Cumulative Delta Classification Strategy

Classification Example
The Trend is Your Friend

The Trend is Your Friend

What is the Cumulative Delta Classification Strategy?  It is about taking trades based on the trend.   

The trend is your friend.  How many times has a wizard of Wall Street said this?  Are you tired of hearing it?

You probably are tired of hearing it because it is used so much, but doesn’t mean a whole lot.  Why?  Well the first reason is your “friend” doesn’t talk to you and tell you his secrets.   I would sure like to know when my friend is going to start a strong trend.  But he forgets to send a text telling you when to buy and sell. 

Second your “friend” will lie to you to try and take you out of a position.  Just when he is telling you to buy, he is really distributing contacts because price is about to fall.

Then you have the wizards of Wall Street telling you to put 6 different MACD, RSI, CCI and stochastics indicators on a chart, and when they all agree, we have a trend.

Only problem is, by that time, its time to take profits, you are a weak hand and you are going to get stopped out.

So with that in mind, ZoneTraderPro set out to create a easy way to classify what the cumulative delta numbers are telling us.  Now we can make our “friend” tell us his secrets.

The Cumulative Delta Classification System

KP2 and KP3
KP2 and KP3

Cumulative Delta Classification

The ZoneTraderPro Cumulative Delta indicator gives us information no one else has.  The Cumulative Delta indicator filters for order size.  Other indicators are based on the size of the fill, and not the size of the order.  Those indicators are useless because you can not see what large lot traders are doing.  

In a recent update to the Cumulative Delta Divergence indicator, 2 numerical statistics were developed.  Those numbers are called the KP2 and KP3 numbers. 

The KP2 numbers tell us the filtered delta from a low to high, or a high to a low.  The KP3 numbers tell us the filtered delta from a high to high or a low to a low.

In the example below, we see that the pullback had a KP2 of -458 (high to the low) and the KP3 was 2130 (low to the low).

The Cumulative Delta Classification Strategy Theory

Looking at the KP3 is the main consideration.  By looking at KP3 we are looking at the cumulative delta.  Instead of looking at the curve of a line we are looking at a hard number.

The second consideration is the KP2 number.  The KP2 number, which is the profit taking pullback, can be evaluated as too high to support a trade decision also.

We are looking for a strong KP3 and a weak KP2.  In the picture on the right, the KP2 pullback was -1189 after very strong numbers on the strong bullish uptrend.  For an 11 tick pullback, that number was high.

Then we had a very successful short exhaustion trade.  Did the KP2 tell us something?

High Kp2
High Kp2
Green Classification
Bullish Green
Bearish Red
Black Classification
Distribution Black
Yellow Classification
Joker Yellow

Bullish Green and Bearish Red

In order to use this system we are going to need to classify the numbers we are seeing.  The two basic types are the bullish and bearish colors.  The software now automatically classifies the KP2 and KP3 numbers.  Basically you take into consideration both numbers, the KP2 and KP3.  The first consideration is the KP3 which is the cumulative delta and then the KP2 which is the current move.

Accumulation Distribution Black

We need to take special notice when the KP2 ratio is approaching or exceeding 95 on the ES contract.  This is not a hard and fast number.  It is different between contracts.  In a market with high liquidity, like the ZN, this number is 5 or 6 times higher.  For a lower liquidity contract like CL, it is maybe 1/2 of that.

This is a new and revolutionary number.  For the first time we are using limit orders, and not order flow, to determine the intent of large lot traders.  In the example above, the divergence software is indicating distribution based on market orders, and the KP2 ratio was telling us they were also distributing contracts at a high rate using limit orders.

The Joker

The system needed a neutral designation, so the joker was created.  We will color something yellow when there is any divergence.  When we have a divergence, by definition we are looking at something that is not clear. 

The chart on the right looks confusing initially if you have never seen or used it.  You have all 4 colors going. But when you understand the theory it is very easy to understand, so let’s decode it.

The KP2 buying delta (low to high) was high (1525) and gave us our green marker.  The KP3 (previous high to current high) is negative by 701 contracts, giving us the red marker and the yellow divergence. Now you understand the yellow color, who is right?  All of these numbers are based on market orders. Are the large number of buyers (KP2) or the sellers from the cumulative delta (KP3) correct?

But the black marker, the KP2 ratio, is based on limit orders and is telling you there is a bearish distribution.

BloodHound is on the chart and is telling us 4 times we had order flow to justify a long trade.  But had more than enough information to say something is wrong and pass on the long trade. 

Also, because of the large KP2 buying delta, we have trapped buyers and an excellent opportunity for a short trade.

The Joker

The Setup

Cumulative Delta Trades
Cumulative Delta Classfication Trades

The setup is pretty simple now that you can classify the cumulative delta numbers.  In the video I tested all of the ZoneTraderPro price patterns, except the counter trend trade.

Then I took any of the strongest 4 order flow signals.  Those signals are the POC Extension, POC Absorption,  Exhaustion, and ZTP Order Flow.  I took signals from both a 4 range and 5 range chart.

BloodHound

Bloodhound is a great tool to assist you in this strategy.  The strategy as presented here is not 100% complete.  It requires additional testing and more statistical analysis.  It requires the trader to develop a stop and a target, which can easily be developed through statistical analysis.

ZoneTraderPro offers discounts to SharkIndicators BloodHound and BlackBird.  Those discounts can be found on the lifetime license purchase page.

Executing the strategy also becomes a lot easier when you let BlackBird handle the entry after a BloodHound signal is received.  The BlackBird introduction video below illustrates two complete trades using BlackBird and this strategy.

Below is a picture of the very simple BloodHound logic used to test the Cumulative Delta Classification strategy.

BloodHound Logic for Cumulative Delta Classification System
BloodHound Logic for Cumulative Delta Classification System

What Can Go Wrong?

Strong Trend

The strong trend is one cause for losses.  In the picture on the right from the video, we see multiple BloodHound entry signals from the strong trend trade.  When price did not respond at the area circled in red, that became a setup for a broken reversal pattern, and this is detailed in the video.

Those trades lost for a reason.  Where we put in a high, we had a KP2 ratio of 120, indicating distribution.  Then the power of ZoneTraderPro Patterns takes over.  A low was put and a trend trade was generated.  But this trade had only a limited reward possibility.  The more profitable pattern was the broken reversal short pattern at the far right of the picture.

Strong Trend Loss
Strong Trend Loss
Loss2

Loss Prevention?

The problem with looking at a static chart for an exercise like this is that you do not know what the live KP2 number was.  You only know the number at the zigzag point.

So when you use market replay, the number as it gets close to the minor zone is a -729.

Look at the live number at the minor support level.  The number was already -1552 for the KP2 number.

This is why it is important to do homework that you can not see naturally on the static chart.

The number will eventually grow to -4143 before the trade works.

Live KP2
What a win looks like
What a win looks like

KP2 For a Win

Here we have a successful strong trend trade.  The KP2 number here was just -239 on the pullback.  There is a notable difference however between this trade and the example from above.  Price did not trade all the way back to the minor zone and KP2 was not indicating hard selling.  But again, this is a higher risk trade.  What is the lower risk?

The exhaustion short trade that followed.  When the market was in a strong trend, the KP2 ratio was 153 giving us a black marker.  After the successful strong trend, price traded higher into the exhaustion pattern where we again had a 102 KP2 Ratio indicating distribution.  Then we had order flow to get a great short trade with many trapped buyers.

We always want to be aware when we have back to back black markers, especially involving exhaustion patterns.

What can go Wrong? Part 2

Exhaustion Losses
Trend Trade Losses after an Exhaaustion Pattern

Trend Trades After Exhaustion

Previously I have advised traders to be careful when taking a trend trade following an exhaustion pattern.  This was called a high risk trend trade.  A large number of these trend trades failed.  Back then it was not possible to explain why.  Here we have two identical trades.  We had a successful exhaustion pattern, with order flow and there were back to back ratio density numbers that indicated accumulation.

This is definitely an area that needs to be explored using this new information.  With BloodHound it becomes very easy to find examples on a large data set to determine if a trend trade should be considered after an exhaustion, or only when exhaustion was not under accumulation.

Another example of back to back black markers involving exhaustion patterns.

KP2 Numbers

Running a market replay on the KP2 numbers did not help much.  They were not extraordinarily large to the upside.  So this explains why the classification works at identifying limit order accumulation.

The point of the entire ZoneTraderPro suite is not to be able able to take every top and bottom. It is to use the price patterns, order flow patterns, divergence patterns and classification system to identify only the best trading opportunities, and pass on the marginal ones.

In each of these patterns, the best pattern and most profitable patterns (17 points) was the long exhaustion trade based on what the classification system told us.

ExhaustionLoss1
Trend Trade Loss 1st Trade
Exhaustion Loss 2nd Trade
Trend Trade Loss 2nd Trade

In Conclusion

When all of the tools that ZoneTraderPro provides are working together with this strategy, we can see some absolutely amazing results.  When ZoneTraderPro was created in 2006 it was only the price patterns and I was always looking for my Holy Grail.  That Holy Grail was to understand why a trade patterns fails.  With the introduction of the trend classification I now have my Holy Grail.  Using the actual traded contracts and the cumulative delta now explains why trades succeed and fail.

The system itself is very easy to use and understand.  And the key is that it is not subjective.  If something isn’t clearly marked and clearly justified, then you are accepting additional unnecessary risk by taking the trade. 

Why take this risk?  Wait 20 minutes until all of the pieces fall into place.

Creating a Cumulative Delta Based Classification and Trading System

In this video we introduce a new concept of classification of the cumulative delta numbers. By using this system, combined with order flow and price patterns, we create a potentially very profitable trading system that is only taking trades based on the trend.

Creating a Cumulative Delta Based Classification and Trading System - Part 2

In this video we look at what it takes to get some data about a profit target.

Cumulative Delta Classification and Trade Review

In this video we look at the 8 successful trades from 9/4/19 and review the classification system

New Software Preview - Automatic Cumulative Delta Classification System

In this video we take a preview look at the new ZoneTraderPro Cumulative Delta Classification

BlackBird Introduction and Trade Review for 10/07/19

In this video we get our first look at SharkIndicators BlackBird strategy software and review the trades for Monday 10/7/19.

Classification Software Release

ZoneTraderPro is pleased to announce the release of the trend classification system for the ZoneTraderPro Order Flow Suite.

Classification Software Review

In this video we review the basics of the classification trading system and what to look for.

The content on this page is not a complete trading strategy and it is not trading advice. It is solely for information purposes and reflects the opinion of the author.

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