Spotting Breakouts As Easy As ACD

The system taught by trading guru Mark Fisher is the one that he and his traders at MBF Clearing Corporation use to make a living on the New York markets every day. They trade everything from basic commodities such as natural gas and crude oil to volatile stocks. His traders brave the commodity pits or work from computer terminals. Does it work? They’ll tell you that it does if you ask anyone at Fisher’s firm what they think of the system.

Key Takeaways

• Mark Fisher conceived of the ACD system and published it in his book, “The Logical Trader.”
• Fisher spotted the importance of the opening range setting the tone for the trading day.
• The system is a breakout strategy that tends to work best in volatile or trending markets.
• The likelihood that the opening range will be either high or low for the day is more than three times what one would expect if market movements were truly random.

Basics of the ACD System

Fisher describes his ACD system and how it works in his book, “The Logical Trader.” He’s quite happy to share the system he uses because he believes that it will become more effective as more people use it.

His system provides A and C points for entry of a trade and B and D points as exit. It’s a breakout strategy that works best in volatile or trending markets with a special group of stocks and commodities. Those with high volatility work best. Fisher frequently uses natural gas and crude oil examples in his book but he also mentions commodities like sugar and a host of stocks.

These references are good tip-offs on the kind of markets for which it can be good to use the ACD.

Figure 1 – S&P 500 Index five-minute chart. Chart provided by Metastock.com. Intraday data by eSignal.com

The S&P 500 Index five-minute chart in Figure 1 shows a range of 10 trading days with ACD signals, The opening range (OR) blue lines are calculated using the range of the first 15 minutes of the trading day. An A-up red line occurs when the index breaks three points above the opening range. An A down red line occurs when the price breaks a set amount below the opening range and stays there.

An indicator like the relative strength index can often help confirm buying and selling signals. A sell signal together with negative divergence makes a good sell signal confirmation. Note the turndown on the eighth day of the month. The trader would reverse their position when a C down was put in at 0.5 points below the opening range low if the index were to put in an A up and then break down below the opening range.

A New System Is Born

Fisher observed the importance of the opening range setting the tone for the trading day while he was working on a system to trade as a graduate student at the Wharton School of Business in the early 1980s.

The opening range was the high or the low of the day from 17% to 23% of the time in the case of crude oil where the opening range at the time was 10 minutes. One would expect the opening range to be the high or the low 1/16 or 6.25%) of the time (1/32 for high and 1/32 for low) if markets were truly random and because there are 32 10-minute periods in the trading day.

The likelihood that the opening range will be either high or low for the day is more than three times what one would expect if market movements were truly random based on the random walk theory. Fisher is not the only person to have discovered this fact. Several trading systems rely on an opening range for providing clues to directional bias.

How to Use ACD

Here’s how a trader would use the ACD system.

They would first monitor world markets about an hour or so before the market opens. This helps them get a feel for what traders around the world are doing.

Next, it’s important to read commodity reports. What reports are coming out today that could have a strong influence on the trader’s market? A crude oil trader would follow OPEC (Organization for Petroleum Exporting Countries) meetings for any signs of a cutback or increase in production quotas, weather reports affecting oil consumption, the weekly oil inventory report, and the weekly natural gas storage figures.

The S&P 500 Index trader follows the first 15 minutes of the market after the market opens. This is the opening range (OR) used in our example. They would mark high and low horizontal lines on their chart for the day. This trader then waits for an A up or an A down to occur. The index moves above the OR and rises a further three points putting in an A up in this case.

The trader then places a stop order and buys the index at the A up. A stop loss would be set below the low value of the OR or B-exit after the trader is in the trade so they would get out if the market moved in the undesired direction for more than this amount. A day trader would exit near the end of the day if the trade continued in the desired direction.

AC down occurs if the A up signal is generated but the index trades then down below the opening range. The trader would exit using the lower limit of the OR (B exit) when this line is penetrated. They would reverse their position and sell short when a C down was put in.

AC down or C up moves are far rarer. They’re interesting because the later in the day they occur, the more intense the move. The less time traders have to exit a trade on a reversal, the more urgent it becomes and the greater the volatility. This is one instance in which staying in a trade overnight might be a good idea, according to Fisher, because markets often experience gaps at the opening of the following day.

Figure 2 – Chart showing five-minute bars

The chart in Figure 2 shows five-minute bars, an opening range, an A up, and a C down. The trade was entered when the equity traded at the A up and exited or stopped out when it traded below the B exit at the bottom of the opening range. A C down trade was entered with a stop (D exit) in case the index closes above the upper limit of the opening range.

AC down occurs if the A up signal is generated but then the index trades down below the opening range. The trader would exit using the lower limit of the OR (B exit) when this line is penetrated. They would reverse their position and sell short when a C down was put in.

Choose Your Timeframe

A day trader might use five minutes as their basis for trading while a longer-term trader might use daily data.

Fisher describes the macro ACD for a longer perspective. This still requires reference to intraday data to determine the opening range and A up or down. The difference is that the longer-term trader keeps a tally of the score each day in a running total.

Fisher assigns daily values based on market action. The day would earn a score of +2. if the equity puts in an A up early in the day and never trades below the opening range. They give it a –2 if it puts in an A down and never closes above OR.

Fisher’s daily scale ranges from +4 to –4. A total is kept and the new daily value is added each day while the oldest score from 30 days ago is removed. The longer-term trader would consider this bullish on a day in which the running tally is increasing. The more rapidly the value is increasing or decreasing, the more bullish or bearish the signal.

Important

The beauty of the ACD system is that it works in almost any time frame.

Special Considerations

The system isn’t a plug-and-play trading strategy that can be used on any equity. The equities that work best for ACD are highly volatile, very liquid, and they’re subject to long trends. Currencies tend to work very well with the ACD system.

We’ve used the S&P 500 Index in our example but Fisher said in a telephone interview that it doesn’t work particularly well. He believes there are far better candidates to trade with the ACD. It also doesn’t work very well on low-volatility equities stuck in a trading range.

What Are the Characteristics of a Volatile Market?

A volatile market exhibits rapid and unexpected movements. Significant gains might be possible but the opposite could occur as well. Rolling the dice in a volatile market runs an increased risk of loss. Market volatility is sometimes expected due to published and anticipated events but it can often come as a surprise.

What Is the Random Walk Theory?

The random walk theory describes market conditions that appear to occur at random. It implies that it’s effectively a waste of time to try to predict them.

What Is a Day Trader?

A day trader bases their trades on intraday market conditions. Day trading involves heavy reliance on predicting short-term changes in a security’s price. The goal is to close all trades by the end of the trading day, ideally at a profit.

The Bottom Line

The ACD system offers another way to look at markets and a method of taking advantage of the daily volatility and trends of stocks, commodities, and currencies. You can obtain a copy of “The Logical Trader” or go to Fisher’s website if you’re interested in learning more. He offers a subscription service to those who would like to get regular information on the values of A and C points on various equities and commodities as well as details on how to best use Fisher’s system.

Disclosure: This article is not intended to provide investment advice. Investing in securities entails varying degrees of risk and can result in partial or total loss of principal. The trading strategies discussed in this article are complex and should not be undertaken by novice investors. Readers seeking to engage in such trading strategies should seek extensive education on the topic.