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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J.

Pring

KST And Relative Strength


by Martin J. Pring

In previous articles, technician and author Martin Pring has analyzed the KST indicator, an oscillator
designed to identify market turns based on time cycles. This month, he explains how to use the KST in
gauging the relative strength of stocks.

n the September STOCKS & COMMODITIES, I introduced the KST, a momentum indicator constructed m a

weighted summed rate of change. To recap, four different smoothed rates of change (R OC) are combined
into one oscillator. This captures the under lying price movements of several different market cycles as
reflected by the various ROC time spans. Trend reversals are signaled when the K ST crosses above or
below its moving average.
KST indicators can be constructed to monitor any type of market trend. By giving different weights to the
different ROC components that make up the KST indicator, we can construct oscillators with different
outlook lengths. One particularly practical use of the Kst indicator is to stack three printouts of the
oscillator, reflecting the short-, intermediate- and long-term trend, on top of each other (Figure 1). The
long-term KST monitors the primary trend of the market (that is, price movements lasting for one, two or
three years); its position gives us some perspective on the trend maturity. The intermediate- and
short-term indicators are used more for timing purposes. For example, if a short-term buy is triggered
when the long-term indicator rises just above the zero level, a bull market rally is indicated. On the other
hand, a short-term buy signal that occurs when the long-term indicator is declining tells us that a bear
market rally is underway. The difference is important, since the former is usually profitable and the latter
deceptive, unreliable and unprofitable.
This arrangement of three KST oscillators into what I call the market cycle model not only helps the trader
or investor position himself in the direction of the main trend but also gives some indication as to its
maturity. For example, when a long-term K ST is overextended on the upside and an intermediate sell

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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J. Pring

FIGURE 1: The KST indicator is a summed weighted measure of rate of change Varying the weights
and the rates of change can produce indicators that measure rate of change for short-term,
intermediate-term and long-term time horizon.

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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J. Pring

signal is generated, the odds are fairly high that the implied intermediate correction will turn out to be the
beginning of a major reversal formation or, more likely, the first downleg of a new bear market.
RELATIVE PRICING
Thus far, we have considered the KST indicator in terms of absolute price, but the analysis can be
extended to relative pricing as well. Relative strength (RS) measures the relationship between two price
series and should in no way be confused with the relative strength index (RSI), which compares the
current price of a security to the past. Normally, an R S line compares a specific item such as a stock to a
base to some market measure such as a stock index. The line is calculated by dividing the stock price by
the market index value and the result is plotted as a continuous line. When the line is rising, the stock is
outperforming the market; when it is in a decline, the market is outperforming the stock. A rising RS line
does not tell us that the absolute or actual price of the stock is appreciating but only that it is
outperforming the market. For example, the market may decline 20%, but the stock may lose only 10% of
its value. Both are losers, but the stock's losses are less than those of the market.
Relative strength can also be used to compare two different price series. The gold/silver ratio, for
example, is a relative strength relationship; so too is the "Ted spread," where Treasury bill prices are
compared with Eurodollars. Even currencies are an expression of relative strengththe dollar versus the
yen, the yen versus the pound and so forth. Here we will confine ourselves to the concept of item versus
basket.
Since relative strength moves in trends like absolute prices do it follows that the KST market cycle model
approach can be extended to this area as well. In my analysis I take a top-down approach. This involves
an examination of the long-term position of the market as a whole, followed by industry groups and
finally the individual stocks included in the group. In this article. we will consider the second stage:
isolating potentially attractive stock groups.

The best buying opportunities occur when the long-term KST of


relative strength is below zero and has started to cross above its
moving average, while at the same time the short and intermediate
series are consistent with a trend that is not overextended.
STOCK GROUP SELECTION
In many ways, the KST approach is more suited for analyzing trends in relative rather than absolute
prices. As the business cycle unfolds, group rotation occurs, leaving the relative pricing system far more
subject to cyclic rhythms than an actual index and stock price. Figure 2 shows the market cycle model for
the relative strength of the Dow Jones financial sector. The series in the top panel is the R S itself, while
the other three are the KST indicators. When the line is rising, the Dow Jones financial sector is
outperforming the market, and vice versa.
The best buying opportunities occur when the long-term KST of relative strength is below zero and has
started to cross above its moving average, while at the same time the short and intermediate series are
consistent with a trend that is not overextended. It is also important to make sure that the Rs itself has

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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J. Pring

FIGURE 2: Rates of change analysis can also be applied to a relative strength chart. The most reliable
buying opportunities are when the long-term KST indicator is below zero and is turning up (up arrows).
Negative indications occur when the long term KST is above zero and tuming down (down arrows).

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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J. Pring

FIGURE 3: When a bull market in stocks begins to mature, the energy stocks tend to take over the
leadership role. The long-term KST should begin to turn up, indicating better relative performance by
the energy group.

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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J. Pring

FIGURE 4: Plotting the long-term KSTs for both the financial relative strength line and the energy
relative strength line displays the rotation of these two stock groups. Strength in one group coincides
with weakness in the other stock group.

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Stocks & Commodities V. 10:11 (476-480): Kst And Relative Strength by Martin J. Pring

generated some kind of buy signal, such as an exponential moving average (EMA) crossover or a trendline
break. In a similar vein, the probabilities do not favor situations in which the long-term KST is in an
overextended reading far above zero. Such readings indicate that the trend of the superior Rs is well
advanced. The trend could well continue for some time, but the law of averages is against it. Far better
would be to search for a group in which the long-term KST is depressed and turning up.
The best approach is to isolate those groups for which the market cycle model is in a positive mode, not
only for the relative price but for the absolute price as well. The last up arrow in Figure 2 indicates a
period when both aspects of the model were positive. Each instance is followed by superior results.
In any given situation, rotation occurs continually between the various industry groups in terms of
relative strength. This can best be appreciated by comparing two groups that traditionally perform at
different stages in the cycle. At the beginning of a bull market, interest-sensitive issues such as financials
typically outperform the market. As the cycle matures, this leadership gives way to inflation-sensitive
issues such as the energy sector (Figure 3). This rotation can be seen in Figure 4, which compares the
long-term KST of relative strength for both series. Note that there is a tendency for them to move in
opposite directions. For example, the KST for the financial series peaked in mid-1986 while the long-term
KST energy relative strength was turning up. The reverse held true in late 1990. Since then, the financial
issues have outperformed the rest of the market and energy has lagged. In late August, the energy Rs
looks as though it is trying to bottom but has not yet succeeded in crossing above its exponential moving
average.
MARKET CYCLE MODEL
Relative KST analysis can not only be used for timing the purchase and sale of securities that make up
industry groups, but also for ascertaining the prevailing stage of the market cycle. When the long-term
KST for the relative strength of financials is bottoming, a new cycle is probably beginning, and when
energy is reversing to the upside, it warns that the cycle is rapidly maturing.
So far in this series of articles we have barely tapped the surface of KST analysis. The concept is far from
perfect, but it does provide the analyst with a good long-term perspective of a specific market from which
more informed short-term decisions can be made. Anyone searching for the Holy Grail is likely to be
disappointed. Hamilton Boulton, founder of the "Bank Credit Analyst," put it this way: "The goal of
imperfection in the investment world is likely to lead to greater profits than the pursuit of perfection."
Martin Pring is the author of a number of books, publishes "The Pring Market Review" and is a
principal of the investment counseling firm Pring-Turner Capital Group.

FURTHER READING
"Pring Market Review," International Institute for Economic Research, Inc., PO Box 329, Washington
Depot, CT 06794. Pring, Martin J. [1991] . Technical Analysis Explained , McGrawHill.
___ [1992]. "Identifying trends with the KST indicator," S TOCKS & COMMODITIES, October.
___ [1992]. "Summed rate of change," STOCKS & COMMODITIES, September.
___ [1992]. "Rate of change," STOCKS & COMMODITIES, August.
___ [1992]. "The KST," audiotape and booklet, International Institute for Economic Research, Inc.

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Stocks & Commodities V10.11 (479): Sidebar: Calculating the KST

CALCULATING THE KST


SUGGESTED KST FORMULAS
The suggested parameters for short,
ROC MA Wt ROC MA Wt ROC MA Wt ROC MA Wt
intermediate and long term can be
Short-term (D)
10
10
1 15 10 2 20
10 3
30
15 4
found in sidebar Figure 1. There
Short-term
(W)
3
3E
1
4
4E
2
6
6E
3
10
8E
4
are three steps to calculating the
Intermediate-term
(W)
10
10
1
13
13
2
15
15
3
20
20
4
KST indicator. First, calculate the
four different rates of change. ReIntermediate-term (W) 10 10E
1 13 13E 2 15 15E 3
20 20E 4
calling the formula for rate of
Long-term (M)
9
6
1 12
6 2 18
6 3
24
9 4
change (ROC) is todays closing
Long-term (W)
39 26E
1 52 26E 2 78 26E 3 104 39E 4
price divided by the closing price n
It is possible to program all KST formulas into MetaStock and the CompuTrac SNAP module.
days ago. This result is then multi(D) Based on daily data. (W) Based on weekly data. (M) Based on monthly data. (E) EMA.
plied by 100. Then subtract 100 to
obtain a rate of change index that SIDEBAR FIGURE 1: The ROC column is the rate of change. The MA column is the moving average value,
uses zero as the center point. Sec- and E after the moving average value indicates that the moving average is an exponential moving average.
ond, smooth each ROC with either a Multiply each smoothed ROC by its weight prior to summing the four smoothed ROCs.
simple or exponential moving avCell F20 is a four-week EMA:
erage (EMA). Third, multiply each smoothed ROC by its
=F19+0.4*(E20-F19)
prospective weight and sum the weighted smoothed ROCs.
The formula for an exponential moving average (EMA)
Cell G20 is a six-week ROC:
requires the use of a smoothing constant () alpha. The
=((B20/B15)*100)-100
constant used to smooth the data is found using the formula
2/(n+1). For example, for n=3, then = 2/(3+1)=0.50. The
Cell H20 is a six-week EMA:
formula for the EMA is:
=H19+0.29*(G20-H19)
E2 = E1 + (P2 - E1)

Cell I20 is a 10-week ROC:


=((B20/B11)*100)-100

where:
E2 = New exponential average
E1 = Prior exponential average
P2 = Current price

Cell J20 is an eight-week EMA:


=J19+0.22*(I20-J19)

Please note the first days calculation does not have a prior
exponential average. Consequently, you just use the first
days price and begin the smoothing process the next day.
Figure 2 is a spreadsheet example of the short-term weekly
KST using exponential moving averages for the smoothing.
Column C is the three-week rate of change. The formula for
cell C20 is:

Finally, cell K20 is the summed weighted smoothed ROCs.


Each smoothed ROC is weighted according to sidebar
Figure 1 and summed:
=D20+(2*F20)+(3*H20)+(4*J20)

The three-week rate of change is smoothed with a


three-week EMA. The constant used to smooth the
data is found using the formula 2/(n+1). For n=3,
then, the constant equals 2/(3+1)=0.50, and thus, the
formula for cell D20 is:
=D19+0.5*(C20-D19)
Cell E20 is a four-week ROC:
=((B20/B17)*100)-100

1
2
3
4
5
6
7
8
9
1 0
1 1
1 2
1 3
1 4
1 5
1 6
1 7
1 8
1 9
2 0

A
B
C
D
E
F
G
H
I
J
K
Date S&P 500 3 week 3 Week 4 Week 4 week 6 Week 6 week 10 Week 8 week Summed
920103
419.34 ROC EMA ROC EMA ROC EMA ROC
EMA Weighted
920110
415.10
ROC
920117
418.86 -0.11
920124
415.48 0.09
-0.92
920131 408.78 -2.41 -2.41 -1.52
920207 411.09 -1.06 -1.73 -1.86
-1.97
920214 412.48
0.91 -0.41 -0.72 -0.72 -0.63
920221 411.46
0.09 -0.16
0.66 -0.17 -1.77
920228 412.70
0.05 -0.05
0.39
0.05 -0.67
920306 404.44 -1.71 -0.88 -1.95 -0.75 -1.06
-3.55
920313 405.84 -1.66 -1.27 -1.37 -0.99 -1.28 -1.28
-2.23
920320 411.30
1.70
0.21 -0.34 -0.73 -0.29 -0.99
-1.80
920327 403.50 -0.58 -0.18 -0.23 -0.53 -1.93 -1.26
-2.88
920403 401.55 -2.37 -1.28 -1.06 -0.74 -2.70 -1.68
-1.77
920410 404.29
0.20 -0.54 -1.70 -1.13 -0.04 -1.20
-1.65
920416 416.05
3.61
1.54
3.11
0.57
2.52 -0.13
0.87
0.87
920424
409.02 1.17
1.35
1.86
1.08 -0.55 -0.25
-0.59
0.54
920501
412.53 -0.85
0.25
2.04
1.47
2.24
0.47
-0.04
0.42
6.26
920508
416.05 1.72
0.99
0.00
0.88
3.61
1.38
2.87
0.96
10.71

SIDEBAR FIGURE 2: SPREADSHEET FOR SHORT-TERM WEEKLY KST. The


first cell value for each EMA column is the cell value directly to the left.

Copyright (c) Technical Analysis Inc.

Courtesy Microsoft Excel

Editor

=((B20/B18)*100)-100