Solution” … Here, I want you to pay close attention, as this idea has taken me a long time to find, and it for once and for all offers a way to “prove” that a market has changed direction conclusively. 

Here we go … We are talking about a “momentum-shift indicator.”  It uses a shift of 4%, plus or minus 1%, in the weekly closing price as a sign of a shift in momentum.  More specifically, what we are talking about is observing that the current week’s close is 3-5% higher than the week before – in the event of an upturn, or 3-5% lower for a downturn .  This means that price action is “probably” reversing its course.  Remember, trading is a business of “probabilities.” 

The key here is that this is the first week that you have observed a roughly 4% differential between the previous week’s close and this week’s.  This is a reasonable indication that momentum is changing. 

“The 4% Solution” is a momentum-shift indicator that provides an early warning that a possible major market move might just be imminent. 

Regarding whether “The 4% Solution” should be 3%, 4%, or 5%, there is no magic here.  Both 3% and 5% will do the trick, although the lower number would increase the number of signals, and the higher number would decrease the number.  More volatile tradables tend to outperform less volatile ones.

 SWING TRADE

This three-bar pattern is the one that futures traders use. It denotes a change in the direction of price.  The commodity establishes a low price as a swing point. Once the commodity closes above the high of the low day, that is a change of direction for an undetermined period.  For a detailed explanation of how this pattern works, please click here.  It works for all markets, not just commodities futures.

CLASSIC “REVERSAL” WEEK 

Record volume and a weekly close toward last week’s high is consistent with a classic “reversal” week that is found at bottoms.  Another variation sees lower price spikes intraweek followed by a weekly close toward the high for the week on record volume.  Either occurrence could be taken as significant evidence of a bottom. 

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