Cumulative Delta Classification Strategy

The Trend is Your Friend
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
Bullish Green
Bullish Green
Bearish Red
Bearish Red
Distribution Black
Distribution Black
Joker Yellow
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.  This is going to take practice and homework.  Basically you need to 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 100 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.

The point is that you need to look at these numbers for the contract you are trading.  Take note of what numbers end up being a reversals and make a decision about what is a good representative number.

The Joker

The system needed a neutral designation, so the joker was created.  There are two basic instances where we will color something yellow.

The first is any divergence.  When we have a divergence, by definition we are looking at something that is not clear.  Look at the numbers on the accumulation.  Those numbers are DEEP red, but the divergence indicator is correct and buyers were accumulating contracts on limit orders.  No other system displays this information.

Accumulation Yellow
Low KP3 Numbers
Low KP3 Numbers

The other instance is when the KP2 and KP3 numbers really are weak and not telling us anything.

Here is the key.  Don’t be afraid to give something a yellow tag.  In the video for this strategy (which I created first), I was somewhat hesitant to use yellows.  In hindsight, we saw numerous trades that didn’t get to the target.  When this happens, go back and look at what the numbers going into the trade were telling you.

Look at the example on the left.  These are two trades highlighted in the video.  The numbers were classified red, but the KP3 numbers were low, just -115 and -146.

The goal of the system was to generate trades that gave us at least 3.75 points, so that after trade confirmation using order flow, we could see a profit of 2.5 points.  These trades went 3.25 and 2.75 respectively.

 

The Right Side of the Trade

You didn’t lose, so that is important.  If you held one or both of the trades, the profit targets were hit on the next leg down.  But this is very important.  These were not the best trades and the answer is in the KP3 number.

Now after studying the issue on your own, you may find that you are missing profitable trades that do hit the target even with not a very strong number.  But you need to do the homework and study the strategy.

One last thought here.  Be sure to look at the previous KP3 numbers.  If you had a KP3 number of -2000 in the recent history, and those contracts haven’t been covered, then that is an argument for the trade, even if the current KP3 is weak.

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.

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.

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 the two trades.  Price did not trade all the way back to the minor zone.

This is why I went back and retested the first example to see what the number was at approximately the same point in that trade and it was a -729.

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. 

KP2 Numbers

Running a market replay on the KP2 numbers did not help much.  They were not extraordinarily large to the upside.

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

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.

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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