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Discovered in 1989 by a semi-legendary bond trader named Nick Stott, it is purportedly a secret day trading formula that will help your day trading reach new heights with minimal risk. Or so goes the story.

Origins of the Camarilla equation

The ‘Camarilla’ equation was discovered in 1989 during day trading by Nick Stott, a successful bond trader in the financial markets.

The equation creates 8 levels that are designed to predict these turning points so that the trader can benefit from them. The equation uses nothing more than the opening, closing, high and low levels of the previous trading day and some interesting math to create those supports and resistances.

Trading the signals

Now these levels are numbered L1-4 for the supports and H1-4 for the resistors, but it is really the L3, L4, H3 and H4 that are most important.

When the price level hits the H3 level, the theory behind the Camarilla equation is that there is strong resistance at that point and that a SHORT trade should be made with a stop loss at the H4 level.

Conversely, there is strong support when the price falls to the L3 level and a LONG trade with a stop loss at the L4 level is the recommendation.

Breakout opportunities

While levels H4 and L4 should normally be reserved for setting stop losses on the above trades, there will occasionally be a point where these points will be broken. If this breakout is sustained over a longer period of time and the price is still moving, a LONG or SHORT trade should be entered.

These trades are not that common, but could produce massive profits (this is what the Camarilla equation suggests).

Select entry point with Camarilla equation

There are two entry points to consider when using the Camarilla equation. First, you could trade once the market hits either the L3 or H3 levels and go AGAINST the current trend, but there is a greater risk that the trend will continue and you will lose if this is your preferred method.

The alternative is to wait after the market breaks the L3 or H3 levels until the opposite actually happens, and enter the trade as soon as the market crosses the appropriate level again. That way, you can trade WITH the trend, which should prove to be a safer option.

So does it work?

If you are interested in whether or not the Camarilla equation offers a viable trading method, you can follow my experiment which tests the given levels for the FTSE 100, Dow Jones and DAX 30 stock markets.

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Source by Stephen Waller