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Stocks & Commodities V. 10:10 (407-413): First Citizen Of Technical Analysis: Arthur Merrill by Thom Hartle

First Citizen Of Technical Analysis: Arthur

Merrill

"The earliest indicators that I really analyzed were chart formations in 1930. I tried point and figure for
a while, but i found that line charts gave me more information, and they could be put on a logarithmic
chart, which is better for price changes."—Arthur A. Merrill
By our reckoning, someone with, say, 10 years' worth of experience in the markets and trading has seen
a great deal—until we remember that Arthur A. Merrill, currently of Merrill Analysis and Analysis Press
and previously of Technical Trends, drew his first bar chart in 1930. His first, earliest calculations were
made on slide rule, long before the pocket calculator or indeed the personal computer became a matter
of course. Who else has had a chance to watch the markets evolve quite the way that Art Merrill has?
Who else has experience quite like his to learn from? STOCKS & COMMODITIES Editor Thom Hartle
interviewed Art Merrill on July 27,1992, in a combination of telephone and correspondence, inquiring
about, among other topics, today's markets compared with yesterday's and whether statistical analysis
has ever steered him wrong.
So, Art, tell us about your early work with the stock market and technical analysis.
Well, I was first inspired by R.W. Schabacker's Stock Market Theory and Practice. It had many of the
stock formations that were described in more detail 18 years later by Edwards and Magee.
I drew my first bar charts in 1930. The next year, Humphrey Neill's book Tape Reading and Market
Tactics added fuel to the technical fire.
Did you keep everything by hand yourself?
Yes. All my data and calculations were made by hand, and I kept up my charts by hand.
I made the earliest calculations by slide rule. From the slide rule, I progressed through the manual
calculator, then the electric calculator, then the pocket calculator—I think I bought the first commercial
model; it was the size of a carton of cigarettes and cost $300—then the programmable calculator with
printer, then the computer, first with audiocassette storage, then diskette, and finally hard drive. It was
quite a progression!
While I have never used it, I have an abacus now hanging behind my computer labeled "backup."

Article Text Copyright (c) Technical Analysis Inc. 1

Stocks & Commodities V. 10:10 (407-413): First Citizen Of Technical Analysis: Arthur Merrill by Thom Hartle

Did you develop a feel for what was happening in the markets?
It was more a visual impression than a feel. A line chart can tell you at a glance about the support and
resistance levels and the trend direction.
Is that lost today with the reliance on computers?
Not necessarily. The computer is a helpful tool, but I don't make any decisions until I see the output in
chart form.

For me overall market, though, I depend on the indicators mat

test out with good batting averages. Some of these are the
advance-decline divergence oscillator, odd-lot shorts, public
shorts, ratio of public to specialist shorts and large block
transactions.
So despite modern technology, you still rely on old-fashioned "impression"?
Again, not necessarily. The computer is a helpful beast, but I don't let him give me a definite buy or sell
mandate. Instead, I like to take his output in chart form and add some judgment before making a decision.
What were some of the first indicators that you studied?
The earliest indicators that I really analyzed were chart formations from Schabacker's Stock Market
Theory in 1930. The indicator was the stock's own price and volume expressed on a line chart. I tried
point and figure for a while, but I found that line charts gave me more information, and they could be put
on a logarithmic scale, which is better for price changes.
I now use log charts (see sidebar), using the point and figure idea to filter out minor moves, using a
percentage filter. I described these in my article in your October 1991 issue.
How was using line charts preferable to point and figure?
Point and figure charting doesn't express volume, and the arithmetic scale bothered me. A log chart
provides better trends.
Do you have any favorite indicators that have been with you since the very beginning?
In individual stocks, I rely on the price log point and figure charts.
For the overall market, though, I depend on the indicators that test out with good batting averages. Some
of these are the advance-decline divergence oscillator, odd-lot shorts, public shorts, ratio of public to
specialist shorts and large block transactions.
When did you first want to test indicators?
I really began to get serious about it in 1981, with the calculation of weights for the various indicators
based on their performance.
Why?

Article Text Copyright (c) Technical Analysis Inc. 2

Stocks & Commodities V. 10:10 (407-413): First Citizen Of Technical Analysis: Arthur Merrill by Thom Hartle

At any given time, some indicators are bullish and some bearish. At the same time, some market
technicians are bullish and some bearish. They are all looking at the same indicators, but they weight
them differently, so coming up with different answers. I sometimes wonder if the bullish technicians tend
to give weight to indicators that agree with their own bullish inclination; and whether bearish technicians
believe the bearish indicators, since they agree with their bearishness.
Viewpoint is important, certainly.
That's why I got interested in checking relative accuracy from the performance record. The computer
certainly helped out. I asked it to check an indicator's opinion every week for 10 years and then to check
whether the market went in that direction the next week, in the next four weeks, 13 weeks, 26 weeks and
a year after the forecast. I could then give the indicator a batting average for the various time periods.
This method was described in more detail in your May 1991 issue.
You base your analysis mostly on statistics; can statistical analysis ever steer you wrong?
Yes. The statisticians recognize two types of errors:
In error type one, the record shows that success isn't demonstrated significantly, but when you perform a
longer test, the new test demonstrates significant success.
In error type two, the record reports significant success, when the longer-term testing shows no
significance. An example of the type two error is the Super Bowl indicator [in which the outcome of the
game predicts the outcome of the stock market]. I sometimes wonder if the astrology test reports aren't
also type two.
So statistics aren't perfect. But they are certainly helpful.
Can you compare today's market to other periods in the market?
I'm very suspicious about these anecdotal comparisons. Conditions are always different in some respects;
the differences may not be obvious, but they may be important. So straight comparisons are impossible.
I don't know who said it, but I like the quote "Conditions are more like they are right now than they have
ever been."
Then what warned you of previous changes in the trend of other markets?
I always got suspicious about what was happening in the markets when I saw crowds around the old
Merrill Lynch kiosk in Grand Central Station or when my barber asked me for tips.
One measure I've found very useful through the years is the price/dividends ratio, the ratio of the DJIA to
its dividends. It's the inverse of the yield on the DJIA. When it gets above 28, I rate it expensive and risky.
This ratio corrects for inflation, since both the numerator and denominator are in dollars, and so the value
of the dollar cancels out. It was described in the October 1988 S&C.
How's it doing?
I'm concerned about this indicator right now because it's been as high as 35, a dangerous level. It has been
this high just once in the last 60 years, in 1987. It wasn't even this high in 1929.
You don't like to compare conditions, but you do study the history of other markets. Can you compare
today's market with other bull markets that way?

Article Text Copyright (c) Technical Analysis Inc. 3

Stocks & Commodities V. 10:10 (407-413): First Citizen Of Technical Analysis: Arthur Merrill by Thom Hartle

I'm concerned about the age and amplitude of our current bull market. It started in October 1987 with the
DJIA at 1712, and it hit its high so far in May this year with the DJIA at 3417.
That's quite a rise.
That's a rise of 99%. The DJIA has almost doubled since the low in 1987. I looked back at the 18 bull
markets we've had since 1898 and found only seven that rose a higher percentage. Eleven of the 18 didn't
reach our current 99% . Our current bull has risen more than the average bull; the chances for a continued
rise are still there, but the probability is diminishing.
So what do you see?
When you look at the duration of the market, the view isn't good. Our May peak was 55 months after the
1987 low; that's more than four years. When you look at the 18 bull markets since 1898, only three were
longer; 15 didn't last 55 months. So the probabilities, based on duration, don't favor continuation.
I'm 86 years old and not as spry as I was at 40. I think the market is also beginning to feel its age.
You have written 53 articles for S TOCKS & COMMODITIES. Do you have any favorites?
That number is no longer any good. My article in your August issue makes it 54!
I'm especially enthusiastic about these articles:
"Advance-decline divergence as an oscillator" (September 1988)
"Price/dividends ratio" (October 1988)
"5% swings" (December 1988)
"Price resistance" (March 1990)
"Last four hour indicator" (April 1991)
"Testing method" (May 1991)
"Filtered waves" (June 1991)
"Log point and figure" (October 1991)
"MW waves" (November 1991)
"Election cycle" (March 1992)
"Stock selection" (June 1992)
You've seen S&C evolve in the past 10 years. What are some changes you have seen in this magazine
over the years?
I can't be specific, but the magazine seems to improve and improve.
One test I have for magazine helpfulness is the number of articles that I clip out for future study and file.
STOCKS & COMMODITIES passes this test enthusiastically.
Is there anything specific that we should emphasize? What would you like to see in our magazine?
Just keep on the same track.

Article Text Copyright (c) Technical Analysis Inc. 4

Stocks & Commodities V. 10:10 (407-413): First Citizen Of Technical Analysis: Arthur Merrill by Thom Hartle

What should a person who is just starting to invest do?

1. Subscribe to Technical Analysis of STOCKS & COMMODITIES magazine.
2. Read the background books, starting with Edwards and Magee.
3. Start watching the overall market and individual stocks, drawing handmade line charts, preferably on a
log scale, to get a feel for what the market's doing.
How should they follow the broad market?
Well, the D JIA is a very poorly designed index, but it does a fair job of representation. It's readily
available, and you can watch it hourly.
The advance-decline line can also give you a picture of the overall market.
What about building and managing portfolios?
Use opinion of market trend and expensiveness to set the percentage of the portfolio to be put in equities
and the percentage in bonds. In the equity section, pick stocks that are increasing their earnings quarter by
quarter, with prices that are zigzagging upward.
Finally, do you have any favorite books?
Yes, two by Art Merrill: Behavior of Prices on Wall Street and Filtered Waves .
Please forgive my modesty! My friends have written many fine books, but I hesitate to mention any, since
I might skip a good one and lose a friend.
Thank you for your time, Art.

FURTHER READING
Edwards, Robert D., and John Magee [1966]. Technical Analysis of Stock Trends , John Magee Inc.
Merrill,Arthur A. [1984]. Behavior of Prices on Wall Street , The Analysis Press.
___ [1977]. Filtered Waves, Basic Theory , Technical Trends.
Merrill Analysis Inc., Elm 3325, 3300 Darby Rd., Haverford, PA 19041.
Neill, Humphrey [1931]. Tape Reading and Market Tactics . Now published by Fraser Publishing.
Schabacker, R.W. [1930]. Stock Market Theory and Practice . Now published by Fraser Publishing.
Technical Trends, PO Box 792, Wilton, CT 06897, (203) 762-0229.

References Copyright (c) Technical Analysis Inc. 5

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

LOGARITHMIC POINT & FIGURE

The point and figure chart, which is built on a filtering technique, is an old favorite. In a one-point chart,
moves of less than one point are filtered out; in a three-point chart, all moves of less than three points are
filtered out. The idea is good, but this type of chart has several drawbacks. First, the chart makes the error
of using points and not percentages. Points are a poor measure of importance in a stock chart. One point
can be very important in a $10 stock but be a very minor move in a $100 stock.
Another limitation of the P&F chart is the use of arithmetic scale, which has a built-in distortion. A 5%
move at the bottom of the chart may be completely hidden, while at the top of the chart it may look like a
major move. On an arithmetic chart, a trend rising at a uniform l0% per week seems almost flat at the
bottom but skyrockets at the top of the trendline. A straight trendline on an arithmetic scale actually has a
decreasing rate of incline as you travel up the line. Another limitation of the point and figure chart is it
ignores the aspect of time.
You can eliminate these limitations with three simple steps. First, set up your filter as a percentage, not in
points. Ignore any reversals of less than your specified percent. Second, use a logarithmic scale for prices,
Third, put time on the horizontal scale of prices (see sidebar Figure 1).
There is one more minor problem: You don't know the location of a turning point until after you have
passed it. I correct for this by using a pencil line or a dotted line until the turning point has been
established by a pullback of the specified percentage.
This style of charting provides two major benefits. First, trendlines are now valid and meaningful, and
second, charts for different stocks or averages are comparable. You can compare a chart for a $100 stock
with one for a $10 stock without worry of distortion.

ADVANCE-DECLINE DIVERGENCE OSCILLATOR (ADDO)

The most popular technique of noting divergence within the stock market is to compare the cumulative
curve of the difference between advances and declines— the A-D line—with the plot of the Dow Jones
Industrial Average (D JIA). Quantifying divergence is difficult because one curve is accumulation and one
curve is price. The ADDO is designed to indicate when the DJIA is diverging from the A-D line.
First, the daily number of advances minus declines is calculated. This difference is divided by the daily
number of unchanged stocks . This added refinement (originally suggested by Edmund Tabell) gives
added emphasis when the market has real conviction. If the number of unchanged stocks is low, the
denominator is low and the ratio becomes a relatively high figure. Keep a cumulative record of this ratio:

Σ ((A-D)/Unchanged)
The daily figures are kept, but the ADDO uses the end-of-the-week figures only.
The second step is to establish a historical reference by comparing the cumulative adjusted A-D line to
the weekly close of the DJIA. Calculate a regression line of the DJIA and the cumulative adjusted A-D line
for the last year. The formula for the regression line will be:

Expected DJIA value =

Article Text Copyright (c) Technical Analysis Inc. 6

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

A + B(cumulative adjusted A-D)

A and B are the constants from the regression formula. This line will produce the average expected value
of the DJIA for any current cumulative adjusted A-D line (see sidebar Figure 2). Then the actual level of
the DJIA is compared to the expected value. ADDO is the percent difference:

ADDO = (100D/(A + BE))- 100

where D= DJIA, E = cumulative adjusted A-D, and A and B are constants produced from the calculated
regression line.
A value higher than 6% is bearish and a value below 1% is bullish. When the indicator is positive, the
DJIA is higher than it should be and when the indicator is negative, the DJIA is lower than it should be.
The most recent testing indicated that this indicator's best accuracy for forecasting the DJIA is 26 and 52
weeks out.

PUBLIC SHORTS AS A PERCENT OF TOTAL NYSE VOLUME

Weekly total short sales figures are a useful set of figures (published in Barron's) for gauging market
moods. You can calculate the total exchange member figures by adding the specialist, floor trader and
other member numbers. Deduct the member data from the total and you have a figure for the
nonmembers— that is, the public. Express the short selling as a percentage of the total weekly volume.
This reveals the size of the shorting, corrected for the volume. A bullish reading occurs when the
indicator is greater than 1.8 and bearish reading occurs when the indicator is less than 1.16 (see sidebar
Figure 4). Recent testing indicates this indicator has success in bullish calls in the 26 and 52-week
outlook, but its bearish calls are better for one, five, 13, 26 and 52 weeks out.

RATIO OF PUBLIC SHORTS TO SPECIALIST SHORTS

This idea was developed by John McGinley and Walter Deemer. The index is a ratio of the short sales by
nonmembers (the public) to the short sales by the specialists. Data are available in Barron's. High values
by the index imply that the public is more bearish than the professional, a positive indication. Bullish
levels occur when the ratio is above 0.54, while bearish indications occur at readings below 0.35 (sidebar
Figure 5). Recent testing indicates that smoothing the ratio with a four-week simple moving average can
improve results. Recent testing shows that this indicator's bullish calls are successful in the one-, 13-, 26-
and 52-week outlook and bearish calls are successful in the one-, five-, 13-, 26- and 52-week outlook.

LARGE BLOCK TRANSACTIONS

This indicator reveals the direction of the enthusiasm of the big operators. The source for the data is
Barron's. The steps used to create the final indicator are:
1. Total the daily figures to produce weekly data. Create separate totals for upticks, downticks and
unchanged for all trades over 50,000.
2. Smooth these three totals with a 14% exponential moving average, which are approximately
equivalent to 13-week simple moving averages. To calculate these exponential moving averages, add
14% of each new statistic to 86% of the preceding average.
3. Calculate a ratio from the exponentials by subtracting the downtick average from the uptick average

Article Text Copyright (c) Technical Analysis Inc. 7

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

and dividing the difference by the unchanged average.

4. Calculate a 52-week moving average of the ratio.
5. Calculate the deviations of the current ratio to its 52-week moving average. You could use this as the
indicator, if you wish.
6. For charting, I take one more step and put the deviations in z-scores by dividing the deviations by the
standard deviation of the preceding 52 weeks. This step simplifies the interpretation of the chart.
Approximately half the data will fall between +0.67 and -0.67. Approximately two thirds of the data
points will be between +1.00 and -1.00; approximately 95 % will be between +2.00 and -2.00. You
can use these levels as benchmarks (see sidebar Figure 6).
Recent testing indicates that bullish calls occur with readings less than -0.98 and are good for the 26- and
52-week outlook. The bearish calls occur at the greater than +1.7 reading and are good for the
one-,five-,13-,26- and 52-week outlook.

TESTING INDICATORS
I devised a method of testing indicators that gives me simple, understandable and useful measures of
performance. The method gives me batting averages. First, accumulate a data file for each indicator,
logging in the indicator's forecasts. I ask each indicator, each week in the past 10 years, whether it is
bullish, bearish or on the fence. Each week I log in the digit "2" if the forecast in that week was bullish,
"1" if bearish and "0" if on the fence.
To check the accuracy of the forecast, I then log in another file, the performance of the D JIA in the period
following the forecast. I ignore the amount of change in the DJIA for simplicity. My performance log of
the DJIA consists of a five-digit number inserted in each week following the forecasts. If the DJIA closed
higher one week later, the digit "2" is the first digit of the five-digit number; if the DJIA closed lower, "1"
would be used and finally a "0" for an unchanged close. The second digit reports performance in the
following five weeks using the same criteria for the first week. Similarly, the third digit report changes in
the 13th week; the fourth digit report changes in the 26th week and the final digit reports the direction of
change in the 52nd week (sidebar Figure 7).
Next, I ask my computer to compare the forecast file with each digit in the benchmark file and tell me the
number of agreements (successful forecasts) and disagreements, and then report a simple batting average.
The successful plus the unsuccessful make up 100% of the batting average; the "on the fence" weeks are
ignored.
Five batting averages are produced, one for each time period. Some indicators were more successful for
the shorter time periods and some were successful for the longer term.
In the final step, the results are checked for significance by calculating a statistic with the name "chi
squared with one degree of freedom, with the Yates correction." We are using a formula for chi squared
based on an expected outcome that is either right or wrong:

X2=(|R-W|-1)2/(R+W)
where:
R = number of times right

Article Text Copyright (c) Technical Analysis Inc. 8

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

W = number of times wrong

Then compare the values with sidebar Figure 8 to measure the significance of the outcome.

PRICE/DIVIDENDS RATIO
This indicator is a measure of expensiveness. It reports the current price of enough stock to yield $1 in
dividends. It's the inverse of stock yield. You can calculate the ratio any time by dividing the D JIA by the
total of the dividends in the preceding four quarters. These dividends are found in a table in Barron's.In
the 60-year history of the ratio, I found 25% of the points above $28.30. The area above this level is
labeled "expensive." The lowest quarter of the points fell below $18.10. This area is labeled "bargains"
(see sidebar Figure 9). Currently, the price/dividend ratio has been as high as 35 (see sidebar Figure 10).
Note: Recent testing of these indicators was performed by Technical Trends. The test period ranged from
1978 to 1991.

SIDEBAR FIGURE 1: Any price moves of less than 10% are not recorded. The scale is logarithmic to
reflect percentage change in price. The dotted lines are earnings per share for the last year multiplied
by a constant. This way the price of the stock can be judged as cheap (low P/E ratios) or rich (high P/E
ratios).

Figures Copyright (c) Technical Analysis Inc. 9

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

SIDEBAR FIGURE 2: The regression line calculates where the DJIA should be in relation to the current
cumulated advance-decline numbers. The ADDO indicator measures how far ahead or behind the A-D
line the DJIA is.

SIDEBAR FIGURE 3: Currently the indicator has been neutral.

Figures Copyright (c) Technical Analysis Inc. 9

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

SIDEBAR FIGURE 4: This indicator has remained in the bullish region (readings above 1.8).

SIDEBAR FIGURE 5: The public/NYSE short sales indicator has remained above the bullish 0.54
reading.

Figures Copyright (c) Technical Analysis Inc. 10

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

SIDEBAR FIGURE 6: In late 1991 the indicator readings fell to bullish readings (below -0.98) while
recent readings have been neutral.

SIDEBAR FIGURE 7: Each column represents the performance in the week following the forecast. A
"1" is used if the DJlA closed lower and a "2" is used if the DJlA closed higher.

Figures Copyright (c) Technical Analysis Inc. 7

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

SIDEBAR FIGURE 8: The chi-squared formula will measure the significance of the results from your
test.

SIDEBAR FIGURE 9: More than 60 years of data indicate that readings above $28.30 are expensive
and readings below $18.10 are bargains.

Figures Copyright (c) Technical Analysis Inc. 8

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: LOGARITHMIC POINT & FIGURE

SIDEBAR FIGURE 10: Currently the P/D ratio has reached 35 and has retreated slightly. The average
peak of bull markets has been 31.

Figures Copyright (c) Technical Analysis Inc. 11

Stocks & Commodities V. 10:10 (407-413): SIDEBAR: ODD-LOT SHORTS

ODD-LOT SHORTS
Short interest—the sale of a borrowed stock—is one of the most useful tools of the technician.
Theoretically, the selling short of a stock is an indication of pessimism and therefore represents buying
power on the sidelines as the short sale must be purchased at some point in the future. This series prior to
the 1980s included small traders taking flyers, while it now includes only specialist odd-lot trading. In
fact, the shorting by the odd-lotter is not reported. Today, this indicator provides clues about how much
program trading has occurred. Large traders get around the uptick rule by selling short in odd-lots with
the specialist.
This index is calculated by dividing the average odd-lot short sales in the last five trading days by the
average of odd-lot sales plus purchases in the same period. Recent testing of this indicator points out that
the bearish calls are poor but the bullish calls are good for 13, 26 and 52 weeks ahead.

Article Text Copyright (c) Technical Analysis Inc. 12

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