Barbara S. Dixon, a protege of trend trading pioneer Richard D. Donchian, wrote an article, revisiting Richard Donchian’s 1934 “Twenty Trading Guides” for stock market traders. Donchian had started a “Trend Timing” letter at age 25 in 1930 for Shearson (which was one of many firms gobbled up by Sanford Weill, during his empire building phase, which culminated in Citigroup). Donchian, revisited and reviewed these rules in 1966, and found they applied to commodities as well. I am transcribing these notes for myself from that article.
Donchian revisited these rules 34 years after the 1934 publication, and it seems they still resonate for traders, 34 years after Barbara S. Dixon’s 1978 article.
(1) Beware of acting immediately on widespread public opinion. Even if correct, it will usually delay the move.
(2) From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
*(3) LIMIT LOSSES, ride profits – irrespective of all other rules.
(4) Light commitments are advisable when a market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable “whipsawing.”
(5) Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.
(6) Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses and to take positions from certain formations such as triangular foci. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.
(7) In a market in which upswings are likely to equal or exceed downswings, a heavier position should be taken for the upswings for percentage reasons – a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%.
(8) In taking a position, price orders are allowable. In closing a position, use “market” orders.
(9) Buy strong acting, strong background commodities and sell weak ones, subject to all other rules.
(10) Moves in which rails (now the Transportation Index) lead or participate strongly are usually worth following more than moves in which rails lag.
(11) A study of the capitalization of a company, the degree of activity of an issue ( a varying factor), and whether an issue is a lethargic truck horse…or a volatile race horse … is fully as important as a study of statistical reports.
(12) A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course a counter-move approaching the sideways range may be expected.
(13) Reversal or resistance to a move is likely to be encountered (a) on reaching levels at which the commodity has fluctuated for a considerable length of time within a narrow range in the past, or (b) on approaching previous highs or lows.
(14) Watch for good buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently (see Rule No. 4).
*(15) Watch for “crawling along” or repeated bumping of minor or major trend lines and prepare to see such trend lines broken.
*(16) Breaking of minor trend lines counter to the major trend gives most other important position-taking signals. Positions can be taken or reversed on stops at such places. (This is possibly the most important of all the technical guides).
(17) Triangles of either slope may mean either accumulation or distribution, depending on other considerations, although triangles are usually broken on the flat side.
(18) Watch for volume climax, especially after a long move.
(19) Don’t count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps.
*(20) During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal. (This has proved to be a very valuable guide.)
According to Dixon, Donchian observed that the rules I’ve footnoted with a “*” (rules 3, 15, 16, 20) were most helpful.
Some explanations of Donchian’s definition and usage of “counter-trend”:
Counter-trend: A sequence of at least 4 days. Traders entry could be on a stop as the price crossed the extreme of the fourth day or on a stop at the extreme of the move. Stops would be placed just under the low of the bottom day or just above the high of the top day.
IF the counter-trend was steep, the price sequence would require more than 4 days.
Even if a steep four-day counter-trend emerged in the direction of an existing trend, it might prove a warning that the rate of price change might be slowing.
Longer counter-trend sequences could provide useful market signals. When longer counter-trends or consolidations are followed, they should be monitored IF the speed of the correction proves inferior to the prior leg of the major move.
Volume: Watch for low volume on “corrections” and for high volume and fast momentum on breakouts. These observations support the notion that the major trend continues.