In this article we’re going over the methodology, rituals, and trading toolbox of Market Wizard Linda Raschke. While studying the toolboxes of legends like Raschke, it’s prudent to remember that Linda probably doesn’t attribute her success to her hundreds of hours of research on the markets, superior pattern recognition skills, or any tool/indicator.
It’s her attitude, interest and work ethic that allowed her to develop the necessary skills, spend hours researching, and validate systems. Linda’s passion and work ethic towards ethic is so strong that she traded through the last day of her pregnancy.
Linda’s been involved in the markets since she was a kid. Her father was a trader–an unsuccessful one at that, who enlisted her to help him leaf through stock charts to find patterns. In her early 20s, she spent her breaks from work hanging out at the Pacific Stock Exchange, networking with traders and watching the markets. One of the traders she met agreed to stake her, which started her career in trading.
From there a launched a multi-decade trading career. On of her hedge funds was ranked 17th out of 4500 funds for the best five year performance by BarclaysHedge. She retired from managing money in 2015, but still trades daily for her own account.
Top Down Approach
Linda Raschke approaches the markets with a top down approach, meaning she looks at market internals and higher time frames to establish her view on shorter term price action. She stresses how important taking a top down view is because it provides market context.
Linda maintains that she doesn’t know of any traders that make a living just from trading the five minute chart, because as you move down to shorter time frames, the noise level increases.
“If I just came in and was doing nothing but look at a 5 minute S&P chart, I might recognize that the previous day was a huge range day, and that today was going to be more of a rotation day. You’re going to trade a rotation-consolidation much differently than you’d trade a range expansion day… it puts it into context, I’m not going to be able to judge if it’s going to be a high to low day or low to high day with just a five minute chart. I really need to look at something like a 120 minute, or a daily candle.”
To develop her top down approach, Linda looks at higher time frames like daily and weekly charts, but also market breadth and internals. Here’s a few of those tools:
- NYSE TICK
- NYSE Advancing – Declining Issues
- NYSE 30–minute volume
- RVX (Russell 2000 Volatility Index, the Russell equivalent to the VIX)
Linda’s Post Market Rituals
Linda Raschke likes to prepare for the next day’s open the day before, right after that day’s close. It allows her to enter the next trading day with a clear mind and trade ‘be present.’ She doesn’t like to be over analytical while she’s trading, she likes to react to the information as it comes. She finds if she does the prep work the morning of, she’ll be in that analytical mindset which she doesn’t find helpful for trading.
Instead of marking up charts inside of a digital platform like eSignal, Linda prefers to do things the old school way, by hand, the way she’s been doing it for decades. There’s something to be said about the physical act of writing things down that does change the way your brain stores information. Adam Grimes, who is a student of Raschke’s work, is also a huge proponent of this.
Here is Linda’s ritual. All of this work only takes her about 30 to 40 minutes a day.
- Write down the day’s closing prices, the previous day’s highs and lows, and market internals levels.
- Forecast tomorrow’s price movement. Will it be a trend or consolidation day? If it’s a trend day, will the market move high to low, or low to high?
- Guess the next day’s high/low. She isn’t trying to pick tops and bottoms by doing this, but it helps her approach the market with a directional bias the next day.
- “I find it’s like taking a test with a #2 pencil, your first guess is usually your best guess”
- Print the best four charts of the markets she trades
Trend or Consolidation Day?: The Most Important Heuristic
There’s generally two types of price action traders: mean reverters, those who try to fade big moves, and trend followers, who get on board after big moves. Linda Raschke has never understood the distinction of being only one type, as she chooses the style to trade each day based off of that day’s price action.
She breaks down each market day with one simple heuristic: is this a trend day or a consolidation day? In other words, on trend days she trades more like a trend follower, and on consolidation days she trades more like a mean reversion trader.
Once Linda has determined whether a given day is a trend or consolidation day, she determines if it’s a buy, sell, or sell short day. This methodology was heavily inspired by George Douglas Taylor, a swing trader from the 1940s who viewed the market in 2-3 day swings. Linda has mentioned in interviews that Taylor’s book The Taylor Trading Technique is her favorite trading book.
Linda Raschke’s Trading Toolbox
5 Day Simple Moving Average
The 5 day SMA is vital to Linda’s trend identification system. She’s done extensive testing and research using this indicator and has built models based on it. Linda used the 5 day SMA to determine that large outlier prices moves happen in the direction of the trend in each market about 9-10 times per year.
Once a market has closed on one side of it’s 5 day SMA for seven days in a row, she considers this an extended run. In an extended run environment, her models have shown that the trend has about a 50% chance of persisting. The powerful part about that number is that when the trend does persist, it can go on a long run, making this a trade with a high expected value.
Losing trades are much smaller than winning trades in this system, because she treats the 5 day simple moving average as her support line, so the trade gets closed at the first close below the 5 day SMA.
2 Day Rate of Change
Linda Raschke uses the 2 day rate of change, a short-term momentum indicator, to develop a directional bias for the trading day. Linda and Larry Connors used the 2 day rate of change to approximate the 2-3 swings used by George Douglas Taylor.
One of Rachke’s core trading philosophies is that momentum precedes price. So we’ll see the increased aggression from the bulls or bears before we see the price move that will result from said aggression/momentum. Linda puts this principle into practice with the two day rate of change.
When she has a directional bias and sees a new high in momentum, the momentum confirms her directional bias, creating an excellent entry point.
In her view, the market is simple to read about 60% of the time, it’s moving directionally and the ROC is making dramatic peaks and troughs, making it very easy for us to get our directional bias for the day. The other 40%, the ROC is pretty much useless.
Putting Them All Together
These indicators become powerful when used in conjunction with the rest of her toolbox: the 5 day simple moving average, the 2 day rate of change, and her famous 3/10 oscillator. The simple moving average is used to identify persisting market trends (seven closes on one side indicates an extended run), the rate of change is used to spot short-term momentum and provide a directional bias, and the 3/10 oscillator as a convergence/divergence indicator.
One of the best trading days of Raschke’s career was when all of her indicators were in unison:
Linda Raschke has traded through all types of market environments: bull markets, bear markets, sideways markets, high volatility, low volatility, electronic, trading pits, etc. She’s been forced to adapt several times, but has retained the same basic market philosophy in the face of dramatically changing market microstructure.
A central principle to take from Linda’s career is the idea that the underlying principles in human behavior is what moves markets, and human behavior doesn’t change.
I’ll leave you with some of Raschke’s advice on learning the markets:
“Understand that learning the market can take years. Immerse yourself in the world of trading and give up everything else. Get as close to other successful traders as you can. Consider working for one for free.”